AIF Registration

Can the NBFC invest in an Alternative Investment Fund?

Can the NBFC invest in an Alternative Investment Fund

Alternative Investment Funds are a type of investment that non-banking financial companies can include in their portfolio. However, the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI) have set specific norms and regulatory measures for them. The SEBI (Alternative Investment Funds), 2012 Regulation and the acceptable restrictions and criteria set by regulators can govern investments in NBFC. The rules that apply to NBFCs, such as investment limits and particular requirements or guidelines that are periodically released by SEBI and RBI, should be followed.

Alternative Investment Funds and NBFC Investment

A group of investors, typically wealthy family offices, banks, NBFCs, and other institutions, as well as corporate treasuries, privately manage alternative investment funds. Typically, these funds invest in debt with high yields. Any Indian investment vehicle known as an alternative investment fund raises money from overseas or sophisticated Indian investors and uses it to make investments in line with predetermined investment policies.

Alternative investment funds are governed by the Securities and Exchange Board of India (SEBI). However, neither the SEBI (Collective Investment Schemes) requirements, 1999 nor the Mutual Funds Regulations, 1996, nor any other fund management requirements apply to AIF Funds.

An organisation registered under the Companies Act of 1956 that engages in the following activities is known as a Non-Banking Financial Company (NBFC): lending and advances; purchasing shares, bonds, stocks, debentures, or other marketable securities issued by the government or local authority; leasing, hire-purchase, insurance; and chit business. This category excludes any institution whose primary business is the purchase or sale of any goods (other than securities), industrial activity, agriculture, or the sale, purchase, or construction of real estate. Another type of non-banking financial firm is a non-banking institution, which is a business entity whose primary activity is accepting deposits under any plan or arrangement as one lump payment, instalments through contributions, or in any other way (Residuary non-banking company).

What is AIF Investment?

The below points will explain what is alternative investment funds and their investment: 

  1. The term “alternative investment fund” (AIF) describes the investment in a class of assets other than stocks, bonds, and cash, which are considered standard investments.
  2. The capacity of alternative investment funds to diversify investment portfolios using a range of non-traditional assets and investment strategies is one of its key benefits. They could also yield substantial returns.
  3. Alternative investment funds are divided into three categories: Category I, II, and III. Each category focuses on a distinct set of assets and industries.
  4. Alternative investment funds can only be invested in by “Accredited Investors” who satisfy certain financial requirements. This ensures that only people with a strong grasp of financial markets and the ability to withstand losses can do so.
  5. Alternative investment funds are subject to different taxes based on their classification and type of income. Usually, there are two levels of taxation involved: one at the investor level and another at the fund level.
  6. Accreditation, due investigation, and application filing are required when investing in alternative investment funds.
  7. Abakkus Value Opportunities Fund, Girik, Multicap Growth Equity Fund, Leaders of Tomorrow (ALOT) Fund, India Value and Growth Fund, and India Contrarian Fund are a few of the top AIFs for investing in India.
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Who is Eligible For Alternative Investment Fund?

Who can invest in alternative investment funds is restricted by strict guidelines because of the high level of risk associated with these investments. First, the Securities and Exchange Board of India (SEBI) guidelines specify that only “Accredited Investors” can deposit money into AIFs. According to SEBI, accredited investors are individuals or companies with extensive knowledge of the financial markets and the capacity to absorb losses. Rich family offices, banks, NBFCs, and other establishments like corporate treasuries are included.

Residents who are Indian

 Alternative investment funds can be invested in by any resident of India who is a sophisticated investor.

Non-resident Indians –

 Under certain restrictions, non-resident Indians who are experienced and sophisticated investors may also be able to invest in an alternative investment fund.

Regarding eligibility for financial aid:

  1. Sophisticated Investors: An investor who earns at least Rs. 20 lakh per year or with a net worth of at least Rs. 2 crores is considered sophisticated.
  2. A corporate entity investing should have a net worth of at least INR 10 crores.
  3. Each investor must deposit a minimum of INR 1 crore in alternative investment funds.

These qualifying requirements make sure that the only people who can invest in AIFs are sophisticated and financially stable individuals who are aware of and able to manage the risks involved.

