Archive for category: Amendments to the Companies Act 2013

-Sikha Bansal, Senior Associate & Harshita Malik, Executive | finserv@vinodkothari.com

Background

The RBI’s regulatory approach to investments by Regulated Entities (REs) in Alternate Investment Funds (AIFs) has undergone a remarkable transformation over the past two years. Initially, the RBI responded to the risks of “evergreening”, where banks and NBFCs could mask bad loans by routing fresh funds to existing debtor companies via AIF structures, by issuing stringent circulars in December 2023¹ and March 2024² (collectively known as ‘Previous Circulars’). The December 2023 circular imposed a blanket ban on RE investments in AIFs that had downstream exposures to debtor companies, while the March 2024 clarification excluded pure equity investments (not hybrid ones) from this restriction. This stance aimed to strengthen asset quality but quickly highlighted significant operational and market challenges for institutional investors and the AIF ecosystem. Many leading banks took significant provisioning losses, as the Circulars required lenders to dispose off the AIF investments; clearly, there was no such secondary market. 

In response to the feedback from the financial sector, as well as evolving oversight by other regulators like SEBI, the RBI undertook a comprehensive review of its framework and issued Draft Directions- Investment by Regulated Entities in Alternate Investment Funds (‘Draft Directions’) on May 19, 2025³. The Draft Directions have now been finalised as Reserve Bank of India (Investment in AIF) Directions, 2025 (‘Final Directions’) on 29th May, 2025. The Final Directions shift away from outright prohibitions and instead introduce a carefully balanced regime of prudential limits, targeted provisioning requirements, and enhanced governance standards. 

Comparison at a Glance

A compressed comparison between Previous Circulars and Final Directions is as follows –

Particulars	Previous Circulars	Final Directions	Intent/Implication
Blanket Ban	Blanket ban on RE investments in AIFs lending to debtor companies (except equity)	No outright ban; investments allowed with limits, provisioning, and other prudential controls	Move from a complete prohibition to a limit-based regime. Max. Exposures as defined (see below) taken as prudential limits
Definition of debtor company	Only equity shares excluded for the purpose of reckoning “investment” exposure of RE in the debtor company	Equity shares, CCPSs, CCDs (collectively, equity instruments) excluded	Therefore, if RE has made investments in convertible equity, it will be considered as an investment exposure in the counterparty – thereby, the directions become inapplicable in all such cases.
Individual Investment Limit in any AIF scheme	Not applicable (ban in place)	Max 10% of AIF corpus by a single RE, subject to a max. of 5% in case of an AIF, which has downstream investments in a debtor company of RE.	Controls individual exposure risk. Lower threshold in cases where AIF has downstream investments.
Collective Investment Limit by all REs in any AIF scheme	Not applicable	Max 20%4 of AIF corpus across all REs	Would require monitoring at the scheme level itself.
Downstream investments by AIF in the nature of equity or convertible equity	Equity shares were excluded, but hybrid instruments were not.	All equity instruments	Exclusions from downstream investments widened to include convertible equity as well. Therefore, if the scheme has invested in any equity instruments of the debtor company, the Circular does not hit the RE.
Provisioning	100% provisioning to the extent of investment by the RE in the AIF scheme which is further invested by the AIF in the debtor company, and not on the entire investment of the RE in the AIF scheme or 30-day liquidation, if breach	If >5% in AIF with exposure to debtor, 100% provision on look-through exposure, capped at RE’s direct exposure5 (see illustrations below)	No impact vis-a-vis Previous Circulars.  For provisioning requirements, see illustrations later.
Subordinated Units/Capital	Equal Tier I/II deduction for subordinated units with a priority distribution model	Entire investment deducted proportionately from Tier 1 and Tier 2 capital proportionately	Adjustments from Tier I and II, now to be done proportionately, instead of equally.
Investment Policy	Not emphasized	Mandatory board-approved6 investment policy for AIF investments	One of the actionables on the part of REs – their investment policies should now have suitable provisions around investments in AIFs keeping in view provisions of these Directions
Exemptions	No specific exemption. However, Investments by REs in AIFs through intermediaries such as fund of funds or mutual funds were excluded from the scope of circulars.	Prior RBI-approved investments exempt; Government notified AIFs may be exempt	Provides operational flexibility and recognizes pre-approved or strategic investments.No specific mention of investments through MFs/FoFs – however, given the nature of these funds, we are of the view that such exclusion would continue.
Transition/Legacy Treatment	Not applicable	Legacy investments may choose to follow old or new rules	See discussion later.

