Treatment of employee dues under IBC has always been a matter of debate. While various judicial precedents have interpreted the provisions of the Code (see discussion later), however, the dilemma may revive with the notification of Code on Social Security, 2020 (“Social Security Code”). The Social Security Code now speaks of retirement benefits being paid in accordance with the priority under IBC; while Courts in the past have ruled that retirement dues will have to be paid beyond the priorities under IBC. Obviously, there was no reference to IBC in the labour laws before. Now that there is an explicit submission to IBC, does it result in a different interpretation as to the payment of dues such as provident fund, gratuity, pension, etc?
In our view, it will be quite a long and costly way to try and get the reconciliation between the labour codes and IBC through jurisprudence; instead, whatever be the policy and intent of the lawmaker should be spelt clearly in the law itself, more so because a comprehensive amendment to the Code is imminent.
[A comparison of the provisions of Code on Social Security Code, 2020 with the erstwhile provisions of relevant Labour Laws is provided in the Annexure to this article]
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2025-12-03 16:38:072026-03-31 12:00:34Call for Clarity: Employee Dues under IBC in light of the Social Security Code
The RBI, as part of its recent consolidation exercise, has consolidated various instructions applicable to NBFCs and issued 34 Master Directions. Our analysis of these can be accessed here.
Loan transfers are now governed by the RBI (Non-Banking Financial Companies – Transfer and Distribution of Credit Risk) Directions, 2025 (‘Transfer Directions’), which assimilates the erstwhile TLE and Co-lending Directions.
One notable change (which was not there in the Draft) appears in the provisions relating to transfer of loan exposures. Para 31 of the Directions provides a carveout for items which will be excluded from the purview of the Directions. One of the exclusions, which has existed since the 2012 Guidelines, is the exclusion for balance transfers. That exclusion has now been removed.
This change raises the question of whether NBFCs are now required to comply with the provisions of the Transfer Directions, even in cases where it is the borrower who requests the transfer of its loan account.
Case of Balance Transfer
Balance transfer is an arrangement where a borrower who has already availed credit from a particular RE identifies another lender willing to offer a loan at a lower interest rate. In such cases, the borrower requests the existing lender to pre-close the loan account using the funds provided by the new lender. The essence is that the transaction happens at the instance of the borrower.
While BTs can take place for a number of reasons, it generally happens when the borrower finds another lender offering loans at a lower interest rate. Other common BT causes include:
Better Loan Terms: More flexible repayment schedules, lower processing fees, reduced foreclosure charges, or longer tenure options.
Top-Up Loan Facility: The new lender may offer a top-up loan along with the transfer at attractive rates.
Improved Customer Service: Borrowers often move due to dissatisfaction with the existing lender’s service quality, delays, or poor communication.
Switching from Floating to Fixed (or vice versa): A borrower may want to change the interest type depending on market outlook or personal preference.
Consolidation of Loans: Borrowers might transfer in order to consolidate multiple loans under one lender for easier management.
BTs typically take place in longer-term loans such as housing loans and LAP.
Typically, the borrower is also charged a prepayment penalty when the existing lender pre-closes the loan account.
Is BT a case of Transfer?
As discussed above, balance transfer is not, per se, a transfer of the loan account between lenders; rather, it is a situation in which one lender effectively steps into the place of another at the request of the borrower.
It may also be noted that the Directions recognise only three modes of transfer of loan accounts:
Assignment
Novation
Loan participation
BT, however, does not fall under any of the above modes.
Further, the introduction to the Transfer Directions states:
Loan transfers are essential to the development of a credit risk market, enabling diversification of credit risk originating in the financial sector and ensure the availability of market-based credit products for a diversified set of investors having commensurate capacity and risk appetite.
BT, on the other hand, does not achieve any credit-risk redistribution. The incoming lender is not purchasing risk, but issuing a fresh loan directly to the borrower. In essence, a balance transfer is not a credit risk transfer; rather a refinancing transaction driven by the borrower’s choice, without any movement of the underlying asset.
However, for banks, the concept of inter-bank transfer of loan accounts exists, whereas for NBFCs, there is only a pre-closure of the loan account by one lender using funds obtained from another lender.
Conclusion
Accordingly, in our view, the position for NBFCs in respect of balance transfers remains unchanged, and there is no requirement to comply with the provisions of the Transfer Directions. It must, however, be ensured that such borrower-initiated transfer requests are responded to by the concerned NBFC within 21 days, as required under Para 19 of Reserve Bank of India (Non-Banking Financial Companies – Responsible Business Conduct) Directions, 2025.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2025-12-02 20:49:252025-12-02 20:49:25The will of the borrower: Do Balance Transfers Count as Loan Transfers?
Private credit is becoming a new force in India’s lending ecosystem. As traditional banks and NBFCs operate under the strict regulations on capital, exposure and asset quality norms, they are often unable, or unwilling to cater to certain borrowers. In addition, for banks in particular, what kind of lending opportunities can be tapped is often a matter of having typecast lending products, policies and procedures. This leaves occasional, however, lucrative gaps in funding needs which are not serviced by regulated lenders. Into these gaps step in Private Credit AIFs (in India), Business Development Companies (BDCs) and Private Collateralized Loan Obligations (CLOs) (in the USA and Australia), these funds can structure deals creatively, customise financing to borrower needs and capture higher-yield opportunities that conventional lenders must pass over. What is emerging is a parallel channel of credit, one that is nimble, agile and focused.
Globally, this shift hasn’t gone unnoticed. Policymakers and institutions like the IMF have flagged the risks tied to private credit markets, especially around opacity, leverage and borrower quality (see below). Yet in India, the momentum continues to build. Tight constraints on banks, the rise of alternative asset managers and the unmet capital needs of businesses beyond the traditional credit universe are all fuelling rapid expansion.
This article examines what private credit is, why it is growing in India, the risks associated with this market and whether their growth creates regulatory arbitrage relative to banks and NBFCs.
What is Private Credit?
As per an IMF paper1, private credit is defined as “non-bank corporate credit provided through bilateral agreements or small “club deals” outside the realm of public securities or commercial banks. This definition excludes bank loans, broadly syndicated loans, and funding provided through publicly traded assets such as corporate bonds.
