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Partly Paid Shares – Whether Doppelganger of Share Warrants?

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– Pammy Jaiswal and Saket Kejriwal | corplaw@vinodkothari.com

Background

In recent times, the use of partly-paid shares has seen some traction[1] where several listed companies[2] came up with issuance of partly-paid shares[3]. While the law provides for the issuance of partly-paid securities, it is important to understand how this instrument has not been used merely as a capital-structuring tool, but arguably, as a regulatory workaround. An analogy may be drawn to a situation where a customer is allowed to purchase a valuable by paying a token money today and pay the full consideration after a period of say 1-2 years at the same price which prevailed at the time of payment of token money. Specifically, promoters and investors appear to be utilizing partly-paid shares as a substitute for share warrants, by paying a minuscule part of the value of shares as a part of application money and the balance payment is allowed to be made at any time in the future, sometimes after an unreasonably long time.

In this article, we argue that the issue of such partly-paid shares is as good as issuing share warrants, However, circumventing the challenges associated with warrants.

Fundamentals of Share Warrants

Ashare warrant is a security issued by a company that grants its holder the right/option to subscribe to equity shares of the company (i.e. Future Equity) at a predetermined price, within  a predetermined period, upon the upfront payment of a token amount referred to as the option premium.

Legal Context

A share warrant, being marketable in nature, provides a right in securities, therefore, it is treated as a security under Section 2(h) of the Securities Contracts (Regulation) Act, 1956. Some of the relevant legal provisions would include:

  • Sections 42, 62 and other relevant provisions of the Companies Act, 2013; and
  • The SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018.

Key Features

  • Right to Decide: A share warrant allows an investor to subscribe to the company’s equity shares in the future, typically at a price lower than the anticipated market price at the time of exercise. Conversely, if the market price at the time of exercise falls below the pre‑determined price, the investor may choose not to subscribe, thereby limiting their loss to the option premium paid (i.e., the upfront cost), rather than incurring the full loss arising from the difference between the initial/subscription value and the reduced market price.
  • Option Premium: The upfront amount paid for obtaining this right is called the option premium i.e. if the current market value of shares is Rs.100, then the issuer may issue equity shares immediately at Rs.100, or Issue a share warrant where the investor pays Rs. 10 upfront for the right to subscribe the equity at Rs. 100 in the future. If, at the time of exercise, the market price of the share has risen to Rs. 120, the investor benefits from locking the price at Rs. 100, making the Rs. 10 upfront cost worthwhile. Conversely, if the market price falls to Rs. 50, the investor may choose not to exercise the warrant, limiting the loss to Rs. 10 i.e. option premium. This forms a part of the net worth of the company. For details on option pricing, may refer to our resource on Option Pricing Model.
  • Forfeiture: If the warrant holder chooses not to exercise the right, the upfront option premium is forfeited.

Pricing

The value of option premium is generally determined by Black Scholes Model, Binomial Options Pricing Model or Monte Carlo Simulation Method. The most appropriate method for calculation of option premium, in the context of companies using warrants as a regulatory workaround, is the Simulation Method.

One of the key features of share warrants is that the longer the life of the option, there is a higher probability of its price being high. In accordance with the above models, issuing share warrants for an extended period can raise the option premium to a point where it becomes undesirable. Therefore, it is recommended that the life of a warrant should be just and reasonable, and that it should not be used as a substitute for long‑term convertible instruments such as OCDs, CCDs, CCPS, or other similar securities.

Difference between warrants and partly-paid up shares

While both partly‑paid shares and warrants involve an upfront payment towards a future right in equity shares, they differ significantly on the following points:

Basis of DifferencePartly-Paid SharesShare Warrants
Right and ObligationHolder is obligated to pay the remaining call money when demanded by the company.   Failure to pay will lead to forfeiture of the subscription and call money received by the company.Holder has a right, but not an obligation, to subscribe to equity shares at a future date.
Nature of InvestmentThese are equity shares issued with part of the value paid upfront, making the holder a shareholder of the company.These are options issued for a premium, entitling the holder to subscribe for equity shares in the future.
ValuationShares are subscribed at fair value computed as on the date of making the first subscription/ call moneyShares are subscribed at current fair value on a future date along with payment of option premium
Shareholder RightsPartly-paid equity shareholders enjoy rights proportionate to their paid-up amount.No rights until conversion.

Why are partly-paid shares doppelgangers ?

Partly-paid shares in its usual nature when used for capital needs in tranches serves the permitted purpose for this concept was introduced, however, this benefit becomes a governance concern when it is used as an alternative to share warrants and as evident from the table above, the two differ in various aspects. The primary reason for this mirroring lies in valuation. In the case of share warrants issued with a longer tenor, the cost of the warrant, representing the right to subscribe to future equity, tends to be higher when calculated using fair value methods, making this option impractical. As an alternative, many companies have opted to issue partly-paid shares, allowing an investor to pay only a minimal upfront amount (similar to the option premium in the case of a warrant) as part of the application money and reserving the right with the investor to infuse the remaining funds for a longer period like 5-10 years which would not be possible in case of warrants as the premium will increase drastically, if calculated as per fair value methods.

Token money to secure allotment of shares

It is imperative to note that in case of share warrants, the price paid upfront is the option premium which is basically the price paid to get the equity at the current value at the future date as against in case of partly-paid shares, where the investor becomes a shareholder on the first payment date by even paying a nominal part amount reflecting the fair value (consisting of part face value and proportionate premium) as on the date of making such first payment. The catch lies in the fact that there is no legal prescription on the maximum time within which a company needs to make the final call on such partly-paid shares (except in case of IPOs) which in case of warrants runs up to 18 months for listed securities as well as size of the calls which in the case of listed companies requires at least 25% of the consideration amount calculated as per the formula for exercise price[4] with reference date being the record date shall be received at the time of option premium. 

