[2019] 

102 taxmann.com 121 (Article)

Date of Publishing: January 24, 2019

India’s own spice in the Bond Market: ‘Masala Bonds'

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VIGNESH IYER
Manager, Vinod Kothari & Co.

Introduction

1. 'Bond' in simple terms means a Loan raised via issuance of an Instrument such as a Debenture
certificate. A bond is an evidence of debt owed by the Company which issues it, primarily known as the
'Issuer', to the lender or investor. Bonds are issued under specific terms and conditions governing and
binding both the Issuer and investor. Unlike the concept of 'Dividend', bonds will yield a fixed rate of
return in the form of 'Interest' for a fixed or perpetual tenure, as the case may be, thereby guaranteeing
a return on investment.

Compared to the scenario of bond market in other countries, the strength of Indian bond market may
be comparatively low with the investors possessing much more interest in investing in the stock market
which is almost the opposite of how it is internationally. From the investors' point of view, the fear of
default in payment of interest/principal by the Issuer plays a vital role when it comes to investing in
bonds. However, the bonds issued by the Government of India do have a fairly good demand from the
investors which may clearly depict the poor degree of trust of the investors on the corporate bonds.

Types of Bonds

2. Bonds are classified into various types based on any of the following factors:

a.   Interest rate - Fixed or floating

b.   Convertibility - Compulsorily Convertible or Optionally Convertible or Non- Convertible
c.   Redeem-ability - Redeemable or Non-redeemable
d.   Tenure - Perpetual or Fixed term
e.   Issuer - Government or Corporates
f.   Security - Secured or Unsecured
g.   Seniority - Senior or subordinate
h.   Coupon rate - Zero coupon or fixed coupon etc.

Based on the types of the bonds issued the terms of conditions of issuance and the provisions of the
applicable laws shall vary.

Masala Bonds

3. The term 'Masala Bond' as it itself sounds is very much desi with respect to its origin. Masala Bonds
are plain vanilla rupee denominated bonds issued by eligible resident entities of India overseas in a
Financial Action Task Force (FATF) compliant financial centres.
The Reserve Bank of India (RBI) vide its circular dated September 29, 20151 (Circular of 2015) came up
with the framework to facilitate for issuance of Rupee denominated bonds overseas within the External
Commercial Borrowings (ECB) Policy of the RBI. The Circular of 2015 2

With the current government focusing on expanding the source of investment from the foreign
investors and to make our country an attractive investment destination, it kept liberalising the norms
related to ECB which includes the framework for issuance of Masala bonds vide issue of various
circulars through RBI from time to time which are consolidated and presented under the 'Master
Direction - External Commercial Borrowings, Trade Credit, Borrowing and Lending in Foreign
Currency by Authorised Dealers and Persons other than Authorised Dealers was just the laying of the
foundation stone as it contained only the broad contours of the framework. In furtherance to the
Circular, 2015, RBI came up with another circular dated April 13, 2016 whereby making certain
amendments to the framework with respect to the minimum maturity period and limits of borrowings
by eligible entities.3

Para 3 of the Master Direction deals with the framework in accordance to which the issuance of Masala
Bonds i.e. the rupee denominated bonds shall be issued by the eligible resident entities.

3.1 Who are the eligible resident entities or who can issue Masala Bonds?

Masala Bonds can be issued by the following entitled resident entities:

a.   Any Company incorporated under the Companies Act, 1956/2013 of India; or

b.   Any Body Corporate specially created out of a specific act of the Parliament of India;
c.   Indian Banks subject to the satisfaction of certain conditions;
d.   SEBI registered Real Estate Investment Trusts (REITs) and Infrastructure
Investment Trusts (InvlTs);

It may be noted that RBI vide their FAQs '' (Master Direction).4

While is interesting to note that while the Department of Industrial Policy and Promotion (DIPP) vide
its Foreign Direct Investment(FDI) Policy on Issue of Rupee Denominated Bonds has expressly
restricted Partnership firms and LLP from issuance of Masala Bonds thereby creating an ambiguity as
an LLP is defined to be a Body Corporate as per the Limited Liability Partnership Act, 2008. The fact
that vide Para 3.3.2 of the Master Direction RBI permits any Body Corporate to issue Masala Bonds and
expressly prohibiting LLPs which are Body Corporates through their FAQs does nothing but further
contributes to the ambiguity.5

In view of the increasing number of LLPs being incorporated, the regulators may consider instituting a
customised framework to permit LLPs to raise funds through issuance of Masala Bonds.

