The RBI’s Watchful Eye on AIFs: Navigating Conflict and Evergreening Risks

[Dhaval Bothra is a law student at Symbiosis Law School, Pune]

As the chief regulator of financial institutions, the Reserve Bank of India (“RBI”) oversees varied entities from commercial banks to non-banking financial companies, ensuring prudent behaviour and protecting the interests of investors. Among the plethora of financial instruments under its purview, alternative investment funds (“AIFs”) have emerged as a dynamic force in recent years. AIFs offer alternative avenues for investment beyond traditional stock markets, catering to high-net-worth individuals and institutional investors seeking diversified portfolios and potentially higher returns. However, the rapid growth and evolving nature of AIFs have also brought to light potential areas of concern, prompting the RBI to issue a recent notification raising red flags and implementing new regulations.

However, the RBI’s recent circular on AIF investments highlights a growing concern: the potential for conflicts of interest and practices that circumvent prudent risk management. The notification specifically tackles the worrisome practice of “evergreening,” where regulated entities substitute direct loan exposure to borrowers with indirect exposure through investments in AIFs with downstream investments in the same borrowers. This practice, while seemingly innocuous, raises the spectre of evergreening. Essentially, by replacing bad loans with investments in AIFs holding those loans, regulate entities may be artificially prolonging the life of such debts, delaying necessary recognition of losses and potentially jeopardizing the overall health of their balance sheets. This opaque maneuver creates a conflict of interest, prioritizing short-term benefits over long-term financial stability.

The impetus for this action stemmed from investigations by both the RBI and the Securities and Exchange Board of India (“SEBI”) uncovering around a dozen cases where AIFs, totaling INR 150-200 billion ($1.8-2.4 billion), were allegedly used to mask problematic loans. These concerns went beyond evergreening, extending to circumvention of foreign investment caps and insolvency regulations. While the financial magnitude of these misuses was relatively small compared to the broader AIF market size, their nature posed a significant threat to financial stability and transparency.

The RBI’s notification, therefore, aims to address these concerns head-on through a series of targeted measures. The notification prohibits regulated entities from investing in AIF schemes with downstream investments in their existing debtor companies, effectively closing the loophole that enabled evergreening through AIFs. Furthermore, existing investments in such schemes must be liquidated within 30 days of the issuance of this circular, further emphasizing the RBI’s resolve to curb these practices.

Impact on Investors and AIFs

The RBI’s regulatory crackdowns on AIF investments ripple through the ecosystem, impacting both funds and investors with a multi-faceted force. For AIFs, fundraising may face initial headwinds. Investors, now aware of potential conflicts and heightened due diligence demands, may adopt a more cautious approach. This initial slowdown, however, can ultimately incentivize a positive shift. AIFs will be compelled to adopt more transparent and robust investment strategies, shedding practices like evergreening for long-term, value-driven approaches. This can attract a new breed of investors seeking sustainable returns on responsible investments, ultimately invigorating the AIF market with a more trustworthy and stable foundation.

The notification also casts a spotlight on regulated entities with existing investments in AIFs harboring downstream exposure to debtor companies. For them, navigating the new landscape presents logistical and financial challenges. Limited exit options may force them to remain invested, potentially facing provisioning requirements that squeeze profitability. However, these challenges also catalyze introspection and responsible action. Regulated entities will be forced to re-evaluate their investment strategies, prioritize financial prudence, and consider divesting from problematic positions. This internal restructuring, while initially uncomfortable, can lead to a healthier and more sustainable approach to AIF investment in the long run.

These regulations offer substantial benefits for investors. By addressing conflicts of interest through clear rules and enhanced oversight, they promote transparency and accountability in the AIF market. Investors can now confidently rely on robust disclosures and responsible investment strategies, eliminating the need to navigate a landscape clouded by potential malpractices. This newfound clarity empowers investors to make informed decisions, fostering a market ecosystem that prioritizes value creation and sustainable growth.