One may argue that, given the fundamental difference between the two instruments is that one comes with a right (warrants) and the other with the security (partly-paid shares), they can not be used as substitutes as in case of partly-paid shares the right to call money lies with the Board and the investor is obligated to pay on demand, failing which shares may be forfeited, resulting in the loss of upfront amount paid.

On the other hand, a share warrant gives a right to the investor to decide when, or even if, to make the payment. If the investor chooses not to exercise the option, the upfront money paid is still forfeited, with the key difference being that the loss occurs at the investor’s discretion.

The above argument is valid theoretically. However, in practice, this mirroring is frequently used by start‑ups, which are generally incorporated as private companies. In such cases, although the ‘right to call money’ rests with the Board of Directors, the Board itself typically comprises the promoters i.e. the very investors who subscribe to these mirrored partly-paid shares or in the case of external investors/subscribers, their appointed representatives form an integral part of the Board. As a result, the obligation on the subscriber to pay the balance can, in reality, be viewed more as a right, given that it is exercised by a Board largely aligned with the interests of the investors themselves.

Additionally, partly-paid shares provide several benefits to the investor, like proprietary rights, chances to book profits in case of transfer, etc.We have discussed the same below:

Proprietary interest of partly-paid shares

Partly-paid shares are not merely rights in equity shares but allotment of the shares itself. Once an investor pays the subscription money/ first call, the shares are allotted to the investor who becomes a shareholder immediately and gets ownership rights from day one. Having said that, while the benefits arising out of such ownership is proportional to the amount paid up on the shares, it still dilutes the stake of the other investors who hold fully paid up shares.

The investor’s economic risk is lower compared to a fully paid-up shareholder since only part of the share price has been paid, the investor’s capital at risk is limited to the amount actually contributed, while the ownership position in the company already stands created.

Chance to book profits by transfer of partly-paid shares 

If an investor who has paid only a nominal amount intends to sell such shares for reasons like liquidity or apprehension of the investee not doing well for some reason, he stands a chance to make profits on the part payment where the fair value of such shares have appreciated at the time of such transfer. A purchaser can acquire ownership interest by paying only the fair value of the amount paid-up, while the remaining payment is effectively locked in at the historical fair value. This allows the investor to benefit from future upside without proportionately funding the company at the prevailing fair value for the unpaid portion, which remains priced at the value as on the date of issuance.

Imagine a situation where Mr. A invests in the partly-paid up equity shares of XYZ Ltd. The fair value of the equity shares is say INR 150 (face value INR 10) where Mr. A invests only INR 30 as paid up amount. Thereafter he decides to sell these partly-paid shares to another investor after 2 years by which time the balance amount is still uncalled. The transfer of these partly-paid shares would be done at a fair value where lets assume the value of the shares have appreciated and as a consideration, Mr. A receives INR 80 as the sale consideration and also passes on the legacy of holding partly-paid shares to the buyer.

However, this issue does not arise in listed companies, where market mechanisms ensure fair price discovery.

An Ideal partly-paid share

Situation where a partly-paid share shall not be considered as a share warrant

In our view, partly‑paid shares should be supported by a concrete plan or blueprint specifying when the call money is expected to be raised along with its purpose. This includes:

  • A defined timeline for making the call on unpaid money;

  • A specific purpose for which the call money will be used; and

  • An upfront subscription amount that is significant and reflects commitment, rather than being a token.

Even if an exact date cannot be determined, it is advisable to link the call to milestones/events ,such as regulatory approvals, project launches, or specific capital needs, rather than leaving it open-ended. This approach distinguishes a legitimate capital-raising intent from doppelganger design of warrants.

Situation where a partly-paid share shall be considered as a share warrant

A partly-paid share may raise regulatory concerns when above conditions do not exist. This includes situations where the initial application amount is nominal, resulting in minuscule capital infusion. Additionally, if the call structure is vague and lacks a defined timeline or commercial justification, it creates ambiguity around the company’s intention to actually raise the remaining capital. The concern is further amplified when the Board of Directors, which holds the discretion to make the call on these partly-paid shares, is influenced or controlled by the very investors who subscribed to these shares. In such scenarios, the obligation to pay the balance amount may become just theoretical.

Conclusion

The intention behind partly-paid shares is to raise capital while allowing the issuer to secure future source of funding, However, when a minuscule amount is paid at the time of subscription of partly-paid shares and the remaining calls are deferred for a long period without any definite /concrete plan, this raises concern as sighted above and from a valuation perspective may not be seen as a partly-paid shares.

[1] Economic Times

[2] Economic Times

[3] Economic TImes

[4] Regulation 67 of SEBI ICDR, 2018

Read more:

Share warrants under cloud – are companies not allowed to issue share warrants?

A Guide for AIF Managers on Investor Eligibility and Regulatory Restrictions

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Simrat Singh, Senior Executive | finserv@vinodkothari.com

Introduction

An AIF raises capital by issuance of units, which are privately placed.  Most AIFs follow a commitment–drawdown model, under which investors agree upfront to commit a specified amount of capital (‘committed capital’). The AIF manager then calls this committed capital, either in full or in tranches, as investment opportunities arise (‘drawdown’). This model helps the AIF to minimise the negative carry that would result from raising investments which are yet to be invested. 

This fund-raising process is shaped not only by SEBI’s AIF framework but also by the oversight of the respective sectoral regulators of the relevant investors. AIFs are meant strictly for sophisticated investors, and as such, various categories of AIF investors, such as insurance companies, pension funds, banks and NBFCs, etc. are subject to their respective regulations. When they invest in an AIF, they must comply with SEBI’s rules as well as the investment norms prescribed by their own regulators, each seeking to regulate how the capital of the investor is deployed. In fact, SEBI regulations are agnostic as to who the investor is, hence, most of the SEBI regulations relate to the AIF or the manager, with limited provisions dealing with investors. For example, whether and to what extent an insurance company or a pension fund can invest in an AIF is driven by the guidelines issued by the sectoral regulators such as IRDAI or PFRDA.

