Game Changer: How New Regulations Could Impact Alternate Investment Funds in India
India is home to many high-performing private investment vehicles; however, a few dubious funds may lead to harsher regulatory scrutiny. Alternative investment funds (AIFs) have been misused by non-bank finance companies (NBFCs) to support real estate projects that were going to default. To overcome this, financiers approached Wall Street firms to create new tailor-made funds that were backed by investors who were issued senior securities and earned interest. The finance company held a smaller junior tranche that ranks lower in the repayment order and first absorbs any losses.
The private funds lent the money to the same stressed borrowers who, in turn, repaid their loans and avoided bankruptcy. Finance firms were pleased, since any mark-to-market losses on the securities held were far lower than the provisioning burden they would have had to bear in case of soured credit. At least some shadow lenders ‘evergreened’ their loan books in this manner to avoid being on the regulatory radar of the Reserve Bank of India (RBI), their regulator. According to a Reuters report, the Securities and Exchange Board of India (SEBI) detected at least a dozen cases involving $1.8 billion to $2.4 billion where AIFs have been misused to sidestep other regulators like the RBI.
The smaller amounts involved in the shady practices of dubious funds may lead to stiff regulation that could slow down the blistering growth of AIFs. AIFs belong to a vast category covering venture capital, private equity, real estate funds, and private credit. Wall Street firms mostly sponsored such fraudulent structures, according to a Mumbai-based Private Equity (PE) investor. The same marquee buyout specialists will be the first to complain when, as a direct consequence, regulation in India takes a sterner turn.
The current alternative asset landscape in India is mostly dominated by international investors. However, a rising number of affluent Indians are looking at them for superior returns than public equity, debt, and residential real estate investments. For a growing class of high-net-worth individuals, the minimum ticket size of $120,000 is no longer a showstopper.
Participation in alternative assets by domestic institutions will increase too, once they are given more leeway to invest in alternative assets such as insurance and pension firms. As this indirectly brings regular Indian savers to the rich person’s playground, this makes it one big reason why SEBI cannot ignore dubious structures. A global PE sponsor buying a riskier portion of a fund would be par for the course, but a local NBFC that’s not the sponsor providing a loan-loss cushion to make its balance sheet look good? Or a big international retailer using a fund to get around foreign direct investment limits? Regulators are losing their patience.
The zeitgeist favors SEBI. In August, the US Securities and Exchange Commission (SEC) released rules to tighten its grip on hedge funds and private equity. The industry associations have sued the SEC, alleging that the agency has gone too far and that the new rules “would fundamentally change the way private funds are regulated in America.” This is perhaps why SEBI wants to act early. Venture capital and hedge funds represent the two ends of the alternative-asset industry in India. The primary middle segment consists of private equities and private credits. These two asset classes used to be a $200 million sideshow just a decade ago; now, they command $83 billion, or more than four-fifths of the $100 billion committed by investors to private funds.
If past growth is any indication, it won’t take long for the firepower to reach a point where the industry can flex its lobbying muscles, both in New Delhi and Washington, to thwart any attempts to rein in the industry. Even now, a tussle between the regulator and the fund lobby has been playing out for more than a year, as reported by a newspaper in July.
Alternative funds will continue to be the fastest-growing segment of India’s investment landscape, according to Crisil, an affiliate of S&P Global, noting in a report last year. Light-touch regulation has made this growth possible as conduits of foreign capital into the country, and the industry has enjoyed a lot of latitude. However, now that local Indian savers are getting entangled, we can expect an end to private funds’ freewheeling ways. The questionable deals of global private equity firms have made that outcome more or less inevitable.
Disclaimer:
The material in this article was compiled using the most recent Acts, Rules, Circulars, Notifications, Provisions, Press Releases, and material applicable at the time. The completeness and correctness of the material ensured with due diligence. It is required of users of this material to consult the relevant, applicable legislation. The data given may change without prior notice and does not constitute professional advice. As a result, Estabizz Fintech disclaims all liability for the results of using such material.