Simply, private credit is the lending by non-bank and non-NBFCs. The sector predominantly involves alternative asset managers2 who raise capital from institutional investors using closed-end funds and lend directly to predominantly middle-market firms3.
How is it Different From Normal Credit?
Unlike traditional credit, private credit is typically tailored to the specific needs of each borrower. Repayment terms can, for instance, be aligned with the timing of a funding round or disbursements can be structured to match capital expenditure plans. Interest rates may also be designed on a step-up basis, linked to the borrower’s turnover. Many elements that are otherwise rigid under RBI-regulated lending can be flexibly structured in private credit (see table 2 below). This flexibility is especially valuable for start-ups and small businesses, which often require customised financing solutions that traditional lenders may be unable to provide.
Parameter
Private Credit
Traditional Credit
Source of Capita
Private debt funds (Category II AIFs), investors like HNIs, family offices, institutional investors
Banks, NBFCs and mutual funds
Target Borrowers
Companies lacking access to banks; SMEs, mid-market firms, high-growth businesses
Higher-rated, established borrowers.
Deal Structure
Bespoke, customised, structured financing
Standardised loan products
Flexibility
High flexibility in terms, covenants, and structuring
Restricted by regulatory norms and rigid approval processes
Returns
Higher yields (approx. 10–25%)
Lower yields (traditional fixed-income)
Risk Level
Higher risk due to borrower profile and limited diversification
Lower risk due to stronger credit profiles and diversified portfolios
Regulation
Light SEBI AIF regulations; fewer lending restrictions
Heavily regulated by RBI and sector-specific norms
Liquidity
Closed-ended funds; limited exit options
More liquid; established repayment structures; some products have secondary markets
Diversification
Limited number of deals; concentrated portfolios
Broad, diversified loan books
Role in Market
Fills credit gaps not served by traditional lenders
Core credit providers in the financial system
Table 1: Differences between private credit and traditional credit
How Much of it is in India?
Global private credit assets under management have quadrupled over the past decade to US$2.1 trillion in 20234. Compared with the rest of the world, the private credit market in India is very small, with estimated assets under management of $25 billion to $30 billion as of March 31, 2025, representing about 0.6% of India’s GDP and 30-35% of the total investments made by AIFs in India.5
Figure 1: Private credit share (1%) as a part of overall corporate lending. Source: RBI, AMFI
Figure 2: Size of Private Credit Market. Source: RBI
Reasons for Rise in Private Credit?
Private credit is expanding rapidly because it steps in where traditional banks hesitate. It provides capital for last-mile project completion, cost overruns and promoter equity infusion; areas that fall outside the comfort zone of regulated lending. The asset class has also delivered consistently higher risk-adjusted returns, a compelling draw for global and domestic investors, especially through long phases of low interest rates.6
A key advantage lies in its flexibility. Private lenders can tailor covenants7, link returns to cash flows and restructure repayment terms during stress, offering a level of customisation that conventional bank credit cannot match. For investors, this translates into both diversification and access to high-growth segments that remain beyond the scope of mainstream credit markets.
Sector specific regulatory gaps: There is a concern that tighter bank regulation will continue to encourage the migration of credit from banks to private credit lenders8. Certain regulatory restrictions on banks directly push borrowers toward private credit:
Real estate: Banks cannot lend for land acquisition (Para 3.3.1, Master Circular – Housing Finance), leading to real estate becoming a major private-credit segment, accounting for about one-third of all private credit deals.9
Mergers & acquisitions: Banks are not expected to lend to promoters for acquiring shares of other companies (Para 2.3.1.6, Master Circular – Loans and Advances). Consequently, 35% of private credit deals involve M&A financing. However, RBI’s Draft Directions on Acquisition Finance proposes to somewhat ease this restriction.10
Apart from the above, The IBC significantly strengthened creditor rights and recovery prospects, boosting confidence among lenders and supporting the growth of private credit. At the same time, many borrowers, particularly smaller firms, those with weak earnings, high leverage or insufficient collateral, struggle to access bank loans making private credit a natural alternative11. This shift was further accelerated by an extended period of low global interest rates, which pushed investors to seek higher-yielding opportunities and increased capital flows into private credit strategies.
The most common structure for channelising private credit is an AIF – more specifically, a Category II AIF. A ‘Private Credit AIF’ is essentially an AIF whose primary investment strategy is direct debt financing (by investing in debt instruments) to borrowers outside the conventional banking/syndicated loan market. Since AIFs are not subject to the same regulatory framework as traditional lenders (for example, no deposit-taking, no CRR/SLR requirements etc.), they can offer tailor-made structures such as step‐up interest rates, bullet repayments, equity warrants, convertible features, etc.
A private credit fund requires long-term, stable capital, and frequent redemption demands can disrupt lending strategy. A closed-ended Category II AIF structure suits this model well, as it locks in investor capital for the fund’s life and prevents premature withdrawals. Private credit deals are idiosyncratic and difficult for outside parties to value or trade, lenders typically rely on long-term pools of locked-up capital for financing. One advantage AIFs have over mutual funds is that mutual funds are restricted to investing only up to 10% of their debt portfolio in unlisted plain vanilla NCDs.
Compared to private equity or venture capital, where performance depends heavily on market conditions and timing exits, private credit offers returns that are largely predetermined by contract. The trade-off, however, is that like most AIFs, these investments typically come with multi-year lock-ins and fewer exit opportunities, underscoring their inherently illiquid nature. Typically, investors which can commit long term capital are well-suited to invest in such AIFs – such as pension funds and sovereign wealth funds etc.
Rise of Business Development Companies
A Business Development Company (BDC) is a U.S. investment vehicle designed to channel capital to small and mid-sized businesses that lack easy access to traditional bank financing or public capital markets. BDCs were created by the U.S. in 1980, through amendments to the Investment Company Act of 1940(see sections 2(48), 54 and 55), with a clear policy objective: to allow retail investors to participate in private credit and growth capital, an area previously accessible only to institutional investors.
