Understanding the Governance & Compliance Framework for AIFs

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– Payal Agarwal, Partner | payal@vinodkothari.com

Alternative Investment Funds (AIFs) are private investment vehicles registered with and regulated by SEBI. Private investment vehicles, as is understood, are investment vehicles that pool investments from investors on a private basis, and make investments in investee entities based on the investment objectives disclosed to the investors. The returns from such investments, net of the expenses incurred by the vehicle, is distributed back to the investors. A typical AIF structure would look like:

The general obligations of AIFs are provided in the SEBI (Alternative Investment Funds) Regulations, 2012 read with the circulars issued from time to time. In addition to that, the Standard Setting Forum for AIFs (SFA) formulates implementation standards for various compliance requirements, as required by SEBI from time to time.

As may be understood, the AIF takes funds from its investors and makes investments in the investees. As between the sponsor/ manager of the Fund and the investors, there is a fiduciary relationship – since the investment decisions taken by the fund manager is on behalf of the investors, and in accordance with the investment objectives disclosed to the investors. Investor protection and transparency and proper due diligence of the investees become crucial in the context of an AIF. As compared to a traditional company, the AIFs are intermediaries between the investors and investees. This article discusses the various compliance requirements as applicable to AIFs.

Governance structure of AIFs

  • Governing body of AIF: Depending on the legal form of the AIF, the governing body of the AIF may compose of trustee (in case of a trust), directors (in case of a company) or designated partners (in case of an LLP).
  • Manager: The primary responsibility of ensuring compliance with the applicable provisions by an AIF is on the manager of the AIF. Similarly, ensuring compliance with the internal policies and procedures of an AIF is also the responsibility of the manager. The manager is appointed by an AIF, and the Sponsor may also be the manager of the Fund.
  • Investment Committee: Constituted by the manager, the Investment Committee approves the decisions of the AIF and is responsible for ensuring that such decisions are in compliance with the policies and procedures laid down by the AIF. The Investment Committee may be composed of internal members (employees, directors or partners of the Manager) as well as external investors (with the approval of the investors in the AIF/ Scheme). The external members may include ex-officio members who represent the sponsor, sponsor group, manager group or investors, in their official capacity. Pending clarification from RBI, currently non-resident Indian citizens are not permitted to act as an external member in the Investment Committee [Reg 20(7) of AIF Regulations read with Chapter 14 of AIF Master Circular].

The responsibilities of the Investment Committee may be waived by the investors (other than the Manager, Sponsor, and employees/ directors of Manager and AIF), if they have a commitment of at least Rs. 70 crores (USD 10 billion or other equivalent currency), by providing an undertaking to such effect, in the format as provided under Annexure 11 of the AIF Master Circular, including a confirmation that they have the independent ability and mechanism to carry out due diligence of the investments.

  • Key Management Personnel: Key Management Personnel (KMP) of the Manager has been defined to mean:
    • members of key investment team of the Manager, as disclosed in the PPM of the fund;
    • employees who are involved in decision making on behalf of the AIF, including but not limited to, members of senior management team at the level of Managing Director, Chief Executive Officer, Chief Investment Officer, Whole Time Directors, or such equivalent role or position;
    • any other person whom the AIF (through the Trustee, Board of Directors or Designated Partners, as the case may be) or Manager may declare as key management personnel. [Para 13.1.2. of the AIF Master Circular]

The responsibilities of the Manager are complied through the Key Management Personnel of such Manager.

  • Compliance Officer: The Compliance Officer is appointed by the Manager, and is responsible for monitoring of compliance with the applicable laws and requirements as applicable to the AIF. Compliance Officer, shall be an employee or director of the Manager, other than Chief Executive Officer of the Manager or such equivalent role or position depending on the legal structure of Manager [Para 13.1.1. of the AIF Master Circular].

The Compliance Officer is responsible to report any non-compliance observed by him within 7 days from the date of observing such non-compliance.

  • Custodian: The Sponsor/ Manager of the AIF is required to appoint a custodian, registered with SEBI, for safekeeping of the securities of the AIF. An associate[1] of the Sponsor/ Manager may also act as a custodian, subject to compliance with certain conditions[2]. The custodian provides periodic reports to SEBI with respect to the investments of AIFs that are under custody with the custodian in accordance with the standards formulated by SFA.

The various roles and responsibilities at the different levels of the governance structure is discussed below.

Code of Conduct for AIFs [Reg 20(1) of AIF Regulations]

The Code of Conduct, as prescribed under the AIF Regulations, puts forth various requirements applicable to the AIFs and other relevant entities. The Code of Conduct is applicable to various responsibility centers charged with the governance requirements in an AIF. The requirements are given in the Fourth Schedule to the AIF Regulations read with Para 13.3. of the AIF Master Circular.

The applicability to various stakeholders along with the requirements are given in the table below:

Person covered by the CoC Requirements to be adhered to under the CoC
AIF
  • Undertake business activities and investments in accordance with the investment objectives in the placement memorandum and other fund documents [to be ensured by the Manager]
  • Be operated in the interest of all investors, and not limited to select investors, sponsor, manager etc [to be ensured by the Manager]
  • Ensure timely and adequate dissemination of information to all investors
  • Ensure existence of effective risk management process and appropriate internal controls
  • Have written policies for mitigation of any potential conflict of interest
  • Prohibition on use of any unethical means to sell, market or induce any investor to buy its units
  • Have written policies and procedures to comply with anti-money laundering lawsnot offer any assured returns to any prospective investors/unitholders.
  • Manager of AIF
  • KMP of Manager
  • KMP of AIF
  • Abide by the laws applicable to AIFs at all times
  • Maintain integrity, highest ethical and professional standards in all its dealings
  • Ensure proper care and exercise due diligence and independent professional judgment in all its decisions
  • Act in a fiduciary capacity towards investors of AIF and ensure that decisions are taken in the interest of the investors
  • Abide by the policies of AIF in relation to potential conflict of interests
  • Not make any misleading or inaccurate statement, whether oral or written, either about their qualifications or capability to render investment management services or their achievements
  • Record in writing, the investment, divestment and other key decisions, together with appropriate justification for such decisions;
  • Provide appropriate and well considered inputs, which are not misleading, as required by the valuer to carry out appropriate valuation of the portfolio;
  • Prohibition on entering into arrangements for sale or purchase of securities, where there is no effective change in beneficial interest or where the transfer of beneficial interest is only between parties who are acting in concert or collusion, other than for bona fide and legally valid reasons;
  • Abide by confidentiality agreements with the investors and not make improper use of the details of personal investments and/or other information of investors;
  • Not offer or accept any inducement in connection with the affairs of or business of managing the funds of investors;
  • Document all relevant correspondence and understanding during a deal with counterparties as per the records of the AIF, if they have committed to the transactions on behalf of AIF
  • Maintain ethical standards of conduct and deal fairly and honestly with investee companies at all times; and
  • Maintain confidentiality of information received from investee companies and companies seeking investments from AIF, unless explicit confirmation is received that such information is not subject to any non-disclosure agreement.
  • Ensure availability of the PPM to the investors prior to providing commitment or making investment in the AIF and an acknowledgment be received from the investor
  • Ensure scheme-wise segregation of bank accounts and securities accountsnot offer any assured returns to any prospective investors/unitholders.
  • Members of Investment Committee
  • Trustee/ Trustee company
  • Directors of Trustee company
  • Directors of AIF
  • Designated Partners of AIF
  • Maintain integrity and the highest ethical and professional standards of conduct
  • Ensure proper care and exercise due diligence and independent professional judgment
  • Disclose details of any conflict of interest relating to any/all decisions in a timely manner to the Manager of the AIF, adhere with the policies and procedures of the AIF with respect to any conflict of interest and wherever necessary, recuse themselves from the decision making process;
  • Maintain confidentiality of information received regarding AIF, its investors and investee companies; unless explicit confirmation is received that such information is not subject to any non-disclosure agreement.
  • Not indulge in any unethical practice or professional misconduct or any act, whether by omission or commission, which tantamount to gross negligence or fraud
  • Not offer any assured returns to any prospective investors/unitholders.
Compliance with Stewardship Code

The AIFs, being institutional investors, it is mandatory for AIFs to comply with the Stewardship Code in terms of Para 13.4 of the AIF Master Circular. This is applicable in respect of investments in listed equity instruments. Annexure 10 of the Master Circular specifies the broad principles of stewardship and provides guidance for its implementation. Further, the AIFs are required to report the status of implementation of the principles atleast on an annual basis (periodicity may differ for different principles), through the website of the AIFs. Such report may also be sent as a part of annual intimation to its clients/ beneficiaries. An article on the stewardship responsibilities of institutional investors may be read here.

Policies to be formulated by AIFs

In order to ensure that the decisions of the AIF are taken in compliance with all applicable laws and regulations, PPM, investor agreements and other fund documents, detailed policies and procedures are required to be kept in place in terms of Reg 20(3). The policies are jointly approved by:

  • Manager and
  • Relevant governing body of the AIF (viz., the trustee/ trustee company/ board of directors/ designated partners etc)

The Manager is required to ensure that the decisions taken by the AIF are in compliance with such policies and procedures.

Further, the policies should be reviewed periodically, on a regular basis and whenever required as a result of business developments, to ensure their continued appropriateness.

