FPIs in a bind over RBI's voluntary retention route for distressed debt

Foreign portfolio investors (FPIs) wanting to invest in stressed assets are in a quandary over taking the Reserve Bank of India’s (RBI’s) voluntary retention route (VRR). 

The RBI threw open the VRR to investors last month, aimed at attracting long-term overseas money into the debt market while ensuring operational flexibility to FPIs to manage their investments. 

FPIs typically invest in stressed assets by way of tradeable instruments such as bonds. 

VRR norms mandate that FPIs invest 25 per cent of the committed portfolio size within one month, and the rest within three months from the date of allotment. The minimum retention period is three years or as decided by the RBI for each allotment by tap or auction. 

According to experts, FPIs can easily take two to three months to structure a stressed asset deal if one accounts for the time taken to raise funds from investors, appoint legal counsel and trustees, get the credit rating done, and deploy funds in the stressed or structured credit opportunities.

“One month is too short a time frame to identify and close a deal. Moreover, the investing world is filled with surprises, and the deal may fall apart at the last minute,” said a senior industry official who deals with FPIs. “So long as the limits are available on tap, there is no issue. But the moment it moves on to bidding, investors will face the problem of whether to identify the deal first and then bid or vice versa.”

Investment limits are currently available on tap and being allotted by the Clearing Corporation of India (CCIL) on a first-come-first-served basis. The investment limits under the current tranche will be open till the limits are exhausted or till April 30, whichever is earlier. 

“The time limit for initial investment needs to be extended to two or three months. If the issuer and investors are new, the timelines can get stretched further. Earlier, in the liquid class of instruments, FPIs got 15-45 days to invest,” said Ajay Manglunia, former fixed income advisory head of a large financial services firm.

A plausible way around this, said experts, was allowing investors to classify or convert some of the current investment under the general route as VRR investment. Alternatively, temporary parking of funds in government securities or an exit mechanism in the case of failed deals could be provided.

“If I have a limit of Rs 5,000 crore in the general category, can I convert part of it, say, Rs 2,000 crore into the VRR category? The current norms do not provide for this,” said another person who deals with FPI clients. 

For computing the committed portfolio size (CPS), one needs to consider investments in terms of the face value of the securities as well as cash holdings in the rupee account. While the computation of the CPS will happen on the face value of securities, FPIs’ investment may only be up to the discounted value of the security. 

“While this seems to be the correct interpretation, a positive clarification or an FAQ from the RBI will help clear doubts,” said the first person quoted above.

The recent corporate liquidity crisis has thrown up another issue. If an FPI chooses to sell the units of a stressed asset at a lower value, the CPS may fall even though the FPI has not taken any money outside India. 

This is because till the time the FPI stays invested, the face value of the investment plus the cash account will be considered for CPS computation. After the FPI exits the investment, only the cash account will be taken into consideration whose value may be lower. 

“How will the CPS be computed in such scenarios? Will FPIs be expected to get in more money to maintain their CPS?” said the person. 

FPI Investment through the VRR has got off to a slow but steady start, according to experts, despite the headroom available under the general route for corporate and government bonds. The RBI had last year put a number of restrictions, including a limit on minimum residual maturity and single/group investor limits in corporate bonds. A number of deals could not move forward due to these restrictions.

FPIs have turned net buyers of Indian bonds this year, aided by the central bank’s liberalisation of the FPI framework and a more stable currency and macroeconomic environment. 

The rupee depreciated 8.4 per cent to 69.77 against the dollar in 2018, and has shed 0.2 per cent this year. FPIs sold Rs 46,500 crore worth of debt papers in 2018, and have net bought papers worth Rs 172 crore this year.