Relaxations to FPIs ahead of Budget, 2020

Timothy Lopes, Executive, Vinod Kothari Consultants Pvt. Ltd.

timothy@vinodkothari.com

As investors wait eagerly in anticipation of what changes Budget, 2020 could bring, the RBI has on 23rd January, 2020[1], provided a boost by revising the norms for investment in debt by Foreign Portfolio Investors (FPIs). This comes as a boost to FPIs as the revised norms allow more flexibility for investment in the Indian Bond Market.

Further the RBI has also amended the Voluntary Retention Route for FPIs extending its scope by increasing the investment cap limit to almost twice the previously stated amount. The amendments widen the benefits to FPIs who invest under the scheme.

This write up intends to cover the revised limits in brief.

Review of limits for investment in debt by FPIs

  1. Investment by FPIs in Government securities

As per Directions issued by RBI[2] with respect to investment in debt by FPIs, FPIs were allowed to make short term investments in either Central Government Securities or State Development Loans. However, the said short term investment was capped at 20% of the total investment of that FPI, i.e., the short term investment by an FPI in Government Securities earlier could not exceed 20% of their total investment.

The above limit of 20% has now been increased to 30% of the total investment of the FPI.

  1. Investment by FPIs in Corporate Bonds

Similar to the above restriction, FPIs were also restricted from making short term investments of more than 20% of their total investment in Corporate Bonds.

The above cap is also increased from 20% to 30% of the total investment of the FPI.

The above increase in investment limits provides more flexibility for making investment decisions by FPIs.

Exemptions from short term investment limit

As per the RBI directions, certain types of securities such as Security Receipts (SRs) were exempted from the above limit. Thus, the above short term investment limit were not applicable in case of investment by an FPI in SRs.

Now the above exemption is extended to the following securities as well –

  • Debt instruments issued by Asset Reconstruction Companies; and
  • Debt instruments issued by an entity under the Corporate Insolvency Resolution Process as per the resolution plan approved by the National Company Law Tribunal under the Insolvency and Bankruptcy Code, 2016

This widens the scope of investment by FPIs who wish to make short term investments in debt.

Further the requirements of single/group investor-wise limits in corporate bonds are not applicable to investments by Multilateral Financial Institutions and investments by FPIs in ‘Exempted Securities’.

Thus this amendment brings in more options for FPIs to invest without having to consider the single/group investor-wise limits.

Relaxations in “Voluntary Retention Route” for FPIs

The Voluntary Retention Route for FPIs was first introduced on March 01, 2019[3] with a view to enable FPIs to invest in debt markets in India. FPI investments through this route are free from the macro-prudential regulations and other regulatory norms applicable to FPI investment in debt markets subject to the condition that the FPIs voluntarily commit to retain a required minimum percentage of their investments in India for a specified period.

Subsequently the scheme was amended on 24th May, 2019[4].

On 23rd January, 2020[5] the RBI has brought in certain relaxations to the above VRR scheme. The changes made are most certainly welcome since it increases the scope of the scheme and provides relaxations to FPIs. The highlights are as under –

Increase in investment cap –

Investment through the VRR for FPIs was earlier subject to a cap of Rs. 75,000 crores. As on date around Rs. 54,300 crores has already been invested in the scheme. Thus based on feedback from the market and in consultation with the Government it was decided to increase the said investment limit to Rs. 1,50,000 crores.

Transfer of investments made under General Investment Limit to VRR –

‘General Investment Limit’, for any one of the three categories, viz., Central Government Securities, State Development Loans or Corporate Debt Instruments, means the FPI investment limits announced for these categories under the Medium Term Framework, in terms of RBI Circular dated April 6, 2018, as modified from time to time.

Now the RBI has allowed FPIs to transfer their investments made under the above mentioned limit to the VRR scheme.

Investment in ETFs that trade invest only in debt

Earlier under the VRR scheme, investments were allowed in the following –

  • Any Government Securities i.e., Central Government dated Securities (G-Secs), Treasury Bills (T-bills) as well as State Development Loans (SDLs);
  • Any instrument listed under Schedule 1 to Foreign Exchange Management (Debt Instruments) Regulations, 2019 notified, vide, Notification dated October 17, 2019, other than those specified at 1A(a) and 1A(d) of that schedule;
  • Repo transactions, and reverse repo transactions.

Pursuant to the amendment, the RBI has allowed FPIs to invest in Exchange Traded Funds (ETFs) investing only in debt instruments.

Further the following features are introduced for the fresh allotment opened by RBI under this route –

  1. The minimum retention period shall be three years.
  2. Investment limits shall be available ‘on tap’ and allotted on ‘first come, first served’ basis.
  3. The ‘tap’ shall be kept open till the limit is fully allotted.
  4. FPIs may apply for investment limits online to Clearing Corporation of India Ltd. (CCIL) through their respective custodians.
  5. CCIL will separately notify the operational details of application process and allotment.