Audit

Annual Audit of terms of PPM

The AIF is required to file Private Placement Memorandum (PPM) with SEBI through a Merchant Banker for the launch of Schemes. The format of PPM is specified under Annexure 1 read with the requirements specified under various other circulars from time to time. In order to ensure that the activities of the AIF are in compliance with the terms of PPM, annual audit of the terms of PPM is required to be done. In this regard, the following needs to be noted:

  • Scope of audit: Compliance with all sections of the PPM. Further, audit of the following sections is optional, viz., ‘Risk Factors’, ‘Legal, Regulatory and Tax Considerations’ and ‘Track Record of First Time Managers’. The format of PPM audit report may be accessed here.
  • Eligibility to conduct audit: an internal or external auditor/legal professional
  • Periodicity of PPM audit: Annual
  • Timeline: within 6 months from the end of the Financial Year
  • Reported to: Governing Body (Trustee or Board of Directors or Designated Partners) of the AIF, Board of directors or Designated Partners of the Manager and SEBI
  • Non-applicability: if no funds are raised from investors, subject to submission of a certificate from CA to that effect within 6 months from end of FY
  • Exemptions: (i) Angel Funds, (ii) AIFs/ Schemes with each investor having a minimum commitment of Rs. 70 crores (USD 10 mn or equivalent), upon providing a waiver for the same. 
Audit of accounts

Reg 20(14) of the AIF Regulations require the books of account to be audited by a qualified auditor annually.

Valuation of Investments of AIF

Reg 23 read with Chapter 22 of the AIF Master Circular specifies the requirements with respect to the valuation of the investments of AIF. The valuation is required to be done by an independent valuer, on a half-yearly basis (may be made an annual requirement subject to consent of 75% of investors in value).

Eligibility criteria have been specified for acting as an independent valuer:

  • shall not be an associate of manager or sponsor or trustee of the AIF
  • shall have at least three years of experience in valuation of unlisted securities
  • shall be a registered valuer with IBBI and a member of ICAI, ICSI or ICMAI or shall be a holding or subsidiary of SEBI-registered CRA

The Manager shall specifically inform the investors, the reasons/ factors for deviation in valuation, in case the deviation is more than:

  • 20% between two consecutive valuations, or
  • 33% in a financial year

In case of Cat III AIFs, the listed and unlisted debt securities are required to be valued by an independent valuer, and the NAV is required to be reported on a quarterly basis for close ended funds, and monthly basis for open ended funds.

Investor complaints and Grievance Redressal Mechanism

Resolution of investor complaints is a role of the Manager of AIF [Reg 24 of AIF Regulations]. Reg 24A requires the Manager to redress investor grievances in a prompt manner, but within a maximum of 21 days from receipt of grievances. The AIF is required to be registered on the SCORES portal for receipt of investor grievances. Further, in terms of Reg 25, the dispute resolution mechanism provided by SEBI (SMARTODR) is applicable to AIFs as well. Refer details under Master Circular for Online Resolution of Disputes in the Indian Securities Market dated 28th December, 2023.

Further, in terms of Para 17.4 of the AIF Master Circular, the AIFs are required to maintain data on investor complaints received against the AIF/ its Schemes on a quarterly basis within 7 days from the end of the quarter, in addition to the disclosure in the PPM. The data includes the following:

S. No. Investor Complaints received from Pending as at the end of the last quarter Received Resolved Total Pending at the end of the quarter Pending complaints > 3months Average Resolution time ^ (in days )
1 Directly from Investors            
2 SEBI (SCORES)            
3 Other Sources            

Matters requiring consent of investors of AIF

The AIFs act in a fiduciary capacity towards the investors, and manage the funds of the investors invested in the AIF. Thus, the decisions of AIF are required to be taken in the interests of the investors. Some matters require approval of the investors of a specified majority, prior to undertaking such activity:

Regulatory reference Matter requiring approval Requisite majority in terms of value of investment 
Reg 9(2) Material alteration to fund strategy 2/3rd of unitholders
Reg 13(5) Extension of tenure of close-ended funds (upto 2 years) 2/3rd of unitholders
Reg 15(1)(e) Investment in associates or units of AIFs managed/ sponsored by its Manager, Sponsor or associates of its Manager or Sponsor 75% of investors
Reg 15(1)(ea) Purchase or sale of investments from/ to: Associates Schemes of AIF managed or sponsored by its Manager, Sponsor or associates of its Manager or Sponsoran investor who has committed to invest at least fifty percent of the corpus of the scheme of AIF 75% of investors, excluding investor covered under (c) where purchase/ sale is from such investor
Reg 20(10) Appointment of external members (other than ex-officio members) in Investment Committee other than as disclosed in the fund documents 75% of investors
Reg 23(2) Reducing frequency of valuation of investments from six months to 1 year 75% of investors
Reg 29(9) In-specie distribution of investments of AIF due to lack of liquidity or enter into liquidation period 75% of investors

Disclosure to investors

The funds of the investors invested in the AIF are managed by the Manager and Sponsor in a fiduciary capacity. In order to ensure transparency, various disclosure requirements apply in terms of Reg 22 of the AIF Regulations – either on a periodic basis or upon the happening of certain events.

Periodic disclosures

The periodic disclosures include:

  • financial, risk management, operational, portfolio, and transactional information regarding fund investments
  • any fees ascribed to the Manager or Sponsor; and any fees charged to the AIF or any investee company by an associate of the Manager or Sponsor

Further, in terms of clause (g) of Reg 22, the following information is required to be disclosed within 180 days from the year end (60 days from the end of each quarter for Cat III AIF):

  • financial information of investee companies.
  • material risks and how they are managed which may include:
    • concentration risk at fund level;
    • foreign exchange risk at fund level;
    • leverage risk at fund and investee company levels;
    • realization risk (i.e. change in exit environment) at fund and investee company levels;
    • strategy risk (i.e. change in or divergence from business strategy) at investee company level;
    • reputation risk at investee company level;
    • extra-financial risks, including environmental, social and corporate governance risks, at fund and investee company level.

Any changes in terms of PPM or other fund documents are required to be intimated to the investors on a consolidated basis within 1 month from the end of each financial year [Para 2.5.3. of AIF Master Circular]

Event-based disclosures

These events are required to be disclosed ‘as and when occurred’:

  • any inquiries/ legal actions by legal or regulatory bodies in any jurisdiction
  • any material liability arising during the AIF’s tenure
  • any breach of a provision of the placement memorandum or agreement made with the investor or any other fund documents
  • change in control of the Sponsor or Manager or Investee Company
  • any significant change in the key investment team

Matters requiring reporting to SEBI

Reg 28 provides power to SEBI to seek such information from the AIFs, as may be required, from time to time. In addition to such powers, there are various specific reporting requirements that are applicable on AIFs under various applicable provisions. These include:

Regulatory reference Matters requiring reporting to SEBI Timelines
Reg 20(12) Any material change from the information provided at the time of application Promptly
Reg 26 Information for systemic risk purposes (including the identification, analysis and mitigation of systemic risks) when so required by SEBI
Para 2.5.2 Any changes in the terms of PPM and other fund documents, along with DD certificate from Merchant Banker  within 1 month from the end of FY
Para 15.1 Reporting on investment activities of AIF in the format specified by SFA 15 calendar days from end of each quarter
Para 15.2 Any violations reported in the Compliance Test Report (refer detailed discussion below) As soon as possible
Reg 20(11) r/w Para 15.4. Investments of AIF that are in custody of the custodian Quarterly

Compliance with provisions applicable to SEBI-registered intermediaries

An AIF, in its capacity of a SEBI-registered intermediary, is required to comply with the SEBI (Intermediaries) Regulations, 2008 read with the circulars issued thereunder. These include, for instance, compliance with the circulars/guidelines as may be issued by SEBI with respect to KYC requirements, Anti-Money Laundering and Outsourcing of activities [Para 13.5 of AIF Master Circular].

The guidelines with respect to anti-money laundering and KYC requirements are contained in a Master Circular dated 6th June, 2024 on the subject. Our various resources on KYC and anti-money laundering can be accessed here.

Compliance Test Report

The manager of AIF is required to report the compliances with various applicable provisions of the AIF Regulations read with the circulars made thereunder, on an annual basis. CTR is submitted within 30 days from the end of the financial year, to the sponsor and trustee (in case AIF is set up as a trust). The trustee/ sponsor provides their comments on the CTR to the manager within 30 days from the receipt of CTR, based on which the manager shall make necessary changes and provide a response within the next 15 days. 

A significant aspect of the CTR is that any violation observed by the trustee/ sponsor is required to be intimated to SEBI, as soon as possible. This requirement is in addition to the obligation of the Compliance Officer to report a non-compliance, within 7 days of becoming aware of the same. The format of CTR is provided in Annexure 12 of the AIF Master Circular.

Other compliances

SEBI specifies various compliances applicable to the AIFs from time to time. The compliances as applicable to the AIFs for the first time during FY 25-26 has been dealt with in our article Regulatory landscape for AIFs: what’s new? Further, there are certain requirements applicable on special categories of AIFs, viz., angel funds, Special Situation Funds, Social Venture Funds etc. Further, there are various prudential requirements applicable to receipt of funds from investors and making of investments by the AIFs.

