Revised ECB framework widens the reach of NBFCs

Arundhuthi Bose

Preamble

The revised ECB framework[1] which the RBI issued on the 30th of November, 2015 comprise of favorable amendments with regard to categories of eligible borrowers. One of the components of the financial sector of the economy, the NBFCs, will be benefitted by the framework. The earlier framework was not as liberal and considerate as the revised framework with respect to NBFCs. This write up tends to focus on the impact of the revised framework on NBFCs and analyze the same compared to the former framework. .

Comparative analysis of the former and the revised ECB framework

1. Eligible borrowers –

Automatic Route: Under the former framework, NBFCs categorized as Non Banking Financial Company-Micro Finance Institutions’ (NBFC-MFIs), by the Reserve Bank, could avail ECBs under Automatic Route.

NBFCs categorized as IFCs by the Reserve Bank, were permitted to avail ECBs under the automatic route as per A.P. (DIR Series) Circular No. 69 dated January 7, 2013 upto 75% of their owned funds. However, the same was subject to fulfillment of compliance norms as stipulated by the Reserve Bank via DNBS circular dated February, 2010 and hedging of the currency risk in full.

NBFCs categorized as Asset Finance Companies (AFCs) by the Reserve Bank had been allowed vide A.P. (DIR Series) Circular No. 6 dated July 8, 2013 ECB under the automatic route, with minimum average maturity period of five years in order to finance the import of infrastructure equipment for leasing to infrastructure projects. However, the same was subject to fulfillment of compliance norms as stipulated by the Reserve Bank via Circular DNBS. PD. CC. No. 85/03.02.089/2006-07 dated December 6, 2006 and hedging of the currency risk in full.

Approval Route: NBFCs could obtain ECB under the approval route, with minimum average maturity of 5 years, from multilateral financial institutions, reputable regional financial institutions, official export credit agencies and international banks to finance import of infrastructure equipment for leasing to infrastructure projects.

NBFC-IFCs desirous of availing ECBs beyond 75 % of their owned funds required the approval of the Reserve Bank and were, therefore, considered under the approval route. However, the same was subject to fulfillment of compliance norms as stipulated by the Reserve Bank via DNBS circular dated February, 2010 and hedging of the currency risk in full.

To sum up the earlier eligibility we may refer the following table:

Serial No.	Type of NBFC	Route
1.	NBFC-MFIs	Automatic
2.	NBFCs that import infrastructure equipment for leasing to infrastructure projects	a. Could obtain ECB under the approval route. b. With minimum average maturity of 5 years c. From multilateral financial institutions, reputable regional financial institutions, official export credit agencies and international banks
3.	NBFC-IFC	Automatic
4.	NBFC-IFCs desirous of availing ECBs beyond 75 %	Approval route subject to fulfilment of compliance norms as stipulated by the Reserve Bank via DNBS circular dated February, 2010 and hedging of the currency risk in full.
5.	NBFC-AFC	Automatic subject to fulfilment of compliance norms as stipulated by the Reserve Bank via DNBS circular dated December, 2006 and hedging of the currency risk in full

As per the revised framework, all NBFCs including NBFC-MFIs have been allowed to be eligible borrowers and avail Indian Rupee denominated ECB with minimum average maturity of 3/5 years.

2. Permitted end-use –

Earlier, eligible NBFC-MFIs, NBFCs-IFC and NBFC-AFC could avail ECB only for specific stipulated purpose.

The revised framework has liberalized the permitted end use thereby enabling NBFCs to utilize ECB proceeds for:

a) On-lending to the infrastructure sector;

b) providing hypothecated loans to domestic entities for acquisition of capital goods/equipments; and

c) providing capital goods/equipment to domestic entities by way of lease and hire-purchases

NBFCs-MFI can raise ECB only for on-lending to self-help groups or for micro-credit or for bonafide micro finance activity including capacity building. Thus, NBFCs can now avail ECB to lend for non-infrastructure purpose as well from following:

i. International banks.

ii. International capital markets.

iii. Multilateral financial institutions (such as, IFC, ADB, etc.) / regional financial institutions and Government owned (either wholly or partially) financial institutions.

iv. Export credit agencies.

v. Suppliers of equipment.

vi. Foreign equity holders.

vii. Overseas long term investors such as:

a. prudentially regulated financial entities;

b. Pension funds;

c. Insurance companies;

d. Sovereign Wealth Funds;

e. Financial institutions located in International Financial Services Centres in India

Borrowing through investment in FCCB –

Earlier, the borrowing issuance of FCCB was permitted but in the revised framework it has been prohibited. NBFCs are permitted to borrow under track III, which is a category for Indian Rupee denominated ECB having a minimum average maturity of 3-5 years.

3. Requirement of hedging –

Earlier, one of the pre-condition for availing ECB was hedging the currency risk in full. The hedging was required to be done to mitigate the risk of currency fluctuation creating an impact on the borrowings. Now, NBFCs will noy be required to hedge as per the revised framework since the borrowings can only be Indian Rupee denominated ECB.

Particulars	Earlier framework	Revised framework
Eligible borrowers	NBFC-MFI, NBFC-IFC, NBFC-AFC	All NBFCs
FCCB	Allowed	Not allowed
Currency exposure	Was there	Not there
Hedging	Required	Not required

Dependence of NBFCs on borrowings

As per the RBI, in its annual report on Trend and Progress of Banking in India, for the year ended 2014[2], for NBFC-ND-SI, borrowings constitute for more than two-third of their liabilities, which rose from Rs. 8104 billion to Rs.8902 billion showing a percentage variation of 9.8% towards the positive.

