This article is written by Arya Mittal from Hidayatullah National Law University. The article deals with recent changes introduced by RBI master directions in relation to external commercial borrowings.
India, being a developing country, has promoted the inward flow of foreign capital for many reasons. Some of the most prominent ways to bring foreign capital are a foreign direct investment, foreign portfolio investment, and external commercial borrowings. The current article deals with external commercial borrowings (ECB) and tries to answer certain questions like – What does ECB mean? Who is eligible for the ECB? What is the legal framework of the ECB? What are the recent developments in the framework and how is it important for the country?
The concept of external commercial borrowings
External commercial borrowings (ECB) refer to debt or borrowing by an eligible resident entity from outside the country from recognized lenders. The term has been defined in Section 2(iv) of FEMA (Borrowing and Lending) Regulations, 2018.
Types of ECBs
ECBs can be broadly classified into foreign currency denominated ECB (FCY denominated ECB) and rupee-denominated ECB (INR denominated ECB).
FCY denominated ECB
Here, ECB is raised in any freely convertible foreign currency. FCY denominated ECB includes Foreign Currency Convertible Bonds (FCCBs), Foreign Currency Exchangeable Bond (FCEB), loans including bank loans, trade credits beyond three years, floating/ fixed-rate notes/ bonds/ debentures (other than fully and compulsorily convertible instruments), and financial lease.
INR denominated ECB
Here, ECB is raised in Indian Rupee. It includes trade credits beyond three years, floating/ fixed-rate notes/ bonds/ debentures (other than fully and compulsorily convertible instruments), loans including bank loans, financial lease, and plain vanilla Rupee denominated bonds issued overseas.
Eligible resident entity
Eligible resident entities include:
- Entities eligible for Foreign Direct Investment (FDI),
- Port trusts
- Units in Special Economic Zone (SEZ)
- Small Industries Development Bank of India (SIDBI)
- EXIM Bank
- Registered entities engaged in micro-finance namely NGOs, not-for-profit companies, trusts, societies
However, entities listed in the last category (point 6) are only allowed to raise INR ECBs.
To be an eligible lender, any of the following conditions should be satisfied:
- A resident of the Financial Action Task Force (FATF) or International Organization of Securities Commissions (IOSCO) compliant country.
- Regional and multilateral financial institutions where India is a member.
- Individuals who are foreign equity holders.
- Individuals subscribed to bonds/debentures listed abroad.
- Foreign branches or subsidiaries of Indian banks (subjected to certain conditions).
Advantages of external commercial borrowings
Diverse investor base
The international arena helps the entities to get access to diverse investors as per their needs.
ECBs need not necessarily be equity-oriented i.e. it will not dilute the ownership of the existing members. This will not give voting powers to the lender and retain the control of the company’s existing stakeholders.
Lower interest rates
As a result of a diverse investor base, entities tend to get loans at lesser rates which they would not have got within the local limits.
Meeting larger requirements
Since the scope for borrowing is expanded by crossing local limits, it helps the entities to meet their larger requirements which might not be possible within the local limits.
The government can regulate the flow of funds more towards a particular sector of the economy which will boost the economy as a whole.
Analyzing the role of FEMA regulations
Laws surrounding the regulation of ECB
Foreign Exchange Management Act, 1999, Foreign Exchange Management (Borrowing and Lending) Regulations, 2018, and Master Directions on External Commercial Borrowings, Trade Credits, and Structured Obligations issued by the Reserve Bank of India (RBI) provide for the regulation of ECBs. RBI has a right to issue Master Directions according to Section 10(4) and Section 11(1) of the Foreign Exchange Management Act, 1999.
In the current article, the scope of the study has been limited to the Master Directions issued by RBI which provided for a new ECB framework/policy. Directions issued on January 16, 2019, February 08, 2019, March 13, 2019, July 30, 2019, and April 07, 2021, have been taken into consideration. The major changes in the policy have been discussed.
Objectives of the FEMA regulations
The regulations aim at the following:
- To regulate borrowing and lending transactions between a party residing in India and a party residing outside India.
- To rationalize the existing framework of external commercial borrowings.
- To strengthen the AML/CFT (Anti-Money Laundering/Combating the Financing of Terrorism) framework.
- To improve the ease of doing business in India.
Prohibition on the drawing of ECBs
Master Directions by RBI provides for restrictive end-uses i.e. a negative list that prohibits the utilization of ECB for certain purposes as enlisted below:
- Real estate activities.
- Investment in the capital market.
- Equity investment.
- Working capital purposes, except in the case of ECB raised from foreign equity holders, are used for working capital purposes, general corporate purposes, or repayment of Rupee loans and ECB raised for working capital purposes or general corporate purposes.
- General corporate purposes, except in the case of ECB raised from foreign equity holders, are used for working capital purposes, general corporate purposes, or repayment of Rupee loans and ECB raised for working capital purposes or general corporate purposes.
- Repayment of Rupee loans, except in case of ECB raised for repayment of Rupee loans availed domestically for capital expenditure and for purposes other than capital expenditure.
- On-lending to entities for the above activities, except in case of ECB raised by NBFCs for working capital purposes or general corporate purposes, for repayment of Rupee loans availed domestically for capital expenditure and purposes other than capital expenditure.
