RBI offers limited respite in AIF investment norms



In recent years, there has been a notable surge in the prominence of Alternative Investment Funds (AIFs) within the Indian investment domain. These funds have emerged as pivotal vehicles, providing investors with diversified avenues that extend beyond conventional investment instruments. However, the advent of this investing avenue has also attracted regulatory scrutiny, particularly concerning downstream investment in debtor companies. In an effort to address these concerns, the Reserve Bank of India (RBI) issued a notification dated December 19, 2023 regarding “Investments in Alternative Investment Funds (AIFs)[1] (the Initial Notification). It primarily aimed at regulating investment in AIFs by regulated entities[2] (REs) and directed the REs, inter alia, not to invest in AIF schemes that have direct or indirect downstream investments in a company to which an RE currently has, or has previously had, a loan or investment exposure at any time during the preceding 12 months (Debtor Company).

The Initial Notification, aimed at addressing concerns relating to possible evergreening, caused some concern across AIFs and REs as most of the larger REs have affiliated AIFs and the flow of funds to them from the REs would completely stop. RBI rationalized the compliance requirements and vide a notification dated March 27, 2024[3] (the Revised Notification) provided certain carve-outs and clarifications in the compliance requirements as stipulated under the Initial Notification.


Evergreening of loans essentially refers to structures through which REs invest in AIF units, and the proceeds of their investments are then invested by an AIF in the Debtor Company to repay the loans availed by the Debtor Company from the RE. In other words, it is a route that the REs use to steer away from any NPA classification, provisioning, and other applicable compliance requirements with respect to loans that are in default or expected to be in default while enabling the borrower to repay the loan without any decrease in their creditworthiness.

The issue of evergreening arises because of the adoption of priority distribution model (PD Models) by AIF schemes. PD Models refers to a waterfall distribution mechanism wherein one class of investors (other than sponsor/manager) shares losses more than their pro-rata holding in the fund as compared to another class of investors i.e., sponsor/manager, since the latter has a priority over former in the distribution of investment proceeds.[4] In an effort to address these concerns, the RBI issued the Initial Notification.


Through the Initial Notification, the RBI directed REs (a) not to invest in AIF schemes that have direct or indirect downstream investments in a Debtor Company; (b) Where an RE is already an investor in an AIF scheme, and the AIF subsequently makes a downstream investment in any such Debtor Company, it was directed to liquidate its investment in the AIF within 30 days of the date of the downstream investment. If an RE has already invested in an AIF scheme having such downstream investment in a Debtor Company as on the date of the Initial Notification, it must liquidate its investments within 30 days of the date of the Initial Notification. (c) in case where REs are unable to liquidate their investments in AIFs within the prescribed time limits, they were directed to make a 100% provision on such investments. Additionally, it was also stipulated that the investments by REs in the subordinated units of any AIF with a PD Model would be subject to full deduction from the RE’s capital funds.

While the Initial Notification addresses the potential evergreening structures, a blanket ban on investments in units of AIFs having downstream investments in Debtor Companies of REs could be counterproductive. Various representations were accordingly made to the RBI for rationalizing some of the provisions of the Initial Notification. The RBI then issued the Revised Notification which clarifies some of the provisions of the Initial Notification.


Notwithstanding the regulatory intent behind the Initial Notification, a complete prohibition on investments in AIFs with downstream investments in Debtor Companies implies a presumption that all such investments constitute evergreening, which indeed is not the case. Noting the feedback and representations from stakeholders, the RBI relaxed the initial stringent requirements and vide the Revised Notification, clarified some of the provisions of the Initial Notification. The Revised Notification stipulated:

  1. Clarification on Downstream Investment – To ensure consistency in investment practices across REs, all the equity-based downstream investments in Debtor Companies are excluded from the purview of the Initial Notification. Only investments in debt securities or hybrid instruments of portfolio companies would be within the remits of Initial Notification.
  2. Investments through Fund of Funds (FoF) and Mutual Funds – If investments are made in the AIF through intermediaries like FoF or mutual funds, it will remain exempted from the applicability of the Revised Notification.
  3. Provisioning Requirements: The Revised Notification mandates provisioning only to the extent of the RE’s investment in the AIF scheme, further invested in the Debtor Company. This provision aimed to align provisioning requirements with the actual risk exposure of REs, thereby reducing financial burdens.
  4. PD Models or Structured AIFs – The Revised Notification makes it clear that an RE’s investment in the subordinated units of any AIF scheme with a PD Model will only be fully deductible, if there are no non-equity investments in the AIF. The Revised Notification also made it clear that the deduction would come from both its Tier-I and Tier-II capital in equal amounts. On the other hand, the lender will have to sell or make provisions against any non-equity investments in the AIF.


The Revised Notification does appear to have provided some relief to the REs for provisioning and other compliance requirements, but some concerns remain. The Revised Notification clarified that equity-based instruments shall be excluded from the restrictions of downstream investment into Debtor Companies, thereby including all other types of investments (non-equity investments) as opposed to the industry’s expectation of excluding investments other than debt instruments, since the issues of evergreening should not arise in case of non-debt investment. There remains some ambiguity on the treatment of certain investments, particularly in relation to compulsory convertible instruments such as CCPS and CCDs. The industry is debating whether such investments need to be converted to equity to comply with the new regulations.

Further, one of the primary and overlooked concern is that not all REs, which have overlapping investments intend to engage in evergreening their portfolios by virtue of their investment in AIFs with non-equity investments. Some investments are independent and are not intended to circumvent any regulatory compliance. Ideally, liquidation or provisioning requirements should only be triggered in the presence of significant default risks or clear evidence of portfolio manipulation. In our view, the introduction of these additional compliance requirements and provisioning may cause REs to seek an excuse from any form of investments into Debtor Companies or consider complete withdrawal from AIF, thereby leading to notable shrinkage of the corpus of existing funds and may be highly detrimental to the other investors, the fund, and the AIF industry at large.


In terms of the SEBI (AIF) Regulations, 2012[5], AIF is defined as a privately pooled investment vehicle that collects funds from sophisticated investors, for investment in terms of a defined investment policy. AIFs inherently operate as blind pool vehicles wherein investment decisions are taken by the investment manager without the investors’ involvement and investment decisions are beyond the influence of any RE which could result in evergreening of non-performing assets. Thus, instead of a blanket restriction on REs to invest into AIFs, such restriction should only apply in an instance where it can be established that an investor is able to influence the investment decisions of the AIFs or where the REs holds majority ownership or control or a minimum of 50% of the AIF’s corpus.

[1]     DOR.STR.REC.58/21.04.048/2023-24.

[2]     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 Co-operative Banks; All All-India Financial Institutions; All Non-Banking Financial Companies (including Housing Finance Companies).

[3]     DOR.STR.REC.85/21.04.048/2023-24.

[4]     Paragraph 11.2 of the Master Circular for AIFs dated May 7, 2024.

[5]     Regulation 2(1)(b) of SEBI (AIF) Regulations, 2012.


This material is for general information only and is not intended to provide legal advice. This material is distributed with the understanding that the authors are not rendering legal, accounting, or other professional advice or opinions on specific facts or matters and, accordingly, assume no liability whatsoever in connection with its use.



Rohan Kumar (Partner)
Shivansh Soni (Associate)


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