Since NBFC-ICs are exempted from complying with concentration norms under the new framework, there is hardly any incentive for choosing core investment company-CIC structure over an investment company
Post the revised regulatory framework a systemically important core investment companies (CIC-SI) has more compliance requirement as compared to non-banking financial companies (NBFC) investment company (IC) (together NBFC-IC). The main intent behind the formation of a CIC was to maintain stake in group companies, however under the new framework, since NBFC-ICs are exempted from complying with concentration norms, there is hardly any incentive for choosing CICs over investment company (ICs).
On 27 March 2015, the Reserve bank of India (RBI) came up with the revised regulatory framework
for non-banking financial companies (NBFCs), which have brought about a plethora of change in the NBFC universe. Under the erstwhile regulations, non-deposit taking NBFCs (NBFC-ND) having asset size of Rs100 crore or more were considered as systemically important and were subject to stringent regulations such as concentration norms, capital adequacy requirement etc. Under the revised framework, the definition of systemic importance has changed increasing the threshold to Rs500 crore from Rs100 crore. Hence, under the new framework, there are two types of NBFC-NDs –
(i) NBFC-NDs with asset size of Rs500 crore or more, i.e., Systemically Important NBFC-ND (NBFC-ND-SI) – These NBFCs shall be governed by the Systemically Important Non-Banking Financial (Non-Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2015
(ii) NBFC-NDs with asset size of less than Rs500 crore, i.e., Non Systemically Important NBFC-ND (NBFC-ND-Non SI) – These NBFCs shall be governed by the Non-Systemically Important Non-Banking Financial (Non-Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2015
NBFCs up to an asset size of Rs500 crore are not subject to most of the compliance requirements, which were applicable to them under the erstwhile regulation, in case their asset size was more than Rs100 crore. The change is a major one since it has changed the shape of how things function in the NBFC sector. In light of this change, the article talks about the fate of a core investment companies (CICs) post the revised framework.
What are CICs?
CICs are companies whose assets are largely invested in their group companies either in the form of equity, preference shares or convertibles bonds or loans. We can also say that such companies are simply passive holding companies, meant for maintaining control over their group companies and do not carry on any other financial activity.
On 5 January 2011, the RBI Vide Notification No. DNBS. (PD) 219 / CGM(US)-2011 had issued ‘The Core Investment Companies (Reserve Bank) Directions, 2011, (CIC Directions) wherein a CIC is defined as an NBFC carrying on the business of acquisition of shares and securities and which satisfies the following conditions as on the date of the last audited balance sheet:-
i. it holds not less than 90% of its net assets in the form of investment in equity shares, preference shares, bonds, debentures, debt or loans in group companies;
ii. its investments in the equity shares (including instruments compulsorily convertible into equity shares within a period not exceeding 10 years from the date of issue) in group companies constitutes not less than 60% of its net assets as mentioned in clause (i) above;
iii. it does not trade in its investments in shares, bonds, debentures, debt or loans in group companies except through block sale for the purpose of dilute ion or disinvestment;
iv. it does not carry on any other financial activity referred to in Section 45I(c) and 45I(f) of the Reserve Bank of India Act, 1934 except granting of loans to group companies, issuing guarantees on behalf of group companies and investment in:
• bank deposits,
• money market instruments, including money market mutual funds
• government securities, and
• bonds or debentures issued by group companies
Under the CIC Directions, only those CICs having asset size of Rs100 crore or more and having public funds, also known as systemically important CICs (CIC-SI) are required to get themselves registered with RBI. The main intent of RBI to regulate the larger CICs was, even though the investments are concentrated in their group companies, with an asset size of Rs100 crore, the CIC-SI are of significant importance to the economy.
Compliance Requirement for a CIC-SI
The CIC-SIs are required to maintain a minimum adjusted net worth (ANW- as defined under Para 9(a) of the Regulatory Framework for Core Investment Companies) of not less than 30% of its aggregate risk weighted assets on balance sheet and risk adjusted value of off-balance sheet items as per the last audited balance sheet. Furthermore, it also has to ensure that its outside liabilities at any time does not exceed 2.5 times of its ANW.
Pertinent to note here is that a CIC-SI, which complies with the abovementioned requirement, is exempted from the maintenance of statutory minimum net owned fund (NOF) as required u/s 45-IA (1) (b) of RBI Act, 1934.
The Need for CICs
Prior to the revised framework, NBFCs with asset size of Rs100 crore were subject to stringent regulations of the RBI. One of the biggest hurdle that the NBFCs faced was concentration norms, whereby, the NBFCs had to restrict their exposures in the investee company(ies) to the extent allowed by the RBI. Thus, the NBFCs, which were primarily engaged in the business of acquisition of shares and securities i.e. an NBFC-Investment Company (NBFC-IC), were unable to maintain any controlling stake in any company, more particularly its group companies, as the same would lead to a breach in the concentration norms. As a resolution to this problem, CICs, which are simply passive holding companies, meant for maintaining control over their group companies, were introduced.
Changes under the Revised Regulatory Framework that effect the Relevancy of CIC
Now that the definition of Systemic Importance has been amended and the threshold has been increased, many NBFCs has become lesser regulated than before. This has ignited a new series of thoughts among the existing CIC-SIs on their business structure, as after the revised framework has come into being the investment company (IC) model has seemed to be more attractive than CICs.
The following table would draw up pros and cons of the IC model and the CIC model –
The outcome of the above table has been summarised below –
1. The NBFC-ICs, irrespective of whether it is an SI or a Non SI, can take unlimited exposure in their group companies and Non SIs are also not required to maintain any minimum capital requirement. On the contrary, a CIC-ND-SI shall have to mandatorily invest upto 90% of its assets in group companies and will also be required to maintain a capital adequacy of 30%.
2. NBFC-ND-IC has the privilege to borrow more on their owned funds i.e. 7 times as compared to CIC-ND-SI which has to maintain a leverage ratio of 2.5 times at all times.
Clearly, post the revised regulatory framework a CIC-SI has more compliance requirement as compared to NBFC-IC. The main intent behind the formation of a CIC was to maintain stake in group companies. However under the new framework since NBFC-ICs are exempted from complying with concentration norms, there is hardly any incentive for choosing CICs over ICs.
(Surbhi Jaiswal works as Manager at Vinod Kothari Consultants Pvt Ltd)