RBI grants additional 3 months to FPIs under Voluntary Retention Route

Shaifali Sharma | Vinod Kothari and Company

corplaw@vinodkothari.com

In March, 2019, the RBI with an objective to attract long-term and stable FPI investments into debt markets in India introduced a scheme called the ‘Voluntary Retention Route’ (VRR)[1]. Investments through this route are in addition to the FPI General Investment limits, provided FPIs voluntarily commit to retain a minimum of 75% of its allocated investments (called the Committed Portfolio Size or CPS) for a minimum period of 3 years (retention period).However, such 75% of CPS shall be invested within 3 months from the date of allotment of investment limits. Recognizing the disruption posed by the COVID-19 pandemic, RBI vide circular dated May 22, 2020[2], has granted additional 3-months relaxation to FPIs for making the required investments. The circular further addresses the questions as to which all FPIs are covered under this relaxation and how the retention period will be determined.

This article intends to discuss the features of the VRR scheme and the implications of RBI’s circular in brief.

What is ‘Voluntary Retention Route’?

RBI, to motivate long term investments in Indian debt markets, launched a new channel of investment for FPIs on March 01, 2019[3] (subsequently the scheme was amended on May 24, 2019[4]), free from the macro-prudential and other regulatory norms applicable to FPI investment in debt markets and providing operational flexibility to manage investments by FPIs. Under this route, FPIs voluntarily commit to retain a required minimum percentage of their investments for a period of at least 3 years.

The VRR scheme was further amended on January 23, 2020[5], widening its scope and provides certain relaxations to FPIs.

Key features of the VRR Scheme:

  1. The FPI is required to retain a minimum of 75% of its Committed Portfolio Size for a minimum period of 3 years.
  2. The allotment of the investment amount would be through tap or auctions. FPIs (including its related FPIs) shall be allotted an investment limit maximum upto 50% of the amount offered for each allotment, in case there is a demand for more than 100% of amount offered.
  3. FPIs may, at their discretion, transfer their investments made under the General Investment Limit, if any, to the VRR scheme.
  4. FPIs may apply for investment limits online to Clearing Corporation of India Ltd. (CCIL) through their respective custodians.
  5. Investment under this route shall be capped at Rs. 1,50,000/- crores (erstwhile 75,000 crores) or higher, which shall be allocated among the following types of securities, as may be decided by the RBI from time to time.
    1. ‘VRR-Corp’: Voluntary Retention Route for FPI investment in Corporate Debt Instruments.
    2. ‘VRR-Govt’: Voluntary Retention Route for FPI investment in Government Securities.
    3. ‘VRR-Combined’: Voluntary Retention Route for FPI investment in instruments eligible under both VRR-Govt and VRR-Corp.
  6. Relaxation from (a) minimum residual maturity requirement, (b) Concentration limit, (c) Single/Group investor-wise limits in corporate bonds as stipulated in RBI Circular dated June 15, 2018[6] where exposure limit of not more than 20% of corporate bond portfolio to a single corporate (including entities related to the corporate) have been dispensed with. However, limit on investments by any FPI, including investments by related FPIs, shall not exceed 50% of any issue of a corporate bond except for investments by Multilateral Financial Institutions and investments by FPIs in Exempted Securities.
  7. FPIs shall open one or more separate Special Non-Resident Rupee (SNRR) account for investment through the Route. All fund flows relating to investment through the VRR shall reflect in such account(s).

What are the eligible instruments for investments?

  1. Any Government Securities i.e., Central Government dated Securities (G-Secs), Treasury Bills (T-bills) as well as State Development Loans (SDLs);
  2. Any instrument listed under Schedule 1 to Foreign Exchange Management (Debt Instruments) Regulations, 2019 other than those specified at 1A(a) and 1A(d) of that schedule; However, pursuant to the recent amendments, investments in Exchange Traded Funds investing only in debt instruments is permitted.
  3. Repo transactions, and reverse repo transactions.

What are the options available to FPIs on the expiry of retention period?

Option 1

 

Continue investments for an additional identical retention period
 

 

 

Option 2

 

Liquidate its portfolio and exit; or

 

Shift its investments to the ‘General Investment Limit’, subject to availability of limit under the same; or

 

Hold its investments until its date of maturity or until it is sold, whichever is earlier.

Any FPI wishing to exit its investments, fully or partly, prior to the end of the retention period may do so by selling their investments to another FPI or FPIs.

3-months investment deadline extended in view of COVID-19 disruption

As discussed above, once the allotment of the investment limit has been made, the successful allottees shall invest at least 75% of their CPS within 3 months from the date of allotment. While announcing various measures to ease the financial stress caused by the COVID-19 pandemic, RBI Governor acknowledged the fact that VRR scheme has evinced strong investor participation, with investments exceeding 90% of the limits allotted under the scheme.

