The Reserve Bank of India (RBI) has directed banks and non-banking financial companies (NBFCs) to not make investments in any Alternative Investment Funds (AIFs) that has downstream investments either directly or indirectly in a debtor company of the bank.
The notice aims to address concerns relating to possible evergreening through this route. The move is also expected to impact the fund flows to AIFs. The debtor company for this purpose mean any company to which the Regulated Entities (RE) currently has or previously had a loan or investment exposure anytime during the preceding 12 months.
“Against the backdrop of ‘evergreening’, the existing structures in the market operated in a regulatory vacuum of not being prohibited and in more instances than not, failed to pass the smell test on account of the spirit of the existing RBI regulations,” said Veena Sivaramakrishnan, Partner – Banking & Finance and Insolvency and Bankruptcy Practice, Shardul Amarchand Mangaldas & Co.
The RBI notice states REs make investments in units of AIFs as part of their regular investment operations. However, certain transactions of REs involving AIFs that raise regulatory concerns have come to its notice. These transactions entail substitution of direct loan exposure of REs to borrowers, with indirect exposure through investments in units of AIFs.
“While it is usually rare for RBI to call out specific structures in 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 fall squarely within the purview of this circular and given the timelines prescribed, they would need to be quickly relooked for alternative structuring,” said Sivaramakrishnan.
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The notice also states that if a Bank / NBFC is already invested in an AIF which makes a downstream investment in any such debtor company, then the bank shall liquidate its investment in the AIF within 30 days from the date of such downstream investment by the AIF or the 30-day from date of issuance of this circular, as applicable.
In case Banks / NBFCs are not able to liquidate their investments within the above-prescribe time limit, they shall make 100% provision on such investments.
Investment by banks in the subordinated units of any AIF with a ‘priority distribution model’ shall be subject to full deduction from Bank’s / NBFC’s capital funds.