One of the consultation papers recently released by the Securities and Exchange Board of India (SEBI) has sparked notable changes in the regulatory framework overseeing Special Situation Funds (SSFs) as set out under the SEBI (Alternative Investment Funds) Regulations, 2012 (AIF Regulations). Falling under the umbrella of Alternative Investment Funds (AIFs), SSFs, as the name suggests, specialize in investing in ‘special situation assets,’ particularly stressed loans available for acquisition. The consultation paper seeks to not only fine-tune the regulatory guidelines for SSFs but also to broaden their impact on the investment landscape.
Key Changes Proposed
- Definition of Related Party
The consultation paper proposes to amend the AIF Regulations to expand the scope of the term ‘associate’ to include ‘related party’ as defined under the Companies Act, 2013, to alleviate conflict of interest concerns. While a welcome suggestion to aid transparency, the textual amendments would have to be reviewed to see the context in which the term ‘related party’ is introduced – i.e., related parties of the fund manager or related party of fund manager, trustee or partner or sponsor.
- Rethinking Special Situation Assets
At present, SSFs are allowed to invest in stressed loans available for acquisition and securities of companies meeting the criteria under the master directions issued by the Reserve Bank of India (RBI) or resolution plans approved under the Insolvency Bankruptcy Code, 2016 (IBC). The consultation paper proposes to change the terminology from ‘available for acquisition‘ to ‘are acquired,’. This proposed change aims to broaden the definition of stressed assets thereby injecting flexibility into SSF operations. However, it raises concerns about potential limitations on SSFs acquiring stressed accounts during the resolution process.
- Investor Eligibility under Section 29A of the IBC
The consultation paper proposes aligning eligibility criteria under section 29 of the IBC not only to SSFs but also to their underlying investors. This move seeks to ensure consistency across asset reconstruction companies (ARCs) and SSFs, addressing the broader investor pool accessible to AIFs.
- Minimum Holding Period
The revised construct proposed in the consultation paper envisages SSFs selling the stressed loans acquired by them, upon expiry of the 6 months’ lock-in period, only to the entities included in the annex to the Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions, 2019. Turning around distressed entities involves a longer gestation period on investments, at the end of which a limited set of potential buyers may prove to be counterproductive to investors of SSFs. Alternatively, a sunset period to the proposed restriction followed by unrestricted transferability or similar flexibility may be considered.
- Reporting on Specified Platform
The consultation paper also mandates SSFs to submit comprehensive information (pertaining to inter alia information on investors, manager/sponsor, assets invested, financing etc., as well as any subsequent change in unit holdings, resolution strategies implemented, recoveries effected, etc.) to an RBI-notified trade reporting platform. This transparency measure includes, fostering seamless information symmetry between SSFs and regulators.
These proposed measures, once refined and implemented, are expected to attract increased participation from foreign investors, infusing much-needed capital into the distressed asset segment.
While the consultation paper, seeking to address key aspects of SSF investment landscape, is a welcome step in the right direction, the overall framework still appears to be wanting in clarity on certain other issues. For instance:
- With respect to acquisition of securities of a listed entity by a SSF, SEBI to clarify on availability of exemptions, if any, from the applicability of open offer and delisting regulations, similar to those available to ARCs at present.
- In introducing AIFs as ‘qualified buyers’ for the purposes of the SARFAESI Act, 2002, RBI had stipulated that AIFs must not invest in security receipts issued by an ARC where the underlying non-performing asset is of a bank that holds >10% equity in the AIF. SEBI to clarify the applicability of this restriction vis-à-vis SSFs.
- Where acquisition of stressed loans by SSFs only leads to partial exits to lenders, recourse to enforcement action under SARFAESI Act, 2002 would not be available to SSFs since they will not qualify as ‘secured creditor’ under the SARFAESI Act, 2002. SEBI and RBI to consider devising an appropriate ancillary framework to address this.
- The current framework and proposed amendments envisage SSFs acquiring only stressed assets. SEBI and RBI to consider enabling SSFs to operate even in the pre-default stage in the secondary market for corporate debt in India in due course.
With actual amendments pursuant to the consultation paper still to be notified, and room for further clarification, the SSF landscape will likely remain dynamic on the regulatory front.