Friday, January 20, 2017

Return of the prodigal blogger?

It's been 2 years since I wrote on this blog. Welcome back everyone! As the Trump presidency rolls into DC, I hope to be more regular. A colleague of mine, Shradha Sachdev wrote this excellent article on FDI in financial services sector (featured in Bar & Bench), with some inspiration and inputs from yours truly. I am setting it out verbatim below.

Liberalizing FDI in Financial Services - Need of the hour?


Traditionally, India has had a bank-dominated financial services sector. However, the importance of non-banking financial companies (NBFCs) has been recognized, not only as a supplement to mainstream banking in meeting the increasing financial needs of the corporate sector but also for delivering credit to the unorganized sector and to small local borrowers.

The RBI Act defines a NBFC broadly as a financial institution that is into lending or investment or collecting monies under any scheme or arrangement but does not include any institutions which carry on agricultural activity, industrial activity, trading and purchase or sale of immovable properties as their principal business.

Contribution of NBFCs to the economy has grown in leaps and bounds from 8.4% in 2006 to above 14% in March 2015[1]. In terms of financial assets, NBFCs have recorded a healthy growth - a compounded annual growth rate (CAGR) of 19% over the past few years - comprising 13% of the total credit and expected to reach nearly 18% by 2018–19[2].

The Indian government understands that industrial growth is impossible in an environment where banks are reluctant to finance new businesses. The Pradhan Mantri Mudra Yojana (PMMY) was launched for the benefit of bottom of the pyramid entrepreneurs. Banks and NBFC-Micro Finance Institutions have reported that the amount sanctioned under PMMY had reached about INR 100,000 crore to over 2.5 crore borrowers by early February 2016, while the target next year is raised to INR 180,000 crore[3].

To complement various initiatives like Make-in-India, Start-up India, Smart Cities, Housing for all, the government has announced a significant change for NBFCs by liberalizing the existing foreign direct investment (FDI) regime in India[4].

In addition to the restricted ambit of activities open to FDI earlier[5], there were other challenges faced. Foe example, asset management activity, even though technically a fee based activity, was treated as a 'fund-based' activity for the purpose of capitalization, thereby attracting prohibitively high capitalization norms linked to foreign ownership. Further, since the list of permitted activities under the current list did not specifically include 'investment activities', regulatory ambiguity existed for FDI in a NBFC engaged in any investment activity. Separately, whenever a majority foreign-owned NBFC created a step down joint venture or a subsidiary, it attracted additional capitalization requirements; this additional capital would have to be brought in through fresh infusion in the parent, thereby further disturbing the foreign investment at the parent entity level.

Expansion of Eligible Activities

Foreign direct investment in NBFCs are no longer restricted to the 18 stipulated activities but have been permitted across all regulated activities. This means that as long as the NBFC is subject to a regulatory authority such as the Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI), Pension Fund Regulatory and Development Authority (PFRDA) etc., it is permitted to raise 100% FDI under the automatic route, irrespective of the activity it performs.

For example, once a commodity broking license is approved by SEBI, a commodity broking company will not require any further approval from the Foreign Investment Promotion Board (FIPB) for bringing in foreign direct investment.

Prior government approval will be required for bringing in foreign investment only in such NBFCs that are not regulated or where only part of the financial services activity is regulated or where there is doubt regarding regulatory oversight[6].

Until now, one of the major difficulties faced by NBFCs while inviting foreign funds was regarding the interpretation of the permitted 18 activities. Financial services being a dynamic sector, the nature of financial services has been evolving and there was no definition or basis for ascertaining the services from which these 18 activities evolved. Further, there was also no practical or reliable mechanism for investors to ask questions relating to whether or not a certain activity is covered within the permitted 18 activities. It would not be incorrect to say that this ambiguity, at times, restricted highly potential businesses from accessing foreign funds.

With permission for inflow of foreign investment in “Other Financial Services” on automatic route, the sector is poised to witness remarkable diversity of players and businesses being intermediaries between mainstream banking and unorganized sectors.

Capitalization Norms

The Government has also done away with the minimum capitalization requirements under the FDI policy[7].

While NBFCs undertaking non-fund based activities[8] were required to comply with a minimum capitalization of USD 0.5 million upfront, those undertaking fund based activities were required to comply with the following requirements;

(i)          USD 0.5 million for FDI upto 51%, to be brought upfront;
(ii)         USD 5 million for FDI more than 51% and upto 75%, to be brought upfront;
(iii)       USD 50 million for FDI more than 75% out of which USD 7.5 million to be brought up front and the balance to be brought in within 24 months.