In this article, we try to bring together, in one place, the key regulatory norms imposed by various regulators; while these are primarily meant for the investor, however, it will be useful for the AIF managers to keep in mind these restraints while expecting or inviting investments from different categories of investors.

Categories of investors and regulatory restrictions on each category

Minimum investment norms: Common across all categories

  1. ₹25 crore for investors in Large Value Funds (reduced from ₹ 70 Crore per investor vide SEBI (Alternative Investment Funds) (Third Amendment) Regulations, 2025) [Reg. 2(1)(pa)];
  2. ₹1 crore for other investors [Reg 10(c)];
  3. ₹25 lakh for employees or directors of the AIF, manager, or sponsor [Reg 10(c)];
  4. No minimum for units issued to employees solely for profit-sharing (and not capital contribution) [Para 4.6 of AIF Master Circular];
  5. For open-ended AIFs, the initial investment must meet the minimum threshold, and partial redemptions must not reduce the holding below this minimum [Para 4.7 of AIF Master Circular].

Individuals

An AIF may raise funds from individual investors, whether resident, non-resident (NRI), or foreign, through private placement, subject to the following conditions (Refer Reg. 10(a) of AIF Regulations r/w Chapter 4 of AIF Master Circular).

  1. Foreign investors: A foreign investor must:
    1. be a resident of a country whose securities market regulator is a signatory to the IOSCO Multilateral MoU (Appendix A) or has a Bilateral MoU with SEBI; or
    2. be a government or government-related investor from a country approved by the Government of India, even if the above condition is not met.

Additionally, neither the investor nor its beneficial owner1:

  1. May be listed on the UN Security Council Sanctions List; or
  2. may be a resident of a country identified by the FATF as having serious AML/CFT deficiencies or insufficient progress in addressing such deficiencies.

If a foreign investor ceases to meet these conditions after admission, the AIF manager must stop making further drawdowns from that investor until compliance is restored.

  1. Joint Investments: Joint investments, for the purpose of investment of not less than the minimum investment amount in the AIF, are permitted only between:
    1. an investor and spouse;
    2. an investor and parent; or
    3. an investor and child.

A maximum of two persons may invest jointly. Any other combination of joint investors must individually meet the minimum investment threshold. (Refer Reg. 10(c) of AIF Regulations r/w Chapter 4 of AIF Master Circular)

  1. Terms of Investment: The terms agreed with investors cannot override or go beyond the disclosures in the PPM [Para 4.3 of AIF Master Circular].
  2. The total number of investors is limited to 1000 investors per scheme; also note that an AIF cannot make a public offer. AIF units are commonly offered through distributors; but even the distributors cannot make an open offer (Please refer to our resource on Dos and Don’ts for AIF Distributors and AIF Managers).

Insurance Companies

  1. Permissible AIF Categories [Para 1.5 of Investments – Master Circular, 2022 read with IRDAI Circular No. IRDAI/F&I/CIR/INV/074/04/2021 dated 05.04.2021]: 
    1. Category I AIFs: Infrastructure Funds, SME Funds, Venture Capital Funds, and Social Venture Funds (‘Specified Cat I AIFs’);
    2. Category II AIFs: Only where at least 51% of the corpus is proposed to be invested in infrastructure entities, SMEs, venture capital undertakings, or social venture entities (‘Specified Cat II AIFs’).
    3. Investment in a Fund of Fund (‘FoF’) is allowed only if such FoF does not directly or indirectly invest funds outside India (Refer Section 27E of Insurance Act, 1938). This is to be ensured by inserting a clause in the Fund offer Documents executed by FoF to restrain such FoF investing into AIFs which invest in overseas companies/funds. Further, investment is not allowed in an AIF which in-turn has an exposure to a FoF in which the insurer already invested. Lastly, no investment in an AIF is allowed which undertakes leverage/borrowing other than to meet operational requirements. 

Compliance of conditions laid down in (iii) are to be certified by the concurrent auditor of the insurer and filed along with quarterly periodical returns. Notably, insurance companies are prohibited from investing in Cat III AIFs

  1. Prohibited Structures: Insurers shall not invest in AIFs that:
    1. offer variable rights attached to units.
    2. invest funds outside India either directly or indirectly [s. 27E of Insurance Act, 1938];
    3. are sponsored by persons forming part of the insurer’s promoter group;
    4. are managed a manager who is controlled, directly or indirectly, by the insurer or its promoters;
  2. Investment Limits: 
    1. For life insurers, combined exposure to AIFs and venture capital funds is capped at 3% of the relevant insurance fund2.
    2. For general insurers, the cap is 5% of total investment assets3.

Exposure to any single AIF cannot exceed the lower of 10% of the AIF’s corpus or 20% of the insurer’s total AIF exposure. For Infrastructure Funds, the 10% limit is enhanced to 20%.

Banks and other Regulated Entities (REs)

Banks and other REs may invest in Category I and Category II AIFs, subject to layered limits:

  1. Bank level: Not more than 10% of the AIF corpus.
  2. Group level: Up to 20% without RBI approval, and up to 30% with prior RBI approval, subject to capital adequacy and profitability conditions.
  3. System level: Aggregate investments by all regulated entities cannot exceed 20% of the AIF corpus.

Banks must ensure that AIF investments do not circumvent banking regulations by creating prohibited indirect exposures. Banks are not permitted to invest in Category III AIFs, except for the minimum sponsor contribution where a bank subsidiary sponsors such a fund. For a more detailed discussion on Banks’ investment in AIFs, refer to our resource here. 

