Background: On 3 February 2015, the Governor of the Reserve Bank of India (RBI) delivered the RBI’s bi-monthly policy statement laying out the important policy decisions that the RBI is expected to take in the next two months (Policy Statement). While the Policy Statement was forward looking and sought to encourage foreign investment in many aspects, it has also adopted a cautious approach toward foreign portfolio investment (FPI) in corporate debt by imposing certain additional conditions on this investment avenue. The Policy Statement was followed by circulars issued by RBI and the Securities and Exchange Board of India (SEBI) which have implemented the changes proposed in the Policy Statement with immediate effect (Circulars).
In this Newsflash, we attempt to give a brief overview of the restrictions imposed by the Circulars.
Current Regulations: The SEBI (Foreign Portfolio Investors) Regulations, 2014 (FPI Regulations) read with Schedule V of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000 (together referred to as Current Regulations) provide that FPIs may invest in corporate bonds listed on a stock exchange subject to an overall cap of USD 51 billion. Further, FPIs are also allowed to invest in unlisted corporate bonds provided that the bonds are listed on a recognised stock exchange within 15 days of the same being subscribed to by an FPI. Apart from the requirement of being listed or to be listed, Current Regulations impose no other restrictions in terms of tenure or minimum maturity for such bonds, so long as the bonds are for a maturity of at least 1 year. Further, under the SEBI (Foreign Institutional Investors) Regulations, 1995 and the FPI Regulations, they are allowed to invest in liquid and money market mutual fund schemes within the USD 51 billion cap.
The Circulars: The Circulars have now imposed the condition that all future investments within the USD 51 billion - corporate debt limit shall be required to be made in corporate bonds with a minimum ‘residual’ maturity of 3 years. It has further clarified that the above condition includes the limits vacated when the current investment by an FPI runs off either through sale or redemption.
The Circulars however, clarify that there is no lock-in obligation on FPIs who are free to sell such securities (including those that are presently held with less than 3 years residual maturity) to domestic investors without any minimum holding period.
Additionally, the Circulars now prohibit FPIs from investing in liquid and money market mutual fund schemes.
Khaitan Comment: The intent of the RBI in proposing the above changes as stated in the Policy Statement is to harmonise the investment conditions in corporate debt with those applicable to government debt where FPI investments are limited to bonds with a residual maturity of 3 years. Further, the intent clearly seems to be to reduce short term liability on the country and also to align this form of lending to an extent with ECB Guidelines, which too has a minimum maturity of 3 years.
However, this restriction may have an impact on fund raising by domestic companies as listed corporate bonds were being increasingly used by companies to raise funds from FPIs including for short term financing requirements of 18-36 months. Further, the requirement that FPIs can only buy a corporate bond with a residual maturity of 3 years, could further impact the development of the nascent secondary corporate bond market in the country where FPIs could play a significant role. Additionally, the bar on FPIs investing in liquid and money market mutual funds may significantly affect the cash management of FPIs pending investments.