India: Investment By A Foreign Venture Capital Investor ("FVCI") Registered Under SEBI (FVCI) Regulations, 2000 (Banking And Finance: October 2016 - December 2016)

In order to further liberalise and rationalise the investment regime for FVCIs and to give a fillip to foreign investment in the Startups, the current regulatory provisions have been reviewed, in consultation with the Government of India and accordingly amendments have been carried out in Schedule 6 of Foreign Exchange Management (Transfer or Issue of security by a person resident outside India) Regulations, 2000 ("Principal Regulations"), through Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) (Third Amendment) Regulations, 2016. Under the revised regulatory framework, FVCIs can now invest in equity or equity linked instrument or debt instrument issued by an Indian 'Startup' irrespective of the sector in which the Startup is engaged without any approval of RBI.

The RBI, vide A.P. (DIR Series) Circular No. 7 dated October 20, 2016, has issued directions to All Category - I Authorised Dealer Banks with respect to Investment by a FVCI registered under SEBI (FVCI) Regulations, 2000. The highlights of this revised regulatory framework for investment by FVCIs are as under:

1. A SEBI registered FVCI will not require any approval from the RBI and can invest in:

  1. Equity or equity linked instrument or debt instrument issued by an Indian company whose shares are not listed on a recognised stock exchange at the time of issue of the said securities/instruments and engaged in any of the sectors specified in annexure to Schedule 6 of the Principal Regulations.
  2. Equity or equity linked instrument or debt instrument issued by an Indian 'startup' irrespective of the sector in which the startup is engaged. The definition of start up has been added in the Principal Regulations.
  3. Units of a Venture Capital Fund (VCF) or of a Category I Alternative Investment Fund (Cat-I AIF) (registered under the SEBI (AIF) Regulations, 2012) or units of a Scheme or of a fund set up by a VCF or by a Cat-I AIF.

2. Downstream investments by a Venture Capital Fund (VCF) or a Cat-I AIF, which has received investment from FVCI, shall have to comply with the provisions for downstream investment as laid down in Schedule 11 of the Principal Regulations.

3. A FVCI may open a foreign currency account and/or a rupee account with a designated branch of an Authorised Dealer for the purpose of making transactions only and exclusively under Schedule 6 of the Principal Regulations.

4. The consideration for all investment by a FVCI shall be paid out of inward remittance from abroad through normal banking channels or out of sale / maturity proceeds of or income generated from investment already made as per paragraph 1 above.

5. There will be no restriction on transfer of any security/instrument held by the FVCI to any person resident in or outside India.

6. An entity receiving investment directly from a registered FVCI will be required to report the investment, mutatis mutandis, in form FCGPR.

Security and Risk Mitigation measure - Technical Audit of Prepaid Payment Instrument issuers

Prepaid payment instruments ("PPIs") are those which facilitate purchase of goods and services against the value stored on such instruments. The value stored on PPIs represents the value paid for by the holder, by cash, by debit to a bank account, or by credit card.

PPIs can be issued as smart cards, magnetic stripe cards, internet accounts, internet wallets, mobile accounts, mobile wallets, paper vouchers and any such instruments which can be used to access the prepaid amount.

The RBI, vide its circular RBI/2016-17/178,DPSS.CO.OSD.No.1485/06.08.005/2016-17, Dated - December 09, 2016 ("Circular") has asked banks and companies issuing PPIs to conduct special security audit saying that any cyber attack could prove a dampener at a time when the Government is urging people to go in for digital transactions in a big way. All authorised entities/banks issuing PPIs in the country are advised to:

  1. Carry out a special audit of their systems by empaneled auditors of the Indian Computer Emergency Response Team (CERT-In) on a priority basis and immediately comply with the audit report recommendations.
  2. Take appropriate measures to mitigate phishing attacks considering that, given the digital push, a large number of users are likely to be first time users of the digital channels.
  3. Implement additional safety measures depending on risk perception or threats as they emerge.

