The year-long “regulatory turmoil” over India’s alternative investment fund (AIF) industry is a classic example of overregulation. The industry is at risk of slow extinction due to thousands of circulars, including the one issued by the Reserve Bank of India (RBI).
As a creation of Parliament, the RBI should be accountable to the members. But it has weaponized its autonomy and appears to be responsible only to itself. It goes against the spirit of liberalization for FinTech companies and AIFs to take over and become overly prescriptive.
In December 2023, the RBI released a circular with the bland title ‘Investing in AIF’. It was like cutting off one’s neck to cure dandruff. To resolve the issue where some AIFs are being utilized by RBI regulated entities (REs) for evergreen loans, the regulator has announced that banks and non-banking financial companies (NBFCs) with exposure to RE debtor companies will It effectively prohibited investing in AIF.
If an AIF’s portfolio company had a credit card backed by a mere term deposit with a bank, the latter would have to write off its investment in the AIF. Over Rs 12,000 crore was written off by banks and NBFCs. The government-sponsored SWAMIH fund for affordable housing has stalled because of this.
The AIF industry protested, but the RBI did not relent. A small group that met with the branch was told it was closed. In March 2024, the regulator issued a circular providing ostensible relief. RE allows you to invest in an AIF that invests in stocks rather than stocks.
This marked a departure from treating the two in the same way, no doubt recognizing that private equity and venture capital funds invest primarily in stocks. Accounting standards classify redeemable shares as debt, so concerns that they could be redeemed were misplaced, as the criteria for redeeming them is the same as for equity.
Another example of the RBI’s failure to consult is the issue of Partial Payment Units (PPUs). A unit of an AIF is a “beneficial interest”, an undefined term that refers to the right to receive a defined portion of the income and assets of an AIF. The Securities and Exchange Board of India (Sebi) has allowed AIFs to issue units on partially or fully paid basis and the same was allowed in RBI’s Form INVI.
However, in early 2023, without prior consultation or notification, Form INVI was amended to prohibit PPUs. After a year of multiple representations, a ‘clarification’ has been inserted in the rules under India’s Foreign Exchange Management Act that AIF units can be paid partially or in full.
This was intended to clarify existing positions. However, the RBI sent an email to the AIF requesting it to admit its negligence and regularize the PPU. Due to this issue, distribution to foreign investors has been stalled and the RBI is reluctant to resolve the issue. This is clearly unfair to AIFs, as the fines are as high as the capital raised.
Despite the AIF introducing convertible currency funds, its $1.5 billion overseas investment limit has not been renewed for more than 30 months, while its mutual funds have been renewed at least twice. Why the dichotomy?
Section 58 of the RBI Act states that the RBI may make regulations “with the prior sanction of the Central Government”. But today, regulators seem to be acting as judge, jury, executioner, and legislator. To make matters worse, the RBI has no appellate powers to overturn it. Any movement.
Sebi often claims that the AIF has a “light touch” regulatory regime. But a light touch from an iron hand can still cause great damage. At the Gatekeepers of Governance 2023 event held in Mumbai, Sebi officials said the AIF had issued 167 circulars. 12 months: This corresponds to a circular approximately every two days. Investors need regulatory stability, not constant rule changes.
A slew of circulars and changes since the start of this year have left the AIF breathless, with many companies spending more time on compliance than on investment. Although sophisticated investors do not need the same protections as retail investors, regulatory risk has now outweighed market risk for them.
Category III AIFs in India have always been treated like stepmothers by regulators. The joke in the industry is, “Mutual fund sahi hai kyunki AIF nahin hai” (Since AIF doesn’t exist, mutual funds are the right choice). Sebi’s new ‘Specified Investment Funds’ regime will allow mutual funds to invest in almost the same areas as Category III AIFs. The minimum ticket size is 10x smaller than AIF.
When you combine the tax benefits of mutual funds with the disastrous uncertainty surrounding Category III AIF taxation, it would be a miracle if AIFs catch the attention of investors within a few years.
Government steps in to save the industry from overregulation. A study by the Venture and Alternative Capital Association of India concludes that for every $10 million of alternative capital invested in a company, $58 million in revenue and 470 direct jobs are generated, along with $12 million in taxes. .
Capital formation through AIFs fosters foreign direct investment, increases tax revenue, and stimulates economic activity by bringing innovation to the market.
But AIF is consumed and confused by compliance. AIFs require three compliance officers for each member of the investment team. AIF funding slowed significantly in 2024 compared to 2023. Overregulation has turned bureaucratic red tape into red tape for investors in India.
The author is Chairman of Arlin Capital Partners.
