Sebi’s Mapping Out a Framework for Special Stress Funds

The regulatory push to create a special category of venture capital funds focusing on buying stressed loans from banks and financial institutions is gathering pace.

At a meeting on December 6, senior officials of the Securities & Exchanges Board of India (Sebi) discussed with fund industry persons the proposal for such ‘Special Situation funds’ which would have minimum corpus of Rs100 crore, accept investment of not less than Rs 10 crore from accredited investors, and have checks and balances to stop promoters of defaulting companies from making a back door entry, three people’s familiar with the matter told ET.

A special situation fund, according to the framework proposed by Sebi, would be exempted from investment concertation norms and rules that require minimum investments in unlisted securities.

Under the regulatory framework such funds would be a separate sub-category under the category 1 alternative investment funds (AIFs)- the regulatory parlance for pooled vehicles like VC and private equity funds. Currently, AIFs are allowed to invest in stock, debenture and security receipts (issued against underlying loans).

However, a special situation funds would be permitted – subject to regulatory clearance –to purchase non-performing loans as well as loans that show early signs of stress with interest overdue of one or two months.

A Sebi spokesman did not comment on the subject. Sources said that while Sebi is actively considering the proposal and sounding out industry persons, the regulations are yet to be finalized.

There have been transactions where AIFs have struck deals with asset reconstructions companies (ARCs) to fund stress asset purchases. But faced with a sluggish stressed loan market, some of the expert groups have advised that AIFs should be allowed to directly buy loans from banks the way asset reconstruction companies do.

This may active securitization deals, develop a vibrant stress asset market and quicken resolution of defaulting companies. One such panel, headed by an RBI official, had suggested allowing ARCs to sponsor AIFs to mobilize funds to buy bad loans.

Despite a mountain of NPAs in the books of banks, the market has failed to take off, thanks to Arcs’ lack of capital and access to funds, along with difference between then and banks over valuation of stress loans.

According to industry sources, the formation of special situation funds (that buy loans) would require a degree of coordination between Sebi which regulates securities issued by borrowing companies and RBI has last word on lending banks and rules governing loans by banks and non-banking finance companies. According to RBI’s ‘Master Direction on Transfer of Loan Exposures 2021’, the respective financial sector regulator has to put in place a framework in consultation with the banking regulator for permitting acquisition of loan.

Besides acquiring stress loans, a special situation fund, as per the proposal, could invest in security receipt (SRs), securities of companies undergoing corporate insolvency resolution, and debt papers which have been rated ‘default grade’ by a credit rating agency. S-ET

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