Conclusion

The changes made by RBI certainly attract more FPIs to the Indian Bond Market and extends its scope. The relaxations come ahead of the Budget, 2020 wherein foreign investors have more expectations for new reforms to boost growth and investment in the Indian economy.

Links to our earlier write ups on the subject –

Recommendations to further liberalise FPI Regulations –

http://vinodkothari.com/2019/06/recommendations-to-further-liberalise-fpi-regulations/

RBI removes cap on investment in corporate bonds by FPIs –

http://vinodkothari.com/2019/02/rbi-removes-cap-on-investments-in-corporate-bonds-by-fpis/

RBI widens FPI’s avenue in corporate bonds –

http://vinodkothari.com/2018/05/rbi-widens-fpis-avenue-in-corporate-bonds/

Investment by FPIs in securitised debt instruments

http://vinodkothari.com/2018/06/investment-by-fpis-in-securitised-debt-instruments/

SEBI brings in liberalised framework for Foreign Portfolio Investors –

http://vinodkothari.com/2019/09/sebi-brings-in-liberalised-framework-for-foreign-portfolio-investors/

 

[1] https://rbidocs.rbi.org.in/rdocs/notification/PDFs/APDIR18184461ABA6F14E2EA51DF0243B610CE6.PDF

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11303&Mode=0

[3] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11492&Mode=0

[4] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11561&Mode=0

[5] https://rbidocs.rbi.org.in/rdocs/notification/PDFs/APDIR19FABE1903188142B9B669952C85D3DCEE.PDF

FAQs on Corporate Social Responsibility

SEBI tightens its norm on resignation of auditors

– Priya Udita

resolution@vinodkothari.com

OVERVIEW

Observing that a lot of statutory auditors of the companies are abruptly resigning before completing their tenure either due to lack of cooperation or lack of information provided by the company, SEBI has taken the matter in its hand to strengthen the norms. Consequently, SEBI issued a Consultation Paper[1] on policy proposals with respect to resignation of statutory auditors from listed entities (‘Paper’) dated July 18, 2019. The Paper discussed the policy proposal with the twin objective of strengthening disclosures to the investors and clarifying the role of the Audit Committee. Our analysis of the Paper can be assessed here.

Based on the policy proposal and public comments, SEBI issued circular on Resignation of statutory auditors from listed entities and their material subsidiaries (‘Circular’)[2] dated October 18, 2019 defining compliance to be followed by the listed entity and its material subsidiary while appointing or reappointing the auditors.

KEY AMENDMENTS

  1. Applicability:

The Circular is applicable on listed entities and its material subsidiaries. The material subsidiaries can be a listed or an unlisted entity. However, it is interesting to comprehend the applicability of the Circular on the debt listed companies (analysed below in our comment section).

Further, the Circular has come into force with immediate effect from the date of its notification.

  1. Exception:

The provisions of this Circular  is inapplicable in case the auditor disqualified under section 141 of the Companies Act, 2013.

  1. Compliance for limited review or audit review while appointing or reappointing the auditors:
  2. Within 45 days from the end of quarter of a financial year- the auditor shall issue the limited review/ audit report for such quarter before resignation.

For Example: if the auditor resigns on May 28, 2019 then the auditor is required to submit limited review of quarter ending on June 30, 2019.

  1. Resignation after  45  days  from  the  end  of  a  quarter  of  a  financial year- then the auditor shall issue the limited review/ audit report for such quarter as well as the next quarter before resignation.

For Example: if the auditor resigns on August 25, 2019, then the auditor needs to issue limited review/audit report of quarter ending on September 30, 2019 as well as December 30, 2019.

  1. However, if the auditor has signed the limited review/ audit report for the first 3 quarters of a financial year- then the auditor shall issue the limited review/ audit report for the last quarter of such financial year as well as the audit report for such financial year before the resignation.
  2. Role of Audit Committee

Though the SEBI (Listing and Disclosure Obligations) Regulation, 2015 (‘SEBI LODR Regulations’) laid down the broad role of the audit committee inter alia the appointment, remuneration of the statutory auditors, but, there was not much for the audit committee to delve once the auditor resigns. Thus, with the intention to further enhance the role of audit committee, SEBI has laid down following procedures:

