RBI Guidelines on Investment in AIF

May 9, 2024
RBI Guidelines (Investment)

By Rupin Chopra and Apalka Bareja

Introduction

The Reserve Bank of India (RBI) has recently made significant strides in the regulatory landscape concerning investment by regulated entities (RE) in Alternative Investment Fund Scheme (AIFs). On March 27, 2024, the RBI released an important circular[1] (hereinafter referred to as “March, 2024 Circular”) aimed at easing the regulations governing such investments. It has been issued in furtherance of the previous circular[2] (hereinafter referred to as “December, 2023 Circular”) issued by the RBI on December 19, 2023, which imposed stringent limitations on investment in AIFs by RE. As per the 2024 Circular, RE are now permitted to invest in AIF schemes with downstream equity investment in debtor companies. However, the investment in schemes with hybrid instrument in debtor companies are prohibited. In this article we delve into the circulars issued by the RBI in December, 2023 & March, 2024, the reason behind the 2024 circular and the potential impact of the 2024 Circular on RE.

December, 2023 Circular

On December 19, 2023, the RBI issued a circular wherein it restricted the banks, Non-Banking Financial Companies (NBFCs), home financiers etc. from investing in AIF which have directly or indirectly invested in the companies which have borrowed the funds from the RE.

As per the circular, the RE were prohibited from investing in any AIF scheme with downstream investment in debtor companies of the RE, either directly or indirectly.

The RBI stipulated that if in an AIF scheme, in which the RE is already an investor, makes such downstream investment, the RE must liquidate its fund within 30 days. If the RE has already made an investment in the scheme with downstream investment, in the debtor’s company, then in such case 30 days period for liquidation will begin from the date of issuance of circular. If the RE fails to liquidate their investment within the prescribed period, then they were required to provision 100% on such investments.

Reasons for the March, 2024 Circular:

The December, 2023 Circular issued by the RBI on investment in AIF raised considerable apprehensions within the financial sector. The main aim of the December, 2023 circular was to prevent the misuse of AIFs for the purpose of evergreening loans. The RBI’s step faced scrutiny due to its possible negative effects on the investment landscape, some of them are as follows:

  • Impact on the AIF Industry: The RBI’s decision to prohibit the RE from investing in the AIF, will adversely affect the AIF landscape, as there will be no domestic investment in the AIF by the banks and NBFCs.
  • Less time for compliance: As per the circular, the banks and NBFCs are required to         liquidate their investments in AIF within a period of 30 days, but is poses significant challenges for them as the investment in AIF are done in crores and liquidating them within the prescribed time will pose significant challenges for them.

Following feedbacks from the stakeholders, the RBI issued a new circular introducing the revision to its previous directions[3]. The updated circular[4] incorporates key changes aimed at addressing concerns raised by various stakeholder. Notable changes include:

  • Explanation on the Downstream Investments: The circular specifies that investments in equity shares of the debtor company of the RE are not considered downstream investment. However, all the other types of investment such as hybrid instruments are included.
  • Conditions for Provisioning: Provisioning (it means the banks sets aside a prescribed amount of money from their profit to compensate for probable loss) is   necessary only for the RE’s investment in the AIF scheme, which is subsequently invested by the AIF scheme in the debtor company, rather than for the entire investment on RE in the AIF scheme.
  • Applicability of Paragraph 3[5]: Paragraph 3 will be applicable only if the AIF does not have any downstream investments in a debtor company of the RE. Compliance with paragraph 2[6] is mandatory if the RE invest in subordinated units of an AIF scheme with downstream exposure to the debtor company.

Impact of the 2024 Circular:

The March 2024 Circular issued by the RBI introduces significant revisions to the regulatory framework governing investments by banks and NBFCs in AIF. The circular addresses key concerns regarding downstream investments, provisioning requirements etc. these amendments aim to provide clarity and streamline the regulatory process, ultimately impacting how the banks and the NBFCs carry out their investments in AIF such as:

  • The circular provides clarity on what constitutes downstream investments, distinguishing equity shares of debtor companies held by RE from other types of investment, such as hybrid investment. This distinction enables the bank and NBFC to better understand and raise capital through AIF.
  • The revised guidelines specify that provisioning is only required for the REs investment in the AIF scheme, which is subsequently invested in debtor’s company. Previously, banks and NBFC were obligated to provision for the entire amount invested by the RE in AIF. Now, banks and NBFC will only need to provision for the amount directly invested in debtor companies, thereby reducing the financial burden on these institutions.

Conclusion

The 2024 March Circular introduced by the RBI signify a proactive approach towards enhancing regulatory clarity and fostering a conducive investment environment. By providing clarity on downstream investments, refining provisioning requirement, etc. the RBI aims to strike a balance between regulatory oversight and facilitating investment activities. These changes are expected to empower banks and NBFC to make informed investment decisions while ensuring compliance with regulatory norms. Overall, the recent circular reflects the RBI’s commitment to promoting transparency, stability and efficiency in the financial sector.

Ritvik Kashyap, Intern at S.S. Rana & Co. has assisted in the research of this article.

[1] Available at: https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12639&Mode=0

[2] Available at: https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12572&Mode=0

[3] Available at: https://bfsi.economictimes.indiatimes.com/news/policy/rbi-eases-aif-norms-clarifies-provisioning-rules/108833718

[4] Available at: https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12639&Mode=0

[5] Paragraph 3 of the December 19, 2023 RBI Circular:  https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12572&Mode=0

[6] Paragraph 2 of the December 19, 2023 RBI Circular: https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12572&Mode=0

Related Posts

RBI’s Master Directions on Prepaid Payment Instruments Post Paytm Restrictions

For more information please contact us at : info@ssrana.com