This was in addition to and irrespective of the minimum capitalization requirements fixed by the relevant sector regulatory authority. Moreover, it was unfair to subject a merchant banking and custodian services to similar capitalization norms without taking the market and investment environment into consideration.

To eliminate the vexatious requirement of complying with multiple capitalization norms, the FDI policy does not stipulate any minimum capital requirements anymore. This means that an NBFC would need to comply with capital requirements fixed, if at all, by the relevant sectoral regulatory authority only. The minimum capitalization requirements shall be decided by the government for NBFCs when raising FDI is falling under approval route.

Interestingly, in view of Foreign Exchange Management (Transfer or Issue of Security by the Person Resident Outside India) (Thirteenth Amendment) Regulations, 2016, for activities that are regulated by a specific act, the foreign investment limits shall be restricted to such limits as may be set out under the relevant act[9].

The impact of this change may be appreciated better by analyzing the capitalization norms stipulated by the relevant regulator for some common financial sector services:

S. No.
Financial Service
Capitalization Norms
Merchant banking
Net worth of not less than INR 50 million.

“Net worth” means the sum of paid-up capital and free reserves of the applicant at the time of making application
Net worth of not less than INR 2 Million.

However, every stock-broker, who acts as an underwriter shall fulfil the capital adequacy requirements specified by the stock exchange of which he is a member.

“Net worth” means,— (a) in the case of an applicant being a proprietary concern or a firm or an association of persons or anybody of individuals, the value of capital contributed to such business by the applicant and the free reserves of any kind belonging to the business of the applicant; and (b) in the case of a body corporate, the value of the paid-up capital and the free reserves as disclosed in the books of account of the applicant at the time of making the application under sub-regulation (1) of regulation 3.
Portfolio Management Services
Net worth of INR 30 Million;

Provided that a portfolio manager, who was granted a certificate under these regulations prior to the commencement of the Securities and Exchange Board of India (Portfolio Managers) (Amendment) Regulations, 2008, shall raise its net worth to not less than one crore rupees within six months from such commencement and to not less than two crore rupees within six months thereafter;

Provided further that the portfolio manager shall fulfill capital adequacy requirement under these regulations, separately and independently, of capital adequacy requirements, if any, for each activity undertaken by it under the relevant regulations.

"Net worth" means the aggregate value of paid up equity capital plus free reserves (excluding reserves created out of revaluation) reduced by the aggregate value of accumulated losses and deferred expenditure not written off, including miscellaneous expenses not written off.
Custodian Services
Net worth of a minimum of INR 500 Million. Explanation-For the purposes of this regulation, the expression "net worth" means the paid-up capital and the free reserves as on the date of the application.
Investment Advisory
Net worth of not less than INR 2.5 Million.

"Net worth" means the aggregate value of paid up share capital plus free reserves (excluding reserves created out of revaluation) reduced by the aggregate value of accumulated losses, deferred expenditure not written off, including miscellaneous expenses not written off, and capital adequacy requirement for other services offered by the advisers in accordance with the applicable rules and regulations.

Further, Investment advisers who are individuals or partnership firms shall have net tangible assets of value not less than rupees one lakh. Provided that existing investment advisers shall comply with the capital adequacy requirement within one year from the date of commencement of these regulations.
Credit Rating agencies
Net worth of not less than INR 50 Million.

Provided that a credit rating agency existing at the commencement of these regulations, with a net worth of less than rupees five crores, shall be deemed to have satisfied this condition, if it increases its net worth to the said minimum within a period of three years of such commencement.
Collective Investment Scheme
Net worth of not less than INR 50 Million.

Provided that at the time of making the application the applicant shall have a minimum net worth of rupees three crores which shall be increased to rupees five crores within three years from the date of grant of registration;
Stock Broker and Sub-broker
Base Minimum Capital stipulated by SEBI[10] as applicable for NSE:

(a) Only Proprietary trading without Algorithmic trading (Algo) – INR 1 Million
(b) Trading only on behalf of Client (without proprietary trading) and without Algo – INR 1.5 Million
(c) Proprietary trading and trading on behalf of Client without Algo – INR 2.5 Million
(d) All Trading Members/Brokers with Algo – INR 5 Million

For MCX, Base Minimum Capital requirements are:
(a) A Member with Algo Trading – INR 5 Million
(b) A Member without Algo Trading – INR 1 Million[11] 
Angel Fund
net worth of at least INR 10 Million; or

Non-Banking Financial Companies
INR 20 Million as the net owned fund (NOF) required for a non-banking financial company to commence or carry on the business of non-banking financial institution, except wherever otherwise a specific requirement as to NOF is prescribed by the Bank;

(1) Every applicable NBFC shall maintain a minimum capital ratio consisting of Tier I and Tier II capital which shall not be less than 15 percent of its aggregate risk weighted assets on-balance sheet and of risk adjusted value of off-balance sheet items.

