Investment by Foreign Portfolio Investors (FPI) in Debt
On 25 April 2019, the Reserve Bank of India (“RBI”) issued a circular permitting foreign portfolio investors (“FPI”) to invest in municipal bonds with a view to broaden access of non–resident investors to debt instruments in India. As per the circular, FPI investment in municipal bonds[1] shall be reckoned within the limits set for FPI investment in State Development Loans (SDLs)[2].
Regulation 21 (1) of SEBI (Foreign Portfolio Investors) Regulations, 2014 provides a list of securities in which a foreign portfolio investor can invest.
Further, the investment in municipal bonds will be treated as debt market investments and will be subject to the existing conditions for investments by FPIs in the debt market, which, inter-alia, include the following:
(a) FPIs being permitted to invest in Central Government securities (G-secs), including in Treasury Bills, and State Development Loans (SDLs) without any minimum residual maturity requirement, subject to the condition that short-term investments by an FPI under either category shall not exceed 20% of the total investment of that FPI in that category.
(b) FPIs being permitted to invest in corporate bonds with minimum residual maturity of above one year, subject to the condition that short-term investments in corporate bonds by an FPI shall not exceed 20% of the total investment of that FPI in corporate bonds. These stipulations would not apply to investments in Security Receipts (issued by Asset Reconstruction Companies) by FPIs.
(c) The cap on aggregate FPI investments in any Central Government security is at 30% of the outstanding stock of that security.
Pursuant to the RBI circular permitting FPIs to invest in municipal bonds, the Securities and Exchange Board of India (“SEBI”) issued a circular dated 9 May 2019, in accordance with the provisions of Regulation 21 (1) (p) of SEBI (Foreign Portfolio Investors) Regulations, 2014.
Regulation 21 (1) of SEBI (Foreign Portfolio Investors) Regulations, 2014 provides a list of securities in which a foreign portfolio investor can invest. Since the list did not include municipal bonds, the circular was issued so as to include municipal bonds within the permitted securities.
With a view to operationalizing the abovementioned endeavor, SEBI is proposing an “Innovation Sandbox”
Framework for Innovation Sandbox
On 20 May 2019, SEBI issued a circular outlining the concept of innovation sandbox. SEBI believes that encouraging adoption and usage of financial technology (“FinTech”) would have a profound impact on the development of the securities market. FinTech can act as a catalyst to further develop and maintain an efficient, fair and transparent securities market ecosystem and create an ecosystem which promotes innovation in the securities market. SEBI believes that FinTech companies should have access to market-related data, particularly, trading and holding data, which is otherwise not readily available to them, to enable them to test their innovations effectively before the introduction of such innovations in a live environment. With a view to operationalizing the abovementioned endeavor, SEBI is proposing an “Innovation Sandbox”, which would be a testing environment where FinTech firms and entities not regulated by SEBI (herein afterwards referred to as participants/applicants) may use the environment for offline testing of their proposed solutions in isolation from the live market, subject to fulfillment of the eligibility criteria, based on market related data made available by Stock Exchanges, Depositories and Qualified Registrar and Share Transfer Agents (QRTAs).
The components and structure of the Innovation Sandbox can be broadly classified into design, legal and administrative categories as detailed in the circular. Further, the eligibility criteria for inclusion into the Innovation Sandbox are as follows:
(a) Applicability - Conceptually, the Innovation Sandbox framework is applicable to any entity, who intends to innovate on the products, services, and/or solutions for the securities and commodities market in India.
(b) Genuine need to test - The applicant should have a genuine need for testing the solution using resources available in the Innovation Sandbox. The applicant should be able to postulate that the solution cannot be developed properly without testing in the Innovation Sandbox.
(c) Testing readiness of the solution - The applicant should have the necessary resources to support testing in the sandbox. The applicant must show testing plans with clear objectives, parameters and success criteria.
(d) Post-testing strategy - The applicant should be able to postulate their post-testing plan.
(e) Direct benefits to consumers - The solution should offer identifiable benefits (direct or indirect) to consumers and to the capital market and the Indian economy at large.
(f) Secure - The solution shall be validated for cybersecurity parameters. The applicant is required to submit a cyber-security compliance certificate as per SEBI’s Cyber Security guidelines.