Framework for imposing monetary penalty on Authorised Payment Systems Operators / banks under Payment and Settlement Systems Act, 2007 ("PSS Act")

The PSS Act provides for the regulation and supervision of payment systems in India and designates the RBI as the authority for that purpose and all related matters. Any person desirous of commencing or operating a payment system needs to apply for authorization under the PSS Act. Section 30 of the PSS Act confers powers upon RBI to impose penalties/fines for certain contraventions/offences more particularly described in section 26 (2) and 26 (6) of the PSS Act. Section 31 of the PSS Act empowers RBI to compound contraventions/ offences committed by the entity. In view of this, the RBI vide its circular No. RBI/2016-17/97, DPSS.CO.OD.No.1082/06.08.005/2016-17 dated - October 20, 2016 ("said Circular") has put in place a framework for imposition of penalty/fine under section 30 of the PSS Act and compounding of contraventions/offences under section 31 of the PSS Act. The brief details of the framework as laid down in the said Circular are as under:

Nature of offences This framework for imposition of penalty/fine/compounding, inter alia, includes the following types of contraventions/offences:
i. Contravention of provisions of the PSS Act.
ii. Non-compliance of directions or order made there under.
iii. Violation of terms and conditions of authorisation.
Compounding 'Compounding' is a voluntary process. The contravener may apply for the compounding of an offence by way of submitting an application in the format prescribed in the said Circular.
Operational Procedure RBI will follow the following procedure before imposing the penalty/fine or compounding of the offence on the payment system operators / banks (entity/ies);
a. Issue of letter to the entity calling for explanation citing the offence.
b. Based on the explanation and information/evidence submitted by the entity, the RBI will examine whether the contravention/offence can be considered for compounding or levy of penalty/fine.
c. Issue of show cause notice for imposing penalty/fine/compounding, in case theRBI is not satisfied by the explanation.
d. Personal hearing to the entity to be given, if requested in writing, before taking any penal action.
e. Imposition of penalty/fine or compounding of contravention/offences.
Amount of Penalty/fine The amount of penalty/fine would be based on the nature of contravention/offences with a minimum penalty of INR 5,00,000. Where the contravention/violation is not quantifiable, a penalty of minimum INR 5,00,000 with a maximum of INR 10 million would be levied.
Method of payment of penalty/fine The RBI will directly debit their current account, while those not having the facility with the RBI will have to deposit the amount into a designated account of the RBI within one week of the issue of written order.
Disclosure The entities, on whom penalty/fine is levied, are required to disclose the penalties/fines in their Annual Financial Statements for the year in which the penalty is levied.

Operating Guidelines for Payments Banks

The RBI had, on November 27, 2014, issued guidelines for setting up of payment banks. According to these guidelines, the primary objective of setting up of payments banks is to further financial inclusion by providing (i) small savings accounts and (ii) payments / remittance services to migrant labour workforce, low income households, small businesses, other unorganised sector entities and other users, by enabling high volume-low value transactions in deposits and payments / remittance services in a secured technology-driven environment.

The RBI examined the need for separate operating guidelines for payments banks in view of the differentiated nature of business and financial inclusion focus of these banks and issued operating guidelines for payment banks vide its circular No. RBI/2016-17/80, DBR.NBD.No.25/16.13.218/2016-17 dated October 6, 2016 ('Circular'). The summarised operating guidelines as given in the said Circular are mentioned herein below:

Prudential Regulation The prudential regulatory framework for payments banks (PBs) will largely be drawn from the Basel standards.
Large exposures limits Large exposure limits shall not be more than five per cent of the total outside liabilities of the PB.
Inter-bank borrowings PBs will be permitted to participate in the call money and Collateralised Borrowing and Lending Obligation ("CBLO") market as both borrowers and lenders. These borrowings would, however, be subject to the limit on call money.
Investment classification and valuation norms PBs shall maintain a minimum investment to the extent of not less than 75 per cent of demand deposit balances and maintain balances in demand and time deposits with other scheduled commercial banks, which shall not be more than 25 per cent of its demand deposit balances ("DDB"). Total deposits shall not exceed 100% of the DDB. PBs will not be allowed to classify any investment, other than those made out of their own funds, as Held-to-maturity category and will not be allowed to participate in 'when issued' and 'short sale' transactions. PBs will be permitted to invest in bank certificate of deposits within the limit applicable to bank deposits.
Restrictions on loans and advances PBs will not be permitted to lend to any person including their directors but they can lend to their employees out of banks own funds.
para-banking activities PBs will not be permitted to undertake any para-banking activity except those allowed as per the Licensing Guidelines.
Product approval PBs should submit application with a list of financial products they intend to offer with a clear description. If any product is introduced later, it should be disclosed to the RBI and the RBI can put certain restrictions on it.
Risk management Credit risk is not applicable and the provisions regarding market risk, Internal controls, audit and compliance and strategic and reputational risk management shall be as applicable to scheduled commercial banks.
Cash Reserve Ratio, Statutory Liquidity Ratio, disclosures and statutory/regulatory reports The cash reserve ratio and statutory liquidity ratio requirements and the various disclosures and statutory/regulatory reports will be as applicable to commercial banks.
Ownership and control regulations The existing provisions in this regard as applicable to private sector banks, as covered in the Master Directions on Issue and Pricing of shares by Private Sector Banks DBR.PSBD.No.95/16.13.100/2015-16 dated April 21, 2016 and Master Directions on Ownership in Private Sector Banks DBR.PSBD.No. 97/16.13.100/2015-16 dated May 12, 2016, are applicable to PBs as well, except what is provided in the existing regulation contained in the Licensing Guidelines.
Corporate governance The existing provisions as applicable to banking companies shall be applicable to PBs as well and constitution and functioning of committees of the board, management level committees, remuneration policies as applicable to private sector banks.
Cash Reserve Ratio, Statutory Liquidity Ratio, disclosures and statutory/regulatory reports The cash reserve ratio and statutory liquidity ratio requirements and the various disclosures and statutory/ regulatory reports will be as applicable to commercial banks.
Banking Operations The annual plans for opening of physical access points by the PBs for the initial five years would need prior approval of RBI. It may liberalize the requirement of prior approval. An employee of the PB should be available for sufficient duration, at a fixed location known to the customers at the district level, to attend to customer grievances and support the agent supervision
Regulation of Business Correspondents ("BCs") PBs can engage all permitted entities including the companies owned by their business partners and own group companies on an arm's length basis as BCs. These companies can have their own branches managed by their employees operating as "access points" or may engage other entities/persons to manage the "access points" which could be managed by the latter's staff. Inter-operability of the BCs will be allowed except for opening of savings and current accounts. BCs cannot undertake any offline transactions and will be exempted from the requirement of having a base branch for a certain number.
Bank charges, lockers, nominations, facilities to disabled persons, etc. Bank charges, lockers, nominations, facilities to disabled persons, as applicable on scheduled commercial banks.
Bank deposits PBs can accept only savings and current deposits. The aggregate limit per customer shall not exceed INR 100,000 as provided in the Licensing Guidelines. All RBI and Banking Regulation Act, 1949 provisions and RBI directions relating to minimum balance, inoperative accounts, unclaimed deposits including transfer of such deposits to the Depositors Education and Awareness Fund maintained by RBI on a regular basis, nominations, cheques/drafts, etc., will be applicable to the PBs. A PB may provide account statements on paper but cannot issue passbook.
KYC requirements PBs may decide not to take the wet signature while opening accounts and instead rely upon the electronic authentication/ confirmation of the terms and conditions of the banking relationship. PBs should ensure that every customer, including customers of mobile companies on-boarded comply with the KYC regulations, which could include simplified account opening procedures.
Foreign exchange business PBs are required to comply with all the conditions attached with the AD Cat II licence issued to them and also implement the provisions of Foreign Contribution (Regulation) Act, 2010 as applicable to commercial banks.
Currency distribution PBs may, at their option, exchange mutilated and defective notes at their branches, subject to compliance with RBI norms. All customer grievance issues related to a particular access point should be addressed both at the access point and at the district level location and PBs will be covered by the Banking Ombudsman. Mechanism of grievance redressal should be clearly communicated to RBI along with the application for licence.
Outsourcing of operations, internet banking and mobile banking The extant provisions in this regard as applicable to scheduled commercial banks, shall be applicable to PBs as well. Further, loading of PPI balances through other bank credit cards will be permitted.
Implementation of Ind AS Implementation of Ind AS would be applicable to PBs once they become scheduled banks.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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