(2) The Tier I capital in respect of applicable NBFCs (other than NBFC-MFI and IDF NBFC), at any point of time, shall not be less than 8.5% by March 31, 2016 and10% by March 31, 2017.

(3) Applicable NBFCs primarily engaged in lending against gold jewellery (such loans comprising 50 percent or more of their financial assets) shall maintain a minimum Tier l capital of 12 percent.

Needless to say, downstream investment by NBFCs having FDI will be subject to the relevant sectoral regulations and provisions of Foreign Exchange Management (Transfer or Issue of Security by the Person Resident Outside India) Regulations, 2000, as may be applicable[12].

Interpretational Issues Remain?

There seems to be a lack of clarity as to whether the financial services activity needs to be 'regulated', or whether the entity needs to be licensed by a regulator for it to avail the automatic route. For e.g. an AIF manager is regulated by SEBI under the SEBI (Alternative Investment Funds) Regulations, 2012 even though the entity itself is not licensed by SEBI.

Further, advisors question as to whether the above conditions could be seen as 'FDI-linked performance conditions', thereby making LLPs engaged in financial services ineligible for receiving FDI. It is not clear if an AIF manager incorporated as an LLP can have any foreign investment[13].

Additionally, there is no uniformly accepted definition of ‘financial services’ in the Indian context. The RBI definition of NBFCs covers certain entities and a number of other activities are regulated by SEBI and other regulators. Traditional Indian financial services entities such as ‘nidhis’, chit funds etc. are restricted rather than regulated by general regulators such as the Ministry of Corporate Affairs.


While the above questions remain to be conclusively answered, a number of financial services such as mutual funds, collective investment schemes, infrastructure debt funds, that have remained largely inaccessible by foreign investors precisely due to lack of clarity on the services included in the 18 stipulated activities, are now open for FDI. With this recent liberalization of FDI norms, India seeks to truly fuel economic growth and development by allowing greater financial services sector penetration to support small and micro businesses. Even businesses with low net worth would be able to take advantage of well-funded NBFCs.

In the uncertain global economy emanating from the ‘Brexit’ from membership of the European Union, upcoming US elections and the slow-down in the Chinese economy, the financial services sector of India is bound to get the attention of global investors that will be lured by the liberalized FDI regime.

[4] RBI Notification No. FEMA.375/2016-RB, dated September 9, 2016 (published in the Official Gazette of Government of India – Extraordinary – Part-II, Section 3, Sub-Section (i) dated 09.09.2016- G.S.R.No.879 (E))
[5] Previously FDI was permissible for (1) Merchant Banking, (2) Under Writing, (3) Portfolio Management Services, (4) Investment Advisory Services, (5) Stock Broking, (6) Asset management, (7) Venture capital, (8) Custodian Services, (9) Factoring, (10) Credit Rating Agency, (11) Leasing & Finance, (12) Housing Finance, (13) Forex broking, (14) Credit Card Business, (15) Money Changing Business, (16) Micro Credit (17) Rural Credit and (18) Financial Consultancy.
[6] Paragraph F.8.1, sub-clause (ii) of RBI Notification No. FEMA.375/2016-RB, dated September 9, 2016
[7] Paragraph F.8.1, sub-clause (i) of RBI Notification No. FEMA.375/2016-RB, dated September 9, 2016
[8] Non- fund based activities are (a) Investment Advisory Services, (b) Financial Consultancy, (c) Forex Broking, (d) Money Changing Business and (e) Credit Rating Agencies.
[9] Paragraph F.8.1, sub-clause (iii) of RBI Notification No. FEMA.375/2016-RB, dated September 9, 2016
[10] SEBI Circular No. CIR/MRD/DRMNP/36/2012 dated December 19, 2012
[11] Circular No.  MCX/MEM/138/2013 dated April 11, 2013
[12] Paragraph F.8.1, sub-clause (iv) of RBI Notification No. FEMA.375/2016-RB, dated September 9, 2016


Wednesday, May 28, 2014

Back with more!

I am posting after almost 6 months - in the meantime, I have moved law firms and have a new set of responsibilities. My NBFC focus at work has decreased a little but I continue to monitor the sector.

Amongst interesting developments, there is the RBI 'moratorium' on registering new NBFCs instituted through the First Bi-monthly Monetary Policy Statement, 2014-15. This was in view of the fact that the law relating to NBFCs is due for a complete overhaul which remains pending.

