Voluntary retention route: A halfway measure?

By Sawant Singh and Aditya Bhargava, Phoenix Legal
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The government and the financial sector regulators, the Reserve Bank of India (RBI) and the Securities and Exchange Board of Indian (SEBI), have considered various measures to ease debt investment rules for foreign portfolio investors (FPIs) such as relaxing group exposure thresholds (20%) and the per issue investment limits (50%). In this vein, the RBI issued a discussion paper in October 2018 on voluntary retention route (VRR) to facilitate foreign portfolio investment in debt.

Under VRR, FPIs will have more operational flexibility in terms of instruments as well as exemptions from concentration limits, and group-level and issue-level thresholds. Following the discussion paper, the RBI issued a circular on VRR on 1 March.

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Sawant Singh
Partner
Phoenix Legal

All FPIs registered with SEBI are eligible to participate in VRR. Investments under VRR are in addition to the limits prescribed for debt investments. For corporate debt under VRR, the investment limit will be `350 billion (US$4.93 billion).

Under VRR, FPIs can invest in instruments such as non-convertible debentures, security receipts issued by asset reconstruction companies, and securitized debt instruments. Investments under VRR will be exempt from minimum residual maturity requirements, issue limits, and category-wise concentration limits.

Eligible instruments exclude units of domestic mutual funds. The minimum retention for investment under VRR will be three years or such other time period as the RBI may prescribe.

Limits under VRR will be allotted through auctions or “on tap”. No FPI will be allotted a limit greater than 50% of the amount offered, where the demand for the amount offered is greater than 100%.

FPIs must invest 75% of the amount allotted (referred to as committed portfolio size or CPS). This amount will be determined on an end-of-day basis and shall be determined on the basis of the face value of the securities.

Aditya Bhargava Phoenix Legal
Aditya Bhargava
Partner
Phoenix Legal

Key features of the auction mechanism include: (a) an FPI must bid the amount they propose to invest, and the retention period of that investment (which must not be less than the prescribed minimum retention period), (b) an FPI can place multiple bids, and (c) the criterion for allotment will be the retention period bid in an auction, and bids will be accepted in the descending order until the aggregate amounts of the accepted bids add up to the auction amount.

Successful FPI applicants must invest 25% of the CPS within one month of the allotment, and the remaining amount within three months from the date of allotment. Before the end of any retention period, an FPI may elect to continue investments under VRR for an identical period, by conveying such decision to their custodians. If an FPI elects not to continue under VRR, they may liquidate their portfolio and exit, or they may (subject to availability) shift their investments to the general investment category.

FPIs can liquidate their investments under VRR prior to the end of any retention period by selling such investments to other FPIs. Custodians cannot permit any repatriation from the cash accounts of an FPI if such transaction leads to an FPI’s assets falling below the minimum threshold of 75% of CPS.

Utilization of limits under VRR and compliance with applicable conditions shall be the responsibility of both FPIs and their custodians. An FPI must enter into separate legal documentation with their custodians in respect of investments under VRR. A separate “special non-resident rupee” (SNRR) account for investment through VRR would need to be opened by the FPI, and all fund flows through VRR must be made through this account. Further, an FPI must open a separate securities account for holding debt securities under VRR.

VRR provides an alternative for FPIs that prefer a sole-investor strategy and who were perceptibly disadvantaged by a regulatory framework that insists on participation and risk-sharing with other FPIs. VRR also re-opens channels for inflow of foreign debt providing much needed relief for domestic borrowers.

However, while welcomed by domestic and foreign stakeholders, VRR is also perceived as a patchwork and a convoluted solution to an already cumbersome regulatory framework. It is hoped that, in the near future, the RBI and SEBI are able to introduce a simplified framework to encourage FPIs and to provide regulatory stability.

Sawant Singh and Aditya Bhargava are partners at the Mumbai office of Phoenix Legal.

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