As per a Federal Reserve Paper: BDCs are a way for retail investors to invest money in small and medium-sized private companies and, to a lesser extent, other investments, including public companies. BDCs are structured in different ways. Public BDCs refer to those with shares traded on national securities exchanges, and those whose shares are not traded on national securities exchanges but placed through SEC-registered or private placement offerings are non-publicly traded BDCs. BDCs typically finance middle-market firms—companies with EBITDA between $5 to $100 million, which historically have had limited access to funding from commercial banks and public debt markets. They also provide finance to development-stage companies in sectors such as technology, life science, healthcare information and services and sustainability industries, and private-equity owned or sponsored companies. Structure and regulatory framework: Legally, a BDC is an unregistered closed-end investment company (fund). To qualify as BDC, a company must invest at least 70% of its assets in ‘eligible portfolio companies’ i.e. firms with market values below $250 million and provide ‘significant managerial assistance’ to its portfolio companies [see section 2(48) of the Investment Company Act, 1940]. These companies are often private, thinly traded public firms, or businesses undergoing financial stress. To avoid corporate-level taxation, they must distribute at least 90% of their taxable income to shareholders each year (like REITs and InvITs in India). BDCs are also permitted to use leverage (up to 2x the amount of assets).
BDCs raise capital through IPOs, follow-on equity issuance, corporate bonds or hybrid securities. While many BDCs are publicly traded on stock exchanges (50 in number), offering daily liquidity to investors, some exist as non-traded BDCs with limited liquidity (47 in number) and yet some as private BDCs (50 in number).12
Investment mix: Although BDCs are permitted to invest in both equity and debt, their portfolios are majorly debt-focused. In practice, 60–85% of a typical BDC portfolio is invested in debt instruments, such as senior secured loans, second-lien loans, or mezzanine debt. Equity investments usually comprise 15–30% of assets.13 Because of this allocation, interest income from loans is the primary driver of BDC earnings. This income tends to be steady and predictable, which aligns well with the BDC structure. For example, Ares Capital, one of the largest BDCs, allocates roughly 78–83% of its portfolio to debt (primarily first-lien loans) and about 17% to equity.
How BDCs generate returns: BDCs generate returns through multiple channels:
Interest income from loans to portfolio companies (the dominant source)
Dividends from preferred or common equity holdings
Capital gains from selling equity stakes or converting and exiting convertible securities
Many BDC loans are floating-rate, which provides partial protection in rising interest rate environments. However, most BDC investments are below investment-grade or unrated and equity positions are often in privately held or financially stressed companies, introducing credit and valuation risk.
Comparison with venture capital, private equity AIFs and Mutual Funds: BDCs are often compared with venture capital and private equity funds because all three invest in private, illiquid companies and may provide strategic or managerial support. The key distinction lies in investor access and structure. Venture capital and private equity funds are privately placed vehicles, restricted to institutions and wealthy investors, with long lock-ups and limited transparency. BDCs, by contrast, are designed to be accessible to retail investors and trade on public exchanges.
This distinction becomes especially relevant when comparing BDCs with AIFs in India, particularly private credit AIFs. Economically, BDCs resemble private credit AIFs; both lend to mid-market companies and rely heavily on interest income. The crucial difference lies in retail participation. In India, AIFs exclude retail participation by making the minimum investment amount of Rs. 1 Crore and prohibiting public issuances. In the U.S., BDCs were created to enable retail participation therefore there are no minimum investment norms and public issuances are allowed for BDCs. In this sense, BDCs can be thought of as private credit AIF-like strategies wrapped in a publicly traded structure, placing them between mutual funds (fully liquid public-market vehicles) and AIFs (illiquid private-market vehicles) on the investment spectrum.
From an Indian regulatory perspective, mutual funds offer the closest structural comparison to BDCs, albeit with important distinctions. Indian mutual funds are not permitted to employ leverage as part of their investment strategy and may borrow only to meet temporary liquidity requirements, capped at 20% of net assets (see Regulation 44 of the SEBI Mutual Fund Regulations). In addition, mutual funds face strict asset-side constraints, including a limit of 10% of the debt portfolio in unlisted plain-vanilla non-convertible debentures (see paragraph 12.1.1 of the SEBI Master Circular on Mutual Funds). These restrictions constrain exposure to illiquid private credit, making a BDC-like structure regulatorily infeasible in India under the mutual fund framework.
Global context: No other major market has created a true equivalent of the BDC. While regions such as Europe, Canada, and Australia have listed private credit funds, specialty finance vehicles, or credit income trusts, these structures typically limit or discourage retail participation. Risk considerations: While BDCs may have stable and regular income, they carry elevated risks. Their portfolios consist largely of non-investment-grade debt and equity in small or distressed companies, often with limited public information. Credit losses, economic downturns or excessive leverage can materially impact returns.
Regulatory Concerns with Growth of Private Credit?
IMF in its 2024 Global Financial Stability Report highlighted risks w.r.t rise in private credit since its growth comes with several structural weaknesses that make the market vulnerable, especially in a downturn. Its rapid expansion is happening largely outside traditional regulatory oversight and because the market has not been stress-tested, the true scale of risk remains unclear. Borrowers tend to be smaller and more leveraged and with most loans being floating-rate, repayment stress can escalate quickly when interest rates rise. Although private credit funds’ leverage appears low compared with other lenders, end borrowers tend to be more highly leveraged than those in public markets, increasing the risks to financial stability.14
The increased complexity and the interconnections with leveraged financial entities create more channels through which unexpected losses in private credit could spread to the broader financial system15
Instruments such as PIK interest16 only defer the problem, increasing loss severity if performance deteriorates. Liquidity is another pressure point since private credit funds are inherently illiquid. Risk is further amplified by layers of hidden leverage, at the borrower, SPV, investor and fund level making contagion hard to track. Layers of leverage are created by the AIF lending against equity to a holding entity, which infuses the equity into an operating company, and the operating company borrowing against such equity.
Because loans are private, unrated and rarely traded, valuation is opaque and losses may remain masked until too late. Growing competition also risks weakening underwriting standards and covenant discipline, particularly as larger banks participate in private deals.
