RBI Clarifies Investment Rules for Regulated Entities in Alternative Funds

Detailed Narrative:

In a move to strengthen the regulatory framework for investments in Alternative Investment Funds (AIFs), India’s central bank has laid out comprehensive guidelines for regulated entities such as banks, financial institutions, and non-banking finance companies. The circular aims to address concerns raised by stakeholders and ensure a consistent approach across the financial sector.

One of the key clarifications pertains to downstream investments made by AIFs. While investments in equity shares of a regulated entity’s debtor company are excluded, all other investments, including hybrid instruments, are considered downstream investments. This distinction is crucial for determining the appropriate level of provisioning required.

Speaking of provisioning, the circular specifies that regulated entities need to set aside provisions only for the portion of their AIF investment that is further invested by the AIF in the debtor company. This means that provisioning is not required for the entire AIF investment, providing relief to regulated entities.

The applicability of certain rules is also clarified. Paragraph 3 of the circular, which outlines specific requirements, applies only when the AIF has no downstream investment in a debtor company of the regulated entity. However, if the regulated entity invests in subordinated units of an AIF scheme that has exposure to the debtor company, compliance with paragraph 2 becomes mandatory.

Addressing capital deductions, the circular stipulates that any proposed deductions from capital will be equally split between Tier-1 and Tier-2 capital. Furthermore, the reference to investment in subordinated units of AIF schemes includes all forms of subordinated exposures, such as investments in the nature of sponsor units.

It’s important to note that investments by regulated entities in AIFs through intermediaries like fund of funds or mutual funds are not covered by the scope of this circular.

The Reserve Bank of India’s proactive stance in issuing these guidelines underscores its commitment to fostering a transparent and well-regulated investment environment. By providing clarity on various aspects of AIF investments, the central bank aims to enhance compliance and maintain stability within the financial system.

FAQs:

Q1: Why did the RBI issue this circular?

A1: The circular was issued to address regulatory concerns and ensure uniformity in how regulated entities implement guidelines for investments in Alternative Investment Funds (AIFs).

Q2: What is the significance of the clarification on downstream investments?A2: The clarification distinguishes between investments in equity shares of debtor companies (excluded) and other investments like hybrid instruments (included). This distinction is crucial for determining provisioning requirements.

Q3: How does the circular impact provisioning requirements?

A3: Regulated entities need to provision only for the part of their AIF investment that is further invested by the AIF in the debtor company, not the entire AIF investment.

Q4: When does paragraph 3 of the circular apply?

A4: Paragraph 3 applies only when the AIF has no downstream investment in a debtor company of the regulated entity. If the AIF has exposure to the debtor company, compliance with paragraph 2 is necessary.

Q5: How are capital deductions handled under the new guidelines?

A5: Proposed deductions from capital will be equally split between Tier-1 and Tier-2 capital. Subordinated exposures, including sponsor units, are considered investments in subordinated units of AIF schemes.

Q6: Are investments through intermediaries like fund of funds covered by the circular?

A6: No, investments by regulated entities in AIFs through intermediaries such as fund of funds or mutual funds are not included in the scope of this circular.

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RBI/2023-24/140

DOR.STR.REC.85/21.04.048/2023-24

March 27, 2024

All Commercial Banks (including Small Finance Banks, Local Area Banks and Regional Rural Banks)

All Primary (Urban) Co-operative Banks/State Co-operative Banks/ Central Cooperative Banks

All All-India Financial Institutions

All Non-Banking Financial Companies (including Housing Finance Companies)

Investments in Alternative Investment Funds (AIFs)

Please refer to the circular DOR.STR.REC.58/21.04.048/2023-24 dated December 19, 2023 (‘Circular’) on the captioned subject, in terms of which instructions were issued to address certain regulatory concerns relating to investment by regulated entities (REs) in the AIFs.

2. With a view to ensuring uniformity in implementation among the REs, and to address the concerns flagged in various representations received from stakeholders, it is advised as under:

(i) Downstream investments referred to in paragraph 2 (i) of the Circular shall exclude investments in equity shares of the debtor company of the RE, but shall include all other investments, including investment in hybrid instruments.

(ii) Provisioning in terms of paragraph 2(iii) of the Circular shall be required only to the extent of investment by the RE in the AIF scheme which is further invested by the AIF in the debtor company, and not on the entire investment of the RE in the AIF scheme.

(iii) Paragraph 3 of the Circular shall only be applicable in cases where the AIF does not have any downstream investment in a debtor company of the RE.

If the RE has investment in subordinated units of an AIF scheme, which also has downstream exposure to the debtor company, then the RE shall be required to comply with paragraph 2 of the Circular.

(iv) Further with regard to paragraph 3 of the Circular:

• proposed deduction from capital shall take place equally from both Tier 1 and Tier-2 capital.

• reference to investment in subordinated units of AIF Scheme includes all forms of subordinated exposures, including investment in the nature of sponsor units.

(v) Investments by REs in AIFs through intermediaries such as fund of funds or mutual funds are not included in the scope of the Circular.

3. 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.

Yours faithfully,

(Vaibhav Chaturvedi)

Chief General Manager