See our other resources on AIFs:

[1] Associate means:

  • a company or a limited liability partnership or a body corporate
  • in which a director or trustee or partner or Sponsor or Manager of the Alternative Investment Fund or a director or partner of the Manager or Sponsor
  • holds, either individually or collectively, more than fifteen percent of its paid-up equity share capital or partnership interest, as the case may be

[2] The conditions include:

(a) Minimum net worth of the Sponsor or Manager of at least twenty thousand crore rupees at all points of time;

(b) fifty per cent or more of the directors of the Custodian do not represent the interest of the Sponsor or Manager or their associates;

(c) the Custodian and the Sponsor or Manager of AIF are not subsidiaries of each other;

(d) the custodian and the Sponsor or Manager of AIF do not have common directors; and

(e) the Custodian and the Manager of AIF sign an undertaking that they shall act independently of each other in their dealings of the schemes of AIF.

From Rooftops to Ratings: India’s Green Securitisation Debut

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– Payal Agarwal, Partner | finserv@vinodkothari.com

Probably the first in India, green securitisation has finally found an entry with the recent issuance of pass-through certificates backed by residential rooftop solar loan receivables in India. The loans were originated by a ‘green-only’ NBFC focussed on climate-positive lending. The present issuance is in the form of green collateral securitisation – since the securitised receivables qualify as ‘green’. Further, given the activities of the originator, it seems that the same may qualify to be a green capital securitisation, with the freed capital of the originator being utilised towards creation of green assets. 

Notably, as per a recent publication of Climate Policy Initiative, the Global Landscape of Climate Finance 2025, India has been ranked as the leading country in the South Asia region in terms of mobilisation of climate finance (as per the data for 2023). Green securitisation may act as a catalyst to the growth of green finance in India. See a whitepaper on the same here.

A broader concept in the context of climate finance is sustainable securitisation, our whitepaper on the same can be accessed here. The recent guidelines of SEBI also permits the issuance and listing of sustainable securitised debt instruments, based on the recommendations of the Working Group constituted for the review of SEBI (Issue and Listing of Securitised Debt Instruments and Security Receipts)  Regulations, 2008, chaired by Mr. Vinod Kothari. An article on the concept of sustainable SDIs may be accessed here.

Our various resources on sustainability finance is available at – https://vinodkothari.com/resources-on-sustainability-finance/

Our various resources on securitisation is available at – https://vinodkothari.com/2025/01/securitisation-resource-centre/ 

Master Direction on ETPs: Key Changes & Compliance Guide

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Harshita Malik, Executive | finserv@vinodkothari.com

Background and Overview:

The evolution of Electronic Trading Platform (‘ETPs’) is rooted in the market’s need for speed, efficiency, and enhanced transparency in dissemination of  trade information. Traditional floor based trading methods struggled with sluggish processes, limited data dissemination, and inefficiencies that couldn’t pace with a global financial landscape. In response, industry players and regulators recognised the need for a digital overhaul, a system that could streamline trade execution, provide real-time market data, and foster a more accurate price discovery mechanism. This led to the emergence of specialised platforms, such as those designed for government securities trading, where primary dealers are entrusted with membership and operations. One such platform is ETP. 

An ETP is a computarised system that facilitates the buying, selling and management of a wide range of financial instruments (listed down below). These platforms enable real-time market data dissemination, order execution, and efficient trade processing. For instance, in India, platforms such as the NDS-OM (Negotiated Dealing System – Order Matching) are well-known examples that specialize in government securities (g-sec) trading. Other entities include various bank-operated ETPs such as BARX operated by Barclays Investment Bank (international) and proprietary systems developed by financial institutions such as 360TGTX operated by Three Sixty Trading Networks (India) Pvt. Ltd. 

On June 16, 2025, the RBI issued Master Direction – Reserve Bank of India (Electronic Trading Platforms) Directions, 2025 (‘New ETP Directions’) in supersession of the Electronic Trading Platforms (Reserve Bank) Directions, 2018 dated October 05, 2018 (‘Erstwhile ETP Directions’). This was based on the feedback received on the Draft Directions issued  on April 29, 2024. 

Applivability:

  • Entities operating ETPs facilitating transactions in eligible instruments,under the New ETP Directions,
  • Grandfathering clause:
    • Any entity already authorised under the Erstwhile ETP Directions shall deemed to have been authorised under the New ETP Directions, or
    • any action already taken under the Erstwhile ETP Directions “shall be deemed to have been taken” under the New ETP Directions. 

In practical terms, operators need not re-submit applications, seek fresh authorisations or revisit past actions as long as compliant under the Erstwhile ETP Directions.

Effective Date:

Effective immediately i.e. from June 16, 2025.

All about Electronic Trading Platforms (‘ETPs’)

Before going ahead to analyse the changes let us understand what ETPs are. ETPs are electronic systems, other than recognised stock exchanges, on which transactions in eligible instruments are contracted. But why would someone prefer trading on ETP rather than other exchanges/ platforms such as stock exchanges? ETPs offer eligible entities multi-instrument trading platforms (dealing with money-market, G-Secs, FX, swaps etc.) with tailored tenures and faster settlement process while stock exchanges cater to listed equities and futures with standardised contracts, retail participation and fixed trading hours.

Who operates these electronic systems?

Any entity as defined in the New ETP Directions incorporated in the form of a company and authorised by the RBI in this regard can operate an ETP. Currently, there are 12 authorised ETP operators under the Erstwhile ETP Directions who shall continue to operate under the New ETP Directions.

Types of ETP: Single Dealer Platform v. Multi-Dealer Platform

BasisSingle Dealer PlatformMulti-Dealer Platform
SellerA single bank or financial institutionSeveral banks and financial institutions
PricingTailored pricing from one provider.Competitive pricing with options from several liquidity providers.
LiquidityLowHigh
Liquidity sourceProvided by a single bank or institution.Aggregated liquidity from multiple banks/institutions.
CustomisationTailored interfaces and services designed for specific clients.More standardized interfaces across multiple dealers; less tailored.
Execution qualityStable and consistent execution within one controlled environmentBest execution can be sought across multiple quotes and providers
SuitabilityClients who value a close banking relationship and prefer a dedicated, controlled trading environment Clients who want to compare and execute trades across a range of prices and liquidity providers
ExampleNDS-OM, operated by Clearcorp Dealing Systems (India) Ltd., provides a secondary market platform for government securities owned by RBI360TGTX, operated by Three Sixty Trading Networks (India) Pvt. Ltd., provides a platform for trading in FX Spot, Forwards, Swaps and Options

Players on ETP

  1. Primary Dealers- In 1995, the RBI introduced the system of PDs in the Government Securities (G-Sec) Market. The objectives of the PD system are to strengthen the infrastructure in G-Sec market, development of underwriting and market making capabilities for G-Sec, improve secondary market trading system and to make PDs an effective conduit for open market operations (OMO).

The RBI currently extends various facilities to the PDs to enable them to fulfill their obligations, including memberships of electronic dealing, trading and settlement systems (NDS platforms/INFINET/RTGS/CCIL).

PDs are classified as below:

  1. Standalone Primary Dealers- NBFC-ML
  2. Bank Primary Dealers- Scheduled Commercial Banks and Central Banks- National and International
BasisStandalone Primary DealerBank Primary Dealers
Entity StructureOperate as independent legal entities, often registered as NBFCs or as dedicated subsidiaries/joint ventures.Operate as a departmental function within a scheduled commercial bank (or its branch, including foreign banks).
Regulatory FrameworkRBI guidelinesRBI Guidelines and bank specific norms
Business focusPrimarily focused on government securities trading and related activities, often with more flexibility to diversify (e.g., underwriting, trading derivatives).The primary dealer function is one element of a larger suite of banking services and is more integrated with the bank’s overall operations.
Operational IndependenceGreater operational autonomy, being solely focused on the government securities marketFunctions as an integral part of the bank’s operations, with decisions influenced by the broader business strategy of the bank
PDs registered with RBISBI DFHI LimitedBank of Baroda, Bank of America
  1. Traders

Analysis of Change

Having understood the nomenclature, we may proceed to analyse the changes and what they mean for Regulated Entities. The primary change and intent of the Draft Directions was to curb unregulated entities and platforms, specifically offshore platforms dealing with foreign exchange trading involving inshore/ domestic investors. Please note that foreign exchange instruments have been a part of eligible instruments, however, due to not being defined, the question whether such offshore ETPs would be covered, was always a question. The Draft Directions recommended certain changes, however, the major change was bringing offshore ETPs under the domain of RBI. However, the finalised New ETP Directions do not deal with this aspect.  

While the RBI largely accepted the foundational architecture proposed in the draft, it has revised certain provisions to provide clarity in many areas, especially around risk and operational aspects which are now expressed in more precise terms along with addition of new provisions around enforcement and transitional mechanisms.

