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

Securitisation- Should India be moving to the next stage of development?

Marketplace lending: Legal issues around “true lender” and “valid when made” doctrines

-Vinod Kothari (vinod@vinodkothari.com)

 

Marketplace lending, P2P lending, or Fintech credit, has been growing fast in many countries, including the USA. It is estimated to have reached about $ 24 billion in 2019[1] in the USA.

However, there are some interesting legal issues that seem to be arising.  The issues seem to be emanating from the fact that P2P platforms essentially do pairing of borrowers and lenders. In the US practice, it is also commonplace to find an intermediary bank that houses the loans for a few days, before the loan is taken up by the “peer” or crowd-sourced lender.

USA, like many other countries, has usury laws. However, usury laws are not applicable in case of banks. This comes from sec 85 of National Bank Act, and sec. 27 (a) of the Federal Deposit Insurance Act.

In P2P structure, the loan on the platform may first have been originated by a bank, and then assigned to the buyer. If the loan carries an interest rate, which is substantially high, and such high interest rate loan is taken by the “peer lender”, will it be in breach of the usury laws, assuming the rate of interest is excessive?

One of the examples of recent legal issues in this regard is Rent-Rite Superkegs West, Ltd., v. World Business Lenders, LLC, 2019 WL 2179688[2]. In this case, a loan of $ 50000 was made to a corporation by a local bank, at an interest rate of 120.86% pa. The loan-note was subsequently assigned to a finance company. Upon bankruptcy of the borrower, the bankruptcy court refused to declare the loan as usurious, based on a time-tested doctrine that has been prevailing in US courts over the years – called valid-when-granted doctrine.

Valid-when-granted doctrine

The valid-when-granted doctrine holds that if a loan is valid when it is originally granted, it cannot become invalid because of subsequent assignment. Several rulings in the past have supported this doctrine: e.g., Munn v. Comm’n Co., 15 Johns. 44, 55 (N.Y. Sup. Ct. 1818); Tuttle v. Clark, 4 Conn. 153, 157 (1822); Knights v. Putnam, 20 Mass. (3 Pick.) 184, 185 (1825)

However, there is a ruling that stands out, which is 2015 ruling of the Second Circuit court in Madden v. Midland Funding, LLC  (786 F.3d 246). In Madden, there was an assignment of a credit card debt to a non-banking entity, who charged interest higher than permitted by state law. The court held that the relaxation from interest rate restrictions applicable to the originating bank could not be claimed by the non-banking assignee.

The ruling in Madden was deployed in a recent [June 2019] class action suit against JP Morgan Chase/Capital One entities, where the plaintiffs, representing credit card holders, allege that buyers of the credit card receivables (under credit card receivables securitization) cannot charge interest higher than permitted in case of non-banking entities. Plaintiffs have relied upon the “true sale” nature of the transaction, and contend that once the receivables are sold, it is the assignee who needs to be answerable to the restrictions on rate of interest.

While these recent suits pose new challenges to consumer loan securitization as well as marketplace lending, it is felt that much depends on the entity that may be regarded as “true lender”. True lender is that the entity that took the position of predominant economic interest in the loan at the time of origination. Consider, however, the following situations:

  1. In a marketplace lending structure, a bank is providing a warehousing facility. The platform disburses the loan first from the bank’s facility, but soon goes to distribute the loan to the peer lenders. The bank exits as soon as the loan is taken by the peer lenders. Will it be possible to argue that the loan should be eligible for usurious loan carve-out applicable to a bank?
  2. Similarly, assume there is a co-lending structure, where a bank takes a portion of the loan, but a predominant portion is taken by a non-banking lender. Can the co-lenders contend to be out of the purview of interest rate limitations?
  3. Assume that a bank originates the loan, and by design, immediately after origination, assigns the loan to a non-banking entity. The assignee gets a fixed, reasonable rate of return, while the spread with the assignee’s return and the actual high interest rate paid by the borrower is swept by the originating bank.

Identity of the true lender becomes an intrigue in cases like this.

Securitization transactions stand on a different footing as compared to P2P programs. In case of securitization, the loan is originated with no explicit understanding that it will be securitized. There are customary seasoning and holding requirements when the loan is incubated on the balance sheet of the originator. At the time of securitization, whether the loan will get included in the securitization pool depends on whether the loan qualifies to be securitized, based on the selection criteria.

