Investing in India through non-convertible debentures

By Ganesh Prasad and Sharad Moudgal, Khaitan & Co
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Indian companies are increasingly looking at alternative means of raising capital. In the past few years, the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI) have taken significant steps to expand the country’s debt market, which is less developed than the equity markets.

A photo of Ganesh Prasad
Ganesh Prasad

One such initiative is to allow foreign debt infusions in Indian companies through non-convertible debentures (NCDs). This has become a popular route for Indian companies to raise capital from overseas investors.

The provisions relating to issuance of debentures under the Companies Act, 1956, apply equally to NCDs. In addition, the issuance of NCDs could be treated as an issuer company accepting a “deposit” under the Companies Act. However, NCDs are typically issued in a manner that allows the issuer company to benefit from certain exemptions under the Companies (Acceptance of Deposits) Rules, 1976.

While issuance of debt instruments is common in the domestic debt market, the RBI and SEBI have encouraged debt financing from overseas entities under the NCD investment route. Under Indian foreign exchange laws, registered foreign institutional investors (FIIs) or qualified foreign investors (QFIs), or entities which maintain a sub-account with a registered FII, may invest in “listed” or “to-be-listed” NCDs issued by an Indian company.

Until recently, the regulations prescribed by the RBI and SEBI conflicted on whether FIIs could invest in to-be-listed NCDs. FIIs adopted a cautious approach and structured their investments by acquiring NCDs upon their listing via the secondary markets only. The conflict has since been remedied and FIIs and QFIs are now permitted to acquire to-be-listed NCDs directly from Indian companies provided that the NCDs are listed within 15 days from their issue and the terms of issue of the NCDs stipulate that the NCDs will be redeemed if listing is not achieved within this time.

The SEBI (Issue and Listing of Debt Securities) Regulations, 2008, deal with the listing of secured and unsecured debt securities (including NCDs) issued by way of a public issue or a private placement by both private and public companies. A public issue of NCDs resembles a public issue of shares by an Indian company, including filing a draft and final offer document, making requisite disclosures, obtaining a credit rating and obtaining requisite “in-principle” approvals.

A photo of Sharad Moudgal
Sharad Moudgal

NCDs may also be issued on a private placement basis, subject to certain conditions prescribed under the regulations, including filing an information memorandum, obtaining a credit rating and ensuring that any security created to secure the NCDs is adequate to ensure 100% asset cover sufficient to discharge the principal amount of the NCDs.

An issuer company desirous of listing NCDs must also comply with the debt listing agreement to be executed with the stock exchange on which the NCDs are sought to be listed. An issuer company must comply with the specific conditions mentioned under the debt listing agreement, including reporting requirements, ensuring timely interest/redemption payments and ensuring maintenance at all times of 100% asset cover.

Key benefits

The NCD investment route has drawn much attention from foreign investors. Key benefits include: (1) NCDs are liquid instruments which may be freely traded; (2) holders of NCDs enjoy a preferential position as creditors in the winding up of an issuer company; (3) NCDs may be secured by Indian assets; (4) no caps are prescribed on the returns from NCDs; (5) the investment conditions prescribed under the foreign direct investment (FDI) route do not apply to NCD investments; (6) returns on NCDs can be linked to identified assets of the issuer company; (7) holders of NCDs, being creditors, can negotiate quasi-equity rights with issuer companies; (8) investments can be structured to maximize capital protection by stipulating a minimum return on the NCDs acquired while also participating in the risks and rewards of the Indian company as an equity holder; and (9) NCDs can be acquired through entities established in tax beneficial jurisdictions, such as Cyprus.

Associated risks

The main risk associated with NCD investments lies in how Indian regulators may perceive them. Viewed with their accompanying rights, such investments could be re-characterized as a means of circumventing regulations on foreign investment in India. For example, investments in the real estate sector could be seen as violating FDI investment conditions as well as end-use restrictions on proceeds from external commercial borrowings. Similarly, regulators could perceive NCD investments by foreign investors in Indian companies as a means of guaranteeing returns on accompanying equity investments made by them.

While the regulations enable NCDs to be secured, Indian foreign exchange laws require that regulatory approval be obtained prior to creating any security interest in favour of non-residents. Opinions differ as to when the approval is to be obtained.

Ganesh Prasad is a partner and Sharad Moudgal is a principal associate at Khaitan & Co. The views of the authors are personal, and should not be considered as those of the firm.

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