SEBI Informal Guidance on Foreign Portfolio Investments in Unlisted Non-Convertible Debentures

[Kosha Thaker is a corporate lawyer with a law firm in Mumbai]

Background

Earlier, registered foreign portfolio investors (“FPIs”) were permitted to invest only in listed non-convertible debentures (“NCDs”) or to-be listed non-convertible debentures (i.e. if the NCDs were listed within a period of 15 days from such investment). There was, however, a special carve out for FPIs investing in unlisted NCDs in the infrastructure sector.

The Reserve Bank of India (“RBI”) and the Securities and Exchange Board of India (“SEBI”) revised the applicable rules in October 2016 and February 2017 respectively, allowing FPIs to invest in unlisted NCDs subject to certain conditions (“Relevant Amendment”). The conditions, inter-alia, being (i) the NCDs should have a minimum residual maturity of up to three years, and (ii) an end-use restriction in respect of investment in real estate business (as defined under the foreign direct investment regulations), capital markets and purchase of land.

Request for Informal Guidance

On 26 April 2016, Puranik Buildcon Private Limited (“Puranik”) issued certain secured, redeemable, listed NCDs to a registered FPI entity. After the Relevant Amendment came into effect, Puranik proposed to delist these NCDs. They made an application to SEBI under the SEBI (Informal Guidance) Scheme, 2003, seeking informal guidance on whether the FPI entity would be permitted to hold the NCDs once they had been delisted (“Informal Guidance”).

After considering the submissions made by Puranik, SEBI took the view that although at the outset there was no prohibition ‘per se’ against the delisting the NCDs, since there was an end-use restriction on investment in real estate business under the Relevant Amendment, and Puranik being engaged in real estate business, the FPI entity would not be permitted to hold NCDs once they had been delisted.

Analysis                                                                                 

An interesting point to consider here is that in this instance SEBI appears to have taken a wide interpretation of the terms ‘end-use restriction’. It seems that SEBI is of the view that FPIs are not permitted to subscribe to unlisted NCDs issued by companies which are engaged in real estate business, irrespective of whether of not the end-use for the proceeds of these NCDs may have been for other activities such as general corporate purposes, including but not limited to capital expenditure, refinance of existing debt and long term working capital. The thumb rule here is that the core business activity of the company should be taken into consideration for determining the ‘end-use’ for the proceeds of the NCDs. This principle may also apply to other end-use restrictions, one of them being investment in capital markets – and hence also covering purely investing companies (including core investment companies)

Further, it may be important to note here that from SEBI’s response in the Informal Guidance it is not clear whether SEBI has evaluated if the business carried out by Puranik would be considered as ‘real estate business’ as defined under the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations (FDI Regulations). Under the FDI Regulations, ‘real estate business’ has been defined to mean “dealing in land and immovable property with a view to earning profit therefrom and does not include development of townships, construction of residential/ commercial premises, roads or bridges, educationalinstitutions, recreational facilities, city and regional level infrastructure, townships. Earning of rent income on lease of the property, not amounting to transfer, will not amount to real estate business…” SEBI’s response to the Informal Guidance merely states that since Puranik has stated that it is in the business of real estate in their Informal Guidance application, it can be reasonably assumed that the proceeds of the NCDs might be utilized by Puranik for real estate business. Puranik’s application for Informal Guidance has not been uploaded on the SEBI website and hence we are unable to get further clarity on this aspect.

Having said that, it continues to remain uncertain whether going forward the business of an entity would be considered for determining the ‘end-use’ of the sale proceeds of the NCDs issued by such entity irrespective of the actual ‘end-use’. Thus, it may be prudent for FPIs to seek clarity on this issue with both SEBI and RBI before proposing to invest in unlisted NCDs by entities engaged in real estate activities or pure investing entities.

–Kosha Thaker