Does private credit need stricter regulation?

By Aditya Vikram Dua and Aniket Sawant, SNG & Partners
0
595
LinkedIn
Facebook
Twitter
Whatsapp
Telegram
Copy link

Private credit has become an attractive source of funding for issuers, compared to traditional sources. This is because the Reserve Bank of India (RBI) has stricter regulations and has tightened lending standards for banks and non-banking finance companies (NBFC).

While private credit is one of the most sought-after sources for the funding needs of various businesses, there has been significant debate as to whether it should be more strictly regulated. Private credit has been used to devise structures and transactions which would otherwise be restricted for banks and NBFCs, together regulated entities (RE). It appears that regulators in India such as the Securities and Exchange Board of India (SEBI) and the RBI have been closely watching developments and have from time-to-time issued regulations to stop the abuse of private credit structures. Examples are the SEBI’s restriction on senior-junior structures for alternative investment funds and the recent circular on restricting REs from investing in funds which make investments in debtor companies of REs (RBI circular).

Aditya Vikram Dua, SNG & Partners
Aditya Vikram Dua
Partner
SNG & Partners

It is well-known that alternate investment fund structures have been abused by REs that transfer their overdue loans to these funds. Typically, the RE subscribes to the units of private funds, which subsequently invest money in the stressed borrowers that, in turn, repay their original loans to the RE. The RE benefits from such loan evergreening as it is not required to recognise such loan accounts as non-performing and can escape higher provisioning requirements. According to a report by Reuters in October, the SEBI had identified some 12 cases of misuse of alternative investment funds, involving between USD1.8 billion and USD2.4 billion. These instances reportedly involve attempts to bypass various financial regulators, including the RBI. While the amounts may seem relatively small, they led to the issue of the recent RBI circular. The aim of the RBI is to end evergreening through the misuse of private credit structures and is well intended, but it may have unintended repercussions and consequences that may adversely affect the private credit market.

It needs to be accepted that the private credit market solves the very real problem of making available credit for certain bona fide purposes and entities, which may not be able to obtain such credit from regular financing channels. While banks and NBFCs are regulated to safeguard the investments of small depositors, regulation around private credit could not be on the same lines as the investors’ money in private credit funds is not repayable on demand and is usually subject to a lock-in period. Investors know the risks affecting their returns and accept that the funds have complex structures when it comes to withdrawals.

Aniket Sawant, SNG & Partners
Aniket Sawant
Principal Associate
SNG & Partners

Investors behind private credit funds are usually high-net-worth persons or institutions with access to excellent legal and other professional advice. They are able to assess the risks and investments are made after due consideration of the fact that such investments are high risk-high reward investments. This is not the case for investment of depositors’ money available with REs.

Regulators worldwide focus on systemic risks or those related to financial stability. While the global private credit market is estimated to be worth USD1.5 trillion, regulators, including those in the US, have not so far considered private credit funds to be high risk. In India, according to data from Prequin, private credit investors had about USD15 billion under management as of December 2022.

The private credit market in India is evolving and growing significantly. After the enactment of the Insolvency and Bankruptcy Code, 2016, private credit funds have been looking at distressed asset acquisition financing, an area in which REs are not able to provide complete solutions because of stringent end-use restrictions.

As more credit funds are registered and seize their opportunities, the market will grow. Further regulation to protect systemic financial stability is inevitable. Regulators will be watching developments closely and will regulate as the need arises. The industry must collaborate with regulators to ensure that new regulations not only prevent malpractice but also foster the healthy progress of this asset class. This is vital as alternative investment funds will continue to be a significant source of financing for many businesses in the future.

Aditya Vikram Dua is a partner and Aniket Sawant is a principal associate at SNG & Partners.

SNG & Partners

One Bazaar Lane, Bengali Market

New Delhi – 110001
India

www.sngpartners.in

Contact details
T: +91 11 4358 2000
E: info@sngpartners.in

LinkedIn
Facebook
Twitter
Whatsapp
Telegram
Copy link