India’s Debt Markets
The Way Forward
July 2017

Contributors:

Page 1

Disclaimer
The information and opinion commentary in this ASIFMA – India’s Debt Markets Paper was preparedby the Asia Securities Industry and Financial Markets Association (ASIFMA) to reflect the views of ourmembers. ASIFMA believes that the information in the Paper, which has been obtained from multiple
sources believed to be reliable, is reliable as of the date of publication. As estimates by individual
sources may differ from one another, estimates for similar types of data could vary within the Paper.
In no event, however, does ASIFMA make any representation as to the accuracy or completeness ofsuch information. ASIFMA has no obligation to update, modify or amend the information in this Paperor to otherwise notify readers if any information in the Paper becomes outdated or inaccurate.
ASIFMA will make every effort to include updated information as it becomes available and in
subsequent Papers.

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ASIFMA is an independent, regional trade association with over 100
member firms comprising a diverse range of leading financial institutions fromboth the buy and sell side including banks, asset managers, law firms andmarket infrastructure service providers. Together, we harness the sharedinterests of the financial industry to promote the development of liquid, deep
and broad capital markets in Asia. ASIFMA advocates stable, innovative andcompetitive Asian capital markets that are necessary to support the region’s
economic growth. We drive consensus, advocate solutions and effect changearound key issues through the collective strength and clarity of one industry
voice. Our many initiatives include consultations with regulators andexchanges, development of uniform industry standards, advocacy forenhanced markets through policy papers, and lowering the cost of doing
business in the region. Through the GFMA alliance with SIFMA in the US and
AFME in Europe, ASIFMA also provides insights on global best practices andstandards to benefit the region.

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TABLE OF CONTENTS
A. Executive Summary............................................................................................................................ 7
1. Evolution of the Indian Bond Markets.......................................................................................... 8
2. Legal & Regulatory Framework (Bankruptcy & Resolution, Netting) ........................................... 8
3. Settlement and Operations – Issues and Suggested Steps for Resolution ................................... 9
4. Offshore Issuance by Indian Issuers – Structures and Legal Framework ..................................... 9
5. Access Channels and the Taxation of Debt Instruments .............................................................. 9
6. Annexure A – The Overview of Taxability in India ...................................................................... 10
7. Annexure B - Tax and Regulatory Overview of Different Instruments ....................................... 10
8. Annexure C – Recommendations ............................................................................................... 10
B. Evolution of the Bond Markets in India ........................................................................................... 11
1. Introduction ................................................................................................................................ 11
2. Government Securities ............................................................................................................... 12
3. State Developmental Loans ........................................................................................................ 14
4. Introduction and Strengthening of Funding Markets ................................................................. 16
5. Widening of the Market ............................................................................................................. 17
6. Introduction of New Products - Development of Derivative Markets ....................................... 21
7. Corporate Bonds: Evolution of the Secondary and Primary Markets ........................................ 22
8. Corporate Bonds: New Endeavours............................................................................................ 25
9. Securitisation and Covered Bond Market (ASIFMA)................................................................... 26
10.Rates and Credit Market Infrastructure (including Ratings) (ASIFMA)....................................... 30
C. The Current Overall Bond Market Legal and Regulatory Framework, Netting, Bankruptcy and
Resolution ........................................................................................................................................ 32
1. Recent Entries in the Indian Bond Market ................................................................................. 32
2. Inter-linkage of the Indian Bond Market with Repos, Swaps and Futures Markets .................. 34
3. Concrete Steps for Attracting Foreign Investment ..................................................................... 36

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4. Protection of Investors ‘a must’ ................................................................................................. 36
5. Indian Bond Market: The Road Map Ahead ............................................................................... 37
D. Settlement & Operations – Recommendations............................................................................... 39
1. Uniform Settlement Cycle for Government Debt Securities ...................................................... 39
2. Rationalization of Debt Limit Rules ............................................................................................ 39
3. Introduction of Early Pay-In ........................................................................................................ 40
4. Other Recommendations ........................................................................................................... 40
E. Offshore Issuance by Indian Issuers – Structures & Legal Framework* .......................................... 41
1. High Yield Issuance ..................................................................................................................... 41
2. Masala Bonds.............................................................................................................................. 44
3. Medium Term Note Programmes ............................................................................................... 46
4. Green Bonds ............................................................................................................................... 47
F. Access Channels and Taxation of Debt Instruments........................................................................ 50
1. Access Channels for Debt Investments....................................................................................... 50
2. Emerging Tax Landscape............................................................................................................. 52
G. Annexure A ...................................................................................................................................... 57
1. Overview of Taxability in India ................................................................................................... 57
H. Annexure B – Tax and Regulatory Overview of Different Instruments ........................................... 60
1. Dated Government Securities .................................................................................................... 60
2. State developmental Loans (SDLs) ............................................................................................. 61
3. Deep Discount Bonds (DDBs), Zero-Coupon Bonds (ZCBs) and Discount Bonds (DBs) .............. 62
4. Perpetual Debt Instruments – Tier I and Debt Capital Instruments – Tier II .............................. 63
5. Listed Non-Convertible Debentures (NCDs)/Bonds (including Credit Enhanced Bonds) ........... 64
6. Unlisted Corporate Debt Securities ............................................................................................ 65
7. Masala Bonds.............................................................................................................................. 66
8. Indian Rupee Denominated External Commercial Borrowings (ECBs) ....................................... 67

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9. Foreign Currency Bonds (FCBs)................................................................................................... 69
10.Cash Settled Interest Rate Futures (IRFs) ................................................................................... 70
11.Units of a Debt Oriented Mutual Fund ....................................................................................... 71
12.Infrastructure Debt Funds (IDF) .................................................................................................. 72
13.Security Receipts and Securitised Debt Instruments.................................................................. 73
14.Units of Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) . 74
I. Annexure C – Recommendations .................................................................................................... 76

ASIFMA would like to extend its gratitude to Clifford Chance, J.P. Morgan, Juris Corp, Nomura and PwC,
and all of the individuals and member firms who contributed to the development of this paper.

