Funding Indian corporates through debt has been traditionally been a preferred mode of funding due to inherent advantages such as security creation, minimum guaranteed returns and tax optimization for both the lender as well as the borrower. The modes for offshore debt funding have been limited to external commercial borrowings (“ECB”), non-convertible debentures (“NCD”), compulsorily convertible debentures and certain hybrid debt instruments. Each of these options have been subjected to regulatory restrictions in terms of eligible lenders, eligible borrowers, end-use restrictions, etc. Tightening of the NCD route, and the introduction of Rupee-denominated bonds under the ECB route have seen the ECB route gain more prominence as a preferred route, despite the challenges in the route for parties.
As part of the Central government’s aim to improve ease of doing business in India, the Reserve Bank of India (RBI) on 16 January 2019 notified a new external commercial borrowings framework (New ECB Framework). The New ECB Framework rationalizes the existing external commercial borrowings framework (Old ECB Framework) by merging the existing Track I (medium-term foreign currency denominated ECB) and Track II (long-term foreign currency denominated ECB) into one track as ‘Foreign Currency Denominated ECB‘. Existing Track III (Indian Rupee denominated ECB) and the Indian Rupee denominated bonds (Masala Bonds) route has been merged as ‘Rupee Denominated ECB‘.
In its attempt to simplify the Old ECB Framework and influence the inflow of foreign debt, the RBI has further expanded the list of eligible borrowers, widened the list of recognized lenders, reduced the minimum average maturity period (MAMP) to 3 years and set a uniform individual limit of USD 750 million in a financial year for eligible borrowers, applicable across both types of ECB. The merging of Track III and Masala Bonds will also enable eligible borrowers to issue Masala Bonds without undergoing the verification process of the RBI that was previously required.
The RBI has also reduced the mandatory hedging requirement from 100% to 70% under the Foreign Currency Denominated ECB option for those entities covered under the term ‘infrastructure space companies’. Further, under the Old ECB Framework, ECB proceeds raised from a recognized lender under Track II (which required a MAMP of 10 years) could be utilized to repay domestic Rupee loans. However, the RBI has removed such refinancing as a permissible end use in the new ECB Framework, unless the ECB is raised from foreign equity holders with a MAMP of 5 years.
Background of Changes in ECB Regulatory Framework
The ECB framework has been governed by the regulations of the RBI framed under the Foreign Exchange Management Act, 1999 (“FEMA”), and the ‘Master Direction – External Commercial Borrowings, Trade Credit, Borrowing and Lending in Foreign Currency by Authorized Dealers and Persons other than Authorized Dealers’ (the “ECB Master Direction”). The RBI on January 16, 2019 has by way of a circular (“Circular”) revised the entire existing regulatory framework for ECBs in India.
Changes in External Commercial Borrowings: Regulatory Framework
♣ Forms of ECB
The framework for raising loans through ECB comprises the following two options:
- Option 1: Track I and Track II ECBs clubbed as ‘Foreign currency denominated ECB’ (“FCY ECB”). Loans including bank loans; floating/ fixed rate notes/ bonds/ debentures (other than fully and compulsorily convertible instruments); Trade credits beyond 3 years; FCCBs; FCEBs and Financial Lease
– Option 2: Track III and Rupee denominated bonds clubbed as INR denominated ECB (“INR ECB”). Loans including bank loans; floating/ fixed rate notes/ bonds/ debentures/ preference shares (other than fully and compulsorily convertible instruments); Trade credits beyond 3 years; and 4 Financial Lease. Also, plain vanilla Rupee denominated bonds issued overseas (RDBs), which can be either placed privately or listed on exchanges as per host country regulations.
Takeaway: The various forms of ECB made the regulatory framework quite complex, and the rationale for the distinction (except for the foreign currency denominated ECB and the Rupee denominated ECB) was considered redundant in recent times. The clubbing of Track I and Track II ECB as a single option, i.e. the FCY ECB and the clubbing of Track III and RDBs into a single ECB option, i.e. INR ECB is a welcome move. The RBI has gradually over the last 12 – 18 months amended the ECB Master Directions such that the regulatory differences between Track I and Track II ECBs, as well as between Track III and RDBs have been narrowing. While there were still pertinent differences between the various options (eligible lenders, eligible borrowers and end use prescriptions), such differences also offered the parties opportunities for regulatory arbitrage. The clubbing of the tracks will result in the ECB regulatory framework being simpler and less complex, and reduce regulatory arbitrage.
