RBI Issues Draft Directions on Regulated Entities' Investments in AIFs

The Reserve Bank of India (RBI) has released draft directions proposing a revised regulatory framework for investments by Regulated Entities (REs) including banks and NBFCs in Alternative Investment Funds (AIFs). These draft norms aim to address concerns around indirect exposure to stressed assets and potential evergreening of loans through AIF structures.

Key Proposals in the Draft:

Exposure Limits: An RE’s investment in a single AIF scheme is proposed to be capped at 10% of the scheme’s corpus, with a collective limit of 15% across all REs.

Unrestricted Investment Threshold: Investments up to 5% of the scheme’s corpus may remain unrestricted under the draft.

Provisioning Requirement: If an RE holds more than 5% in an AIF that subsequently invests in companies already indebted to that RE, the RE must provision 100% of its exposure proportionate to such downstream investments, excluding equity shares and convertible instruments.

Prospective Application: The directions, once finalized, would apply prospectively. Existing investments would continue to be governed by the current framework.

Exemptions: AIFs set up for strategic purposes may be considered for exemption, subject to government consultation.

Legal Implications & Analysis:

The draft directions signal a tightening regulatory posture on circular and indirect exposure risks in the financial sector. Key legal and compliance considerations include:

Increased Oversight: REs will be required to enhance diligence before investing in AIFs, including a thorough assessment of downstream investment structures.

Contractual Transparency: Fund managers may be expected to revise disclosure obligations to RE investors to enable compliance, impacting fund structuring and LP agreements.

Provisioning Risk: The 100% provisioning clause could act as a deterrent and influence REs’ willingness to participate in certain AIFs, particularly those with debt-focused strategies.

Stakeholders are encouraged to review the draft carefully and provide feedback to the RBI by June 8, 2025. This is a critical opportunity for the financial and investment community to influence the final regulatory framework.