By Andy Mukherjee
There are plenty of high-performing private investment vehicles in India, but it’s the few that are being set up for dubious purposes that may bring harsher regulatory scrutiny to the country’s most rapidly expanding asset class.
So far, the most egregious use of these so-called alternative investment funds has been by nonbank finance companies, several of whom have employed these bespoke structures for pure regulatory arbitrage.
When it looked like their big-ticket borrowers, especially real-estate projects, were going to default, some financiers took recourse to new funds tailormade 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 pecking order and is the first to absorb any losses.
The private funds then lent money to the same stressed borrowers who, in turn, repaid their original loans and avoided bankruptcy proceedings. Finance companies were happy, too, 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 in India have “evergreened” their loan books to avoid being on the radar of the Reserve Bank of India, their regulator. But the Securities and Exchange Board of India, the stock-market watchdog, has cottoned on to the sleight of hand. According to a Reuters report in October, the SEBI has detected at least a dozen cases involving $1.8 billion to $2.4 billion where alternative investment funds have been misused to sidestep other financial regulators including the 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 alternative funds, a broad category that includes venture capital, private equity, real estate funds, and private credit. A prominent Mumbai-based PE investor pointed out to me that it’s mostly the Wall Street firms that sponsored the cute structures. The same marquee buyout specialists will be the first to complain when, as a direct consequence, regulation in India takes a sterner turn. The lawyers who advised on these deals would wash their hands off.
Currently, it’s international investors who dominate the alternative-asset landscape in the world’s most-loved emerging market. But a rising number of affluent Indians are also looking at them for returns superior to what they can get from public equity, debt and residential real estate. For a growing class of high-net-worth individuals, the minimum ticket size — Rs 1 crore ($120,000) — is not a showstopper.
However, the game will not stop with the rich. Domestic institutions’ participation will increase, too, once insurance and pension firms are given more leeway to invest in alternative assets. Since that will indirectly bring the regular Indian saver to the rich person’s playground, it’s one big reason why the SEBI can’t afford to ignore the dodgy structures. A global PE sponsor buying a riskier portion of a fund would be par for the course, but a local nonbank finance company that’s not the sponsor providing a loan-loss cushion to make its balance sheet look good? Or a big international retailer using a fund to get around New Delhi’s foreign direct investment limits? The regulators are losing their patience.
The zeitgeist is in SEBI’s favor. The US Securities and Exchange Commission, under Chair Gary Gensler, came out with rules in August to tighten its grip on hedge funds and private equity. Their industry associations have sued the SEC, alleging that the agency has gone too far and that the new rules “would fundamentally change the way private funds are regulated in America.”
Which is perhaps why the SEBI wants to act early. The alternative-asset industry in India has venture capital and hedge funds as its two bookends. The main body, however, consists of private equity and private credit. Whereas just a decade ago these two asset classes were a $200 million sideshow, now they command $83 billion, or more than four-fifths of the $100 billion committed by investors to private funds.
If this past growth is any guide, it won’t take too long for the firepower to grow to a point where the industry can flex its lobbying muscles — both in New Delhi and Washington — to thwart any attempt to rein it in. Even now, it isn’t exactly easy for SEBI. A tussle between the regulator and the fund lobby has been playing out for more than a year, the Economic Times reported in July.
The stakes are increasing on both sides. Alternative funds will continue to be the fastest-growing segment of India’s investment landscape, CRISIL, an affiliate of S&P Global Inc., noted in a report last year. That growth has been made possible by light-touch regulation: As conduits of foreign capital into the country, the industry has enjoyed a lot of latitude. But now that the local saver is getting entangled, expect an end to private funds’ freewheeling ways. Global PE firms’ questionable deals have made that outcome inevitable.
Disclaimer: This is a Bloomberg Opinion piece, and these are the personal opinions of the writer. They do not reflect the views of www.business-standard.com or the Business Standard newspaper
FAQs
Private credit securities may be illiquid, present significant risks, and may be sold or redeemed at more or less than the original amount invested. There may be a heightened risk that private credit issuers and counterparties will not make payments on securities, repurchase agreements or other investments.