NBFCs

An NBFC shall not individually contribute more than 10 percent of the corpus of an AIF Scheme. [See Para 8 of RBI ( NBFC –  Undertaking of Financial Services) Directions, 2025]. The system-level investment limit of 20% for all REs shall also apply. Notably, unlike banks, NBFCs can invest in Cat III AIFs. 

Pension, Provident and Gratuity Funds

Pursuant to a 15 March 2021 notification, non-government Provident Funds, Superannuation Funds, and Gratuity Funds may invest up to 5% of their investible surplus in Specified Cat I AIFs and Specified Cat II AIFs, classified as “Asset Backed, Trust Structured and Miscellaneous Investments”.

Key conditions include:

  • Minimum AIF corpus of ₹100 crore;
  • Maximum exposure of 10% to a single AIF (not applicable to government-sponsored AIFs);
  • Investments restricted to India-based entities only;
  • The AIF sponsor and manager must not be part of the fund’s promoter group.

For Government  Sector Schemes such as UPS/NPS/NPA Lite/Atal Pension Yojna and Corporate CG schemes, the conditions are the same as above for non-government pension funds. 

Mutual Funds

Mutual funds are governed by the SEBI (Mutual Funds) Regulations, 1996. The Seventh Schedule to these regulations sets out the permissible investment universe. Units of AIFs are not included, and accordingly, mutual funds cannot invest in AIF units.

  1. beneficial owner as determined in terms of sub-rule (3) of rule 9 of the Prevention of Money-laundering (Maintenance of Records) Rules, 2005 ↩︎
  2. The relevant insurance fund would refer to the specific fund of a life insurer from which an investment is made, rather than the insurer’s overall balance sheet. This is because Life insurers maintain separate, ring-fenced funds for different lines of business, such as the life fund, pension fund, annuity fund or ULIP fund and investments must be made out of, and limits calculated with reference to, the particular fund whose money is being deployed. ↩︎
  3. Investment assets would refer to the total pool of assets held by a general insurer that are available for investment, across all lines of non-life insurance business. Unlike life insurers, general insurers do not maintain separate, ring-fenced policyholder funds for each product. Instead, premiums collected from various non-life insurance policies are invested as a consolidated portfolio, and regulatory investment limits such as exposure to AIFs are calculated with reference to the insurer’s aggregate investment assets shown on its balance sheet. ↩︎

See our other resources on AIFs:

  1. CIV-ilizing Co-Investments: SEBI’s new framework for Co-investments under AIF Regulations
  2. Understanding the Governance & Compliance Framework for AIFs
  3. FAQs on specific due diligence of investors & investments of AIFs;
  4. RBI bars lenders’ investments in AIFs investing in their borrowers;
  5. Capital subject to ‘caps’: RBI relaxes norms for investment by REs in AIFs, subject to threshold limits;
  6. Can CICs invest in AIFs? A Regulatory Paradox;
  7. Trust, but verify: AIFs cannot be used as regulatory arbitrage;
  8. 2020 – Year of change for AIFs;
  9. AIF ail SEBI: Cannot be used for regulatory breach;

SEBI removes redundancy to ease compliance

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– Team Corplaw | corplaw@vinodkothari.com

SEBI removes redundancy to ease complianceDownload

See our other resources:

  1. SEBI Clears the Way : HVDLEs Set to Move from “High Value” to “Higher Value” 
  2. SEBI fixes the cut-off date for re-lodgement of physical transfers

Securities Market Code: Consolidation, principled regulation-making, and decriminalisation

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– Payal Agarwal, Partner | Vinod Kothari & Company | corplaw@vinodkothari.com

Year 2025 will go down in the history of independent India as the year of the most brisk legislative activity – mostly by way of consolidation of some of the major laws. Income Tax Act, labour laws, securities markets, IBC, RBI Regulations etc – everywhere, we find the lawmakers have been quite busy themselves,  of course making the subjects and companies even busier. The Securities Market Code (SMC) has been introduced in the Lok Sabha, pursuant to the announcement in the Union Budget 21-22. Divided into a total of 18 chapters, the SMC seeks to consolidate and repeal the following: 

  • SEBI Act, 1992, 
  • Depositories Act, 1996, and 
  • Securities Contracts (Regulation) Act, 1956

The Code reflects a structural consolidation exercise, however, also with an underpinning attempt to make rule making more practical and principled, providing for investor protection by reintroducing ombudsman, providing legal sanctity to inter-regulatory coordination, covering complex securities transactions, etc. Further, the gazette notifications issued in relation to the aforesaid Acts are also proposed to be made a part of the Code. 

Major proposals 

  • Providing timelines & limitation period for investigations and validity of interim orders, with scope of extension in some cases
  • Classification between fraudulent/ unfair practices and market abuse, towards better clarity with powers to order cease and desist, authorisation for seizure of books etc. in case of market abuse 
  • Strengthening powers and functions of SEBI by enabling power to issue subsidiary instructions, undertaking periodic research and regulatory impact assessment studies etc. 
  • Issue of new regulations in relation to SEBI Ombudsperson, restitution to persons suffering losses on account of contravention etc. 
  • Introduction of new terms such as – market participants (issuers and investors), Securities Market Service Providers (Intermediary + MII + SRO) etc. 
  • Clarity in the scope of securities and recognition to “other regulated instruments”
  • Clarifications in relation to scope of investment vehicles, title over securities held with depository etc. 

