Alternate investment funds could face harsher regulation in India

livemint.com:

RBItrage. When it looked like their big-ticket borrowers like real-estate projects were going to default, some financiers took recourse to new funds tailor-made for them by Wall Street firms. Investors who pooled money were issued senior securities, earning them interest.

The finance company also contributed but in a smaller junior tranche that ranks lower down in the repayment order and is the first to absorb any losses. These private funds then lent money to the same stressed borrowers who, in turn, repaid their original loans and avoided bankruptcy proceedings. Finance companies were pleased, since any mark-to-market losses on the securities they now held would be far lower than the provisioning burden they would have had to bear in case of soured credit.

This is how at least some shadow lenders ‘evergreened’ their loan books to avoid being on the radar of the Reserve Bank of India (RBI), their regulator. But the Securities and Exchange Board of India (Sebi) has cottoned on to that sleight of hand. According to a Reuters report, Sebi detected at least a dozen cases involving $1.8 billion to $2.4 billion where AIFs ave been misused to sidestep other regulators like RBI.

The amounts involved may be small, but the problem with such shady practices is that they invariably lead to stiff regulation. And that could slow down the blistering growth of AIFs, a broad category that includes venture capital, private equity, real estate funds and private credit. A Mumbai-based PE investor pointed out to me that it’s mostly Wall Street firms that sponsored these cute structures.