Highlights of Major Changes: 

  • Expanded applicability to include outsourcing entities under the purview of the New ETP Directions in essence
  • Carve out to single dealer banks and Standalone Primary Dealer (‘SPD’)
  • Transition to an electronic application process: Moving away from physical submission, the application process is now streamlined through the PRAVAAH portal
  • Quarterly and annual reporting requirements for the operators introduced mandating regular updates thereby tightening regulatory oversight
  •  Framework for data preservation and sharing post-authorisation 

Comparison at a Glance:

AreaErstwhile ETP DirectionsNew ETP DirectionsImplications
Application process for authorisationPhysical submissionThrough PRAVAAH Portal of RBIStreamlining the process, enhancing accessibility, efficiency, and real-time tracking for applicants as well as regulators 
Quarterly reportingNo such requirementQuarterly reporting on functioning of ETPs by Operators (details covered below)Operators to provide periodic updates on operational performance, ensuring regulatory oversight
Annual ReportingNo such requirementAnnual reporting on compliance of the New ETP Directions and terms and conditions prescribed (details covered below)Operators to yearly confirm their adherence to updated regulatory guidelines and contractual conditions
Eligibility CriteriaDid not apply to ETPs operated by SCBs Apply to all the entities including SCBs operated ETPs (except exemption covered below)Banks must now play by the same rulebook as other operators, additionally Public Sector Banks shall have to  incorporate (or spin off) a Companies Act vehicle, infuse requisite capital and adhere to technological standards.
Until now, Public Sector Banks that operate an ETP slipped neatly around the RBI’s “company‐only” eligibility gate. The New ETP Direction takes away that privilege. From the day the change takes effect, every ETP, bank-owned or not must meet the same bar
Preservation, access and use of dataDid not have a provision for treatment of data in the event of cancellation of authorisationSpecifies the requirement to share data, along with form and manner, with the RBI or any agency in the event of cancellation of authorisation as may be called upon by the RBI or any other agency.Enhanced regulatory oversight and post-termination accountability on operators
Definition of ‘Entity’“….an agency formed as a ‘company’ and incorporated under the Companies Act, 2013 (or earlier acts)”“….any person, natural or legal.”Language of the New ETP Directions seems to widen the scope of entity, however reading the impact along with para 6(f)(iii), it only brings the outsourcing entities under the widened scope
Grandfathering RuleNot needed (first issue)All licenses/actions under Erstwhile ETP Directions shall be treated as validNo fresh registration required
ExemptionETPs operated by banks for their customer on a bilateral basis as long as no market is being created for the securitiesCarve out to SCBs (including branches of Foreign Banks operating in India) and SPDs wherein the bank or the SPD operating the electronic system is the sole quote/price provider and a party to all transactions contracted on the system.Banks and SPDs can operate proprietary trading platforms without the full weight of the standard compliance requirements set for multi-dealer platforms. This can streamline their internal processes and reduce regulatory and technological burdens.Acting as the sole quote provider makes these institutions both the operator and counterparty. This can improve execution speed and reduce inter-dealer friction.A single market maker model may lead to faster execution but can constrain competitive pricing, potentially resulting in wider spreads if the operator does not face rival pricing pressures from other dealers.While banks and SPDs gain efficiency due to lesser compliances, they must remain vigilant about disclosure and transparency requirements to avoid any adverse effects on market integrity.Banks and SPDs may develop more tailored platforms, exclusive systems to capture niche market segments.Synchronization with global norms that treat single-dealer platforms as an extension of the dealer’s book and not that of an exchange.

Reporting Requirements:

These new requirements shall have to be complied with along with the existing reporting requirements under the Erswhile ETP Directions from the effective date of the New ETP Directions. Accordingly, the first quarterly report shall be required to be submitted on or before 15th July, 2025 and the annual report shall be submitted on or before 30th April, 2026. The manner of reporting by ETP operators as per the New ETP Directions has been listed below:

Reporting RequirementReporting AuthorityFrequencyFormatTimeline
NewFunctioning of the platform, including but not limited to the following points:Events resulting in disruption of activities, during the quarter, if anyInstances of market abuse, during the quarter, if anyDetails about any material change in trading procedure or technology carried out during the quarterRBIQuarterlyAnnex-2 of the New ETP DirectionsOn or before 15th day of the month following the quarter
Compliance with the New ETP Directions and terms and conditions prescribed at the time of authorisationRBIAnnuallyNot specifiedon or before the 30th of April of the succeeding financial year
Data relating to activities on the ETPRBIPost cancellation of authorisationAs may be prescribedAs may be prescribed
ExistingTransaction informationTrade repository or trading platformAs may be prescribedAs may be prescribedAs may be prescribed
Other report, data and/or information as required by RBIRBIAs may be prescribedAs may be prescribedAs may be prescribed
Data/informationAny agency as required by Indian LawsNot specifiedNot specifiedNot specified
Event resulting in disruption of activities or market abuseRBIEvent-basedNot specifiedNot specified

Conclusion:

By introducing defined protocols for risk management, data governance and reporting, the updated framework seeks to close existing regulatory gaps. Key provisions of the New ETP Directions include, amongst others, a clear exemption for single–dealer platforms and a streamlined application process via the PRAVAAH portal. These measures ensure legal continuity. Ultimately, this transformative framework not only reinforces the integrity of the trading ecosystem but also cultivates an environment conducive to innovation.

Regulatory landscape for AIFs: what’s new?

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– Payal Agarwal, Partner | corplaw@vinodkothari.com

Alternative Investment Funds (AIFs) have come up as a regulators’ favourite in the recent years with both SEBI and RBI tightening regulatory controls around the same within their respective domains. The use of AIF as regulatory arbitrage in recent years calls for such strict regulatory boundaries.  The growth of AIFs appears quite decent, with statistics showing a cumulative investment of  Rs. 5.38 lac crores made by AIFs, against Rs. 5.63 lac crores of funds raised (as on 31st March, 2025). Compared to the market size as at the end of 31st March, 2023, the market has grown by more than 50% as at the end of 31st March, 2025. Category II AIFs occupy the highest share, with Category III AIFs following suit. As the market size increases, so does the regulatory supervision.

This article deals with the regulatory requirements for AIFs that find their first-time mandatory applicability during FY 25-26, and would form a part of the Compliance Test Report (CTR) to be issued for FY 25-26 (see later part of this article).

Certification requirements for key investment team of Manager of AIF

Vide a 2023 amendment, the active schemes of AIFs as on 13th May, 2024 and those launched on or after 10th May, 2024 are required to have at least one key personnel in the key investment team of its Manager, with relevant certification as specified by SEBI. The NISM certification requirement, prescribed on 13th May, 2024, as extended, is required to be complied latest by 31st July, 2025.

Holding investments in dematerialised form

AIFs have been mandated to hold investments in dematerialised form, subject to certain relaxations. The timelines, as extended vide circular dated 14th February, 2025, attract dematerialisation requirements as below:

Date of investment by AIFApplicability of dematerialisationInapplicability of dematerialisationDematerialisation to be ensured by
On or after 1st July, 2025MandatoryScheme of an AIF whose: Tenure ends on or before 31st October, 2025  orExtended tenure as on 14th February, 2025Immediately
Prior to 1st July, 2025Not applicable, except: If investee company is mandated under applicable law to facilitate dematerialisation (for e.g. – CA, 2013 requires mandatory dematerialisation of shares except in case of small company or WoS of public company etc)AIF exercises control over the investee company, either on its own or along with other SEBI regd. intermediaries mandated to hold investments in demat formOn or before 31st October, 2025

Due diligence of investors and investments of AIF

An April 2024 amendment to the AIF Regulations, followed by a circular dated 8th October, 2024 read with the Implementation Standards formulated by the Standard Setting Forum for AIFs (‘SFA’)  requires an AIF to carry out various due diligence checks through its Manager and its Key Management Personnel (KMP) with respect to investors and investments of the AIF, to prevent facilitation of circumvention of the specified regulatory frameworks. The scope and requirements for the due diligence has been detailed in our article and further elaborated in the form of FAQs (read here).

In addition to the ongoing due diligence requirements, a one-time due diligence was required for existing investments as on the date of the Circular (8th October, 2024), the report of which was required to be submitted to the custodian on or before 7th April, 2025.

Cybersecurity and Cyber Resilience Framework (CSCRF)

The Cybersecurity and Cyber Resilience Framework (CSCRF), notified vide the circular dated 20th August, 2024 as revised vide the circular dated 30th April, 2025, categorises AIFs based on the AUM at manager level. Accordingly, the following categorisation follows:

Corpus of all AIFs, VCFs and their schemes managed by a managerCategorisation under CSCRF
> Rs. 10000 croresMid-size REs
3000 crores < AUM < 10000 croresSmall-size REs
< Rs. 3000 croresSelf-certification REs

The classification w.r.t. Qualified REs (the topmost categorisation) does not apply in case of AIFs.

The timeline for compliance with the requirements as per the CSCRF is 30th June, 2025 (as extended by the circular dated 28th March, 2025) based on which cyber audit is to be conducted from FY 25-26 and the report shall be submitted to SEBI.

Consequence of non-compliance: negative reporting in Compliance Test Report

The manager of AIF is required to report the compliances with various applicable provisions of the AIF Regulations read with the circulars made thereunder, on an annual basis. CTR is submitted within 30 days from the end of the financial year, to the sponsor and trustee (in case AIF is set up as a trust). The trustee/ sponsor provides their comments on the CTR to the manager within 30 days from the receipt of CTR, based on which the manager shall make necessary changes and provide a response within the next 15 days.

A significant aspect of the CTR is that any violation observed by the trustee/ sponsor is required to be intimated to SEBI, as soon as possible.

The format of CTR is provided in Annexure 12 of the Master Circular for Alternative Investment Funds (AIFs) dated 7th May, 2024.

