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SEBI Addresses Stressed Assets In Financial Companies


The financial system of India has over the years been plagued by stressed assets thereby propelling the requirement of significant capital infusion into banks, Non-Banking Financial Companies (“NBFCs”) and other financial institutions.

Under such circumstances financial institutions are not able to provide credit facilities to sectors which would assist in overall economic development in India. Noteworthy herein is that the stressed assets of Indian NBFCs and mortgage lenders are expected to rise by 10-11% by the end of financial year 2021-22, with COVID-19 affecting almost all their asset classes.[1]

The Securities and Exchange Board of India (“SEBI”), in an attempt to address the stressed assets woes of the banking and finance industry has paved way for introduction of a new sub-category of Alternative Investment Fund (“AIF”) called ‘Special Situation Fund’ (“SSF”) under Category I Alternative Investment Funds (“AIFs”) under the SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”).

 In this regard, on January 24, 2022, SEBI has notified the SEBI (Alternative Investment Funds) (Amendment) Regulations 2022[2] (“Amendment Regulations”), as further supplemented by a SEBI circular dated January 27,2022[3] introducing SSF to address the aforementioned issues. Given that AIFs manage and raise privately pooled funds from sophisticated investors who are open to high-risk investments, they can effectively serve as a source of risk capital to deal with the issue of stressed loans. Such a move is expected to bring in a new set of investors in the stressed asset space and create a more efficient market for buying distressed assets.

Special Situation Funds

The Amendment Regulations primarily provide for a new chapter (i.e. Chapter III-B) within the AIF Regulations defining SSFs as a sub-category under Category – I AIFs that invest in ‘special situation assets’, in accordance with its investment objectives and such SSF may act as a ‘resolution applicant’ under the Insolvency and Bankruptcy Code, 2016 (“IBC”).

However, prior to the Amendment Regulations, AIFs were only permitted to invest in debt by way of investment in debt securities and were prohibited from providing loans. Therefore, the AIFs currently tend to invest in distressed assets through investing in securities of stressed companies and Security Receipts (“SRs”) issued by ARCs. Notably, staying invested in an investee company for longer duration is quintessential for turnaround of companies lingering through a state of distress.

In this regard, AIFs should prove to be the most suitable investment vehicle for resolution of stressed assets, especially when coupled along with the managerial skills required to turn around a struggling business. As SEBI also notes in its board meeting memorandum, the purchase of stressed loans at a discounted price from the original lender should prove to be attractive to AIFs as they will have a claim on the assets of the portfolio companies to the extent of outstanding loans.

Special Situation Assets

  • Notably, Category I AIFs invest, inter alia, in sectors which the Government or regulators consider as socially or economically desirable and which are generally perceived to have positive spill over effects on the economy. Further, SEBI or Government or other regulators in India might consider providing incentives or concessions to such AIFs. SSFs are allowed to invest in special situation assets which includes:

  • Stressed loans available for acquisition in terms of Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 (“Transfer Directions”) or as part of a resolution plan approved under IBC;

  • Security receipts issued by ARCs;

  • Securities of investee companies (i) whose stressed loans available for acquisition in terms of Transfer Directions or as part of a resolution plan approved under IBC; (ii) against whose borrowings, security receipts have been issued by an ARC; (iii) whose borrowings are subject to corporate insolvency resolution process under Chapter II of IBC; (iv) who have disclosed all the defaults relating to the payment of interest/ repayment of principal amount on loans from banks / financial institutions; and

  • Any other asset/security as may be prescribed by SEBI from time to time.

With the introduction of such provisions, SSFs will be able to provide much needed capital to companies in distress, which are unable to function optimally and generate value for stakeholders due to over-leveraging, but may have potential of a turnaround.

Key Features of SSFs

SEBI while introducing the SSFs has provided for a slew of relaxations to make them more attractive and conducive for investors and fund manager alike, as discussed below.

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