Time-bound investigations and interim orders 

  • Limitation period for investigation: eight years from the date of default or contravention
    • Extension permitted in case of matters referred by Investigating Officer or matters having systemic impact on the securities market  [Clause 16] 
  • Investigation to be completed within 180 days
    • In case of delay, status to be provided along with the reasons for delay in writing, and extension to be sought from a Whole-time Member [Clause 13] 
  • Interim orders to be valid for upto 180 days
    • Extension may be granted for upto 2 years pending adjudication/ completion of inspection/ investigation [Clause 27]

Adjudication of penalties 

  • Maximum penalty to be linked with whether or not the default results in unlawful gain or losses to the investors or other persons, and whether such gain or loss is quantifiable
  • Decriminalisation of offences, provisions in relation to fines limited to offences such as market abuse, failure of compliance with orders of SEBI etc. 
  • Additional factors to be considered for adjudication of penalty incorporated based on judicial precedents 

Clarity in the scope of securities

  • Securities to include notes or papers issued for the purpose of raising of capital, which are listed or proposed to be listed, other regulated instruments etc. 

Classification between fraudulent/ unfair practices and market abuse 

  • To classify grave acts adversely affecting the integrity of securities market as “market abuse” 
  • Powers of SEBI to order cease and desist, authorisation for seizure of books etc. in case of market abuse 

Re-introduction of SEBI Ombudsperson

  • In case of non-redressal of grievances through GRM within specified period (180 days from receipt of grievance), may file a complaint with Ombudsperson within 30 days

Introduction of new terms

  • Market participant –  a person or its agent participating in the securities markets as an issuer or an investor; SEBI may issue instructions, call for information, etc from market participants
  • Securities market service provider – Intermediary + Market Infrastructure Intermediary (stock exchange, depository & clearing corporation) + SRO.
    • Obligations of SMSP given under Clause 35 – includes fair disclosure of information, investment of money collected by it in the manner as specified, furnishing information etc.
      • To be specified by the regulations 
  • Subsidiary instructions 
    • Power to issue to be with Chairperson along with WTM or by two WTMs of Board
      • To clarify ambiguity or laying down procedural requirements 
    • Contravention to be considered as contravention of the primary regulations 

Clarifications proposed

  • Records of depository to act as conclusive proof of title over security [Clause 58(2)]
  • Issuance and holding of securities in dematerialised form only [Clause 55(2) & (3)]
    • Option with the holder for holding in physical form has been omitted 
  • Right to be consulted or to give directions not a safeguard from being considered as investment scheme [Clause 32]

Strengthening India’s Corporate Bond Market: A Look at NITI Aayog’s Recommendations

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Simrat Singh | finserv@vinodkothari.com

India’s aspiration to become a US $30 Trillion economy by 2047 rests on its ability to mobilise long-term, stable and affordable capital. Debt capital can be an attractive source for this. While banks have historically been the backbone of credit intermediation in India, a bank-dominated financial system may be inadequate to meet the financing needs of a developing country like India which includes long-gestation exposures to infrastructure, climate transition, manufacturing and other emerging sectors. Recognising this constraint, NITI Aayog’s report on Deepening the Corporate Bond Market in India (‘Report’) lays out reforms to develop corporate bonds as another major tool for mobilising long-term low-cost capital. 

In this note we highlight some of the reforms being advocated in the Report.

Key Thrust Areas of Reforms:

Regulatory Efficiency 

A central theme of the Report is the need to reduce regulatory friction arising from fragmented and overlapping oversight by SEBI, RBI and the MCA for corporate bonds. Inconsistent treatment of similar bonds, procedural complexity, overlapping disclosures and different approval timelines are identified as major constraints, particularly for public issuances and lower-rated issuers. A specific concern highlighted is issuer-based regulation: bonds issued by banks and NBFCs are regulated by the RBI, while similar bonds issued by non-financial corporates fall under SEBI and MCA oversight. This results in different disclosure standards and compliance processes for similar bonds

To combat this, first, the Report calls for stronger inter-regulatory coordination and recommends measures such as mutual recognition of disclosures, a joint regulatory help desk/single point of contact as well as joint circulars detailing the jurisdictions of each regulator – essentially a centralised coordination mechanism involving SEBI, RBI, MCA and the Ministry of Finance.

Second, the Report emphasises the need to rationalise disclosure norms for public bond issuances, which are significantly more onerous than those applicable to private placements. This asymmetry has led to an overwhelming reliance on private placements, which account for nearly 98% of corporate bond issuances in India (p. 25). Drawing on global practices, the Report recommends a differentiated disclosure regime for well-compliant issuers (p. 66). Specific reforms include extending the validity of offer documents from one year to two or three years, removing ISIN-wise issuance constraints, simplifying PAS-2 and Information Memorandum filings through digital automation on the MCA portal, and introducing a “Well-Known Seasoned Issuer” framework to enable fast-track access to public bond markets for reputed issuers.

Third, the Report stresses the need for regulatory clarity for hybrid instruments, including covered bonds1, securitised debt and infrastructure-linked securities. Many instruments used globally to fund long-term assets do not fit neatly within India’s regulator-specific silos. Jurisdictional ambiguity (which regulator oversees which instrument?) and the absence of standardised regulatory treatment have impeded market development. The Report recommends clearly defined frameworks to facilitate market clarity. In this context, it also highlights tax distortions; for instance, SDIs2 currently attract significantly higher TDS than corporate bonds. The Report states that SDIs are taxed at a higher rate than corporate bonds which prevents securitisation of bonds. However, effective 1.04.2025, SDI TDS rates are aligned with bond rate; both at 10% (See section 194LBC of Tax Act).

Market Infrastructure and Liquidity

Bonds are heterogeneous instruments, varying by type of issuer, tenor, covenants and structure. Unlike equities, electronic order matching alone cannot ensure immediacy of execution or continuous liquidity in the secondary market, particularly in lower-rated or infrequently traded bonds. Despite progress through electronic platforms such as RFQ for secondary trading and EBP for primary issuance, trading volumes remain shallow and concentrated in highly rated bonds.

