Sebi eases borrowing rules for AIFs to address drawdown shortfalls

The Securities and Exchange Board of India (Sebi) has relaxed rules to allow Category I and II alternative investment funds (AIFs) to borrow funds to cover shortfalls in drawdown amounts, aiming to simplify business operations.

In trading, a drawdown represents the decline in the value of an investment or trading account from its peak to its lowest point. Investments made during a drawdown may be smaller if the value of securities remains below the previous peak for an extended period.

According to existing regulations, Category I and II AIFs were restricted from borrowing funds directly or indirectly, except for meeting temporary funding needs and daily operational expenses, with borrowings limited to 30 days on no more than four occasions in a year.

The markets regulator has now permitted these AIFs to borrow to address temporary shortfalls in funds requested from investors for investments in portfolio companies, subject to specific conditions.

According to Sebi, the intention to borrow funds to cover shortfalls in drawdown amounts must be disclosed in the scheme's private placement memorandum (PPM). 

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Besides, such borrowings should only occur in emergencies and as a last resort, when an investment opportunity is imminent, but the drawdown amount from investor(s) has not been received by the AIF before the investment date, despite the manager's best efforts.

Sebi also said that the borrowed amount must not exceed 20% of the proposed investment in the investee company, 10% of the investable funds of the AIF scheme, or the undrawn commitment from investors other than those who failed to provide the drawdown amount, whichever is lower.

The cost of such borrowing shall be charged only to investor(s) who failed to provide the drawdown amount for making investments, Sebi added.

New AIF rules: cooling-off and extensions

According to Sebi's circular issued on Monday, all Category I and II AIFs must maintain a 30-day cooling-off period between two borrowing periods, as permitted under AIF Regulations.

It also allows large value funds (LVFs) to extend their tenure by up to five years, subject to the approval of two-thirds of the unit holders by value of their investment in the LVF.

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Existing LVF schemes that have not disclosed a definite extension period in their PPM, or whose extension period exceeds the permissible five years, must align the extension period within three months, the Sebi circular added.

Navin Dhanuka, Founder and CEO of Altern Capital, said the new circular strikes a balance between enhancing operational flexibility for AIFs and maintaining rigorous oversight and investor protection.

 “These guidelines provide AIFs with valuable options to tackle liquidity challenges and capitalize on time-sensitive investment opportunities. On the other side, it is important to manage the potential risks associated with borrowing, such as overreliance, higher costs for delinquent investors, and added administrative complexities." 

"These guidelines represent a significant advancement in the regulatory framework for AIFs, aligning with Sebi's broader vision of fostering a robust and transparent securities market,” Dhanuka added.

Siddharth Pai, founder of 3one4 capital said that Sebi's move permitted leverage, a key component of AIFs worldwide, which had always been missing for Indian AIFs. 

“AIFs are dependent on investors honoring drawdowns, wherein the AIF calls in capital from investors to make inpaivestments. These are time sensitive, so a single investor missing it may jeopardize the investment. The move by SEBI permits leverage in such cases and places the costs associated with it squarely on the defaulting investor. It's a step towards liberalising leverage for the asset class and making it globally competitive” he said. 

Ranjani Raghavan and Sneha Shah contributed to this story.

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