How Can NBFC Invest In Alternative Investment Funds?

The following factors should be taken into account by NBFC when investing in alternative investment funds:

  1. Accreditation: NBFC must make sure they fulfil the requirements outlined by SEBI for AIF investors to be eligible.
  2. Registration: The Securities and Exchange Board of India requires alternative investment funds to register properly. Before investing with that alternative investment fund, NBFCs should confirm that they comply with SEBI requirements. 
  3. Due Diligence: Research the alternative investment fund thoroughly. Recognise the investment strategy of the fund, the industries it will invest in, the track record and experience of the fund management, the costs associated with it, and the hazards.
  4. Application: Send in the application form, the required document, and the money for the investment.
  5. Reporting Requirements: NBFCs must normally abide by SEBI’s disclosure guidelines, which may include disclosing in their financial statements any investments they have made in alternative investment funds.

Restriction Imposed by RBI for NBFCs in Alternative Investment Fund Investments

The Reserve Bank of India strengthened the guidelines for institutional investments in Alternative Investment Funds to reduce the practice of banks and non-banking financing firms (NBFCs) evergreening loans. Evergreening is a practice that has drawn attention in the complicated world of non-banking financial firms (NBFCs) and Alternative Investment Funds (AIFs) since the 1Reserve Bank of India (RBI) recently intervened. This financial move is a complex dance between NBFCs, troubled borrowers, and alternative investment funds to conceal possible defaults and uphold a façade of sound financial standing.

The Art of Evergreening

Evergreening is a set of acts that, while they seem to fix a financial problem at first glance, actually just lengthen the loan’s term. After the NBFC makes its initial investment in the alternative investment fund, the latter buys bonds issued by the financially troubled borrower. As the borrower repays the initial loan, the NBFC stays out of the crucial 90-day window by not designating it as an NPA.

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The risk of the borrower failing on the loan provided by the alternative investment fund is the catch. However, since the alternative investment fund is a fixed-term investment vehicle, the NBFC can put off dealing with this problem for a few years. Everyone concerned expects a favourable conclusion within the allotted term, but the risk is hidden.

RBI’s Intervention

The RBI has instructed REs, including NBFCs through the Circular, not to participate in alternative investment fund schemes that contain direct or indirect downstream investments in a firm that an NBFC has had or is currently having a loan or investment exposure to at any point in the previous year. If a Regulated Entity Investor has previously invested in an AIF scheme and the AIF goes on to make a downstream investment in any Debtor Company, the RE is required to liquidate their AIF investment within 30 days after the downstream investment date. The RE, including NFC, must liquidate its investments within 30 days of the Circular’s date, or by January 18, 2024, if it has already invested in an AIF scheme with a downstream investment in a debtor company as of that day. REs, including NBFC, are required to make a 100% provision on their alternative investment fund assets if they are unable to liquidate them within the allotted time frames.

Furthermore, investments made by REs in any alternative investment fund with subordinated units and a priority distribution plan are fully deducted from the RE’s capital funds under the Circular. According to the Securities and Exchange Board of India’s (SEBI) Master Circular for Alternative Investment Funds (AIFs), dated July 31, 2023, the priority distribution model is a distribution waterfall mechanism used by some AIF schemes. Under this mechanism, one class of investors shares losses greater than pro rata to their AIF holdings than another class (the senior class) because the latter has priority in distribution over the former. By means of its circular dated November 23, 2022, SEBI has forbidden schemes of alternative investment funds that have implemented the previously mentioned priority distribution model from taking on new commitments or investing in new investee companies until SEBI makes a final decision regarding priority distribution models.

The Circular tackles issues with loans that are evergreened through arrangements in which real estate investors purchase alternative investment fund units, with the revenues from such investments being reinvested by an alternative investment fund in the Debtor Company to pay back the loans that the Debtor Company obtained from the RE. Concerning loans that are in default or are anticipated to default, REs may be able to get around the classification, provisioning, and other related compliance obligations by using such arrangements.

