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Sidharrth Shankar a Partner at J. Sagar Associates, analyses the term ‘Core Investment Companies’ added by the RBI to the Indian finance lexicon and clarifies whether an investment or a holding company qualifies as a NBFC.
The RBI officially added a new term ‘Core Investment Companies’ (CICs) to the Indian finance lexicon earlier this month. In doing so, the central bank has finally offered some clarity to the long standing question of whether an investment or holding company qualifies as a non-banking finance company (NBFC). The answer, it appears, is more “sort of.” Though the introduction of the CICs brings much needed clarity, the accompanying regulatory framework still leaves several questions unanswered!
In the past, concerns about the regulatory characterization of such companies arose because, as the RBI has also recognized, there were practical difficulties in determining whether a company held shares as an “investment” or in the course of “business.” Only the latter motive would fall under the ambit of NBFC regulation and thus attract regulatory scrutiny. However, thanks to RBI’s notification on the regulatory framework applicable to CICs, we now know that certain CICs will be considered NBFCs albeit justifiably deserving a “differential treatment in the regulatory prescription”.
As per the new mandate, CICs with having an asset size less than Rs. 100 crore are exempted from registration with the RBI (as a CIC or NBFC); and those with larger balance sheet will be designated “systemically important” and must obtain a certificate of registration from the RBI.
Holding companies that meet the following incremental requirements will qualify as CICs (and thus benefit from special regulatory treatment):
(a) it holds not less than 90% of its total assets in the form of an investment in equity shares, preference shares, debt or loans in “group companies”;
(b) its investments in equity shares (including instruments compulsorily convertible into equity shares within a period not exceeding 10 years from the date of issue) in group companies constitutes not less than 60% of its total assets;
(c) it does not trade in its investments in shares, debt or loans in group companies except through a block sale for the purpose of dilution or disinvestment; and
(d) it does not carry on any other financial activity except making investments in bank deposits, money market instruments, government securities, and intra-group loans and guarantees.
Systemically important CICs will be subjected to a twofold regulatory regime. First, they would be required to maintain a minimum capital ratio, whereby their adjusted net worth shall not be less than 30% of their aggregate risk weighted assets on- and off-balance sheet. Second, they would be subject to a maximum leverage ratio, whereby their liabilities must not exceed 2.5 times their adjusted net worth. Certifications as to compliance will also be required.
Prima facie, it would not seem difficult for most holding companies to comply with the capital adequacy and leverage ratios as usually the respective figures prescribed by the RBI customarily reflect the upper cap in any case. There are, however, some potential issues arising from the proposed framework.
First, the RBI has not defined the term “group company.” The prerequisite for the CIC designation as holding at least a 90% investment in group companies could prove overtly restrictive if “group” status implies some form of control as opposed to mere affiliation. Private equity and venture capital investments, for example, almost always involve minority investments. Similarly, other holding companies may hold interests in joint ventures. Secondly, the restriction on any other financial activities (apart from investment in downstream group companies and certain other liquid instruments) may need to be relaxed to permit minority investments and investments in mutual funds. Thirdly, the RBI’s notification states that for the purpose of the Rs. 100 crore registration threshold, all CICs “belonging to a Group will be aggregated.” In light of the exact definition of what constitutes a group, there may be operational issues in performing such aggregation calculations. Also, NBFCs are not (currently) permitted to borrow from banks for investments made in corporate shares or debentures or to provide any types of loans or advances to their subsidiaries and group companies. The regulatory framework implicitly deals with the latter issue; there is, however, no express clarity on the former.
Policymakers have taken crucial steps in recent years to open India’s doors to investment while maintaining prudent regulation. The RBI’s new framework on CICs is another such step and should be welcomed for reducing significant regulatory uncertainty. Clarifying the few, but important, uncertainties that still remain would be a further improvement, benefiting all market participants.
Sidharrth Shankar is a Partner at J. Sagar Associates where he handles the firm’s corporate and commercial work along with Banking & Finance, including Mergers & Acquisitions, Project Finance and Private Equity investments.