News Excerpt:

The Reserve Bank of India (RBI) relaxed the norms it announced on investments in Alternative Investment Funds (AIFs) last year.

Key points of modified AIF’s Norms: 

• RBI said that its regulated entities (REs) will now be required to make provisioning only to the extent of the amount invested by the AIF scheme in the debtor company and not the entire investment.
• Equity shares of the debtor company are excluded from the definition of "downstream investments," allowing banks and NBFCs to invest in AIFs even if the scheme has equity investments in the company to which they have already lent.
• The term ‘debtor company’ has been defined to include any company to which the RE currently has or previously had a loan or investment exposure anytime during the preceding 12 months.
• The above instructions have been issued in exercise of the powers conferred by Sections 21 and 35A of the Banking Regulation Act, 1949 read with Section 56 of the Act ibid; Chapter IIIB of the Reserve Bank of India Act, 1934 and Sections 30A, 32 and 33 of the National Housing Bank Act, 1987.
• These instructions are applicable to all -
• Commercial banks (including Small Finance Banks, Local Area Banks and Regional Rural Banks)
• Primary (Urban) Co-operative Banks/State Co-operative Banks/ Central Co-operative Banks
• All-India Financial Institutions
• Non-Banking Financial Companies (including Housing Finance Companies)

Significance of the modified norms:

• It will lower the burden on the NBFCs, which had done 100 percent provisioning for the total investments in AIFs after the lapse of the 30 days given by RBI to liquidate such assets.
• The provisioning will now be proportionate to the downstream investment in the debtor company by the AIF.
• However, there is ambiguity regarding the treatment of existing REs and whether they can still honor capital calls to AIFs not meeting specific criteria in the new circular.
• The RBI has also excluded investments made through intermediaries like fund of funds and mutual funds.
• The relaxation of norms benefits venture capital and private equity funds, allowing them to raise money from banks and REs more easily.

About AIF:

• Alternative Investment Fund, or AIF, means any fund established or incorporated in India that is a privately pooled investment vehicle that collects funds from sophisticated investors, whether
• Indian or foreign and invests them in accordance with a defined investment policy for the benefit of its investors. 

SEBI has classified AIF in three parts:

Category I AIFs:

• AIFs which invest in start-up or early stage ventures or social ventures or SMEs or infrastructure or other sectors or areas which the government or regulators consider as socially or economically desirable and shall include venture capital funds, SME Funds, social venture funds, infrastructure funds and such other Alternative Investment Funds as may be specified.

Category II AIFs:

• AIFs which do not fall in Category I and III and which do not undertake leverage or borrowing other than to meet day-to-day operational requirements and as permitted in the SEBI.
• Various types of funds such as real estate funds, private equity funds, funds for distressed assets, etc. are registered as Category II AIFs

Category III AIFs:

• AIFs which employ diverse or complex trading strategies and may employ leverage including through investment in listed or unlisted derivatives.
• Various types of funds such as hedge funds, PIPE Funds, etc. are registered as Category III AIFs.