Concept of External Commercial Borrowings under the FEMA Act, 1999.

May 27, 2022
FEMA

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External Commercial Borrowings under the FEMA Act 1999

External Commercial Borrowings (ECB) is borrowings made by an eligible entity in India from any recognised entity outside India for commercial reasons. Debt financing has traditionally been a favoured type of company finance due to inherent benefits such as security creation, minimum guaranteed returns, and tax efficiency for both the lender and the borrower. As a result, funding through the ECB technique is becoming more common in bringing investment or loan for new projects under Reserve Bank of India permitted locations (RBI). This article will go through External Commercial Borrowings under the FEMA Act, 1999.

The goal of this essay is to help readers understand the External Commercial Borrowings and its influence on the Indian economy.

Table of Content

The Basis of External Commercial Borrowings (ECB)
The Concept of External Commercial Borrowings (ECB)
Framework of External Commercial Borrowings (ECB)
Leverage and Limitation
Raising the ECB Procedure
Reporting by the ECB
Endnote

The Basis of External Commercial Borrowings (ECB)

ECBs are governed by the RBI Master Direction- External Commercial Borrowings, Trade Credits, and Structured Obligations, as well as the Foreign Exchange Management Act, 1999. (FEMA).

The Concept of External Commercial Borrowings (ECB)

External Commercial Borrowings are commercial loans given by qualifying resident companies to recognised non-resident business that must fulfil criteria such as the Minimum Average Maturity Period (MAMP), allowed and non-permitted end-uses, maximum All-In-Cost (AIC), and so on.

Secure commercial loans
Recognized Mortgage Lenders (Non-Resident)
Borrowers who qualify (Resident)
For permitted end use and under set limits (MAMP, AIC)

Framework of External Commercial Borrowings (ECB)

The framework for raising loans through the ECB (hence it acts as the ECB Framework) consists of two options:

Sr. No.

Parameters

ECBs denominated in foreign currencies

ECBs denominated INR

Repayment & Borrowing

Borrowing in INR or FCY and repaying in FCY

Borrowing in INR or FCY and repaying in INR

Types of ECB

Loans inclusive of Bank loans
Other than completely and compulsorily convertible instruments, floating/fixed rate notes/bonds/debentures;
Trade credits that are more than three years old;
FCCBs (Foreign Currency Convertible Bonds);
FCEBs (Foreign Currency Exchangeable Bonds); and
Lease on Financial Terms

Loans inclusive of Bank loans
Other than completely and compulsorily convertible instruments, floating/fixed rate notes/bonds/debentures/preference shares;
Trade credits that are more than three years old;
Lease Financial; and
Bonds denominated in Indian rupees issued in other countries

Borrowers who are eligible

All entities eligible for FDI (Indian Co., LLP, NBFC, VCF)
Trusts for Ports
SEZ SIDBI units; and
India’s Exim Bank

All companies that are qualified to issue FCY ECB; and
Registered entities engaging in microfinance activities, such as registered not-for-profit companies, registered societies/trusts/cooperatives, and registered Non-Governmental Organizations.

Recognized Lenders

The lender must be a resident of a jurisdiction that is a member of the Financial Action Task Force (FATF) or the International Organization of Securities Commissions (IOSCO), including when transferring ECB. However,

Multilateral Financial Institutions (such as the IMF and the World Bank) and Regional Financial Institutions (such as the Asian Development Bank and the European Investment Bank) of which India is a member shall also be treated as recognised lenders.
b) Individuals as lenders are only authorised if they are foreign equity investors or subscribe to bonds/debentures listed in another country; and
Foreign branches/subsidiaries of Indian banks are only authorised as FCY ECB recognised lenders (except FCCBs and FCEBs). Subject to relevant prudential standards, foreign branches/subsidiaries of Indian banks can act as arrangers/underwriters/market-makers/traders for Rupee Denominated Bonds issued overseas.

Underwriting by overseas branches/subsidiaries of Indian banks for issuances by Indian banks, on the other hand, will be prohibited.

Minimum Average Maturity Period (MAMP)

The ECB’s MAMP will be three years.
Call and put options, if any, shall be ineligible for exercise prior to the fulfilment of the minimum average maturity.
However, for the specific categories listed below, the MAMP shall be as follows:

Sr. No.	Category	MAMP
1.	Manufacturing enterprises can raise up to USD 50 million or its equivalent in ECB every fiscal year.	1 Years
2.	ECB obtained from a foreign equity investor for operating capital, general company operations, or repayment of Rupee loans	5 Years
3.	ECB raised for: (i) Working capital or general company purposes (ii) NBFC on-lending for working capital or general company purposes	10 Years
4.	The ECB was created to: (i) repay rupee loans obtained domestically for capital expenditure; and (ii) on-lending by NBFCs for the same reason.	7 Years
5.	ECB is being raised for the following objectives: (i) repayment of rupee loans obtained domestically for purposes other than capital expenditure; and (ii) on-lending by NBFCs for the same purpose.	10 Years

for the categories listed in (b) to (e) above –

ECB cannot be issued by overseas branches or subsidiaries of Indian banks.
(ii) The required MAMP must be scrupulously followed in all situations.

