In September last year, the Reserve Bank of India (“RBI”) issued guidelines allowing, for the first time, Indian corporates to issue rupee denominated dollar settled bonds in the international capital markets (so-called “Masala bonds”).

This product did not take off initially due to the lack of investor appetite, given the currency risk is borne solely by investors (and the depreciating Indian Rupee at the time) as well as a perceived lack of liquidity (given the fact that local banks are subject to limited exceptions from dealing in Masala bonds). These issues as well as other concerns were discussed in a paper entitled “Development of India’s Corporate Bond Market” published by the India-UK Financial Partnership (a partnership launched by the Indian Finance Minister and the UK Chancellor of the Exchequer) published on 2 November 2015, which was the subject of our last client bulletin dated 17 November 2015.

However, recent changes and clarifications by the Indian regulatory authorities together with improved investor confidence in the Indian economy and the Indian rupee as well as a hunt for yield by investors have resulted in a number of successful issues over the last few weeks.

A Recap

A broad range of issuers (including corporates, body corporates, Real Estate Investment Trusts and Infrastructure Investment Trusts) are able to issue Masala bonds. The funds raised can be used for most activities except a small negative list including on-lending, purchase of land and activities prohibited by the Indian FDI policy. The foreign currency-rupee conversion is based on the market rate on the date of settlement. No all-in-cost ceiling is prescribed for Masala bonds but it should be “commensurate with the prevailing market rate”. Investors are permitted to hedge their exposure in rupee through permitted derivative products with AD Category - I banks in India (all of the public Indian banks).

What Has Changed?

While many of the requirements of Masala bonds prescribed by the RBI in its initial circular continue to remain the same (including a wide net of eligible issuers, plain vanilla bonds permitted only, broad use of proceeds except prohibited activities, no all-in cost ceiling, hedging permissible, etc.), the RBI has, through a subsequent circular dated 13 April 2016 (the “RBI April Circular”), made certain changes to the regulatory framework and the Ministry of Corporate Affairs (the “MCA”) has also issued certain clarifications through its notification dated 3 August 2016 (the “MCA Notification”), some of which are discussed, in brief, below:

Minimum maturity

The minimum maturity period has been reduced from five years to three years. The need to hedge at least five years previously made this product expensive for investors despite attractive coupon rates. A three year minimum period is in line with the typical DCM market practice for these products. One of the three deals successfully completed recently (by HDFC) took advantage of this relaxation and had a maturity period of only 37 months.

Maximum Amount

The maximum amount which can be issued under these bonds under the automatic route (i.e. without needing approval) is now expressed in INR rather than USD and has been set at INR50 billion (approximately USD750 million). Proposals to borrow beyond INR50 billion in a financial year will require the RBI’s approval.

Offer document exemption

Previously, views were divided among lawyers as to whether Chapter III of the Companies Act (India), which applies to all securities issued by Indian issuers and in respect of which foreign currency bonds were exempt, applied to the issue of Masala bonds given that they are not technically “foreign currency” bonds. The better view, however, was that Chapter III does not apply and this was the approach taken by the recent Masala bond issues by HDFC, NTPC and Adani Transmission. Helpfully, the MCA has now clarified the position in its MCA Notification and confirmed that the requirements of Chapter III do not apply to the issue of Masala bonds.

Investor eligibility

The criteria for investor eligibility has been amended to include certain other conditions in relation to investors’ residence (including being from FATF member and IOSCO signatory jurisdictions). In addition, the RBI April Circular also required that issuers incorporate in their agreements/offer documents (a) an ability to obtain a list of primary bond holders to provide to the Indian regulatory authorities on request; and (b) disclosure to the effect that subsequent sales or transfers of the bonds can be made to investors in jurisdictions which are FATF members and who are IOSCO signatories.

While the market practice to address the above requirements is still developing, we have seen slightly varying approaches in the recent issues. In the HDFC issue, the lead managers gave representations that this investor eligibility criteria has been met while in NTPC both the issuer and the lead managers gave this representation. In both cases, no representation was given as to subsequent resales. In the Adani Transmissions issue, the holders and beneficial owners of the bonds are deemed to represent that they meet the eligibility criteria by purchasing the bonds. Further, the offering circular stated that the issuer or its duly appointed agent may from time to time request Euroclear and Clearstream to provide them with details of the accountholders.

Whilst obtaining information in respect of the holders in the primary distribution might not be an issue (as this can be obtained from the managers of the deal), it is unclear how subsequent transfers will be monitored. In particular, in respect of bonds cleared through a clearing system, issuers generally have no right to information from Euroclear or Clearsteam and such clearing systems do not and will not agree to monitor re-sales and subsequent transfers that take place through them.

Moving Forward

Whilst the market initially only anticipated that Indian public-sector undertakings will avail themselves of this product given the challenges described earlier in this briefing, private corporates (most recently, HDFC and Adani Transmissions) have also tapped this market and have done so relatively successfully. We believe this will pave the way forward for more Indian issuers to use Masala bonds as an additional means of raising funds. We expect this to boost the Indian offshore DCM market.

While certain issues continue to remain to be resolved (such as limited flexibility of nature of instruments that can be issued (currently, plain vanilla bonds only) and a flat withholding tax of 5% on Masala bonds), Masala bonds offer an attractive option for issuers looking for rupee funding as well as offshore investors seeking yield given an otherwise low to negative interest rate environment in more developed markets.