What to expect going forward?

RBI, through a series of circulars (dated 19th December 2023 and 27th March 2024 respectively), regulates the investments made by the RBI-regulated entities in AIFs, putting a prohibition on the regulated entities from making investments in any scheme of AIFs which has downstream investments either directly or indirectly in a debtor company of such an entity. Draft Directions have been issued recently, proposing to permit investments by RBI-regulated entities upto a certain percentage of the corpus of the AIF scheme. Read more about the same here. Once notified, the same would relax the investment norms for RBI regulated entities in AIFs.

Further, SEBI has, in its meeting held on 18th June 2025, approved certain amendments for AIFs, particularly for angel funds. This aims to strengthen the regulatory regime around investments by angel funds considering the abolishment of angel tax in India, while also relaxing certain investment norms by such angel funds. Further, SEBI has approved co-investment schemes that may be offered by Cat I and Cat II AIFs, facilitating co-investment to accredited investors of a particular scheme of an AIF, in unlisted securities of an investee company  where  the  scheme  of  the  AIF  is  making  investment  or  has invested. The AIF Regulations presently permits co-investments through a co-investment portfolio manager. 

Thus, the approach of regulators seems to be gradually softening, attempting to bring a balance between regulatory supervision and ease of business considerations.

SEBI approves a mix of reforms for regulated entities

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– Easing ESOPs for IPO-bound companies, relaxations to SEBI regd. intermediaries, providing clarity for uniformity of practices  

– Team Corplaw | corplaw@vinodkothari.com

Various proposals have been approved by SEBI in its Board meeting dated June 18, 2025, pertaining to various relevant regulations. The approved changes may impact various market participants – listed entities as well as IPO-bound companies, SEBI registered intermediaries and regulated entities such as REITs, Invits, AIFs, FPIs, etc. We briefly discuss some of the important proposals as approved by SEBI. 

Relief for promoters in IPO-bound companies: easing rules on ESOPs and offer for sale 

  • Relaxation in eligibility norms with respect to Offer for Sale (OFS) in IPO (see Consultation Paper here)
    • Exemption from minimum holding period of 1 year extended to equity shares arising from conversion of Compulsory Convertible Securities (CCS), where such CCS were acquired pursuant to an approved scheme (earlier limited to equity shares) to assist in reverse flipping (i.e. shifting the country of incorporation from a foreign jurisdiction to India) [Reg 8 & 105 of ICDR Regulations].
  • Enabling Minimum Promoter Contribution (MPC) by Relevant Persons (apart from promoter) through equity shares arising from conversion of fully paid-up CCS  
    • Relevant Persons comprise of AIFs, FVCIs, Scheduled Commercial Banks, PFIs, insurance cos etc.
  • Founders-turned-promoters can retain share based benefits, ESOPs granted 1 year prior to filing of DRHP (see Consultation Paper here)
    • Brings relaxation for treatment of options granted prior to becoming a promoter, which was otherwise required to be liquidated

Dematerialisation of shares: pre-IPO and post-listing requirements 

  • Mandatory dematerialization of securities held by critical pre-IPO shareholders before filing of DRHP (see Consultation Paper here):
    • Following categories covered:
      • Promoter Group
      • KMPs
      • Directors
      • Employees
      • Selling Shareholders
      • QIBs
      • Senior Management
      • Financial sector entities 
    • To reduce volume of physical shares 
    • CA, 2013 also requires mandatory dematerialisation of holding of promoters, directors and KMP of companies prior to undertaking any share based corporate action [Rule 9A and 9B of Companies (Prospectus and Allotment of Securities) Rules]
  • Corporate actions by listed entities in dematerialised form only
    • For shares to be issued pursuant to consolidation/split of face value of  securities  and  scheme  of  arrangements
      • CA, 2013 already requires companies to issue shares in dematerialised form only

Fund raising mandatory for social enterprises registered with SSE, relaxations in eligibility conditions for registration 

  • Mandatory fund raising through SSE 
    • Registration to lapse if social enterprise registered with SSE does not raise funds within 2 years from registration
  • Definition of “Not for Profit Organization” expanded [Reg 292A(e) of ICDR]
    • Trusts registered under Indian Registration Act, 1908 permitted (extant regulations refer to Indian Trusts Act, 1882 and a trust registered under the public trust statute of the relevant state) 
    • Charitable society registered under relevant state Act (extant regulations covered only society registered under the Societies Registration Act, 1860)
    • Companies registered under Section 25 of the erstwhile Companies Act, 1956 (clarity provided since extant regulation refers to section 8 of 2013 Act) 
  • List of eligible activities expanded to align with Schedule VII of the Act, 2013 (pertaining to CSR activities)
  • Criteria of 67% of total activities reflecting in eligible activities (through revenues, expenditure or total customer base) relaxed
    • To be applicable only to “for profit social enterprises” 
  • Annual disclosures bifurcated into financial and non-financial disclosures
    • Different timelines to be prescribed for such disclosures 
    • CP prescribes the extant 60 days’ period for non-financial disclosures, and upto 31st October after end of FY for financial disclosures 
  • Self-reporting of Annual Impact Report instead of certification from Social Impact Assessor
    • For social enterprise that has not raised funds through the SSE 
  • Change in nomenclature of “Social Impact Assessment Firm” to “Social Impact Assessment Organization”(SIAO) and eligibility conditions for the SIAO prescribed 
    • SIAO to is permitted to conduct social impact assessment provided they have at least two social impact assessors in full time employment 
    • Having an and such impact assessors have experience of at least 3 years of conducting social impact assessment.
    • Social impact assessor to sign the report if SIAO does not have 3 years’ track record 

Revamping of regulatory framework for Angel Funds under AIF Regulations 

[refer SEBI consultation paper dated November 13, 2024 and February 21, 2025]

  • Mandatory registration of Angel Investors as Accredited Investors(AI)  
    • Attracts independent verification of investor status
    • Grandfathering of earlier investments as non AI, and implementation through glide path 
  • Accredited Investors included as Qualified Institutional Buyer in ICDR for investments in Angel Funds.
  • Relaxation in investment norms by angel funds in investee company 
    • Floor and cap relaxed from Rs. 25 lacs to Rs. 10 lacs, and from Rs. 10 crores to Rs. 25 crores respectively 
    • Concentration limits of 25% per investee company removed.
    • Follow on investments permitted in investee company, though may no longer be start-up
  • Scheme may now have more than 200 AIs
  • Minimum continuing interest of Sponsor/ Manager at investment level instead of Fund level
    • higher of 0.5% of investment amount or Rs. 50,000
    • Earlier the commitment was required to be maintained at a fund level only

SEBI regulated entities enabled to carry out activities not regulated by SEBI

  • Merchant Bankers and Debenture Trustees have been permitted to carry out activities not regulated by SEBI within the same legal entity subject to following conditions:
    • DT may undertake activity within the purview of any other financial sector regulator (FSR), subject to compliance with the regulatory framework specified by such regulator 
    • For activities not within the purview of SEBI or other FSR, the same shall  be  fee-based and non-fund-based activity and pertain to FSR
      • Had been previously required to hive off such activities pursuant to SEBI Board Meeting decision in December, 2024
  • Custodians permitted to carry out other financial services under  the regulatory oversight  of  other  financial sector regulators within  the  same  legal  entity
  • subject  to  having  adequate  mechanisms  to  address  issues  of conflicts of interest
  • Non-bank associated custodians offering services which are not overseen by any financial sector regulator to : 
  • Disclose clearly that such activities are outside the purview of, and without  recourse  to  SEBI
  • Set up distinct strategic business units (SBUs) for undertaking activities not under the purview of SEBI with adequate mechanisms to address issues of conflicts of interest

Clarity of responsibilities and uniformity measures for DTs

  • Specifying rights of DT and corresponding obligations on issuer under LODR
    • To enable DT in enforcing its rights 
  • Enabling provisions for providing format for model debenture trust deed (DTD) [Refer Annexure-1 of Consultation paper dated Nov 04, 2024 for the model DTD as proposed by SEBI]  
  • Modification in manner of utilization of Recovery Expense Fund (REF) (see an article on REF here)
    • Elaboration of list of expenses for which REF can be utilised
    • To provide ease to DTs to take prompt action upon default by listed entity   

Relaxations in regulatory norms for REITs and InvITs [see consultation paper dated May 02, 2025]

  • Definition of ‘public’ under REITs / InvITs to be amended to include related  parties  of  the sponsor,  investment  manager/manager  and  project  manager to qualify as public if such related parties are Qualified Institutional Buyers
    • Relevant for determination of minimum public holding 
    • Related party of REIT/ InvIT viz. sponsor, sponsor group, investment manager, project manager are not regarded as ‘public’
  • Adjustment of negative net distributable cash flows generated by the Holdco against  cash received from the SPVs
    • Net cash flow post adjustment to be distributed to unitholders
  • Alignment of timelines of submission of various reports including quarterly reports, valuation reports with the timelines for submission of financial results.
  • Reduction of minimum allotment lot for privately placed InVITs to INR 25 lacs from INR 1 crore to align with the trading lot in secondary market.