Practical challenges add to this vulnerability. Collateral enforcement may not always hold up legally, say due to restrictions on transferability of collateral (say, shares of a private company). Equity-linked security is volatile as well, and during distress, equity tends to lose its value almost completely. In essence, private credit offers flexibility and returns, but its opacity, leverage, illiquidity and weaker borrower profiles create risks that could surface sharply in stress conditions. Private credit certainly warrants closer attention. Nonbank lenders, especially private credit funds, have grown rapidly in recent years, adding to financial stability risks because they are less transparent and not as firmly regulated.
Do private credit AIFs create any regulatory arbitrage?
What you cannot do directly, you cannot do indirectly – the age-old maxim might apply in case a RE which is otherwise barred by RBI for an object, uses the AIF route to achieve that object. Below we examine some of the distinctions in the regulatory oversight:
Function
Private Credit AIFs
RE
Credit & Investment rules
Credit underwriting standards
No regulatory prescription
No such specific rating-linked limits. However, improper underwriting will increase NPAs in the future.
Lending decision
Manager-led
Investment Committee under Reg. 20(7) may decide lending
Manager controls composition of IC;
IC may include internal/external members;
IC responsibilities may be waived if investor commitment ≥₹70 Cr w/ undertaking Primarily i.e. the main thrust should be in: – Unlisted securities; and/or – Listed debt rated ‘A’ or below
Lending decisions guided by Board-approved credit policy
Exposure norms
Max 25% of investible funds in one investee company.
Exposure is limited to 25% of Tier 1 Capital per borrower and 40% per borrower group for NBFC ML;
No such limit for NBFC BL.
Banks can lend maximum upto 15% of their Tier 1 + Tier 2 capital to a single borrower. Large exposure norms may apply in case of banks and Upper Layer NBFCs
End-use restrictions
None prescribed under AIF Regulations, results in high investment flexibility
Banks cannot lend for land acquisition or for funding a M&A deal [refer ‘sector-specific regulatory gaps’ above] NBFCs do not have any such restrictions. They do have internal limits on sensitive sector exposures which includes capital market and commercial real estate [See Para 92 of SBR]
Related party transactions
Need 75% investors consent [reg 15(1)(e)]
Board approval mandatory for loans ≥₹5 Cr to directors/relatives/interested entities;
Disclosure + abstention from decision-making;Loans to senior officers requires Board reporting [See para 93 of SBR]
Capital, Liquidity & Leverage Requirements
Capital requirements
No regulatory prescription as the entire capital of the fund is unit capital
Minimum net owned funds of ₹10 Cr, CRAR 15% for NBFC-ML and above [See para 133.1 of SBR]9% CRAR in case of banks,
Liquidity & ALM
Uninvested funds may be parked in liquid assets (MFs, T-Bills, CP/CDs, deposits etc.) [15(1)(f)]
NBFC asset size more than 100 Cr. have to do LRM [Para 26]
Leverage limits
No leverage permitted at AIF level for investment activities Only operational borrowing allowed
Leverage ratio of BL NBFC cannot be more than 7 No restriction on NBFC ML however, CRAR of 15% makes results into leverage limit of 5.6 times For Banks, in addition to CRAR, there is minimum leverage ratio is 4%
Monitoring, Restructuring and Settlements
Loan monitoring
No regulatory prescription
RBI-defined SMA classification, special monitoring, provisioning & reporting.
Compromise & settlements
No regulatory prescription
Governed by RBI’s Compromise & Settlement Framework
Governance, Oversight & Compliance
Governance & oversight
Operate in interest of investors Timely dissemination of info Effective risk management process and internal controls Have written policies for conflict of interest, AML. Prohibit any unethical means to sell/market/induce investors Annual audit of PPM termsAudit of accounts 15(1)(i) – investments shall be in demat form Valuation of investments every 6 months
A Risk Management Committee is required for all NBFCs. [See para 39 of SBR] AC [94.1], NRC [94], CRO [95] ID and internal guidelines on CG [100] required for NBFC-ML and above
Diversity of borrowers
Private credit AIFs usually have 15-20 borrowers.
Far more diversified as compared to AIFs
Pricing
Freely negotiated which allows for high structuring flexibility
Guided by internal risk model
Table 2: Differences in regulatory oversight between AIFs and Regulated Entities (REs)
The core difference between private credit AIFs and RBI-regulated lenders lies in regulatory intent. SEBI is a disclosure-driven market regulator, it relies on transparency, governance and informed investor choice. RBI is a prudential regulator tasked with protecting systemic stability, and therefore imposes capital buffers, exposure limits and stricter supervision. Private credit AIFs operate within SEBI’s lighter, disclosure-based approach, while banks and NBFCs function under RBI’s risk-averse framework. This does not always create arbitrage, but it does allow credit activity to grow outside the prudential perimeter. As private credit scales, a coordinated SEBI-RBI framework may be necessary to preserve flexibility without compromising financial stability.
It is important to recognise that Category I and Category II AIFs are prohibited from taking long-term leverage. As a result, any loss arising from their lending or investment exposures does not cascade into the wider financial system. Therefore, concerns around applying capital adequacy requirements to these AIF categories are largely unwarranted.
Conclusion
Though still a small fragment of India’s wider corporate lending landscape, private credit AIFs are steadily gaining ground reaching those nooks and crannies of credit demand that banks and NBFCs often cannot, or would not, serve. Their ability to operate beyond the traditional comfort zone of regulated lenders is what makes this segment structurally relevant and increasingly attractive to borrowers and investors alike.
At the same time, rapid expansion brings the potential for regulatory arbitrage. The RBI has already acknowledged this risk, most notably through its actions on evergreening via AIF structures, ultimately resulting in exposure caps of 10% for individual regulated entities and 20% collectively, along with mandatory full provisioning where exposure exceeds 5% in an AIF lending to the same borrower. These measures serve as guardrails to prevent private credit vehicles from functioning as an indirect tool for evergreening of loans.
A middle-market firm is a firm that is typically too small to issue public debt and requires financing amounts too large for a single bank because of its size and risk profile. The size of middle-market firms varies widely. In the United States, they are sometimes defined as businesses with between $100 million and $1 billion in annual revenue. ↩︎
Payment-in-kind (PIK) is noncash compensation, usually by treating accrued interest as an extension of the loan. ↩︎
See our other resources of Alternative Investment Funds here
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2025-12-02 11:01:512026-01-07 14:56:59Private Credit AIFs: Lenders of Last Resort?
