Friday, November 25, 2016

Foreign Portfolio Investments in Unlisted Non-Convertible Debentures

[The following post is contributed by Amitabh Robin Singh, who is a corporate lawyer practising in Mumbai.]

Last month, the Reserve Bank of India ("RBI") allowed Foreign Portfolio Investors ("FPIs") to invest in unlisted non-convertible debentures ("NCDs"). This has been done by way of an amendment to the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 ("FEMA 20").

Earlier, FPIs were permitted to invest only in NCDs which are either listed or to be listed. Where they are to be listed, such listing must take place within 15 days of investment made in them. There was a carve-out to this rule which permitted FPI investment in unlisted NCDs in the infrastructure sector (as defined in the guidelines governing external commercial borrowings).

Under the new provision which amends Schedule 5 of FEMA 20, FPIs will be allowed to invest in unlisted NCDs irrespective of the sector in which the issuing company operates. The RBI circular announcing the new regime lays down certain end use restrictions, being investment in real estate business (as defined in FEMA 20), capital markets and purchase of land.

This is a welcome move and may spur investments in the Indian corporate bond market, due to the fact that the company which is issuing the NCDs will not be required to undergo the listing process nor will it need to comply with the applicable chapters of the Securities and Exchange Board of India ("SEBI") (Listing Obligations and Disclosure Requirements) Regulations, 2015.

Another benefit to the investee company is that it will no longer be required to comply with certain provisions of the Companies Act, 2013 ("Companies Act") which apply to listed companies. sections 177 and 178 of the Companies Act mandate that "every listed company" constitute an audit and nomination and remuneration committee respectively. Under the status quo, this even includes private companies which have listed only their NCDs. However, the Companies Law Committee in its report of February of this year suggested that this anomaly be remedied by modifying sections 177 and 178 to exempt private companies which have listed NCDs as per SEBI guidelines. Pursuant to this, the Companies (Amendment) Bill, 2016 ("Amendment Bill") (which is currently pending in parliament) proposes to amend sections 177 and 178 to change the threshold to "every listed public company". Hence, if the Amendment Bill becomes law in its present form, the (private) investee company that is listing only its NCDs will be relieved from the obligation to constitute the abovementioned committees. An interesting point to consider here is that the Amendment Bill does not intend to exclude a public company which has not listed any of its securities other than NCDs.

Hence, as we can see, the issuer of the NCDs will be relieved from certain listing costs and compliances such as submitting financial results to the relevant stock exchange, etc. Also, pending passage of the Amendment Bill, exemption from certain Companies Act compliances will be had due to the fact that the NCDs are not listed.

However, one significant stumbling stone for this policy may be related to the ability to avail of certain benefits under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 ("SARFAESI"). It may be noted that the Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Act, 2016 was lauded for extending the benefits available to a "secured creditor" to debenture trustees registered with SEBI appointed by any company for secured "debt securities". However, the definition of the term "debt securities" is restricted to debt securities listed in accordance with SEBI guidelines. Now, while investors who have subscribed to or purchased listed NCDs will be able to avail of the quicker and more effective process of enforcement of security contemplated under Section 13 of SARFAESI, the holders of unlisted debentures will have no such benefits.

In pursuance to the amendment to FEMA 20, SEBI's board, in its meeting of November 23, 2016 has decided to amend the SEBI (Foreign Portfolio Investors) Regulations, 2014 to make unlisted NCDs a permissible instrument for FPI investment. This will be done by amending Regulation 21 (Investment Restrictions,) of the said regulations to reflect the new position.

Therefore, while this move to allow FPI investment in unlisted NCDs is a step in the right direction to garner the interest of foreign investors in the Indian corporate bond market, it may fall short on the aspect of enforcement of security interest. As a result of this, it may be unable to generate the amount of inbound investments as envisaged.

- Amitabh Robin Singh

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