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Regulation of Evergreening Through AIFs: Analysing the RBI’s Recent Notification

[Tarasha Gupta is a third-year B.A., LL.B (Hons.) student at Jindal Global Law School]

Last month, the RBI issued a notification restricting the scope of investment by banks / NBFCs / financial institutions (“Regulated Entities”, or “REs”) in Alternative Investment Funds (“AIFs”). The notification comes after the SEBI informed the RBI of instances of NBFCs evergreening loans through AIFs over a year ago, and subsequent investigations by the SEBI and RBI into about a dozen cases of alleged misuse of AIFs by NBFCs in October last year.

Evergreening refers to the practice of banks/NBFCs to prevent a loan from becoming an NPA by granting further loans to the borrower to repay the initial principal amount. Avoiding classification as an NPA allows REs to avoid higher provisioning compliances and presents a better picture of the Entity’s profitability. The practice has become widespread and many banks have been flagged for divergence in their NPA reporting compared to the RBI’s assessment of NPAs.

This post breaks down how REs attempt to evergreen loans and circumvent the law through AIFs, and analyses current regulations and the RBI’s latest notification designed to combat such practice.


SEBI Regulations on AIFs

AIFs are privately pooled investment vehicles that operate by collecting funds from investors and investing it in accordance with a defined investment policy. AIFs are regulated by the SEBI through the SEBI (Alternative Investment Funds) Regulations, 2012 (“SEBI AIF Regulations”). The Regulations provide for three categories of AIFs:

1.     Category I AIFs: includes SME Funds, social venture funds, infrastructure funds

2.     Category II AIFs: includes real estate funds, private equity funds (PE funds), debt funds (funds primarily investing in the debt or debt securities of companies), etc.

3.     Category III AIFs: includes hedge funds, PIPE Funds, etc.

By investing in AIFs, REs may try to avoid classifying defaulting accounts as NPAs, either by selling their stressed loans to AIFs set up by the Entities themselves, or by investing into debt funds holding the debt/debt securities of companies who have taken a loan from them. Ultimately, money would be going out of the RE’s pocket and into that of the debtor company, which fits the definition of evergreening. It is apparent that such uses of AIFs would be contrary to the purpose for which they were envisaged; SEBI’s answer to Question 7 on the Frequently Asked Questions on the SEBI (Alternative Investment Funds) Regulations, 2012 clarifies that a debt fund cannot be utilized for the purpose of giving loans, as it is a privately pooled investment vehicle.

Additionally, several provisions of the SEBI AIF Regulations appear to operate against such use of AIFs. For example, Regulation 21 of the SEBI AIF Regulations specifies the fiduciary duty of AIF Sponsors and Managers towards investors, and provides for disclosure and mitigation of conflicts of interests. Managers and Sponsors are to avoid conflicts of interest with all associated persons. Thus, if the very set up and operation of the AIF is such that it benefits the RE as an investor over others through such evergreening, such practices might be against conflict of interest norms.

Regulation 22 of the SEBI AIF Regulations provides for the transparency and disclosure of information to investors regarding risks, fees ascribed to the Manager or Sponsor of the AIF, etc. This may additionally be employed against AIFs and their managers to disclose any investments done to evergreen loans and defeat the laws providing against it.

Regulation 25 provides that the AIF must lay down a procedure for resolution of disputes between the investors and/or AIF Manager or Sponsor. This procedure could, therefore, also be used to solve disputes related to the use of AIF corpus to invest in companies indebted to, or the loans of, the REs who may have invested in, or set up, the AIF.


RBI’s New Notification & Analysis

Through its notification dated 19 December 2023 (“Notification”), the RBI specified 4 provisions to address possible evergreening through AIFs. First, REs cannot invest in any AIF scheme which has direct or indirect downstream investments in a debtor company (defined as a company to which the RE has had loan or investment exposure at any time during the last 12 months).

Second, if an AIF scheme in which a RE has already invested in makes a downstream investment in a debtor company, the Entity must liquidate its investment within 30 days of the date of such downstream investment, or, if the RE has already invested in such scheme, within 30 days from the date of issuance of the Notification.  

Third, if the REs do not liquidate their investments in within the prescribed time limit as aforesaid, they will have to make a 100% provision on such investments.

However, it is important to note that AIFs will not be invested in by the REs alone; even if the REs make a 100% provision on such investment, the use of the AIF for such purpose will have impacts on other investors as well. The Notification does not mitigate any of the possible impacts on other investors, which may have been done through a mandatory disclosure requirement, or otherwise. This is especially crucial considering the SEBI’s previous concerns that no investor in an AIF should be given preferential treatment that may impact other investors’ rights (reflected in its approach towards priority distribution models). Regardless, in the absence of such express provision in the current Notification, Regulations 21, 22 and 25 of the SEBI AIF Regulations might still be employed to mitigate the impact of such continued investment in the defaulting investee company on other investors of the AIF.


Finally, the Notification provides that if REs invest in any subordinated units of any AIF scheme with a priority distribution model, this shall be subject to a full deduction from the Entity’s capital funds. In the priority distribution model (as defined by the SEBI’s 2022 Circular), one class of investors in an AIF shares loss in a proportion higher than their holding in the AIF; comparatively, other classes of investors/unit holders have ‘priority’ in distribution.

It becomes apparent that the Notification does not explicitly provide for cases where the lender itself sets up the AIF and uses it to buy its own stressed loans. Rather, it seems to be restricted to cases where the lender invests in the debtor company through an AIF. Thus, while the Notification is a step in the right direction, it does not fully cover the entire scope of mechanisms through which AIFs may be employed for evergreening.



A look at the SEBI AIF Regulations suggests that the Notification strengthens existing regulations on AIFs to combat their use for evergreening. In doing so, it builds on the existing framework regarding AIFs, rather than suggesting anything contrary to, or outside the ambit of, the Regulations. While it is a progressive step to combat some of the ways in which NPA classification and provisioning norms are circumvented, it does so by only focusing on downstream investments by AIFs in debtor companies, and not the entire scope through which evergreening may take place using AIFs. Regardless, in the post-Covid and post-financial crisis economy, the Notification is an important step toward bridging the divergence in NPA reporting and the detrimental impact of concealing NPAs to tidy up Regulated Entities’ books. 

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