♣ Eligible borrowers
– All entities eligible to receive FDI. Further, the following entities are also eligible to raise ECB:
a) Port Trusts;
b) Units in SEZ;
d) EXIM Bank; and
e) Registered entities engaged in micro-finance activities, viz., registered Not for Profit companies, registered societies/trusts/cooperatives and Non-Government Organizations (permitted only to raise INR ECB).
Takeaway: One of the most important considerations for determining if ECB was a viable option for raising offshore debt was whether the proposed borrower is eligible to raise ECB. This was often considered to be a substantial bottleneck, considering that the ECB framework also provided for end-use restrictions in terms of the funds raised through the ECB (see below).
The RBI has now done away with the specific eligibility requirements, and prescribed that any entity eligible to raise FDI shall be permitted to raise ECB. This is a positive move in considering that the list of entities eligible to raise FDI are sufficiently regulated in any case under the regulations applicable to FDI. The specific permission for real estate investment trusts and infrastructure investment trusts have been removed since FDI is permitted in such entities, and they would qualify for availing ECB in any case. Basis the same logic, an interesting aspect to be noted here is that FDI is also permitted in certain limited liability partnerships (“LLP”), and hence ECB may also be availed of by LLPs. It is unclear if the RBI intended to open the ECB route for LLPs as well, but if this is the case, it would provide a much needed encouragement to LLPs as well, and may result in growth in the number of LLPs used for structuring investments.
♣ Eligible lenders
For both FCY ECB and INR ECB:
– All residents of a FATF or IOSCO compliant country.
– Individuals are eligible to be lenders under the ECB framework if they are foreign equity holders (i.e. hold 26% directly or 51% indirectly in the borrower).
Takeaway: The Circular revises the persons who are eligible to be lenders under the ECB framework. While earlier specified persons were only entitled to be eligible lender (under the 3 tracks), the RDB route was preferred since there was no specific requirement on a person to be an eligible lender. However, by now having the same eligibility for lenders under the FCY ECB and INR ECB, lenders who were not eligible under track I and track II are also now eligible. This would provide a major push for such lenders, who wanted to lend in foreign currency, but were unable to due to ineligibility as lenders. This also broadens the options available for potential lenders under the ECB framework.
Another major benefit of the changes introduced under the Circular is the removal of the restriction on related parties (defined under the applicable accounting standard) to invest in RDBs. Captive lending, i.e. lending by parent companies to its Indian subsidiaries has often been a preferred mode of investment into subsidiaries by offshore parents. However, this restriction on subscription of RDBs by related parties resulted in this option being unavailable to parent companies till now. The removal of the restriction would also provide offshore parents the option to invest through RDBs.
♣ Minimum average maturity period
FCY ECB and INR ECB: MAMP of 3 years (irrespective of amount). However, manufacturing sector companies may raise ECBs with MAMP of 1 year for ECB up to USD 50 million or its equivalent per financial year.
Further, for ECB raised from foreign equity holders for general corporate / working capital purposes, the MAMP is 5 years.
Takeaway: The Circular has removed the distinction between the MAMP applicable under the various tracks and RDB. The new ECB framework has a single MAMP applicable to both FCY EBC as well as INR ECB. This is a welcome step since the distinguishing factor between the various tracks was becoming redundant. For instance, the long MAMP under Track II was proving to be a deterrent for parties to avail ECB under Track II.
♣ End-use restrictions
FCY ECB and INR ECB: The end use restrictions in case of both FCY ECB and INR ECD are
(a) real estate activities;
(b) investment in capital market;
(c) equity investments;
(d) repayment of Rupee loans (except if from foreign equity holder);
(e) working capital purposes and general corporate purposes (except if from foreign equity holder); and
(f) on-lending for the above activities.
Takeaway: While the Circular has sought to simplify and harmonize the end-use restrictions across the various tracks and RDB by prescribing a single negative / restrictive end-use prescription. However, an unwanted implication of the harmonizing the end-use restriction is that the restrictions that were not applicable to Track II and RDBs earlier (most notably being general corporate purpose and working capital purposes) are now applicable to them. This could have major implications for ECBs through RDBs, since general corporate purposes / working capital purposes was one of the pre-dominant purposes for which ECB was raised.
