The regulatory environment for investment in corporate debt by foreign portfolio investors (FPIs) has been turbulent with sweeping changes introduced by the Reserve Bank of India (RBI) in April 2018, followed by other changes introduced on 15 June by both the RBI and the Securities and Exchange Board of India (SEBI). Unlike global financial regulatory rule-making practices, these changes were introduced without the issuance of consultation papers seeking feedback of market participants. These developments, and their manner of introduction, created anxiety among issuers, FPIs and other market participants.

In view of recent developments in domestic and international financial markets, various measures were considered to improve the flow of foreign investments into India, particularly in corporate debt. These included easing of rules applicable to FPIs, including relaxing the applicability of the group exposure thresholds (20%) and the per issue investment limit (50% of an issue) that were put in place by the RBI's and SEBI's circulars of 15 June.

In its statement on developmental and regulatory policies of 5 October, the RBI stated it would issue a discussion paper on a voluntary retention route (VRR) for FPIs to invest in debt. The statement said that under VRR, FPIs would have more operational flexibility in terms of instruments, as well as exemptions from concentration limits, and group-level and issue-level thresholds. An FPI that voluntarily commits to retain a minimum percentage of its investments in India for a period of its choice would be eligible to participate in this route. FPIs would be able to apply for investment limits for VRR through auctions conducted by the RBI.

The discussion paper, issued on 5 October, confirms the objective of VRR, "to attract long-term and stable FPI investments into debt markets while providing FPIs with operational flexibility to manage their investments". Under VRR, FPIs can invest in all corporate debt instruments including commercial paper. Investments under VRR will be exempt from the following prescriptions of the June circulars: (a) minimum residual maturity requirements, (b) single and group exposure limits (i.e., FPI exposure to a single group cannot exceed 20% of its bond portfolio) and issue limits (i.e., an FPI cannot invest more than 50% in a single bond issue), and (c) category-wise concentration limits.

Under VRR, investment limits will be determined by the RBI from time to time "based on macro-prudential considerations and assessment of investment demand". Such limits will be allocated to FPIs in an auction based on the retention period proposed by the FPI. For every VRR auction, the RBI will announce the total investment amount to be auctioned, and the minimum retention period applicable to allotments under such auction. An FPI's bid must comprise the amount it proposes to invest and the minimum retention period for that amount. An FPI (including its related FPIs) cannot bid for more than 50% of the auction amount. Bids will be accepted in descending order of the retention period until the auction investment amount is over. The discussion paper refers to allocated limits as committed portfolio size (CPS).

Following successful allocation of limits, an FPI must invest the CPS in debt instruments for the entire duration of the proposed retention period. Minimum investment by an FPI in the retention period must be 67% of the CPS (excluding cash and deposits), and this will be determined on an "end-of-day" basis.

The amount of investment by an FPI will be determined on the basis of the face value of the securities invested. Successful bidders will be given one month to invest the CPS, commencing from the date of announcement of auction results. A minimum of 67% of the CPS has to be invested within this one month period. The retention period will commence from the expiry of this one-month period.

An FPI must enter into separate legal documentation with their custodian in respect of investments under VRR. Further, an FPI must open a separate securities account for holding debt securities under VRR, as well as a separate special non-resident rupee (SNRR) account for investment through VRR. All fund flows relating to investment through VRR must be made through the SNRR account.

The discussion paper has received mixed reviews. The mechanism of issuing a discussion paper has been appreciated, and is a much-needed departure from previous instances of rule-making for FPIs.

Although the objective of the discussion paper is laudable, the changes proposed appear somewhat convoluted. Concerns have also been raised on the implementation of these changes, particularly because the paper's proposal places the onus of compliance with both the FPI and its custodian.

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