Temporary borrowing
Also written Temporary borrowing (Category I and II) · Temporary funding requirements · Drawdown-shortfall borrowing
The only fund-level borrowing Category I and II AIFs may do: for temporary funding needs, for no more than 30 days, on no more than 4 occasions a year, and up to 10% of investable funds.
In plain language
Category I and II AIFs are not meant to use borrowed money to boost returns. Their investors carry the risk of unlisted companies already; the regulations do not let the manager add debt on top.
But funds have timing problems. An investment has to be paid for on a date, and the cash from investors may arrive a few days late. Temporary borrowing is the narrow exception for that: short, infrequent and small.
A second, related permission covers one specific timing problem — an investor who has not paid a capital call before a deal closes.
How it works
The general rule (Chapter 17). No leveraging at fund level is permitted for Category I or Category II AIFs, directly or indirectly, except for meeting temporary funding requirements:
| Limit | Figure |
|---|---|
| Duration | Not more than 30 days |
| Frequency | Not more than 4 occasions in a year |
| Size | Not more than 10% of investable funds |
Category I AIFs may engage in hedging, including buying credit default swaps, and Category II AIFs may engage in hedging, as SEBI specifies — hedging is not leverage for this purpose.
The drawdown-shortfall permission (SEBI circular of 19 August 2024). To ease business, Category I and II AIFs may also borrow to meet a temporary shortfall in the amount called from investors for making an investment (the "drawdown amount"). Conditions:
- only in an emergency and as a last recourse;
- when the investment opportunity is about to close and the drawdown has not arrived before the investment date, despite the manager's best efforts;
- the cost is charged only to the delaying investor(s);
- a 30-day cooling-off period between two periods of borrowing, counted from the date of repayment of the previous borrowing.
Exceptions and contrasts.
- IFSC: these restrictions do not apply to Category I and II AIFs domiciled in an IFSC. They may take leverage if the maximum leverage and its calculation are disclosed in the placement memorandum, investors consent, and the fund has a risk management framework suited to its size, complexity and risk profile.
- Category III: may take leverage through derivatives or borrowing, up to 2 times NAV, calculated at scheme level. Borrowing at fund level as part of the investment strategy is unique to Category III.
A worked example
Kaveri Growth Fund (illustrative) is a Category II AIF with investable funds of Rs 200 crore. It has agreed to invest Rs 30 crore in a company, with completion on 10 September.
The shortfall. It issues a capital call for Rs 30 crore. By 9 September, investors have paid Rs 22 crore; one investor, Mr Sethi, has not paid his Rs 8 crore despite reminders, and the seller will not extend the date.
Can it borrow?
| Test | Kaveri | Passes? |
|---|---|---|
| Within the general limit of 10% of investable funds | Rs 8 crore vs Rs 20 crore | Yes |
| Emergency, last recourse, deal about to close | Completion 10 September | Yes |
| Manager used best efforts to collect | Reminders documented | Yes |
The workbook sets the drawdown-shortfall permission out separately from the general 30-day / 4-occasion / 10% limits; this example stays inside both.
It borrows Rs 8 crore on 10 September and repays it on 30 September, when Mr Sethi pays — 20 days, inside the 30-day limit.
Who pays the interest. At an illustrative 10% a year:
Rs 8,00,00,000 × 10% × 20 ÷ 365 = Rs 4,38,356
The whole amount is charged to Mr Sethi alone, not to the other investors.
The cooling-off. The borrowing was repaid on 30 September, so Kaveri cannot borrow again before 30 October.
Why NISM asks about it
Chapter 17 (Regulatory Framework), section 17.9.2 (Category I) and section 17.9.3 (Category II) carry the 30 days / 4 occasions / 10% rule and the drawdown-shortfall permission; section 17.10.3 sets Category III leverage at 2 times NAV; Chapter 15 notes that fund-level borrowing for strategy is unique to Category III. Expect straight recall of the three limits, a question on who bears the cost of drawdown-shortfall borrowing, and a comparison with Category III leverage.
Common exam traps
- 30 days, 4 occasions a year, 10% of investable funds — the three numbers are asked together and swapped freely in wrong options.
- 10% of investable funds, not of corpus and not of NAV.
- The cost of drawdown-shortfall borrowing falls only on the delaying investor.
- The 30-day cooling-off runs from repayment, not from the date the earlier loan was taken.
- Category III is different: leverage up to 2 times NAV is permitted.
- IFSC-domiciled Category I and II AIFs are outside these limits if they disclose leverage, obtain consent and have a risk framework.
- Hedging is permitted for Category I and II and is not the same as fund-level leverage.
Where this is taught
Free preparation for NISM Series XIX-CRelated terms
- Category III AIFThe AIF category for funds running diverse or complex trading strategies with leverage — hedge funds and their kin — and the only category denied tax pass-through status.
- Credit Default SwapA contract in which a protection buyer pays a regular premium to a protection seller, who agrees to pay any loss in value on a specified reference obligation if a credit event such as default occurs.
- LeverageControl of a large contract value for a small upfront outlay — premium for an option buyer, margin for a futures position — which multiplies percentage gains and percentage losses by the same factor.
- Leverage riskThe risk that borrowing or derivative positions magnify a fund's losses — which is why SEBI caps Category III leverage at two times NAV and permits Category I and II almost none.
- Category I AIFThe AIF category for funds the government or a regulator treats as socially or economically desirable — venture capital, angel, SME, social impact, infrastructure, special situation and CDMDF funds.
- Category II AIFThe residual AIF category: anything that is neither Category I nor Category III and takes no fund-level leverage beyond a narrow temporary carve-out — private equity, private debt and fund-of-funds.
- DrawdownThe process by which the manager of a Category III AIF calls committed capital from investors as the fund needs it — also known as a capital call.
- Investable FundsThe corpus of an AIF scheme net of the administration and management expenditure estimated for the fund's tenure — the base on which Social Impact Fund investment limits are measured.
- Borrowing feesThe fee a fund pays to borrow securities so that it can take a short position — an additional cost of the short, quite separate from interest on borrowed cash.
- Offsetting positionsNetting a Category III AIF's long and short positions in the same stock, index or commodity with the same maturity, so that its leverage is measured on net rather than gross exposure.
- Fund-level leverageBorrowing or gearing taken by the AIF itself rather than inside a portfolio company — permitted for investment purposes only to Category III AIFs, and capped at 2 times NAV.