 "Reserve Bank of India, RBI")
In the middle of concerns about the circumvention of regulations by alternative investment funds (AIFs), the Reserve Bank of India (RBI) issued an advisory on Tuesday to banks and financial companies to curb the evergreening of loans and misuse of the AIF route.
According to the RBI advisory, banks, non-banking financial companies (NBFCs), and other financial institutions like the National Bank for Agriculture and Rural Development and the Small Industries Development Bank of India (Sidbi) will not be able to make investments in any scheme of AIFs that has downstream investments directly or indirectly in a debtor company of the bank/NBFC.
This implies that if the bank or NBFC currently has exposure or had previously lent at any time during the preceding 12 months to a company, they cannot invest in an AIF scheme investing in the same company.
The RBI’s advisory comes against the backdrop of the findings of the Securities and Exchange Board of India (Sebi), which said that the cases of circumvention amount to “tens and thousands of crores”.
Last month, a Sebi official stated that the market regulator had shared the data with RBI on AIFs being structured to enable the evergreening of financial sector assets to avoid non-performing asset (NPA) recognition.
“We have shared this data with RBI, and RBI agrees with our assessment. We have seen cases where AIFs have been used to circumvent Foreign Exchange Management Act regulations — where a particular entity not allowed to invest in another does so via an AIF,” the Sebi official had said.
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AIF officials said that the RBI decision could lead to heavy exits from the schemes or write-downs on certain investments.
“If an AIF scheme, in which regulated entity (bank or NBFC) is already an investor, makes a downstream investment in any such debtor company, then the regulated entity shall liquidate its investment in the scheme within 30 days from the date of such downstream investment by the AIF,” said RBI.
If the RBI-regulated entity is not able to liquidate its investments within the 30-day timeline, then it will have to make a 100 per cent provision on such investments, advised RBI.
“The regulators are closing the loophole and making it watertight. We need to watch out for the impact on large wholesale NBFCs with fund structures,” said a debt AIF manager.
The AIF industry has raised concerns about the impact and challenges in tracking such investments. Industry officials have said that they have commenced work on their submissions to both regulators.
“This is akin to throwing the baby out with the bathwater. Several banks have signed agreements for AIF investments. This will also restrict investments by Sidbi, the government’s initiative to provide credit. Many AIFs invest in listed entities too, and there could be some credit provided by these financial institutions already. Even if a credit card or banking facility is availed of by the entity where the AIF plans to invest, then the bank/NBFC cannot invest in the said AIF,” said an AIF official.
“While it is usually rare for the RBI to specify structures of the nature mentioned in the circular, it does not necessarily come as a surprise, as the RBI has always been concerned with hidden NPAs and evergreening as a principle. The priority/senior–junior structures adopted by certain entities would squarely fall within the purview of this circular, and given the prescribed timelines, they would need to be quickly reconsidered for alternative structuring," said Veena Sivaramakrishnan, partner-banking and finance and insolvency and bankruptcy practice, Shardul Amarchand Mangaldas & Co.
Industry officials said that the decision would deter banks and NBFCs from investing in debt AIFs or the funds facilitating venture debts.
AIFs are privately pooled investment products investing in startups and small and medium-sized enterprises, private equity (PE) funds, private credit providers, etc.
AIFs fall under the regulatory ambit of Sebi.
“Many banks would also have a cash credit or overdraft facility to the startups in some way or another. In such cases, they won’t be able to invest in AIFs which also have downstream investments in such a startup,” said another industry player.
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.
Until the first six months of the calendar year, a total of Rs 3.5 trillion was invested through AIFs. The number of AIFs and investments by these schemes has grown multifold in the past five years. Until 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 for investors.
RBI DIRECTIVES & INDUSTRY CONCERNS: A SNAPSHOT
- Banks, NBFCs will have to liquidate investments in the scheme within 30 days if an AIF has any downstream investment
- RBI directs institutions to make a 100% provision on such investments if not liquidated within 30 days
- RBI’s advisory follows concerns raised by Sebi regarding circumvention through AIFs
- The AIF industry is concerned about exits by financial institutions and growth prospects
