Thursday, October 1, 2015

RBI Introduces Rupee-Denominated Bonds Regime

[The following guest post is contributed by Vinod Kothari of Vinod Kothari & Co.]

Continuing with some other recent moves to liberalise the options of raising debt from external sector, the Reserve Bank of India (“RBI”) on 29 September, 2015 announced new guidelines (the “Guidelines”) for issuance of rupee-denominated bonds (“RDBs”) overseas.

The Guidelines are much more liberalised compared to the draft version issued earlier this year.  The earlier version had end-use restrictions pertaining to external commercial borrowings (“ECBs”). The final version has replaced the end-use restrictions with a narrow negative list, thereby enabling companies to issue RDBs virtually for any purpose, including for working capital.

Also, as compared to the proposed framework for ECBs released some days earlier, the maturity of the RDBs under the Guidelines is only 5 years.

This author is of the view that the RDB option will be used by Indian companies extensively, and will be put to several imaginative uses, the full picture of which will emerge only over a period of time. We take below a quick look at some of the significant features of the RDB framework.

Several options for companies

Indian companies may issue bonds to overseas investors with absolutely no restrictions if the investors register in India as foreign portfolio investors (“FPIs”) and invest domestically in listed bonds. There is a concessional rate of withholding tax for this purpose.[1] These bonds are bonds issued in India – hence, there are no restrictions on the end-use. Leaving aside some exceptions, these bonds have to be listed bonds, in order to make them eligible for subscription by FPIs.

The RDBs, on the other hand, are subscribed to by overseas investors directly. The end-use restrictions, discussed below, are minimal. There is no need for any registration as an investor in India. Withholding taxes will be applicable based on the domicile of the country from where the money comes, and the treaty that India has with that country.

Indian companies also have the option of issuing foreign currency convertible bonds (“FCCBs”). FCCBs are hybrid instruments as they carry an equity conversion option. In addition, they are subject to ECB restrictions too.

RDBs are rupee-denominated, and are issued to overseas investors. They may be secured or unsecured, or listed or unlisted, rated or unrated. Hence, this seems to provide to Indian companies are a very different option as compared to the existing options.

Who can issue?

The Guidelines leave it completely open for any Indian company to issue RDBs. This includes non-banking finance companies (“NBFCs”), housing finance companies, or other Indian companies. Therefore, NBFCs, which have hitherto been denied access to ECBs may also make use of RDBs.

The facility is otherwise open only to companies –therefore, real estate investment trusts (“REITs”) and Infrastructure Investment Trusts (“InvITs”) which are organised as trusts, would not have otherwise been eligible to issue RDBs. However, the Guidelines explicitly allow REITs and InvITs to make use of RDB facility for raising leverage.

Can special purpose vehicles issue the bonds? Prima facie, we see no restraint on the issuance of the bonds by SPVs as well.

The ECB option is typically not allowed to entities in the services sector, other than some specified services. Will the RDB option be available to service sector entities?  To this, the answer seems clearly, yes, as the RBI has not stated that only entities currently entitled to raise ECBs will be eligible to issue the RDBs. Note that the original wording of the draft guidelines was: “Indian corporates eligible to raise ECB are permitted to issue Rupee linked bonds overseas. The corporates which, at present, are permitted to access ECB under the approval route will require prior permission of the Reserve Bank to issue such bonds and those coming under the automatic route can do so without prior permission of the Reserve Bank.”. In the final Guidelines, this has been replaced by the following: “Any corporate or body corporate is eligible to issue Rupee denominated bonds overseas.” Therefore, it is clear that there is no restraint on who may issue RDBs.

End-use restrictions

One of the biggest drawbacks in the draft Guidelines was that it was proposing to put end-use restrictions.[2] In the final Guidelines, there is only a minimal negative list. The negative list consists of the following:

- Real estate activities other than for development of integrated township / affordable housing projects: Note that the expression “real estate business” is defined in RBI master circulars and it means buying, selling or dealing in real estate.

- Investing in capital market and using the proceeds for equity investment domestically: That is to say, the borrowings cannot be used for making domestic downstream investments. There must not be a direct nexus between raising of the RDBs and investment in equities by the issuer entity. The restriction cannot be taken to mean that the issuer must not be holding any equity investments at all. Can the issuer be an NBFC? We see no problem in that. In case of investment companies, including core investment companies, the RDB option does not seem permissible, but for asset finance companies, loan companies (see below as well), etc., there does not seem to be any bar.

- Activities prohibited as per the foreign direct investment (“FDI”) guidelines: Prohibited activities as per FDI include real estate business, tobacco, or other strategic activities. Note that NBFC activity is not a prohibited activity – it only has minimum capitalisation requirements.

- On-lending to other entities for any of the above objectives: Once again, the bar is not for on-lending per se, but for on-lending for one of the restricted activities above. That is to say, it is not that a loan company or asset finance companies cannot make use of the RDB option – if the borrower is not engaged in one of the activities listed in the negative list.

- Purchase of land.

Maturity and cost

The Guidelines require a minimum of 5 years’ maturity. Note that generally, in ECB guidelines, the requirement is of “average maturity”. The RBI seems to have gone by the presumption that RDBs will have a bullet maturity – hence, the guidelines do not mention average maturity. However, if the bonds are not bullet bonds, that is, they are amortising bonds, it may be logical to read the maturity requirement as referring to average maturity rather than total maturity.

There is no cost restriction at all – the guidelines simply say that the cost should be commensurate with cost of domestic borrowing. As domestic borrowing cost will admittedly be different for different entities, it seems that there will no control exercised by the RBI on how much coupon the issuer seeks to pay on the RDBs.

The investors in the RDBs may or may not hedge their rupee risk. Therefore, the spreads on the bonds will include a (a) credit risk premium; and (b) a currency risk premium. Since at least the first risk is entity specific, and the second risk is a function of what view someone takes on the potential movements in exchange rate, issuers will be free to determine the spreads with the investors.

Conclusion

In our view, the RDB option ushers a complete new era for debt-raising by Indian companies, and will integrate financial markets in India further with the rest of the world. We can certainly envisage several innovative applications of the RDB option by companies going forward.

- Vinod Kothari




[1] Sec 194LD provides a concessional rate for payments up to 1 July 2017.
[2] The was one of the key points discussed in the Bond Market Summit organised earlier this year: see http://vinodkothari.com/secsummit. Panelists in the Summit strongly recommended that end-use restrictions should be removed. Representatives of RBI were also there in the Summit.

1 comment:

Pallav Patodia said...

Excellent article. I had a doubt about the Indian rupee denominated ECB and it got cleared after reading your article.