The Reserve Bank of India ("RBI") has issued draft directions on May 19, 2025 titled Reserve Bank of India (Investment in AIF) Directions, 2025 ("Draft Directions") which propose certain revisions to the current regulatory framework governing investments in Alternative Investment Funds ("AIFs") by commercial banks, primary (urban)/ state/ central co-operative banks, all-India financial institutions and non-banking financial companies (including housing finance companies) ("REs").
Existing Framework
Investments by REs in AIFs is currently governed by the circular bearing no. DOR.STR.REC.58/21.04.048/2023-24 dated December 19, 2023 ("Original Circular"), read with the clarifications issued in relation to the Original Circular vide circular bearing no.DOR.STR.REC.85/21.04.048/2023-24 dated March 27, 2024 ("Clarification Circular").
The Original Circular primarily focused on preventing evergreening of loans. For this purpose, RBI restricted REs from making investments in any scheme of AIFs which directly or indirectly invested in entities to which the RE has had any exposure, whether current or in the preceding 12 (twelve) months ("Debtor Company"). Following representations received from stakeholders, RBI later stipulated, by way of the Clarification Circular that, the restriction would not apply where investments have been made by the AIF scheme in equity shares (excluding hybrid instruments) of the Debtor Company.
As per the Original Circular, the REs were required to either liquidate their investment in the AIF scheme within 30 (thirty) days from the date of downstream investment or issuance of the Original Circular, as applicable, or make 100% (one hundred percent) provisions on their investments in such AIF scheme. RBI later clarified through the Clarification Circular, that provisioning would only be required to the extent of the investment made by the RE in the AIF scheme which is further invested by the AIF in the Debtor Company.
Revised Framework
The key changes prescribed by the RBI in the Draft Directions have been discussed hereunder:
1. Debtor Companies
Under the Draft Directions, the definition of Debtor Company, specifically excludes any exposure of the RE to equity instruments of such company, i.e., equity shares,compulsorily convertible preference shares ("CCPS") or compulsorily convertible debentures ("CCDs") [Direction 4].
2. Establishment of internal policies
The Draft Directions mandate that REs establish investment policies that have suitable provisions to ensure compliance with extant regulatory norms, specifically the test of evergreening [Direction 5].
3. Quantitative limits instead of complete prohibition
The Draft Directions have introduced a tiered structure of permitted investments by REs in AIF schemes based on the percentage of investments by the RE in the AIF. All REs are individually restricted from holding more that 10% (ten percent) of the corpus of an AIF scheme [Direction 6(a)]. Further, total investments of all REs in the corpus of an AIF scheme has been capped at 15% (fifteen percent)[Direction 6(b)]. Also, no downstream investment restrictions have been placed on a RE if they invest less than or equal to 5% (five percent) in the corpus of an AIF scheme [Direction 6(c)].
4. Investment in hybrid instruments
Under the Original Circular read with the Clarification Circular, the restriction on investment by the RE is applicable to downstream investments made by the AIF scheme in hybrid instruments (excluding equity shares) of the Debtor Company. Under the Draft Directions, this restriction has been relaxed, whereby in addition to investment in equity shares, investments by an AIF scheme in Debtor Companies either by way of CCPS or CCDs have also been excluded [Direction 6(c)].
5. Removal of liquidation requirement
Unlike the Original Circular, the Draft Directions do not provide for a 30 (thirty) day timeline for liquidation of investments made by the RE in the AIF scheme. Where a RE has invested more than 5% (five percent) in the corpus of an AIF scheme and such AIF scheme makes an investment in a Debtor Company, the RE is required to make 100% (one hundred percent) provision to the extent of its proportionate investment in the Debtor Company through the AIF scheme [Direction 6(c)].
6. Introduction of exemption framework
The Draft Directions also provide that RBI may, in consultation with the Government of India, exempt certain AIFs from the restrictions provided under Direction 6 of the Draft Directions.
It may be noted that all outstanding investments or subsequent drawdowns out of commitments made prior to the effective date of the directions, would continue to be governed by the provisions of the existing circulars i.e., the Original Circular and the Clarification Circular.
Argus View
Through the Draft Directions, RBI proposes to close the loop on investments in AIFs by REs, especially in light of the due diligence requirements specified by the Securities and Exchange Board of India ("SEBI") in the SEBI (Alternative Investment Funds) Regulations, 2012, read with the circular dated October 8, 2024, issued by SEBI. For more details on the due diligence requirements prescribed by SEBI, please refer to our update here. While the Draft Directions have further harmonised the regulatory regime by RBI and SEBI, the percentages prescribed under SEBI and RBI are not in complete alignment since the obligations under the SEBI circular are triggeredinter aliawhere the RE individually or along with investors of the same group contributes towards 25% (twenty five percent) or more of the corpus of the AIF scheme, while the Draft Directions prescribe a cap of 15% (fifteen percent) over all investments by REs in the corpus of an AIF scheme.
Most pertinently, the Draft Directions indicate a shift in the RBI's approach from complete prohibition to a more balanced framework with safe harbour provisions and quantitative limits, which is a welcome change for REs and AIFs alike. However, the caps introduced on the composite funding by REs will require REs to diversify their investment portfolios. It may also be noted that, while the Clarification Circular clearly specified that investments by REs in AIFs through intermediaries such as mutual funds would not be included within the scope of the Original Circular, the same exemption has not been specifically provided for in the Draft Directions.
A copy of the Draft Directions can be accessed here.
A copy of the Original Circular can be accessed here.
A copy of the Clarification Circular can be accessed here.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