INR bonds differentiated from INR borrowings

At this juncture, we need to trace out the differences between the conditionality of INR bonds and INR borrowings. The framework for the issuance of INR bonds and INR borrowings[3] provides different conditions for eligible borrowers[4], recognised investors, end use restrictions, etc.

The following table enumerates the differences between the same:-

Conditions	INR Bonds	INR Borrowings
Eligible borrowers	i. Any corporate or body corporate is eligible to issue Rupee denominated bonds overseas. ii. Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) coming under the regulatory jurisdiction of the Securities and Exchange Board of India are also eligible.	i. Al l entities listed under Track I and Track II. ii. All Non-Banking Financial Companies (NBFCs). iii. NBFCs-Micro Finance Institutions (NBFCs-MFIs), Not for Profit companies registered under the Companies Act, 1956/2013, Societies, trusts and cooperatives (registered under the Societies Registration Act, 1860, Indian Trust Act, 1882 and State-level Cooperative Acts/Multi-level Cooperative Act/State-level mutually aided Cooperative Acts respectively), Non-Government Organisations (NGOs) which are engaged in micro finance activities1. iv. Companies engaged in miscellaneous services viz. research and development (R&D), training (other than educational institutes), companies supporting infrastructure, companies providing logistics services. v. Developers of Special Economic Zones (SEZs)/ National Manufacturing and Investment Zones (NMIZs).
Recognised investors	i. Any investor from a FATF compliant jurisdiction. ii. Banks incorporated in India will not have access to these bonds in any manner whatsoever. Indian banks, however, can act as arranger and underwriter. iii. In case of underwriting, holding of Indian banks cannot be more than 5 per cent of the issue size after 6 months of issue. iv. Further, such holding shall be subject to applicable prudential norms.	i. International banks. ii. International capital markets. iii. Multilateral financial institutions (such as, IFC, ADB, etc.) / regional financial institutions and Government owned (either wholly or partially) financial institutions. iv. Export credit agencies. v. Suppliers of equipment. vi. Foreign equity holders. vii. Overseas long term investors such as: a. prudentially regulated financial entities; b. Pension funds; c. Insurance companies; d. Sovereign Wealth Funds; e. Financial institutions located in International Financial Services Centres in India. 2. In case of NBFCs-MFIs, other eligible MFIs, not for profit companies and NGOs, ECB can also be availed from overseas organisations3 and individuals.
End use restrictions	The proceeds can be used for all purposes except for the following: i. Real estate activities other than for development of integrated township / affordable housing projects; ii. Investing in capital market and using the proceeds for equity investment domestically; iii. Activities prohibited as per the foreign direct investment (FDI) guidelines; iv. On-lending to other entities for any of the above objectives; and v. Purchase of land.	1. NBFCs can use ECB proceeds for: a. On-lending to the infrastructure sector; b. providing hypothecated loans to domestic entities for acquisition of capital goods/ equipments; and c. providing capital goods/equipment to domestic entities by way of lease and hire-purchases 2. Developers of SEZs/ NMIZs can raise ECB only for providing infrastructure facilities within SEZ/ NMIZ. 3. NBFCs-MFI, other eligible MFIs, NGOs and not for profit companies registered under the Companies Act, 1956/2013 can raise ECB only for on-lending to self-help groups or for micro-credit or for bonafide micro finance activity including capacity building. 4. For other eligible entities under this track, the ECB proceeds can be used for all purposes excluding the following: i. Real estate activities ii. Investing in capital market iii. Using the proceeds for equity investment domestically; iv. On-lending to other entities with any of the above objectives; v. Purchase of land
Individual limits	Under the automatic route the amount will be equivalent of USD 750 million per annum. Cases beyond this limit will require prior approval of the Reserve Bank.	The individual limits of ECB that can be raised by eligible entities under the automatic route per financial year for all the three tracks are set out as under: a. Up to USD 750 million or equivalent for the companies in infrastructure and manufacturing sectors; b. Up to USD 200 million or equivalent for companies in software development sector; c. Up to USD 100 million or equivalent for entities engaged in micro finance activities; and d. Up to 500 million or equivalent for remaining entities.

From the table, it is evident that the framework for issuance of INR bonds is more flexible as compared to INR borrowings. Moreover, in the case of borrowings we have permitted end-use list whereas for bonds we simply have a negative list, apart from which the proceeds from bonds be used in any means. Another difference we may note is the difference in the amount eligible to be borrowed over and above which approval is required, which has been dealt with generously in INR bonds than in INR borrowings. This shows that the framework for issuance of INR borrowings is more restrictive than for INR bonds.

Coming to the question of having different conditions for INR bonds and INR borrowings, as suggested by the Sahoo Committee[5], the objective of regulating ECBs is to address the potential market failure that can arise from currency exposure. In the case of INR bonds as well as INR borrowings, there is no currency exposure. Hence, the reason for the variance between these two frameworks is ambiguous and has not been recommended by the Sahoo Committee. Thus, there is a requirement to have uniform conditions for both the routes from a policy perspective since, keeping currency risk as the base there is no difference between INR denominated bonds and INR denominated borrowings.

Conclusion

Though NBFCs have been given wider scope in terms of eligibility as more variants of the same has been allowed in the market of ECB as borrowers, having different criteria for bonds and borrowings with INR denomination might create a gap between the intent of the revised framework. Once these differences are sorted, the implementation of the framework will face lesser hassles and NBFCs will surely see the revised fame work as a boon.

[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=10153&Mode=0

[2] https://rbi.org.in/Scripts/PublicationsView.aspx?id=16165

[3] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=10153&Mode=0

[4] https://taxguru.in/rbi/ecb-policy-issuance-rupee-denominated-bonds-overseas.html

[5] http://finmin.nic.in/reports/SahooCommittee_ecbReport_20150225.pdf