The RBI has now issued a notification relating to mergers and acquisitions involving NBFCs. This now makes mergers and acquisitions relating to NBFCs (whether deposit accepting or not) subject to prior approval of the RBI. The policy rationale behind this approach is to ensure that the acquirer / resulting entity following the merger/ acquisition is a “fit and proper person” that has the necessary qualifications to carry on the business of the NBFCs, and such that a transaction is not prejudicial to public interest or the interest of depositors. Interestingly, the RBI notification defines “control” as having the same meaning assigned to it in the SEBI Takeover Regulations. Therefore, any type of control over management and policy decisions of the company, whether through acquisition of shares or through other means such as shareholder agreements could fall within the purview of the RBI approval requirement. Hence, even acquisitions of minority stakes in NBFCs may be subject to scrutiny if they are accompanied by significant rights granted to acquirers/ investors through  protective provisions such as board nominations, quorum rights, veto rights and the like that may be contained in shareholders’ (or similar) agreements or in the articles of association of companies. In other words, the approval requirement may be triggered not just for outright acquisitions or takeovers but also investments that are accompanied by significant protective rights to the investors.

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Friday, December 13, 2013

Participation of NBFCs in insurance sector

As per the extant instructions in relation to NBFCs participating in the insurance business issued on May 27, 2011, in case more than one company (irrespective of doing financial activity or not) in the same group of the NBFC wishes to take a stake in the insurance company, the contribution by all companies in the same group shall be counted for the limit of 50 per cent equity investment in the Insurance JV company.

In the operation of an insurance company, very often, the IRDA requires an insurance company to expand its capital taking into account the stipulations of the Insurance Act and the solvency requirements of the insurance company. The restriction of a group limit of the NBFC to 50% of the equity of the insurance JV company prescribed in the above mentioned circular may act as a constraint for the insurance company in meeting the requirement of IRDA.

Upon review, the RBI has decided that in cases where IRDA issues calls for capital infusion into the insurance JV company, the RBI may, on a case to case basis, consider need-based relaxation of the 50% group limit specified in the RBI circular dated May 27, 2011. The relaxation, if permitted, will be subject to compliance by the NBFC with all regulatory conditions specified in the relevant RBI circular dated February 10, 2004 and such other conditions as may be necessary in the specific case.


Thursday, July 18, 2013


Issue of debentures on private placement basis by NBFCs

NBFCs raise money by issuing capital/debt securities including debentures by way of public issue or private placement. In the case of public issue of such securities, institutions and retail investors can participate. Private placement, on the other hand, may involve institutional investors. The RBI has observed that NBFCs have lately been raising resources from the retail public on a large scale, through private placement, especially by issue of debentures. Hence, the RBI has issued guidelines in this regard, which require NBFCs to space out such issuances and also aim to bring NBFCs at par with other financial entities as far as private placement is concerned by restricting the maximum number of subscribers to forty nine (currently the ceiling of investors stipulated by the Companies Act 1956 for private placement is not applicable for NBFCs). In addition, certain clarifications are also made with regard to security cover for any debenture issue and the treatment of unsecured debentures as public deposits.

Upon further representations by industry, the RBI has revised the above guidelines as follows:

(a) The instruction with regard to minimum gap between two successive issuances of privately placed NCDs will not be operationalized immediately. A decision on the appropriate minimum time gap would be taken by the RBI  in due course. NBFCs, in the meantime, are advised to put in place before the close of business on September 30, 2013, a Board approved policy for resource planning which, inter-alia, should cover the planning horizon and the periodicity of private placement.

(b) Keeping in view the Primary Dealers’ obligations with regard to G-Sec market, it has been decided that the provisions of the said guidelines  shall not be applicable to Primary Dealers.

(c) The restrictions contained in paragraph 2.iii (viz., that an NBFC shall only issue debentures for deployment of funds on its own balance sheet and not to facilitate resource requests of group entities/ parent company / associates) shall not be applicable to Core Investment Companies.

(d) The provisions of paragraph B of the Annex to the said circular (i.e. NBFCs shall ensure that at all points of time the debentures issued, including short term NCDs, are fully secured. Therefore in case, at the stage of issue, the security cover is insufficient /not created, the issue proceeds shall be placed under escrow until creation of security, which in any case should be within one month from the date of issue) shall not apply to subordinated debt, as defined under paragraph 2(1)(xvii) of the Non-Banking Financial (Non-Deposit Accepting or Holding Companies Prudential Norms (Reserve Bank) Directions, 2007.

(e) Further, paragraph 1.i may be read as follows: “private placement means non-public offering of NCDs by NBFCs to such number of select subscribers and such subscription amounts, as may be specified by the Reserve Bank from time to time”.

