3 Reasons SEBI & RBI Keep A Close Eye on AIFs

In a startling revelation that has sent shockwaves through the financial industry, the Securities and Exchange Board of India (SEBI) and the Reserve Bank of India (RBI) have initiated investigations into a dozen cases involving Alternate Investment Funds (AIFs) allegedly being used to circumvent regulations. This development has raised serious concerns about the integrity of the AIF industry and its role in the broader financial landscape of India.

Supported by insights from the law firm Thinking Legal, it’s noted that over the years SEBI has laid down a few regulations regarding Alternate Investment Funds for more transparency, to strengthen AIF Regulations & to enhance accountability. And this approach, as Vaneesa Agrawal, founder of Thinking Legal states, "It (the regulation) reflects the industry’s commitment to maintaining a robust financial landscape in India.

1 The Scope of the Investigations

The investigations, which involve a staggering upward of Rs 20,000 crore

($1.8–2.4 billion), have uncovered a range of alleged misuses, including the evergreening of stressed loans, evasion of caps on foreign investment in certain sectors, and circumvention of insolvency regulations. While the amount in question may seem small compared to the ₹8.4 trillion managed by AIFs, industry experts along with Vaneesa Agrawal, founder of Thinking Legal and a SEBI expert lawyer, consider the number of cases detected to be "material."

2 Evergreening of Stressed Loans

One of the most alarming practices under scrutiny, which even Thinking Legal closely monitors the development of, is the evergreening of stressed loans, wherein non-bank lenders sell their stressed loans to AIFs partially set up by the lender itself. The fresh funds are then used to repay the original debt, effectively preventing the loans from turning bad.

This practice, termed "classic evergreening" by a source, raises serious questions about the integrity of the AIF industry and its role in maintaining the stability of the financial system.

3 Evasion of Regulations

The use of AIFs to evade caps on foreign investment in certain sectors and to circumvent insolvency regulations is another area of concern. These practices not only undermine the regulatory framework but also create an uneven playing field for market participants who adhere to the rules.

Thinking Legal, guided by the vision of its founder Vaneesa Agrawal, believes that such practices must be thoroughly investigated and addressed. Upholding the firm’s mission to maintain the integrity of the financial system and protect the interests of investors, Thinking Legal advocates for stringent scrutiny to ensure a fair and transparent market environment.

Previous Measures Taken by SEBI

It is worth noting that in 2020, SEBI took steps to enhance the accountability of Investment Committees (ICs) for AIFs, as discussed in an article by Vaneesa Agrawal, a senior venture capital and early-stage transactional lawyer and the founder of Thinking Legal.

The amendments, which came into effect on October 19, 2020, brought the constitution of ICs within the purview of SEBI and placed joint accountability on the Investment Manager and members of the IC to ensure the AIF’s compliance with regulations, private placement memorandum (PPM), other fund documents, and applicable laws.

SEBI’s Response to the Current Findings

In response to the current findings, the expert lawyers at Thinking Legal noted that SEBI has taken several measures to enhance transparency and accountability in the AIF industry. The market regulator has mandated AIFs to report both assets and liabilities via India’s share depositories starting at the end of this month, as per a circular issued in June.

Furthermore, SEBI is encouraging the industry to self-regulate and implement a code of conduct for its members.

Ananth Narayan, a whole time member of SEBI, recently addressed the issue at a conference in Mumbai, stating, "We have found various cases of AIF structures being used to circumvent other regulations. These cases do bother us even when we want the industry to grow."

This concern is echoed by Vaneesa Agrawal, founder of Thinking Legal, emphasizing the need for robust oversight.

The Need for Collaboration

As the AIF industry continues to attract billions of dollars from local and global high net-worth investors, it is imperative that all stakeholders — regulators, industry participants, and investors — collaborate to create a robust and transparent framework that promotes the healthy growth of the industry while preventing the misuse of AIFs for regulatory arbitrage or other malicious purposes.

Guided by Vaneesa Agrarwal, Thinking Legal believes that the recent investigations by SEBI and RBI serve as a wake-up call for the AIF industry. These investigations underscore the need for greater transparency, accountability, and self-regulation.

The misuse of AIFs to circumvent regulations is a serious issue that demands immediate attention from regulators, industry participants, and investors alike. The ongoing investigations by SEBI and RBI are a testament to the commitment of these regulatory bodies to maintain the integrity of the financial system and protect the interests of investors.

As the situation unfolds, Thinking Legal will continue to monitor developments and provide insights on this matter. It is crucial for all stakeholders to remain vigilant and proactive in addressing any instances of misuse or misconduct in the AIF industry.

For more information on this topic and other legal and regulatory developments in the financial sector, please visit the Thinking Legal blog hub.