SEBI and RBI Update | Investment by FPIs in Debt Securities

SEBI vide circular number IMD/FPIC/CIR/P/2018/101 (available here) (“SEBI Circular”) and RBI vide circular number RBI/2017-2018/199 A.P. (DIR Series) Circular No. 31 (available here) (“RBI Circular”), both dated June 15, 2018, revised the law pertaining to investments by Foreign Portfolio Investors (“FPI”) in debt related securities. The stated intent of the changes is to provide operational flexibility.

Many of the changes were already covered in A.P. (DIR Series) Circular No. 24 dated April 27, 2018. However, the RBI Circular appears to consolidate the law regarding investment limits applicable to FPIs.

Some of the changes have been summarised hereunder:

1. Definitions

(a) ‘Short-Term Investments’ shall mean investments with residual maturity upto 1 year.

(b) ‘Related FPIs’ shall mean an ‘investor group’, i.e., in case the same set of ultimate beneficial owner(s) invest through multiple entities, such entities shall be treated as part of same ‘investor group’.

(c) ‘Entities related to the corporate’ shall mean ‘related parties’ as defined under the Companies Act, 2013. Please note that issuers that are owned or controlled by the Central or State Governments shall be exempted from this definition.

2. Short-Term Investments

Short-Term Investments made by an FPI shall not exceed 20% of total investment by such FPI in any category (“Short-Term Investment Condition”). Compliance with the Short-Term Investment Condition shall be reckoned at the end of each day. Such investments may exceed 20% of total investments, only if the investments are made on or before April 27, 2018 and do not include any investments made after April 27, 2018.

3. Security-wise limit

The cap on aggregate FPI investments in any Central Government security, has been revised to 30% of the outstanding stock of that security, from the current limit of 20%.

4. Requirement of minimum residual maturity

(a) Government related debt securities. FPIs are permitted to invest in Central Government securities, Treasury Bills, and State Development loans (“Government Securities”) without any minimum residual maturity requirement. Short Term Investments in Government Securities would be subject to the Short-Term Investment Condition. Please note that earlier the maturity requirement was of 3 years.

(b) Corporate bonds. FPIs are permitted to invest in corporate bonds with minimum residual maturity of above one year, subject to Short-Term Investments in corporate bonds by FPIs complying with the Short Term Investment Condition.

(c) Security Receipts issued by asset reconstruction companies. The requirement of minimum residual maturity would not apply to investments by FPIs in security receipts issued by asset reconstruction companies.

5. Investment limits

(a) Monitoring.

Government Securities: Earlier FPIs were permitted to invest in Central Government Securities till the limits prescribed for FPIs (from time to time) hit 90% utilisation. Thereafter, an auction was held for allocation of the remaining limits.

Now, an online monitoring system has been introduced by the Clearing Corporation of India Limited for investments by FPIs in Government Securities. The auction mechanism used previously has been discontinued with effect from June 1, 2018.

The CCIL shall monitor the limits for investments by FPIs in Government Securities. However, the mechanism for this is yet to be notified by CCIL. Please note that the depositories were monitoring the utilisation limits of the Government Securities.

Further, the depositories are required to share the investor group data with RBI and CCIL on a monthly basis, with respect to investment by FPIs in Government Securities.

Corporate Debt: The depositors are required to monitor the investments in corporate debt by FPIs at the investor group level. Custodians are responsible for monitoring their own clients.

(b) Breach of investment limits.

Government Securities: Any transaction in breach of the investment limits in Government Securities shall have to be reversed and noted by the custodian and FPIs. Further, upon such reversal by way of a sale or redemption of Government Securities, the concerned FPIs may reinvest within a period of two working days from the date of sale or redemption (including date of sale or redemption). While this is not clearly specified in the circular, it appears that reinvestment only upto the limit would be permitted.

If such reinvestment is not made within the time period of two working days, the reinvestment would be required to be subjected to availability of limits for that category.

Corporate Debt: For corporate debt, depositories would identify the FPIs in breach of the investment limits, and inform their respective custodians, who in turn shall advise their FPI clients of the needful.

(c) Responsibility for compliance.

Government Securities: The primary responsibility to comply with all applicable limits for an FPI in Government Securities and minimum residual maturity shall lie with the FPI and custodians.

Corporate Debt: The primary responsibility to comply with all applicable limits for an FPI in corporate debt shall lie with the FPIs.

6. Concentration Limits

(a) For investments in Government Securities and corporate debt securities, the following concentration limits are applicable:

(i) Long-term FPIs: 15% of prevailing investment limit for that category.

(ii) Other FPIs: 10% of prevailing investment limit for that category.

(b) Investments in excess of concentration limits. In case an FPI has investments (“INV O”) in excess of the concentration limit on the effective date, (i.e., the date on which the concentration limits come into existence as prescribed by RBI), it will be allowed to undertake additional investments such that its portfolio size at the end of any day (“INV T”) does not exceed INV O plus 2.5% of investment limit for the category on the effective date. Once INV T falls below the prevailing concentration limit for the category, the FPI shall be free to make investments up to the applicable concentration limit.

(c) Within concentration limits. In case an FPI has investments (“INV 0”) within the concentration limit, but in excess of 7.5% (12.5% in case of FPIs in the ‘Long-term’ category) of the investment limit for the category on the effective date, that FPI shall be allowed to undertake additional investments such that its portfolio size at the end of any day (“INV T”) does not exceed INV 0 plus 2.5% of the investment limit for the category on the effective date. Once INV T falls below the prevailing concentration limit for the category, the FPI shall be free to make investments up to the applicable concentration limit.

(d) All other FPIs shall be allowed to invest up to the applicable concentration limit.

7. Other Limits for Corporate Bonds

(a) Aggregate investment. Investments by any FPI (including investments by related FPIs) in corporate bonds shall not exceed 50% of any issue of a corporate bond. In case such investment is more than 50% of any single issue, no further investments shall be permitted until this requirement has been complied with.

(b) Single investor. An FPI shall not have an exposure of more than 20% of its corporate bond portfolio to a single corporate (including exposure to Entities related to the corporate).

As on April 27, 2018. If the exposure is in excess of 20% to any corporate (including exposure to Entities related to the corporate), the FPI shall not make further investments in that corporate until the requirement specified above has been complied with.

After April 27, 2018. Investments made by FPIs after April 27, 2018 till March 31, 2019 would be exempted from this requirement.

Newly registered FPIs. FPIs registering after April 27, 2018 are permitted to comply with this requirement by March 31, 2019, or within six months from the date of registration, whichever is later. The intent is to permit newly registered FPIs to build up a diversified portfolio.

(c) Exemptions: Please note that the requirement mentioned in paragraph 7(a) and 7(b) above would not be applicable to investments by Multilateral Financial Institutions and investments by FPIs in security receipts issued by asset reconstruction companies.

8. Pipeline investments in corporate bonds

(a) Any on-going investment transactions by FPIs in corporate bonds, wherein: (i) the parameters such as price/rate, tenor and amount of the investment were finalised between the FPI and the issuer on or before April 27, 2018; (ii) the actual investment shall commence by December 31, 2018; and (iii) the investment is in conformity with the extant regulations governing FPI investments in corporate bonds prior to April 27, 2018.

(b) Please note that the custodians may assess and permit (or not permit) the pipeline investments without reference to the RBI.

9. Partly paid-up

FPIs shall not invest in partly paid debt instruments.