The recent regulatory moves by Reserve Bank of India (RBI) have ignited considerable discussions in the Indian financial landscape. What started as a decisive measure to curb the subtle practice of "evergreening" has evolved into a nuanced regulatory dance, aiming to balance financial stability with the growth of the burgeoning AIF industry.
It all roots back to the RBI's concerns regarding the potential misuse of AIF structure to obscure troubled assets and evergreening of loans. "Evergreening" involves providing fresh credits to the existing distressed borrower for repayments of their existing, overdue debts, thereby keeping the financial record clean by skipping the classification of the existing loans as Non-Performing Assets (NPAs). While in the short run, this might aid keeping the balance sheet clean but in a longer run it raises serious concerns regarding genuine financial health and transparency.
The December 2023 Circular1 was a clear sign from RBI to curb Regulated Entities (including Banks and NBFCs) from investing in any AIF Scheme that directly or indirectly had a downstream investment in any of the "debtor company" of the Regulated Entity (RE). A "debtor company" was broadly defined to include any company which borrowed loans or had investment made by the RE in the preceding 12 months. A non-compliance w.r.t liquidation of such investments within 30 days mandates a 100% provisioning on the RE's exposure which further created shockwaves in the market and caused immediate concerns for both the REs and AIFs.
Industry Pushback and Initial Adjustments
Although well-intended, the December 2023 circular created multiple operational hurdles in the industry particular pertaining to REs being unable to honor their capital commitment or forced, pre-mature exits from the current investments by the AIFs to comply with the circular. The expansive definition of "debtor company" further fueled widespread concerns about its impact on capital formation and the AIF ecosystem.
In response to the extensive representation from the industry stakeholders, RBI further issued a clarificatory circular in March 20242, which brought some welcome relief by:
- Excluding Equity Shares – It specified that the downstream investments by AIF into the equity shares of the debtor company shall not invite liquidating/provisioning restrictions as mentioned in the earlier released circular. This was a crucial distinction which acknowledged that equity investments typically involve a different risk profile and carry different intent than debt.
- Proportionate Provisioning – Instead of a 100% provisioning on the entire AIF investment, it was limited to the extent of the proportionate exposure of the particular RE into that AIF scheme that is downstream invested into a debtor company (excluding equity).
Adding to this evolving regulatory landscape, the Security Exchange Board of India (SEBI) in April 20243, came up with significant amendments to the Alternative Investment Fund (AIF) Regulations. These changes, particularly the insertion of Regulation 20(20) mandated the AIF, their managers, and the Key Management Personnels (KMPs) to exercise specific due diligence concerning their investors and investments. This statutory obligation reflects SEBI's proactive stance in addressing the market concerns of various financial sector regulations (including RBI norms on evergreening) and fostering great transparency and maintaining compliance within the AIF ecosystem.
The Latest Draft Directions: A Calibrated Approach
In a recent development, RBI has come up with a revised draft of directions4, released in May 2025 which is open for public feedback until June 8, 2025. The latest iteration seeks to balance the imperative of curbing evergreening with a need to foster a supportive environment for legitimate AIF Investors. The key proposals include:
- Individual RE exposure limit – A single RE contribution to any AIF scheme will be capped at 10% of that scheme's corpus.
- Collective RE Limit – Cumulatively, all RE's contribution cannot be more than 15% in any single AIF scheme.
- Relaxed Threshold – Investment by a RE up to 5% of an AIF scheme's corpus in a debtor company of that specific RE (excluding equity, Compulsorily Convertible Preference Shares, and Compulsorily Convertible Debentures), will be permitted without triggering the stricter provisioning requirement.
- Conditional 100% provisioning – If the investment by a RE exceeds 5% limit as mentioned in point 3, then 100% provisioning is to be done to the extent of its proportionate exposure.
- Strategic Exemptions – Exemption to certain AIFs may be provided by RBI, in consultation with the Government, that has been established for strategic purposes.
- Prospective Application – The revised directions will apply prospectively, meaning existing investments and commitments will continue to be governed by the previous norms.
Market Impact and Path Forward
The latest draft directions, while still imposing certain restrictions, have been largely welcomed by the industry in the process to progress towards greater clarity and a more balanced regulatory approach.
For REs, the defined limits provide a welcome guidance over the permissible investment levels. The relaxed provisioning for equity linked investments and the proportionate provisioning approach will alleviate some financial strain, encouraging the genuine participation in AIF. However, continuous due diligence to monitor downstream investments will remain paramount.
Under AIFs, the flexibility for REs to invest up to a certain threshold without triggering provisioning concerns is a positive development for fundraising. The exclusion of equity from the whole narrative is a significant win for the venture capital and private equity funds. Nonetheless, AIFs will have to get more stringent with the compliances and make timely disclosures to their Limited Partners (LPs) so that they are not caught in the "evergreening" web. The industry will likely continue to advocate for clearer definitions and perhaps broader exemptions for specific fund types for maintaining balance in the financial ecosystem.
Conclusion
The RBI's journey in regulating RE investments in AIF reflects a proactive and adaptive regulatory approach. From the initial stringent clampdown to the subsequent calibrations, RBI is striving to create an ecosystem where the advantages of the alternative investments can be leveraged while effectively mitigating the systematic risks. The market is keen to watch the outcome of the finalization of these directions and their long-term impact on the capital flows and investment strategies whilst India continues its journey of a robust and transparent financial ecosystem. The ongoing dialogue between the regulator and the industry will be pivotal in finding the optimal balance for growth and stability.
Footnotes
1. Investments in AIFs, RBI circular RBI/2023-24/90 dated December 19, 2023.
2. Investments in AIFs, RBI circular RBI/2023-24/140 dated March 27, 2024.
4. https://rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=60481
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