Voluntary Retention Route for Foreign Portfolio Investors

Posted On - 7 May, 2019 • By - Kulin Dave

In March 2019, the Reserve Bank of India (RBI) along with
Government of India and the Securities and Exchange Board of India (SEBI)
introduced a separate scheme called “Voluntary Retention Route”[1]
to encourage Foreign Portfolio Investors (FPI) to lock their investments in
India for a considerable period. This route has been introduced in an attempt
to boost foreign investment in the Indian debt market by such investors, as the
market witnessed a sharp decline after the FPIs sold their debt securities worth
INR 1900 Crore in February 2019[2].

This scheme was earlier proposed in October 2018 by the RBI
through a discussion paper[3]
and, following the representations and suggestions from market participants, it
released a circular[4]
that notified the FPIs regarding the Voluntary Retention Route provided to them
to voluntarily invest in both government securities like treasury bills and
state development funds as well as corporate debt instruments (specified in
schedule 5 of the Foreign Exchange Management (Transfer or Issue of Security by
a Person Resident outside India Regulations, 2017; excluding units of domestic
mutual funds and dated government securities) subject to the condition that the
investment must be locked in India for a minimum period of three years.

Key Features:

The
circular notifies that investment through the VRR route shall be free of any
regulatory approvals applicable to investments normally made by the FPIs in
India in the debt market. This implies that there shall be more freedom than
regular foreign debt investors if such route is followed. Also, the “Minimum
Residual Maturity Requirements” which are currently applicable on corporate
bonds in India (as specified in paragraphs 4(b), (e) and (f) respectively of
A.P. (DIR Series) Circular No. 31[5]
dated June 15, 2018) shall also not be
applicable on the investments made through the VRR, provided the FPI maintains
a minimum of 75 percent investment for three years in India. For government
bonds, the RBI had earlier in 2018 removed such restrictions on central
government securities and state development loan categories subject to the
condition that the total investment made by an FPI in any category shall not
exceed 20 percent in case these securities have a residual maturity of less
than a year.
The
cap set for investment through the VRR is fixed at INR 40,000 crore for
government debt and INR 35,000 crore for corporate debt per annum. An amount
higher than this can be invested only with the prior approval of the RBI and
the allocation i.e. the “Committed Portfolio Size” (CPS) of each investor shall
be carried out by the Clearing Corporation of India Limited (CCIL) on “first
come, first-served” basis.
The
RBI has again introduced the auction process to allow the FPIs to invest in
India in a fair manner. Through the auction, the FPIs have been allowed to
place their bids regarding their total investment and the retention period
proposed by them in each category of securities. The allocation shall be made
to them on the basis of the retention period specified by them i.e. the
investor with the highest retention period being allocated the CPS first.
After
the allocation is made, the investors are required to invest minimum 25 percent
of their CPS in the first month of allotment and at least 75 percent of their
CPS in the total retention period. Such amount shall be determined on the face
value of the securities. The return of money to the cash accounts of such FPIs
shall not be allowed if such withdrawal leads to a decline of more than 75
percent of CPS during their retention period.
It
has been already discussed how volatile investments through FPIs are due to
their event-specific nature. Therefore, the RBI, in March 2019 released another
circular[6]
to reduce the risk of losses that might be caused to the investors due to a
change in the exchange rate and associated risks. Through the circular, RBI has
now allowed authorized dealers to offer derivative contracts to participants
under the VRR and the products available for hedging purposes are forwards,
options, cost reduction structures and currency swaps with rupee and one of the
currencies. The FPIs are also allowed to freely cancel and rebook the derivate
contracts.

Accordingly, amendments were made to
the Foreign Exchange Management (Transfer or Issue of Security by a Person
Resident Outside India) Regulations, 2017 where a clause was added:

“(5)(a) A
Foreign Portfolio Investor or a Non-Resident Indian (NRI) or an Overseas
Citizen of India (OCI) may trade or invest in all exchange traded derivative
contracts approved by Securities and Exchange Board of India from time to time
subject to the limits prescribed by Securities and Exchange Board of India and
conditions specified in Schedule 5”.

The RBI has undertaken several measures to address the
liquidity concerns from the Indian debt market. Earlier, in January 2019, it
revised the “External Commercial Borrowings” (ECB) norms to open the funding
doors in India. Through the VRR scheme too, it shall be possible to allow funds
to be invested in the defaulted assets of India, which shall help the banks to
alleviate their concerns over the non-performing assets.

The RBI has also looked into some operational aspects of funding through this route to avoid any difficulty in the future. It requires the FPIs to open one or more separate special non-resident rupee (SNRR) accounts for investment through the route. All fund flows relating to investment through the route shall reflect in such account(s).