RBI Circular

RBI’s Relief for Governing Bank’s Investments in AIFs

RBI's Relief for Governing Bank's Investments in AIFs

The circular stated the exclusion of an investment in the equity shares of the debtor company of the REs but included all the various investments, including the hybrid instruments from the downstream investment. These provisions are required for the regulated entities. The regulated entities’ investment in the AIF scheme required a provision that stated the investment by the AIFs in the debtor company instead of in the entire investment in the AIF scheme. The 19th December 2023 circular issued holds a similar aim as the present circular to address the concerns and mitigate the risk related to investment in AIFs, and the recent circular also addressed the concerns flagged in the concerns or representations received from the stakeholders. The RBI’s circular intends to ensure uniformity in implementing guidelines for investments in AIFs amongst regulated entities. By addressing regulatory concerns and providing clarifications on downstream investments, provisioning, and applicability, the circular means to enhance transparency and compliance in this sector.

Invest Outside the Box: Get Started with the AIFs with their Types of AIFs

The RBI is a regulatory body that deals with or manages financial institutions or schemes. So, as per the regulations or amendments issued by the RBI, various changes have been made to one of the financial schemes, AIFs, which have been available in different types and provide investors access to unique asset classes. However, SEBI has classified AIFs right into 3 categories such as:

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Category 1:

  • Venture Capital Fund
  • Angel Funds
  • Infrastructure Funds
  • Social Venture Funds

Category 2:

  • Private Equity Funds
  • Debt Funds
  • Fund of Funds

Category 3:

  • Private Investment in Public Equity Fund (PIPE)
  • Hedge Funds

AIFs provide several benefits that make them attractive to investors seeking to expand or diversify their portfolios because they provide direct exposure to non-traditional asset classes, minimizing risk in the overall portfolio, greater return possibility as compared to traditional investment options and access to investment opportunities that are not available in the traditional markets of investment.

Recent Circular Provides Information about the Downstream Investments

The recent circular excludes the investment in the equity shares of the debtor company of the regulated entities from the downstream investment but includes all the other investments as in the previous circular issued on December 19 2023. The circular intends to prevent regulated entities from indirectly or directly from investing in the AIFs scheme in a debtor company of the Regulated Entities. By disallowing investments in AIFs with downstream investments in debtor companies, the RBI tried to curb the potential risks related to evergreening practices. Evergreening involves replacing existing loans with new loans to cover financial difficulties, but the present circular includes all other investments in the AIFs scheme.

Provisioning Requirements stated in the Recent Circular

The recent circular highlights the provisioning criteria and states that the provisioning is required only for the portion of investment made by the Regulated entities in the AIF scheme, which is further invested by the AIF in the debtor company, and it is not necessary for the entire investment made by the regulated entities in the AIF scheme because the previous circular of 19th December 2023  issued to mandate that if an AIF scheme in which the Regulated entities have already invested, makes a downstream investment in a debtor company then the Regulated entities are required to liquidate their investments in the scheme within 30 days and the provision stating the 100% provision on such investments if the liquidation isn’t completed within the stated time.

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Deduction from Capital

As stated in paragraph 3 and paragraph 2 of the circular dated 19th December 2023 states about addressing concerns relating to the evergreening practices where direct loan exposures of the regulated entities to borrowers are replaced with indirect exposures through AIF investments and where the circular prohibits the regulated entities from investing in any scheme of AIFs which has a downstream investment made required to liquidate its investment in the scheme within 30 days from date of such downstream investment by the AIFs and if the REs are not able to liquidate their investment within the stated time then they are required to make the 100% provisioning on such investments but as the new circular issued the regulatory updates where it is stated that the provision is made only for the portion of the investment made by the regulated entities in the AIF scheme. Moreover, as the previous circular stated about the investment by the Regulated entities in the subordinate units of any of the AIF’s schemes was made subject to full deduction from the Regulated Entity’s capital, but in the recent circular, the proposed deduction from the capital took place equally from the Tier1 and Tier 2 Capital. Also, the reference to investment in subordinated units included various forms of subordinated exposures, including the sponsor units.

Know the brief about both the Circulars of the RBI on the investment in AIFs

The previous amendment prevents regulated entities from investing in AIF schemes that have downstream investments in debtor companies of the RE. This restriction intends to avoid scenarios where direct loan exposures of REs to borrowers are replaced with indirect exposures through AIF investments but with the recent update, the circular excludes investments in equity shares of the debtor company of the regulated entity from downstream investments but includes all other various investments including hybrid instruments. Also, the recent update mandates the recent circular highlights the provisioning criteria and states that the provisioning is required only for the portion of investment made by the Regulated entities in the AIF scheme. These changes collectively aim to enhance transparency, address regulatory concerns and uphold financial stability in the context of regulatory entities’ investment in AIFs. The RBI’s update highlights positive procedures to stop evergreening practices and exposure to high-risk debtor companies to safeguard the financial system.

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Conclusion

AIFs can be an important addition to the investment portfolio, offer diversification, and provide higher returns and exposure to the unique asset classes, so the RBI issued a circular to ensure uniformity in implementing the guidelines for investment in AIFs among regulated entities and address the concerns to provide the clarification of the previous circular. RBI addressed the regulatory concerns and provided clarifications on downstream investments, provisioning, and applicability. The recent circular means to enhance transparency and compliance in this sector.

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