The Reserve Bank of India (Transfer of Loan Exposures) Master Directions, 2021 issued on September 24, 2021 (‘RBI Master Directions’) provided dispensations for an entity that is permitted by a financial sector regulator, other than Reserve Bank of India (‘RBI’), to purchase loans. Such entities can acquire loans: (1) in terms of a resolution plan under RBI (Prudential Framework for Resolution of Stressed Assets) Directions, 2019; and (2) which result in exit of specified Indian lenders (i.e. banks, non-banking financial companies, other financial institutions, etc.).

The Securities and Exchange Board of India (‘SEBI’) had in its Board meeting dated December 28, 2021 proposed to introduce a new sub-category of category I alternative investment funds (‘Category I AIFs’) known as ‘Special Situations Fund’ (‘SSF’). Please refer to our Client Alert dated January 4, 2022, in this regard, accessible here.

Subsequently, SEBI had on January 24, 2022 notified amendments (‘Amendment Regulations’) to the SEBI (Alternative Investment Funds) Regulations, 2012 (‘AIF Regulations’) to introduce a new chapter on SSFs under the AIF Regulations.

Further, SEBI has on January 27, 2022 issued a Circular setting out certain guidelines on SSFs (‘Circular’).

Special Situation Funds

The Amendment Regulations and the Circular set out that SSFs are Category I AIFs which: (1) can only invest in ‘special situation assets’ in accordance with its investment objectives; and (2) additionally can act as a resolution applicant under the Insolvency and Bankruptcy Code, 2016 (‘IBC’) by complying with the eligibility requirements thereunder.

‘Special situation assets’ are defined under the Amendment Regulations to include:

1.     Stressed loans:

(a)   Available for acquisition in terms of Clause 58 of the RBI Master Directions (or in terms of any other policy of RBI or Government of India issued in this regard from time to time); and

(b)   Acquired as part of a resolution plan approved under IBC.

Important notes:

(i)    Basis Paragraph 58 of the RBI Master Directions, SSFs can step in (arguably jointly with other buyers) for comprehensive resolution of all INR loans of a stressed borrower held by Indian banks / financial institutions. The guidelines do not, at this stage, contemplate or permit acquisition of individual loans (for debt aggregation or otherwise).

(ii)   The market view is that for SSFs to acquire stressed loans under the aforesaid RBI Master Directions, it would need to be recognised by RBI as a permitted transferee (which recognition is awaited).

(iii)  More clarity is awaited on the ability of an SSF to acquire stressed loans as part of a resolution plan approved under the IBC.

2.     Security receipts issued by an asset reconstruction company registered with RBI.

3.     Securities of investee companies:

(a)    Whose stressed loans are available for acquisition in terms of Clause 58 of the RBI Master Directions, or as part of a resolution plan approved under the IBC or in terms of any other policy of the RBI or Government of India issued in this regard from time to time;

(b)    Against whose borrowings, security receipts have been issued by an asset reconstruction company registered with the RBI;

(c)    whose borrowings are subject to corporate insolvency resolution process under Chapter II of IBC; and

(d)    who have disclosed all the defaults relating to the payment of interest/ repayment of principal amount on loans from banks/ financial institutions/ systemically important non-deposit taking non-banking financial companies/ deposit taking non-banking financial companies and /or listed or unlisted debt securities in terms of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 and such payment default is continuing for a period of at least 90 calendar days after the occurrence of such

Provided that in case of sub-clauses (c) and (d), the credit rating of the financial instruments or credit instruments or borrowings of the company has been  downgraded to ‘D’ or equivalent.

4.     Any other asset as may be specified by SEBI from time to time.

Other Requirements

1.     Minimum Corpus

 The applicable minimum corpus requirement for SSFs is INR 1,000,000,000 (approx. US$ 14 million).

2.     Minimum Commitment

The minimum capital commitment requirement for investors proposing to invest in SSFs is INR 1,00,000,000 (approx. US$ 1.4 million). The minimum capital requirement for an accredited investor to invest in SSF is INR 50,000,000 (approx. US$ 0.7 million). Further, in case of investors who are employees or directors of the SSF, or employees or directors of the manager of the SSF, the minimum value of investment is INR 2,500,000 (approx. US$ 33,395).

3.     Diversification Limits

The minimum diversification limit generally applicable to Category I AIFs of investing a maximum of 25% of its investable funds in an investee company, is not applicable to SSFs.

4.     Others

(a)    SSFs are not permitted to invest in companies incorporated outside India.

(b)    SSFs are not permitted to invest in: (i) their associates; (ii) the units of any other AIFs other than the units of a SSFs; and (iii) units of SSFs managed or sponsored by its manager, sponsor or associates of its manager or sponsor.

(c)    SSFs will not accept investments from any other AIF other than an SSF.

(d)    SSFs can only invest in special situation assets.

(e)    The following are applicable to any investment by an SSF in the stressed loan acquired under Clause 58 of the RBI Master Directions, as amended from time to time:

(i)     A minimum lock-in period of six months is applicable. The lock-in period is not applicable in case of recovery of the stressed loan from the borrower;

(ii)    SSF may acquire stressed loan upon inclusion of SSF in the respective annex of the RBI Master Directions; and

(iii)   SSF must comply with the same initial and continuous due diligence requirements for its investors, as those mandated by RBI for investors in asset reconstruction companies.

 Key Takeaways

While the Amendment Regulations is a progressive step by SEBI and will help in attracting investments in special situation assets, recognition by RBI for SSFs as permitted transferees under RBI Master Directions is still awaited by the market. Clarity is also awaited on SSFs being permitted to acquire loans as part of a resolution plan approved under IBC. SSFs are envisaged to step in for comprehensive resolution (singly or arguably, jointly with other buyers) of all INR loans of a stressed borrower held by Indian banks / financial institutions (and does not currently contemplate or permit acquisition of individual loans). The deletion of the diversification limits will encourage setting up of multiple alternative investment funds for investment in stressed assets without having to ensure that a suite of deals is available for such SSFs to invest in.