All-in-Cost Ceiling per annum Other Costs

The benchmark rate plus a spread of 450 basis points.

Prepayment charges/penal interest, if applicable, for default or breach of covenants shall not exceed 2% over the negotiated rate of interest on the outstanding principal amount and will fall outside of the all-in-cost cap.

End-uses (Negative list)

The following would be on the negative list, for which the ECB revenues could not be used:

Real estate transactions
Capital market investment
Capital investment
Working capital reasons, with the exception of the ECB indicated in 5(b) and 5(c) above.
General company objectives, with the exception of the ECB stated in 5(b) and 5(c) above.
Repayment of Rupee loans, with the exception of the ECB stated in 5(d) and 5(e) above.
On-lending to entities for the aforementioned activities, with the exception of ECB raised by NBFCs as described in 5(c), 5(d), and 5(e) above.

Rate of Exchange

Currency conversion of the FCY ECB into the INR ECB

FCY ECB into INR ECB can be at the exchange rate existing on the day of the agreement for such change between the parties involved, or at a rate less than the rate prevailing on the date of the agreement, if the ECB lender agrees.

To convert to Rupees

The exchange rate applicable on the day of settlement shall be the rate in effect at the time of settlement.

Provision for Hedging

In the case of foreign currency exposure, company’s raising ECB are expected to follow the hedging rules established by the relevant sectoral or prudential authority. Companies in the infrastructure space:

They must have a risk management policy that has been approved by the Board.
Furthermore, such corporations are required to hedge 70% of their ECB exposure if the average maturity of the ECB is less than 5 years.
The designated AD Category-I bank must ensure that the 70% hedging requirement is met during the ECB’s currency and report the situation to the RBI using Form ECB 2.

The following operational components of hedging must be ensured:

Coverage: The ECB borrower will be expected to use financial hedges to cover both the principal and the coupon. The financial hedging for all ECB exposures should begin at the moment of each such exposure (i.e. the day the liability is created in the books of the borrower).

Tenor and rollover: A minimum tenor of one year would be necessary for the financial hedge, with periodic rollover, ensuring that the exposure on account of the ECB is not unhedged at any moment during the currency of the ECB.

Natural Hedge: Natural hedging shall be accepted in place of financial hedge solely to the extent of balancing planned cash flows / revenues in matching currency, net of any other projected outflows. An ECB may be regarded naturally hedged for this purpose if the offsetting exposure matures/cash flows during the same accounting year.

Overseas investors can hedge their Rupee risk using approved derivative instruments with AD Category I banks in India.
Investors can also gain access to the domestic market through branches / subsidiaries of Indian banks overseas or branches of foreign banks with a back-to-back presence in India.

10.

Change in borrowing currency

The ECB may freely change its currency from one freely convertible foreign currency to another freely convertible foreign currency as well as to INR.

It is not permissible to exchange INR for any freely convertible foreign currency.

Leverage and Limitation

Every fiscal year, all qualified debtors can raise ECB up to USD 750 million or equivalent via the automated procedure. Furthermore, for FCY-denominated ECB received from direct foreign equity holders, the ECB liability-equity ratio cannot exceed 7:1 for ECB raised under the automated approach. If the total outstanding amount of all ECB, including the proposed one, is less than USD 5 million or its equivalent, this percent will not apply.

Raising the ECB Procedure

All ECB can be raised automatically if they match the conditions established in this framework. In cases when the approval route is involved,

Borrowers may submit an application for inspection to the RBI in the necessary format (Form ECB) through their AD Category I bank.
These situations will be weighed against the general rules, the macroeconomic environment, and the merits of the particular proposals.
ECB proposals submitted at the Reserve Bank that above a certain threshold limit (which may be changed from time to time) will be forwarded to the RBI’s Empowered Committee.
The Empowered Committee will have both external and internal members, and the RBI will make the final decision in cases where the Empowered Committee’s recommendations are followed.
Entities interested in raising ECB using the automated approach should contact an AD Category I bank with their proposal and a fully completed Form ECB.

Reporting by the ECB

Borrowers must report genuine ECB transactions to the AD Category I bank on a monthly basis using Form ECB 2 Return.

Endnote

For the near future, the international market is projected to be favourable, resulting in increased borrowings by India. With the RBI’s oversight, defining industry-specific variations for the automatic and approved routes, expressly stating the end-use limitation and minimum average maturity length, and so on, it is expected that ECBs would be the priority for attracting investment to India. Furthermore, with the RBI authorising the use of ECB revenues for loan repayment, the Indian GDP is projected to remain stable while also allowing Indian companies to seek necessary funding from the outside market at cheaper interest rates, which may not be approved through local banks or NBFC.

If you are interested in knowing more about the ECB under FEMA. Then kindly connect to our experts on Legal Window.

CS Urvashi Jain (M.COM, LLB, ACS)

CS Urvashi Jain is an associate member of the Institute of Company Secretaries of India. Her expertise, inter-alia, is in regulatory approvals, licenses, registrations for any organization set up in India. She posse’s good exposure to compliance management system, legal due diligence, drafting and vetting of various legal agreements. She has good command in drafting manuals, blogs, guides, interpretations and providing opinions on the different core areas of companies act, intellectual properties and taxation.

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