On 20 July, foreign portfolio investors (FPIs) and investors in rupee denominated bonds (RDBs) got an unwelcome surprise in the form of a circular from the Securities and Exchange Board of India (SEBI) that effectively halted the subscription of corporate debt by FPIs and other foreign investors. But twin late-September moves by SEBI and the Reserve Bank of India (RBI) have restored some level of certainty for FPIs and foreign investors as well as Indian borrowers.

By way of background, a circular from SEBI on 4 August 2016 had established the limit up to which FPIs and other foreign investors could subscribe to corporate debt as ₹2.44 trillion, being roughly the rupee equivalent of US$51 billion (the then prevailing limit). SEBI's 20 July circular prescribed that when investments in corporate debt (including RDBs) reach 95% of the prescribed limit: (a) depositories would be required to halt all subscription to corporate debt; and (b) such investments could then only be made on the basis of corporate bond investment limits made available to FPIs and foreign investors based on auctions conducted by the National Stock Exchange and the Bombay Stock Exchange.

The 20 July circular further required the temporary ceasing of issuance of RDBs until corporate bond investment limits dropped to 92% of the prescribed limit. The circular also prescribed the mechanism for such auctions as well as certain other criteria such as the maximum amount (of the auctioned limit) that could be held by an FPI.

To state that this resulted in operational difficulties for both FPIs and domestic issuers would be putting it mildly. Various types of borrowers that were unable to access bank credit are now used to accessing the bond market to raise funds (including from FPIs and foreign investors). While certain FPIs participated in auctions, the lack of information on bidding rates and market expectations meant that this was a cumbersome process. Where FPIs purchased auctioned limits, this resulted in higher borrowing costs for borrowers.

While recent regulatory moves capping returns curtailed the issuance of RDBs, the complete stop was unexpected and unpalatable. While it may be argued that FPIs and foreign investors could have been more vigilant in monitoring corporate bond investment limits, the 20 July circular reinforced the notion of regulatory uncertainty in India, thus dampening interest among foreign investors.

Investment bankers immediately asked the government and the financial sector regulators to rectify this situation. Their suggestions included changing the mode of calculation of corporate bond investment limits by pegging them at prevailing currency exchange rates.

Circulars issued by the RBI on 22 September and by SEBI on 29 September have partly rectified the situation. The 22 September circular stated that investment limits for RDBs would be removed from corporate bond limits and would instead be considered under the limits for external commercial borrowings. This would result in freeing of limits of ₹440 billion for corporate bond investments, which would be made available in a phased manner, with ₹227.3 billion in the third quarter and ₹170 billion in the fourth quarter of the financial year 2017-18. Further, ₹95 billion in each of the above quarters would be reserved for investment in the infrastructure sector by long-term FPIs such as sovereign wealth funds, multilateral agencies, endowment funds, insurance funds, pension funds and foreign central banks.

The 22 September circular was further operationalized by SEBI's 29 September circular (the prescriptions of which are materially similar to the RBI's circular). These changes will be effective from 3 October, and will hopefully also remove the requirement for FPIs to participate in auctions for corporate bond investment limits.

These changes make good sense particularly because the bond market has become an effective substitute to tackle the slow pace of credit growth by Indian banks. However, the near-halt of investment by FPIs and foreign investors along with demonetization and the hurried rollout of GST formed an unfortunate trifecta, which reinforced the perception by FPIs and foreign investors of a continually unpredictable regulatory environment in India. Going forward, in line with international financial regulatory practices, a consultation period for any financial regulatory changes followed by a "cooling" period before which any such regulatory changes are implemented could engender confidence among foreign investors.

Considering the relatively jittery state of credit growth in India currently, the role of FPIs and foreign investors in providing much needed debt funding to Indian borrowers is of the utmost importance.

Originally published by India Business Law Journal.

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