FPI & Debt Securities – Hop on Hop off

Reserve Bank of India (“RBI”) vide circular dated June 15, 2018 (“Circular”) revised norms with respect to investments made by Foreign Portfolio Investors (“FPIs”) in corporate debt securities in India. While the Circular was supposed to have eased norms with respect to investment in corporate bonds by introducing new amendments like revising the minimum residual period of 3 years to 1 year, the Circular, at the same time, had restricted FPIs from investing in more than 50% of a single issue of corporate bond and also restricted FPIs from investing more than 20% of its debt portfolio into a single corporate entity. These two restrictions dampened FPI investments in debt market and created a blockage on the flow of foreign capital from FPIs into India. RBI may have intended to diversify risk for FPIs and incentivize them into seeking more investment opportunities; however these two conditions halted, upto a large extent, investment transactions in debt securities by FPIs.

Given the widespread consternation generated as a result of the restrictions imposed by the Circular and the likely implications on investments in debt markets in India by FPIs, RBI on October 5, 2018, made another attempt and released a discussion paper titled, ‘Voluntary Retention Route’ for investment by FPIs by (“VRR Paper”) which proposes to introduce a separate channel to enable investments by FPIs in debt markets in India (“VRR Route”).

We have examined the VRR Paper and some of the key aspects proposed in the VRR Paper are as follows:

·         RBI to prescribe a limit on the total amount that may be invested via the VRR Route (“Investment Limit”).

·         Investment Limit shall be in addition to ‘General Investment Limit’ as per RBI Circular No. 22 dated April 6, 2018.

·         The total amount for investment through the VRR Route shall be separately indicated for government securities and corporate debt and shall be individually allocated to FPIs through an auction process

·         RBI shall allocate an investment amount to each FPI (“Committed Portfolio Size”) which allocation will be determined basis the period for which the FPI proposes to invest the Committed Portfolio Size (“Retention Period”). The Retention Period shall be for a minimum of 3 years or a period as prescribed by RBI for each auction.

·         FPIs are required to, within a period of 1 month from the date of announcement of auction results, invest a minimum of 67% of the Committed Portfolio Size, in debt instruments and remain invested for the Retention Period.

·         Investments through this route shall be exempt from regulatory restrictions imposed by the Circular such as the cap on short-term investments (less than one year) at 20% of portfolio size, concentration limits and caps on exposure to a corporate group (20% of portfolio size and 50% of a single issue).

·         Income from investments through the VRR Route may be reinvested at the discretion of the FPI and such investments can exceed the Committed Portfolio Size.

·         FPIs shall open a special non-resident rupee ‘SNRR’ bank account for investment made through the VRR Route and securities account for holding debt securities under the VRR Route.

·         FPIs, one month prior to Retention Period, can choose to extend the Retention Period, for an additional period equivalent to the Retention Period. FPIs can also exercise their option to exit, liquidate its portfolio or move the investments to the ‘General Investment Limit’ at the end of the Retention Period.

·         FPIs can exit and liquidate their investments, prior to the Retention Period, by selling their investments to other FPIs.

Although the VRR Paper seeks to provide operational flexibility for investments by FPIs in corporate debt instruments in India and eliminate the challenges faced by FPIs due to the Circular, the real impact can be assessed only once the final circular is out. With the proposed relaxation being enforced, FPIs will be able to access the VRR Route by voluntarily committing to retain a certain percentage of their investments in India for a period of their choice. While the timelines and modalities around the implementation of the auction process and the structuring of investment transactions by FPIs still remain to be tested, given the relaxation proposed to be introduced by RBI, FPIs may be able to undertake investment transactions, in debt securities as sole or majority investors. One can argue that there exists a strong case for removal of the two conditions imposed by the Circular in place of a new policy or scheme.

Foreign capital is one of the most important ingredients for continuous growth of the economy considering the financial crunches and scarcity of domestic capital. Therefore, the need of the hour is to remove any such obstacles for allowing FPIs, amongst others, source of foreign capital, to invest into Indian debt securities.

Authors

Hardeep Sachdeva, Senior Partner
Ankit Jaiswal, Associate