However, in case of most P2P programs, the intent of the platform is evidently to distribute the loan to peer-lenders. The facility from the bank is, at best, a bridging facility, to make it convenient for the platform to complete the disbursement without having to wait for the peer-lenders to take the portions of the loan.

US regulators are trying to nip the controversy, by a rule that Interest on a loan that is permissible under 12 U.S.C. 85 shall not be affected by the sale, assignment, or other transfer of the loan. This is coming from a proposed rule by FDIC /OCC in November, 2019[3].

However, the concerns about the true lender may still continue to engage judicial attention.

Usurious lending laws in other countries

Usurious lending, also known as extortionate credit, is recognised by responsible lending laws as well as insolvency/bankruptcy laws. In the context of consumer protection laws, usurious loans are not regarded as enforceable. In case of insolvency/bankruptcy, the insolvency professional has the right to seek avoidance of a usurious or extortionate credit transaction.

In either case, there are typically carve-outs for regulated financial sector entities. The underlying rationale is that the fairness of lending contracts may be ensured by respective financial sector regulator, who may be imposing fair lending standards, disclosure of true rate of interest, etc. Therefore, judicial intervention may not be required in such cases. However, the issue once again would be – is it justifiable that the carve-out available to regulated financial entities should be available to a P2P lender, where it is predesigned that the loan will get transferred out of the books of the originating financial sector entity?

Conclusion

P2P lending or fintech credit is the fastest growing part of non-banking financial intermediation, sometimes known as shadow banking. A lot of regulatory framework is designed keeping a tightly-regulated bank in mind. However, P2P is itself a case of moving out of banking regulation. Banking laws and regulations cannot be supplanted and applied in case of P2P lending.

Further research

We have been engaged in research in the P2P segment. Our report[4] on P2P market in India describes the basics of P2P lending structures in India and demonstrates development of P2P market in India.

Our other write-ups on P2P lending may also be referred:

 

 

 

[1] https://www.statista.com/outlook/338/109/marketplace-lending–consumer-/united-states#market-revenue

[2] https://www.docketbird.com/court-documents/Rent-Rite-Super-Kegs-West-LTD-v-World-Business-Lenders-LLC/Corrected-Written-Opinion-related-document-s-44-Written-Opinion-48-Order-Dismissing-Adversary-Proceeding/cob-1:2018-ap-01099-00049

[3] https://www.occ.gov/news-issuances/news-releases/2019/nr-occ-2019-132a.pdf

[4] http://vinodkothari.com/2017/10/india-peer-to-peer-lending-report/

RBI introduces another minimum details PPI

BACKGROUND

The Reserve Bank of India (RBI) has vide its notification[1] dated December 24, 2019, introduced a new kind of semi-closed Prepaid Instrument (PPI) which can only be loaded from a bank account and used for purchase of goods and services and not for funds transfer. This PPI has been introduced in furtherance of Statement on Developmental and Regulatory Policies[2] issued by the RBI. The following write-up intends to provide a brief understanding of the features of this instrument and carry out a comparative analysis of features of existing kinds of PPIs and the newly introduced PPI.

BASIC FEATURES

The features of the newly introduced PPIs has to be clearly communicated to the PPI holder by SMS / e-mail / post or by any other means at the time of issuance of the PPI / before the first loading of funds. Following shall be the features of the newly introduced PPI:

  • Issuer can be banks or non-banks.
  • The PPI shall be issued on obtaining minimum details, which shall include a mobile number verified with One Time Pin (OTP) and a self-declaration of name and unique identity / identification number of any ‘mandatory document’ or ‘officially valid document’ (OVD) listed in the KYC Direction.
  • The new PPI shall not require the issuer to carry out the Customer Due Diligence (CDD) process, as provided in the Master Direction – Know Your Customer (KYC) Direction (‘KYC Directions)[3].
  • The amount loaded in such PPIs during any month shall not exceed ₹ 10,000 and the total amount loaded during the financial year shall not exceed ₹ 1,20,000.
  • The amount outstanding at any point of time in such PPIs shall not exceed ₹ 10,000.
  • Issued as a card or in electronic form.
  • The PPIs shall be reloadable in nature. Reloading shall be from a bank account only.
  • Shall be used only for purchase of goods and services and not for funds transfer.
  • Holder shall have an option to close the PPI at any time and the outstanding balance on the date of closure shall be allowed to be transferred ‘back to source.’