The Circular has removed the distinction between the MAMP applicable under the various tracks and RDB. The new ECB framework has a single MAMP applicable to both FCY EBC as well as INR ECB. This is a welcome step since the distinguishing factor between the various tracks was becoming redundant. For instance, the long MAMP under Track II was proving to be a deterrent for parties to avail ECB under Track II.
♣ All-in-Cost Ceiling
Like the Old ECB Framework, the New ECB Framework provides for a uniform all-in-cost of benchmark rate plus 450 basis points and excludes prepayment charges/fees from the all-in-cost ceiling. However, unlike the Old ECB Framework, the new framework now provides for a cap of 2% over and above the contracted rate of interest on the outstanding principal amount in relation to prepayment charges.
♣ Uniform Individual Limits
All eligible borrowers can raise ECBs up to USD 750 million in a financial year under the automatic route. Further, in case of FCY denominated ECB raised from direct foreign equity holder ECB liability-equity ratio for ECBs raised under the automatic route cannot exceed 7:1. However, this ratio will not be applicable if outstanding amount of all ECBs, including proposed one, is up to USD 5 million or equivalent.
A rule-based dynamic limit of 6.5% of the GDP at current market prices for outstanding stock of ECBs has also been announced through a RBI circular dated 20 December 2018. Details of how such dynamic limits will be implemented are awaited.
♣ Reduced Hedging Requirements
Reduction in mandatory hedging requirement from 100% to 70% for ‘infrastructure space companies‘ under the Foreign Currency Denominated ECB track.
‘Infrastructure space companies‘ inter alia includes companies in the infrastructure sector and non-banking finance companies undertaking infrastructure financing.
♣ Late Submission Fee (LSF) for delay in Reporting
Any borrower, who is otherwise in compliance of ECB guidelines, except for a delay in reporting drawdown of ECB proceeds before obtaining LRN or Form ECB 2 returns, can regularize the delay by payment of a late submission fee, as prescribed.
However, Form ECB and Form ECB 2 returns reporting contraventions will be treated separately. Non-payment of late submission fee will be treated as a contravention of reporting provision and shall be subject to compounding or adjudication as provided in FEMA.
|Type of Return/Form
|Period of delay
|Form ECB 2
|Up to 30 calendar days from due date of submission
|Form ECB 2/Form ECB
|Up to three years from due date of submission/date of drawdown
|INR 50,000 per year
|Form ECB 2/Form ECB
|Beyond three years from due date of submission/date of drawdown
|INR 100,000 per year
With the inclusion of this change, borrowers who are otherwise in compliance can regularize their reporting delays without having to go to the RBI for compounding contraventions.
♣ Monthly Reporting of actual transactions
The borrowers are required to report actual ECB transactions through Form ECB 2 Return (Annex II) through the AD Category I bank on monthly basis so as to reach DSIM within seven working days from the close of month to which it relates. Changes, if any, in ECB parameters should also be incorporated in Form ECB 2 Return.
♣ ECB facility for Startups
AD Category-I banks are permitted to allow Startups to raise ECB under the automatic route as per the following framework:
1. Eligibility: An entity recognized as a Startup by the Central Government as on date of raising ECB.
2. Maturity: Minimum average maturity period will be 3 years.
3. Recognized lender: Lender / investor shall be a resident of a FATF compliant country. However, foreign branches/subsidiaries of Indian banks and overseas entity in which Indian entity has made overseas direct investment as per the extant Overseas Direct Investment Policy will not be considered as recognized lenders under this framework.
4. Forms: The borrowing can be in form of loans or non-convertible, optionally convertible or partially convertible preference shares.
5. Currency: The borrowing should be denominated in any freely convertible currency or in Indian Rupees (INR) or a combination thereof. In case of borrowing in INR, the non-resident lender, should mobilize INR through swaps/outright sale undertaken through an AD Category-I bank in India.
6. Amount: The borrowing per Startup will be limited to USD 3 million or equivalent per financial year either in INR or any convertible foreign currency or a combination of both.
