[By Yash Arjariya]
The author is a student of Hidayatullah National Law University, Raipur.
Introduction: The Regulatory Framework
The issuance of partly paid units of Alternative Investment Funds (‘AIF’) has been a general market practice, with the same being expressly allowed by the Securities Exchange Board of India (‘SEBI’) in the AIF Regulations, 2012. Similarly, the Non-debt Instruments Rules, 2019 (‘NDI Rules’) also seemed to allow the issuance of partly paid units of AIF to Persons Resident Outside India (‘PROI’). The definition of ‘units’ in rule 2(aq) of the NDI Rules read as “beneficial interest of an investor in an investment vehicle,” where an ‘investment vehicle’ included, amongst other things, an AIF as well. Thus, the permissible stance of the SEBI as to the issuance of partly paid units and no bar in the NDI Rules meant that, as a general trend, partly paid units were issued to PROIs in the AIF Industry.
There was a development in this regard in March 2024, where the Ministry of Finance amended the definition of ‘units’ in the NDI Rules 2019 to include partly paid-up units within the definition of ‘units. Thus, this looked like a clarification to the Industry, and it was thought that the Ministry had merely clarified that units under NDI rules always included partly paid units of the AIF. Therefore, as per the market’s understanding, this was a reiteration of the existing position by formal inclusion rather than a change in the law.
However, via its Circular dated May 21, 2024, the Reserve Bank of India (‘RBI’) introduced a new perspective on the March 2024 amendment in the NDI Rules. It interprets the amendment as enabling in nature, which means, as per the RBI’s understanding, there cannot be any issuance of partly paid units of AIFs to PROIs before the amendment in March 2024. The RBI’s Circular seeks to regularise the issuance of such units before the amendment by paying a ‘compounding fee.’ This shift in interpretation has left the Industry in a state of confusion and uncertainty, as it challenges the long-standing market practice.
This article delves into the amendment to NDI Rules and the subsequent RBI Circular, focusing on two crucial points. First, it examines the potential impact on the Industry’s legitimate expectations and the prevalent general practice. Second, it evaluates the alignment of the RBI’s interpretation with general principles of interpretation. The article concludes that the RBI’s understanding of the amendment to NDI Rules, as conveyed through the Circular, may not be viable or at least beneficial to the Industry, raising concerns about the potential negative implications on both the law and the Industry’s legitimate expectations.
Amendment to NDI Rules: Change or no Change
On the point of law, it needs to be understood that the March amendment 2024 to the NDI Rules was only clarificatory in the sense that it did not substantially alter the definition of units but only clarified the existing position that partly paid units of AIF has always been included in the ambit of ‘units.’ Further, as a matter of general principles of interpretation, an explanation added to a provision always applies retrospectively unless otherwise explicitly provided [¶ 21, State of Bihar v. Ramesh Prasad Verma]. Thus, when the market had constantly been issuing partly paid units of AIFs to PROI, the explanation added by amendment can only be reasonably thought to outlay the position of law when the explanation has no explicit intent to operate prospectively. Therefore, this amendment could not be said to be a change of a substantial nature but only a clarification of what existed in law at all times.
Further, attention needs to be also paid to InVi form filings. The form InVi is filed by AIFs with Authorised Dealer Banks (‘AD’) when they issue the units of AIFs to PROIs. There has been a general and uniform practice till that ADs were accepting InVi form filings for partly paid units of AIFs to PROIs. Thus, it was not a case that the practice was not legitimised, instead the AIFs furnished the data to regulators in case of issuance of such partly paid units to PROIs.
Therefore, the RBI’s circular represents a significant and unexpected change in the market, disrupting the established trends and practices. It does so by interpreting the March 2024 amendment as a substantive change rather than a clarification, a departure from the general understanding of the amendment’s nature.
RBI Circular: Case of Interpretative perspective
The amendment to NDI Rules 2024, initially perceived as a clarification by the industry, was not seen as a substantive change operating prospectively. However, when the RBI released its Circular, the nature of the amendment was altered, causing confusion. The Circular communicated that the amendment authorised the issuance of partly paid units of AIFs to PROIs, and any issuance prior to the amendment was deemed impermissible. This sudden change in interpretation has left many in the industry perplexed and in need of clear understanding.
There are three problems that arise with respect to the Circular. First, the nature of the ‘Explanation’ added to the definition of ‘units’ in NDI rules is not a substantive provision in any sense of the term. The plain meaning of the amendment brought as ‘Explanation’ itself shows that it is merely meant to explain or clarify certain ambiguities [¶ 46 (SCC Copy), S. Sundaram Pillai v. V.R. Pattabiraman]. And that such clarificatory or explanatory changes operate retrospectively, i.e., they are deemed to be there since the law (NDI Rules, in this case) was brought in place [¶ 8.1, Sree Sankaracharya University of Sanskrit v. Manu]. Thus, the RBI circular is flawed when it perceives change to NDI Rules, which is added as an explanation, as prospective without any indication of that effect in the Rules.
Second, the RBI seeks to regularise the issuance of partly paid units of AIFs to PROIs before the amendment through the payment of compounding fees. However, the regularisation needs to be clarified. The framework laid through the Circular proposes that the Investment Manager (‘IM’) of the AIFs that issued such units to PROIs before the amendment to NDI Rules will need to approach the AD Banks to report the issuance and then subsequently pay a ‘compounding fee’ to RBI. The calculation of the compounding fee is done as per the Master Direction- Compounding of Contraventions under FEMA, 1999. However, it is not clear how the compounding fee will be calculated or instead on what amount the fee will be calculated; whether it will be based on the total value of the partly paid unit (including paid and unpaid value) or a percentage amount based on drawn down structure of contribution through such partly paid AIF units (on already contributed amount or the amount owed). Thus, the calculation of the compounding amount will be dust-unsettled until the basis of the calculation of such fee is clarified by the RBI.
Third, it is submitted that RBI may not be the right body to administer the NDI Rules as it is Government of India that releases the said rules. Thus, it will be beyond RBI’s powers to interpret and change the scope of the rules or their amendment through a Circular. At the cost of repetition, it is again reiterated that neither based on any substance in such an amendment to NDI Rules nor as per general principles of interpretation could such prospective effect be attributed to the amendment.
Conclusion
As explained above, the RBI’s Circular is not desirous on favourable market regulation in terms of consistency and nor as per law. There can two potential scenarios unfolding in near future with respect to it. First, it will require some more attention of the RBI in forthcoming days when AD Banks approach it for compounding proceedings and fee calculation related issues- as to what needs to be determined as the value for such calculation.
Second, there may also be litigation on the obligation to pay such ‘compounding fee’, as IMs of the AIFs may not want to pay penalty fee on what has been understood by the market as always permissible considering the language of NDI Rules and the amendment. Further, there will also be increasing difficulty on payment of such fee by IMs of AIFs, as to how to source such ‘compounding fee’ because the same could not have been provisioned while issuing partly paid units to PROIs.