COMPARATIVE ANALYSIS

The Master Direction on Issuance and Operation of Prepaid Payment Instruments[4] contain provisions for two other kinds of semi-closed PPIs having transaction limit of ₹10,000. The features of these PPIs seem largely similar. However, there are certain differences as shown in the following table:

 

Basis PPIs upto ₹ 10,000/- by accepting minimum details of the PPI holder

(Type 1)

PPIs upto ₹ 1,00,000/- after completing KYC of the PPI holder 

(Type 2)

PPIs upto ₹ 10,000/- with loading only from bank account

(Type 3)

Issuer Banks and non-banks Banks and non-banks Banks and non-banks
PPI holder identification procedure Based on minimum details (mobile number verified with One Time Pin (OTP) and self-declaration of name and unique identification number of any of the officially valid document (OVD) as per PML Rules 2005[5]) KYC procedure as provided in KYC Directions Based on minimum details (mobile number verified with One Time Pin (OTP) and a self-declaration of name and unique identity / identification number of any ‘mandatory document’[6] or OVD as per KYC Directions[7]
Reloading Allowed Allowed Allowed (only from a bank account)
Form Electronic Electronic Card or electronic
Limit on outstanding balance ₹ 10,000 ₹ 1,00,000 ₹ 10,000
Limit on reloading ₹ 10,000 per month and ₹ 1,00,000 in the entire financial year Within the overall PPI limit ₹ 10,000 per month and ₹ 1,20,000 during a financial year
Transaction limits ₹ 10,000 per month ₹ 1,00,000 per month in case of pre-registered beneficiaries and  ₹ 10,000 per month in all other cases ₹ 10,000 per month
Utilisation of amount Purchase of goods and services Purchase of goods and services and transfer to his bank account or ‘back to source’ Purchase of goods and services
Conversion Compulsorily be converted into Type 2 PPIs (KYC compliant) within 24 months from the date of issue No provisions for conversion Type 1 PPIs maybe converted to Type 3, if desired by the holder
Restriction on issuance to single person Cannot be issued to same person using the same mobile number and same minimum details more than once No such provision No such provision
Closure of PPI Holder to have option to close and transfer the outstanding balance to his bank account or ‘back to source’ Holder to have option to close and transfer the outstanding balance to his bank account or ‘back to source’ or to other PPIs of the holder Holder to have option to close and transfer the outstanding balance ‘back to source’ (i.e. the bank account of the holder only)
Pre-registered Beneficiary Facility not available Facility available Facility not available

THE UPPER HAND

Based on the aforesaid comparative analysis, it is clear that for issuance of the newly introduced PPI or the Type 3 PPI, the issuer is not required to undertake the CDD process as provided in the KYC Directions. Only authentication through mobile number and OTP supplemented with a self-declaration regarding of details provided in the OVD shall suffice. This implies that the issuer shall not be required to “Originally See and Verify” the KYC documents submitted by the customer. This would result into digitisation of the entire transaction process and cost efficiency for the issuer.

Compared to the other 2 kinds of PPIs, one which requires carrying out of the KYC process prescribed in the KYC Directions and the other, which can be issued without carrying out the prescribed KYC process but has to be converted into Type 2 PPI within 24 months, this new PPI can be a good shot aiming at ease of business and digital payments upto a certain transaction limit.

CONCLUSION

The newly issued PPI will ensure seamless flow of the transaction. As compared to other PPIs, it will be easier to obtain such PPIs. Further, the limitations such as reloading only from the bank account, restriction of transfer of money from PPI etc. are some factors that shall regulate the usage of such PPIs. These may, however, pull back their acceptance in the digital payments space.

 

 

[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11766&Mode=0

[2] https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=48803

[3] https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=11566

[4] https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=11142

[5] “officially valid document” means the passport, the driving licence, the Permanent Account Number (PAN) Card, the Voter’s Identity Card issued by the Election Commission of India or any other document as may be required by the banking company, or financial institution or intermediary

[6] Permanent Account Number (PAN)

[7] “Officially Valid Document” (OVD) means the passport, the driving licence, proof of possession of Aadhaar number, the Voter’s Identity Card issued by the Election Commission of India, job card issued by NREGA duly signed by an officer of the State Government and letter issued by the National Population Register containing details of name and address.

 

Our other write-ups relating to PPIs can be viewed here:

 

Our other resources can be referred to here:

 

 

 

MPC meeting – New type of PPI and more

finserv@vinodkothari.com

The Statement on Developmental and Regulatory Policies[1] dated 05 December, 2019 has been issued by the RBI pursuant to the fifth bi-monthly Monetary Policy Committee meeting.

