Masala Bonds: RBI’s Master Chef Recipe

On September 29, 2015, the Reserve Bank of India (RBI) donned its master chef toque and introduced a recipe for issue of Rupee denominated bonds (colloquially nicknamed as “Masala Bonds”) under external commercial borrowing (ECB) regime. Since then, several corporates have already announced plans or begun to take preparatory steps to issue such bonds.

The ability to issue Masala Bonds is a positive and refreshing departure from the conventional and confining ECB framework. The new framework, if implemented effectively, could be a win-win situation for both issuers and investors. Indian issuers can benefit by raising Rupee debt from overseas investors at possibly lower interest rates than available domestically and use the proceeds for varied purposes, including working capital or debt repayment. A wide pool of offshore investors can benefit from investing in Indian debt at higher rates of interest than they would probably have earned offshore (even after deducting any hedging costs), and such debt can also be secured by the Indian companies as well as guaranteed by Indian group companies.

A few key principles appear to underscore the Masala Bonds regulatory framework.

• Market driven and flexible approach: The framework provides issuers liberty in determining the all-in-cost ceiling on Masala Bonds based on prevailing market conditions, rather than prescribing a limit. This free pricing approach is a welcome move and in line with international standards. Further, investors have also been granted access to the domestic market through branches or subsidiaries of Indian banks abroad or branches of foreign bank with Indian presence on a back to back basis. Another major relaxation is the ability to use the proceeds of Masala bonds for any purpose barring a few restricted purposes, such as real estate activities, investing in capital markets or equity investments, use in activities prohibited under the foreign direct investment (FDI) guidelines, purchase of land or on-lending for any of aforementioned restricted purposes. The MS Sahoo Committee had recommended removing all restrictions on end use for ECBs except the negative list prescribed for FDI. While the RBI has still not adopted those recommendations for ECBs, a liberalisation of the end-use restrictions for Masala Bonds is clearly a step in the right direction.

• Equal Access: Unlike the ECB guidelines which impose restrictions on the type of entities that can borrow ECBs, the RBI has permitted any corporate (including services companies) or body corporate, SEBI registered REITs and InvITs to issue such bonds. This is an opportune time for such a relaxation as many Indian corporates are facing difficulties in repayment of foreign currency debt and could tap this route to avail rupee denominated debt and ensure stability in future debt servicing.

• Greater outreach: Under the ECB guidelines, only certain categories of persons are recognised lenders, and such categories do not include investors such as sovereign wealth funds, pension funds, hedge funds, debt funds or family offices. RBI has substantially increased the group of eligible investors/lenders for Masala Bonds to any investor from a Financial Action Task Force (FATF) compliant jurisdiction, thereby providing the opportunity to other international players to participate and also increasing the sources of funding for Indian corporates. The only exception is for banks incorporated in India, who cannot access Masala Bonds, but can act as arrangers and underwriters, subject to certain conditions. Further, issuers have been provided the ability to privately place the bonds or list them on stock exchanges. While the bond must have a minimum maturity period of 5 years and there can be no put or call options during the period, it is hoped that if such bonds are listed, it will provide some flexibility to investors to exit in a secondary market during the tenure of the bond.

• Tax incentivisation: Recently, the Central Board of Direct Taxes has issued a press release clarifying that interest payable on Masala Bonds will also be subject to a withholding tax at the rate of 5% similar to off-shore dollar denominated bonds. The press release also clarifies that any capital gains arising in case of appreciation of rupee between the date of issue and the date of redemption against the foreign currency in which the investment is made would be exempt from capital gains tax. While the press release has rendered much needed clarity on the tax treatment of Masala bBonds, it will be pertinent to see the exact nature of amendments that will be incorporated in the Income Tax Act, 1961 through the Finance Bill, 2016.

However, in order for RBI’s Masala Bonds recipe to cook well, some ambiguities need to prompt attention.

• Firstly, clarification is needed on whether provisions on private placement under the Companies Act, 2013 will have to be complied with for issue of such Masala Bonds. In November 2014, the Ministry of Corporate Affairs had clarified that such provisions are not applicable for foreign currency convertible bonds or foreign currency bonds issued under the Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipts Mechanism) Scheme, 1993. Another circular on similar lines for Masala Bonds is essential.

• Secondly, it is important to clarify the minimum tenure requirement for Masala Bonds. The ECB guidelines provide that ECBs must have a minimum “average” maturity, whereas the Masala Bonds framework has a minimum maturity condition. It is unclear whether the Masala Bonds can be redeemed in part, from time to time, as long as parts of the Masala Bonds are still redeemed on or after 5 years. Another question is whether such Masala Bonds can be fully redeemed prior to the 5 year term on the occurrence of an event of default or certain other events such as change of control or a future offering of securities of the issuer. The current ECB guidelines do not allow borrowers to prepay an ECB if the minimum average maturity will not be maintained as a result of such prepayment, thereby implying that RBI approval is needed for prepayment of the ECB in case of an event of default that occurs prior to maturity. However, if a similar interpretation is applied for Masala Bonds, it will be difficult for issuers to access a wider pool of investors.

• Additionally, since the Masala Bonds will have to be settled in foreign currency, appropriate regulatory provisions need to be in place to permit net settlement by offshore investors of hedges entered into with Indian banks.

The Masala Bond route has the potential to improve foreign debt management for Indian corporates. But in order for issuers to efficaciously use this route, a speedy resolution of the above issues is vital.