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A. Executive Summary
Ever since India ushered in a burst of economic reforms starting in the early nineties, there has beena metamorphosis in the Indian capital markets, which has posted impressive growth across several
dimensions. Even so, there is scope for improvement across a number of are ranging from the more
visible physical infrastructural constraints to the less visible institutional, social, legal, regulatory andgovernance deficits have collectively impeded the further development of the Indian markets – somuch so that even though growth rates and the progress witnessed in Indian capital markets inabsolute terms might appear to be impressive, these have been outpaced by even faster capital
market developments – particularly in the fixed income space – in the other regional emerging
markets, China in particular. ASIFMA (together with our co-authors) have endeavoured to take stockof recent developments (since the publication of ASIFMA’s last India bond markets roadmap in 2013)
and to lay down some clear markers for the future evolution of the Indian fixed income markets.
For a long period of time post-independence in 1947, India has had a relatively closed capital account,which the Indian regulatory authorities have only begun to open gradually. Since the dawn of theeconomic reform era in the early 1990s, the domestic Indian markets (both debt and equity) haveshown substantial growth. Turning to some specific numbers, net cumulative foreign investment inequities has grown from nothing in 1992 to USD 128.5bn as of end-2016, while the comparable figures
for debt stands at USD 42.1bn. These figures account for about 6.4% of the total Indian equity market
capitalization and approximately 3.0% of the combined value of the Indian debt markets (source:
Business Standard). While the overall growth figures over the last 25 years have been impressive,these figures are still relatively low compared to the other, more open capital markets globally.
Across other metrics too, there are several areas in which the Indian fixed income markets could see
structural changes for the better, despite stand-alone growth rates being relatively impressive – forinstance, while Indian corporate debt as a percentage of GDP has grown from less than 5% to about
15% of GDP over a five-year period starting in 2012, this figure is considerably less than even a smaller
ASEAN market such as Malaysia, where corporate debt penetration is around 40% of GDP. Thus, there
is considerable room for growth in corporates accessing the capital markets (as opposed to the more
traditional loan markets), more so in an environment where bank non-performing loans (NPLs) haveweighed heavily on Indian bank profitability and capital ratios in recent years.
A mix of restrictive rules regarding issuance, high public sector borrowing requirements, uncertainties
around tax policy and the propensity of the Indian regulatory authorities to implement frequent rulechanges without sufficient market consultation, shortcomings (at least till recently) in areas such as
bankruptcy, resolution and netting, the lack of benchmark yield curves, illiquidity in the secondary
markets except in a limited number of on-the-run benchmark instruments, the lack of a trading culture
among several classes of institutional investors, the lack of well-developed fund management andinsurance industries and the low rate of capital formation coupled with the low level of private sectorsavings, have all weighed on the development of the fixed income markets.
We have attempted to address all these issues in the course of this document and have organized our
discussion along the following lines:
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1. Evolution of the Indian Bond Markets
In this section, we have reviewed some of the key points and the various recommendations we madein the “2013 India Bond Market roadmap” and have outlined how both the Indian cash bond andderivatives markets (particularly the government bond markets) have developed, with the key role
played by the Clearing Corporation of India Limited (CCIL), in the areas of trading and clearing. Even
though a great deal of progress has occurred, some of our recommendations have yet to be met –particularly with respect to the lack of liquidity in anything but the on-the-run issues and the adoptionof a “mark-to-market” (as opposed to a hold-to-maturity) mindset among several market participants.
We then review the growth in the corporate bond markets, the different types of instruments, thevolumes traded, the holding pattern of securities among various classes of investors, the developmentof the repo markets and the need for a “classic repo” market and the progressively wider participationin the Indian bond markets among a wider range of Foreign Portfolio Investors (FPIs). We also assess
the growth and development of Indian mutual fund investments in the debt markets.
Finally, we look at developments in the Indian securitization markets, the granting of access to FPIs in
recent months and the rationalization/removal of certain tax barriers to investment in Indian
securitization structures. We also evaluate the Indian credit markets infrastructure, particularly thecreation of ratings agencies and the increasingly key role they play in the Indian ratings space. Whileforeign ratings agencies have a presence in India (both direct and indirect), more needs to be done toalign the local Indian scale of ratings to international norms. Additionally, while trading, clearing andsettlement infrastructures have developed, linkages of Indian securities depositories with
International Central Securities Depositories (ICSDs) would prove especially beneficial for collateralmobility internationally.
2. Legal & Regulatory Framework (Bankruptcy & Resolution, Netting)In this section, we discuss the overall domestic legal and regulatory framework governing the Indian
fixed income markets, in particular, the division of oversight responsibilities between the Reserve
Bank of India (RBI) and the Securities & Exchange Board of India (SEBI). We also discuss some of thenewer fixed income products introduced into the domestic bond markets (and the regulations
governing such instruments) such as municipal bonds and gold sovereign bonds.
Next, we consider the linkages between the cash markets and derivatives/hedging instruments suchas swaps and futures and the evolution of the repo markets in India. While several positive
developments have occurred in the swaps market (such as the setting up of bilateral margining, central
clearing and the mandating of “Legal Entity Identifiers” (LEIs), much more needs to be done. Turning
to the repo markets, there has been progress here as well, but has been relatively limited. While rerepo is permitted under certain conditions in the government securities markets, this has not been
allowed for corporate bonds. As for other steps, central clearing and reporting of repos and more
recently, the legalization of a tri-party repo framework have all been taken. That said, a true “classic
repo” framework remains some distance away in India.

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Additionally, issues related to the adoption of close-out netting, the new bankruptcy & insolvency
regime (which is expected to provide an impetus to close-out netting) and the “Financial Resolution &Deposit Insurance Bill” (FRDI), all of which align the Indian markets more closely with international
standards, are also discussed. Finally, specific measures for investor protection and the granting ofincreased access to FPIs are covered in this section. Specific proposals made by the Indian regulatory
authorities to further develop the bond markets, such as rules governing the re-issuance of bonds andthe adoption of the Electronic Book Provider (“EBP”) mechanism are explored in greater detail.
3. Settlement and Operations – Issues and Suggested Steps for Resolution
In this section, specific issues related to the settlement and operations infrastructure with respect tothe Indian fixed income markets are highlighted and specific solutions are proposed for theirresolution. Specifically, the lack of a uniform settlement cycle, undue complexity in managing FPI limits
and the need to consolidate the multiple circulars pertaining to guidelines for FPI investments in the
Indian bond markets are discussed.
4. Offshore Issuance by Indian Issuers – Structures and Legal Framework
This section focuses on the external/international component of the Indian bond markets and focuses
specifically on some of the innovative High Yield (HY) deal structures employed in accessing thesemarkets. A brief overview of how these structures can be compared and contrasted with HY issuancefrom other jurisdictions such as China (with a focus on covenant packages and credit support
mechanisms) is explored in detail in this section.
In terms of specific instruments, the newly introduced Masala bond market’s overarching regulatory
framework, together with some of the more recent (in our view, counterproductive) restrictions thathave been imposed are discussed in some detail. Finally, rules governing Indian Medium Term Note
(MTN) programmes and the fast-developing green bond market are also covered.
5. Access Channels and the Taxation of Debt Instruments
The final section of the document provides exhaustive coverage around the “access channels”
available for all FPIs for investment in a whole range of Indian debt instruments – ranging from dated
government securities, to zero-coupon bonds, non-convertible debentures, perpetuals, Masala bonds,
debt-oriented mutual funds, securitized instruments, infrastructure investments and Real Estate
Investment Trusts (REITs), among others.
The paragraphs following the discussion of FPI access channels provide a detailed overview of thecomplex Indian tax framework – specific topics discussed include the latest developments with regard
to the revision of Indian tax treaties with a number of countries, the General Anti-Avoidance Rules(GAAR), rules related to “Base Erosion and Profit Sharing” (BEPS), Thin Capitalization Rules, Income
Computation and Disclosure Standards (ICDS) and “Overseas Transfer Provisions”.
Additionally, this section also discusses the “Safe Harbour Provisions” for international investors in the
Indian capital markets and the newly established framework for the establishment of International
Financial Services Centres (“IFSCs”) with the Gujarat International Finance Tech City (“GIFT City”) being
Page 9the first such IFSC. Tax exemptions and incentives for investment in IFSCs are also alluded to in thissection.
The remaining sections are all Annexures/Appendices, which complement and add round out thediscussions centred on the topics above.
6. Annexure A – The Overview of Taxability in India
This annexure is a comprehensive overview of how tax is determined, assessed and administered on
income streams and capital gains, based on various criteria – the residency of the taxpayer and thecharacterization/accrual of income. The imposition of various specific taxes – such as withholding
taxes and Minimum Alternative Tax (MAT) is discussed, along with the applicability of the various tax
treaties with reference to specific situations.
7. Annexure B - Tax and Regulatory Overview of Different Instruments
This annexure is an instrument by instrument description of each of the various classes of debt
securities covered in “Section F” – Access Channels – above, with respect to the conditions that
regulate FPI investment in and taxation of each of these securities. Specific details are provided on thetypes of investors, investment conditions, investment limits, taxes on income and capital gains andwithholding taxes (if applicable), pertaining to each class of fixed income instrument, among otherrelevant details.
8. Annexure C – Recommendations
An exhaustive set of recommendations, based on our discussion/analysis of the various issues
highlighted in each of the sections above – is contained in this final annexure. These recommendations
range from general/broad suggestions at a macro level, to very specific ones – dealing withsuggestions that are pertinent to certain micro aspects of the Indian fixed income markets – such as
settlement timelines, to give one example.