Considering the difficulties in investing 75% of allotted limits, it has been decided that an additional 3 months will be allowed to FPIs to fulfill this requirement.

Which all FPIs shall be considered eligible to claim the relaxation?

FPIs that have been allotted investment limits, between January 24, 2020 (the date of reopening of allotment of investment limits) and April 30, 2020 are eligible to claim the relaxation of additional 3 months.

When does the retention period commence? What will be the implication of extension on retention period?

The retention period of 3 years commence from the date of allotment of investment limit and not from date of investments by FPIs. However, post above relaxation granted, the retention period shall be determined as follows:

FPIS

 

RETENTION PERIOD
*Unqualified FPIs Retention period commence from the date of allotment of investment limit

 

**Qualified FPIs opting relaxation

 

 

Retention period commence from the date that the FPI invests 75% of CPS
Qualified FPIs not opting relaxation

 

Retention period commence from the date of allotment of investment limit

*Unqualified FPIs – whose investments limits are not allotted b/w 24.01.2020 and 30.04.2020

**Qualified FPIs to relaxation – whose investments limits not allotted b/w 24.01.2020 and 30.04.2020 

What will be the consequences if the required investment is not made within extended period of 3 months?

Since no separate penal provisions are prescribed under the circular, in terms of VRR Scheme, any violation by FPIs shall be subjected to regulatory action as determined by SEBI. FPIs are permitted, with the approval of the custodian, to regularize minor violations immediately upon notice, and in any case, within 5 working days of the violation. Custodians shall report all non-minor violations as well as minor violations that have not been regularised to SEBI

Concluding Remarks

The COVID-19 disruption has adversely impacted the Indian markets where investors are dealing with the market volatility. Given this, FPIs are pulling out their investments from the Indian markets (both equity and debt). Thus, relaxing investments rules of VRR Scheme during such financial distress, will help the foreign investors manage their investments appropriately.

You may also read our write ups on following topics:

Relaxations to FPIs ahead of Budget, 2020, click here

Recommendations to further liberalise FPI Regulations, click here

RBI removes cap on investment in corporate bonds by FPIs, click here

SEBI brings in liberalised framework for Foreign Portfolio Investors, click here 

For more write ups, kindly visit our website at: http://vinodkothari.com/category/corporate-laws/

To access various web-lectures, webinars and other useful resources useful for the Corporate and Financial sector, visit and subscribe to our Youtube channel: https://www.youtube.com/channel/UCgzB-ZviIMcuA_1uv6jATbg

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

[2]https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11896&Mode=0

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

[4]https://www.rbi.org.in/Scripts/BS_CircularIndexDisplay.aspx?Id=11561

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

[6] https://rbidocs.rbi.org.in/rdocs/notification/PDFs/NT199035211F142484DEBA657412BFCB17999.PDF

Resources on MSME financing

Major reforms have been introduced for the MSMEs, providing the required boost to the sector. MSMEs have recently been put into the limelight with several regulatory and financial reforms concerning them.

We have put up this page to provide the access to all relevant resources on the subject at one place, along with our analysis. Hope that the readers find it useful.

Self-dependent India: Measures concerning the financial sector

FAQs on the Economic Stimulus Package- Financial Services

Regulator’s move to repair the NBFC sector

Recent changes in MSME sector

FAQs on delayed payment to MSMEs

Interest subvention scheme for MSMEs

Filing of return for delayed payment to MSMEs- Effective or frittering?

Snapshot of the initiatives for MSMEs

Transitory liberalisation of asset classification norms for MSMEs

Slew of measures for MSME sector

Help in the hour of need: RBI relaxes asset classification norms for MSME accounts

MSME factoring gets a priority sector status: Likely to give boost to sagging factoring volumes

Waking up from slumber: Government notifies revival and rehabilitation scheme for MSMEs

Reviving an MSME – The New Way

Will the Companies Act 2013 impede MSMEs from bond markets?