From 28th Nov 2025, all RBI regulated entities are governed by a completely new set of regulations.
We provide a complete comparative snapshot of the familiar old regulations and the new avatars. We have also shortlisted the changes, if any, as also commented for your comfort where there are no changes from the earlier regime.
Actionables: While there are rarely any significant substantive changes, however, REs may, at an early date, bring this major rewriting exercise to the knowledge of their boards, and proceed to make consequential changes in policies, SOPs, etc.
Capital markets are subject to higher fluctuations and volatility, and hence, Capital Market Exposures (CME) carry a higher risk, naturally requiring higher level of control and prudential norms by the regulator. The RBI recently released Draft Reserve Bank of India (Commercial Banks – Capital Market Exposure) Directions, 2025, consolidating and amending the regulatory directions pertaining to CMEs. The proposed amendments are significant, providing for a flexibility of financing “acquisitions” in the secondary market while also strengthening the prudential requirements in relation to CMEs.
Where the CoC has no regulated financial entity and a single unregulated financial creditor holds over 66% of the voting share, effectively dominating all decisions, IBBI in its Discussion Paper dated 17th November, 2025 proposed that the five largest operational creditors will also be brought into the CoC meeting, giving them a seat and a voice in the discussions, even though they will not have voting rights.
Such operational creditors will be entitled to receive the notice, agenda and minutes of the meeting and may participate in deliberations. Notably, they cannot cast their vote in any of the agenda and merely attend the meeting as observers. However, the proposal suggests that the RP shall record their observations, if any, in the minutes.
The rationale behind such inclusion is that, in cases where the CoC does not have any regulated lender and an unregulated creditor effectively controls decisions with more than 66%, it raises a genuine concern about the quality and objectivity of CoC decision-making. Such a creditor may not have the financial or institutional expertise that banks and regulated entities typically bring to the process, and in some cases may even be a friendly or aligned party. This creates a risk that decisions may not withstand scrutiny and may dilute the credibility of what is otherwise treated as the CoC’s commercial wisdom.
However, the proposal does not fully take into account the following:
Whether possible under subordinate law: The Code already provides for exclusion of related party financial creditors from CoC. The Code does not permit further exclusions or inclusions to be specified by IBBI. The only scenario where IBBI regulations can step in is where there are NO financial creditors. Therefore, whether this proposed inclusion of operational creditors is possible by way of amendments in regulations, can be a point of discussion. Notably, the constitutionality and the “intelligibility” of the distinction between financial and operational creditors was discussed and settled in very early rulings of the SC on the Code – viz., Swiss Ribbons Pvt. Ltd. & Anr v. Union of India & Ors., Committee of Creditors of Essar Steel India Limited Through Authorised Signatory v. Satish Kumar Gupta & Ors. In those rulings as also in the frame of the Code, the image of a CD under insolvency has been one who has multiple financial creditors, primarily banks. The structure of the Code does not realize that in practice, there are several outliers. There are situations where insolvency may be a design rather than a fait accompli. In such cases, there may be a so-called financial creditor who has been introduced to avoid the formation of a CoC with operational creditors. Hence, the concern that IBBI is trying to address is quite well appreciated, but the issue is – are these remedies possible without the main law being amended?
Regulated vs. unregulated financial creditors: The proposal seeks to distinguish between “regulated” vs. “unregulated” financial entities. The concerns as to quality, objectivity may still be there, as being a regulated entity does not guarantee these features. There are some 8000-odd NBFCs which are regulated. Technically, even the non-corporate moneylenders may also have registration under State money-lending laws and may claim to be regulated. The mere fact that a financial creditor is regulated does not ensure objectivity and transparency.
In fact, assume there is a single regulated entity holding the financial debt. The very fact that one entity has 66% share (that is, the voting share required to have decisions passed) in the admitted financial claims gives the creditor the right of complete control on the proceedings.
The inclusion of OCs without voting rights raises concerns about utility: Their presence adds no real decision-making power, calling into question the practical value of their participation. The only silver lining may be that as the minutes of CoCs will capture the observations of the OCs, the NCLT while approving the plan may have regard to the fairness or otherwise of the decisions of the CoC. Going by the weight of SC views that AAs do not have the right to question the commercial wisdom of the CoC, whether a solo-powered CoC’s decisions will also carry the same aura of commercial wisdom remains to be seen.
The core issue remains unaddressed: An unregulated financial creditor with over 66% voting share continues to dominate outcomes, while the OCs’ views are merely recorded without any mandatory impact on final decisions.
The proposal diverges from the BLRC’s foundational reasoning: The BLRC Committee reasoned that members of the creditors committee have to be creditors both with the capability to assess viability, as well as to be willing to modify terms of existing liabilities in negotiations. This proposal thereby contradicts the BLRC framework.
In this regard, the BLRC Committee noted as follows:
“Typically, operational creditors are neither able to decide on matters regarding the insolvency of the entity, nor willing to take the risk of postponing payments for better future prospects for the entity. The Committee concluded that, for the process to be rapid and efficient, the Code will provide that the creditors committee should be restricted to only the financial creditors.”
Our Views:
Even though the intent behind such a proposal is noble, it may fail its desired objective.. The intent of this provision can succeed only if the rights of OCs are clearly laid down. Securing a seat in CoC meetings and a right to put forward their views may be a welcome step for bringing OCs into the process. However, the actual influence that OCs can exert as mere observers remains uncertain. Only with time will it become clear whether their inclusion practically alters decision making in CoC meetings or merely remains a symbolic entry.
Also read our detailed article titled “Subordination of Operational Creditors Under IBC: Whether Equitable” [Published on 26th July, 2018]
Other Proposals in the DP:
1. Mandate that the IM shall include the details of all allottees, including their names, amounts due, and units allotted, as reflected in the CD’s records, regardless of whether they have filed formal claims and require that the resolution plan provides for the treatment of such allottees.
