This article is written by Arnaz Pestonji, pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.
Table of Contents
Introduction
Foreign funding is a critical source of finance procured by Indian entities to meet their capital requirements. Generally, funds are raised by entities through equity financing, debt financing or a combination of both. External Commercial Borrowings (“ECB”) are commercial loans raised by Indian entities from foreign lenders to borrow funds from an offshore debt market. Indian entities are significantly driven to avail ECB’s on account of lower interest rates, higher quantum of borrowing and less compliance requirements.
ECB’s are raised by prospective borrowers under the automatic route or the approval route. Under the approval route, a request to obtain ECB’s is made to the Reserve Bank of India (“RBI”) by the prospective borrower’s authorised dealer bank (AD Category I bank). Once the approval is received, draw-down (disbursement) of ECB proceeds can take place after Loan Registration Number (“LRN”) from the RBI is obtained.
Borrowing and lending of ECB’s between entities resident in India and outside India is regulated by the RBI under the Foreign Exchange Management Act, 1999. The Foreign Exchange Management (Borrowing and Lending) Regulations, 2018 are the primary regulations governing the ECB transactions. The regulations provide enabling provisions regarding ECB’s but lack necessary framework to carry out ECB transactions.
ECB framework in India
Recognizing the necessity to facilitate foreign lending and the absence of comprehensive framework on ECB’s in India, the RBI revamped the erstwhile ECB framework by issuing a circular[1] dated January 16, 2019 (the “New ECB Framework”). The New ECB Framework prescribed detailed guidelines on the procedure to raise loans through ECB and provided specific parameters in relation to the same.
Subsequently, the RBI introduced the Master Directions[2] dated March 26, 2019 on “External Commercial Borrowings, Trade Credits and Structured Obligations” in supersession of earlier directions[3] and in compilation of former RBI circulars[4] pertaining to ECB’s. The Master Directions, as updated from time to time have further liberalised and streamlined the framework on ECB’s.
Key changes introduced in pursuance to the new ECB Framework
- Merging of Tracks: Earlier, ECB’s were comprised into the following three categories:
- Tracks I (foreign currency denominated ECB with a maturity period of 3-5 years);
- Track II (foreign currency denominated ECB with a maturity period of 10 years);
- Track III (Indian Rupee denominated ECB with a maturity period of 3-5 years).
The New ECB Framework has removed the track system and has comprised the framework for raising loans through ECB into two categories namely “Foreign Currency denominated ECB” (“FCY ECB’s”) and “INR Denominated ECB’s” (“INR ECB’s”). Track I and Track II ECB’s were merged into a single category viz. FCY ECB’s whereas Track III ECB’s and Rupee Denominated Bonds (i.e. Masala Bonds) were merged into one category viz. INR ECB’s.
- Forms of ECB: ECB’s can be denominated in foreign currency or Indian rupees. Under the New ECB Framework, FCY ECB’s and INR ECB’s can be availed by way of loans including bank loans, floating/fixed rate notes; bonds; partially convertible, optionally convertible or non-convertible debentures; trade credits beyond 3 years; and financial lease. FCY ECB’s can also be availed by way of foreign currency convertible bond and foreign currency exchangeable bond; whereas INR ECB’s can further be availed by way of preference shares and plain vanilla rupee denominated bonds issued overseas.
- Eligible Borrowers: The New ECB Framework has widened the scope of eligible borrowers by including all entities who are eligible to receive foreign direct investment as per the FDI policy. Additionally, Port Trusts; Units in SEZ; SIDBI; EXIM Bank of India; registered entities engaged in micro-finance activities, viz., registered not for profit companies; registered societies, trusts, cooperatives and non-government organisations are also eligible to borrow ECB’s.
- Recognised Lenders: The erstwhile ECB framework prescribed lenders for each track. The New ECB Framework has simplified the definition of recognised lenders to include lenders who are residents of Financial Action Task Force or International Organisation of Securities Commission’s compliant countries. The list of recognised lenders further includes:
- Multilateral or Financial Institution where India is a member country;
- Individuals who hold foreign equity or are subscribers of debentures or bonds listed abroad;
- Foreign branches or subsidiaries of Indian banks who raise FCY ECB’s.
- Minimum Average Maturity Period (MAMP): The erstwhile ECB framework provided a MAMP of 3/5 years for Track I and Track III ECBs and a MAMP of 10 years for Track II ECBs. The New ECB Framework provides a uniform MAMP of 3 years for all ECBs except for certain specific categories. For instances, manufacturing companies raising ECB’s up to USD 50 million shall have a MAMP of 1 year.