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B. Evolution of the Bond Markets in India
1. Introduction
Over the last five years, India has been considered a key growth economy in Asia and one of the“markets to be in” for foreign investors, as the country consistently recorded annual GDP growth rates
in excess of 7% (till the most recent post-demonetization period), making it the fastest growing G-20
economy for a period of time. In short, India is now considered an emerging success story, more so
after the new government signalled its intent to carry out (and has implemented) several reforms,
many of them centred on the ease of doing business.
However, there are some economic and financial infrastructure bottlenecks that need to be eased tofurther encouraging foreign investments. Weak corporate balance sheets, need for further tax andlabour reforms, high NPLs and low credit growth in an uncertain global economic environment, havetaken some of the shine off the India growth story. The implementation of a consistent andcoordinated policy to further develop the Indian financial markets would confer great benefits to Indiaand its citizens. A more structured approach would enable a much safer and more appealing market
for issuers and investors and ultimately result in a stronger economy for India.
At a more micro level, we do note that the Indian authorities have recognized that a robust bondmarket is critical for growth of any country and India is no different. A developed bond market
significantly increases the depth of the financial markets as it helps in serving the needs of both theprivate and public spheres better. This assumes a role of even greater significance given the context
that bank balance sheets are now extremely weak, thus impeding loan growth, but some of thatgrowth has now shifted to the bond markets, whose development (particularly in the corporate bondarea) has accelerated over the last few years. Hence, it comes as no surprise that the Indian regulatory
and monetary authorities recognize this and have been taking continuous steps to deepen the fixedincome market in India.
In consequence, the total domestic bond market has grown from around USD 1.0tn at the end of 2012
to approximately USD 1.5tn by March 2017, with government securities (both Central and State)accounting for USD 1.06tn (Source: Livemint data and ASIFMA estimates). More significantly,
corporate bonds as a percentage of GDP have grown from around 5.0% in 2012 to around 14% in 2016
(Source: ASIFMA and Livemint), although this level of penetration is still considerably lower than thatof Malaysia, where the corporate bonds to GDP ratio is in excess of 40%. At a greater level of detail,the following are the types of bonds that are issued in the Indian domestic bond markets:
1. Government bonds and Treasury Bills (T-Bills): issued directly by the government of India, theso called G-Secs; T-Bills are shorter-dated securities, up to one-year in duration;
2. Borrowing by state governments: State Development Loans (SDLs), which are dated securities
issued by single states within India for meeting their market borrowing needs;
3. Corporate bonds (including Public Sector Unit (PSU) bonds – issued by sovereign/quasisovereign entities and bonds issued by banks/financial institutions): this market has room toPage 11develop further. While the value of corporate bonds outstanding has expanded from single
digit to double digit percentages as a proportion of GDP, there is a long way to go;
4. Masala bonds – these are INR-denominated bonds issued offshore and are a form of offshore
borrowing – this is a product that has been legalized relatively recently;
5. Securitised Debt Instruments: These are issued either in the form of debentures or PassThrough Certificates – Foreign investors have recently been given access to this market andmoreover, tax treatment of these instruments has been made more advantageous.
6. Municipal bonds: these are bonds issued by Urban Local Bodies (ULBs) for financing specificprojects, typically linked to infrastructure; the framework for the issuance of these
instruments was recently announced by SEBI and the first issuance was done recently.
7. Gold Sovereign Bonds: This is again a product introduced relatively recently, to help makeIndia’s large gold holdings in private hands, more liquid besides being put to more productiveuses.
8. Green bonds: The framework for green bonds issuance was introduced in India in 2016 and a
few transactions, mostly by financial institutions, have been completed.
The ultimate objective of RBI has been to ensure complete transparency and increasing liquidity acrossthe curve, thereby helping in better discovery of prices for both government and corporate bonds.
Clearly articulated steps have been taken by RBI over the course of last three to four years to ensure
this is achieved. Further, to make the market more vibrant, RBI has also been introducing new
products and encouraging more types of investors to actively contribute to the bond market. Thatsaid, more needs to be done to bring the Indian fixed income markets on par with the more developed
regional bond markets. In the following sections, we will outline how bond markets have evolved inIndia in last few years and set out recommendations on how this market could be further improved.
2. Government Securities
Since the last report on the Indian bond markets published in 2013, there has been considerable
progress that the Indian government securities markets have recorded. We outlined several areas
pertaining to the Indian government securities market where there was/is room for improvement andarticulated specific advocacy points, which we urged the Indian authorities to consider adopting.
While it is fair to say that many of the suggested changes/improvements to the Indian government
securities framework have been passed, there is room for more improvement.
Specifically, we urged the development of benchmark yield curves across the maturity spectrum andthe need for greater liquidity in the secondary markets (through the adoption of more of a trading
mentality among market participants, a move away from “held-to-maturity” portfolios to the adoptionof a “mark-to-market/held-for-trading” approach, which in turn would be facilitated by a reduction in
the Statutory Liquidity Ratio (SLR), encouraging the development of a broader and more active
domestic and foreign investor base, including pension funds, mutual funds, insurance companies andother real money investors, besides developing a variety of hedging tools including repo andPage 12derivatives). Over the last half decade, while a great deal of forward movement has occurred, progressin at least a few of the areas has been decidedly mixed.
The volumes traded in the government bonds market have increased as the borrowing program of thegovernment has increased over the years. In terms of secondary market activity in government bonds,
the volumes traded across the yield curve since the last few years have seen a change in distribution.
The benchmark 10y has been the most traded security (with the highest percentage of volumes being
traded in the 7y-10y bucket). However, since 2014-15 we have seen a pickup in volumes traded in the
5y and 5y-7y bucket which has led to better discovery of the bond curve in less than 7y tenors. The
10y-15y bucket which is the second most traded bucket has seen a decline in share in total volumes
traded.
The longer end of the curve which is > 15y maturity however continues to be less traded accountingfor 1-3% of volumes. This is because the most active participants in this segment are investors likepension funds and insurance firms who are long only investors and undertake less trading activity inthis segment. Thus, one of our goals, the suggested encouragement of traders to trade across thematurity spectrum has not yet been met. That said, the authorities are conscious of the need for longer
dated benchmarks and in order to make the longer end more relevant for investors like Employee
Provident Fund Organizations (EPFOs) and insurance companies a 40 year bond was issued for the firsttime in 2015.
G-Sec Volumes
100,000

91,496
79,68680,00059,20960,00040,00085,57624,80825,522

2009-10

2010-1130,991

20,0002011-12

2012-132013-142014-152015-16

INR bnTable 1: G-Sec traded volumes
Source: CCIL

In terms of structural developments in connection with the market’s trading infrastructure, cash bondtrading in the government securities market has evolved in a unique direction. The Negotiated Dealing
System – Order Matching (NDS-OM) framework of the CCIL effectively acts as a “Central Limit OrderBook” on which the bulk of government bonds trade (and is also the CCP – Central Counterparty – forall secondary market trades in the government bond market, which have to be mandatorily

Page 13cleared/settled through CCIL). This represents a marked difference from most other markets, where
government bonds are generally traded OTC, or on a Request for Quote (RFQ) basis.
In the context of CCIL playing a central role in both the government bond (and repo) markets, therecognition of CCIL as a CCP equivalent to a European CCP by ESMA in March 2017, ahead of theeffective start date of MIFID II in January 2018, is a welcome development. ASIFMA has long advocatedthat Asian CCPs (including and especially CCIL) obtain equivalence (with both the US and European
CCPs), to ensure a smooth transition to the new regulatory regimes (MIFID II in the case of Europe).
The benchmark on the run bonds continue to be the most liquid securities that are traded on the NDSOM screen and the broker market. Yet another initiative with a view to ensure more liquidity in illiquidbonds is the market making program for Primary Dealers (PDs), where PDs offer two way quotes on
the screen on selected securities. This will lead to more trading activity in illiquid securities andcorrespondingly better discovery of the yield curve.
Tenor-wise Issuance of Government Bonds (INR billion)
Up to 5Y
5-7Y
8-10Y
11-15Y
16-20Y
110
1,160
1,230
1,190
930
810
1,610
1,470
930
200
1,970
1,430
1,120
730
1,750
1,630
820

2013-142014-152015-16
2016-1721-40Y
950
1,100
1,130
890

Table 2: Tenor-wise Issuance of Bonds
Source: CCIL

Tenor-wise Distribution of Traded Volumes (INR crores)
<5y

%

>5-7y

%

>7-10y%>10-15y%15-20y%>20-40y%2014-15Q4

304,20513

31,8841

980,22643

881,52939

25,071

1

62,1133

2015-16Q1

386,973

1734,7242

1,139,598

50

638,30528

33,830147,3172

2015-16Q2

246,532

11

54,214

3

1,435,526

67

345,300

16

27,631

1

44,9992

2015-16Q3

283,526

15

253,748

13

797,31341

504,134

26

50,1283

43,1432

2015-16Q4

554,15225

206,0459693,75532

663,53230

36,132

2

37,1092

2016-17Q1

578,12520

303,13811

903,69032

964,38134

37,005

1

41,4771

2016-17Q2

517,38510455,477

9

1,908,203

372,202,993

42

59,825

1

61,4701

2016-17Q3

342,1097

379,7788

2,089,302

45

1,658,342

36

59,807

1

63,5281

2016-17Q4

317,37412

165,7046

1,370,790

53

646,997

25

26,937

1

44,635

2

Table 3: Tenor-wise Distribution of traded volumes
Source: CCIL

3. State Developmental Loans
The amount of SDLs traded, as a percentage of total volumes, have also increased over the last few
years as states have increased reliance on market borrowings from 69.7% of outstanding liabilities inMarch 2015 to 74.7% by end March 2017. Over the years we have seen a steep increase in SDL
issuances. From a gross borrowing figure of INR 1182bn in 2009-10 it has increased to INR 3820bn in2016-17.

