The Reserve Bank of India (RBI) has recently revised its circular issued in December 2023 which prohibits regulated entities (RE) from investing in units of alternative investment fund (AIF) that have downstream investments either directly or indirectly in a ‘debtor company’ of the RE.
The December Circular required the REs, which have already invested in such AIFs, to liquidate their investment in such AIFs within 30 days from the date of downstream investment by the AIF date of the December circular (in case of existing investments). In case REs are not able to liquidate as above, they are required to make 100 per cent provision on such investments.
The term ‘debtor company’ has been defined to include any company to which RE currently has or previously had a loan or investment exposure anytime during the preceding 12 months.
While the December circular issued by RBI addresses the potential evergreening structures, however, a blanket ban on investments in units of AIF having downstream investments in debtor companies of REs perturbed the industry. Several representations were made to RBI by stakeholders regarding the unintended consequences of the RBI circular.
Last week, the RBI revised the December circular and made certain relaxations. RBI has provided that where a 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.
Additionally, the revised circular has clarified 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.
Also, the RBI has now exempted investments by REs in AIFs through intermediaries such as fund of funds or mutual funds from the scope of the Circular.
While RBI’s relaxations bring the necessary relief to the industry, the same also raises certain issues.
The situation of hybrid instruments is not exempted. This would include investment in Compulsorily Convertible Preference Shares/ Debentures (‘CCPS’/ ‘CCDs’) by the AIFs. This may not be intended as CCPS/ CCDs are quasi-equity and not a debt instrument.
There is an adequate case for exempting CCPS/ CCD investments as well. In the absence of clarity on CCPS/ CCDs, the AIF industry may look to convert them into equity shares before accepting investments from REs.
A plain reading of the revised Circular suggests that where a RE invests Rs 10 crore in an AIF (have a corpus of Rs 100 crore) and the AIF invests Rs 5 crore in RE’s debtor company, then now the provisioning requirement for the RE should be to the tune of Rs 5 crore only (unlike Rs 10 crore as per December Circular). Another view could be that the RE should make a provision of only Rs 0.5 crore [i.e., 10 per cent of Rs 5 crore since RE contributes Rs 10 crore (being 10 per cent) of the AIF corpus of Rs 100 crore].
The RBI (including other regulators) have been dynamic in implementing changes to address stakeholder concerns. Some further clarifications concerning hybrid instruments and provisioning requirements would be welcomed.
(Punit Shah (Partner) and Vishal Lohia (Associate Partner) Dhruva Advisors)
_20241011180130_original_image_10.webp)
_20240925123624_original_image_48.webp)
