Shruti RajanPartner
Khyati GoelSenior Associate
Rebecca CardosoAssociate
Key Developments
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Norms for lenders investing in alternative investment funds tightened to address regulatory concerns
The Reserve Bank of India (RBI) has tightened the norms for banks, financial institutions, and non-banking financial companies (NBFC) (collectively, lenders) investing in Alternative Investment Funds (AIF). This move is aimed at addressing concerns regarding the substitution of direct loan exposure of lenders to borrowers with indirect exposure through investments in units of AIFs, which results in a potential 'evergreening' of loans.
Lenders are now barred from investing in AIF schemes with downstream investments either directly or indirectly in a 'debtor company' of the lender (any company to which the lender has or previously had a loan or investment exposure, anytime during the preceding 12 months). If an AIF scheme, in which a lender has already invested, makes downstream investments in any such debtor companies, the lender will be mandated to liquidate its investment within 30 days from the date of such downstream investment by the AIF. Lenders unable to liquidate their investments within this prescribed period will be obligated to make 100% provision on such investments.
The circular, issued on 19 December 2023, came into effect immediately, underscoring the RBI’s intent to take stricter measures to ensure financial prudence on stressed loans. However, besides disrupting the investments of lenders, who must now take rapid measures to liquidate their investments within the short timeline, this move also significantly reduces the potential pool of assets under management for AIFs.
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New scale-based regulatory framework for non-banking financial companies
RBI issued a Master Direction that introduces a 'scale-based' regulatory framework for NBFCs, superseding existing regulations that had drawn distinctions between systemically important and non-systemically important NBFCs for the purposes of regulation. Effective from October 2023, a new classification system has been implemented based on a tiered structure, which takes into account different factors such as asset size, scale of activity, and risk perception. The categories are as follows:
- Base Layer
The Base Layer comprises non-deposit taking NBFCs with assets below INR 1,000 crore and NBFCs that are peer-to-peer lending platforms, account aggregators, non-operative financial holding companies, and NBFCs without public funds and not having any customer interface.
- Middle Layer
The Middle Layer comprises all deposit-taking NBFCs (regardless of their asset size), non-deposit taking NBFCs with assets of INR 1,000 crore and above, and NBFCs that are standalone primary dealers, infrastructure debt fund-NBFCs, core investment companies, housing finance companies, and NBFC-infrastructure finance companies.
- Upper Layer
The Upper Layer comprises NBFCs specifically identified by RBI for warranting enhanced regulatory requirements. This identification is based on predefined parameters and scoring methodology. Further, the top ten eligible NBFCs by asset size (irrespective of any other factor) fall within this category.
- Top Layer
This category is ideally to remain empty. It serves as a buffer and may be populated when, for instance, RBI deems certain NBFCs (in the Upper Layer) to pose a substantial systemic risk.
The new categorisation is aimed to provide clarity and ease of compliance, since by consolidating various regulations for NBFCs of different scales and activities into one place, the Master Direction ensures that all NBFCs can operate within a common, consistent framework. NBFCs must now realign their operations to ensure adherence to the new regulatory standards and remain attentive for further updates or clarifications.
- Base Layer
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Framework for 'trading plans' under insider trading regulations to be modified to make them less onerous
The Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015 (SEBI PIT Regulations) had implemented the concept of 'trading plans' (TP) to enable persons perpetually in possession of unpublished price sensitive information (UPSI) to trade in securities in a compliant manner. However, since the implementation of this concept, market feedback suggests that TPs are not popular on account of being impractical and onerous. In this light, the Securities and Exchange Board of India (SEBI) has issued a consultation paper proposing changes to the framework governing TPs.
The key proposals include:
- reducing the cool-off period between disclosure and implementation of TPs from six months to four months;
- reducing the minimum coverage period from 12 months to two months; and
- eliminating the requirement of a black-out period for trading in TPs
These proposals are aimed at incentivising market participants to opt for TPs.
Further, it is proposed that contra-trade provisions should be made applicable to TPs, and disclosure of TPs to stock exchanges should be done within two days from the date of approval of the TP.
The consultation paper reflects SEBI's proactive approach to review and streamline regulatory compliances based on concerns received from stakeholders.
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New regulatory framework proposed for index providers to increase transparency and accountability
SEBI has approved a proposal to introduce a new regulatory framework for index providers to foster transparency and accountability in the governance and administration of financial benchmarks in the securities market.
The proposed SEBI (Index Providers) Regulations, 2023, prescribe an eligibility criterion for index providers along with a gamut of associated compliances, such as the methodology for index calculation, disclosure requirements, and periodic audits. Applicants registering as index providers must also confirm adherence to the principles for financial benchmarks of the International Organisation of Securities Commissions.
This move recognises index providers as consequential players in the securities market, the indices of which serve as a benchmark for assessing the performance of wealth management vehicles. This move also comes on the back of the increasing attention that index providers have been receiving in other jurisdictions across the globe, given the volume of passive assets that track these indices. The SEBI is expected to issue a detailed regulatory framework in the coming months.
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Requirements for grant of certification to accredited investors streamlined
SEBI has simplified the requirements for the grant of certification to accredited investors. The accreditation process is now solely based on the applicant's Know Your Customer (KYC) and financial information, as opposed to earlier, where documents such as proof of basis of valuation of assets were also required to be furnished. Further, various entities such as individuals, Hindu Undivided Families (HUF), family trusts, sole proprietorships, trusts, and corporates must meet specific income and net worth criteria to be accredited investors, with alternative requirements also applicable.
Previously, the accreditation was valid for a year, which has now been revised to two years. The streamlined accreditation process is not intended to preclude market intermediaries from conducting their own additional due diligence when onboarding accredited investors as clients.
This move comes into effect immediately and bears out SEBI's commitment to market development, as the simplified process and extended validity period provide a more efficient and reasonable timeframe for accreditation.
Over the next quarter, both SEBI and RBI are expected to continue paying close attention to the AIF industry and tweak the regulatory framework to guard against indirect evergreening of loans. This is further borne out by SEBI's recent move to amend the AIF Regulations to ensure the protection of investors, demonstrating the financial regulators' proactiveness towards market development in India. Given the slew of consultation papers and proposed regulatory frameworks issued by SEBI recently, we can expect a few of them to be actioned out in the coming quarter, with the regulator's ethos being to effectively balance investor protection and ease of doing business.
