The Reserve Bank of India (RBI) has tightened the rules for Alternative Investment Funds (AIFs)

  • The Reserve Bank of India (RBI) has tightened regulations for Regulated Entities (REs) in order to reduce the practice of evergreening loans through investments in Alternative Investment Funds (AIFs).
  • All banks, India Financial Institutions, and Non-Banking Financial Companies (NBFCs), including Housing Finance Companies, are subject to the rules.

About Alternative Investment Funds (AIFs)

DefinitionAIFs are privately pooled investment vehicles established in India that aggregate cash for investment from sophisticated investors.
RegulationGoverned by the SEBI (Alternative Investment Funds) Regulations, 2012.
FormationCan be formed as a company, Limited Liability Partnership (LLP), trust, etc.
Investor ProfileAimed at high rollers in India, including both indigenous and foreign investors. Because of the large investment amounts, it is generally preferred by institutions and high net worth people.
Categories of AIFsCategory I: Invests in start-ups, early-stage companies, SMEs, and other similar entities. Venture capital funds, angel funds, and other similar entities are included.Category II funds include those that are not in Categories I or III, such as real estate funds, debt funds, and so on. Except for operating needs, no leverage or borrowing.Category III: Uses complicated trading tactics and may employ leverage. Hedge funds, PIPE funds, and other similar investments are included.
Fund StructureCategory I and II AIFs must be closed-ended and have a three-year minimum duration.AIFs under Category III might be open-ended or closed-ended.

Background Information and Regulatory Concerns

  • Investment Practices: As part of their routine investment activities, REs frequently invest in AIF units.
  • RBI’s Points of View: The RBI raised regulatory concerns about some transactions involving AIFs that replaced direct loan exposure for indirect exposure.

The New RBI Guidelines

  • Investment Restriction: REs are barred from investing in any AIF scheme that has downstream investments in a debtor company of the RE, either indirectly or directly.
  • Mandatory Liquidation: If an AIF scheme in which a RE already has a stake makes a downstream investment in a debtor company, the RE must liquidate its stake in the scheme within 30 days after the AIF’s investment.
  • Existing interests: REs have 30 days from the issue of the circular to liquidate existing interests in such schemes. Failure to do so necessitates a full provision for these investments.
  • Deductions from Capital Funds: Investments by REs in subordinated units of any AIF scheme with a ‘priority distribution model’ are fully deductible from the RE’s capital funds.
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