Regulator’s move to repair the NBFC sector

-Mridula Tripathi

(finserv@vinodkothari.com)

The evolving impact on people’s health has casted a threat on their livelihoods, the businesses in which they work, the wider economy, and therefore the financial system. The outbreak of this pandemic is nothing like the crisis faced by the economies in the year 2007-08 and imperils the stability of the financial system. The market conditions have forced traders to take aggressive steps exposing the system to great volatility thereby resulting in crashing asset values. Combating the pandemic and safeguarding the economy, the financial sectors across the globe have witnessed numerous reforms to hammer the aftermaths of the global crisis. Read more

Special Liquidity Facility for Mutual Funds

By Anita Baid (finserv@vinodkothari.com)

[Posted on April 27, 2020 and updated on April 30, 2020]

The Reserve Bank of India (RBI) has been vigilantly taking necessary measures and steps to mitigate the economic impact of Covid-19 and preserve financial stability. The capital market of our country has also been exposed to the disruption. The liquidity strains on mutual funds (MFs) has intensified for the high-risk debt MF segment due to redemption or closure of some debt MFs. This was witnessed when Franklin Templeton Mutual Fund[1] announced the winding up of six yield-oriented, managed credit funds in India, effective April 23, citing severe market dislocation and illiquidity caused by the coronavirus. Sensing the need of the hour and in order to ease the liquidity pressures on MFs, RBI has announced a special liquidity facility for Mutual Funds (SLF-MF)[2] of Rs. 50,000 crore.

Under the SLF-MF, the RBI shall conduct repo operations of 90 days tenor at the fixed repo rate. The SLF-MF is on-tap and open-ended, wherein banks shall submit their bids to avail funding on any day from Monday to Friday (excluding holidays) between 9 AM and 12.00 Noon. The scheme shall be open from April 27, 2020 till May 11, 2020 or up to utilization of the allocated amount, whichever is earlier. An LAF Repo issue will be created every day for the amount remaining under the scheme after deducting the cumulative amount availed up to the previous day from the sanctioned amount of Rs. 50,000 crores. The bidding process, settlement and reversal of SLF-MF repo would be similar to the existing system being followed in case of LAF/MSF. Further, the RBI will further review the timeline and amount, depending upon market conditions.

As per the press release, the RBI will provide funds to banks at lower rates and banks can avail funds for exclusively meeting the liquidity requirements of mutual funds in the following ways:

  • extending loans, and
  • undertaking outright purchase of and/or repos against the collateral of investment grade corporate bonds, commercial papers (CPs), debentures and certificates of Deposit (CDs) held by MFs.

Accordingly, the funds availed by banks from the RBI at the repo window will be used to extend loans to MFs, buy outright investment grade corporate bonds or CPs or CDs from them or extend the funds against collateral through a repo.

The RBI has further vide its notification dated April 30, 2020, extended the regulatory benefits under the SLF-MF scheme to all banks, irrespective of whether they avail funding from the RBI or deploy their own resources under the scheme. Banks meeting the liquidity requirements of MFs by any of the aforesaid methods, shall be eligible to claim all the regulatory benefits available under SLF-MF scheme without the need to avail back to back funding from the RBI under the SLF-MF.

It is important to note that in terms of regulation 44(2) of the SEBI (Mutual Funds) Regulations, 1996[3], a MF shall not borrow except to meet temporary liquidity needs of the MFs for the purpose of repurchase, redemption of units or payment of interest or dividend to the unit holders and, further, the mutual fund shall not borrow more than 20% of the net asset of the scheme and for a duration not exceeding six months.

As per the aforesaid SEBI regulations, MFs should normally meet their repurchase/redemption commitments from their own resources and resort to borrowing only to meet temporary liquidity needs. Therefore, under the SLF-MF scheme as well banks will have to be judicious in granting loans and advances to MFs only to meet their temporary liquidity needs for the purpose of repurchase/redemption of units within the ceiling of 20% of the net asset of the scheme and for a period not exceeding 6 months. While banks will decide the tenor of lending to /repo with MFs, the minimum tenor of repo with RBI will be for a period of three months.

Similar to the incentives given to the banks in case of LTRO schemes, the following shall be available for banks extending funding under the SLF-MF-

  1. the liquidity support availed under the SLF-MF would be eligible to be classified as held to maturity (HTM) even in excess of 25% of total investment permitted
  2. Exposures under this facility will not be reckoned under the Large Exposure Framework (LEF)
  3. The face value of securities acquired under the SLF-MF and kept in the HTM category will not be reckoned for computation of adjusted non-food bank credit (ANBC) for the purpose of determining priority sector targets/sub-targets
  4. Support extended to MFs under the SLF-MF shall be exempted from banks’ capital market exposure limits.

The RBI’s move is much needed to ease the liquidity stress on the MF industry. However, as has been seen in the TLRTO 2.0 auctions, banks are taking a cautious approach before using this facility provided by RBI. However, it is expected that this will ensure easing of liquidity and also boost investor sentiment.

