The Reserve Bank of India (RBI) has instructed banks and non-banking financial firms (NBFCs) not to invest in any Alternative Investment Funds (AIFs) that have downstream investments in a bank debtor company, either directly or indirectly.
The purpose of the notification is to address concerns about potential evergreening along this route. It is anticipated that the change will also affect the money flows to AIFs. For this purpose, any company to which the Regulated Entities (RE) have had or will have a loan or investment exposure at any point in the last 12 months is considered a debtor company.
According to Veena Sivaramakrishnan, Partner, Banking & Finance and Insolvency and Bankruptcy Practice, Shardul Amarchand Mangaldas & Co., “because of the spirit of the existing RBI regulations, the existing structures in the market operated in a regulatory vacuum of not being prohibited against the backdrop of ‘evergreening’ and in most cases failed to pass the smell test.”
REs invest in AIF units as part of their routine investment operations, according to the RBI notification. It is aware, meanwhile, of some RE transactions involving AIFs that give rise to regulatory questions. Indirect exposure to borrowers through investments in AIF units is used in place of direct loan exposure from REs to borrowers in these transactions.
Although the RBI never calls out specific structures of the kind described in the circular, it is not unexpected given the RBI’s longstanding concerns about evergreening as a principle and hidden non-performing assets. The senior-junior priority structures that certain corporations have chosen would be clearly covered by this circular, and considering the deadlines, they would need to look into alternate structuring as soon as possible, according to Sivaramakrishnan.
According to the notice, a bank or non-bank financial institution that has already invested in an AIF that has made a downstream investment in a debtor company must liquidate its investment in the AIF within 30 days of the date of the AIF’s downstream investment or, if that is earlier, within 30 days of the date this circular was issued.
The banks and non-bank financial companies (NBFCs) will forfeit all of their investment if they are unable to liquidate it in the time frame specified above.
Bank and NBFC capital funds will be fully deducted from any investment made by banks in the subordinated units of any AIF that uses a “priority distribution model.”