The Report recommends expanding electronic trading, enhancing post-trade reporting (to improve price discovery) and increasing the proportion of trades settled on a Delivery-versus-Payment (DVP) basis3. Absence of a robust market-making ecosystem is seen as a major constraint on secondary-market liquidity (pp. 22, 36, 106). Limited risk appetite and balance-sheet constraints deter intermediaries from providing continuous two-way quotes, especially in lower-rated and longer-tenor bonds.

To address this, the Report recommends enabling market-making through regulatory incentives and improved access to repo markets. In particular, the creation of a standing repo facility by RBI for high rated corporate bonds would allow market makers4 to monetise inventories efficiently and support continuous liquidity provision. While corporate bonds are included in the RBI’s list of repo-eligible instruments, their treatment differs materially from Government securities (G-Secs). Repos in G-Secs are exempt from CRR and SLR computation which means Banks can access funds through G-Sec repos without providing SLR and CRR on those funds. In contrast, cash raised through repos backed by corporate bonds is treated as a liability for CRR and SLR purposes, hence banks have to provide CRR and SLR on the resulting liquidity. Also, unlike G-Secs, which are centrally cleared and settled through CCIL, corporate bond repos lack a single, standardised clearing and settlement mechanism; they are cleared through F-TRAC and stock exchanges. The result is that the volume of corporate bond repo is negligible (exact data on corporate bond repo could not be sourced).

The Report also flags structural weaknesses in the credit rating ecosystem, including rating inflation, conflicts of interest under the issuer-pays model, and excessive regulatory reliance on ratings (p. 71). Strengthening governance standards is the key recommendation for credit ratings. To improve credit rating access for smaller issuers, the Report suggests exploring alternative credit assessment models, including technology-driven frameworks using GST-returns and other turnover based data and digital transaction histories.

Further, the Report recommends strengthening the existing framework requiring large corporates to raise a portion of incremental borrowings through debt securities (LCB Framework)5. Proposed enhancements include increasing the minimum market borrowing requirement and progressively extending the framework to smaller corporates with lower thresholds.

Drawing on the IMF’s FSAP 2025, the Report also recommends allowing high-quality corporate bonds to be used as collateral in RBI’s repo operations. International experience from the ECB, Bank of Japan, and Reserve Bank of Australia suggests that such measures can enhance secondary-market liquidity and broaden the investor base, subject to appropriate safeguards.

Equally important is the creation of a government-backed, centralised corporate bond data repository. Fragmented data across regulators and exchanges currently hampers price discovery and covenant monitoring. A unified, real-time repository is recommended to improve transparency for issuers, investors, and regulators.

Innovation in Instruments and Market design

The Report makes it clear that regulatory reforms alone are insufficient; product and market innovation are essential to expand depth and distribute risk. India’s bond market remains narrow not only due to investor risk aversion but also due to the limited availability of instruments aligned with diverse risk–return preferences and long-gestation financing needs. Green bonds, sustainability-linked bonds6, and transition bonds are identified as important instruments for financing climate action and infrastructure. However, the absence of a standardised green taxonomy and concerns around greenwashing have constrained growth. The Report, therefore, recommends establishing clear definitions, disclosure standards and verification frameworks to ensure credibility and scale ESG-oriented bond markets.

The Report proposes institutionalising a dedicated class of Corporate Bond Dealers (CBDs), modelled on the U.S. primary dealer system. Eligible banks, NBFCs and other financial institutions would be required to provide continuous two-way quotes, supported by incentives such as capital relief on bond inventories and access to RBI refinance and repo facilities. Enhanced market surveillance, real-time trade reporting, price dissemination and inventory disclosures are also recommended.

Investor and Issuer Participation

Broadening the investor base is identified as another critical reform pillar. Long-term institutional investors such as insurance companies, pension funds and provident funds are natural holders of long-duration bonds, yet regulatory investment norms constrain exposure only to higher-rated securities. The Report recommends a calibrated relaxation of these norms.

For retail investors, the Report proposes lowering minimum investment thresholds (from existing ₹ 10,000), increasing retail quotas in public bond issuances, particularly for tax-free and ESG-linked bonds7, and simplifying TDS provisions to address tax inefficiencies in secondary market trades. OBPPs have been acknowledged to contribute to secondary market liquidity, however, the volumes are low. Further, there is no mention of concerns w.r.t downselling through OBPPs which was recently highlighted by SEBI8

On the issuer side, India’s corporate bond market remains heavily concentrated among AAA and AA-rated entities. To address this imbalance, the Report advocates scaling up credit enhancement mechanisms such as PCEs and support from development finance institutions. It also highlights the need to promote longer-tenor issuances, especially for infrastructure and climate-linked projects, where asset lives significantly exceed typical corporate bond maturities. In this context, it is noteworthy that NITI Aayog has cited our resource, “Partial Credit Enhancement: A Catalyst for Boosting Infrastructure Bond Issuances?”, in the Report while discussing the role of partial credit enhancement mechanisms in deepening the corporate bond market (pp. 75 and 99). Further, regulatory subsidies for first-time or low-volume issuers and pooled issuance platforms to facilitate market access for smaller issuers is also recommended (pp. 65, 75).

The Report recognizes that CDS are underdeveloped. Currently, CDS can be purchased only by investors who already own the underlying bond, which prevents trading in the CDS market. Further, only single-name CDS are permitted, which means a separate CDS contract is required for each issuer, unlike global markets such as the U.S., where index CDS allows one CDS to cover a basket of bonds. Lastly, there is a limit on FPI investors providing CDS which is 5% of the outstanding corporate bond market. These restrictions have resulted in limited CDS protection. The Report also recommends bigger NBFCs to act as CDS market makers

Conclusion

NITI Aayog’s recommendations envisage a corporate bond market that evolves from a supplementary funding channel into a core pillar of India’s financial system. If implemented in a coordinated manner, these reforms could expand the market to ₹100–120 trillion by 2030, improve financial stability, and channel long-term capital into productive investment. The real challenge, however, lies in execution, particularly in achieving sustained regulatory coordination and market-making capacity. Addressing these constraints will be critical if corporate bonds are to play a meaningful role in financing India’s long-term growth and infrastructure ambitions under the vision of Viksit Bharat by 2047.

