The recent Reserve Bank of India’s ban on all investments in AIFs with downstream investments in debtor companies has raised concerns among stakeholders. Critics argue that this approach assumes that all such investments are equivalent to evergreening, potentially hindering legitimate investment structures.
In a circular issued on December 19, 2023, the Reserve Bank of India (RBI) has directed regulated banks, financial institutions, and non-banking financial companies (NBFCs) to refrain from holding units of Alternative Investment Funds (AIFs) that have invested in a “debtor company” of such regulated entities. This move comes as a response to concerns related to potential evergreening practices, where investments in AIFs could be misused to mask bad debt.
While the RBI’s intent to curb evergreening practices is recognised, the regulatory action has faced criticism for its broad-brush approach.
Impact on Stakeholders
The circular’s impact on AIFs is multifaceted. AIFs, especially those with downstream investments in debtor companies, now face increased scrutiny and potential disruption. The requirement for regulated entities to liquidate their AIF investments within 30 days poses practical challenges, including finding buyers in a constrained market.
Regulated entities, including banks and NBFCs, find themselves navigating the aftermath of the circular. The mandate to liquidate AIF investments may lead to significant write-offs, impacting their financial positions. Moreover, the prohibition raises questions about the ability of regulated entities to benefit from the growth and capital appreciation associated with start-ups.
The circular’s implications for Indian enterprises are twofold. On one hand, it may hinder the flow of Indian-sourced institutional capital into the start-up ecosystem, potentially affecting the government’s initiatives like Start-up India. On the other hand, the move aims to bring transparency and prevent potential misuse of AIF structures, which could benefit the overall health of the financial sector.
Constitutional concerns
Constitutional concerns are raised by some stakeholders, questioning the circular’s adherence to Article 14, which provides the right to equal protection of the law. The broad restrictions without a reasonable classification may be seen as arbitrary. Additionally, the circular’s impact on Article 19(1)(g), guaranteeing the right to carry on any occupation, trade, or business, is being scrutinised, as it seemingly restricts this right for regulated entities.
Stakeholders are urging the RBI to reconsider the circular, advocating for a more nuanced approach that takes into account the diverse nature of AIF investments.
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