Impact of the Circular on the AIF Investment by NBFC

The restriction placed by the Circular looks to be a positive move since it will prevent loans from being disguised as evergreening and the accumulation of unidentified non-performing assets through intricate alternative investment fund structures. However, the complete prohibition on all AIF investments seems excessive. The Circular does not make it clear if debt or equity investments are covered by the investment ban.

However, because the NBFC will have to either exit from the investment in the AIFs or guarantee 100% provisioning on such investments in cases where the AIF invests in a Debtor Company, the aforementioned restrictions are likely to discourage REs, including NBFC, from investing in AIFs in the future, even for legitimate reasons like risk diversification. Therefore, in the future, the REs, including NBFC, may demand assurance from the AIFs that the AIF will not make any investments in any of the REs’ current debtor companies.

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Even though the legislative limitation under the Circular is limited for those AIFs that have invested in Debtor Companies, there may be practical challenges in ensuring that there are no investments in AIFs that have invested in Debtor Companies. Given the severe repercussions of a violation, compliance-sensitive REs like NBFC may avoid investing in AIFs entirely, consequently restricting expansion and funding to this sector due to the contraction of AIFs’ pools of investible assets. AIFs will face pressure to disinvest right away due to the existence of overlapping investments in the market. It’s also feasible that REs will be forced to write off a portion of their AIF assets due to the strict deadlines set by the RBI in the Circular.

Conclusion

NBFCs have to stay updated on the recent regulatory restrictions imposed by the RBI and SEBI regarding investment in alternative investment funds. These rules may occasionally be updated and modified in response to new circumstances. Although NBFC can participate in AIF, it is crucial to maintain compliance with the current regulatory framework. To guarantee regulatory compliance and to determine where to invest and where not to, you should seek professional guidance.  

FAQs: –

  1. Can NBFC invest in AIF?

    Yes, the investment from NBFCs can be accepted by alternative investment funds. However, they are subject to the rules and regulations established by the Securities and Exchange Board of India and the Reserve Bank of India. 

  2. Who are accredited investors?

    A business entity or an individual who is permitted to deal with securities that are not available to the general public can be considered an accredited investor. Furthermore, it's possible that these securities are not registered with any financial regulatory body. However, an individual or a corporate entity must meet the eligibility requirements established by the market regulator to become an accredited investor. The Security and Exchange Board of India established the accredited investor process in India, enabling high-net-worth individuals (HNIs) who meet the conditions of the regulatory body to invest in listed companies.

  3. What was this circular's intended purpose?  

    Evergreening may have occurred as a result of funding borrowers through AIFs due to the multiple REs, including NBFC, that have linked alternative investment funds. In other words, the money would be invested by the AIF in a debtor company, which would then maintain its account as a performing asset.

  4. How long is the liquidation term that the circular mentions? 

    Lenders are given thirty days to sell off the investments listed above. Lenders must also fully account for these investments if they are unable to sell their holdings within this time limit.

  5. Who are all primarily prohibited from investing in alternative investment funds as per the RBI Circular?

    As per the Reserve Bank of India circular on investments in alternative investment funds, all regulated entities, including banks, Non-Banking Financial Companies, Housing Financial Companies, Cooperative Banks, and all Financial Institutions, are prohibited from making investments in alternative investment funds.

  6. Who are all excluded from investing in alternative investment funds as per the RBI Circular?

    All regulated entities, including banks, cooperative banks, non-banking financial companies, housing financial companies, and all financial institutions, are forbidden from investing in alternative investment funds that are misusing the alternative investment funds for evergreening, according to the Reserve Bank of India's circular on the subject.

  7. What is this circular's primary effect? 

    Most of the bigger regulated firms are connected to AIFs. Money transfers from the RE to them would completely stop. The circular sweep is non-discriminatory and wide. RE finance will be stopped for all AIFs, not just those who are affiliated. 

  8. Does NBFC have to follow the guidelines set down by SEBI and RBI?

    Although NBFC can participate in alternative investment funds, it is crucial to maintain compliance with the current regulatory framework. NBFCS must remain informed about the latest regulatory limitations placed on investing in AIFs by the RBI and SEBI. 

References

  1. https://www.india.gov.in/official-website-reserve-bank-india

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