The Reserve Bank of India (RBI) on Wednesday issued a circular for lenders about investments in alternative investment funds (AIFs). The central bank has given directions to the banks to disclose the extent of their investments in alternative investment funds.
As per the latest directions, RBI has said banks need to only set aside provisions to the extent of their investment in the AIF scheme, which is further invested by the AIF in the debtor company, and not on the lender’s entire investment in the AIF scheme.
“With a view to ensuring uniformity in implementation among the REs, it is advised [that] downstream investments shall exclude investments in equity shares of the debtor company of the regulated entity (RE), but shall include all other investments, including investment in hybrid instruments,” the circular stated.
The RBI has issued the instructions in exercise of the powers conferred by Sections 21 and 35A of the Banking Regulation Act, 1949 read with Section 56 of the Act ibid; Chapter IIIB of the Reserve Bank of India Act, 1934 and Sections 30A, 32 and 33 of the National Housing Bank Act, 1987.
In December 2023, RBI had restricted banks and NBFCs from investing in AIFs, which have downstream investments in debtor companies. If banks or NBFCs had such investments in AIFs, they were given 30 days to liquidate their holdings or make 100% provisions against them.
The Wednesday’s circular further said:
> Provisioning in terms of paragraph 2 (iii) of the Circular 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.
> Paragraph 3 of the Circular shall only be applicable in cases where the AIF does not have any downstream investment in a debtor company of the RE.
> If the RE has investment in subordinated units of an AIF scheme, which also has downstream exposure to the debtor company, then the RE shall be required to comply with paragraph 2 of the Circular.
> Investments by REs in AIFs through intermediaries such as fund of funds or mutual funds are not included in the scope of the Circular.
These instructions are applicable to all commercial banks (including Small Finance Banks, Local Area Banks and Regional Rural Banks), all Primary (Urban) Co-operative Banks/State Co-operative Banks/ Central Co-operative Banks, all All-India Financial Institutions, and all Non-Banking Financial Companies (including Housing Finance Companies).
In December 2023, RBI had prohibited the REs from making investment in units of AIFs having downstream investments either directly or indirectly in a ‘debtor company’ of the REs.
The term ‘debtor company’ has been defined to include any company to which the RE currently has or previously had a loan or investment exposure anytime during the preceding 12 months.
In response to the RBI’s regulatory directives, Piramal Enterprises Ltd (PEL) and IIFL Finance told the stock exchanges that they have initiated the process of making provisions.
Piramal Enterprises, accompanied by its subsidiaries, announced a comprehensive AIF exposure totalling Rs 1,737 crore in compliance with the RBI’s AIF norms.
IIFL Finance disclosed a combined investment of Rs 21.37 crore in IIFL Fintech Fund, along with an outstanding debt exposure of Rs 3.28 crore linked to one of the fund’s downstream investments.
The total value of other Alternative Investment Fund (AIF) investments was around Rs 909.81 crore, excluding any downstream investments or exposure acquired in the preceding 12 months.
“The recent RBI circular does provide some operational and regulatory clarity but also raises new questions. 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. However, 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. Furthermore, 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,” Siddarth Pai, Founding Partner, 3one4 Capital, & Co-Chair, Regulatory Affairs Committee, IVCA.
“On the updated RBI circular on investments in AIFs, our preliminary assessment is that the much awaited requirement from the market, that 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.
Secondly, 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. Technically, the reading of the circular is that in a Rs 1000 crores fund, for example, if the RE investment is let’s say INR 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 INR 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 INR 10 crores, the provisioning requirement was on the entire investment of INR 100 crores by the RE. This is a welcome change to that effect,” said Dipen Ruparelia, Head of Products, Vivriti Asset Management.
“This circular should bring a sigh of relief both for AIFs and the banks/NBFCs. The carving out of equity investments from the applicability of the earlier circular should allow a large majority of VCFs and PE funds to continue with the investments by REs as well as to go out and raise capital from REs. Secondly, limiting the provisioning to pro-rata exposure to underlying debtor company makes logical sense and should help dilute the adverse provisioning impact for REs linked to it’s entire exposure to an AIF. Lastly, clarification regarding non-applicability of the circular of Dec 19 to fund of funds is logical and should help immensely DFIs like SIDBI, NABARD, NIIF, etc,” said Siddharth Shah, Partner at Khaitan & Co.
