New SEBI guidelines for borrowing by Category I and II AIFs

The 206^th meeting of the Board of the Securities and Exchange Board of India (SEBI) was held in Mumbai on June 27, 2024. At this meeting, SEBI issued new guidelines for borrowing by Category I and II Alternative Investment Funds (“AIF”). In order to facilitate the ease of doing business and to provide operational flexibility to AIFs, SEBI’s Board approved a proposal to expressly permit Category I and II AIFs to borrow, for a period of upto 30 days, for the purpose of meeting temporary shortfall in drawdown from investors, while making investments. The cost of any such borrowing would need to be  charged to the specific investors responsible for the shortfall. Further, with a view to curtail any possible roll-over of borrowing, there shall be a cooling-off period of 30 days between two borrowings availed by Category I and II AIFs.

At present, Regulation 16(1) of the Securities and Exchange Board of India (Alternative Investment Funds), 2012 (SEBI AIF Regulations) states that Category I AIFs shall not borrow funds directly or indirectly or engage in any leverage except for meeting temporary funding requirements for not more than 30 days, on not more than four occasions in a year and not more than 10% of its investable funds. Regulation 17(c) of the SEBI AIF Regulations has an identical provision with respect to Category II AIFs.

Though the new guidelines don’t say so in as many words, it is most likely that the new guidelines will replace the existing guidelines and this will be made clear only when the actual amendments are issued by SEBI to implement the decisions taken at its Board meeting.

The key differences between the new (yet-to-be-implemented) and old (existing) guidelines are as follows:

• Under the current rules for borrowing, Category I and II AIFs can borrow to meet temporary funding requirements subject to the time period and multiplicity restrictions explained above. In practice, this permitted an AIF which spotted a good investment opportunity to borrow from a Bank or an NBFC and use such funds to make the investment, then issue a drawdown notice on investors and repay the Bank and/or NBFC using the capital call received from the investors. Once the new guideline comes into effect, Category I and II AIFs can borrow only if and after any investor fails to pay the drawdown amount on the due date.
• Under the new guideline, the interest and other costs associated with the borrowing would have to be charged to the investors who defaulted in honouring the drawdown notice. The current rules permit the fund to bear the cost of the borrowing.
• Under the current rules, a fund can borrow only four times a year, with each borrowing for a term of 30 days. Under the new rules, a fund can borrow as many times as it wants to, provided there is a cooling-off period of 30 days between two borrowings availed by Category I and II AIFs. The new rules also require each borrowing to not exceed 30 days.

The minutes of the Board meeting held on June 27, 2024 can be found here.

The new guidelines are a reiteration of SEBI’s belief that an AIF should be funded by its investors and not through borrowings. These new guidelines will make it much more difficult for Category I and II AIFs to borrow since the cost of such borrowing has to be met by investors who are already in default! Further, since the borrowing cannot be for a period of more than 30 days, it is assumed that the defaulting investor shall repay within such 30-day period. Banks and NBFCs would hesitate to lend to AIFs on such terms. It is possible that the actual amendments that will be issued by SEBI to implement this new guideline will state that the AIF can repay the loan using the Fund’s corpus and also bear the interest and other costs of borrowing and (seek to) recover the loan and such expenses from the defaulting investors. If so, it would be possible for Category I and II AIFs to borrow, but going forward, the quantum of borrowing by AIFs will be greatly reduced since any borrowing can take place only after an investor(s) has defaulted.

We hope you have found this information useful. For any queries/clarifications please write to us at insights@elp-in.com  or write to our authors:

Vinod Joseph, Partner – Email – vinodjoseph@elp-in.com

Paridhi Jain, Associate, Email – paridhijain@elp-in.com