Excerpt from Livemint Article, Published on Jan 03, 2024

The Reserve Bank of India (RBI) recently issued a circular restricting regulated entities (REs) from investing in Alternative Investment Funds (AIFs) with downstream investments in debtor companies, which has raised practical concerns in the financial sector. The circular aims to curb the potential ‘evergreening’ of loans by REs, preventing structures where investments in AIFs indirectly sustain exposures to debtor companies.

The directive requires REs to liquidate investments in such AIFs within 30 days of downstream investments or the circular’s issuance for existing investments. Failure to comply mandates a 100% provision on these investments. The definition of a ‘debtor company’ includes any firm to which the RE had loan or investment exposure in the past year.

While the RBI’s intent to address evergreening risks is clear, the blanket ban on AIF investments in debtor companies may have unintended consequences. Critics argue that this approach could erroneously classify all AIF investments, impacting even financially stable entities, as part of evergreening strategies. Moreover, compliance challenges abound. AIF investments often involve illiquid assets, making liquidation within the prescribed timeline difficult, especially for close-ended Category 1/2 AIFs.

Additionally, finding buyers for these AIF units now poses a challenge as cautiousness prevails among potential purchasers due to regulatory scrutiny. REs that are sponsors of these AIFs may have to find new sponsors if they want to sell their investments. This would require SEBI approval and could disrupt the AIF’s continuity, which is against SEBI AIF regulations that require sponsors to be involved throughout the tenure.

Industry voices emphasize the need for clarifications from the RBI to alleviate concerns among REs and the AIF sector. While the RBI’s aim to deter evergreening is commendable, the current circular’s impact on genuine investments and the practical hurdles it poses require careful reconsideration.

This directive may inadvertently stifle genuine investments, dissuade REs from AIF participation, and create imbalances between domestic and foreign institutional investors. Clarity and amendments from the RBI are eagerly awaited to address industry apprehensions.

To delve deeper into this topic, please read the full article on Livemint.