 

[1] With assets worth more than Rs 86,000 crore as of the end of March, Franklin Templeton is the ninth largest mutual fund in the country

[2] https://www.rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=49728

[3] Last updated on March 6, 2020- https://www.sebi.gov.in/legal/regulations/mar-2020/securities-and-exchange-board-of-india-mutual-funds-regulations-1996-last-amended-on-march-06-2020-_41350.html

Restructuring of debt securities not to be treated as default, clarifies SEBI

-Financial Services Division (finserv@vinodkothari.com)

Unprecedented crises call for unprecedented measures; the good thing is that all regulators are responding soon enough to the need for tweaking regulations, valuation rules, provisioning norms, accounting norms, and so on, to allow companies to adjust themselves to the new world that we are being ushered in.

SEBI has come up with a Circular no SEBI/HO/IMD/DF3/CIR/P/2020/70 dated 23rd April, 2020[1] (Circular), to the effect that mutual funds will not have to treat restructuring of a debt security as a case of “default”. With this, the funds have been able to avert having to make as much as 50% provision for what was deemed as a case of default.

It is notable that there have been court rulings whereby companies have evoked the “force majeure” clause to seek breather to repayment of debt securities[2].

Given the sensitiveness of the situation, this Circular has come as breather for a lot of financial sector entities, especially the ones actively engaged in securitisation, and ofcourse mutual funds. This write-up intends to first set a context to the Circular and then discuss the potential impact of the Circular.

Deemed Default in Case of Restructuring and Valuation Rules

A circular on valuation of money market and debt securities[3] issued by SEBI stated that “Any extension in the maturity of a money market or debt security shall result in the security being treated as “Default”, for the purpose of valuation”.

As per the valuation norm, mentioned above, mutual funds are required to take a haircut on the value of debt securities declared as default. In this regard, AMFI[4] has issued benchmarks for haircuts, based on which the valuation agencies are required to consider haircut as high as 50%, thereby reducing the value of the securities to half.

This circular turned out to be a major stumbling block for the mutual funds while extending the tenure of PTC transactions vis-à-vis the RBI’s moratorium on term loans in the wake of COVID 19 pandemic. The same has been discussed at length in the following section.

Restructuring of Pass Through Certificates

On March 27, 2020, the Reserve Bank of India (RBI) introduced COVID-19 Regulatory Package[5]  which provided for moratorium on payment of instalments for term loans falling due between 1st March, 2020 and 31st May, 2020[6]. The moratorium has to be extended to all the loans, irrespective of whether they have been sold off by the originators by way of securitisation or direct assignment.

The moratorium as per the RBI’s framework, forced the originators to alter the payout structures originally agreed with the investors under PTC/ DA transactions, so as to pass on effect of moratorium to the investors as well. However, the problem arose when the matter was placed before mutual funds. The mutual funds are major investors in PTCs, representing approximately 43% of securitisation issuances in India[7]. The mutual funds became wary of any extension or modification in the terms of the PTCs, due to apprehensions on valuation losses due to reasons discussed earlier in this write-up.

This created a deadlock between the originators and mutual funds (as investors). On one hand, there was a pressure on the originators to extend moratorium across all the borrowers, on the other hand, the mutual funds were apprehensive in accepting the revised terms due to a potential valuation loss.[8]

Considering the situation, the SEBI issued the Circular to address the issues with respect to valuation of debt securities.

Restructuring of Debentures

Restructuring by deferral of the maturity is something that may be done in case of debentures as well. Debentures may have been (a) private placed; or (b) publicly offered. The former is the more common route for mutual funds to invest.

Any change in the terms of issue amounts to modification of rights of debenture-holders. There is no provision under the Companies Act or SEBI regulations dealing with modification of rights of debenture-holders. Therefore, such modification can be done subject to and in accordance with the terms of issue.

Typically, in case of private placement, the consent of debenture-holders, either directly or through the debenture trustees, is required to be obtained. On the part of the Company, the power to modify the terms usually reside with the Board of Directors or are delegated by the Board to a Committee or a person or persons.

In case of publicly offered debentures, in addition to obtaining the above mentioned consent, compliance with provisions of SEBI LODR Regulations is also required to be ensured.

How can Debenture Issuers Make Use of the SEBI Circular?

  • The restructuring must be solely on account of the COVID crisis. It should be possible to demonstrate that the asset pool or ALM arrangement, but for the impact of the crisis, was adequate enough to take care of the scheduled maturity of the bond.
  • It should be possible to demonstrate that the underlying asset cover still remains healthy, and conditions such as asset cover etc. are benign complied with.
  • The necessary formalities of obtaining required consents must have been done.

If these conditions are fulfilled, a bond issuer may be able to get the consent of the investors without the investors having to provide deep haircuts on account of a deemed default.

