External Commercial Borrowings under FEMA Act, 1999

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External Commercial Borrowings under FEMA Act 1999

External Commercial Borrowings (ECB) is borrowings taken by an eligible entity in India for commercial purposes from any recognised entity outside India. Debt financing has long been a preferred source of funding for business due to intrinsic benefits such as security creation, minimum assured returns, and tax efficiency for both the lender and the borrower. As a result, funding via the ECB method is gaining popularity in bringing investment or loan for new projects under Reserve Bank of India allowed regions (RBI). In this article we’ll discuss about External Commercial Borrowings under FEMA Act, 1999.

The purpose of this article is to assist readers comprehend the ECB and its impact on the Indian economy.

Table of Content

Background of External Commercial Borrowings (ECB)

The RBI Master Direction- External Commercial Borrowings, Trade Credits, and Structured Obligations, as well as the Foreign Exchange Management Act, 1999, govern ECBs (FEMA).

Meaning of External Commercial Borrowings (ECB)

External Commercial Borrowings are commercial loans made by qualifying resident company to recognised non-resident businesses that must meet characteristics such as the Minimum Average Maturity Period (MAMP), approved and non-permitted end-uses, maximum All-In-Cost ceiling (AIC), and so on.

  • Obtain commercial loans
  • Lenders Who Have Been Recognized (Non-Resident)
  • Borrowers who are eligible (Resident)
  • For allowed end use and in accordance with established parameters (MAMP, AIC)

Framework of External Commercial Borrowings (ECB)

The framework for raising loans through the ECB (hence it acts as the ECB Framework) consists of two options:

Sr. No. Parameters ECBs denominated in foreign currencies ECBs denominated INR
1. Repayment & Borrowing Borrowing in INR or FCY and repaying in FCY Borrowing in INR or FCY and repaying in INR
2. Types of ECB ·         Loans inclusive of Bank loans

·         Other than completely and compulsorily convertible instruments, floating/fixed rate notes/bonds/debentures;

·         Trade credits that are more than three years old;

·         FCCBs (Foreign Currency Convertible Bonds);

·         FCEBs (Foreign Currency Exchangeable Bonds); and

·         Lease on Financial Terms

 ·         Loans inclusive of Bank loans

·         Other than completely and compulsorily convertible instruments, floating/fixed rate notes/bonds/debentures/preference shares;

·         Trade credits that are more than three years old;

·         Lease Financial; and

·         Bonds denominated in Indian rupees issued in other countries
3. Borrowers who are eligible ·         All entities eligible for FDI (Indian Co., LLP, NBFC, VCF)

·         Trusts for Ports

·         SEZ SIDBI units; and

·         India’s Exim Bank

 ·         All companies that are qualified to issue FCY ECB; and

·         Registered entities engaging in microfinance activities, such as registered not-for-profit companies, registered societies/trusts/cooperatives, and registered Non-Governmental Organizations.
4. Recognized Lenders The lender must be a resident of a jurisdiction that is a member of the Financial Action Task Force (FATF) or the International Organization of Securities Commissions (IOSCO), including when transferring ECB. However,

a)      Multilateral Financial Institutions (such as the IMF and the World Bank) and Regional Financial Institutions (such as the Asian Development Bank and the European Investment Bank) of which India is a member shall also be treated as recognised lenders.

b)      b) Individuals as lenders are only authorised if they are foreign equity investors or subscribe to bonds/debentures listed in another country; and

c)      Foreign branches/subsidiaries of Indian banks are only authorised as FCY ECB recognised lenders (except FCCBs and FCEBs). Subject to relevant prudential standards, foreign branches/subsidiaries of Indian banks can act as arrangers/underwriters/market-makers/traders for Rupee Denominated Bonds issued overseas.

Underwriting by overseas branches/subsidiaries of Indian banks for issuances by Indian banks, on the other hand, will be prohibited.
5. Minimum Average Maturity Period (MAMP) a)      The ECB’s MAMP will be three years.

b)      Call and put options, if any, shall be ineligible for exercise prior to the fulfilment of the minimum average maturity.

c)      c) However, for the specific categories listed below, the MAMP shall be as follows:

Sr. No. Category MAMP
1. Manufacturing enterprises can raise up to USD 50 million or its equivalent in ECB every fiscal year. 1 Years
2. ECB obtained from a foreign equity investor for operating capital, general company operations, or repayment of Rupee loans 5 Years
3. ECB raised for:

(i) Working capital or general corporate purposes

(ii) NBFC on-lending for working capital or general corporate purposes

 10 Years
4. The ECB was created to:

(i) repay rupee loans obtained domestically for capital expenditure; and

(ii) on-lending by NBFCs for the same reason.

 7 Years
5. ECB is being raised for the following objectives:

(i) repayment of rupee loans obtained domestically for purposes other than capital expenditure; and

(ii) on-lending by NBFCs for the same purpose.

 10 Years

for the categories listed in (b) to (e) above –

(i)                 ECB cannot be issued by overseas branches or subsidiaries of Indian banks.