Is private credit regulated? ›
Private credit is available in the private market alongside private equity, hedge funds, private real estate, and venture capital. The Securities and Exchange Commission (SEC) has certain authorities that are relevant to private securities markets, which are less regulated than public markets are.
How are private credit funds valued? ›
The initial issuance of a loan will contain terms and conditions which are congruent with current market conditions and the expected return profile. Often the yield for a private investment is priced based on a spread over the secured overnight financing rate (SOFR). As the SOFR market moves, the yield moves.
Has private credit's golden age already ended? ›
Private-credit investors are now supplying the third wave of money. Since 2020 such firms, which often also run private-equity funds, have raised more than $1trn. When interest rates rose in 2022 and banks stopped underwriting new risky loans, private credit became the only game in town.
Is it worth investing in private credit? ›
Overall, private credit investment can be a great way for investors to earn high returns and diversify their portfolio. However, it is important to remember that there is more risk involved with this type of investment than there is with traditional bank loans.
What is the concern of private credit? ›
For policymakers worried about systemic risk, the big concern with private credit is over poor underwriting potentially leading to high credit losses that hidden leverage might then transmit to unexpected parties, including regulated banks and limited partners in private credit funds such as regulated insurance ...
Why are firms turning to private credit? ›
Private credit offers greater certainty with clear terms, interest rates, and timelines. Robust Investment Returns: Private credit remains a strong investment strategy, with returns outperforming other asset classes.
How are private credit funds taxed? ›
Private credit funds are usually taxed as partnerships and investors will receive an annual Schedule K-1 showing their pro rata share of the fund's gains, losses, income, credits, and distributions. An investment in a private credit fund will complicate an investor's tax return and increase tax preparation costs.
What is the difference between a private credit fund and a private equity fund? ›
The Bottom Line. Investing in private credit involves making loans to companies or individuals and collecting interest payments, while private equity investors acquire an ownership stake in a company whose shares don't currently trade on the public markets.
Is private credit in a bubble? ›
Interviewed yesterday by David Rosenberg of Rosenberg Research, his Toronto-based independent research firm, Gundlach voiced skepticism about the health of asset classes ranging from private credit to 30-year Treasury bonds. Both Gundlach and Rosenberg agreed the boom in private credit represented a “bubble.”
Why has private credit grown? Investors. Private credit began expanding in the wake of the 2008 financial crisis. With interest rates near zero, returns to government and corporate bonds were unattractive to institutional investors and wealthy individuals.
Who buys private credit? ›
Private credit is a kind of fixed-income investment that allows investors – typically accredited investors and institutional investors – to purchase off-market debt of private companies.
When did the Golden Age stop? ›
Although there's some contention as to when the golden age began and ended, most critics agree that it “existed” in some capacity from the late 1910s into the early 1960s.
How does a Golden Age end? ›
In Hesiod's version, the Golden Age ended when the Titan Prometheus conferred on mankind the gift of fire and all the other arts. For this, Zeus punished Prometheus by chaining him to a rock in the Caucasus, where an eagle eternally ate at his liver.
When did the golden era end? ›
The Golden Age of American animation, between 1928 (sound) and the 1960s (television). The Golden Age of Hollywood, which lasted from the end of the silent era in American cinema in the late 1920s to the 1960s.
Are private investments risky? ›
Higher Return Potential
Private investments involve a number of risks, including illiquidity, lower transparency and less regulatory oversight than is found in public securities. They are also frequently early-stage or involve untested business models and management teams.
What are the drawbacks of private financing? ›
Disadvantages of using private placements
a reduced market for the bonds or shares in your business, which may have a long-term effect on the value of the business as a whole. a limited number of potential investors, who may not want to invest substantial amounts individually.
What is the disadvantage of private investors? ›
2 Cons of using private investors
One of the main challenges is that you will have to give up some control and ownership of your business to your investors. This means that you may have to share your profits, report your performance, or consult them on major decisions.