Page 14

State government borrowings were unevenly distributed with bunching up of borrowings in thesecond half of the year. There has been more visibility for the market on issuance of SDLs and statewise issuance calendars are published on a quarterly basis. This has led to an increase in market
participation and also the percentage of SDLs traded in the secondary market has increased over thelast few years as can be seen from the table below.
SDL Gross Borrowing (INR billion)
4500
4000
3500
3000
2500
2000
1500
1000
500
0
2009-10

2010-11

2011-12

2012-132013-142015-16

2016-17

Table 4: SDL Gross Borrowing
Source: RBI

Instrument wise % of Traded Volumes% of Traded Volumes
2014-15Q4
2015-16Q1
2015-16Q2
2015-16Q3
2015-16Q4
2016-17Q1
2016-17Q2
2016-17Q3
2016-17Q4

G-Secs
90.0
89.1
87.6
86.3
88.7
89.1
91.8
91.9
84.8

SDL
2.5
2.2
3.1
3.9
3.9
3.5
3.3
2.9
5.3

T-Bills
7.5
8.7
9.2
9.7
7.4
7.4
4.9
5.3
9.9

Table 5: Instrument wise % of Traded Volumes
Source: CCIL

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4. Introduction and Strengthening of Funding Markets
While the Indian repo market has seen significant changes since 2013, notably the introduction of
mandatory trade reporting on the National Dealing System (NDS) of the CCIL, India has still yet to
adopt the “classic repo” framework advocated by ASIFMA in our 2013 India bond market roadmap.
For more on the legal framework governing the Indian repo market, please see the “Legal &Regulatory” section.
Turning to the evolution of the repo markets themselves, the liquidity operations by RBI have moved
to a term repo framework post October 2013. Earlier the banking system was entirely dependent on
the fixed rate LAF window where liquidity at a fixed rate (repo rate) was provided by RBI and excess
liquidity was taken out through the use of fixed rate (reverse repo). In October 2013 term repos wereannounced for the first time wherein 7day and 14day term repos were announced through a variable
rate auction mechanism. Over the last three years we have seen increased use of variable rate of term
repo and term reverse repo facilities across tenors from 2d-128d for managing banking system
liquidity. According to RBI’s annual report with the institution of the revised liquidity management
framework, the role of term repo auctions under the liquidity adjustment facility (LAF) has become
significant. Normal 14-day and fine tuning term repos of varying tenors ranging from 2 to 56-day
accounted for about 90 per cent of the average net liquidity injection under the LAF during the year.
Liquidity Management: Various Instruments

Table 6: Liquidity Management: Various Instruments
Source: RBI Annual Report 2015-16

As the term repo and reverse repo markets have evolved, the reliance of inter-bank community on
call money markets has declined. There has been a decline in call money volumes in the last quarterof 2016-17 as the banking system has been parking its entire excess liquidity with RBI.

Page 16

Percentage of Traded Volumes in CBLO, Repo and Call Market% of Volumes
2014-15Q4
2015-16Q1
2015-16Q2
2015-16Q3
2015-16Q4
2016-17Q1
2016-17Q2
2016-17Q3
2016-17Q4

CBLO
60.8
60.7
62.8
57.5
53
54.9
56.3
59.1
62.8

Repo
27.2
28.1
25.8
30
31.7
31.9
32.9
29.8
28.4

Call
12
11.2
11.3
12.5
15.3
13.2
10.8
11.1
8.8

Table 7: Percentage of Traded Volumes in CBLO, Repo and Call Market
Source: CCIL

5. Widening of the Market
FPI Participation
The participation of FPIs have increased over the last three years as RBI provided a calendar for
opening up limits in government bond markets and SDLs on a quarterly basis. The RBI in its monetary
policy statement in September 2015 laid down a medium term framework for FPI limits in consultation
with the government. The limits would be increased in phases to 5% of the outstanding stock by March2018. For more details on FPI participation in the Indian bond markets, see the section of FPI accesschannels below.
Year Wise FPI Investments in Debt (INR billion)
FPI Investments
Mar-14Jun-14
Sep-14
Dec-14

G-Secs
847
1052
1396
1503

Corporate Bonds
840
915
116
1438

SDL
0
0
0
0

Mar-15Jun-15
Sep-15
Dec-15

1529
1516
1528
1617

1890
191
1869
1793

0
0
0
36

Mar-16Jun-16
Sep-16
Dec-16

1657
1645
1804
1508

1689
1613
1704
1621

45
39
15
11

Table 8: Year Wise FPI Investments in Debt
Source: NSDL

Page 17

FPI % Holdings in G-Sec
4.5
4
3.5
3
2.5
2
1.5
1
0.5

Nov-16

Sep-16

Jul-16May-16

Mar-16

Jan-16

Nov-15

Sep-15

Jul-15May-15Mar-15Jan-15

Nov-14

Sep-14Jul-14May-14Mar-14Jan-14

Nov-13

Sep-130

Table 9: FPI % Holdings in G-Sec
Source: RBI

Ownership Pattern in Government Securities
Over the last three years we have seen reduced ownership in government bonds by commercial banks.
This has been as a result of SLR cuts by RBI. The SLR or “Statutory Liquidity Ratio” is a requirement for
all regulated banking entities to invest a certain proportion of their total assets in G-Secs. This ratio
has varied over the years but in recent years, the trend has been down. SLR rates have been reduced
by 25 bp every quarter starting from April 2016. One of our key advocacy points has been for a
reduction in the SLR, which has indeed come down over the years to 20.8% currently, from levels inexcess of 38% a few years ago. Nevertheless, the continuing large government fiscal deficits will tend
to limit the extent to which SLRs can fall. On the other hand RBI has gradually opened FPI limits whichhave increased FPI participation and ownership since the last three years. FPI holdings have increased
from 1.4% in September 2013 to 3.13% in December 2016.
Yet another factor worth noting is that FPI investments in the Indian bond markets overall (and notjust in the G-Secs market) would receive a significant boost is if India is included in the major bondindices (specifically the JPM EM bond index). Thus, India should strive to be included in the relevantbond indices globally, more so as the world is moving towards “passive indexing” as the dominant
investment philosophy. This is an effective way of not only attracting but also retaining funds in India
as these are “long-term” flows and not hot money.

Page 18

Holding Pattern in G-Secs% Holding in G-SecsCommercial Banks
Non-Bank PDs
Insurance Companies
Mutual Funds
Co-operative Banks
Financial Institutions
Corporates
Foreign Portfolio Investors
Provident Funds
RBI
OthersState Governments

2014
42.77
0.34
21.02
1.68
2.57
0.73
1.12
3.62
7.47
14.5
4.18
0

2015
43.59
0.35
21.9
2.52
2.71
0.68
0.86
3.68
7.11
12.07
4.51
0

2016
40.92
0.28
22.55
1.96
2.63
0.86
1.05
3.13
6.24
14.61
5.77
1.8

Dec 2014
4.18 0

14.5
42.77

7.47

3.62
1.12
0.73
2.57
1.68

21.02
0.34

1 Commercial Banks

2 Non-Bank PDs

3 Insurance Companies

4 Mutual Funds

5 Co-operative Banks

6 Financial Institutions

7 Corporates

8 Foreign Portfolio Investors

9 Provident Funds

10 RBI

11 Others

State Governments

Page 19

Dec 2015
4.51 0

12.07
7.11

3.68
0.68

43.59

0.86
2.71
2.52
21.9
0.35

1 Commercial Banks

2 Non-Bank PDs

3 Insurance Companies

4 Mutual Funds

5 Co-operative Banks

6 Financial Institutions

7 Corporates

8 Foreign Portfolio Investors

9 Provident Funds

10 RBI

11 Others

State Governments

Dec 2016
1.8
5.77
14.61
40.92
6.24
3.13
1.05
0.86

2.63
22.55
1.96

0.28

1 Commercial Banks

2 Non-Bank PDs

3 Insurance Companies

4 Mutual Funds

5 Co-operative Banks

6 Financial Institutions

7 Corporates

8 Foreign Portfolio Investors

9 Provident Funds

10 RBI

11 Others

State Governments

Table 10: Holding pattern in G-Secs
Source: RBIPage 20

6. Introduction of New Products - Development of Derivative Markets
In our 2013 report, ASIFMA had advocated for the development of futures, swaps and derivatives
markets, to effectively complement the cash bond markets. Over the last 4-5 years, significant
developments have occurred in this regard, with the establishment of interest rate futures markets
traded on the exchanges and the trading of INR interest rate derivatives introduced on the CCIL.
Exchange now offers futures on 5, 10 and 13-year G-Secs and 91-day treasury bills. These instruments
are cash-settled and can be used for hedging the risk arising from interest rate movements as well as
for trading. There have been significant developments in the Interest Rate Futures (IRF) market overthe past few years with futures being introduced on the 5y and 15y on-the-run bonds in 2015 inaddition to the future on 10y bonds. The near month maturity IRF on the 10y benchmark bondcontinues to be the most traded future and accounts for the majority of volumes. After a weak startof IRF market in 2003 there was a significant push from RBI to make the market more liquid and robust.
The total value traded increased from January 2014 and continued to increase in 2015. However, thetotal value traded has decreased in 2016.
Total Value Traded in NSE IRF Market (INR billion)