Specific Provisions of the Circular

  • An extension of term of a security would not be considered as a default only when the valuation agency is of a view that such delay in payment or extension of maturity has  arisen  solely  due  to  COVID-19 pandemic  lockdown  and/or  in  light  of  the  moratorium  permitted  by  the RBI.
  • In case of difference in the valuation of securities provided by two valuation agencies, the conservative valuation i.e. the lower of the two values shall be accepted.
  • The relief from attraction of provision of default shall be limited to the period the moratorium is in operation.
  • AMCs shall continue to be responsible for true and fairness of valuation of securities.

Conclusion

Due to the obvious outcome of reduction in value of the assets, the mutual funds, as investors of debentures or PTCs, had been rejecting the proposals of issuers/originators/servicers as the case maybe with respect grant of moratorium to the borrowers. Mostly the Mutual Funds which are major investors in PTCs have been denying the grant of moratorium benefit to the borrowers owing to the reduction in value of AUM that would follow. With introduction of this Circular, the problem of taking deep haircuts on the value on account of deemed default stand resolved.

Mutual Funds are now expected to give a green signal on grant of moratorium by lenders. This would help to finally meet the objective of providing relief to the country at the time of the current crisis.

 

 

 

 

[1] https://www.sebi.gov.in/legal/circulars/apr-2020/review-of-provisions-of-the-circular-dated-september-24-2019-issued-under-sebi-mutual-funds-regulations-1996-due-to-the-covid-19-pandemic-and-moratorium-permitted-by-rbi_46549.html

[2] Our write-up dealing with Force Majeure clauses in agreements may be referred here: http://vinodkothari.com/2020/03/covid-19-and-the-shut-down-the-impact-of-force-majeure/

[3] https://www.sebi.gov.in/legal/circulars/sep-2019/valuation-of-money-market-and-debt-securities_44383.html

[4] https://docs.utimf.com/v1/AUTH_5b9dd00b-8132-4a21-a800-711111810cee/UTIContainer/Standard%20Hair%20Cut%20matrix__AMFI20190606-110846.pdf

[5] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11835&Mode=0

[6] Our detailed FAQs relating to the moratorium may be viewed here: http://vinodkothari.com/2020/03/moratorium-on-loans-due-to-covid-19-disruption/

[7] http://vinodkothari.com/2020/01/shadow-banking-in-india/

[8] Issue discussed at length in a virtual conference organised by Indian Securitisation Foundation: Agenda and minutes may be referred on the following links:

http://vinodkothari.com/2020/04/virtual-conference-on-impact-of-rbis-moratorium-on-ptc-transactions/

http://vinodkothari.com/2020/04/minutes-of-the-isf-virtual-conference/

The Great Lockdown: Standstill on asset classification

– RBI Governor’s Statement settles an unwarranted confusion

Timothy Lopes, Executive, Vinod Kothari Consultants

finserv@vinodkothari.com

Background

In the wake of the disruption caused by the global pandemic, now pitted against the Great Depression of 1930s and hence called The Great Lockdown[1], several countries have taken measures to try and provide stimulus packages to mitigate the impact of COVID-19[2]. Several countries, including India, provided or permitted financial institutions to grant ‘moratorium’, ‘loan modification’ or ‘forbearance’ on scheduled payments of their loan obligations being impacted by the financial hardship caused by the pandemic.

The RBI had announced the COVID-19 Regulatory Package[3] on 27th March, 2020. This package permitted banks and other financial institutions to grant moratorium up to 3 months beginning from 1st March, 2020. We have covered this elaborately in form of FAQs.[4]

However, there was ambiguity on the ageing provisions during the period of moratorium. That is to say,  if an account had a default on 29th February, 2020, whether the said account would continue to age in terms of days past due (DPD) as being in default even during the period of moratorium. Our view was strongly that a moratorium on current payment obligation, while at the same time expecting the borrower to continue to service past obligations, was completely illogical. Such a view also came from a judicial proceeding in the case of Anant Raj Limited Vs. Yes Bank Limited dated April 6, 2020[5]

However, the RBI seems to have had a view, stated in a mail addressed to the IBA,  that the moratorium did not affect past obligations of the customer. Hence, if the account was in default as on 1st March, the DPD will continue to increase if the payments are not cleared during the moratorium period.

Read more

Would the doses of TLTRO really nurse the financial sector?

-Kanakprabha Jethani | Executive

Vinod Kothari Consultants P. Ltd

(kanak@vinodkothari.com)

Background

In response to the liquidity crisis caused by the covid-19 pandemic, the Reserve Bank of India (RBI) through a Press Release Dated April 03, 2020[1] announced its third Targeted Long Term Repo Operation (TLTRO). This issue is a part of a plan of the RBI to inject funds of Rs. 1 lakh crores in the Indian economy. Under the said plan, two tranches of LTROs of Rs. 25 thousand crores each have already been undertaken in the months of February[2] and March[3] respectively. This move is expected to restore liquidity in the financial market, that too at relatively cheaper rates.

