Context

The Reserve Bank of India (RBI) has made revisions to regulations entities (REs) regarding their investments in Alternative Investment Funds (AIFs).

RBI Relaxes Rules on lenders’ Investment in AIFs

• The Provisions apply to banks and other financial institutions (called REs). Under the new rule, regulated entities (REs) must reserve funds only for the portion of their investment in the AIF scheme that is subsequently invested by the AIFs in a debtor’s company, not for the entire investment in the AIF scheme.

• The circular doesn’t apply to investments made by REs in AIFs through intermediaries like fund of funds or mutual funds.

What are Alternative Investment Funds (AIFs)? 

• Alternative Investment Funds (AIFs) are private investment pools created in India.
• They gather funds from sophisticated investors, including both Indian and foreign individuals, for investment activities.
• AIFs function in accordance with the SEBI (Alternative Investment Funds) Regulations of 2012.
• These funds can be structured in various forms such as companies, Limited Liability Partnerships (LLPs), trusts, and more.

Risks Associated with investment in Alternative Investment Funds (AIFs)

• High Minimum Investment Requirement.
• Lock-in Periods: Many AIFs enforce lock-in periods to restrict investors from withdrawing funds immediately.
• Complexity and Risk: AIFs involve complex investments with higher risks compared to traditional options.
• Fee Burden: AIFs generally impose higher fees, which can significantly reduce investor returns.
• Limited Transparency: Despite regulatory oversight, AIFs may lack transparency, making it challenging for investors to assess their holdings accurately.

Reasoning Behind the RBI Modifications

• Ensuring Consistency:

  • Same rule for AIF: The RBI wants all regulated entities (REs) to follow the same rules when investing in Alternative Investment Funds (AIFs).
    • This ensures fairness and clarity in how investments are managed across the board.

• Addressing Stakeholder Concerns:

• • Transparency and responsiveness: The RBI has taken into consideration stakeholders’ concerns in AIF investments to enhance transparency and responsiveness in the investment process.

• Simplification of Investment Process:

  • Exclusion of Equity Shares: Investments in equity shares of the debtor company of the RE will not be counted as downstream investments.
    • This helps simplify the investment process and reduces potential conflicts of interest.

• Management of Risks Through:

  • Inclusion of Other Investments: All other investments, including hybrid instruments, would be considered downstream investments.
    • This ensures that all relevant investments are properly accounted for, which helps manage risks more effectively.

• Assessment of Actual Risks Involved in Alternative Investment Funds (AIFs):

  • Focus on Provisioning: Now, REs only need to reserve funds for the part of their investment in the AIF scheme that is further invested in the debtor company.
    • This change aligns regulatory requirements with the actual risks involved in AIF investments.

• Prevention from Evergreening of Loans:

  • In December 2023, the RBI had stopped REs from investing in AIF units that had downstream investments in any debtor’s company of the REs.
    • This move was aimed at preventing the practice of extending loans indefinitely, known as evergreening of loans.

Also Read: RBI Report On Panchayati Raj Finance