 RBI Master Circulars

As usual, the RBI has come out with revised master circulars on July 1, 2013. The master circulars pertaining to NBFCs are linked here.
RBI Notices
My learned colleague, Mr. Jayant Thakur, CA has pointed out in the Indian Corporate Law blog that RBI has recently sent notices to thousands of companies asking them whether they are NBFCs. And, if yes, why they have not registered. This is worrying because if a Company is an NBFC and has not registered, it entails serious consequences for the Company and its concerned directors/officers. For example, the law provides for minimum and mandatory punishment of one year for non-registration as NBFC.

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Tuesday, June 11, 2013

NBFCs not to be partners - Clarifications

The RBI noticed that some NBFCs have large investments in/ have contributed capital to partnership firms. In view of the risks involved in NBFCs associating themselves with partnership firms,
by way of a circular dated March 30,  2011, the RBI prohibited NBFCs from contributing capital to any partnership firm or to be partners in partnership firms. In cases of existing partnerships, NBFCs were advised to seek early retirement from the partnership firms.

By way of a circular dated June 11, 2013, certain additional clarifications have been made: 

(a) The prohibition on partnership firms will also include Limited Liability Partnerships (LLPs).

(b) The aforesaid prohibition will also be applicable with respect to associations of persons, these being similar in nature to partnership firms.

The RBI has advised NBFCs which have already contributed to the capital of a LLP/ association of persons or is a partner of a LLP/ association of persons to seek early retirement from such LLP/ association of persons. Logically, these restrictions are meant to prevent any adverse ripple-effect on the non-banking financial sector.

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Arbitration of Shareholder Disputes

On a completely divergent note, in an article in the Financial Express, my colleague Debashish Sankhari and I have looked at whether disputes of oppression and mismanagement in relation to the affairs of a company can be adjudicated through arbitration. This is an important practical question for many a financial investor (and even a long-term strategic investor) who has agreed to arbitration clauses in the investment/ shareholder agreements, and which may also have been incorporated in the articles of association of the company.

After examining various CLB orders and the Supreme Court judgement in Booz Allen & Hamilton, we come to the conclusion that the test to determine as to whether the matter/ claim of oppression and mismanagement is to be relegated to arbitration is to examine as to whether the allegations of oppression/mismanagement can by adjudicated without reference to the terms of the arbitration agreement. In other words, the nature of the allegations should be such that if established, it could definitely be declared as an act of oppression/ mismanagement. In such cases, the matter cannot be referred to arbitration.


CICs - Entry into Insurance Business

By way of a circular dated April 1, 2013, the RBI has notified a separate regulatory framework for the entry of CICs into the insurance business. Prior to this, CICs were governed by the guidelines applicable to NBFCs under the circular DNBS(PD).CC.No.13/02.01/99-2000, dated June 30, 2000 issued by the RBI.

As per this circular, only such CICs registered with RBI, which satisfy the eligibility criteria (as mentioned below), are permitted to set up a joint venture company for undertaking insurance business with risk participation, subject to certain safeguards. The eligibility criteria for joint venture participant are as follows (as per the latest available audited balance sheet):

(a) The Owned Fund of the CIC shall not be less that INR 5,000,000,000;

(b) The level of net non performing assets shall be not more that 1% of the total outstanding advances;

(c) The CIC should have registered net profit continuously for three (3) consecutive years;

(d) The track record of performance of the subsidiaries, if any, of the concerned CIC should be satisfactory;
(e)The CIC shall comply with all the applicable regulations (including provisions of the  the Master Circular on Regulatory Framework for Core Investment Companies dated July 2, 2012, issued by the RBI ('CIC Master Circular')).

While no limit on the investment has been set by the said notification, the maximum equity contribution that such a CIC can hold in the joint venture company will be as per the Insurance Regulatory and Development Authority approval.

Further, NBFCs (in the group or outside the group) are not allowed to join an insurance company on risk participation basis and hence are required not to provide direct or indirect financial support to the insurance venture. Within the group, CICs are permitted to invest up to 100% of the equity of the insurance company (either on solo basis or in joint venture with other non-financial entities in the group).

CICs are prohibited from entering into insurance business in the capacity of “agents”. Further CICs cannot carry on insurance business departmentally.

As per this circular, all CICs (registered with the RBI) entering into insurance business as investor or on risk participation basis will be required to obtain prior approval of the RBI. CICs exempted from registration with the RBI (CICs other than systemically important CICs, as per the CIC Master Circular) are exempted from requirement of prior approval under the CIC Insurance Notification, provided such CICs fulfill all the necessary conditions of exemptions under the CIC Master Circular.

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