7. All-in-cost: Shall be mutually agreed between the borrower and the lender.
8. End uses: For any expenditure in connection with the business of the borrower.
9. Conversion into equity: Conversion into equity is freely permitted subject to Regulations applicable for foreign investment in Startups.
10. Security: The choice of security to be provided to the lender is left to the borrowing entity. Security can be in the nature of movable, immovable, intangible assets (including patents, intellectual property rights), financial securities, etc. and shall comply with foreign direct investment / foreign portfolio investment / or any other norms applicable for foreign lenders / entities holding such securities. Further, issuance of corporate or personal guarantee is allowed. Guarantee issued by a non-resident(s) is allowed only if such parties qualify as lender under ECB for Startups. However, issuance of guarantee, standby letter of credit, letter of undertaking or letter of comfort by Indian banks, all India Financial Institutions and NBFCs is not permitted.
11. Hedging: The overseas lender, in case of INR denominated ECB, will be eligible to hedge its INR exposure through permitted derivative products with AD Category – I banks in India. The lender can also access the domestic market through branches/ subsidiaries of Indian banks abroad or branches of foreign bank with Indian presence on a back to back basis. Note: Startups raising ECB in foreign currency, whether having natural hedge or not, are exposed to currency risk due to exchange rate movements and hence are advised to ensure 14 that they have an appropriate risk management policy to manage potential risk arising out of ECBs.
12. Conversion rate: In case of borrowing in INR, the foreign currency – INR conversion will be at the market rate as on the date of agreement.
13. Other Provisions: Other provisions like parking of ECB proceeds, reporting arrangements, powers delegated to AD banks, borrowing by entities under investigation, conversion of ECB into equity will be as included in the ECB framework. However, provisions on leverage ratio and ECB liability: Equity ratio will not be applicable. Further, the Start-ups as defined above [8.2. (i)] as well as other start-ups which do not comply with the aforesaid definition but are eligible to receive FDI, can also raise ECBs under the general ECB route/framework.
♣ Standard Operating Procedure (SOP) for Untraceable Entities
The New ECB Framework introduces a new concept of ‘SOP for Untraceable Entities‘ which provides the action plan to be undertaken by the RBI against untraceable entities who are in contravention of reporting provisions under the New ECB Framework, for eight quarters or more.
i. Definition: Any borrower who has raised ECB will be treated as ‘untraceable entity’, if entity/auditor(s)/director(s)/ promoter(s) of entity are not reachable/responsive/reply in negative over email/letters/phone for a period of not less than two quarters with documented communication/ reminders numbering 6 or more and it fulfills both of the following conditions:
a. Entity not found to be operative at the registered office address as per records available with the AD Bank or not found to be operative during the visit by the officials of the AD Bank or any other agencies authorized by the AD bank for the purpose;
b. Entities have not submitted Statutory Auditor’s Certificate for last two years or more;
ii. Action:The followings actions are to be undertaken in respect of ‘untraceable entities’:
a. File Revised Form ECB, if required, and last Form ECB 2 Return without certification from company with ‘UNTRACEABLE ENTITY’ written in bold on top. The outstanding amount will be treated as written-off from external debt liability of the country but may be retained by the lender in its books for recovery through judicial/ non-judicial means;
b. No fresh ECB application by the entity should be examined/processed by the AD bank;
c. Directorate of Enforcement should be informed whenever any entity is designated ‘UNTRACEABLE ENTITY’; and
d. No inward remittance or debt servicing will be permitted under auto route
♣ ECB by Entities under Restructuring
Entities under a restructuring scheme/corporate insolvency resolution process can raise ECBs only if specifically permitted under the resolution plan.
Compliance with the guidelines
The primary responsibility for ensuring that the borrowing is in compliance with the applicable guidelines is that of the borrower concerned. Any contravention of the applicable provisions of ECB guidelines will invite penal action under the FEMA. The designated AD Category I bank is also expected to ensure compliance with applicable ECB guidelines by their constituents.
The revision of the regulatory framework for ECB by the RBI is a positive step in simplifying the extant regime for ECB, and has resulted in substantial easing of the regime for debt funding by foreign corporates. The tax sops that have been introduced for ECBs, coupled with relaxation on LLPs raising ECBs, bucket of eligible lenders and the purpose for which ECBs can be raised, should encourage further ECB flows into the country.