See our other resources on bonds

  1. Bond Credit Enhancement Framework: Competitive, rational, reasonable
  2. Demystifying Structured Debt Securities: Beyond Plain Vanilla Bonds
  3. Bond market needs a friend, not parent
  4. SEBI Securitisation Regulations: Track Record, Risk retention and Investment size among several new requirements
  5. Mandatory listing for further bond issues
  6. NHB’s PCE Scheme for HFCs
  7. Corporate Bonds and Debentures
  1. Covered bonds are secured debt instruments backed by a segregated pool of high-quality assets, offering investors dual recourse to both the issuer and the underlying assets. May refer to our resource on covered bonds. ↩︎
  2. May refer to our book Listing Regulations on Securitised Debt Instruments and Security Receipts ↩︎
  3. DVP is a settlement mechanism in which the transfer of securities and funds occurs simultaneously, eliminating counterparty and settlement risk
    ↩︎
  4.  May refer to our resource ‘Bond issuers set to become Market Maker to enhance liquidity’ ↩︎
  5. May refer to our resource ‘Mandatory bond issuance by Large Corporates: FAQs on revised framework’ ↩︎
  6. May refer to our resources ‘Sustainability or ESG Bonds’ and ‘From Rooftops to Ratings: India’s Green Securitisation Debut’ ↩︎
  7. May refer to our resource ESG Debt Securities: Framework for Issuance and Listing in India ↩︎
  8. May refer to our resource “Downstreamed through intermediaries: Deemed public issue concerns for privately placed debt” ↩︎

Banks’ exposure to AIFs: Group-wide limits introduced

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– Simrat Singh | Finserv@vinodkothari.com

The RBI has long been stitching up the seams where AIF structures threatened to pull at the fabric of Banking regulation. The latest amendment to the Reserve Bank of India (Commercial Banks – Undertaking of Financial Services) Directions, 2025 is another careful thread in that ongoing work. The provisions apply not only to banks directly but also to exposures routed through their group entities (meaning subsidiary, JV or associate of the bank). Banks (and their group entities) may still participate in AIFs but only within closely drawn boundaries. The message is unambiguous: the AIF route cannot be used to skirt evergreen exposures or manufacture regulatory arbitrage. 

Limits on investment in AIF schemes

For Category I and Category II AIFs, limits apply at both the individual bank level and at the group level.

  • At the bank level, no bank may contribute more than 10% of the corpus of any AIF scheme;
  • At the bank group level, investments are permitted within a corridor:
    • Less than 20% of the corpus of Cat I or Cat II AIFs may be invested without prior approval, provided the parent bank continues to meet minimum capital requirements and has reported net profit in each of the preceding two financial years. This means even the AMC along with the bank cannot hold more than 20%;
    • Between 20% and 30% of the corpus may be invested with prior RBI approval.

A systemic cap overlays this: contributions from all regulated entities  – banks, NBFCs, co-operative banks and AIFIs etc. – cannot collectively exceed 20% of any AIF corpus. Similarly investment in the unit capital of REITs and InvITs is capped at 10%, within the overall ceiling of 20% of net worth for equity, convertible instruments and AIF exposures. 

A question may arise on whether such limits, as applicable to investments in AIFs, would also be applicable to making investments in FMEs operating in IFSC? Practically, Indian banks are unlikely to invest in FMEs, because such investments would cause the FME to lose its tax benefits. For an FME to qualify as a “specified fund”, all its units must be held by non-residents, except those held by the sponsor. When this condition is met, the income of the fund is exempt under Section 10(4D) and the income received by non-resident investors is exempt under Section 10(23FBC) of the Income Tax Act. 

No circumvention of regulations through investments in AIFs 

Banks shall ensure that their exposure in an investee company through their investments in AIF schemes does not result in circumvention of any regulations applicable to banks. (see para 38D). This would mean that where a bank is restricted from having any exposure in an investee company (this may include restrictions on account of the end-use of funds, or restrictions in terms of limits to exposures etc), such exposures cannot be made indirectly through making investments in AIF schemes, which, in turn, leads to the bank’s exposures to such investee companies. 

Prohibition on Category III AIFs

The clearest prohibition concerns Category III AIFs. Banks are not permitted to invest in their corpus at all. If a subsidiary is a sponsor, it may hold only the minimum contribution required under SEBI’s regulations (which currently is lower of 5% of the corpus or ₹10 Crore as per proviso to Regulation 10(d) of the SEBI AIF Regulations, 2012). Highly traded, leveraged or long-short strategies are thus kept outside the perimeter of bank funding in a deliberate effort to insulate bank balance sheets from hedge-fund-type risk.

Globally, regulators have taken a different, more permissive route. In the United States, banks are not barred from investing in hedge-fund-type vehicles. Instead, the Volcker Rule restricts ownership to de-minimis levels, generally up to 3% of a fund and 3% of Tier 1 capital in aggregate.1

Under Basel’s CRE 60 framework, investments in funds are permitted, however, discipline lies in capital treatment:

  • If the bank can look-through to underlying exposures, risk weights are based on the underlying assets2;
  • Where transparency is not available, risk weights can rise to punitive levels, up to 1,250% –  making opaque fund exposures extremely capital-intensive.

Recently, IMF in its October 2025 Financial Stability Report has highlighted that banks’ exposures to non-banks, including private-credit and private-equity funds, have grown materially, raising concerns about concentration and potential spill-over risks.

