The evolution of the credit market has been influenced by various factors, including changes in the economic landscape, regulatory frameworks, and the emergence of new financial entities.
Traditionally, banks and NBFCs played a central role in meeting the credit needs of the investors. The regulatory frameworks for banks and NBFCs were designed to ensure financial stability and ensure protection of investors. However, as economies expanded, certain investors with a high-risk appetite sought more diverse, flexible, and specialized financial products, viewing traditional banking options as restrictive.
In response to this demand, specialised financial products were structured for these sophisticated private investors seeking higher returns and diversification beyond traditional debt instruments. To facilitate investments in these products, pools of funds, such as Venture Capital (VC) Funds or AIFs, were generated from these investors. The financial structuring of these products was managed by specialised professionals, tailored to the preferences of investors with an appetite for high-risk/high-return opportunities. The regulatory environment for these funds also provides more flexibility compared to the stringent regulations governing banks and NBFCs.
Given the extreme risk-reward profile, in order to diversify their risk, REs also started investing a portion of their funds in such products. This investment model has been driven by the confidence derived by other investors in such AIFs, that is, while, on one side, REs benefit from the expertise of fund managers who make informed decisions for investors, leveraging their knowledge and experience, on the other side, AIFs also capitalize on the confidence that other investors derive from having an established RE as part of the investor group.
To uphold the integrity of the relationship between sponsors and AIFs, the regulatory framework also incorporated specific provisions. Notably, under Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”), investment manager or sponsor are required to maintain a continuing interest of at least two and a half percent (five percent in case of category III AIF) of the fund’s corpus or five crore rupees (ten crores in case of category III AIF), whichever is lower. Similarly, Regulation 21 of the AIF Regulations mandates sponsors and investment managers to promptly disclose all conflicts of interest as they arise or appear likely to arise.
Source: Barandbench
