In September 2015, the Reserve Bank of India (“RBI”) issued guidelines allowing, for the first time, Indian corporates to issue rupee denominated US dollar settled bonds in the international capital markets (“Masala bonds”).
In April and August 2016, the RBI and the Ministry of Corporate Affairs, respectively further revised (in some instances relaxed) the Masala bond guidelines in an endeavour to make Masala bonds more attractive to issuers and investors. We have, in our previous client bulletins, discussed the Masala bond guidelines as they have developed over the course of the last two years - these can be accessed here and here.
In the most recent circular issued by the RBI on 7 June 2017 (“2017 Circular”), the RBI has tightened the Masala bond regulations in a move that is likely to reduce the popularity of this product as a fund raising tool for Indian issuers.
What Has Changed?
The latest 2017 Circular revises some of the features (including, among others, market-driven pricing and minimum maturity) that have been key to the success of the Masala bond market to date. The amendments are discussed, in brief, below:
The minimum maturity period for Masala bonds was initially set at five years and then reduced to three years in 2016. However, in its 2017 Circular the RBI has reintroduced the five years minimum maturity period for bonds with an issue size of USD50 million (or its equivalent in Indian Rupees) or greater. Bond issues below that amount will retain the minimum maturity of three years. We understand that for most issuers it will only make sense from a cost perspective to tap the international capital markets to raise funds in excess of USD100 million otherwise the local domestic market may offer a cheaper source of funding. As mentioned in our earlier bulletin, we believe that a three year minimum maturity period is more in line with the market practice for products of this nature. Requiring these issues to have a five year term would limit the investor base to "buy and hold" investors given the limited secondary market for this product. In addition, it would also make this product less attractive for foreign investors as they would be exposed to longer (and more expensive) hedging risk.
One of the more attractive features of Masala bonds for onshore Indian issuers over foreign currency denominated external commercial borrowings ("ECBs") had been the ability to issue without any caps on pricing which had prevented many smaller/high yield issuers from tapping the international bond market. Previously, pricing for Masala bonds just needed to be commensurate with prevailing market conditions. The 2017 Circular now requires the all-in-cost of a Masala bond issue to be capped at 300 basis points over the prevailing yield on Indian government securities with a corresponding maturity. This would mean that high yield issuers that have relied on the earlier Masala bond guidelines to issue high yield bonds (and issues currently planned) will struggle to come to market under the 2017 Circular.
It is worthwhile noting that a cap on all-in-cost at 300 basis points over the government securities reference rate puts Masala bonds at the lowest all-in-cap set by the RBI for ECBs which applies to borrowings with maturity of between three to five years. The ECB guidelines actually prescribe higher all-in-cost caps for borrowing with maturities greater than five years (450 basis points over LIBOR. It is 500 basis points over LIBOR for borrowings greater than 10 years). We understand that at 300 basis points over the reference rate, many potential Masala bond issuers will find it difficult to price an issue given that investors will expect a premium for the currency risk as well as liquidity and credit risk that they would have to bear with this product. It should be noted that the all-in-cost cap is meant to cover all transaction fees and expenses incidental to a bond issue including ratings expenses, auditor costs, legal costs, etc. For a typical international bond offering, once all of these costs and expenses are considered, there may be little room left over from the 300 basis points cap to price a deal to market levels.
In addition to the existing criteria for investor eligibility set by the RBI in its previous circulars (including investors’ residence, investor being from a FATF member and IOSCO signatory jurisdictions), the 2017 Circular now also excludes a "related party" as defined in Indian Accounting Standards-24 from investing in Masala bonds.
The term ‘related party’ is given a very wide meaning under the Indian Accounting Standards and covers not only affiliates (that is entities above, below and on the same level as the issuer in a group structure) but also joint venture companies and entities which exercise significant influence over the activities of such entity. This change would prevent many issuers from being able to use the Masala bond guidelines to obtain funding from offshore affiliates through privately placed bond issues which have been popular since the introduction of the Masala bond guidelines.
Examination by Foreign Exchange Department of the RBI
Another feature of Masala bonds which made them an attractive funding source for issuers was the ability to issue under the automatic route (that is, without requiring approval) for principal amounts of up to INR50 billion (approximately USD750 million) in a financial year. The 2017 Circular now requires an eligible issuer looking to issue Masala bonds of any amount to obtain sign-off from the Foreign Exchange Department (the "FED") of the RBI. As of now, there is no guidance as to the nature of such sign-off and whether it will be purely an administrative process or will it be a more substantive approval process based on the merits of the proposed transaction.
It appears that the 2017 Circular is intended to align the Masala bond guidelines with the ECB guidelines. In doing so, it has made Masala bonds less accessible to many issuers and investors particularly in the high yield space where the absence of an all-in pricing cap previously held much promise for this market. Under the 2017 Circular, for example the highly publicised ReNew Power high yield bond structure would no longer be possible. It also puts a stop to the use of Masala bonds to facilitate intra-group funding which has proliferated in the recent months.