To aid infra finance, Sebi proposes allowing AIF funds to pledge investee company equity

The paper also noted that global securities market regulators (such as the US SEC and UK FCA) and IOSCO have highlighted the risk of systemic financial sector leverage on the back of private capital investments.

To allow alternative investment funds (AIFs) to participate better in infrastructure projects, the market regulator has proposed allowing Category I and Category II funds to pledge the equity of their investee companies to help these investee companies raise loans.

AIF is a privately pooled investment vehicle that collects funds from investors for investing them.

In a consultation paper dated February 2, the Securities and Exchange Board of India (Sebi) has discussed the need for allowing this practice and the risks that arise from this.

These two categories are not allowed to borrow either directly or indirectly or engage in any leverage except for meeting temporary funding requirement. Category III funds are allowed to borrow or engage in leverage for investing, but subject to certain conditions.

This new proposal is to give categories I and II more flexibility.

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The paper noted the government's active promotion of infrastructure development over the past few years, and Budget FY2023-24 highlighting the importance of private capital in funding infra investment.

The regulator received various representations from the AIF industry on why they have not been able to participate often in infra projects.

The industry has said that it is essential to allow AIFs to create encumbrance on their equity investments in infrastructure companies, to obtain project finance.

This is because project finance is only given against pledge of equity of the project, that is, the equity of the special-purpose vehicle holding the project. This pledge provides lenders the right to step into the project in case the SPV defaults on its payment obligation. If such equity pledge isn't permitted, the ability of such projects to get lending is "severely hampered".

The regulator noted that AIFs have been successful in channelising global institutional monies into infrastructure funds that have contributed to infrastructure development.

The note added, "Such AIFs typically own the equity of downstream project SPVs and hence such equity need to be pledged to project finance lenders. If pledging of equity by AIFs remains constrained, then AIFs would be at a significant disadvantage relative to all other equity participants (listed public companies, unlisted private companies, global pension funds, sovereign funds, global funds, etc.)"

The paper also noted that global securities market regulators (such as the US SEC and UK FCA) and IOSCO have highlighted the risk of systemic financial sector leverage on the back of private capital investments.