For larger participation of new category of overseas investor i.e. Qualified Foreign Investors (“QFIs“) to invest in Indian Secondary Market, both Securities and Exchange Board of India (“SEBI”) and Reserve Bank of India (“RBI”) has issued guidelines allowing overseas individual investors to invest up to $51 billion in corporate bonds and debt schemes of mutual funds without any lock-in period or residual maturity clause. RBI vide RBI/2012-13/134 A. P. (DIR Series) Circular No. 7 dated 16th July, 2012 and SEBI vide circulars CIR/ IMD/ FII&C/ 17 / 2012 dated 18th July, 2012 has decided to allow QFIs to purchase debt securities on repatriation basis.
BROAD BASE OF DEFINITION OF QFI
QFIs shall mean a person who is resident in a country that is a member of Financial Action task Force (“FATF”) or a member of a group which is a member of FATF and resident in a country that is a signatory to International Organization of Securities Commission (“IOSCO’s”) Multilateral Memorandum of Understanding (“MMoU”) or a signatory of a bilateral MoU with SEBI.
Following persons are not covered in the definition of QFIs:
- the person who is not resident in a country listed in the public statements issued by FATF from time to time on jurisdictions having a strategic Anti Money Laundering and Combating Financing of Terrorism AML/CFT deficiencies to which counter measures apply or that have not made sufficient progress in addressing the deficiencies or have not committed to an action plan developed with the FATF to address the deficiencies;
Further such person is not resident in India and is not registered with SEBI as a Foreign Institutional Investor (FII) or Sub-Account of an FII or Foreign Venture Capital Investor (FVCI).
ELIGIBLE INSTRUMENTS AND ELIGIBLE TRANSACTIONS
QFIs shall be permitted to invest through SEBI registered Qualified Depository Participants (“QDPs”) in eligible corporate debt instruments, viz. listed Non-Convertible Debentures (“NCDs”), listed bonds of Indian companies, listed units of Mutual Fund debt Schemes and “to be listed” corporate bonds (hereinafter referred to as ‘eligible debt securities’) directly from the issuer or through a registered stock broker on a recognized stock exchange in India.
The QFI transactions shall be limited to the following debt securities:
- Purchase and sale of corporate debt securities listed on recognized stock exchange(s).
- Purchase of corporate debt securities through primary issues, if the listing on recognized stock exchange(s) is committed to be done with 15 days from such investment;
- Sale of corporate debt securities by way of buyback or redemption by the issuer.
- Purchase and sale of units of debt schemes of Indian mutual funds.
ACCOUNT, MODE OF PAYMENT / REPATRIATION AND DEMAT ACCOUNT
QFIs shall open a single non-interest bearing Rupee Account with an AD Category- I bank in India, for the limited purpose of routing the receipt and payment for transactions relating to purchase and sale of units of eligible debt securities. The account shall be funded by inward remittance through normal banking channel and by credit of the sale/redemption/buyback proceeds (net of taxes) and on account of interest payment on debt securities. The funds in this account shall be utilized for purchase debt securities for QFIs or for remittance (net of taxes) outside India. The DP will operate such non-interest bearing Rupee Accounts on behalf of the QFIs and at the instructions of the QFIs. QFIs shall open a single demat account with a QDP in India for investment in all debt securities under the QFI scheme. Both QDPs and AD Category-I banks shall ensure KYC of the QFIs for opening and maintenance of the single non- interest bearing Rupee accounts as per the extant norms.
LIMITS
QFIs are permitted to invest in corporate debt securities (without any lock-in or residual maturity clause) and Mutual Fund debt schemes subject to a total overall ceiling of USD 51 billion. This limit shall be over and above USD 20 billion for Foreign Institutional Investors (FII) investment in corporate debt. QFIs can invest without obtaining prior approval until the aggregate investments reaches 90% of USD 51 billion. For fresh purchases by QFIs after this cap, prior approval of the depositories is required to be obtained. The QFIs should make such request for prior approval to the concerned depository through the DP specifying therein the name of the QFI, PAN and other unique identification number relating to that QFI, by way of any mode of communication as specified by the depositories in consultation with each other. The depositories shall jointly publish/ disseminate the aggregate investment of QFIs to public, on daily basis.
MISCELLANEOUS
QFIs shall remit foreign inward remittance through normal banking channel in any permitted currency (freely convertible) directly into their single non- interest bearing Rupee account maintained with an AD Category-I bank. The pricing of all transactions and investment in all debt securities by QFIs shall be in accordance with the relevant and applicable guidelines issued from time to time. Both QDPs and AD Category-I banks (maintaining QFI accounts) will also ensure reporting to SEBI along with Reserve Bank of India. QFIs shall be permitted to hedge their currency risk on account of their permissible investments (in debt instruments) in terms of the guidelines issued by the Reserve Bank from time to time. Each QFI shall obtain a separate and distinct PAN. There is no requirement of registration of QFI with any of the regulator, except that they have to deal with qualified depository participant.
SOME APPREHENSIONS BY QFI
As QFIs need KYC requirements like PAN and tax return filings, these are believed to serve as hurdles to the scheme. The biggest apprehension is going through the complicated process of procuring a PAN in India and also filing tax returns.
