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In April 2010 in its annual monetary policy for 2010-11, the Reserve Bank of India (RBI) observed: “The regulatory framework for NBFCs [non-banking financial companies] has evolved in the recent past with particular focus on interconnectedness and systemic risk.”

Perceiving access to public funds as a systemic issue, the RBI felt there was a need to closely regulate and monitor NBFCs. These include systemically important non-deposit taking NBFCs, i.e. systemically important core investment companies (SICICs).

Deserving different treatment

The RBI also observed that core investment companies (CICs) deserve to be treated differently in the regulatory provisions that apply to SICICs. CICs, which hold shares in group companies, invest in these companies not to trade in their stock, but rather to hold stakes in the companies. CICs do not generally carry on any other financial activity.

Therefore, in August 2010 the RBI proposed guidelines to regulate CICs and SICICs. In view of the feedback to the guidelines received from market participants and in order to advantageously regulate the credit system of the country, on 5 January the RBI issued the Core Investment Companies (Reserve Bank) Directions, 2011, setting out the regulatory framework for CICs and SICICs.

What is a CIC?

The directions define CICs as NBFCs that undertake the business of acquisition of shares and securities. Such NBFCs are required to comply with the following conditions as, on the date of their last audited balance sheet:

• Not less than 90% of their net assets are to be held in the form of investments in equity shares, preference shares, bonds, debentures, debt or loans in group companies;
• Their investments in the equity shares (including instruments which are compulsorily convertible into equity shares within a period not exceeding 10 years from the date of issue) in group companies should constitute not less than 60% of their net assets;
• They should not trade in their investments in shares, bonds, debentures, debt or loans in group companies, except through block sale for the purpose of dilution or disinvestment; and
• They should carry on only the following financial activity:

1. 1. 1. Investment in bank deposits, money market instruments, money market mutual funds, government securities and bonds or debentures issued by group companies;
      2. Granting of loans to group companies; and
      3. Issuing guarantees on behalf of group companies.

Systemically important CICs

SICICs are categorized as CICs that have total assets of not less than ?1 billion (US$21.5 million) either individually or in the aggregate along with other CICs in the group and which raise or hold public funds.

Registering SICICs and CICs

The directions mandate that every SICIC is required to apply to the RBI for registration within six months of the directions being issued, i.e. by 5 July.

In order to ensure the smooth implementation of these statutory requirements, companies that apply for a certificate of registration within the stipulated six month period will be permitted to carry on their existing business till the RBI disposes of their application.

In addition, a CIC which becomes a SICIC must register with the RBI within three months of becoming a SICIC.

Capital and leverage ratio

SICICs are subject to a two-fold regulatory regime:

• They are required to maintain a minimum capital ratio, whereby their adjusted net worth must not be less than 30% of their aggregate risk weighted assets on balance sheet and risk adjusted value of off-balance sheet items as on the date of their last audited balance sheet as at the end of the financial year.
• They would be subject to a maximum leverage ratio, whereby their liabilities must not exceed 2.5 times their adjusted net worth. Certifications as to compliance are also mandated by the directions.

SICICs that adhere to the above capital requirements and which maintain the prescribed leverage ratio have been exempted from compliance with the statutory minimum net owned fund requirements.

Prudent regulation

These directions are viewed as a step towards opening up the economy to investment while maintaining prudent regulation. Conceptualization of CICs through the directions has also brought about a measure of clarity as to whether companies holding shares as investments or in the course of their business activities would come within the ambit of a NBFC and thus be regulated as such.

Shardul Thacker is a partner at Mulla & Mulla & Craigie Blunt & Caroe.