2. Disclosure of receivables, JDAs and information on assets which are under attachment, should be mandatorily included in the IM
3. When the CoC recommends liquidation even though a compliant resolution plan of value greater than the liquidation value was received, the reasons for recommendation for liquidation shall be recorded and submitted in the application for liquidation to the NCLT.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2025-11-26 11:16:592025-11-26 11:23:37A voice without a vote: IBBI proposes OCs as observers amongst unrelated FCs in CoC
This episode of Mahattva – Voices that Matter, brings together the heads of two prominent MFIs. Microfinance has been attracting attention of the entire financial system, with concerns as well as with significant optimist curiosity. Clearly, this is one segment of the financial system where financial inclusion is at its very core. We intend to have a range of questions of what are the causes of the current state of things, opportunities, way forward, induction of capital and debt, and regulatory advocacy.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2025-11-25 10:47:312025-11-25 14:33:44Microfinance: State of the Industry and Way Forward
The structure of a trust inherently creates a separation of roles, typically involving three distinct parties viz. the author/settlor, trustee, and beneficiaries. While the control/operations rests with the trustee, economic benefit lies with the beneficiaries, and the settlor may continue to exert influence through the trust deed or reserved powers, thus making it difficult to clearly identify who actually “owns” or “controls” the trust. This intrinsic separation of legal control, economic interest and potential influence renders trusts far more opaque than other conventional structures like companies or partnerships. What makes the structure even more complicated is that trusts are mostly governed by 19th century laws. Trusts are not required to publicly file information about their beneficiaries; in many cases, trustees may even contend that they are not maintaining any such regular list.
Adding to this complexity is the fact that trusts may be structured in different forms. Based on the degree of control with the trustees, trusts may be discretionary, where the trustee has full discretion to identify the beneficiaries and/or their share, or non-discretionary, where the beneficiaries have identifiable and predetermined rights in the trust property.There are trusts where the determination of beneficiaries is either contingent or future – for example, children and grandchildren of the settlor. In discretionary trusts, beneficiaries may not have a defined share or enforceable claim at any given point, making it unclear whether they can be treated as beneficial owners at all. In non-discretionary trusts, although the beneficiaries are identifiable, the trustee continues to hold legal title, again blurring the line of who truly “owns” the trust.
For Reporting Entities1 (“REs”), including Banks and NBFCs, identification and onboarding becomes more complex when the customer is a non-individual entity. The extent of verification varies by entity type, and trusts in particular create added challenges because of the reasons cited above.
Relevance of Identifying Beneficial Owners (‘BO’)
Before discussing how REs should identify a trust’s BO, it is important to understand why they must do so. Under para 9 and 10 of the RBI KYC Directions, 2016, every regulated entity is required to frame a Customer Acceptance Policy which, at a minimum, mandates that no account-based relationship or transaction may be undertaken unless full Customer Due Diligence (‘CDD’) is completed. The same is based on R.10 of The FATF Recommendations.
As defined under para 3(b) Clause (v) of RBI KYC Directions, 2016, “Customer Due Diligence means identifying and verifying the customer and the beneficial owner using reliable and independent sources of identification”. Further, clause 3 under explanation to the above para extends this requirement to “Determining whether a customer is acting on behalf of a beneficial owner, and identifying the beneficial owner and taking all steps to verify the identity of the beneficial owner, using reliable and independent sources of identification.”. Similar to what is prescribed under Rule 9(1) of PML Rules, 2005.
As part of CDD, REs are required to identify customers and their BOs, which in turn places a corresponding obligation on customers to truthfully disclose their ownership structure and furnish relevant documents that establish the identity of a natural BO. This process obliges REs to verify the authenticity and completeness of the information and documents submitted, use these findings to determine whether to establish the business relationship and to appropriately assign a risk rating.
However, in practice, BOs may be reluctant to provide their KYC documents due to privacy concerns, fear of scrutiny, or because complex structures were intentionally designed to keep the BO’s identity concealed.
Who are ‘beneficial owners’?
As per para 3(a)(iv) clause (d) of RBI KYC Directions, “Where the customer is a trust, the identification of beneficial owner(s) shall include identification of the author of the trust, the trustee, the beneficiaries with 10 percent or more interest in the trust and any other natural person exercising ultimate effective control over the trust through a chain of control or ownership”. A similar definition is provided under Rule 9(3) of PML Rules, 2005.
Aforesaid definitions originates from The FATF Recommendations which clearly defines that in context of legal arrangements i.e. Trust, beneficial owner includes: “(i) the settlor(s); (ii) the trustee(s); (iii) the protector(s) (if any); (iv) each beneficiary, or where applicable, the class of beneficiaries and objects of a power; and (v) any other natural person(s) exercising ultimate effective control over the arrangement. In the case of a legal arrangement similar to an express trust, beneficial owner refers to the natural person(s) holding an equivalent position to those referred above.”
In a discretionary trust, the trustee has full discretion, whereas in a non-discretionary trust, beneficiaries have fixed rights and the trustee has limited discretion. This influences who can practically be identified as exercising control.
Now, in the case of a discretionary trust, the above framework is usually manageable because the trustee, who exercises control, may not object to being identified as a BO. However, in a non-discretionary trust, the trustee does not exercise independent discretion. In such cases, the trustee may express reluctance to be classified as a BO because he does not “benefit” from the trust in an economic sense and may view BO identification as an unwarranted extension of responsibility. This confusion often results from equating BO with someone who derives economic benefit, whereas under AML laws the emphasis is on identifying at least one identifiable individual, ensuring that there is an accountable natural person whom authorities and REs can pursue in the event of ML/TF concerns, regardless of whether they receive monetary benefit.
Difference between BO and Beneficiary
It is important to understand that the terms “beneficiary” and “beneficial owner” serve different purposes. The objective of identifying the BO is not to treat the trustee or settler as recipients of trust benefits, but to ensure that the RE can clearly trace the natural persons involved in controlling, directing, and/or benefiting from the trust arrangement. BO identification is a regulatory requirement aimed at preventing misuse of trusts for ML/TF purposes, not a determination of who is entitled to trust assets. When viewed this way, trustee and settler identification becomes a matter of transparency and risk assessment, not a reclassification of their legal or economic rights under the trust.
Identification of the natural person behind the Trust
REs typically encounter two scenarios that require them to look behind the trust structure, first, when the trust is the direct customer, second, when the trust is recognised as a BO of another entity.