Regulatory Implications

This circular emerges within a broader regulatory context and signals a crucial alignment with SEBI guidelines. This unified front against potential conflicts of interest reinforces transparency and accountability, strengthening the regulatory framework for the AIF landscape. The notification resonates with SEBI’s focus on robust disclosures and responsible investment practices, showcasing a concerted effort to foster a healthy and sustainable growth trajectory for AIFs. However, further regulatory development remains crucial to address emerging challenges and ensure the market’s continued evolution along responsible lines. Potential areas for focus include:

  1. Refining exit options: Providing regulated entities with more flexible and efficient avenues to exit AIF investments with downstream exposure can mitigate potential financial strains and encourage responsible divestment practices.
  2. Enhancing data transparency: Implementing more stringent data reporting requirements on AIF investments and underlying assets can further strengthen oversight and investor confidence.
  3. Tackling new frontiers: As innovation disrupts the financial landscape, the regulatory framework needs to adapt to address emerging concerns in areas like alternative data usage and fintech integration within AIF strategies.

This shift necessitates stricter internal controls, enhanced data transparency, and a focus on responsible investment practices outlined by the SEBI (Alternative Investment Funds) Regulations, 2012.

Alternative Solutions for Consideration

While the RBI aims to mitigate potential conflicts of interest within AIFs, acknowledging the need for alternative solutions is crucial to maintaining a balance between transparency and robust investment opportunities. Striking this balance necessitates exploring avenues that safeguard investors while enabling healthy growth for AIFs and regulated entities.

One potential alternative lies in strengthening information disclosure and investor education. By mandating granular data transparency on AIF investments, including underlying assets and potential downstream exposure, investors can make informed decisions based on complete information. This can be further bolstered by robust investor education programs such as the “Strategic Framework for Investor Education and Financial Literacy” by the International Organization of the Securities Commission (“IOSCO”), empowering them to identify and navigate potential conflicts of interest. To support this, SEBI’s circular dated 19 December 2023 on “Principles of Financial Market Infrastructures”could be implemented simultaneously due to its heavy emphasis on transparency, governance, and operational resilience.

Another avenue involves implementing stricter due diligence frameworks for regulated entities investing in AIFs. A multi-layered due diligence process as explained by IOSCO, encompassing both qualitative and quantitative assessments of AIFs and their underlying investments, can mitigate the risk of evergreening and other problematic practices. This can be supported by independent third-party verification of AIF investments, adding an extra layer of transparency and accountability. Inspiration can be taken from something similar done by the United States of America for Private Fund and Hedge Fund Managers.

Furthermore, fostering a culture of responsible investment within AIFs can act as a proactive solution. Encouraging long-term value creation alongside robust risk management practices can steer AIFs away from short-term, conflict-ridden strategies. Implementing clear internal governance frameworks and conflict of interest policies, adhering to SEBI’s guidelines, can further institutionalize this responsible approach.

Finally, exploring innovative investment structures can offer additional solutions. For instance, developing segregated AIF structures tailored to specific investor groups with aligned risk appetites can mitigate potential conflicts as seen in the European Union. Likewise, utilizing blockchain technology as seen in Singapore for instance, can enhance data security and record-keeping and can contribute to greater transparency and auditability within AIF investments.

It is crucial to remember that finding the optimal solutions will require a collaborative effort from all stakeholders. Continued dialogue between regulators, AIFs, regulated entities, and investors will be key to identifying the most effective approaches that minimize conflict of interest without stifling legitimate investment opportunities. By embracing innovative solutions and a commitment to responsible practices, the AIF ecosystem can navigate this crucial juncture and emerge stronger, fostering sustainable growth while safeguarding investor interests.


The RBI’s recent notification on AIFs represents a proactive response to emerging concerns, particularly focusing on conflicts of interest and the potentially deceptive practice of “evergreening.” The regulatory measures, in alignment with SEBI guidelines, aim to fortify transparency and accountability in the AIF landscape. This not only impacts the immediate operations of funds and regulated entities but also sets the stage for a more robust and sustainable market in the long run. The regulatory implications echo a unified commitment to responsible investment practices, yet further developments are essential to address evolving challenges. Potential refinements include enhancing exit options, strengthening data transparency, and adapting to emerging trends in fintech integration. While the RBI’s efforts are commendable, alternative solutions such as strengthened information disclosure, stringent due diligence frameworks, fostering a culture of responsible investment, and exploring innovative structures are crucial for striking a balance between transparency and facilitating healthy growth. Collaboration among regulators, AIFs, regulated entities, and investors remains pivotal in navigating this transformative phase, ensuring the AIF ecosystem thrives while upholding investor interests and fostering sustainable growth.

Dhaval Bothra

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