2014
2015
2016

Total Value Traded
2967.85832.853156.78
Table 11: Total Value Traded in NSE IRF Market
Source: NSE

The other active segment in the derivative market is interest rate swaps. Recently CCIL has launched
ASTROID – Anonymous System for Trading in Rupee OTC Interest Rate derivatives. This platform waslaunched in August 2015 and offers trading in MIBOR from 1 month up to 10 years. The swaps tradedon ASTROID are guaranteed from the point of trade. The trades executed on this platform are linked
to CCIL’s clearing and settlement system for rupee Overnight Index Swap (OIS) trades. The volumes
on ASTROID platform have picked up since inception; however it continues to be low compared to the
traditional platforms. The volumes in the OIS market have also decreased over the years as is evident
from the table below.
Interest Rate Swaps Transactions (INR billion)

2007-08
2008-09
2009-10
2010-11
2011-12
2012-132013-14

No of Trades
79,49540,912
20,352
33,05733,642
22,71325,514

Notional Amount
47,281
26,448
14,521
23,597
24,51020,21622,967
Page 21

2014-15
2015-16

21,153
20,746

20,292
21,329

Table 12: Interest Rate Swaps Transactions
Source: CCIL

7. Corporate Bonds: Evolution of the Secondary and Primary Markets
While the corporate bond market is small as compared to the government bond market, the growthseen in this space is worth noting. Historically, corporates have primarily depended on banks for theirsources of funding. With banks taking a back seat due to various issues like high cost of funds, NonPerforming Assets (NPAs), stress in the balance sheet, etc., better rated corporates started tapping
the bond markets because of the lower cost of funding in these markets. Lower deposit rates, the lackof tax free bonds, tax efficient return from debt funds ensured large flow of funds into their debt
schemes. This phenomenon continued over the last few years and as a result we see much more liquidand vibrant credit markets. We have seen a substantial growth in the corporate bond market – over
35% Compound Annual Growth Rate (CAGR) in last 7 years. FY 2013-2014 was abnormal when RBI
hiked overnight rates to defend the currency and most of the issuers went back to the loan markets.
The issuance of corporate bonds in the year 2015-2016 was lower because of the absence of large
power sector financing companies because of the implementation of the “Ujjwal DISCOM Assurance
Yojana” (UDAY) scheme by the Government of India, whereby State Electricity Boards converted theirloans to bonds. By way of further background, this scheme is aimed at the revival and revitalization of
the distressed State Electricity Distribution Companies (the so-called DISCOMs).
The recently concluded FY 2016-17 witnessed the highest ever total of funds raised through corporate
bonds through private placement, totaling INR 7,035bn. These funds were raised by a total of 661
institutions and corporates. Also, according to Prime Database, total public corporate bond issuancethrough yearend March 2017 rose 51% yoy to USD 51bn.
Total Debt Private Placements (INR billion)
Year
2010-11
2011-12
2012-132013-142014-152015-16
2016-17

Amount
2,026
2,592
3,528
2,879
4,657
4,922
7,035

% Change
28%
36%
-18%
62%
6%
43%

Table 13: Total Debt Private Placements
Source: Prime Database

95% of the issuance happens in fixed rate bonds because of the demand for these bonds. The liquidityof both floating rate and structured bonds is very poor in the secondary market, as a result of which
there are very few issuances.

Page 22

The growth of debt mutual funds has played a large role in increasing the primary and secondary
volumes of corporate bond markets.
Growth in Debt Mutual Funds (INR billion)
Year
2012
2013
2014
2015
2016
2017

Income2908.443959.854606.715157.735654.597437.83

Liquid fund803.54933.921332.81625.62
1994.04
3140.86

Gilt
36.59
80.74
61.15
146.14163.06148.75

Total
3748.57
4974.51
6000.666929.49
7811.69
10727.44

Change
32.7%
20.6%
15.5%
12.7%
37.3%

Table 14: Growth in Debt Mutual Funds
Source AMFI

Debt Fund Deployment of Funds
Type of Instrument
Credit Products
Govt Bonds
Banks CD/FD
CBLO Others

2014
75.0%
12.2%
6.9%
5.8%

2015
69.6%
18.0%
7.7%
4.7%

2016
73.4%
16.8%
6.6%
3.1%

2017 YTD
75.0%
11.2%
6.9%
6.8%

Table 15: Debt Fund Deployment of Funds
Source: SEBI

The above table shows how debt mutual funds have been allocating funds into various assets classes.
On average, the allocation to credit products has been 75%.
Growth of Secondary Volumes for Corporate Bonds (INR billion)
Year
2007-2008
2008-20092009-20102010-20112011-20122012-20132013-20142014-2015
2015-20162016-2017

No of Trades
19079
22683
38230
44060
51533
66383
70887
75791
70123
88495

Value
959
1,482
4,012
6,053
5,938
7,386
9,708
10,913
10,224
14,707

Table 16: Growth of Secondary Volumes for Corporate Bonds
Source: SEBI

Page 23

Percentage Break up by Issuer Type
Issuer Type
Public Sector Financial Institutions
State Financial Institutions
Public Sector Undertakings
State Level Undertakings
Private Sector-NBFC & Others

2012-1352.46%
1.53%
11.24%
2.44%
32.33%

2013-1453.49%
0.55%
11.53%
1.36%
33.07%

2014-15
54.13%
0.20%
7.22%
1.40%
37.05%

2015-1640.56%
0.00%
6.56%
4.85%
48.04%

2016-1727.27%
0.04%
9.55%
2.91%
60.23%

Table 17: percentage Break up by Issuer Type
Source: Prime Data baseRating Profile of the Issuer
RatingAAA
AA+
AA
AAOthers

2012-1364.32%
15.47%
7.21%
4.69%
8.32%

2013-1469.90%
13.55%
5.64%
3.47%
7.44%

2014-1564.79%
13.97%
5.63%
6.09%
9.52%

2015-201656.05%
11.05%
6.09%
5.93%
20.88%

Table 18: Rating Profile of the Issuer
Source: Prime Data base

Historically 80% of the issuance used to be in the AAA and AA+ categories, but this trend has beenchanging recently with mutual funds starting credit funds comprising of lower rated bonds, as lower
rated corporates looking to tap corporate bond markets have tended to move away from banking
loans which are very expensive. Moreover, with bank NPLs growing and capital charges on bank loans
to lower-rated companies becoming onerous, corporates have no recourse but to turn to thecorporate bond market.
Certificates of Deposit (CD) and Commercial Paper (CP) Issuances
As the credit growth slowed down in India, we saw CD issuance drop drastically. But, at the sametime, with banks taking long time in transmitting the rates cuts from RBI, we saw more and more
corporates tapping the CP market.
CD and CP Issuances (INR billion)
Date
CP Outstanding% Change CD Outstanding % Change Total% Change2012
911.9
4195.35107.2
2013
1092.619.8%
3896.1-7.1%
4988.7-2.3%
20141066.1
-2.4%
3758
-3.5%
4824.1-3.3%
2015
1932.781.3%
2809.7-25.2%
4742.4-1.7%
20162602.434.7%
2105.9-25.0%
4708.3-0.7%
20173979.752.9%
1557.4-26.0%
5537.1
17.6%
Table 19: CD and CP Issuances
Source: RBIPage 24

