Investments in Alternative Investment Funds (AIFs)

The Reserve Bank of India (“RBI”) issued a circular regarding tightening the norms for lenders who invest in alternative investment funds (“AIF”) on December 19^th 2023, bearing No.: DOR.STR.REC.58/21.04.048/2023-24. In pursuance thereof, various banking as well as non – banking financial companies (“Regulated Entities”) have been advised against using their AIF routes in order to ‘evergreen’ their loans. Although it is common practice for Regulated Entities to make investments in AIFs as a part of their regular investment operations, RBI has noticed that these transactions also entail substitution of direct loan exposure of Regulated Entities to borrowers, with indirect exposure through investments in units of AIFs.

The term ‘evergreen loans’ refers to a loan wherein the repayment of principal amount is not required for a stipulated period of time or during the lifetime of the loan and merely payment of interest is required instead of the borrowed amount. Thereby, it involves extending additional or new loans to a borrower in the event of inability to pay the existing loans. Consequently, it conceals the true and genuine status of the non-performing assets or bad loans.

The objective behind the RBI’s decision is to refrain the banking as well as the non-banking financial corporations from using the AIF channel as a method to increase or expand the lifespan of their loans or provide them artificial support and sustenance. RBI has also let out a direction to such Regulated Entities against making any investments in such AIF schemes which has downstream investment in a debtor company of the Regulated Entities, either directly or indirectly. All debtor companies of the Regulated Entities to which the Regulated Entities currently have or previously had a loan or investment exposure anytime during the preceding 12 months fall within the ambit of such restriction. Moreover, in cases where a Regulated Entity is already an investor in an AIF and it goes on to make a downstream investment in any debtor company, it is also required to sell off its investments in the investment fund scheme within a stipulated period of 30 days from the date of such downstream investment. If the Regulated Entities have already invested in such schemes as on date, they shall liquidate within 30 days from the date of issuance of the said circular.

The circular has also stated that in case of failure to comply with the guidelines or if Regulated Entities are unable to liquidate their investments within the notified period, a provision of 100% shall be applicable upon such investments. Additionally, investments by the Regulated Entities in the subordinate units of any AIF scheme with a ‘priority distribution model’ shall also be subject to complete deduction from the applicable Regulated Entities’ capital funds. RBI’s circular is a welcome step towards creating a secured financial market wherein attempts have been made to increase transparency and reduce the risks of making volatile investments by business entities.  Further, an immediate pressure of disinvestments has also been created upon AIFs wherein an increased outflow of Regulated Entities disinvesting from such entities may be anticipated.