More changes from the RBI: Good news for bond market

By Sawant Singh and Aditya Bhargava, Phoenix Legal
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In line with its (now) prevailing approach of providing a mix of principle-based and prescriptive regulations, which also take into account market feedback and market conditions, the Reserve Bank of India (RBI) via a circular on 13 April introduced changes to the framework on issuance of rupee denominated bonds. These changes are both procedural and substantive and, similar to previous such efforts, are intended to further ease doing business in India.

Sawant Singh
Sawant Singh

The RBI announced in its monetary policy statement of 29 September 2015 that limits for foreign investment in corporate bonds would be fixed in rupees instead of US dollars. The limit has now been fixed at ₹2,443.23 billion. The aggregate of all rupee denominated bonds issued to foreign investors and all debt securities issued to foreign portfolio investors (FPIs) has to be within this limit.

While relatively low key, this procedural change provides much needed administrative clarity in that it is now simpler for issuers, regulators and market watchers (such as rating agencies and industry statistics compilers) to track issuances of bonds to foreign investors. The earlier fixing of limits in dollars created some confusion on the manner of computation and the date of determination of conversion of dollars into rupees. The limit for individual issuers has been fixed at ₹50 billion per financial year (instead of US$750 million earlier). Any issuer proposing to issue bonds beyond this limit in any financial year can do so with prior RBI approval.

An important substantive change is the reduction of the minimum maturity requirement of rupee denominated bonds to three years from five, to align with the minimum maturity requirement for debt securities issued to FPIs. This ensures consistency in the prevailing routes for raising funds through issuance of bonds to foreign investors and also reduces the possibility of regulatory arbitrage. As many interested foreign investors had expressed discontent about the minimum maturity requirements, this reduction is expected to improve demand for rupee denominated bonds.

The 13 April circular has also tightened the requirements for foreign investors eligible to invest in rupee denominated bonds. Now these bonds can only be issued in a country that fulfils the following requirements: it is a member of the Financial Action Task Force (FATF) or a member of a FATF-like regional body; its securities market regulator is a signatory to the International Organization of Securities Commissions’ Multilateral Memorandum of Understanding (Appendix A signatory) or a signatory to a bilateral memorandum of understanding with the Securities and Exchange Board of India for information sharing arrangements; and it has not been identified in the public statement of the FATF as (a) a jurisdiction with deficiencies in anti-money laundering compliance or combating financing of terrorism compliance, or (b) a jurisdiction that has not made sufficient progress in respect of such deficiencies or has not committed to a plan with the FATF to address such deficiencies. Further, only residents of the above-mentioned countries can subscribe to rupee denominated bonds. With the intent to monitor compliance with these criteria, the circular also requires that agreements and offer documents for rupee denominated bonds incorporate a condition that allows issuers to obtain the list of “primary bond holders” whenever required and to provide this list to Indian regulators.

Aditya Bhargava
Aditya Bhargava

Considering that the circular intends to align investor eligibility criteria for rupee denominated bonds with FPIs and that one of its provisions enables Indian regulators to monitor that rupee denominated bonds are only held by eligible investors, it is possible that a subsequent circular may clarify that “primary bond holders” would also include current bond holders, i.e. holders that have purchased bonds in the secondary market from holders that have initially subscribed to such bonds in a primary issue.

Recent reports have noted the widening gap on interest spreads between bond financing and cash loans raised from banks and financial institutions. With the difference as much as 100 basis points in some cases, some companies are considering shifting their borrowings to bond financing instead of cash loans. This is in line with trends in countries such Japan and the US, where the share of the bond market is significantly higher than credit offtake from banks.

This development portends a significant uptick in the demand for bond issuances under the FPI framework as well as under the rupee denominated bonds framework. However, there are some teething issues that need to be addressed for the bond market to achieve its full potential. For instance, foreign investors have also shown interest in investing in the commercial paper market, but are not able to do so because of the minimum maturity requirements. Similarly, the lack of a mature credit default swap market as well as the lack of options for hedging foreign currency along with rupee conversion risk also render rupee denominated bonds less attractive. Further, clarity on the availability of the withholding tax benefit on rupee denominated bonds by way of a legislative change rather than through ad hoc notifications would provide regulatory stability (and predictability) and thus benefit the market for rupee denominated bonds.

Sawant Singh is a partner and Aditya Bhargava is a principal associate at the Mumbai office of Phoenix Legal.

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