The route for drawing ECBs
ECB up to USD 750 million or equivalent per financial year shall be permitted automatically if they are in compliance with other provisions of the framework. For startups, ECB is limited to USD 3 million or equivalent per financial year. This means that they will not require prior approval from the Reserve Bank of India within the prescribed limits. They need to submit Form ECB to Designated AD Category I bank who will be responsible for considering ECB proposal and also assuring its compliance. Any non-compliance would attract penalties and adjudication under FEMA.
Otherwise as stated above, an entity can raise ECB by requesting RBI. In such a case, they need to approach the RBI with Form ECB for examination with the help of their AD Category I bank.
Overview of the changes in the new regulation
Classification of ECBs
ECBs were classified into three categories and the same has now been done away with. Now, the ECBs are bifurcated into foreign currency denominated ECBs and Indian rupee-dominated ECBs.
Eligibility for borrowers
Entities were earlier classified into Track I, II, and III in order to avail ECBs. Now, the policy has been liberalized by allowing entities eligible for FDI to avail ECBs. As a result, even certain LLPs are now eligible to avail ECB which was previously not possible.
Eligibility for lenders
Just like the borrowers, the lenders were also categorized in tracks. However, in the new policy, the eligibility of lenders has been diversified as discussed earlier.
Prohibition on drawing of ECBs as discussed above has been provided in the new framework.
Minimum average maturity period
Minimum Average Maturity Period (MAMP) has now been made uniform by prescribing a period of three years. However, there can be exceptions in the following cases:
- MAMP can be one year for manufacturing sector companies who raise ECBs up to USD 50 million or its equivalent per financial year.
- MAMP shall be five years in case ECB raised from foreign equity holder is appropriated for working capital purposes, general corporate purposes, or repayment of Rupee loans.
- MAMP shall be ten years in case ECB is raised for working capital purposes or general corporate purposes or on-lending by NBFCs for working capital purposes or general corporate purposes.
- MAMP shall be seven years in case ECB is raised for repayment of Rupee loans availed domestically for capital expenditure or on-lending by NBFCs for the same purpose.
- MAMP shall be ten years in case ECB is raised for repayment of Rupee loans availed domestically for purposes other than capital expenditure or on-lending by NBFCs for the same purpose.
It is important to remember that for points 2 to 5, MAMP should be mandatorily complied with and in these cases, foreign branches/subsidiaries of Indian banks will not be considered as eligible lenders.
Like previously, the current framework also provides for a uniform all-in-cost of benchmark rate plus 450 basis points. Now, it explicitly stipulates that the proceeds of ECB shall not be used for payment of charges and interests. However, now, it provides for a cap of 2% over and above the contracted rate of interest on the outstanding principal amount in relation to prepayment charges.
Liability equity ratio
The new policy provides that the ECB liability equity ratio raised under automatic route cannot exceed 7:1 in case of foreign currency-denominated ECB (FCY-denominated ECB) raised from a foreign equity holder. However, this condition will not apply if the outstanding amount of all ECB, including the current ECB, does not exceed USD 5 million or its equivalent.
In the previous framework, a hedging requirement of 100 percent was mandatory in the case of specified companies if the borrowings matured between a period of three to five years under foreign currency denominated ECB. Currently, the requirement is reduced to 70 percent and is applicable under foreign currency denominated ECB. However, now a new term has been introduced i.e. infrastructure space companies. As per the definition of the term, companies in the infrastructure sector, NBFCs undertaking infrastructure financing, Housing Finance Companies regulated by National Housing Bank, Holding Companies/ Core Investment Companies undertaking infrastructure financing, and Port Trusts shall be included in its ambit. It is the duty of the AD Category I Bank to assure that hedging requirements are fulfilled. Additionally, the provision also covers other operational aspects such as coverage, tenor and rollover, and natural hedge.
Form for reporting ECB
Earlier, Form 83 was submitted for reporting ECB whereas now Form ECB needs to be submitted to report ECB in case they need to raise the funds through the approval route.
SOP for untraceable entities
A new concept named Standard Operating Procedure (SOP) has been designed for untraceable entities. It states that AD Category I Banks should follow the prescribed procedure in case any untraceable entity is in non-compliance with the reporting provisions for eight or more quarters. It provides an action plan that will be followed in case any untraceable entity is found to be in non-compliance with the reporting provisions.
Entities under restructuring
An entity facing a corporate insolvency resolution process or under a restructuring scheme can raise ECBs only if the resolution plan explicitly allows it to do so. Earlier, it was mandatory to take the consent of the Corporate Debt Restructuring Empowered Committee or Joint Lender Forum.
Late submission fee
Borrowers now have an opportunity to regularise the delay in reporting of drawdown of ECB proceeds if they comply with ECB guidelines. The procedure for the same is as follows:
- Delay up to 30 calendar days from the due date of submission – Form ECB 2 along with INR 5000.
- Delay up to three years from the due date of submission/date of drawdown – Form ECB 2/ECB along with INR 50,000 per year.
- Delay beyond three years from the due date of submission/date of drawdown – Form ECB 2/ECB along with INR 1,00,000 per year.
It is important to remember that though the delay can be regularised non-payment of the late fees would attract penal action and adjudication under FEMA.
External Commercial Borrowings is one of the emerging sources for bringing foreign capital to India. With the introduction of a new framework i.e. Master Directions issued by the RBI, the norms have been relaxed substantially which has improved the ease of doing business in India. Provisions of the automatic route, increased scope for eligible borrowers and lenders, simpler classification of ECBs, regularising delays by submitting late fee reduced hedging requirements, etc. will hopefully prove to be a boon for the economy in the years to come. This will help to develop resident entities which will boost the economy as a whole.
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