On 24 May 2019, SEBI published a report of the working group on "FPI Regulations" and put it up for public comments.
The Securities and Exchange Board of India publishes the report of the working group set up to recommend amendments to the FPI Regulations
On 24 May 2019, SEBI published a report of the working group on "FPI Regulations" and put it up for public comments. The report contains recommendations with respect to FPI registration process, know your client (KYC) and simplification of documentation, investment restrictions and other aspects. Certain key recommendations proposed by the working group are as follows:
(a) Ease of access - fast track on-boarding process for select category II FPIs, review of broad based condition for appropriately regulated entities, pension fund to be considered for category I FPI registration, deemed broad based status for insurance/ reinsurance entities, simplified registration for multiple investment manager (MIM) structures, entities established in the international financial services centre (IFSC) be deemed to have met the jurisdiction criteria for FPIs, etc.
(b) Simplification of documentation - removal of ‘opaque structure” definition, simplified KYC documentation for category III FPI, KYC reliance on the same group regulated entity of custodian for non-PAN documents, etc.
(c) Review of Investment restriction - Liberalized investment cap, harmonization between investment restrictions in FPI regulations and the applicable foreign exchange regulations, reclassification of investment from FPI to FDI, permitting FPIs for off-market transactions, review of restriction on sovereign wealth funds for investment in corporate debt securities etc.
(d) Other aspects - strengthening of clubbing restrictions, alignment between FPI and alternative investment fund (AIF) routes, strengthening of offshore derivative instrument (ODI) framework, etc.
Framework for issuance of differential voting rights shares
The SR shareholder should be a part of the promoter group whose collective net worth does not exceed INR 500 Crores.
On 27 June 2019, SEBI issued a framework to enable issuance and listing of shares with differential voting rights, commonly known as DVRs in India. Such shares have rights disproportionate to their economic ownership. The key proposals approved by SEBI Board are as follows:
(a) Eligibility: A company having superior voting rights shares (SR shares) would be permitted to do an initial public offering (IPO) of only ordinary shares to be listed on the main board, subject to fulfillment of eligibility requirements of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 and the following conditions:
(i) The issuer company is a tech company (as per the definition in Innovators Growth Platform) that is intensive in the use of technology, information technology, intellectual property, data analytics, bio-technology or nano-technology to provide products, services or business platforms with substantial value addition.
(ii) The SR shareholder should be a part of the promoter group whose collective net worth does not exceed INR 500 Crores. While determining the collective net worth, the investment of SR shareholders in the shares of the issuer company shall not be considered.
(iii) The SR shares have been issued only to the promoters/ founders who hold an executive position in the company.
SR shares shall be treated at par with the ordinary equity shares in every respect, including dividends, except in the case of voting on resolutions.
(iv) The issue of these SR shares has been authorized by a special resolution passed at a general meeting of the shareholders.
(v) SR shares have been held for a period of at least 6 months prior to the filing of red herring prospectus (RHP).
(vi) SR shares have voting rights in the ratio of minimum 2:1 to maximum 10:1 compared to ordinary shares.
(b) Listing and Lock-in: SR shares shall also be listed on Stock Exchanges after the issuer company makes a public issue. However, SR shares shall be under lock-in after the IPO until their conversion to ordinary shares. Transfer of SR shares among promoters shall not be permitted. No pledge/ lien shall be allowed on SR shares.
(c) Rights of SR shares: SR shares shall be treated at par with the ordinary equity shares in every respect, including dividends, except in the case of voting on resolutions. The total voting rights of SR shareholders (including ordinary shares), post listing, shall not exceed 74%.
Audit committee shall comprise of only independent directors.
(d) Enhanced corporate governance: Companies having SR shareholders shall be subject to enhanced corporate governance as follows:
(i) At least ½ of the Board and 2/3rd of the committees (excluding audit committee) as prescribed under SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“SEBI LODR Regulations”) shall comprise of independent directors.
(ii) Audit committee shall comprise of only independent directors.
