India: Voluntary Retention Route: A Halfway Measure?

The government and the financial sector regulators (Reserve Bank of Indian (RBI) and the Securities and Exchange Board of Indian (SEBI)) has brought in various measures to ease investment and related rules for foreign portfolio investors (FPIs).

The RBI and SEBI circulars of June 2018 eased group exposure thresholds (20%) and per issue investment limit (50%) of an issue. The RBI issued a discussion paper in October 2018 on voluntary retention route (VRR) to facilitate FPI investment in debt.

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. Following the discussion paper, the RBI issued a circular on VRR on 1 March.

All FPI investors registered with SEBI are eligible to participate in VRR. Investments under VRR are in addition to the limits prescribed for debt investments. For corporate debt under VRR, the investment limit will be `350 billion (US$4.93 billion). With respect to corporate debt, FPIs can, under VRR, invest in instruments such as non-convertible debentures, security receipts issued by asset reconstruction companies, and securitized debt instruments. Investments under VRR will be exempt from minimum residual maturity requirements, issue limits, and category-wise concentration limits.

Eligible instruments exclude units of domestic mutual funds. The minimum retention for investment under VRR will be three years or such other time period as the RBI may prescribe.

Limits under VRR will be allotted through an auction or "on tap". No FPI will be allotted a limit greater than 50% of the amount offered, where the demand for the amount offered is greater than 100%. FPIs must invest 75% of the amount allotted (referred to as committed portfolio size or CPS). This amount will be determined on an end-of-day basis and shall be determined on the basis of the face value of the securities.

Key features of the auction mechanism include: (a) FPIs must bid the amount it proposes to invest, and the retention period of that investment (which must not be less than the prescribed minimum retention period), (b) FPIs can place multiple bids, and (c) the criteria for allotment will be the retention period bid in an auction, and bids will be accepted in the descending order until the aggregate amounts of the accepted bids add up to the auction amount.

Successful FPI-applicants must invest 25% of the CPS within one month of the allotment, and the remaining amount within three months from the date of allotment.

Before the end of any retention period, an FPI may elect to continue investments under VRR for an identical period, by conveying such decision to its custodian. If an FPI elects not to continue under VRR, it may liquidate its portfolio and exit, or it may (subject to availability) shift its investments to the general investment category.

An FPI can liquidate its investments under VRR prior to the end of any retention period by selling such investments to other FPIs. Custodians cannot permit any repatriation from the cash accounts of an FPI if such transaction leads to the FPI's assets falling below the minimum threshold for deployment (75% of CPS).

Utilization of limits under VRR and compliance with applicable conditions shall be the responsibility of both the FPI and its custodian. An FPI must enter into separate legal documentation with their custodian in respect of investments under VRR. A separate "special non-resident rupee" (SNRR) account for investment through VRR would need to be opened by the FPI, and all fund flows through VRR must be made through this account. Further, an FPI must open a separate securities account for holding debt securities under VRR.

As a matter of process, as FPIs are regulated by both the RBI and SEBI, both of them issue directions, in parallel, on the regulatory framework. As SEBI has not yet issued a similar circular, the full implementation of VRR is still unclear. While VRR has been welcomed by FPIs and domestic stakeholders, it is perceived as a patchwork and a convoluted solution to an already cumbersome regulatory framework. It is hoped that, in the near future, the RBI and SEBI are able to introduce a simplified framework to encourage FPIs and to provide regulatory stability.

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