The following write-up intends to provide an understanding of what TLTRO is, how it is supposed to enhance liquidity and provide relief, who can derive benefits out of it and what will be its impact. This article further views TLTROs from NBFCs’ glasses to see if they, being financial institutions, which more outreach than banks, avail benefit from this operation.

Meaning

LTRO is basically a tool to provide funds to banks. The funds can be obtained for a tenure ranging from 1 year to 3 years, at an interest rate equal to one day repo. Government securities with matching or higher tenure, would serve as a collateral. Usually, the interest rate of one day repo is lower than that of other short term loans. Thus, banks can avail cheaper finance from the RBI.

Banks will have to invest the amount borrowed under TLTROs in fresh acquisition of securities from primary or secondary market (Specified Securities) and the same shall not be used with respect to existing investments of the bank.

In the current LTRO, the RBI has directed that atleast 50% of the funds availed by the bank have to be invested in investment grade corporate bonds, commercial papers and debentures in the secondary market and not more than 50% in the primary market.

Why were the existing measures not enough?

Ever since the IL&FS crisis broke the liquidity supply chain in the economy, the RBI has been consistently putting efforts to bring back the liquidity in the financial system. For almost a year, the RBI kept cutting the repo rate, hoping the cut in repo rates increases banks’ lending power and at the same time reduces the interest rate charged by them from the customers. Despite huge cuts in repo rates, the desired results were not visible because the cut in repo rates enhanced banks’ coincide power by a nominal amount only.

Another reason for failure of repo rate cuts, as a strategy to reduce lending rates, was that repo rate is one of the factors determining the lending rate. However, it is not all. Reduction in repo rates did affect the lending rate, but the effect was overpowered by other factors (such as increased cost of funds from third party sources) and thus, the banks’ lending rates did not reduce actually.

Further, various facilities have been introduced by the RBI to enhance liquidity in the system through Liquidity Adjustment Facility (LAF) which includes repo agreements, reverse repo agreements, Marginal Standing Facility (MSF), term repos etc.

  • Under LAF, banks can either avail funds (through a repurchase agreement, overnight or term repos) or extend loans to the RBI (through reverse repo agreements). Other than providing funds in the time of need, it also allows the banks to safe-keep excess funds with the RBI for short term and earn interest on the same.
  • Under MSF (which is a new window under LAF), banks are allowed to draw overnight funds from the RBI against collateral in the form of government securities. The rate is usually 100 bps above the repo rate. The amount of borrowing is limited to 1% of Net demand and Term Liabilities (NDTL).
  • In case of term repos, funds can be availed for 1 to 13 days, at a variable rate, which is usually higher than the repo rate. Further, the funds that can be withdrawn under such facility shall be limited to 0.75% of NDTL of the bank.

Although these measures do introduce liquidity to the financial system, they do not provide banks with ‘durable liquidity’ to provide a seamless asset-liability match, based on maturity. On the other hand, having funds in hand for a year to 3 years definitely is a measure to make the maturity based assets and liabilities agree. Thus, giving banks the confidence to lend further to the market.

Bits and pieces to be taken care of

The TLTRO transactions shall be undertaken in line with the operating guidelines issued by the RBI through a circular on Long Term Repo Operations (LTROs)[4]. A few points to be taken care of are as follows:

  • The RBI conducts auctions (through e-Kuber platform) for extending such facility. Banks have to bid for obtaining funds from such facility. The minimum bid is to be of Rs. 1 crore and the allotment shall be in multiples of Rs. 1 crore.
  • The investment in Specified Securities is to be mandatorily made within 30 days of availment of funds. In case the bank fails to deploy funds availed under TLTRO within 30 days, an incremental interest of repo rate plus 200 basis points shall be chargeable, in addition to normal interest, for the period the funds remain un-deployed.
  • The banks will have to maintain the amount of specified securities in its Hold-to-Maturity (HTM) portfolio till the maturity of TLTRO i.e. such securities cannot be sold by banks until the term of TLTRO expires. Further, in case bank intends to hold the Specified Securities after the term of TLTRO expires, the same shall be allowed to be held in banks’ HTM portfolio.

Impact

The TLTRO operation of the RBI is expected to bring about a relief to the financial sector. The LTRO auctions conducted recently received bids amounting to several times the auction amount. Thus, a clear case of extreme demand for funds by banks can be seen. Although, the recent auctions are yet to reap their fruits, the major benefits that may arise from this operation are as follows:

  • The liquidity in the banking system will get increased. Resultantly, the banks’ lending power would increase. Thus, injecting liquidity into the entire economy.
  • Since, the marginal cost of funds of the banks will be based on one-day repo transactions’ rate, the same shall be lower as compared to other funding options of similar maturity. A reduced cost of funds for the banks will compel banks to lend at lower rates. Thus, making the short-term lending cheaper.