(e) Coat-tail Provisions: Post-IPO, the SR equity shares shall be treated as ordinary equity shares in terms of voting rights (that is one SR share shall have only one vote) in the following circumstances:
(i) Appointment or removal of independent directors and/or auditor;
(ii) In case where promoter is willingly transferring control to another entity;
(iii) Related party transactions in terms of SEBI (LODR) Regulations involving SR shareholder;
(iv) Voluntary winding up of the company;
(v) Changes in the company’s Article of Association or Memorandum of Association - except any changes affecting the SR instrument;
The issue of fractional rights shares by existing listed companies shall not be allowed hereon.
(vi) Initiation of a voluntary resolution plan under the Insolvency and Bankruptcy Code, 2016;
(vii) Utilization of funds for purposes other than business;
(viii) Substantial value transaction based on materiality threshold as prescribed under SEBI (LODR) Regulations;
(ix) Passing of special resolution in respect of delisting or buy-back of shares; and
(x) Any other provisions notified by SEBI in this regard from time to time.
(f) Sunset Clauses: SR shares shall be converted into ordinary shares in following circumstances/ events:
(i) Time Based: The SR shares shall be converted to Ordinary Shares on the 5th anniversary of listing. The validity can be extended once by 5 years through a resolution. SR shareholder would not be permitted to vote on such resolutions.
(ii) Event Based: SR shares shall compulsorily get converted into ordinary shares on occurrence of certain events such as demise, resignation of SR shareholders, merger or acquisition where the control would be no longer with SR shareholder, etc.
(g) Fractional Rights Shares: The issue of fractional rights shares by existing listed companies shall not be allowed hereon. The need for allowing issue of fractional rights shares by listed companies may however be reviewed after gaining enough experience with the use of SR shares.
Risk Management Framework of Liquid Funds and prudential norms
On 27 June 2019, SEBI Board after deliberations approved the risk management framework of liquid funds and prudential norms governing investments in debt and money market instruments. The key proposals approved are as follows:
- Liquid schemes shall be mandated to hold at least 20% in liquid assets such as, cash, Government securities, treasury bills and Repo on Government securities.
- The cap on sectoral limit of 25% shall be reduced to 20%. The additional exposure of 15% to housing finance companies (HFCs) shall be restructured to 10% in HFCs and 5% exposure in securitized debt based on retail housing loan and affordable housing loan portfolios.
- The valuation of debt and money market instruments based on amortization shall be dispensed with completely and shall be based on mark to market.
- Liquid and overnight schemes shall not be permitted to invest in short term deposits, debt and money market instruments having structured obligations or credit enhancements.
- A graded exit load shall be levied on investors of liquid schemes who exit the scheme up to a period of 7 days.
- Mutual Fund schemes shall be mandated to invest only in listed non-convertible debentures and the same would be implemented in a phased manner. All fresh investments in commercial papers (CPs) shall be made only in listed CPs pursuant to issuance of guidelines by SEBI in this regard.
- All fresh investments in equity shares by Mutual Fund schemes shall only be made in listed or to be listed equity shares.
- Prudential limits on total investment by a Mutual Fund scheme in debt and money market instruments having credit enhancements and on investment by Mutual Fund scheme in such debt securities of a particular group, as a percentage of debt portfolio of the respective scheme have been prescribed at 10% and 5% respectively.
- There should be adequate security cover of at least 4 times for investment by Mutual Fund schemes in debt securities having credit enhancements backed by equities directly or indirectly.
[1] Municipal bonds are debt obligations issued by States, cities, counties and other governmental entities to fund day-to-day obligations and to finance capital projects such as building schools, highways and other projects for the public good. For example, if a municipal corporation establishes a new metro rail link, then it can issue municipal bonds to fund the project.
[2] In terms of the RBI/2018-19/152 A.P. (DIR Series) Circular No. 26 dated 27 March 2019, the revised limit for FPI investment in State Development Loans (SDLs) shall be 2% of outstanding stocks of securities in FY 2019-20.
Vineet Aneja
Managing Partner | Clasis Law
M: +91-9810405782
I am the Managing Partner as well as a founding partner of Clasis Law. My professional journey as a lawyer began more than 20 years ago and I have a plethora of experience across practice areas such as corporate commercial, retail, hospitality, employment, e-commerce, education, healthcare, white collar. I have provided specialized transactional and advisory services across sectors, covering diverse areas including:
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