ISSUE VI : Core investment companies – Liberalized NBFCS

Core Investment Companies – liberalized NBFCs

Introduction

A Core Investment Company (“CIC”) is primarily a company whose assets are in the form of investments in shares of other group companies. Often such companies are largely set up as “holding companies” who maintain control over their subsidiaries by owning their majority stock. Unlike Non-Banking Financial Companies (“NBFCs”) these companies do not enter into multiple transactions of borrowing and lending. Till recently CICs were regulated by the RBI (India’s federal bank) as NBFCs¹. On August 12, 2010, the RBI finally came up with a separate set of regulations for governing them, in the form of a regulatory framework.² The RBI provided this framework based on the view that while CIC’s may be similar to NBFCs in some ways, they deserved a differential treatment.³

The RBI formally defined CIC as a NBFC carrying on the business of acquisition of shares and securities, satisfying the following conditions:⁴

• It holds at least 90% of its total assets in the form of investments in equity and preference shares, debt or loans in group companies.
• Its investments in equity shares in group companies constitutes at least 60% of its total assets.
• It does not trade in the aforementioned investments except for the purpose of dilution or disinvestment through block sale.
• It does not carry on any other financial activities other than investment in bank deposits, money market instruments, government securities, loans to and investments in debt issuances of its group companies or guarantees issued on behalf of its group companies.

This bulletin briefly examines the concept of a CIC and the regulatory framework established by the RBI.

1. Regulatory Framework

1. Registration with the RBI

Earlier, a company fulfilling the abovementioned criteria was not required to register with the RBI. Many such companies had also been granted express exemptions. However, it was seen that it was becoming increasingly difficult for the RBI to assess which company was investing in the shares of other companies solely for the purpose of holding stock or

trading. The RBI has now clarified the position by widening the interpretation of the words “carrying on the business of acquisition of shares” as defined under the RBI Act, 1934 (“RBI Act”). Now, a company that invests in the shares of another company even if it is only for the purpose of “holding stake” is considered as “carrying on the business of acquisition of shares” under the RBI Act.

Under section 45 I(c)(ii) of the RBI Act, any non-banking institution which carries on as its business, the acquisition of shares, stock, bonds, etc issued by a government or local authority, qualifies as a “financial institution” i.e., a Non-Banking Financial Institution (“NBFI”). Further, any NBFC that carries on the business of a NBFI is required to register with the RBI. Thus, it follows that since a CIC is engaged in the business of a NBFI it will also need to comply with the requirement laid down in the RBI Act and, accordingly, register itself with the RBI.

There is, however, an exception. The RBI has made it mandatory only for CICs with an asset size of INR 100 crore (US$ 20 million approx) or more to register with the RBI regardless of any earlier exemptions. These have been termed as “CICs of Systemic Importance” (“CIC-SI”). All such CICs have been provided with a period of 6 months from the date of this August 12, 2010 notification to apply to the RBI and obtain a certificate of registration. Thus, CICs with an asset size of less than INR 100 crores are exempt from registration.

1.2 Minimum Capital Adequacy Ratio and Leverage Ratio5

Every CIC-SI is required to ensure that its outside liabilities do not exceed 2.5 times its adjusted net worth as on the date of its last audited balance sheet. “Outside liabilities” have been defined as the total liabilities appearing on the liabilities side of the balance sheet, excluding, the “paid up capital” and “reserves and surplus” and including (a) all forms of debt and obligations that have the characteristics of debt, and (b) the value of guarantees issued. This imposes a restriction on the ability of CICs to raise funds from outside the group.

Every CIC-SI is required to maintain a minimum capital adequacy ratio whereby their adjusted net worth is at least 30% of their aggregate risk weighted assets on the balance sheet and risk adjusted value of “off-balance sheet” items as on the date of the last audited balance sheet.

1.3 Exemptions

A CIC-SI that complies with the aforesaid regulations specifically with respect to the capital adequacy requirements and leverage ratio, may be exempted by the RBI from maintenance of a minimum “Net Owned Fund” and the requirements of the “Non-Banking Financial (Non-Deposit Accepting or holding) Companies Prudential Norms (Reserve Bank) Directions, 2007” including the requirements of capital adequacy and exposure norms. By inserting the word “may”, the RBI appears to have the right to exercise discretion in granting

this exemption. The August 12 Regulations also lay down provisions whereby CIC-SI’s, while applying for registration, can apply to the RBI with an “action-plan” for complying with the conditions discussed in para 2.1 and 2.2 and then avail the exemptions discussed above. The RBI can examine the application and, accordingly, grant the registration certificate with the necessary terms and conditions. This will help the applicant CIC in meeting the statutory requirements as well as avail the exemptions.

1.4 Compliance

Failure of a CIC-SI to register with the RBI within the prescribed six month period will be construed as a contravention of section 45 IA of the RBI Act. This contravention is punishable with imprisonment for a term of 1-5 years, as well as, a fine between INR 1-5 lakhs (US$ 2200 to 10,000 approx).6 The defaulting company, as well as the person(s) in charge of its business at the time of the contravention, will be held liable. As in the case of branch and liaison offices, even registered CIC’s are required to provide annual statutory certificates from the auditors stating that they are in compliance with the August 12 Regulations within one month from the date on which their balance sheets are finalized. Clearly, the RBI is tightening its hold and making all efforts to ensure that this move to regulate CICs separate from NBFC’s is followed through and does not give them the opportunity to take unnecessary advantage of their newly liberalized environment.

Conclusion

NBFC’s are required to comply with several statutory obligations and requirements on account of the status they enjoy. The RBI took into account the difficulties that CICs were facing in trying to comply with these requirements and formulated the August 12 Regulations liberalizing CICs in terms of their regulatory obligations. Companies that were so far being regulated as NBFCs will be able to breathe a sigh of relief. The August 12 Regulations are relatively recent and the six month period is nearly up. It will be interesting to see how many companies have actually registered themselves with the RBI and what further steps the RBI may take to fine tune the process. It will also be interesting to see if the RBI modifies this restriction on outside liability in the future. Holding companies also raise funds through loans and the August 12 Regulations have clearly restricted this aspect. Further, as a result of separate guidelines dealing solely with CICs, companies that had so far escaped monitoring by getting an exemption will also come within the purview of the RBI. This is clearly an attempt in making all dealings and process transparent and unambiguous. But, the perennial question remains – how rapidly will the regulator enforce?

Authored by: Tanya Mehta

1 A NBFC has been defined as a financial non-banking institution (which is a company) that engages in the business of receiving deposits under any scheme or arrangement or lending in any manner.
2 See RBI/2010-11/168 DNBS(PD)CC.NO.197/03.10.001/2010-11 Regulatory Framework for CICs dated August 12, 2010 (“the August 12 Regulations”)
3 Regulation 7 (2) of the August 12 Regulations
4 Regulation 7 (2) of the August 12 Regulations
5 Regulation 6 (iii) & (iv) of the August 12 Regulations