Who can invest?

3.2 RBI has laid down a strict criteria with respect to the eligible investors in Masala bonds.

Para 3.3.3 of the Master Direction expressly provides that Masala Bonds can only be issued AND can
only be subscribed by a resident of a country:
 a.   that is a member of Financial Action Task Force (FATF) or a member of a FATF-
Style Regional Body; and
b.   whose securities market regulator is a signatory to the International Organization of
Securities Commission's (IOSCO's) Multilateral Memorandum of Understanding
(Appendix A Signatories) or a signatory to bilateral Memorandum of Understanding
with the Securities and Exchange Board of India (SEBI) for information sharing
arrangements.
c.   Multilateral and Regional Financial Institutions where India is a member country.

By a plain reading of the provision as set out in Para 3.3.3. of the Master Direction, it appears that it
may not be enough that the investor/subscriber as his origin from a Country which satisfies the
eligibility criteria as set out in (a) and (b) above but should also that such investor/subscriber should be
resident of such eligible countries.

We may analyse the same with an example:

Mr. X is a citizen of Country Y which is an eligible Country for issuance of Masala Bonds. If an Indian
Company issues Masala Bonds, Mr. X shall be entitled to invest/subscribe only if he has been a
resident of his Country Y and not by merely being a citizen of Country Y. Consequently, if Mr. X is
resident in a Country, say Country Z, which does not satisfy the eligibility conditions for issuance of
Masala Bonds, irrespective of the Mr. X being the citizen of such an eligible Country, the issuance shall
not be permissible as Country Z does not feature in the list of eligible countries.

This reflects the degree of precaution that the Government and RBI have taken while introducing a new
source of finance.

However, it may be noted that whether issuance of Masala Bonds in Country Y is permitted in a case
where the subscriber i.e. Mr. X is a citizen of Country Z (non-eligible country) but a resident of Country
Y, is still a question mark left unanswered by RBI either in the Master Direction or FAQs.

3.3 Prohibitions

Masala Bonds shall not be issued in any country which is identified in the public statement of FATF
as a jurisdiction having a strategic Anti-Money Laundering or Combating the Financing of Terrorism
deficiencies to which counter measures apply or a jurisdiction that has not made sufficient progress in
addressing the deficiencies or has not committed to an action plan developed with the FATF to address
the deficiencies.

Further, Related Party covered under the ambit of the definition as provided under Ind-AS 24 is
expressly prohibited from subscribing or investing in or purchasing of Masala Bonds.

Related Party under Ind-AS 24 permits FDI under the Automatic Route in LLPs operating in
sectors/activities where 100% FDI is allowed through the automatic route and where there are no FDI-
linked performance conditions and further where such LLPs are also permitted to make Downstream
Investments subject to certain conditions, it is quite intriguing as to why LLPs have been expressly
prohibited to issue Masala Bonds.6
A related party is a person or entity that is related to the entity that is preparing its financial
statements (in this Standard referred to as the 'reporting entity').

(a)   A person or a close member of that person's family is related to a reporting entity if
that person:
(i)   has control or joint control of the reporting entity;
(ii)   has significant influence over the reporting entity; or
(iii)   is a member of the key management personnel of the reporting entity or of a
parent of the reporting entity.
(b)   An entity is related to a reporting entity if any of the following conditions applies:
(i)   The entity and the reporting entity are members of the same group (which means
that each parent, subsidiary and fellow subsidiary is related to the others).
(ii)   One entity is an associate or joint venture of the other entity (or an associate or
joint venture of a member of a group of which the other entity is a member).
(iii)   Both entities are joint ventures of the same third party
(iv)   One entity is a joint venture of a third entity and the other entity is an associate of
the third entity.
(v)   The entity is a post-employment benefit plan for the benefit of employees of either
the reporting entity or an entity related to the reporting entity. If the reporting
entity is itself such a plan, the sponsoring employers are also related to the
reporting entity.
(vi)   The entity is controlled or jointly controlled by a person identified in (a).
(vii)   person identified in (a)(i) has significant influence over the entity or is a member of
the key management personnel of the entity (or of a parent of the entity).

