RBI relaxes regulations for ECB collateral

External commercial borrowings (ECBs) refer to commercial loans (in the form of bank loans, buyers credit, suppliers credit and bonds) from offshore lenders to a resident Indian.

The norms relating to ECBs are set out in the Foreign Exchange Management (Borrowing or Lending in Foreign Exchange) Regulations, 2000; the Master Circular on External Commercial Borrowings and Trade Credits, dated 1 July; and circulars occasionally issued under ECB regulations.

The regulations state with regards to collateral for ECBs, that the choice of security is left to the parties, however, charges over immovable assets and securities (such as shares) are cross-referred to other regulations.

This is being construed in the market to mean that approval by the Reserve Bank of India (RBI) is required only where the security interest is sought to be created on immovable assets and securities.

Authorized dealer approval

The RBI recently modified the above position through AP (DIR Series) Circular No. 1, dated 11 July, as a result of which, RBI approval is no longer required for the creation of security interests over immovable assets and securities and the issue of corporate personal guarantees.

The new regulations simply require a “no objection” to be obtained from an AD Category I Bank (authorized dealer), subject to certain conditions. For immovable property, the charge should be co-terminus with the maturity of the ECB; the no objection should not be construed as permission (by a non-resident) to actually acquire immoveable property in India; and in the event of enforcement or innovation, the immovable property must only be sold to a person residing in India, with the sale proceeds repatriated to liquidate the outstanding ECB.

For securities, the pledge should be co-terminus with the maturity of the ECB; the transfer of securities should be in accordance with the extant foreign direct investment policy in the case of a pledge invocation; and a certificate must be obtained from the statutory auditors of the company to confirm that the ECB proceeds have been utilized for permitted end-use.

It is interesting to note that the auditor’s certificate in relation to the utilization of ECB proceeds towards permitted end-use is required only with regards to a pledge of securities. This is a bit odd given that as per the ECB regulations, ECBs have to be utilized only for permissible end-uses.

The RBI has also delegated to the authorized dealer, the power to grant permission for ECBs guaranteed by either personal or corporate guarantees.

The circular also stipulates that a no objection would not constitute and should not be construed as obviating the need to obtain any other requisite or necessary approval.

Two issues continue to linger even after the issuance of the recent circular: (a) Whether providing security interest by way of collateral over movables requires prior RBI approval, and (b) Whether the need to obtain the no objection of an authorized dealer can be obviated if security interest (on whatever form of collateral) is created in favour of an onshore security trustee, even though the beneficiaries are offshore lenders.

We have come across situations in the past where pursuant to an application to the RBI for approval for the creation of security interest over movable assets, the RBI has responded stating that no approval is required.

We are also aware of instances where the RBI has written back (in similar cases) saying permission is not required. The latter is a view shared by many in the market.

This raises an interesting issue as to whether the creation of security over movables (by a resident for the benefit of a non-resident) falls within the ambit of a capital account transaction, and given that there is no general RBI approval (either by way of any regulation, circular or notification), whether prior RBI approval would be required.

However there seems to be some ambiguity about this matter and the widely prevalent view is that no prior RBI approval is required.

We, however, believe that creation of a security interest on movables is on the same footing as the crossborder securitization of receivables, as regards which, there is unanimity that prior RBI approval is required.

In fact, we have reasons to believe that the RBI is currently not inclined to grant permission for the cross-border securitization of receivables.

Perhaps this dichotomy can be rationalized by the view that the permission of the RBI is not required for creating a security interest over movables constituting fixed assets, but is required for receivables!

Creating a security interest in favour of an onshore security trustee for the benefit of offshore lenders, would, nevertheless, qualify as a capital account transaction.

H Jayesh is the founder partner and Rewati Bobde is an associate at Juris Corp. The firm is a full-service law firm based in Mumbai and specializes in financial transactions including capital markets and securities, banking, corporate restructuring and derivatives.