Trust itself is the customer
When the trust itself is the customer, the BO identification framework is relatively straightforward. The PML Rules clearly prescribe that the following individuals must always be treated as BOs:
the author/settlor,
the trustee(s), and
any beneficiary holding 10% or more interest, where such interest is defined or quantifiable.
These natural persons fall squarely within the definition of beneficial owners and should be identified and verified without debate.
Where specific beneficiaries cannot be identified, for example, in a public charitable trust, or in a private trust where beneficiaries do not meet the 10% threshold, the obligation to identify BOs does not fall away. In such cases, the RE must still identify:
the author/settlor,
the trustee(s), and
any natural person exercising ultimate effective control, if any, .
Thus, the absence of identifiable beneficiaries does not dilute the requirement.
Indirect Identification (Trust as a BO / Shareholder / Partner of Another Entity)
Complexity increases when the customer is not the trust, but another legal entity, such as a company, LLP, or partnership, in which a trust holds a substantial stake. In such cases, identifying the natural person as BO requires a deeper “look-through” analysis.
The Interpretive Note to Recommendation 10 of The FATF Recommendations provides a structured cascading approach to determine BOs of legal persons. This approach should be applied sequentially2:
Step 1: Identify the natural persons with controlling ownership interest
Determine whether any natural person ultimately owns or controls the entity through direct or indirect ownership (including ownership via the trust), if yes, identify the person(s) as BO.
Step 2: Identify natural persons exercising control through other means
If no natural person is identifiable through ownership, identify the natural persons exercising control of the entity through other means, such as through one or more juridical persons.
In such cases, the BO definition for trusts should not be imported from the definitions as discussed above i.e. all parties to the trust need not automatically be treated as BOs of the entity concerned.
Instead, the focus should be on identifying the natural person(s), whether trustee or settlor, who genuinely hold or exercise the relevant control over the underlying company, and evaluating them against the test of control.
Step 3: Identify the Senior Managing Official (SMO)
If no natural person can be identified under Step 1 or Step 2, the reporting entity must identify and verify a Senior Managing Official of the customer entity itself.
Intent behind this clause, might be to cater to conditions where the legal person is held by another legal person which is, in turn, held by a trust or where the trust is a charitable trust with no identifiable beneficiaries and no effective control exercised by the trustee, the chain may not yield any natural person with a controlling ownership or control interest. In such situations, the responsibility reverts to the customer entity itself, and the senior managing official (SMO) of the customer is identified as the BO for CDD purposes.
While the concept of a BO and the concept of a Significant Beneficial Owner (SBO) under the Companies Act both aim to identify the natural persons behind an entity, the two frameworks differ significantly in scope and approach. The SBO definition focuses on identifying individuals who hold a prescribed level of ownership or control, and it does not provide a structured fallback if no individual meets that threshold.
In contrast, the BO identification under the Rule 9(3) PML Rules follows a cascading approach i.e. REs must first identify natural persons with ownership, then those who exercise control through other means. Further, only when neither approach detects a clear individual do the rules require identifying the senior managing official as the BO of last resort. This ensures that BO identification cannot be left blank, every entity must ultimately map to a natural person for AML purposes, even where no SBO exists, so that transactions are not carried out in benami or opaque structures.
Conclusion
It is important to clarify that being identified as a BO is primarily a regulatory formality for compliance. It does not alter a person’s rights, liabilities, or relationship with the trust or entity. The core objective is simply to ensure that there is a clearly identifiable natural person connected to the legal entity so that the RE can complete its due diligence and satisfy ALM requirements. Following are the limited obligations of being identified as a BO:
Provide basic KYC documents or Official Valid Document (OVDs) for verification of identity;
Respond to any follow-up queries during onboarding or monitoring; and
Undergo periodic KYC updates, as requested by the RE.
As per Section 2(wa) of PMLA Act, 2002 “reporting entity” means a banking company, financial institution, intermediary or a person carrying on a designated business or profession. ↩︎
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2025-11-23 14:31:492025-11-25 15:09:21The Hidden Hand: Understanding Beneficial Ownership in case of Trusts
Materiality thresholds increased, significant RPTs relaxed for small-value RPTs and newly incorporated subsidiaries
Highlights:
Following a 32-pager consultation paper proposing significant amendments to RPT provisions, towards ease of doing business, rolled out by SEBI on August 4, 2025, several amendments were approved by SEBI in its Board Meeting on 12th September, 2025. The SEBI (Listing Obligation and Disclosure Requirements) (Fifth Amendment) Regulations, 2025 have been notified on 19th November, 2025 amending the RPT framework for listed entities.
Some of our comments on the proposals, as recommended to SEBI, have also been accepted in the approved decisions. Our comments on the Consultation Paper may be read here.
Applicability of the Amendment Regulations
While the Amendment Regulations have been notified, the amendments with respect to the RPT framework are effective from the 30th day of the notification of the Amendment Regulations, that is, with effect from 19th December, 2025.
1. Materiality Thresholds: From One-Size-Fits-All to several sizes for the short-and-tall
A scale-based threshold mechanism has been approved, such that the RPT materiality threshold increases with the increase in the turnover of the company, though at a reduced rate, thus leading to an appropriate number of RPTs being categorized as material, thereby reducing the compliance burden of listed entities. The maximum upper ceiling of materiality has been kept at Rs. 5,000 crores, as against the existing absolute threshold of Rs. 1000 crores. The thresholds have been provided in Schedule XII, along with an illustration towards better understanding of the materiality thresholds.
Materiality thresholds as specified in Schedule XII:
Annual Consolidated Turnover of listed entity (in Crores)
Approved threshold (as a % of consolidated turnover)
Maximum upper ceiling (in Crores)
< Rs.20,000
10%
2,000
20,001 – 40,000
2,000 Crs + 5% above Rs. 20,000 Crs
3,000
> 40,000
3,000 Crs + 2.5% above Rs. 40,000 Crs
5,000 (deemed material)
Back-testing the proposal scale on RPTs undertaken by top 100 NSE companies show a 60% reduction in material RPT approvals for FY 2023-24 and 2024-25 with total no. of such resolutions reducing from 235 and 293, to around 95 to 119. The 60% reduction may itself be seen as a bold admission that the existing regulatory framework was causing too many proposals to go for shareholder approval.