  1. For the auditors:
  2. In case of conflict with the management of the listed entity due to lack of cooperation or non-availability of information, the auditor can approach the chairman of the audit committee of the listed entity.
  3. Where the auditor proposes to resign, all concerns with respect to the proposed resignation, along with relevant documents should be given to the audit committee.
  4. Further where the proposed resignation is due to non-receipt of information/explanation from the company, the auditor will have to inform the audit committee of the details of information asked and not provided by the management.
  5. For the Audit Committee:
  6. In case of concern raised due to non-availability of information, audit committee must receive such concern directly and immediately without specifically waiting for the quarterly audit committee meetings.
  7. On receipt of information from the auditor relating to the proposal to resign, the audit committee/board of directors must deliberate on the matter as soon as possible but not later than the date of the next audit committee meeting and communicate its views to the management and the auditor.
  8. Disclaimer by the auditor:

Where the auditor does not receive the information demanded for the purpose of auditing, an appropriate disclaimer in the audit report must be provided in accordance with the Standards of Auditing as specified by ICAI/NFRA.

  1. Obligations of the listed entity/material subsidiary
  2. The listed entity/its material subsidiary are required to ensure that the new compliance is included in the terms of appointment at the time of appointment or reappointment of the auditors. In case of existing auditors, the appointment letter is needed to be modified to give such effect.
  3. The listed entity/its material subsidiary need to obtain the information about the auditor’s resignation in a format as specified in the Circular. Further, the listed entity has the obligation to ensure disclosure of the same under Sub-clause  (7A)  of  Clause  A  in Part  A  of Schedule  III under Regulation 30(2) of SEBI LODR Regulations.
  4. The listed entity/material subsidiary will provide all the relevant document or information as required by the auditor during the period from its proposal to resign and submission of the limited review/audit report.
  5. The listed entity will disclose the views of the audit committee to the stock exchange as soon as possible and not later than later than twenty four hours after the date of such audit committee meeting.

ANALYSIS

Firstly, we need to understand the current regulatory provisions governing the resignation of the auditors and the need felt by SEBI to issue this Circular.

Section 140(2) of the Companies Act, 2013 along with the Companies (Audit and Auditors) Rules, 2014 mandates the auditor to file a statement in a prescribed form to the company and to the Registrar citing reasons for resignation, within 30 days from the date of resignation. In addition to that, sub-clause (7A) of Clause A in Part A of Schedule III under Regulation 30(2) of the SEBI (LODR) Regulations prescribes that the listed entity shall disclose detailed reasons of the resignation to the stock exchange within 24 hours of such resignation. ICAI’s auditing standards (SA-705) enumerates that in a situation where the possible effects on the financial statements of undetected misstatements are both material and pervasive such that a qualification of the opinion would be inadequate to communicate the gravity of the situation, the auditor can resign. According to the Rule 5 of National Financial Reporting Authority Rules, 2018 (‘NFRA Rules’), every auditor of the entities covered by these rules are required to file an annual return in form NFRA 2 with the authority giving details with respect to the audit as well as resignations given in the past 3 years.

Though the law provided these rules and regulation, the rising trend on abrupt resignations by the auditor citing reason as ‘pre-occupation’ were leaving the investors vulnerable to various threats. Due to resignation of the large audit firms, SEBI was forced to review its listing and disclosure obligations. In order to enhance accountability of auditors and protect the investors from the insecure environment due to abrupt resignation, SEBI felt the dire need to regulate such resignations and took the step in a right direction by issuing this Circular.

OUR COMMENT

The Circular was much needed as the rules governing the resignation of auditors across different forums were inadequate. The Circular, in addition to regulation of abrupt resignation, will give a helping hand to the auditors especially in case of lack of cooperation by the management, if any, faced by them. This will ultimately benefit SEBI to look into the matter for potential fraudulent or vulnerable transactions. Further the enhancing role of the audit committee is commendable.

However, the Circular has few gaps such as the applicability of Circular on debt listed entities. Now, there can be various scenarios. Suppose the listed entity ‘A’ has a material subsidiary ‘B’. The Circular will be applicable where ‘B’ is unlisted but a material subsidiary of ‘A’. The question arises where ‘B’ is a debt listed entity only, whether the Circular will be applicable? In our view, the Circular will be applicable in the instant case since B is a material subsidiary.

Further, it is important to note that the intimation requirements under the Circular are two-fold and both are parallel to each other serving different intents. In the first part, the listed entity has to inform the stock exchange within 24 hours of the resignation as per Sub-clause (7A) of Clause A in Part A of Schedule III under Regulation 30(2) of SEBI LODR Regulations, whereas in the second part the audit committee is required to inform the stock exchange as soon as possible from the date of resignation but not later than date of next audit meeting.  The intimation under the second part will carry the views of the audit committee on the concerns raised by the auditor before resignation whereas the intimation under Regulation 30 is an intimation of a material event. We shall be coming out with our set of FAQs on the Circular discussing the same at length from various perspectives.

[1] See the paper here.

[2] See the Circular here.