(ii)              (ii) The required MAMP must be scrupulously followed in all situations.
6. All-in-Cost Ceiling per annum Other Costs The benchmark rate plus a spread of 450 basis points.

Prepayment charges/penal interest, if applicable, for default or breach of covenants shall not exceed 2% over the negotiated rate of interest on the outstanding principal amount and will fall outside of the all-in-cost cap.
7. End-uses (Negative list) The following would be on the negative list, for which the ECB revenues could not be used:

a)      Real estate transactions

b)      Capital market investment

c)      Capital investment

d)      Working capital reasons, with the exception of the ECB indicated in 5(b) and 5(c) above.

e)      General corporate objectives, with the exception of the ECB stated in 5(b) and 5(c) above.

f)       Repayment of Rupee loans, with the exception of the ECB stated in 5(d) and 5(e) above.

g)      On-lending to entities for the aforementioned activities, with the exception of ECB raised by NBFCs as described in 5(c), 5(d), and 5(e) above.
8. Rate of Exchange Currency conversion of the FCY ECB into the INR ECB

FCY ECB into INR ECB can be at the exchange rate existing on the day of the agreement for such change between the parties involved, or at a rate less than the rate prevailing on the date of the agreement, if the ECB lender agrees.

 To convert to Rupees

The exchange rate applicable on the day of settlement shall be the rate in effect at the time of settlement.
9. Provision for Hedging In the case of foreign currency exposure, firms raising ECB are expected to follow the hedging rules established by the relevant sectoral or prudential authority. Companies in the infrastructure space:

·         They must have a risk management policy that has been approved by the Board.

·         Furthermore, such corporations are required to hedge 70% of their ECB exposure if the average maturity of the ECB is less than 5 years.

·         The designated AD Category-I bank must ensure that the 70% hedging requirement is met during the ECB’s currency and report the situation to the RBI using Form ECB 2.

The following operational components of hedging must be ensured:

·         Coverage: The ECB borrower will be expected to use financial hedges to cover both the principal and the coupon. The financial hedging for all ECB exposures should begin at the moment of each such exposure (i.e. the day the liability is created in the books of the borrower).

·         Tenor and rollover: A minimum tenor of one year would be necessary for the financial hedge, with periodic rollover, ensuring that the exposure on account of the ECB is not unhedged at any moment during the currency of the ECB.

·         Natural Hedge: Natural hedging shall be accepted in place of financial hedge solely to the extent of balancing planned cash flows / revenues in matching currency, net of any other projected outflows. An ECB may be regarded naturally hedged for this purpose if the offsetting exposure matures/cash flows during the same accounting year.

 ·         Overseas investors can hedge their Rupee risk using approved derivative instruments with AD Category I banks in India.

·         Investors can also gain access to the domestic market through branches / subsidiaries of Indian banks overseas or branches of foreign banks with a back-to-back presence in India.
10. Change in borrowing currency The ECB may freely change its currency from one freely convertible foreign currency to another freely convertible foreign currency as well as to INR. It is not permissible to exchange INR for any freely convertible foreign currency.

Limitation and Leverage

Under the automated method, all qualifying borrowers can raise ECB up to USD 750 million or equivalent every fiscal year. Furthermore, for FCY-denominated ECB received from direct foreign equity holders, the ECB liability-equity ratio for ECB raised via the automated method cannot exceed 7:1. This percentage will not apply if the total outstanding amount of all ECB, including the proposed one, is less than USD 5 million or its equal.

Procedure for Raising the ECB 

All ECB can be raised automatically if they meet the requirements specified in this framework. In instances involving the approval route,

  • Borrowers may submit an application to the RBI in the required format (Form ECB) for inspection through their AD Category I bank.
  • Such circumstances will be assessed in light of the overall guidelines, the macroeconomic situation, and the merits of the individual proposals.
  • ECB suggestions received at the Reserve Bank that above a specific threshold limit (which may be adjusted from time to time) will be presented to the RBI’s Empowered Committee.
  • The Empowered Committee will include both external and internal members, and the RBI will make the final judgement in instances based on the Empowered Committee’s recommendations.
  • Entities wishing to raise ECB under the automated method should contact an AD Category I Bank with their proposal and completely completed Form ECB.

ECB Reporting

Borrowers are expected to report real ECB transactions on a monthly basis via Form ECB 2 Return to the AD Category I Bank.

Endnote

The foreign market is likely to be a favourable market for the foreseeable future, resulting in greater borrowings by India. With the RBI’s check on the ECB, developing industry-specific differences for the automatic route and approval route, explicitly outlining the end-use limitation and minimum average maturity duration, and so on, it is envisaged that ECBs would be the priority for attracting investment to India. Furthermore, with the RBI authorising the use of ECB earnings for loan repayment, the Indian GDP is likely to maintain its stability while also allowing Indian enterprises to seek essential capital from the outside market with lower interest rates, which may not be permitted through local banks or NBFC.

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