Investment by FPIs in securitised debt instruments

By Anita Baid,(anita@vinodkothari.com)(finserv@vinodkothari.com)

Investments by Foreign Portfolio Investors (FPIs) in unlisted debentures and securitised debt instruments (SDIs) issued by Indian companies was allowed pursuant to SEBI notification dated 27th February, 2017[1]. Earlier in November, 2016, Reserve Bank of India (RBI) had also permitted investment by FPIs in unlisted non-convertible debentures and securitised debt instruments issued by Indian companies[2]. The said amendments by the securities market regulator and financial services regulator were the final push which was needed to encourage more FPI investments in India.

Previously, FPIs could invest only in debt securities of companies engaged in the infrastructure sector. This was a clear indication that the government aimed to develop the infrastructure sector in India. But eventually, it seemed that the government did not want to restrict this to infrastructure only and wanted to reap all the benefits for developing a dynamic and facilitating bond market in the country.

Economic development and smooth flow of funds into the economy are the twin sides of the same coin and the government of India has very well taken this into account while amending the FPI regulation. Allowing FPI investments in unlisted debt instruments of Indian companies, was a step by the government to relax the burden which the companies had to bear, while raising funds in the form of equity. The regulation  in turn blocked the companies from tapping into fresh funds and listing of debt instruments, which called for additional burden of complying with a host of other regulations.

Companies are now able to raise debt funding from foreign sources in the form of unlisted debt, i.e., without listing the instrument.

Apart from unlisted debt instruments, FPI investments in SDIs have also gained a lot of popularity. SDI has been defined under SEBI (Public Offer and Listing of Securitised Debt Instruments) Regulations, 2008 as –

“securitised debt instrument” means any certificate or instrument, by whatever name called, of the nature referred to in sub-clause (ie) of clause (h) of section 2 of the Act issued by a special purpose distinct entity

Further, section 2(h) (ie) of the Securities Contracts (Regulation) Act, 1956 defines the term ‘securities’ to include-

(ie) any  certificate  or  instrument  (by  whatever  name  called),  issued  to an  investor  by  any issuer  being  a  special  purpose  distinct  entity which  possesses  any  debt  or  receivable,  including  mortgage  debt, assigned  to  such entity,  and  acknowledging  beneficial  interest of such investor in such debt or receivable, including mortgage debt, as the case may be;

However, SDIs which are eligible for FPI investments have to be –

1. any certificate or instrument issued by a special purpose vehicle (SPV) set up for securitisation of asset/s where banks, FIs or NBFCs are originators; and/or
2. any certificate or instrument issued and listed in terms of the SEBI Regulations on Public Offer and Listing of Securitised Debt Instruments, 2008.

Accordingly, instruments issued by other than the ones listed above will neither be regulated by the central bank of the country nor the securities market regulator.

Recently, RBI has further relaxed the regulations for investments by FPI, which has been welcomed by the industry at large. At the same time it has also tighten investor-wise exposure limits.

The RBI vide its notification dated 27^th April, 2018[3], amended on 1^st May, 2018[4] has relaxed their terms of investments in corporate bonds by FPIs. The intent behind these changes are to accelerate the demand for shorter maturity papers that matures within the span of twelve months. Treasury bills, commercial papers and certificate of deposits are few ubiquitous short-term maturity instruments.

Further, exposure limits on FPI investment in corporate bonds have also been introduced. The relevant extract of the circular is reproduced herein below:

“(e) Single/Group investor-wise limit in corporate bonds

FPI investment in corporate bonds shall be subject to the following requirements:

(i) Investment by any FPI, including investments by related FPIs, shall not exceed 50% of any issue of a corporate bond. In case an FPI, including related FPIs, has invested in more than 50% of any single issue, it shall not make further investments in that issue until this stipulation is met.

(ii) No FPI shall have an exposure of more than 20% of its corporate bond portfolio to a single corporate (including exposure to entities related to the corporate). In case an FPI has exposure in excess of 20% to any corporate (including exposure to entities related to the corporate), it shall not make further investments in that corporate until this stipulation is met. A newly registered FPI shall be required to adhere to this stipulation starting no later than 6 months from the commencement of its investments.”

Prior to change, FPIs were only permitted to invest in corporate bonds with minimum residual maturity of three years or above. Pursuant to the recent amendment, FPIs are permitted to invest in corporate bonds with minimum residual maturity of above one year. Further, investments by an FPI in corporate bonds with residual maturity below one year shall not exceed, at any point in time, 20% of the total investment of that FPI in corporate bonds. Also, on a whole, the investment by an FPI including related FPIs cannot be more than 50% of any issue of corporate bonds.The major issues that need to be specifically emphasized on are –

1. whether pass through certificates (PTCs) issued by special purpose trust (SPV), under a securitization transaction, would qualify to be a corporate bond,
2. whether, residual maturity norms shall apply in case of SDIs, and
3. whether investment made in the PTCs issued by the SPV be treated as an exposure on the originator and will it fall under the aforesaid concentration limits.

Firstly, it is pertinent to note that the concentration limits are for issuance of corporate bonds. In case securities are issued by an SPV, the same does not fall under the category of corporate bond. Para 21(1) of the SEBI (Foreign Portfolio Investors) Regulations, 2014^[5] provides a list of instruments in which FPIs can invest. The list originally included corporate securities like non-convertible debentures/bonds, shares, securities etc. issued by an Indian company. However, subsequently the regulations were amended to include securitised debt instruments issued by SPVs. It can be argued, the very intention of including the SDIs was because the instruments were not originally covered under items provided therein. Therefore, it can be safely concluded that SDIs cannot be considered as corporate bonds.

Since, SDIs are not considered as corporate bonds itself, the residual maturity limit shall also not be applicable. Hence, investment by FPIs in securitised debt instruments shall not be subjected to the minimum residual maturity requirement.

Secondly, in securitization transactions, the originator sells the receivables to the SPV on true sale and non-recourse basis. The SPV issues PTCs on a private placement basis, backed by the receivables owned by the SPV and the investors subscribes to the PTCs. The exposure of the investor is on the SPV and ultimately on the underlying receivables and not on the originator, save and except for any credit enhancement provided for the transaction which puts an obligation on the originator.

Moreover, the priority sector lending (PSL) requirements of commercial banks are also fulfilled by investing in PTCs, wherein there is a see-through approach. The regulators do not look at the PTC as a security of the issuer, but consider it based on a see-through approach for complying with the PSL requirements. Therefore, investments made in PTCs cannot be considered as exposure on the originator.

Though the regulations issued by SEBI and their interpretation supports the aforesaid argument, there seems to be a difference in opinion between RBI and SEBI on the nature of securities. Further, since the concentration limits have been issued by the RBI, the RBI viewpoint becomes crucial. In RBI parlance, the word “corporate bonds” includes SDIs as well, and therefore, the view taken across the industry is that concentration norms will also be applicable in case of investment by FPIs in SDIs.

[1] https://www.sebi.gov.in/sebi_data/attachdocs/1488197031529.pdf

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=10718&Mode

[3] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11266&Mode=0

[4] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11268&Mode=0

[5] https://www.sebi.gov.in/legal/regulations/apr-2017/sebi-foreign-portfolio-investors-regulations-2014-last-amended-on-march-6-2017-_34690.html