The foreign portfolio investor (FPI) framework introduced in 2014 was welcomed as a prime example of regulatory streamlining. However, the framework has presented challenges, particularly for investments in Indian corporate debt. Until recently, corporate debt investments by FPIs were regulated by a series of circulars issued by the Reserve Bank of India (RBI) in 2015. The 2015 circulars were recast by circulars issued by the RBI on 27 April and 1 May.
Although the RBI had signalled in October 2017 that it would undertake a "detailed review" of the regulatory framework on debt investment by FPIs, and had dropped a similar hint in a 6 April circular, the 2018 circulars have caught FPIs and other stakeholders unawares.
The April circular permits FPIs to invest in corporate debt with a residual maturity of one year, compared with three years previously. The May circular clarifies that FPIs can invest in corporate debt with a residual maturity of less than one year subject to such investments not exceeding 20% of the total investment of FPIs in corporate bonds. The April circular also introduces concentration thresholds, where investment by long-term FPIs is capped at 15% of the prevailing investment limit for FPIs, and the investment of other FPIs is capped at 10% of the prevailing investment limit for FPIs.
The April circular also introduces single and group investor limits, where investment by an FPI (including its related FPIs) must not exceed 50% of any issue of corporate bonds. While "related" was not defined in the April circular, the May circular clarifies that the term refers to "all FPIs registered by a non-resident entity", and provides an example: "Illustratively, if a non-resident entity has set up five funds, each registered as an FPI for investment in debt, total investment by the five FPIs will be considered for application of concentration and other limits."
The April circular also prescribes that an FPI's exposure to corporate bonds issued by an Indian issuer (including such issuer's related parties) cannot exceed 20% of the FPI's corporate bond portfolio. The May circular clarifies that in this context, the term related would have the meaning given to it in the Companies Act, 2013. While the April circular rules out investment by FPIs in partly paid instruments, the other prescriptions of the 2018 circulars are limit/threshold oriented and are not in the nature of absolute prohibitions.
The easing on minimum residual maturity period has been welcomed by both corporate bond investors and issuers. In view of fluctuating currency conversion and interest rates, issuers are pleased to have the flexibility to issue shorter term bonds so that they are not bound to a high-interest facility without the chance of prepayment. Investors are pleased to be allowed to invest in shorter maturity bonds as this enables better liquidity management at their end.
However, the unexpected prescribing of concentration thresholds and single/group investor limits has dampened the positive sentiment generated by the relaxation on maturity. Although parallels for these thresholds can be drawn from similar limits for Indian banks and non-banking financial companies, the rationale for such a comparison is misplaced in that the funds lent by Indian lenders are mostly raised from domestic sources, which makes concentration in a borrower (and its related entities) a public policy issue. A similar concern for corporate debt investments by FPIs seems incongruous.
FPIs have also been taken aback by the 50% limit on investment by an FPI (along with related FPIs) in a corporate issue. This too was unexpected, and has no apparent rationale or regulatory imperative. This prescription directly affects investment strategies for existing FPIs as well as investors that are considering obtaining an FPI licence, and has significantly disconcerted investors and issuers alike. The May circular's attempt to clarify the meaning of "related FPIs" has caused further confusion, as the clarification does not take into account the constituents of an FPI or link it to any globally accepted objective criteria (such as accounting standards). Consequently, there is still lack of clarity on the determination of a "related FPI".
While the consolidation of various investment routes into the FPI route was a good move, the subsequent regulatory flip-flops have taken the sheen off this. From a regulatory perspective, and considering that FPIs are now significant stakeholders in corporate debt, a consultative process prior to issuing a new regulatory framework would have been useful. This would have provided sufficient warning to market participants about the impending changes and would also have enabled the regulator to issue a clear framework rather than the current patchwork.
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