3.4 Can Indian Banks spice up their portfolio with Masala Bonds?

RBI in its initial framework governing the issuance of Masala Bonds had permitted Indian Banks to
participate in the space of Rupee Denominated Bonds Overseas only as arrangers and underwriters but
not as issuers.

In order to develop the market of Masala Bonds overseas and also to provide additional avenue for
Indian Banks to raise capital/long term funds, RBI came up with a circular dated November 03, 2016 is
defined as follows:7

(i)   Perpetual Debt Instruments (PDI) qualifying for inclusion as Additional Tier 1
capital and debt capital instruments qualifying for inclusion as Tier 2 capital, by way
of Rupee Denominated Bonds overseas; and
(ii)   Long term Rupee Denominated Bonds overseas for financing infrastructure and
affordable housing

However, underwriting by branches/subsidiaries of Indian banks for issuances by Indian banks is

prohibited.

3.5 Procedure to raise funds through Masala Bonds?

  The available route for any issuance of Masala Bonds is the Approval Route
wherein the eligible resident entity shall forward the proposal through the AD bank
to Foreign Exchange Department, Central Office, Mumbai of the RBI for
examination;
  Once the proposal is approved, the borrowing entity may then approach the
Department of Statistics and Information Management through their AD Category I
 Bank and submit Form 83 for obtaining Loan Registration Number (LRN);
  Reporting through Form ECB 2 return shall be required in the same manner as in
case of other ECBs;
  Masala Bonds may be privately placed or listed on exchanges as per host country
regulations;
  RBI also advises the borrow entities to fulfil reporting requirements/ maintain
details of issuance of such bonds as required by government or by other regulators/
bodies/ Acts.

3.6 End-use restrictions

Para 3.3.5 of the Master Direction clearly prohibits utilisation of the proceeds of the funds raised by
issuing Masala Bonds for the following activities in the same manner in which Para 5.1 of the FDI
Policy:

a.   Real estate activities other than development of integrated township/affordable

housing projects;
b.   Investing in capital market and using the proceeds for equity investment
domestically;
c.   Activities prohibited as per the foreign direct investment guidelines;
d.   On-lending to other entities for any of the above purposes; and
e.   Purchase of Land I

Para 3.3.5 of the Master Direction expressly provides that apart from the abovementioned activities the
proceeds from issuance of Masala bonds can be used for ail purposes.

3.7 Other parameters to be satisfied

  The exchange rate for foreign currency - Rupee conversion shall be the market rate
on the date of settlement for the purpose of transactions undertaken for issue and
servicing of the bonds;
  The borrowing by financial institutions under the framework of Masala Bonds shall
be subject to the leverage ratio prescribed, if any, by the sectoral regulator as per the
prudential norms;
  The overseas investors are eligible to hedge their exposure in Rupee through
permitted derivative products with AD Category 1 banks in India and investors can
also access the domestic market through branches/subsidiaries of Indian banks
abroad or branches of foreign banks with Indian presence on a back to back basis.

3.8 Benefits of issuing Masala bonds

  Masala Bonds definitely brings in a new avenue of source of borrowings for the
eligible resident entities;
  Masala Bonds being denominated in Indian rupees helps the Indian Rupee gain
strength with the increase in demand and supply;
  The risk of hedging is passed on to the foreign investor as the bonds are
denominated in Indian Rupees thereby insulating the Indian issuer from adverse
interest rate fluctuations;
  Masala Bonds creates a diversified portfolio.

With multiple programs like 'Make in India', 'Start-up India' being launched by the government to
strengthen the country's business economy and to turn the country into an attractive destination,
Masala Bonds are one such lucrative source of borrowing benefitting the corporates and the Indian
economy.

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1.
https://rbidocs.rbi.orq.in/rdocs/notification/PDFs/APDIR17F3216FECE3F0441C8E1107F5
E2BA1927. PDF
2.
https://rbidocs.rbi.orq.in/rdocs/notification/PDFs/AP6Q90DB7643EF9E417498C1F37B49B
E27A2.PD F
3. https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=10204#C48
4. https://www.rbi.org .in/Scripts/FAqView.aspx?ld=113#q2
5. https://dipp.gov.in/sites/default/files/CFPC_2017_FINAL_RELEASED_28.8.17_0.pdf
6. http://mca.qov.in/Ministry/pdf/INDAS24.pdf
7ss. https://www.rbi.ora.in/Scripts/NotificationUser.aspx?ld=10675&Mode=0