As the Indian economy has grown over the years, so have the means of raising foreign debt by Indian companies. What began with limited investment channels for foreign banks and certain qualified institutional investors, has now flourished into a robust foreign debt investment market. Based on the commercial considerations driving a deal, Indian corporates can now raise ECBs under multiple tracks, issue various kinds of rupee denominated bonds, or avail of monies through fund structures such as alternative investment funds (AIFs) and real estate investment trusts (REITs).
Added to this mix is the foreign portfolio investment (FPI) route. What sets FPI apart is the degree of commercial flexibility it accords to investors and companies. For example, end-use and pricing norms applicable to FPI investments are relatively relaxed. Because of this, FPI is often the preferred option for raising debt, particularly short-term debt and working capital funding requirements.
The latest addition in this concoction is the introduction of a new mode of investment by Foreign Portfolio Investors – the Voluntary Retention Route (VRR). Starting from a discussion paper circulated in October, 2018 (FPI Discussion Paper), which has subsequently crystallised into a formal regulation through a circular passed by the Reserve Bank of India (RBI) on March 1, 2019 (FPI-VRR Circular), VRR offers Foreign Portfolio Investors (FP Investors) a greater degree of flexibility in choosing the amount they wish to invest in both the Government and corporate bond market as well as the quantum of time for which the investment will remain in India.
FPI – Recent Past and Current Trends
Currently, there are over 9,000 registered FP Investors, with 2018 seeing the steepest rise in FP Investor registration count. While FP Investors have historically shown interest in the corporate debt market, recent trends indicate that interest of FP Investors in corporate bonds is reducing, with 2018 witnessing maximum net outflow of FPI debt.
Market participants attribute various reasons for this trend. There is general consensus that the regular and sweeping changes to FPI norms by the RBI have been a major cause of turbulence. A case in point is the RBI’s sudden introduction of concentration norms for FPIs between April and June last year without releasing any discussion paper or formally seeking views of the interested stakeholders. Key changes included: (i) a cap on an FP Investor’s exposure to a corporate entity (which include the investee company and its group concerns), which was fixed at 20% of such FP Investor’s corporate bond portfolio; and (ii) a cap on investment by an FP Investor (including its related FP Investors) in a single corporate bond issue, which was fixed at 50% of such issue. Undoubtedly, the regulatory unpredictability has generated a negative market sentiment.
The other reason is reduced projected returns for investment in India vis-à-vis other investment destinations. Increased projected yield for US-bonds, reduced corporate earnings of Indian companies and a weakening rupee are nudging FP Investors to be more cautious and causing FPI outflows from India.
In this economic context, a regulatory push was required to draw the interest of FP Investors back towards the corporate debt market. For Indian corporate entities particularly, FPI functions as a convenient source for raising debt to meet their general corporate and capital funding requirements. In light of this, the RBI relaxed the concentration norms applicable to FPIs within the general investment limits. One significant move was the removal of the 20% corporate bond exposure cap. In what we think is a continuation of this liberalisation drive, the RBI has now introduced VRR for FPI in both G-secs and corporate bonds, as an alternate route for FPIs.
Breaking Down the Voluntary Retention Route
At the heart of the VRR scheme is giving greater autonomy and flexibility to FP Investors by making investments through this route free of “macro-prudential and other regulatory norms applicable to FPI in debt markets”. A key marker of the same is that all investment through VRR is exempt from prevailing concentration norms applicable to FPI under the general investment route.
In addition to this, the RBI has set aside additional limits of INR 40,000 Crores in G-Secs and INR 35,000 Crores in corporate bonds, for investment by FPIs through VRR, which is outside of the general investment limits prescribed for FPIs. For VRR investments in corporate debt, like the general FPI route, eligible instruments include non-convertible debentures issued by Indian companies and NBFCs, perpetual debt instruments issued by banks and securitised debt instruments.
The investment amount to be utilised by FP Investors (called a Committed Portfolio Size or CPS) is allotted to each FP Investor by the RBI through auctions or an on-tap window. In auctions, FP Investors make bids for a CPS through two variables – the amount they wish to invest and the minimum retention period for that investment. However, the minimum retention period bid by FP Investors cannot be lower than 3 years or as prescribed by the RBI prior to the auction. The RBI may thereafter select FP Investors and allot them a CPS in descending order of retention periods that have been proposed.