Some quick updates and highlights of regulatory changes are given below –

1) Review of NBFC-P2P Directions- Aggregate Lender Limit and escrow accounts

Current limit for borrowers and lenders across all P2P platforms is ₹10 lakh, and exposure of a single lender to a single borrower is – ₹50,000 across all NBFC-P2P platforms.

It has been decided that in order to give the next push to the lending platforms, the aggregate exposure of a lender to all borrowers at any point of time, across all P2P platforms, shall be subject to a cap of ₹50 lakh.

Further, it is also proposed to do away with the current requirement of escrow accounts to be operated by bank promoted trustee for transfer of funds having to be necessarily opened with the concerned bank. This will help provide more flexibility in operations. Necessary instructions in this regard will be issued shortly.

 

2)  The ‘On tap’ Licensing Guidelines for Small Finance Banks have now been finalised and are being issued today.

 

3)New Pre-Paid Payment Instruments (PPI) 

It is proposed to introduce a new type of PPI which can be used only for purchase of goods and services up to a limit of ₹10,000. The loading / reloading of such PPI will be only from a bank account and used for making only digital payments such as bill payments, merchant payments, etc. Such PPIs can be issued on the basis of essential minimum details sourced from the customer. Instructions in this regard will be issued by December 31, 2019.

 

4) Development of Secondary Market for Corporate Loans – setting up of Self Regulatory Body

As recommended by the Task Force on the Development of Secondary Market for Corporate Loans, the Reserve Bank will facilitate the setting up of a self-regulatory body (SRB) as a first step towards the development of the secondary market for corporate loans. The SRB will be responsible, inter-alia, for standardising documents, covenants and practices related to secondary market transactions in corporate loans and promoting the growth of the secondary market in line with regulatory objectives.

Watch out for detailed articles on these topics to be published on our website soon.

[1] https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=48803

RBI revises qualifying assets criteria for NBFC MFIs

Team, Vinod Kothari Consultants Pvt. Ltd.

finserv@vinodkothari.com

The RBI on November 08, 2019[1] revised the limits relating to the qualifying assets criteria, giving a much needed boost to Micro-Finance Institutions. The change in limits comes pursuant to the Statement on Developmental and Regulatory Policies[2] issued as part of the Monetary Policy Statement dated 04 October, 2019.

A detailed regulatory framework for MFI’s was put into place in December, 2011 based on the recommendations of a Sub-Committee of the Central Board of the Reserve Bank. The regulatory framework prescribes that an NBFC MFI means a non-deposit taking NBFC that fulfils the following conditions:

  • Minimum Net Owned Funds of Rs. 5 Crore.
  • Not less than 85% of its net assets are in the nature of qualifying assets.

Thus meeting the qualifying assets criteria is crucial to be classified as an NBFC-MFI. The income and loan limits to classify an exposure as an eligible asset were last revised in 2015.

In light of the above and taking into consideration the important role played by MFIs in delivering credit to those in the bottom of the economic pyramid and to enable them to play their assigned role in a growing economy, it was decided to increase and review the limits.

Revised Qualifying assets criteria

The changes are highlighted in the table below:

Qualifying Assets Criteria
Erstwhile Criteria Revised Criteria
Qualifying assets shall mean a loan which satisfies the following criteria:
  i.       Loan disbursed by an NBFC-MFI to a borrower with a rural household annual income not exceeding ₹ 1,00,000 or urban and semi-urban household income not exceeding ₹ 1,60,000;    i.      Loan disbursed by an NBFC-MFI to a borrower with a rural household annual income not exceeding ₹ 1,25,000 or urban and semi-urban household income not exceeding ₹ 2,00,000;
ii.       Loan amount does not exceed ₹ 60,000 in the first cycle and ₹ 1,00,000 in subsequent cycles;  ii.      Loan amount does not exceed ₹ 75,000 in the first cycle and ₹ 1,25,000 in subsequent cycles;
iii.       Total indebtedness of the borrower does not exceed ₹ 1,00,000; iii.      Total indebtedness of the borrower does not exceed ₹ 1,25,000;
Note: All other terms and conditions specified under the master directions shall remain unchanged.

The Statement on Developmental and Regulatory Policies called for revisions in the household income and loan limits only. The notification of the RBI additionally, in light of the change in total indebtedness of the borrower, felt it necessary to also increase the limits on disbursal of loans.

The revised limits are effective from the date of the circular, i. e. November 08, 2019.

[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11727&Mode=0

[2] https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=48318

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