SEBI REGULATION FOR LISTING OF NCDs
The SEBI (Issue and Listing of Debt Securities) Regulations, 2008 (“Debt Regulation”) provides a comprehensive guidelines for listing of Debt securities in the stock market in India. The regulation provides the key elements and detail procedure which needs to be complied for Listing of Debt securities in the stock Market. Therefore complying with this regulation QFI can list their NCDs in the stock exchange which they have acquired through investment in a company under the prescribed limit. As per the regulation, a Company cannot make any public issue of debt securities if as on the date of filing of draft offer document and final offer document as provided in the regulation, the Company or the person in control of the Company, or its promoter, has been restrained or prohibited or debarred by the SEBI from accessing the securities market or dealing in securities and such direction or order is in force.
An Indian company is required to satisfy the following key conditions for listing of its NCDs on a recognized stock exchange:
- receipt of an in-principle approval for listing of debt securities on a recognized stock exchange;
- issuance of NCDs in compliance with the provisions of the Companies Act and other applicable laws;
- receipt of credit rating from at least 1 credit rating agency registered with SEBI and disclosure of such credit rating in the offer document;
- execution of agreements with a SEBI registered depository for dematerialization of NCDs that are proposed to be issued to the public or proposed to be issued and listed; and
- Disclosures required under the Debt Regulations should be made.
KEY CONSIDERATION
- Credit ratings: Obtain credit rating from at least one credit rating agency registered with the SEBI and it must be disclosed in the offer document.
- Appointment of Trustee and listing: The issuer company is required to appoint a debenture trustee in accordance with the SEBI (Debenture Trustees) Regulations, 1993 (“Trustees Regulations”)and execute a trust deed wherein the trustee shall act for the benefit of the investors subscribing to the NCDs.(Debt Regulation no. 15). The offer documents also need to disclose proposal to create charge or security interest (if any) in respect of debt securities, along with its implications and necessary undertakings. The issuer company is also required to comply with conditions of listing of such debt securities as specified in the Simplified Listing Agreement (for debt securities issued by SEBI), including creation and maintenance of redemption reserves at all times, timely payment of interest on NCDs and covenant to not materially modify terms of issue without prior approval of the stock exchanges.
- Security Interest: Under Indian foreign exchange laws, except in the case of certain exempted transactions, creation of security interest in favor of non-residents requires prior approval of the RBI. However, no RBI approval is required for securing listed NCDs (by way of pledge, mortgage of property, hypothecation of receivables, etc.) in favor of the debenture / security trustee, i.e., a domestic entity that acts for and in the interest of the NCD holders. In case of an enforcement event, the trustee has the authority to liquidate such security and only the proceeds of the enforcement would be remitted outside the country. Under the debt Regulation the issuer and the merchant banker is under an obligation to ensure that the security created to secure the debt securities is adequate to ensure 100% asset cover for the debt securities (Regulation 26(6)).
- Maturity and Lock-In: Unlike the laws governing ECBs, the Debt Regulations do not impose restrictions like minimum maturity period, lock-in requirements, (except in the case of unlisted bonds issued under infrastructure bond segment) end use restrictions, ceiling on interest etc, in addition to the returns assured on the coupon and redemption premium on the NCDs.
A BRIEF COMPARATIVE ANALYSIS FOR DEBT INVESTMENT THROUGH FDI (CCD) AND QFI (NCDs) ROUTE
| Particulars | CCD-FDI | NCDs -QFI |
| Equity Ownership | Initially debt, but equity on conversion. | Mere lending rights; however, veto rights can ensure certain degree of control. |
| ECB Qualification | Assured returns on FDI compliant instruments, or put option granted to an investor, may be construed as ECB, | Purchase of NCDs by QFI from the Indian company on the floor of the stock exchange is expressly permitted and shall not qualify as ECB. |
| Coupon Payment | Interest pay out may be limited to SBI PLR + 300 basis points. Interest can be required to accrue and paid only out of free cash flows. | Arm’s length interest pay out should be permissible resulting in better tax efficiency. Higher interest on NCDs may be disallowed. Interest can be required to accrue only out of free cash flows. Redemption premium may also be treated as business expense. |
| Security Interest | Creation of security interest is not permissible either on immoveable or movable property | Listed NCDs can be secured (by way of pledge, mortgage of property, hypothecation of receivables etc.) in favor of the debenture trustee who acts for and in the interest of the NCD holders |
| Sectoral conditionalities | Only permissible for FDI compliant activities | Sectoral restrictions not applicable |
| Equity Upside | Investor entitled to equity upside upon conversion. | NCDs are favorable for the borrower to reduce book profits or tax burden. Additionally, redemption premium can be structured to provide equity upside which can be favorable for lender since such premium may be regarded as capital gains which may not be taxed if the investment comes from Singapore or Cyprus |
| Administrative expenses | No intermediaries required | NCD listing may cost around INR 25-30lakh including intermediaries cost. In case of QFI, there may be additional cost as fees charged by the QDP. |
Disclaimer: The entire contents of this document have been developed on the basis of relevant information and are purely the views of the authors. Though the authors have made utmost efforts to provide authentic information however, the authors and the company expressly disclaim all and any liability to any person who has read this document, or otherwise, in respect of anything, and of consequences of anything done, or omitted to be done by any such person in reliance upon the contents of this document.