The concept of a core investment company (CIC) was first introduced by the Reserve Bank of India (RBI) in 2010. While, at that time, the RBI clarified that companies which invest in shares of other companies, even for the purpose of holding a stake in such company, should be regarded as carrying on the business of a non-banking financial institution, it specifically acknowledged that such class of non-banking financial institution should be afforded differential treatment. This led to the introduction of a differentiated framework for CICs – the main points of difference being the substitution of the capital to risk-weighted assets ratio (as applicable to non-banking financial companies (NBFCs)) with different capital requirements and an exemption from the rules on investment and credit concentration.
The recent downfall of a prominent group helmed by a highly rated CIC brought the relatively lighter-touch regulatory regime for CICs into focus and demonstrated the need to strengthen the same – in particular, to tackle issues regarding:
- leveraging;
- complexity in group structures;
- governance; and
- a lack of rigorous regulatory supervision.
In this context, the RBI formed a working group – chaired by Tapan Ray, former secretary of the Ministry of Corporate Affairs – to review the regulatory and supervisory framework for CICs. On 13 August 2020, after considering the working group's recommendations, the RBI modified the regulatory regime for CICs via a circular. Some of the key changes introduced are discussed below.
Capital knock for direct and indirect CIC investments
The capital requirement which currently applies to all systemically important CICs (CIC NDSIs) ensures that such companies' adjusted net worth is at least equal to 30% of their aggregate risk-weighted assets on their balance sheet and the risk-adjusted value of off-balance sheet items. Another key requirement with which CIC NDSIs must comply is the leverage ratio (ie, ensuring that their outside liabilities do not exceed two-and-a-half times their adjusted net worth).
In order to address the risk of overleveraging by multiple CICs within one group, the RBI has introduced a requirement for CICs to deduct, from their owned funds, the amount equal to any direct or indirect capital contributions made by one CIC to another, to the extent that such amount exceeds 10% of the owned funds of the investing CIC, for the calculation of their adjusted net worth. Any such reduction will automatically affect the calculation of the aforesaid capital requirement and leverage ratio. To the extent that investments which pre-date this circular result in the aggregate investments made by one CIC in other CICs exceeding 10% of the owned funds, the RBI has introduced a 'glide path' which will apply until 31 March 2023.
While the rationale for the change is clear, it raises the following concerns:
- The method of arriving at an 'indirect' investment by one CIC in another for the purposes of the capital knock is not fully articulated and may require further clarification. For example, if a CIC invests a certain amount into a non-CIC which in turn holds shares in a CIC, it is unclear whether such investment would automatically be construed as an indirect investment in a CIC or whether it is to be so construed only where there is a demonstrable back-to-back investment of the same funds in the step-down CIC.
- The universal application of the capital knock, irrespective of whether the investing CIC made the investment into the step-down CIC using borrowed funds or equity or internal accruals, appears to be incongruous given that the rationale for the introduction of the provision was to prevent excessive leverage at multiple levels – a situation which may not arise in case of investments being made out of the proceeds of equity or internal accruals of the investing CIC.
Limiting layers of CICs within groups
In order to address the complexity of group structures and the existence of multiple CICs within one group, the circular restricts the number of layers of CICs which can comprise a group (including the parent CIC) to two, irrespective of the extent of the direct or indirect holding or control exercised by one CIC over the other. If a CIC makes any direct or indirect equity investment in another CIC, it will be deemed a layer for the investing CIC. While this restriction applies from the date of the circular, existing entities have until 31 March 2023 to reorganise their group structures and adhere to this requirement.
While the working group's recommendation to include a provision capping layers drew inspiration from the Companies Act 2013 and, in particular, the Companies (Restriction on Number of Layers) Rules 2017, the meaning and scope of a 'layer' as articulated in the circular (ie, any direct or indirect investment by a CIC in another) is markedly different from the Companies Act 2013, which confines layers to subsidiaries. Also, the exact methodology for calculating the number of layers in a widely spread group with multiple CICs is not fully articulated and a clarification from the regulator (through the issuance of FAQs or otherwise) would be helpful in this regard.
New risk monitoring requirements
The circular requires the parent CIC in a group – or, where there is no identifiable parent, the CIC with the largest asset size – to form a group risk management committee (GRMC), which must be chaired by an independent director and have at least two independent directors as members. The GRMC is primarily tasked with undertaking risk management at the group level and must report to the board. In addition, all CICs with an asset size of more than Rs50 billion must appoint chief risk officers with clearly specified roles and responsibilities.
CICs must also submit to the board a quarterly statement of deviation certified by their CEO or chief financial officer indicating deviations in the use of proceeds of any funding obtained by creditors and investors from the purpose stated in the application, approval letter or offer document for such funding.
Corporate governance and disclosure requirements
CICs are now subject to the requirements to ensure the fit and proper status of their directors which currently apply to systemically important NBFCs, including the requirement to implement a board-approved policy in this regard.
The circular also introduces a host of additional disclosure requirements for CICs, including disclosures required to be made on their website and in their annual financial statements. For example, CICs must publish on their website their corporate governance report and the management discussion and analysis covering, among other things:
- the industry structure;
- developments, risks and concerns for the group; and
- the adequacy of internal controls.
Consolidated financial statements
In addition to reiterating the requirement for CICs to prepare consolidated financial statements as per the Companies Act 2013, the circular requires CICs to include disclosures in respect of entities which meet the definition of a 'group' as per RBI directions but need not otherwise be consolidated as per statutory provisions or the applicable accounting standards. In light of the broad definition of 'companies in the group'(1) under the existing directions, which includes categories such as companies with a common brand name, this may require certain CICs to obtain and include information about various entities which were not previously covered by their consolidated financial statements. This requirement applies from the date of the circular and CICs must implement the required protocols with a view to preparing their consolidated financial statements for the financial year ending 2021.
Investment in money market instruments with maturity of up to one year
Under the pre-amendment CIC master directions, the exceptions for CICs from not carrying on any other financial activities included investments in money market instruments, including money market mutual funds and liquid mutual funds. The circular now allows CICs to invest in money market instruments, including mutual funds which invest in money market instruments and debt instruments with a maturity of up to one year. This is a welcome move which will provide greater flexibility to CICs to make treasury investments of their surplus funds until required for deployment for their core activities.
The circular states that systemically important core investment companies will henceforth be called 'CICs', and that exempted CICs will now be called 'unregistered CICs'.
The circular requires CICs to adhere to the guidelines on the submission of data to credit information companies which apply to systemically important NBFCs and the RBI's 13 March 2020 circular on the implementation of Indian accounting standards.
Overall, the new framework is a welcome move and will help to improve corporate governance, monitoring and risk management for CICs. However, the enhanced compliance and disclosure requirements mean that existing CICs, especially those with lean teams, must implement the operational means necessary to comply with the framework on an ongoing basis. It would be helpful if the regulator expressly clarified the few ambiguities discussed above to aid CICs in their efforts to realign group structures and investments to adhere to the circular.
Endnotes
(1) 'Companies in the group' means an arrangement involving two or more entities related to each other through any of the following relationships:
- 'subsidiary-parent' (defined in terms of Account Standard (AS) 21);
- 'joint venture' (defined in terms of AS 27);
- 'associates' (defined in terms of AS 23);
- 'promoter-promotee' as provided for in the Securities and Exchange Board of India (Acquisition of Shares and Takeover) Regulations 1997 for listed companies;
- 'related parties' (defined in terms of AS 18);
- companies with a common brand name; and
- companies with investments in equity shares of 20% and above.