8. Corporate Bonds: New Endeavours
As mentioned above, the corporate sector relies too heavily on banks for lending and raising funds tofinance their business going forward. Everyone, including the RBI, understands that developing astrong and sound corporate bond market will alleviate the pressure on banks and provide corporations
an alternative way to finance themselves. Further, not only does a strong corporate bond market
foster healthy competition, the transparency of corporate bond markets will also force corporations
to respond directly to the concerns of investors and stakeholders. This will in turn facilitate thedevelopment of a deep corporate bond market which will improve the corporate governance,
efficiency and discipline within the corporate sector.
Given this, the Indian regulatory authorities have greatly increased incentives for corporate bondissuance. These include the granting of permission to banks to issue lower-rated bonds that are Basel
3 compliant (AT1 and Upper T1 & T2 issuance) to shore up capital, the liberalization of FPI limits toinvest in domestic corporate bonds, creating a framework for institutional investors to invest in realestate & infrastructure trusts and the introduction of offshore INR bonds or Masala bonds, described
below:
Introduction of New Products: Masala Bonds
Masala bond is a - INR denominated, euro-clearable, any currency settled (currency risk lies with theinvestors) bond issued offshore. It was introduced in 2016 and so far, has already seen an issuance of
INR 200bn – refer Table 20.
Masala Bond Issuance (INR billion)
Issuer Name
Housing Development Finance Corp Ltd
Adani Transmission Ltd
NTPC Ltd
Housing Development Finance Corp Ltd
Indiabulls Housing Finance Ltd
Fullerton India Credit Co Ltd
ECL Finance Ltd
Shriram Transport Finance Co Ltd
Housing Development Finance Corp Ltd
NTPC Ltd
National Highways Authority of India

Cpn
7.88
9.1
7.38
7
8.57
8.13
9.05
8.25
6.88
7.25
7.3

Issue Date
21/07/2016
29/07/2016
10/08/2016
09/09/2016
15/09/2016
24/10/2016
28/10/2016
18/01/2017
30/03/2017
03/05/2017
18/05/2017

Maturity
21/08/2019
29/07/2021
10/08/2021
09/01/2020
15/10/2019
24/11/2019
28/12/2019
18/02/2020
30/04/2020
03/05/2022
18/05/2022

Amount Issued
30.00
5.00
20.00
20.00
13.30
5.00
5.02
11.50
33.00
20.00
30.00
192.82

Table 20: Masala Bond Issuance
Source: Nomura

Masala bonds are an excellent product for the investors as it allows them to: a) invest in INR corporatebond risk without having to go through the cumbersome FPI route (and thus no need to apply for alicense); b) since Masala bonds are repo-able, they can take leverage against it, thereby enhancing

Page 25

their returns; c) these bonds are euro-clearable and hence allow for an opportunity for multi-currency
settlement.
For issuers, while they have to bear 15-20bps additional cost to their equivalent onshore issuance (as5% withholding tax (WHT) is paid by the issuer in this case), such costs should actually be comparedagainst the more costly USD / EUR MTN where they run currency risk and pay high hedging cost. Also,
this allows them to tap into a completely new and diversified set of customer base.
Further, as corporate bond limits get filled – given the current run rate – this may allow offshore
investors to still fund onshore corporates. The legal and regulatory framework around Masala bonds(and some of the more recent changes to this framework), are discussed in Section E below.
Additionally, a comprehensive overview of the entire Masala bond framework including an exhaustive
analysis of investor access channels and the tax framework can be found in Section F and Annexure B
respectively.
Other Work-In-Progress Potential Measures
The H R Khan working group on development of corporate bonds in India made many
recommendations which have been partially implemented and some are work-in-progress.
Some of the key recommendations are:
1. Reissuance of bond by frequent issuers to improve the liquidity of the ISINs. For more on this
topic see the “Proposals of SEBI for developing the Indian bond market” in Section C below.
2. FPIs are now allowed to invest in unlisted bonds of issuers who will not use those funds forreal estate and capital markets exposure.
3. Electronic book of private placement of bonds has been introduced by the exchanges and has
been operating successfully.
4. Uniform valuations guidelines across regulators for valuation of corporate portfolios ofdifferent investors class like banks, mutual funds, insurance companies are in the pipeline.
5. The introduction of DvP settlement for bonds traded OTC has been implemented.
Repo in corporate bonds through an electronic platform operated by Central Counterparties (CCPs) is
one of the key reforms in progress.
9. Securitisation and Covered Bond Market (ASIFMA)
A well-regulated securitisation system is commonly recognized as an efficient financing mechanism
for mortgage financing, credit cards, auto loans and even infrastructure enhancements and municipal
expansion. Covered bonds and high quality securitisations are a means of tapping the capital markets
for funding, backed by pools of good quality assets. Under the securitisation model, loans are issued
by an originator (typically a commercial bank), and then aggregated and packaged into multiple
securities with different characteristics of risk and return that appeal to different investor classes.
Disclaimer (Nomura)
The information provided herein is only for your information and should not be relied upon for any other purpose. Under no circumstances shall Nomura have any liability whatsoever
for any information contained in the presentation or any reliance upon or otherwise resulting from or in connection with or relating to the use of (including the inability to use or themisinterpretation of) the presentation. No representations, warranties or undertakings (express or implied) are made and no responsibility is accepted by Nomura as to the accuracy orvalidity of the information in the presentation. The expression "Nomura" refers to Nomura Fixed Income Securities Private Limited together with it affiliates.

Page 26

The development of securitisation of non-performing assets in India received a major boost over the
2002-05 period, following the enactment of the Securitisation and Reconstruction of Financial Assets& enforcement of Securities Interest Act (SARFAESI), 2002 (‘the Act’) 1. The Act encompasses the areasof: securitization of financial assets; reconstruction of non-performing financial assets; recognition to
any security interest created for due repayment of a loan as security interest under the Securitisation
Act, irrespective of its form; banks and financial institutions have the power to enforce the security
without intervention of the courts; setting up the Central Registry for registration of the transactionof securitisation, reconstruction and creation of security interests.
One specificity and problem with securitisation in India is that securitisations follow a trust structurei.e. the assets are transferred by way of sale to a trustee, who holds it in trust for the investors. In thissituation, a trust is not a legal entity in law but it is entitled to hold property that is distinct from theproperty of the trustee. Therefore, the trust performs the role of the Special Purpose Vehicles (SPV),
without having the legal status of an SPV.
Market Developments
Growth in Residential Mortgage Backed Securities (RMBS), Mortgage-Backed Securities (MBS) and
Collateralized Debt Obligations (CDOs) fueled the rapid growth of the securitisation market through2005, as new classes of investors and issuers gained confidence in the stability of and prospects forthe further development of the market. Furthermore, investor familiarity with the underlying asset
classes, stability in the performance of past pools and the relatively short tenor of issuances also
helped boost the market.
After a brief dip in 2006, caused by the tightening of capital requirements, strong growth in ABS andCDO volumes boosted the Indian securitization market through the first half of 2009, when the aftereffects of the global financial crisis did have a negative impact. Even so, the absence of transactions
involving complex derivatives and CDS in the Indian context meant that Indian securitization volumes
did stay relatively robust, in the immediate aftermath of the financial crisis.
The structured issuance volumes have grown considerably in the last few years in India. ABS is thelargest product class driven by the growing retail loan portfolio of banks and other Financial
Institutions (FIs), investors’ familiarity with the underlying assets and the short maturity period ofthese loans. The MBS market has been rather slow in taking off despite a growing housing financemarket due to the long maturity periods, lack of secondary market liquidity and the risk arising fromprepayment/repricing of the underlying loan.
During FY2014, the overall securitisation market (including rated bilateral transactions) in India shrunk
further by 5% over the previous year, in value terms. The number of transactions was also lower by
4% in FY2013 than that in the previous fiscal year. While the number and volume of ABS transactions
declined by about 14%, the number of RMBS transactions more than doubled in FY2014, (an increaseof 75% in value terms).

Page 27

Trend in Securitisation Issuance by Value per Financial Year (INR million)
FY 13

FY 14

FY 15

FY 16

FY 17*

AmountShareAmountShareAmountShareAmountShareAmountShare

ABS272,30090%

235,040

82%

163,300

95%

246,860

99%

281,700

31.3%

RMBS

30,25010%

52,960

18%

8,400

5%

2,700

1%

145,800

16.2%

Total Retail Securitization

302,550 100%

288,000 100%

171,700 100%

249,560 100%

427,500 100%

Vehicle Loans*

-

-

-

-

-

-

-

-

324,000

36%

Microfinance+Others *

-

-

-

-

-

-

-

-

148,500

16.5%

Overall Total

302,550 100%

288,000 100%

171,700 100%

249,560 100%

Growth

-20%

-5%

-40%

+45%

NC.

