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.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

1 comment

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

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