Key Takeaways: 

Detailed analysis on certain aspects of the Final Directions is as follows:

Prudential Limits 

Under the Previous Circulars, any downstream exposure by an AIF to a regulated entity’s debtor company, regardless of size, triggered a blanket prohibition on RE investments. The Final Directions replace this blanket ban with prudential limits:

• 10% Individual Limit: No single RE can invest more than 10% of any AIF scheme’s corpus.
• 20% Collective Limit: All REs combined cannot exceed 20% of any AIF scheme’s corpus; and
• 5% Specific Limit: Special provisioning requirements apply when an RE’s investment exceeds 5% of an AIF’s corpus, which has made downstream investments in a debtor company.

Therefore, if an AIF has existing investments in a debtor company (which has loan/investment exposures from an RE), the RE cannot invest more than 5% in the scheme. But what happens in a scenario where RE already has a 10% exposure in an AIF and the AIF does a downstream investment (in forms other than equity instruments) in a debtor company? Practically speaking, AIF cannot ask every time it invests in a company whether a particular RE has exposure to that company or not. In such a case, as a consequence of such downstream investment, RE may either have to liquidate its investments, or make provisioning in accordance with the Final Directions. Hence, in practice, given the complexities involved, it appears that REs will have to conservatively keep AIF stakes at or below 5% to avoid the consequences as above. 

Now, consider a scenario – where the investee AIF invests in a company (which is not a debtor company of RE), which in turn, invests in the debtor company. Will the restrictions still apply? In our view, it is a well-established principle that substance prevails over form. If a clear nexus could be established between two transactions – first being investment by AIF in the intermediate company, and second being routing of funds from intermediate company to debtor company, it would clearly tantamount to circumventing the provisions. Hence, the provisioning norms would still kick-in. 

Provisioning Requirements

Coming to the provisioning part, the Final Directions require REs to make 100 per cent provision to the extent of its proportionate investment in the debtor company through the AIF Scheme, subject to a maximum of its direct loan and/ or investment exposure to the debtor company, if the REs exposure to an AIF exceeds 5% and that AIF has exposure to its debtor company. The requirement is quite obvious – RE cannot be required to create provisioning in its books more than the exposure on the debtor company as it stands in the RE’s books. 

The provisioning requirements can be understood with the help of the following illustrations:

Scenario	Illustration	Extent of provisioning required
Existing investment of RE in AIF Scheme (direct loan and/or investment exposure exists as on date or in the past 12 months)	For example, an RE has a loan exposure of 10 cr on a debtor company and the RE makes an investment of 60 cr in an AIF (which has a corpus of 800 cr), the RE’s share in the corpus of the AIF turns out to be 7.5%. The AIF further invested 200 cr in the debtor company of the RE.	The proportionate share of the RE in the investment of AIF in the debtor company comes out to be 15 cr (7.5% of 200 cr). However, the RE’s loan exposure is 10 crores only. Therefore, provisioning is required to the extent of Rs. 10 crores.
Existing investment of RE in AIF Scheme (direct loan and/or investment exposure does not exist as on date or in the past 12 months)	Facts being same as above, in such a scenario, the provisioning requirement shall be minimum of the following two:-15 cr(full provisioning of the proportionate exposure); or-0 (full provisioning subject to the REs direct loan exposure in the debtor company)	Therefore, if direct exposure=0, then the minimum=0 and hence no requirement to create provision.

Some possible measures which REs can adopt to ensure compliance are as follows: 

1. Maintain an up-to-date, board-approved AIF investment policy aligned with both RBI and SEBI rules;
2. Implement robust internal systems for real-time tracking of all AIF investments and debtor exposures (including the 12-month history);
3. Require regular, detailed portfolio disclosures from AIF managers;
4. appropriate monitoring and automated alerts for nearing the 5%/10%/20% thresholds; and
5. Establish suitable escalation procedures for potential breaches or ambiguities.