Our Analysis and Comments
With the amendments becoming effective, RPT regime is all set to be a lot relaxed, with the absolute threshold for taking shareholders’ approval to be doubled to Rs. 2000 crores. In addition, for larger companies, there will be a scalar increase in the threshold, rising to Rs. 5000 crores. A lot lesser number of RPTs will now have to go before shareholders for approval in general meetings.
In times to come, a multi-metric approach, depending on the nature of the transaction, may be adopted, drawing on a consonance-based criteria as seen in Regulation 30 of the LODR Regulations, thus offering a more balanced and effective approach. See detailed discussion in the article here.
2. Significant RPTs of Subsidiaries: Plugging Gaps with Dual Thresholds
Extant provisions vis-a-vis Amended Regulations
Pursuant to the amendments in 2021, RPTs exceeding a threshold of 10% of the standalone turnover of the subsidiary are considered as Significant RPTs, thus, requiring approval of the Audit Committee of the listed entity. The following modifications have been approved with respect to the thresholds of Significant RPTs of Subsidiaries:
‘Material’ is always ‘Significant’: RPTs of subsidiary would require listed holding company’s audit committee approval if they breach the lower of following limits:
10% of the standalone turnover of the subsidiary or
Material RPT thresholds as applicable to listed holding company
This is a mathematical impossibility, since materiality threshold is based on “consolidated turnover”, and hence, includes the turnover of the subsidiary. Further, unlike networth, turnover cannot be a negative number, and hence, even if one or more of the subsidiaries of the listed entity are loss-making entities, the same cannot reduce the consolidated turnover of the listed entity to a number below the standalone turnover of its subsidiaries, whose accounts are being consolidated with the entity.
Exemption for small value RPTs: The threshold for Significant RPTs is subject to an exemption for small value RPTs based on the absolute value of Rs. 1 crore. Thus, where a transaction between a subsidiary and a related party (of the listed entity/ subsidiary), on an aggregate, does not exceed Rs. 1 crore, the same is not required to be placed for approval of the Audit Committee of the listed entity, even if the aforesaid limits are breached.
Alternative for newly incorporated subsidiaries without a track record: For newly incorporated subsidiaries which are <1 year old, consequently not having audited financial statements for a period of at least one year, the threshold for Significant RPTs to be based on lower of:
10% of aggregate of paid-up capital and securities premium of the subsidiary, or
Material RPT thresholds as applicable to listed holding company
The aggregate value of paid-up capital and securities premium, to be considered for the purpose of determination of Significant RPTs, should not be older than three months prior to the date of seeking AC approval. Since the value of paid-up capital and securities premium would be available with the company on a real-time basis, the same does not result in any additional compliance burden.
Our Analysis and Comments
For newly incorporated subsidiaries, the Consultation Paper proposed linking the thresholds with net worth, and requiring a practising CA to certify such networth, thus leading to an additional compliance burden in the form of certification requirements. Following the approval in SEBI BM, the Amendment Regulations provide a threshold based on paid-up share capital and securities premium, and hence, certification requirement does not arise.
3. Clarification w.r.t. validity of shareholders’ Omnibus Approval
Existing provisions vis-a-vis Amended Regulations
The existing provisions [Para (C)11 of Section III-B of LODR Master Circular] permit the validity of the omnibus approval by shareholders for material RPTs as:
From AGM to AGM – in case approval is obtained in an AGM
One year – in case approval is obtained in any other general meeting/ postal ballot
Pursuant to the Amendment Regulations, the timelines have been incorporated as a proviso to Reg 23(4). Further, a clarification has been incorporated that the AGM to AGM approval will be valid till the date of next AGM held within the timelines prescribed as per section 96 of the Companies Act.
4. Exclusions for retail purchases
Proviso (e) to Regulation 2(1)(zc) of the extant SEBI LODR Regulations exempted transactions involving retail purchases by employees from being classified as Related Party Transactions (RPTs), even though employees are not technically classified as related parties. Conversely, it includes transactions involving the relatives of directors and Key Managerial Personnel (KMPs) within its ambit.
The CP proposed that the exemption related to retail transactions should be expressly limited to related parties (i.e., directors, KMPs, or their relatives) to grant the appropriate exemption.
Under the extant framework, retail purchases made on the same terms as applicable to all employees were excluded from the meaning of RPTs when undertaken by employees, but not when made by relatives of directors or KMPs. This led to an inconsistent treatment, where similarly situated individuals receive different regulatory treatment solely on the basis of their relationship with the company.
Pursuant to the Amendment Regulations, the exclusion for retail purchases has been extended to the relatives of the directors/ KMP, when undertaken on “terms which are uniformly applicable/offered to all employees, directors, key managerial personnel and relatives of directors or key managerial personnel ”. While the language refers to terms offered to “employees, directors, key managerial personnel and relatives of directors or key managerial personnel”, the same cannot be read to mean that preferential terms can be granted to “director”, “KMPs” or “relatives of such directors/ KMPs” as a separate class. The terms need to be uniform to what is otherwise offered to “employees” by such a listed entity/ its subsidiaries.
5. Exemptions for RPTs between holding company and WoS
Regulation 23(5)(b) provides an exemption from audit committee and shareholder approvals for transactions between a holding company and its wholly owned subsidiary. However, the term “holding company” used in this context has remained undefined, leaving ambiguity as to whether it refers only to a listed holding company or includes unlisted ones as well.
A clarification has been inserted to provide the interpretational guidance that the term ‘holding company’ refers to the listed entity. The relevance of the aforesaid clarification would primarily be in cases where the unlisted subsidiary of the listed entity enters into a significant RPT with its wholly owned subsidiary (step-down subsidiary of the listed entity). Pursuant to the aforesaid proposal, as approved, no exemption will be available in such a case.
Conclusion
The amendments seem more or less welcoming, relaxing the RPT regime for listed entities. With the new leadership at SEBI meant to rationalise regulations, it was quite an appropriate occasion to do so. In sum, SEBI’s iterative approach to RPT governance demonstrates commendable responsiveness, contributing to the ease of compliances and in turn, of doing business by the companies.
Reload document 
Open in new tab 