Read more:

SEBI’s stringent norms for secured debentures

No shares, no say, yet a promoter: How marital ties create fictional “promoter groups”
Follow the SEBIscope channel on WhatsApp

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

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-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:

Particulars2023 Circular read with 2024 clarificationDraft Directions
Investment by REs in scheme of AIFRE completely prohibited from investing in any scheme of AIF which has downstream investments in debtor company of the RE.Any investment already made had to be liquidated within 30 days of the issuance of the Circular. Similarly, where the RE had already invested, but AIF makes investment in a debtor company of RE, RE shall liquidate investments in AIF within 30 days.To be allowed subject to individual and collective limits:Max. contribution of single RE to an AIF scheme – 10% of its corpusMax. contribution of multiple REs – 15% of its corpusSee illustrations later in this article.
Debtor companyShall mean any company to which the RE currently has or previously had a loan or investment exposure anytime during the preceding 12 months.Shall imply any company to which the RE currently has or previously had a loan or investment exposure (excluding equity instruments) anytime during the preceding 12 months.
Provisioning requirementsInability to liquidate investments within 30-day liquidation period would entail 100% provisioning against such investments.Investment by the RE in such AIF allowed upto 5% of the corpus of the AIF scheme, without looking into the form of downstream investments made by AIF. Hence, no provisioning required.
If investment by RE exceeds 5%, it will require full capital, if downstream investments by AIF in debtor company are not permissible investments (see below). See illustrations later in this article
Provisioning required proportionately and not on entire investmentsProvisioning is 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 schemeNorms remain the same – RE shall be required to make 100 per cent provision to the extent of its proportionate investment in the debtor company through the AIF Scheme
Permissible forms of investments by AIF scheme in debtor companyInvestment in equity shares (by AIF scheme in debtor company) were excluded from the prohibition by 2024 clarification. However hybrid instruments were still included.All forms permitted, if investment by RE does not exceed 5%. Therefore, even debt investments by AIFs are permissible.Only equity shares, CCPS, and CCDs allowed, if investments by RE exceeds 5%. If AIF makes other forms of investments in debtor company, RE will have to provide for full capital.Note that, irrespective of the form of downstream investments by AIF in the debtor company, RE can take a maximum exposure of 10% in an AIF.
Priority distribution modelinvestment by REs in the subordinated units of any AIF scheme with a ‘priority distribution model’ shall be subject to full deduction from RE’s capital funds. Deduction shall be made from Tier I and II equally.Norms remain the same.
Investment policyNo specific requirement Investment policy to have suitable provisions to ensure that investments in an AIF Scheme comply, in letter and spirit, with the extant regulatory norms. In particular, such investments shall be subject to the test of evergreening.
Exemption by regulatorNo specific enabling provisionExempted category to be decided by RBI in consultation with GoI.

Illustrations on investment limits by RE

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

ScenariosImplications under Draft Directions
Investment of Rs. 10 Crores by an RE in an AIF scheme having corpus of 50 croresCannot make since the threshold limit of 10% will be breached.
Investment of Rs. 5 Cr by an RE in an AIF scheme having corpus of 50 crores with other REs contributing Rs. 15 CrWhile the investment by the RE individually is within the limit of 10%, the collective investment is more than 15%. Hence, such an investment cannot be made by the concerned RE. Further, since the total investment of 15 cr by other REs will also breach the threshold of 15%, the investments will not be possible.
Investment of Rs. 5 Cr by an RE in an AIF scheme having a corpus of 50 Cr. The AIF in turn has a downstream debt investment in a debtor company of the RE. Cannot be made since the limit of 5% will be breached.
Investment of Rs. 1 Cr by an RE in an AIF scheme having a corpus of 50 Cr. The AIF in turn has a downstream debt investment in a debtor company of the RE. This constitutes only 2% of the corpus of the AIF scheme. Hence, permissible – even when the downstream investment of the AIF is a debt investment.
Investment of Rs. 5 Cr by an RE in an AIF scheme having a corpus of 50 Cr. The AIF in turn has a downstream equity investment in a debtor company of the RE. Can be made as the downstream investment of the AIF is in equity of the debtor company. However, the maximum cap of 10% would apply to the RE.

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.

Bond Credit Enhancement Framework: Competitive, rational, reasonable

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-Vinod Kothari (vinod@vinodkothari.com)

The RBI’s proposed framework for partial credit enhancement for bonds has significant improvements over the last 2015 version

The RBI released the draft of a new comprehensive framework for non-fund based support, including guarantees, co-acceptances, as well as partial credit enhancement (PCE) for bonds. The PCE framework is proposed to be significantly revamped, over its earlier 2015 version.

Note that PCE for corporate bonds was mentioned in the FM’s Budget 20251, specifically indicating the setting up of a PCE facility under the National Bank for Financing of Infrastructural Development (NaBFID).

A quick snapshot of how PCE works and who all can benefit is illustrated below:

The highlights of the changes under the new PCE framework are:

What is PCE?

Partial Credit Enhancement (PCE) is a risk-mitigating financial tool where a third party provides limited financial backing to improve the creditworthiness of a debt instrument. Provision of wrap or credit support for bonds is quite a common practice globally. 

PCE is a contingent liquidity facility – it allows the bond issuer to draw upon the PCE provider to service the bond. For example, if a coupon payment of a bond is due and the issuer has difficulty in servicing the same, the issuer may tap the PCE facility and do the servicing. The amount so tapped becomes the liability of the issuer to the PCE provider, of course, subordinated to the bondholders. In this sense, the PCE facility is a contingent line of credit. 

A situation of inability may arise at the time of eventual redemption of the bonds too – at that stage as well, the issuer may draw upon the PCE facility. 

Since the credit support is partial and not total, the maximum claim of the bond issuer against the PCE provider is limited to the extent of guarantee – if there is a 20% guarantee, only 20% of the bond size may be drawn by the issuer. If the facility is revolving in nature, this 20% may refer to the maximum amount tapped at any point of time.

Given that bond defaults are quite often triggered by timing and not the eventual failure of the bond issuer, a PCE facility provides a great avenue for avoiding default and consequential downgrade.  PCE provides a liquidity window, allowing the issuer to arrange liquidity in the meantime. 

Who can be the guarantee provider?

PCE under the earlier framework could have been given by banks. The ambit of guarantee providers has been expanded to include SCBs, AIFIs, NBFCs in Top, Upper and Middle Layers and HFCs. However, in case of NBFCs and HFCs, there are additional conditions as well as limit restrictions. 

As may be known, entities such as NABFID have been tasked with promoting bond markets by giving credit support. 

Who may be the bond issuers?

The PCE can be extended against bonds issued by corporates /special purpose vehicles (SPVs) for funding all types of projects and to bonds issued by Non-deposit taking NBFCs with asset size of ₹1,000 crore and above registered with RBI (including HFCs).

What are the key features of the bonds?

  1. REs may offer PCE only in respect of bonds whose pre-enhanced rating is “BBB minus” or better.
  2. REs shall not invest in corporate bonds which are credit enhanced by other REs. They may, however, provide other need based credit facilities (funded and/ or non-funded) to the corporate/ SPV. 
  3. To be eligible for PCE, corporate bonds shall be rated by a minimum of two external credit rating agencies at all times.
  4. Further, additional conditions for providing PCE to bonds issued by NBFCs and HFCs:
    1. The tenor of the bond issued by NBFCs/ HFCs for which PCE is provided shall not be less than three years. 
    2. The proceeds from the bonds backed by PCE from REs shall only be utilized for refinancing the existing debt of the NBFCs/ HFCs. Further, REs shall introduce appropriate mechanisms to monitor and ensure that the end-use condition is met. 

What will be the form of PCE? 

PCE shall be provided in the form of an irrevocable contingent line of credit (LOC) which will be drawn in case of shortfall in cash flows for servicing the bonds and thereby may improve the credit rating of the bond issue. The contingent facility may, at the discretion of the PCE providing RE, be made available as a revolving facility. Further, PCE cannot be provided by way of guarantee. 

What is the difference between a guarantee and an LOC? If a guarantor is called upon to make payments for a beneficiary, the guarantor steps into the shoes of the creditor, and has the same claim against the beneficiary as the original creditor. For example, if a guarantor makes a payment for a bond issuer’s obligations, the guarantor will have the same rights as the bondholders (security, priority, etc). On the contrary, the LOC is simply a line of liquidity, and explicitly, the claims of the LOC provider are subordinated to the claims of the bondholders.

If the bond partly amortises, is the amount of the PCE proportionately reduced? This should not be so. In fact, the PCE facility continues till the amortisation of the bonds in full. It is quite natural to expect that the defaults by a bond issuer may be back-heavy. For example, if there is a 20% PCE, it may have to be used for making the last tranche of redemption of the bonds. Therefore, the liability of the PCE provider will come down only when the outstanding obligation of the bond issuer comes to less than the size of the PCE.

Any limits or restrictions on the quantum of PCE by a single RE?

The existing PCE framework restricts a single entity to providing only 20% of the total 50% PCE limit for a bond issuance. It is now proposed that the sub-limit of 20% be removed, enabling single entity to provide upto 50% PCE support. 

Further, the exposure of an RE by way of PCEs to bonds issued by an NBFC/ HFC shall be restricted to one percent of capital funds of the RE, within the extant single/ group borrower exposure limits.

Who can invest in credit-enhanced bonds?