Avg. Deal Size

1,510

1,490

1,040

1,170

NC

900,000 100%

Financial Year 2013 - 17, i.e. April 1, 2013 to March 31, 2017. FY2017 data are estimates• Data available for FY2017 only
Table 21: Trend in Securitization Issuance by Value per Financial Year
Source: ICRA

Issues and Recent Developments
India’s growth is expected to remain stronger than the global average and more robust than the
median for similarly rated sovereigns. India will have long-term funding needs which could be provided
by the securitisation market to finance housing, infrastructure and urbanization projects.
The legal framework for securitisation is at a nascent stage in India as it is restricted to certain
institutions namely, banks and financial institutions only. Amendments to the Securities Contracts
Regulation (SCR) Act are certainly futuristic steps and well-deserved appreciation must be given
towards these steps. It is hoped that in the future, more and more transactions may be included underthe Act so that the market matures and reaches an advanced stage like the UK or the US, as thisprocess will support economic growth.
Development of the market for securitisation in India will need efforts of the Central Government,
State Governments, RBI and SEBI, has permitted mutual funds to invest in these securities. To
galvanize the market, FPIs can also be allowed to invest in a wide range securitised debt instruments– a process that has already begun. FPIs are already familiar with these instruments in other markets
and can, therefore be expected to help in the development of this market. However the measurestaken in India are still incomplete and more dedicated efforts would be necessary for a robust growthof asset securitisation market in India.
There are several issues facing the Indian securitisation market such as:• Stamp duty: In India, stamp duty is payable on any instrument which seeks to transfer rights
or receivables. Therefore, the process of transfer of the receivables from the originator to the
SPV involves an outlay on account of stamp duty, which can make securitization commercially
Page 28

unviable in states that still have a high stamp duty. A number of states have reduced theirstamp duty rates, though quite a few still maintain very high rates ranging from 5-12 per cent.
To the investor, if the securitized instrument is issued as evidencing indebtedness, it would bein the form of a debenture or bond subject to stamp duty, and if the instrument is structured
as a Pass Through Certificate (PTC) that merely evidences title to the receivables, then suchan instrument would not attract stamp duty. Some states do not distinguish between
conveyances of real estate and that of receivables, and levy the same rate of stamp duty.
SEBI has suggested to the government on the need for rationalization of stamp duty with aview to developing the corporate debt and securitization markets in the country, which may
going forward be made uniform across states as also recommended by the Patil Committee.
• Foreclosure Laws: Lack of effective foreclosure laws also prohibits the growth of securitizationin India. The existing foreclosure laws are not lender friendly and increase the risks of MBS bymaking it difficult to transfer property in cases of default.
• Taxation related issues: Some ambiguity remains in the tax treatment of MBS, SPV trusts, andNPL trusts. However, one positive development is that the taxation structure has beenchanged from distribution tax at SPV level to taxation in the hands of investors, thereby
increasing total after-tax returns. This has led to a boost in securitization/ABS issuancethrough FY2017.
• Legal Issues: Investments in PTCs are typically held-to-maturity. As there is no trading activity
in these instruments, the yield on PTCs and the demand for longer tenures especially frommutual funds is dampened. Till recently, PTCs were not explicitly covered under the Securities
Contracts (Regulation) Act, definition of securities. This was however amended with the
Securities Contracts (Regulation) Amendment Act, 2007 passed with a view to providing a legal
framework for enabling listing and trading of securitized debt instruments. This will bringabout listing of PTCs which in turn will support market growth, which will hopefully help toresolve the “lack of liquidity” issue.
Securitisation requires a stable and predictable operating environment. India must establish clear
legislative, legal and regulatory guidelines for market participants, incentivize the development of highquality data for proper risk assessment, and increase foreign participation.
To this end the regulators have carried out an amendment to the rules governing investment by FPIs
in India by expanding the list of areas in which FPIs can invest: These include:
Securitised debt instruments, including (i) any certificate or instrument issued by a special purpose
vehicle (SPV) set up for securitisation of asset/s with banks, FIs or Non-bank Financial Companies(NBFCs) as originators; and/or (ii) any certificate or instrument issued and listed in terms of the SEBI
“Regulations on Public Offer and Listing of Securitised Debt Instruments, 2008”.
On reading of the above text, it is quite clear that FPIs will be able to invest in both listed and unlisted
certificates/ instruments issued by SPVs set up for securitisation of assets. Here it is also important tonote that the originators of the assets should be either banks, FIs or NBFCs.
Page 29

In February 2017, SEBI explicitly permitted FPIs to invest in securitized debt instrument (SDI). The SDIs
include (i) certificate or instrument issued by a special purpose vehicle set up for securitization ofassets where banks, financial institutions or non-banking finance companies are originators; and/or(ii) certificate or instrument issued and listed in terms of the SEBI (Public Offer and Listing of Securitsed
Debt Instruments) Regulations, 2008.
(Sources: ASIFMA, ICRA, Vinodkothari.com)
10. Rates and Credit Market Infrastructure (including Ratings) (ASIFMA)
One of the most important elements for a robust credit/fixed income market is an independent credit
ratings industry, which renders a bond market attractive and accessible. While India has seen thecreation of a number of local ratings agencies (such as CRISIL, ICRA & CARE) and the entry of theinternational ratings agencies through acquisition or via the creation of standalone local entities, moreremains to be done. To this end, it is gratifying that SEBI intends to announce a ratings agency
framework with greater supervision. A well-supervised and established credit rating industry will
provide investors with more transparency with respect to the types of securities they are trading. In
particular, one of the reasons why investors are not willing to participate in the bond market is themismatch between the price of the bonds and the actual and real risk they carry. To create a more
attractive environment for investments, the credit rating industry must adhere to international bestpractices. By doing so, investors can take advantage of an international standardized rating, which willin turn make the market more transparent and reliable which will attract both domestic and foreign
investors.
With the premise that the government is able to halt the tendency of rising interest rates, banks mustalso start to recognize mark-to-market losses. By doing so, they would be compelled to trade
securities, rather than holding them to maturity. The more advanced the trading in the secondary
market is, the more necessary is the establishment of a solid risk management function. If banks canactually develop an independent risk management function, they can become involved in the tradingof corporate bonds, at every level of the yield curve. This would give the option of access to the bondmarket for some corporations whose issued bonds carry a low rating and high yield. This is the stage
where an appropriate risk management function kicks in, assessing the bank exposure to a certain
type of security and taking further action to hedge and balance out the exposure.
Nurturing a thorough market infrastructure system also entails meeting the need for international
settlement and financing of local bonds. This will help the Indian financial system to be further
embodied within the international system. Local bonds will then have a wider range of potential
investors, competing with each other and therefore allowing more efficient and less costly financing.
Also, this openness will attract foreign firms and give them the opportunity to participate in the market
and to reuse the bonds in their funding efforts.
To further integrate the Indian financial market within the international marketplace, CCPs such as the
CCIL have now been internationally recognized by the European Securities and Markets Authority(ESMA) in order to provide clearing services for all market participants. This is a positive development,

Page 30

since it signals that CCIL will now comply with international practices, thus being even more attractive
to foreign investors. ASIFMA has long supported CCIL’s application for recognition and is glad to notethat this objective has now been attained, at least partially. One point worth noting is that recognitionof CCIL by the Commodities and Futures Trading Commission (CFTC) in the US, is still outstanding.
The trading and clearing of government securities and corporate bonds by CCIL, the clearing agency
for G-Secs, and NSCCL, the clearing arm of the National Stock Exchange (NSE) of India, has beenfunctioning smoothly, thereby giving more credit to the clearing system as a whole. The use of clearing
systems for the reporting of usage of not just cash bonds/securities but also derivatives instruments
such as futures, CDS and other swaps is an encouraging step, since the focus will then be on thereporting of risk, rather than the restriction of derivatives usage. Also, tailoring the use of thesederivatives instruments in line with the usage of similar instruments globally will encourage usage andacceptability.
Nonetheless, bridging the local settlement system with ICSDs (Euroclear/Clearstream), would
constitute a further step in the development of the bond market, as they allow easier movement of
global collateral across borders via their “collateral highway”. Combined with offshore settlements,
this could create the basis for using local bonds as collateral in the event that market participants needaccess to USD cash, as we have seen recently.

