Concerned about Alternative Investment Funds (AIFs) circumventing restrictions, the Reserve Bank of India (RBI) issued an advisory to banks and financial institutions on Tuesday to reduce loan evergreening and misuse of the AIF route.
According to the RBI recommendation, banks, non-banking financial firms (NBFCs), and other financial institutions such as Nabard and Sidbi will be unable to invest in any AIF scheme that has downstream investments in a debtor company of the bank/NBFC.
It means that if a bank or NBFC has current exposure to or has lent to a firm in the previous 12 months, they cannot engage in an AIF plan that invests in the same company. The RBI's warning comes in the wake of findings by the Securities and Exchange Board of India (Sebi), which claimed that incidents of circumvention amount to 'tens of thousands of crores'. According to a Sebi official, the market regulator provided data with the RBI last month on AIFs built to facilitate evergreening of banking sector assets to escape NPA designation.
"We shared this information with the RBI, and the RBI concurs with our assessment." "We have seen cases where AIFs have been used to circumvent FEMA regulations—where one entity that is not permitted to invest in another does so through an AIF," the Sebi official explained.
According to AIF executives, the RBI decision could result in large exits from the schemes or write-downs on some investments. "If an AIF scheme, in which a regulated entity (RE) [bank or NBFC] is already an investor, makes a downstream investment in any such debtor company, then the RE shall liquidate its investment in the scheme within 30 days from the date of such downstream investment by the AIF," the Reserve Bank of India (RBI) said. If the RBI-regulated entity is unable to liquidate their interests within the 30-day period, they must make a full provision for such investments, according to the RBI.
"The regulators are closing the loophole and making it watertight with this." "We need to keep an eye on the impact on large wholesale NBFCs with funds structures," a debt AIF manager said. The AIF sector has expressed worry about the impact and difficulties in tracking such investments. Industry leaders stated that they have begun to prepare their responses to both regulators.
"It's like throwing out the baby with the bathwater." Several banks have signed AIF investment agreements. This will also limit investments by Sidbi, the government's own credit-providing effort. Many AIFs also invest in publicly traded companies, and these financial institutions may have already granted some credit. Even if the firm where the AIF intends to invest has a credit card or banking facility, the bank/NBFC cannot invest in the abovementioned AIF," said an AIF official who requested anonymity. According to industry officials, the ruling will discourage banks and NBFCs from investing in debt AIFs or funds that facilitate venture debts.
AIFs are privately pooled investment instruments that invest in startups and SMEs, private equity funds, private credit providers, and other similar entities. Sebi has regulatory authority over AIFs. Category II AIFs mostly invest in debt and private equity. "Many banks would also provide cash credit or overdraft facilities to startups in some way." In such circumstances, they will be unable to participate in AIFs that also have downstream assets in such a company," according to another industry participant.
As of June 30 this year, AIFs raised investment commitments worth Rs 8.44 trillion, of which Rs 6.96 trillion is for category II AIFs. Till the first six months of the calendar year, a total of Rs 3.50 trillion was invested through the AIFs. The number of AIFs and investments by these schemes has grown multi-fold in the last five years. As of June 2018, the investment amount stood at around Rs 75,000 crore. Legal players said that the exits by banks and NBFCs could impact the valuation and the Net Asset Value (NAV) for investors.