Under the existing framework, only the entities providing PCE were restricted from investing in the bonds they had credit-enhanced. However, the new Draft Directions expand this restriction by prohibiting all REs from investing in bonds that have been credit-enhanced through a PCE, regardless of whether they are the PCE provider. The draft regulations state that the same is with an intent to promote REs enabling wider investor participation.

This is, in fact, a major point that may need the attention of the regulator. A universal bar on all REs from investing in bonds which are wrapped by a PCE is neither desirable, nor optimal. Most bond placements are done by REs, and REs may have to warehouse the bonds. In addition, the treasuries of many REs make opportunistic investments in bonds.

Take, for instance, bonds credit enhanced by NABFID. The whole purpose of NABFID is to permit bonds to be issued by infrastructure sector entities, by which banks who may have extended funding will get an exit. But the treasuries of the very same banks may want to invest in the bonds, once the bonds have the backing of NABFID support. There is no reason why, for the sake of wider participation, investment by regulated entities should be barred. This is particularly at the present stage of India’s bond markets, where the markets are not liquid and mature enough to attract retail participation. 

What is the impact on capital computation?

Under the Draft Directions the capital is required to be maintained by the REs providing PCE based on the PCE amount based on applicable risk weight to the pre-enhanced rating of the bond. Under the earlier framework, the capital was computed so as to be equal to the difference between the capital required on bond before credit enhancement and the capital required on bond after credit enhancement. That is, the existing framework ensures that the PCE does not result into a capital release on a system-wide basis. This was not a logical provision, and we at VKC have made this point on various occasions2. 

Related Resources –

  1.  Union Budget 2025: Key Highlights and Reforms focusing on Financial Sector Entities ↩︎
  2. Partial Credit Enhancement: A Catalyst for Boosting Infrastructure Bond Issuances? ↩︎

Roads to Riches: A snapshot of InvITs in India

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Simrat Singh – corplaw@vinodkothari.com | finserv@vinodkothari.com

Introduction

An Infrastructure Investment Trust (InvIT) is a pooled investment vehicle designed to facilitate collective investment in infrastructure assets. It allows investors to earn returns from assets such as roads, power plants, and telecom towers without direct ownership. Structured as a trust, InvITs generate revenue through various avenues such as toll collections, power tariffs and lease payments etc depending upon the underlying asset class. This mode of investment provides investors with a stable income stream through regular dividends while offering potential capital appreciation.

InvITs attract both institutional and retail investors seeking long-term, predictable returns, making them a crucial instrument in bridging the funding gap for infrastructure development. By serving as an efficient alternative to traditional financing methods, they contribute significantly to the sector’s growth and sustainability.

This article explores the progress of InvITs in India, examining the key asset classes they encompass, emerging asset categories, and a brief overview of the regulatory framework governing their operations.

InvITs: Journey so far

Since the launch of India’s first InvIT, the IRB InvIT Fund, in March 2016, InvITs have evolved significantly. Since FY 2020, InvITs have mobilized a remarkable ₹129,267 crore, helping bridge a portion of the USD 1.4 trillion investment required in infrastructure to achieve India’s goal of a $5 trillion economy by 2030.

Source: SEBI’s statistics on Fund raising by REITs and InvITs

InvITs have emerged as a viable investment avenue for those seeking long-term, stable returns. Foreign investors hold a substantial share of equity in InvITs, reflecting the strong global interest in India’s infrastructure sector. However, retail participation remains limited due to a lack of awareness and high ticket size. As of September 30, 2024, the total AUM of InvITs stood at ₹5.87 lakh crore. Calculating returns on InvITs can be challenging, especially for privately placed InvITs, due to the lack of readily available data. However, when it comes to capital appreciation in publicly listed InvITs, returns have generally been unimpressive (a glimpse of this is shown in the chart below which has been prepared after analysing the listing price and the price as on 1.04.2024 of units of Public InvITs). This is primarily because investors in these units prioritize steady income through interest and dividend payments over capital gains. At this juncture, it will be interesting to note that out of the 25 registered InvITs in India, only 5 have had public issues.

Overview of asset classes under InvITs

Legally, any asset listed under the Ministry of Finance notification dated October 7, 2013, can be included in an InvIT. However, in practice, as of March 31, 2024, InvITs primarily manage assets worth ₹5.87 lakh crore in the following categories and in the following proportions:

Source: CareEdge Ratings

After reviewing the websites and placement memorandums of all the InvITs registered in India, we can categorize them based on the following asset classes in which they operate:

Sr. No.Name of InvITUnderlying asset class
1Digital Fibre Infrastructure TrustTelecom & data transmission
2Altius Infra Trust
3Capital Infra TrustRoads
4Highways Infra trust
5IRB InvIT Fund
6Shrem Invit
7Roadstar Infra Investment Trust
8Interise Trust
9Oriental InfraTrust
10Nxt-Infra Trust
11Maple Infrastructure Trust
12IRB Infrastructure Trust
13Indus Infra Trust
14Cube Highways Trust
15Athaang Infrastructure Trust
16Anantham Highways Trust
17Powergrid Infrastructure Investment TrustPower transmission
18IndiGrid Infrastructure Trust
19Energy Infrastructure TrustPipeline infrastructure
20TVS Infrastructure TrustWarehousing
21NDR InvIT Trust
22Intelligent Supply Chain Infrastructure Trust
23Sustainable Energy Infra TrustRenewable energy
24Anzen India Energy Yield Plus Trust
25SchoolHouse InvITEducational infrastructure

Revenue generation mechanisms by asset class

Telecom

Telecom InvITs, such as Digital Fibre Infrastructure Trust (DFIT) and Altius Infra Trust, generate revenue by leasing telecom infrastructure to operators. DFIT, for instance, owns and operates fiber optic networks leased to large companies like Reliance Jio. It also earns interest income from its 51% stake in Jio Digital Fibre Private Limited (JDFPL). Altius generates revenue through long-term Master Service Agreements (MSAs), including rental charges, location premiums and infrastructure expansion fees. These structured agreements ensure predictable cash flows, enhancing the financial resilience of telecom InvITs.

Power Transmission

One of the major players in this sector, Powergrid Infrastructure Investment Trust (PGInvIT) generates revenue through long-term Transmission Service Agreements (TSAs), typically spanning over 35 years. These agreements ensure stable income by collecting transmission charges from power distribution companies (DISCOMs) and state electricity boards. Revenue is pooled and managed by the Central Transmission Utility of India Limited, reducing counterparty credit risks and ensuring timely payments.

Road Infrastructure

One of the most popular and growing asset class, road InvITs generate income through:

  1. Toll Collections: Vehicles pay toll charges for road usage.
  2. Annuity payments: The government or contracting authority makes periodic payments for a specified period to ensure steady cash flows.
  3. Hybrid models: A combination of toll income and government annuities under the Hybrid Annuity Model.

For example, National Highways Infra Trust (NHIT), backed by the National Highways Authority of India (NHAI), monetizes highway assets under the Built-Operate-Transfer (BOT) model. NHIT raised ₹46,000 crore through InvIT issuances, providing investors with steady income while enabling NHAI to reinvest in new projects.

Warehousing

Warehousing InvITs in India generate revenue primarily through long-term lease agreements with logistics companies, e-commerce firms, and manufacturers. These leases often follow a triple net lease, ensuring stable cash flows.

  1. TVS Infrastructure Trust manages 10.6 million square feet of Grade A warehousing and leases these assets to major corporations such as Amazon and Nestlé.
  2. NDR InvIT Trust reported a 5.65% revenue growth in Q3 FY 2025, with a 98% occupancy rate.
  3. Intelligent Supply Chain Infrastructure Trust, sponsored by Reliance Retail, follows a similar leasing model.

Pipeline Infrastructure

As on date there is only one InvIT which operates pipeline assets and it generates revenue through tariff-based gas transportation fees, regulated by the Petroleum and Natural Gas Regulatory Board. This InvIT secures long-term contracts and capacity reservation fees, ensuring stable revenue. They also benefit from interconnection fees with third-party pipelines, expanding income streams.

Educational Infrastructure

SchoolHouse InvIT, India’s first educational asset focused InvIT, earns revenue by leasing school and student housing properties to educational institutions under long-term agreements (15-30 years). The triple net-lease model, where tenants cover maintenance, property tax, and insurance, ensures minimal revenue leakage.

Overview of regulatory landscape for InvITs

The SEBI (Infrastructure Investment Trusts) Regulations, 2014 (‘InvIT Regulations’) categorize InvITs into three types. The key conditions related to their issuance, distribution, and borrowings are summarized in the table below:

FeaturePublic Private ListedPrivate Unlisted
Mode of initial offerPublic issuePrivate placementPrivate placement
Minimum asset valueRs. 500 Cr.Rs. 500 Cr.Rs. 500 Cr.
Minimum initial offer sizeRs. 250 Cr.Rs. 250 Cr.Rs. 250 Cr.
Listing requirementMandatoryMandatoryNot permitted
Minimum subscription in initial offer from any investorINR 10,000 – INR 15,000INR 1 Crore / 25 CroreINR 1 Crore / 25 Crore
Distribution requirementAt least 90% of NDCF ; at least once every six monthsAt least 90% of NDCF; at least once every yearAt least 90% of NDCF; at least once every year
Permitted investorsCan invite funds from public as well (subject to minimum public float as per Reg 14(1A) Institutional investors and body corporates, whether Indian or foreignInstitutional investors and body corporates, whether Indian or foreign
Borrowing limitUp to 25% of asset value – no approval required
More than 25% but up to 49% of asset value:Obtain credit ratingApproval of unit holders
More than 49% but up to 70% of asset value:AAA ratingRecord of at least 6 distributions.Approval of unit holders. (75%)		As per trust deed
Number of investorsMinimum 20Minimum 5 and maximum 1,000Minimum 5 and maximum 1,000

Lock-in requirements for sponsors. 