- End use restrictions: ECB proceeds cannot be utilised for certain purposes, e.g. real estate activities, investment in capital market, equity investment or on lending to another entity. Except as otherwise provided hereinbelow, ECB’s cannot be raised for working capital purposes, general corporate purposes, repayment of rupee loans, or on lending for any of the above activities. Pursuant to the New ECB Framework, eligible borrowers are now allowed to raise ECBs.
- from a foreign equity holder for working capital purposes, general corporate purposes or for repayment of INR loans for a MAMP of 5 years.
- for working capital purposes or general corporate purposes and on-lending by NBFCs for the same purpose for a MAMP of 10 years.
- for repayment of INR loans availed domestically for capital expenditure or on-lending by NBFCs for the same purpose for a MAMP of 7 years.
- for repayment of INR loans availed domestically for purposes other than capital expenditure and on-lending by NBFCs for the same purpose for a MAMP of 10 years.
- ECB Limit: The erstwhile ECB framework provided specific limits for eligible borrowers engaged in specific activities in particular sectors. Under the New ECB Framework, ECB’s can be raised under the automatic route by all eligible borrowers up to USD 750 million or its equivalent per financial year. In case of FCY ECB’s raised under the automatic route from direct foreign equity holders, the borrowers ECB liability-equity ratio cannot exceed 7:1 unless the outstanding amount of all ECB’s, including the proposed one, is up to USD 5 million or its equivalent.
- All-In-Cost: All-In-Cost refers to the maximum cost the eligible borrower is allowed to incur in an ECB transaction. The erstwhile ECB framework did not include any specific components for calculation of all-in-cost. Under the New ECB Framework, all-in-cost includes various components such as the rate of interest, other fees, expenses, charges, guarantee fees, export credit agency charges, whether paid in FCY or INR and excludes Commitment fees and withholding tax payable in INR.
- Form 83: The New ECB Framework has revised the reporting structure of ECB’s. Earlier Indian borrowers were required to obtain LRN by submission of Form 83 to the AD Category I Bank. Form 83 has been replaced with Form ECB. In order to obtain LRN, borrowers are required to submit duly certified Form ECB.
- Raising of ECB by start-ups: Entities recognised by the Central Government as ‘start up’ are allowed to raise ECB up to UDS 3 million or its equivalent per financial year for a MAMP of 3 years from recognised lenders. The start-ups are permitted to use the ECB’s for any expenditure in connection with their business.
- Late submission Fee: The New ECB Framework prescribes regularization of delays by payment of late submission fees as mentioned below by eligible borrowers who have delayed in reporting of drawdown of ECB proceeds before obtaining LRN or delay in monthly reporting of the ECB transactions via Form ECB 2 returns, provided that, the eligible borrowers are otherwise in compliance of the ECB Framework.
- Loan to Eligible Lenders: The New ECB Framework allows eligible lenders to raise ECB’s by way of Rupee loans availed domestically for capital expenditure in manufacturing and infrastructure sectors from the Indian Banks and not the foreign branches and overseas subsidiaries of such banks, provided that, the resultant ECB complies with the norms prescribed in the ECB Framework.
- Creation of Security: Under the New ECB Framework, AD Category I banks are permitted to allow issue of corporate and/or personal guarantees and create securities in favour of the eligible lender to secure ECB’s raised by the eligible borrower, provided that, the underlying ECB complies with the norms prescribed in the ECB Framework, the Loan Agreement includes a security clause pertaining to the security created by the eligible borrower in favour of the eligible lender, No-objection certificate from existing lenders in India has been obtained.
Conclusion
The New ECB Framework aims to increase the inflow of foreign currency in India, facilitates offshore debt funding, promotes cross-border financial activities, and reduces the dependence of Indian entities on the stressed banking system in India. The significant changes made to the ECB Framework by relaxing the end use restrictions, merging the track system, replacing the sector wise borrowing limit with a uniform borrowing limit, altering the eligibility criteria for lenders and borrowers is a welcome step as the changes intend to increase the ease of doing business in India by reducing the challenges faced by Indian entities in availing ECB’s.
References
[1] A.P. (DIR Series) Circular No. 17
[2] FED Master Direction No.5/2018-19
[3] FED Master Direction No.5/2015-16
[4] A. P. (DIR Series) Circular No. 17 dated January 16, 2019, A. P. (DIR Series) Circular No. 18 dated February 08, 2019 and A. P. (DIR Series) Circular No. 23 dated March 13, 2019.
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