The picture from NBFCs’ glasses

Barely out of the IL&FS storm, the shadow bankers had not even adjusted their sails and were hit by another crisis caused by the covid-19 disruption. While the RBI is introducing measures for these lenders to cope with the crisis such as moratorium on repayment instalments[5], stay on asset reclassification based on the moratorium provided etc. The liquidity concerns of NBFCs remain untouched by these measures.

Word has it, the TLTRO is expected to restore liquidity in the financial system. Only banks can bid under LTRO auctions and avail funds from the RBI. This being said, let us look at how an NBFC would fetch liquidity from this.

Banks would use the funds availed under TLTRO transactions to invest in Specified Securities of various entities. Let us assume a bank avails funds of Rs. 1 crore under LTRO. Out of the funds availed, the bank decides to invest 50% in Specified Securities of companies in non-financial sector and 50% in entities in financial sector. Assuming that the entire 50% portion is invested in Specified Securities of 20 NBFCs equally. Each NBFC gets 2.5% of the funding availed by the Bank.

In the primary market

For the purchase of Specified Securities through primary market, the question of prime importance is whether it is feasible for an NBFC to come up with a fresh issue in the current scenario of lockdown. It is not feasible for an NBFC to plan an issue, obtain a credit rating, and get done with all other formalities within a period of 30 days. Thus, the option of fresh issue would generally be ruled out. Primary issues in pipeline may get banks as their investors. However, existence of such issues in pipeline are very low at present.

If an NBFC decides to go for private placement and gets it done within a span of say around a week, it can succeed in getting fresh liquidity for its operations. However, looking at the bigger picture, the restriction of investing only in investment grade securities bars the banks from investing in NBFCs which have lower rating i.e. usually the smaller NBFCs (more in number though). So the benefit of the scheme gets limited to a small number of NBFCs only. Thus, the motive of making liquidity reach the masses gets squashed.

In the secondary market

Above was just a hypothetical example to demonstrate that only a fraction of funds given out under LTRO would actually be used to bring back liquidity to the stagnant NBFC sector. It is important to note here that the liquidity is being brought back through purchase of securities from the secondary market, which does not result in introduction of any additional money to the NBFCs for their operations.

The liquidity enhancement in secondary market would also be limited to Specified Securities of investment grade. Thus, as already discussed, only the bigger size NBFCs would get the benefit of liquidity restoration.

Conclusion

The TLTRO is a measure introduced by the RBI to enhance liquidity in the system. Although it provides banks with liquidity, the restrictions on the use of availed funds bar the banks to further pass on the liquidity benefit. As for NBFCs, the benefit is limited to making the securities of the NBFCs liquid and the introduction of fresh liquidity to the NBFC is likely to be minimal.

Further, the benefit is also likely to be limited to bigger NBFCs, destroying the motive of making liquidity reach to the masses. A few enhancements to the existing LTRO scheme, such as directing the banks to ensure that the investment is not concentrated in a few destinations or prescribing concentration norms might result in expanding liquidity reach to some extent and would create a chain of supply of funds that would reach the masses through the outreach of such financial institutions.

News Update:

The RBI Governor in his statement on April 17, 2020[6], addressed the problem of narrow outreach of liquidity injected through TLTRO and announced that the upcoming TLTRO (TLTRO 2.0) would come with a specification that the proceeds are to be invested in investment grade bonds, commercial paper, and non-convertible debentures of NBFCs only, with at least 50 per cent of the total amount availed going to small and mid-sized NBFCs and MFIs. This is likely to ensure that a major portion of the investments go to the small and mid-sized NBFCs, thus expanding the liquidity outreach.

 

[1] https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=49628

[2] https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=49360

[3] https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=49583

[4] https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=49360

[5] Our detailed FAQs on moratorium on loans due to Covid-19 disruption may be referred here: http://vinodkothari.com/2020/03/moratorium-on-loans-due-to-covid-19-disruption/

[6] https://rbidocs.rbi.org.in/rdocs/Content/PDFs/GOVERNORSTATEMENTF22E618703AE48A4B2F6EC4A8003F88D.PDF

 

Our write-up on stay on asset classification due to covid-19 may be referred here: http://vinodkothari.com/2020/04/the-great-lockdown-standstill-on-asset-classification/

Our other write-ups on NBFCs may be referred here: http://vinodkothari.com/nbfcs/

RBI granted moratorium on term loans: Impact on securitisation and direct assignment transactions

Abhirup Ghosh

abhirup@vinodkothari.com

In response to the stress caused due to the pandemic COVID-19, the regulatory authorities around the world have been coming out relaxations and bailout packages. Reserve Bank of India, being the apex financial institution of the country, came out a flurry of measures as a part of its Seventh Bi-Monthly Policy[1][2], to tackle the crisis in hand.

