Background
A case was made for giving relaxation to companies, which have their assets predominantly as investments in shares for holding stake in group companies but not for trading, and companies which do not carry on any other financial activity i.e. Core Investment Companies (CICs), from the regulatory provisions applicable to Non-Banking Financial Companies (NBFCs).
CICs were not considered as carrying on the business of acquisition of shares and securities in certain circumstances. Companies fulfilling the above criteria were not required to obtain Certificate of Registration (COR) from Reserve Bank of India (RBI) u/s 45 IA of the Reserve Bank of India Act, 1934 (the RBI Act). Practical experience showed that it is difficult to determine whether a company has invested in the shares of another company for the purpose of holding stake or for the purpose of trade. For example, even where initially investments had been made for holding stake in the investee company, for various reasons these shares could be sold or additional shares could have been purchased.
RBI issued in April 2010 draft regulatory framework for CICs and solicited suggestions from stakeholders. Keeping in mind the background and the representations received from stakeholders, RBI has, on 12 August 2010, announced regulatory framework for NBFCs which are CICs. RBI will issue appropriate notifications to operationalize the regulatory framework announced.
This Alert provides an overview of the regulatory framework announced.
Overview of the Regulatory Framework for CICs
1. What is a CIC?
CIC would be defined as under:
A NBFC carrying on the business of acquisition of shares and securities which satisfied the following conditions:-
- it holds not less than 90% of its Total Assets in the form of investment in equity shares,preference shares, debt or loans in group companies;
- its investments in the equity shares (including instruments compulsorily convertible into equity shares within 10 years from the date of issue) in group companies constitutes not less than 60% of its ‘Total Assets’;
- it does not trade in its investments in shares, debt or loans in group companies except through block sale for the purpose of dilution or disinvestment;
- it does not carry on any other financial activity referred to in Section 45I(c) and 45I(f) of the RBI Act except investment in bank deposits, money market instruments, government securities, loans to and investments in debt issuances of group companies or guarantees issued on behalf of group companies.
2. Are all CICs required to be registered as NBFC?
- CICs with an asset size of less than `1 billion would be granted exemption from registration under Section 45-IA of the RBI Act. For this purpose all CICs belonging to a Group will be aggregated.
- CICs with an asset size of `1 billion or more are considered as Systemically Important Core Investment Companies (CICs-ND-SI). CIC-ND-SI would be required to obtain Certificate of Registration (COR) from RBI even if they have been advised in the past by RBI that registration was not required.
3. Is there any time period for obtaining COR for CIC-ND-SI?
- CIC-ND-SI – Within a period of 6 months from the date of notification to be issued
- CICs with an asset size of less than `1 billion – Within 3 months of the date of achieving a balance sheet size of `1 billion.
4. Whether a CIC is required to adhere to compliance requirements with respect to net-owned funds and exposure norms?
A CIC-ND-SI which adheres to the requirements regarding capital adequacy and leverage ratio, may be exempted from compliance with:-
a. maintenance of statutory minimum Net Owned Fund (NoF) and
b. Non-Banking Financial (Non-Deposit Accepting or holding) Companies Prudential Norms (Reserve Bank) Directions, 2007 including requirements of capital adequacy and exposure norms mentioned therein.
- Capital adequacy: Every CIC-ND-SI shall ensure that at all times it maintains a minimum Capital Ratio whereby its Adjusted Net Worth shall not be less than 30% of its aggregate risk weighted assets on balance sheet and risk adjusted value of off-balance sheet items as per the latest audited balance sheet as at the end of the financial year.
- Leverage Ratio: Every CIC-ND-SI shall ensure that its outside liabilities at all times shall not exceed 2.5 times its Adjusted Net Worth as per latest audited balance sheet as at the end of the financial year.
5. What are the implications of non-compliance?
- A CIC-ND-SI which fails to apply to RBI within a period of 6 months for obtaining COR will be treated as contravening the provisions of the RBI Act.
- CICs-ND-SI applying for COR but not adhering to the capital adequacy and leverage ratio requirement, may approach RBI with an action plan so as to avail exemptions. While examining the action plan, RBI may impose such conditions / restrictions as it deems fit. 6. Are there any other continuous compliance requirements for CIC-ND-SI?
- CIC-ND-SI shall submit annual certificate from their statutory auditors regarding compliance with the CIC guidelines within 1 month from the date of finalization of the balance-sheet.
Other Definitions
- Adjusted Net Worth:-
Owned Funds (as defined) + 45% of Revaluation Reserve arising from revaluation of investments in quoted investments
(+)
50% of the unrealized appreciation in the book value of quoted investments (being excess of aggregate market value over the book value) + increase in the equity share capital during the financial year
(-)
diminution in the aggregate book value of quoted investments (being excess of the book value over the market value of quoted investments) + decrease in equity share capital during the financial year
Above has to be computed as per latest audited balance sheet as at the end of the financial year.
- Market Value of Quoted Investments:-
Average of the highs and lows of the quoted prices of the investments, on a recognized stock exchange where the investment is most actively traded, during the period of 26 weeks immediately preceding the end of the financial year at which date the last audited balance sheet is available.
- Outside Liabilities:-
Total liabilities as appearing on the liabilities side of the balance sheet
(i) Excluding ‘paid up capital’ and ‘reserves and surplus’; but
(ii) Including all forms of debt and obligations having the characteristics of debt whether created by issue of hybrid instruments or otherwise and value of guarantees issued whether appearing on the balance sheet or not.
- Total Assets:-
Total assets as appearing on the assets side of the balance sheet but excluding :-
(i) cash and bank balances;
(ii) investment in money market instruments;
(iii) advance payments of taxes; and
(iv) deferred tax asset.
Analysis
- In case a business group has more than one investment vehicle for making investments in group companies, the exemptions from NBFC registration would be considered based on asset size of all such vehicles at group level. This would mean that exemption from registration as NBFC for CIC with asset size of less than ` 1 billion and part of the same Group will not be available.
- One would have to see the fine prints of the notifications that may be issued by RBI in this regard including the definition of “Group”.
Source: RBI’s Circular DNBS (PD) CC.No. 197/03.10.001/2010-1 1 issued by RBI on 12 August 2010
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