To ensure that sponsors maintain a minimum stake in the investment, Regulation 12 of the InvIT Regulations outlines the following lock-in requirements based on a gliding platform approach.

Minimum holding periodLock-in requirement
For a period of 3 years from listing. (Units in excess of 15% to be locked in for a period of 1 year from listing)15% of total Units
From the beginning of 4th year and till the end of 5th year from the date of listing 5% of total Units or Rs. 500 crores, whichever is lower 
From the beginning of 6th year and till the end of 10th year from the date of listing3% of total Units of the InvIT or Rs. 500 crores, whichever is lower
From the beginning of 11th year and till the end of 20th year from the date of listing 2% of total Units of the InvIT or Rs. 500 crores, whichever is lower 
after completion of the 20th year from the date of listing 1% of total Units of the InvIT or Rs. 500 crores, whichever is lower 

Applicability of the Listing Regulations, 2015

Regulation 26G of the InvIT Regulations specifies the applicability of certain provisions of the Listing Regulations to InvITs, with necessary modifications. These provisions includes: 

  1. Constitution of the following:
    1. Audit Committee
    2. Nomination and Remuneration Committee
    3. Stakeholder Relationship Committee
    4. Risk Management Committee
  2. Limits on maximum number of Directorships
  3. Appointment and qualification of Independent Directors

Conclusion

InvITs have significantly transformed India’s infrastructure investment landscape, providing an alternative financing mechanism that bridges the funding gap while offering investors stable returns. Their evolution from road and power transmission assets to emerging categories like warehousing, pipeline infrastructure, and educational institutions highlights their growing versatility. Despite challenges such as limited retail participation and moderate capital appreciation in public InvITs, the segment continues to attract institutional investors, particularly foreign investors, signaling strong confidence in India’s infrastructure sector.

As the regulatory framework evolves to enhance transparency, governance, and investor confidence, InvITs are poised to play an even greater role in India’s economic growth. By enabling long-term capital infusion into essential infrastructure projects, they not only support the nation’s $5 trillion economy vision but also ensure sustainable development across key sectors. Looking ahead, increased awareness, improved accessibility, and regulatory refinements could unlock further potential for InvITs, making them a more attractive and robust investment avenue in the years to come.

Gains on sale of Zombie loans: RBI’s year-end bonus to banks  

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– Vinod Kothari & Dayita Kanodia (finserv@vinodkothari.com)

“There is no such thing as government money – only taxpayer money.”

— Margaret Thatcher

RBI has introduced a significant amendment to the prudential treatment of Security Receipts (SRs) guaranteed by the Government of India through its latest circular dated March 29, 2025. What this amendment briefly means is, that for sale of bad loans to NARCL, funded by issue of sovereign-backed SRs, the banks may book a gain equal to the sale consideration minus the provisioned value of the bad loans. Interestingly, this treatment will be applied not only to transactions done after the amendment, but to existing SRs held by banks too. 

By way of a background, National Asset Reconstruction Company Limited (NARCL), along with its sister body India Debt Resolution Company Ltd. (IDRCL), was created to clean up the legacy stressed assets with an exposure of Rs 500 crore and above in the Indian Banking system. A 2021 cabinet note approved the grant of GOI guarantee for the SRs issued by NARCL for the bad loans it will buy from banks. When banks sell bad loans to NARCL (or, for that matter, to any other ARCs), they put in 15% of their own funds, and for the balance, they issue a paper called SRs. While presumably the bad loans are to be bought at their fair value, given that the chunk of the value is funded by the issue of this paper, one may understand that the fair valuation is quite often an abstraction.

As per para 77 of the TLE Directions, in respect of the stressed loans transferred to the ARC, the transferors are required to carry the investment in their books on an ongoing basis, until its transfer or realization, at lower of the redemption value of SRs arrived based on the NAV as above, and the NBV of the transferred stressed loan at the time of transfer. Hence, there is no gain on sale booked at the time of the sale, even if the sale is at higher than the net book value.

However, the RBI made a specific amendment, targeted at NARCL SRs (as those are the only ones guaranteed by GOI), having the effect of saying that, in view of the GOI guarantee, banks holding the SRs may value them at their face value. As a result, banks may book the entire difference between the sale consideration of the bad loans, and the net-of-provisions value of the loans, as a gain on sale or reversal of the provision. Either way, the credit goes to P&L account.

Key Highlights of the Circular

There are, of course, several caveats to booking this gain on sale. First of all, let everyone understand that the loans have been languising in the books of the banks for several years, and therefore, they would have mostly slipped in the category of “doubtful assets”, requiring steep and progressively scaling-up provisions.  Therefore, it is quite likely that the fair value, which may, in turn, be influenced by the likely value in case of a resolution plan or liquidation, or the value of the underlying secured assets, may be substantially higher than the provisioned value.

The circular makes the following crucial changes to the treatment of SRs guaranteed by the sovereign:

  1. Reversal of Excess Provision: When a loan is transferred to an ARC for a value higher than its Net Book Value (NBV), the excess provision can be reversed to the P&L account. However, this is permitted only if the sale consideration consists solely of (i) cash and (ii) SRs guaranteed by the Government of India. 
  2. Deduction from regulatory capital: Despite allowing provision reversals or gain on sale, the RBI mandates that the non-cash component (SRs) must be deducted from Common Equity Tier 1 (CET 1) capital/Tier 1 Capital. Additionally, no dividends can be paid out of the SRs component, ensuring that banks do not distribute unrealized profits to shareholders. This means that the provision reversal or gain on sale will stay in the bank’s balance sheet as a non-distributable surplus. How long will this credit remain non-distributable? Since the government guarantee is valid only for 5 years, it is incumbent that NARCL will do either a resolution or liquidation of the borrower sooner than this period. Eventually, the SRs may receive cash distribution, either by way of realisation from the bad loans, or by way of the devolvement of the GOI guarantee, or both. Will the non-distributable credit become part of usual distributable profits when the value of the SRs is realised? While the circular does not give clarity on the subsequent treatment of the credit, our understanding says, yes.
  3. Periodic Valuation Based on NAV: The SRs will be periodically valued based on the Net Asset Value (NAV) declared by the ARC, derived from the recovery ratings of such instruments. Here once again, it is not clear whether the recovery ratings will be disregarding the underlying GOI guarantee. Logically, since the SRs are fully guaranteed, there is no reason for the rating to drop. But if the recovery ratings are done disregarding the guarantee, then the valuation of the SRs is bound to drop in the near future, making the FY 24-25 profit short-lived. 
  4. Final Valuation of SRs: If SRs remain outstanding after the final settlement of the government guarantee or upon the expiry of the guarantee period, they will be valued at a nominal price of ₹1. 
  5. Conversion of SRs: If the SRs are converted into another form of instrument as part of the resolution process, their valuation and provisioning will follow the provisions outlined under the Prudential Framework for Resolution of Stressed Assets dated June 7, 2019.

The Implications of RBI’s Move

The amendment, issued just 2 days to the end of the fiscal year, means a lot to the profit and loss accounts of the banks holding the SRs. 

However, on a policy front, it leaves several questions to be answered. The loans were evidently bad to their core. If the loans had any value in the hands of the banks, the banks would have used the several tools in their arsenal to recover them. Not that ARCs were unknown to the banks, or that IBC was far away from them. Therefore, if the banks were tempted to sell them to NARCL, the only reason would have been that the sale consideration, to the extent of 85% in form of paper-against-paper, was attractive. This paper, in the form of the SRs, suddenly means a lot of value in what was all this while not turning into value at all.

Central Government guarantee of Rs.30,600 crore to back Security Receipts issued by NARCL for acquiring stressed loan assets has been approved by the Union Cabinet. NARCL proposes to acquire stressed assets of about Rs. 2 Lakh crore in phases through 15% Cash and 85% in SRs. IDRCL will be engaged for management and value addition once NARCL acquires the assets. 

It may be noted that according to the FAQs released by the Ministry of Finance on the subject, such sovereign guarantee will incentivize quicker action on resolving stressed assets thereby helping in better value realization. The FAQs state that this approach will also permit freeing up of personnel in banks to focus on increasing business and credit growth. Further, it will bring about improvement in the bank’s valuation and enhance their ability to raise market capital.

GOI guarantee is essentially tax payer’s money, eventually to fill the gap left in recovering a bad loan. Of course the bad loan is money lent by a bank to a bad borrower. Therefore, indirectly, the cost of this bad lending is transferred to the taxpayers.

It is quite okay for the GOI to recapitalise banks, but is it okay for the RBI or  GOI to insert an item on the P/L accounts of banks by converting an imaginary profit into value?

Related Articles- 

  1. One stop RBI norms on transfer of loan exposures
  2. FAQs on Transfer of Loan Exposure

Webinar on Industry Standards Note on disclosure for RPTs

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