Capital subject to “Caps”: RBI relaxes norms for investment by REs in AIFs, subject to threshold limits

-Sikha Bansal (finserv@vinodkothari.com)

Introduction

The RBI has issued Draft Reserve Bank of India (Investment in AIF) Directions, 2025 (‘Draft Directions’), vide Press Release dated 19th May, 2025, marking a significant revision to the existing regulatory framework governing investments by regulated entities (REs) in Alternative Investment Funds (AIFs). These new directions, once finalised, will replace the existing circulars dated December 19, 2023 (“2023 Circular”), and March 27, 2024 (“2024 Clarification”) (collectively, referred to as “Existing Directions”), which currently govern such investments.

The Existing Directions prohibit REs from making investments in any scheme of AIFs which has downstream investments either directly or indirectly in a debtor company of the RE. In case of any such investment full provision is required to be maintained by the RE. Such prohibition is imposed to address the concerns of evergreening while making investments by an RE. See our analytical article on the same here.

However, the Draft Directions now propose to allow investment by the RE in such AIF upto 5% of the corpus of the AIF scheme. Any investment exceeding this 5% limit will require full capital if AIF has made debt investments in the debtor company. Note that these norms are entirely directed towards debt or debt instruments (whether at the RE level or the AIF level), as all sorts of equity instruments (equity shares, compulsorily convertible preference shares and compulsorily convertible debentures) are excluded – detailed discussion follows.

Comparison of Existing and Draft Directions

Below is a snapshot of what is going to change once the Draft Directions are finalised and notified, and certain important implications are discussed further:

Illustrations on investment limits by RE

Below are certain illustrations to explain the implications of the investment thresholds under Draft Directions:

Certain points of discussion/implications

• Prospective applicability: The Draft Directions, once notified, will be applicable prospectively. It says, “These Directions shall come into force from the date of final issue (‘effective date’), substituting the existing circulars. Provided that, all outstanding investments as on the effective date, or subsequent drawdowns out of commitments made prior to the effective date, shall continue to be guided by the provisions of the existing circulars.” Therefore, no relaxations would be available to the existing investments/commitments by REs. If the same had not been liquidated so far – those will require to be liquidated. The Draft Directions will apply only to fresh investments by REs.

• Maximum cap on investments by RE in AIF: Under Existing Directions, there is a blanket prohibition on RE to invest in AIF scheme which has invested in a debtor company. However, if such downstream investment is in equity shares, such prohibition would not apply. As such RE could invest in the said AIF without any limits. However, now, even if the AIF has invested only in equity instruments of the debtor company (equity shares, CCPS and CCDs), RE can only invest upto 10% of the corpus of the AIF scheme. Hence, to that extent, the Draft Directions are more restrictive than the Existing Directions. Note that, SEBI Circular on specific due diligence with respect to investors and investments of the AIFs does not provide any carve out for equity investments.

• Exclusion of equity instruments (equity shares, CCDs and CCPS) from investment exposure of REs in the debtor company: Such exclusion is not explicitly there in the Existing Directions; which might have led to a possible interpretation that investment would include any nature of investment, including equity. Although, it was evident from the use of terminology that a debtor company would only mean a company where RE has extended only debt. The Draft Directions has clarified the same through explicit exclusion. Therefore, the directions will be applicable only where RE has investment in debt/debt instruments of the investee company.

• Investments in AIF through intermediary funds: Existing directions exclude investments by REs in AIFs through intermediaries such as fund of funds or mutual funds from the scope of the directions. However, Draft Directions are silent on the same. We are of the view that such exclusion should continue to apply – as funds such as mutual funds are required to be well-diversified in terms of the SEBI Regulations, and investment decisions are taken by an independent investment manager.

Closing Remarks

We had earlier indicated that the Existing Directions may need to be reviewed and softened. The Draft Directions take a step in the same direction – however, a few concerns may still remain open. For instance, the Draft Directions retain the outreach of these restrictions to all AIFs, and not only affiliated AIFs. In our previous article, we had discussed how the concerns as to evergreening, etc. would arise mostly in cases involving affiliated AIFs, and not those AIFs which are completely unrelated to the RE..Further, no distinction has been made between various categories of AIF – therefore, investments in any AIF (Cat I, II, III) would be governed by these directions.