On 27 March 2024, the Reserve Bank of India (RBI) brought clarifications in its December circular prohibiting the regulated entities (REs) such as non-banking financial companies (NBFCs) from investing in units of alternative investment funds (AIFs) having downstream investments either directly or indirectly in a ‘debtor company’ of the REs. In a recent circular, RBI said that in the cases where an RE has invested in an AIF, such AIF’s investments shall exclude investments in equity shares of the debtor company of the RE, but shall include all other investments, including investment in hybrid instruments.
Also, the banking regulator has said that the 100 per cent provisioning which was required to be made by the RE shall be required only to the extent of investment by the RE in the AIF scheme which is further invested by the AIF in the debtor company, and not on the entire investment of the RE in the AIF scheme.
Provisioning not for the entire investment by RE in AIF
Industry experts have hailed the RBI’s move regarding proportionate provisioning norms in AIFs. Dipen Ruparelia, Head of Products, Vivriti Asset Management said, “There is a clarification which is positive to the tune that provisioning requirement takes in only to the extent of overlap in portfolio entities made by the AIFs.”
Citing an example to elaborate on the mechanism, Ruparelia said, “Technically, the reading of the circular is that in a Rs 1,000 crores fund, for example, if the RE investment is let’s say Rs 100 crores and if the AIF, for example, has made investment in common debtor entity which is only Rs 50 crores, then now the provisioning requirement would be to the tune of the Rs 50 crores and not the entire Rs 100 crores of AIF exposure by the RE. Previously, the interpretation was that even in the case of the exposure by the AIF was only Rs 10 crores, the provisioning requirement was on the entire investment of Rs 100 crores by the RE. This is a welcome change to that effect.”
Jyoti Prakash Gadia, Managing Director at Resurgent India highlighted that the policy guidelines are intended to prevent possible evergreening of loans of the existing debtors of banks through the investment route by using AIF as an intermediary and added, “The clarification with regard to provisioning requirement is rightly emphasising the amount of investment by AIF in debtor company, which remains unadjusted and not the entire amount of investment by the bank in AIF (which can be broadly for a purpose other than specific evergreening).”
Equity shares exemption, but inclusion of hybrid instruments creates ambiguity
The central bank has said in the regulation that REs shall not make investments in any scheme of AIFs which has downstream investments either directly or indirectly in a debtor company of the RE. Such investment now excludes investments in equity shares of the debtor company of the RE but shall include all other investments, including investment in hybrid instruments.
Siddarth Pai, founding partner, 3one4 Capital, and Co-Chair, Regulatory Affairs Committee, Indian Venture and Alternate Capital Association (IVCA) inferred that the recent RBI circular does provide some operational and regulatory clarity but also raises new questions. Pai further added, “Changes such as the Regulated Entity’s provisioning being proportionate to the downstream investment in the portfolio company by the AIF is a welcome move. Excluding investments through Funds of Funds and mutual funds will increase capital participation in AIFs.”
Pai also mentioned, “The exclusion of equity shares from the definition of downstream investments works only for investments in listed companies. It fails to account for the Private Equity and Venture Capital investments, which are in the form of compulsory convertible instruments such as CCPS and CCDs. The industry is debating as to whether they would need to convert all their hybrid secured to equity to allow REs to stay invested in their funds.”
Pai also emphasised that there is still ambiguity as to whether existing REs can still honour capital calls to AIFs who do not meet the specific criteria in the new circular. The industry will reach out for further clarity on the matter, he added.
However, Punit Shah, Partner from Dhruva Advisor is of the view that the relaxation will certainly help the AIF as well as the financial services industry, as a maximum investment would be in the nature of equity investments by AIFs.
“The situation of hybrid instruments is not exempted. This would include investment in Compulsorily Convertible Preference Shares (CCPS) by the AIFs; this may not be intended as CCPS are quasi-equity and not a debt instrument. There is an adequate case for exempting CCPS investments as well,” added Shah.
Ruparelia added that on the updated RBI circular on investments in AIFs, their preliminary assessment is that the much-awaited requirement from the market, that Development Finance Institutions (DFIs) and banks should be exempted overall from the applicability of the circular is not covered. “Which we think is a big miss and not what people would’ve expected,” Ruparelia emphasised.