After allotment, an FP Investor has to commit 25% of its CPS within 1 month of allotment, while the remaining (up to 75% of its CPS) is required to be committed within 3 months thereafter. Exit rights of FP Investors are also unfettered as FP Investors are permitted to transfer their investments under VRR to another FP Investor, provided such purchasing FP Investor complies with the original retention terms of the investment. Unlike for FPI through the general investment route, the FPI-VRR Circular is silent on the transfer of investments by an FP Investor to a domestic investor.
Post the completion of the retention period, FP Investors may either liquidate their investment or transfer the investments to their general investment limits, if available. Having said that, in any case the RBI has permitted FP Investors to roll-over their investments for an identical retention period.
Points to Ponder
Market participants are of the view that the simplicity of the VRR will, in all likelihood, lead to maturity and depth in the Indian corporate bond market. Apart from general benefits of increasing liquidity in the Indian corporate bond market, it is also expected that VRR will allow offshore funds to invest in distressed assets, thereby permitting banks to unlock liquidity that is stuck in non-performing assets, which will aid price discovery of such assets.
Further, the five-month gap between the VRR Discussion Paper and the FPI-VRR Circular within which a structured approach towards VRR was adopted by the RBI in consultation with the Securities Exchange Board of India (SEBI), is a welcome change from the erstwhile practice of having multiple modifications to FPI norms to address concerns on a point-by-point basis.
Another welcome move towards harmonisation of FPI regulations is the recent SEBI circular dated March 12, 2019 which states that, going forward, no further circulars will be issued by SEBI to give effect to RBI directions on investment conditions applicable to FPI in corporate debt securities. It is no surprise that FPI data for March, 2019 indicates the success of the VRR, with FPI in corporate debt seeing a significant increase. What remains to be seen is whether the Voluntary retention route will be the much-needed panacea to ensure stable long-term FPI in the corporate debt market.
 For example, FPI inflow in the June-August quarter of 2017 aggregated to USD 5.3 Billion, while ECB inflow for the same period aggregated to USD 0.3 Billion. See https://www.financialexpress.com/economy/cad-widens-to-2-5-of-gdp-in-q3-on-account-of-a-higher-trade-deficit/1532387/
 Foreign Portfolio Investors can be governments, central banks, multilateral organisations, corporate bodies, broad based funds and trusts who have obtained a certificate of registration as an FPI under the SEBI (Foreign Portfolio Investors) Regulations, 2014.
 The discussion paper, published on the RBI website on October 5, 2018, can be accessed from here.
 RBI circular no. RBI 2018-19/135 dated March 1, 2019 (available here).
Over 600 FP Investors were registered with SEBI in 2018, as per NSDL data. See https://economictimes.indiatimes.com/markets/stocks/news/2018-witnesses-highest-fpi-registrations-in-four-years/articleshow/67278380.cms?from=mdr
 As of December, 2018, net outflows by FP Investors in the debt market was close to INR 52,700 Crores. See https://www.livemint.com/Money/XvrfxeOgowt1zR38CXyDIK/FIIs-withdraw-nearly-Rs-1-trillion-from-Indian-capital-marke.html
 RBI circular no. RBI/2017-18/168 dated April 27, 2018 (available here) and RBI circular no. RBI/2017-18/170dated May 1, 2018 (available here), superseded by RBI circular no. RBI/2017-18/199 (available here) (read with corresponding SEBI circulars).
 RBI circular no. RBI/2018-19/123 dated February 15, 2019 (available here)
 See both the VRR Discussion Paper and the FPI-VRR Circular.
 Eligible instruments are those specified in Schedule 5 of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2017, other than dated treasury bills and units of domestic mutual funds.
 For FPI through the general investment route, transfer of investment by FP Investors to domestic investors has been permitted by RBI vide circular no. RBI/2014-15/448 dated February 3, 2015 (available here).
 As per data available on the NSDL website, FPI in debt, for the month of March aggregates to INR 12,000 Crores. See https://www.fpi.nsdl.co.in/web/Reports/Yearwise.aspx?RptType=6.