India therefore stands apart. Where other jurisdictions rely on expensive capital and other constraints to manage hedge-fund-type exposures, the RBI has chosen to keep such structures outside the banking perimeter altogether. 

Provisioning and Capital Treatment

Capital consequences have also been tightened. Where a bank holds more than 5% of the corpus of an AIF that subsequently invests – other than in equity instruments3 – into a debtor company of the bank, a 100% provision must be created for the bank’s proportionate exposure (See our write-up on the same here). This directly addresses the risk that AIFs could become conduits for evergreening or indirect refinancing of stressed loans.

Overall Perspective

The Amendment Directions extend the guardrails on AIF participation to the bank group, as against the previous approach of regulating only the bank’s exposures. Guardrails are numerical and backed by provisioning and capital consequences. Any breach in the limits require reporting to RBI, with clear reasons and plan for corrective actions. For existing investments, banks are required to provide an action plan by 31st March, 2026 – ensuring the compliances within a maximum of 2 years, viz., 31st March 2028. 

RBI’s stance is more conservative than many international regimes, but the regulatory intent is unmistakable: prudential norms are not to be diluted simply because exposure is packaged through an AIF.

  1. See Section 619 of Dodd-Frank Wall Street Reform and Consumer Protection Act, 2010 ↩︎
  2.  CRE 60 offers three routes for capital treatment – look-through, mandate-based and fall-back – chosen according to how much visibility the bank has into the fund’s underlying assets. ↩︎
  3. Equity instruments means equity shares, compulsorily convertible preference shares (CCPS) and compulsorily convertible debentures (CCDs) ↩︎

See our other relevant resources:

  1. Bank group NBFCs fall in Upper Layer without RBI identification
  2. Group-level regulation: RBI brings major regulatory restrictions on banks and group entities
  3. RBI norms on intra-group exposures amended
  4. New NBFC Regulations: A ready reckoner guide

Private Credit AIFs: Lenders of Last Resort?

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Updated as on 7th January, 2025

Simrat Singh | Finserv@vinodkothari.com

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. 

ParameterPrivate CreditTraditional Credit
Source of CapitaPrivate debt funds (Category II AIFs), investors like HNIs, family offices, institutional investorsBanks, NBFCs and mutual funds
Target BorrowersCompanies lacking access to banks; SMEs, mid-market firms, high-growth businessesHigher-rated, established borrowers.
Deal StructureBespoke, customised, structured financingStandardised loan products
FlexibilityHigh flexibility in terms, covenants, and structuringRestricted by regulatory norms and rigid approval processes
Returns Higher yields (approx. 10–25%)Lower yields (traditional fixed-income)
Risk LevelHigher risk due to borrower profile and limited diversificationLower risk due to stronger credit profiles and diversified portfolios
RegulationLight SEBI AIF regulations; fewer lending restrictionsHeavily regulated by RBI and sector-specific norms
LiquidityClosed-ended funds; limited exit optionsMore liquid; established repayment structures; some products have secondary markets
DiversificationLimited number of deals; concentrated portfoliosBroad, diversified loan books
Role in MarketFills credit gaps not served by traditional lendersCore 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:

  1. 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
  1. 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: 

FunctionPrivate Credit AIFsRE
Credit & Investment rules
Credit underwriting standardsNo regulatory prescriptionNo such specific rating-linked limits. However, improper underwriting will increase NPAs in the future.
Lending decisionManager-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 normsMax 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 restrictionsNone prescribed under AIF Regulations, results in high investment flexibilityBanks 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 transactionsNeed 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 requirementsNo regulatory prescription as the entire capital of the fund is unit capitalMinimum 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 & ALMUninvested 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 limitsNo 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 monitoringNo regulatory prescriptionRBI-defined SMA classification, special monitoring, provisioning & reporting.
Compromise & settlementsNo regulatory prescriptionGoverned by RBI’s Compromise & Settlement Framework
Governance, Oversight & Compliance
Governance & oversightOperate 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 borrowersPrivate credit AIFs usually have 15-20 borrowers.Far more diversified  as compared to AIFs
Pricing Freely negotiated which allows for high structuring flexibilityGuided 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. 

  1. IMF Global Financial Stability Report 2024 ↩︎
  2. Ibid ↩︎
  3. 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. ↩︎
  4. IMF Global Financial Stability Report 2024 and Federal Reserve Note dated May 23, 2025 ↩︎
  5. India’s private credit market is coming of age: S&P Global and SEBI Data ↩︎
  6. RBI’s Financial Stability Report June 2024 ↩︎
  7. Customized lending terms can include, for example, the option to capitalize interest payments (that is, pay in kind) in times of poor liquidity ↩︎
  8. Cai and Haque 2024 ↩︎
  9. India’s private credit market is coming of age: S&P Global ↩︎
  10. See our article ‘Draft RBI Directions: Banks may finance Acquisitions’ ↩︎
  11. Chernenko, Erel, and Prilmeier 2022 ↩︎
  12. Source: https://sbia.org/bdc-council/ (Numbers are as on Q4 2024). ↩︎
  13. Source: S&P Global ↩︎
  14. Growth in Global Private Credit: Reserve Bank of Australia ↩︎
  15. From the speech of Fed Reserve Governor Lisa D. Cook on financial stability ↩︎
  16.  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

The Hidden Hand: Understanding Beneficial Ownership in case of Trusts

/1 Comment/in , , /by

Saket Kejriwal, Assistant Manager | corplaw@vinodkothari.com, finserv@vinodkothari.com

Background

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.

However, even in such cases, the SMO is identified purely for the purposes of AML laws, as discussed above. (see para 31 of the FATF Guidance on Beneficial Ownership of Legal Persons). 

Difference between BO and SBO

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.
  1.  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.
    ↩︎
  2.  Refer footnote no. 37 of The FATF Recommendations ↩︎