The Reserve Bank of India has issued a notification dated December 19, 2023 (Notification), which seeks to address concerns of evergreening by banks and NBFCs. The Notification, which states that there have been certain transactions which entailed substitution of direct loan exposure of Regulated Entities to borrowers, with indirect exposure through investments in units of AIFs, is addressed to all commercial banks, co-operative banks, All-India financial institutions and NBFCs (including housing finance companies) (Regulated Entities) and prohibits Regulated Entities from investing in any scheme of an alternative investment fund (AIF) which has downstream investments either directly or indirectly in a debtor company of such Regulated Entity. For this purpose, any company to which the Regulated Entity currently has or previously had a loan or investment exposure anytime during the preceding 12 (twelve) months shall be considered to be a debtor company of the Regulated Entity.
The Notification further stipulates the following:
This Notification is likely to discourage Regulated Entities from investing in AIFs in future even for genuine reasons (such as diversification of risk) since, after an investment in an AIF has been made, if the AIF invests in a debtor company of such bank/NBFC, the Regulated Entity will have to either exit from its investment in the AIF or make 100% (one hundred percent) provision on such investment. It is also likely that henceforth, before investing in an AIF, Regulated Entities, shall require a commitment from the AIF that the AIF shall not invest in any existing debtor company of such Regulated Entity. Such a commitment may be inserted in the AIF’s PPM through an amendment, with the consent of a super-majority of investors or may be contained in a side-letter issued by the AIF to the Regulated Entity if the AIF’s PPM permits the issuance of side-letters.
The Notification would have caused less collateral damage if it had contained thresholds for its application. For example, the Notification could have provided that the prohibition on Regulated Entities investing in AIFs that have invested in debtor companies would apply only if a Regulated Entity’s investment in the AIF is atleast 25% of the AIF’s investment in the debtor company and such Regulated Entity’s loan to such debtor company shall fall due within one year of such Regulated Entity’s investment in the AIF.
Interestingly, the Notification does not apply when a Regulated Entity invests in an AIF’s scheme even if another scheme of the same AIF or any scheme of an AIF which has the same investment manager, invests in a debtor company of such Regulated Entity. Therefore, if a bank has invested in Scheme A of an AIF, a plain reading of the Notification does not prohibit Scheme B of the same AIF or Scheme K of another AIF which has the same investment manager as Scheme A, from investing in a debtor company of the bank.
Please find the notification here
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