One of the measure, which aims to pass on immediate relief to the borrowers, is extension of moratorium on term loans extended by banks and financial institutions.  We have in a separate write-up[3] discussed the impact of this measure, however, in this write-up we have tried to examine its impact on the securitisation and direct assignment transactions.

Securitisation and direct assignment transactions have been happening extensively since the liquidity crisis after the failure of ILFS and DHFL, as it allowed the investors to take exposure on the underlying assets, without having to take any direct exposure on the financial intermediaries (NBFCs and HFCs). However, this measure has opened up various ambiguities in the structured finance industry regarding the fate of the securitisation or direct assignment transactions in light of this measure.

Originators’ right to extend moratorium

The originators, will be expected to extend this moratorium to the borrowers, even for the cases which have been sold the under securitisation. The question is, do they have sufficient right to extend moratorium in the first place? The answer is no. The moment an originator sells off the assets, all its rights over the assets stands relinquished. However, after the sale, it assumes the role of a servicer. Legally, a servicer does not have any right to confer any relaxation of the terms to the borrowers or restructure the facility.

Therefore, if at all the originator/ servicer wishes to extend moratorium to the borrowers, it will have to first seek the consent of the investors or the trustees to the transaction, depending upon the terms of the assignment agreement.

On the other hand, in case of the direct assignment transactions, the originators retain only 10% of the cash flows. The question here is, will the originator, with 10% share, be able to grant moratorium? The answer again is no. With just 10% share in the cash flows, the originator cannot alone grant moratorium, approval of the assignee has to be obtained.

Investors’ rights

As discussed above, extension of moratorium in case of account sold under direct assignment or securitisation transactions, will be possible only with the consent of the investors. Once the approval is placed, what will happen to the transactions, as very clearly there will be a deferral of cash flows for a period of 3 months? Will this lead to a deterioration in the quality of the securitised paper, ultimately leading to a rating downgrade? Will this lead to the accounts being classified as NPAs in the books of the assignee, in case of direct assignment transactions?

Before discussing this question, it is important to understand that the intention behind this measure is to extend relief to the end borrowers from the financial stress due to this on-going pandemic. The relief is not being granted in light of any credit weakness in the accounts. In a securitisation or a direct assignment, the transaction mirrors the quality of the underlying pool. If the credit quality of the loans remain intact, then there is no question of the securitisation or the direct assignment transaction going bad. Similarly, we do not see any reason for rating downgrade as well.

The next question that arises here is: what about the loss of interest due to the deferment of cash flows? The RBI’s notification states that the financial institutions may provide a moratorium of 3 months, which basically means a payment holiday. This, however, does not mean that the interest accrual will also be suspended during this period. As per our understanding, despite the payment suspension, the lenders will still be accruing the interest on the loans during these 3 months – which will be either collected from the borrower towards the end of the transaction or by re-computing the EMIs. If the lenders adopt such practices, then it should also pass on the benefits to the investors, and the expected cash flows of the PTCs or under the direct assignment transactions should also be recomputed and rescheduled so as to compensate the investors for the losses due to deferment of cash flows.

Another question that arises is – can the investors or the trustee in a securitisation transaction, instead of agreeing to a rescheduling of cash flows, use the credit enhancement to recover the dues during this period? Here it is important to note that credit enhancements are utilised usually when there is a shortfall due to credit weakness of the underlying borrower(s). Using credit enhancements in this case, will reduce the extent of support, weaken the structure of the transaction and may lead to rating downgrade. Therefore, this is not advisable.

We were to imagine an extreme situation – can the investors force the originators to buy back the PTCs or the pool from the assignee, in case of a direct assignment transaction? In case of securitisation transactions, there are special guidelines for exercise of clean up calls on PTCs by the originators, therefore, such a situation will have to be examined in light of the applicable provisions of Securitisation Guidelines. For any other cases, including direct assignment transactions, such a situation could lead up to a larger question on whether the original transaction was itself a true sale or not, because, a buy-back of the pool, defies the basic principles of true sale. Hence, this is not advisable.

[1]https://rbidocs.rbi.org.in/rdocs/Content/PDFs/GOVERNORSTATEMENT5DDD70F6A35D4D70B49174897BE39D9F.PDF

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11835&Mode=0

[3] http://vinodkothari.com/2020/03/moratorium-on-loans-due-to-covid-19-disruption/