Further, it shall be noted that the intent is NOT to bar REs from ever investing more than 5% in AIFs. The cap is soft, provisioning is only required if there is a debtor company overlap. But the practical effect is, unless AIFs develop robust real-time reporting/disclosure and REs set up systems to track (and predict) debtor overlap, 5% becomes a limit for specifically the large-scale REs for practical purposes. 

Investment Policy

The Final Directions call for framing and implementing an investment policy (amending if already exists) which shall have suitable provisions governing its investments in an AIF Scheme, compliant with extant law and regulations. Para 5 of the Final Directions does not mandate board approval of that policy, however, Para 29 of the RBI’s Master Directions on Scale Based Regulations stipulates that any investment policy must be formally approved by the Board. In light of this broader governance requirement, it is our view that an RE’s AIF investment policy should similarly receive Board approval. Below is a tentative list of key elements to be included in the investment policy:

• Limits: 10% individual, 20% collective, with 5% threshold alerts;
• Provision for real-time 12-month debtor-exposure monitoring and pre-investment checks;
• Clear provisioning methodology: 100% look-through at >5%, capped by direct exposure; proportional Tier-1/Tier-2 deduction for subordinated units; and
• Approval procedures for making/continuing with AIF investments; decision-making process
• Applicability of the provisions of these Directions on investments made pursuant to commitments existing on or before the effective date of these Directions.

Subordinated Units Treatment

Under the Final Directions, investments by REs in the subordinated units⁷ of any AIF scheme must now be fully deducted from their capital funds, proportionately from Tier I and Tier II as against equal deduction under the Previous Circulars. While the March 2024 Circular clarified that reference to investment in subordinated units of AIF Scheme includes all forms of subordinated exposures, including investment in the nature of sponsor units; the same has not been clarified under the Final Directions. However, the scope remains the same in our view.

What happens to positions that already exist when the Final Directions arrive?

As regards effective date, Final Directions shall come into effect from January 1, 2026 or any such earlier date as may be decided as per their internal policy by the REs. 

Although, under the Final Directions, the Previous Circulars are formally repealed, the Final Directions has prescribed the following transition mechanism:

Time of making Investments by RE in AIF	Permissible treatment under Final Directions
New commitments (post-effective date)	Must comply with the new directions; no grandfathering or mixed approaches allowed
Existing Investments	Where past commitments fully honoured: Continue under old circulars
	Partially drawn commitments: One-time choice between old and new regimes

Closing Remarks

The RBI’s evolution from blanket prohibitions to calibrated risk-based oversight in AIF investments represents a mature regulatory approach that balances systemic stability with market development, and provides for enhanced governance standards while maintaining robust safeguards against evergreening and regulatory arbitrage. 

Of course, there would be certain unavoidable side-effects, e.g. significant operational and compliance burdens on REs, requiring sophisticated real-time monitoring systems, comprehensive debtor exposure tracking, board-approved investment policies, and enhanced coordination with AIF managers. Hence, there can be some challenges to practical implementation.  Further, the success of this recalibrated regime will largely depend on the operational readiness of both REs and AIFs to develop transparent monitoring systems and proactive compliance frameworks. 

1.  https://vinodkothari.com/2023/12/rbi-bars-lenders-investments-in-aifs-investing-in-their-borrowers/ 
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2.  https://vinodkothari.com/2024/03/some-relief-in-rbi-stance-on-lenders-round-tripping-investments-in-aifs/ 
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3.  https://vinodkothari.com/2025/05/capital-subject-to-caps-rbi-relaxes-norms-for-investment-by-res-in-aifs-subject-to-threshold-limits/ ↩︎
4.  The limit was 15% in the Draft Directions, the Final Directions increased the limit by 5 percentage points.
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5.  This cap at RE’s direct loan and/or investment exposure has been introduced in the Final Directions.
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6.  Para 29 of the RBI’s Master Directions on Scale Based Regulations stipulates that any investment policy must be formally approved by the Board. 
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7. SEBI, vide Master Circular for AIFs, had put restrictions on priority distribution model. Later, pursuant to Fifth Amendment to SEBI (AIF) Regulations, 2024, SEBI issued a Circular dated December 13, 2024 wherein certain exemptions were allowed and differential rights were allowed subject to certain conditions. See our article here. ↩︎