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C. The Current Overall Bond Market Legal and Regulatory
Framework, Netting, Bankruptcy and Resolution
Regulatory Updates on the Developments in the Indian Bond Market
Given that a well-developed bond market is vital for the health of the economy, endeavours have been
made by the financial regulators in India for promoting exactly that objective in an orderly manner.
In India, bonds are largely governed by the provisions of the Companies Act, 2013; notifications andregulations issued by the RBI and regulations and circulars issued by SEBI. On the overall policy front,
the Ministry of Finance (MOF), through various departments, acts as the premier policy maker withrespect to financial legislation, capital markets regulation and taxation. In addition, the MOF, throughthe recent establishment of the Public Debt Management Office (PDMA) is also taking on a bigger rolein managing the country’s internal debt. The Companies Act, 2013 inter alia makes provisions for themode of issuance of bonds (private placement or public issue). RBI, inter alia is charged with the
responsibility of regulating the issuance of and investments in bonds by banks and non-banking
finance companies, foreign investments in India and modes of raising capital offshore and money
markets. SEBI, the capital markets regulator of India, concerns itself with issuance and listing of bondson the stock exchanges and regulating intermediaries
The Indian regulators are working in tandem to develop a bond market which complements thebanking system in India and provides an alternative source of finance to corporates for long term
investments.
1. Recent Entries in the Indian Bond Market
In the past, the conventional bond market in India mainly involved products such as non-convertible
debentures, foreign currency bonds, zero coupon bonds and structured products. A need was felt to
introduce new products in the bond market that would supplement the Government’s wave ofdeveloping infrastructure in India by raising debt both onshore and offshore. The Indian bond market
thus witnessed the introduction of two new products i.e. Municipal bonds and Masala bonds (we willtake a more detailed look at the regulatory framework for Masala bonds in the section below). Further,
the Government is making an attempt to popularize holding gold in dematerialized form through gold
sovereign Bonds (GSBs) while Indian entities are entering the arena of Green Bonds, (which is
discussed in the section below).
a. Municipal Bonds
While municipal bonds have been utilised to their maximum potential in countries like the US andChina, it was only in 2015, that SEBI issued the SEBI (Issue and Listing of Debt Securities by
Municipality) Regulations, 2015 (Municipal Bond Regulations) making provisions for issuance andlisting of municipal bonds. Municipal Bond Regulations define a municipal bond (also known as‘muni-bond’) as a long-term bond issued directly by the local municipality or state-owned
enterprise for funding infrastructure projects, e.g. public institutions, roads, and highways.

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The Municipal Bond Regulations classify municipal bonds into revenue bonds and generalobligation bonds. The classification is based on the underlying assets that will be used to service
the principal and interest payments. While the revenue bonds will be serviced by revenues fromone or more identified projects, the general obligation bonds would be serviced through tax
revenues collected by the municipalities. To ensure investor confidence, SEBI has ensured that
the Municipal Bond Regulations prescribe strict disclosure standards for the municipal bodies.
After the introduction of the Municipal Bond Regulations, the Pune Municipal Corporation
became the first local body in the India to raise public coffer aggregating to INR 2bn by issuingmunicipal bonds. As per reports, the issue was oversubscribed six times and received
subscriptions worth INR 12bn, thereby showing the appetite of the Indian investors for suchbonds.
The municipal bond market has massive potential in India. Infrastructure projects are the needof the hour in India and a regulated municipal bond market will ensure a steady flow of capitalnecessary to fund these projects. As regards investment opportunities, it may provide analternative investment opportunity to conservative Indian investors investing in fixed deposits,
small saving schemes or gold as it provides reasonable return with relatively less risk. This may inturn deepen the capital markets.
However, various supply side constraints could prove to be challenging in the development of themunicipal bond market. To prepare for these challenges, capital investments and other financial
management decisions made by municipal bodies need to be made with caution. Increasing themarketability of municipal bonds, establishing bond banks and creating a secondary bond market
are some of the ways to strengthen the municipal bond market and ensure its optimalfunctioning.
b. Gold Sovereign Bonds (“GSBs”)
The Sovereign Gold Bonds scheme was introduced by the Government of India in 2015 under theGovernment Securities Act, 2005. The scheme is keeping in line with the Government’s efforts torestrict its excessive gold imports into India along with other schemes such as Gold Deposit andGold Monetization. Each year, gold is the second-largest imported commodity in value. A hugeamount of gold is currently locked away in Indian households, thereby not playing a productiverole in the economy.
GSBs provide an alternative of holding gold in dematerialized form so as to deal with theinvestment demand of physical quantities of gold whilst reducing importation of gold into India
and diverting investment in more productive areas of the economy. The terms and conditions of
the issuance of the GSBs are notified by the RBI periodically, depending upon the number of series
announced for subscription per year, along with an annual set of Operational Guidelines for thesame. GSBs are issued in the form of Government of India stock, for which the investors receive
a physical holding certificate. The physical holding certificate is eligible for conversion into
dematerialized form. Currently, only a person resident in India can subscribe to GSB.

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The three important benefits of GSBs are (i) coupon rate; (ii) tax exemptions; and (iii) physicalsecurity. GSBs have been exempted from capital gains tax arising on the redemption of thesebonds. GSBs allow the investor to hold gold as investment and benefit from capital appreciation
as well as receive a small interest income.
2. Inter-linkage of the Indian Bond Market with Repos, Swaps and Futures Markets
Development of the bond market is harmonious with the development of repos and swaps market.
Repos provide the primary dealers with a broader range of hedging strategies by linking the money
markets and bond markets. This allows the security dealers to obtain short term liquidity and evencheap capital to finance their bids at auctions of new issues. Swaps markets enable the market of a
specific country to integrate into the broader international financial system by bringing together two
counterparties who have different interests in different markets and help in attracting a wider numberof foreign investors who in turn bring portfolio investments thus enabling the bond markets to groweven further. Similarly, a well developed futures market is beneficial for attracting foreign capital into
India, since futures allow for the hedging of interest rate and currency risks.
a. Repo Market
Repos have been permitted in government securities (issued by both the Central Government
and State Governments) and corporate bonds in the Indian market. Repos in corporate bonds
inter alia include repos in commercial papers, certificate of deposits, non-convertible debenturesand bonds issued by multilateral financial institutions like the World Bank Group (e.g., IBRD, IFC),
the Asian Development Bank or the African Development Bank and other such entities as may be
notified by the RBI from time to time.
Traditionally, the repo market in India differed from the “classic” repo which envisages thetransfer of title of security and allows the counterparty to use the security for a variety of
purposes. This permits the counterparty to further use the security as it owns the security for a
new repo, covering naked short positions, collateral, and securities lending or as a liquidity
management instrument. However, in India, the security acquired under repo could not be soldby the repo buyer (lender of the funds) during the period of repo. RBI, in 2015, relaxed thisrestriction by permitting re-repo in government securities acquired under reverse repo, subject
to certain conditions. At present, re-repo is restricted to government securities and does notextend to corporate bonds.
RBI has further made reporting of repo trades mandatory on platforms created by the CCIL or its
subsidiary the Clearcorp Dealing Systems (India) Ltd.
RBI’s most recent initiative has been the introduction of Tri-Party Repo (Tri-Party Repo
Framework) in relation to both government securities and corporate bonds. The proposed TriParty Repo Framework by the RBI is aimed at enabling market participants to use underlying
collateral more efficiently and facilitates the development of the term repo market in India. It is
not yet clear whether this will finally result in the use of GMRA documentation.

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b. Swaps Market
The swaps market in India broadly is composed of parties with varied exposures to interest rateand currency risk, such as banks, primary dealers, mutual funds, insurance companies andcorporates. Swaps have been traded in the Indian markets since the 1990s. While banks andprimary dealers (to a limited extent) have been permitted to make markets in India, all otherentities are permitted to use these products only to hedge their currency or interest rate risk.
The Indian swaps market has evolved over the years. The products that have been traded in themarkets have gradually evolved from being simple ‘plain vanilla’ swaps to some sophisticatedcost reduction structures. The Indian OTC derivatives market has witnessed significant growthover the last few years. While there has been limited growth in the options and credit derivative
markets, the OTC derivatives market has largely evolved on the basis of the swap market in India.
RBI has made tremendous efforts to ensure a healthy swaps market by implementing G-20
initiatives. The steps taken by the RBI in this direction include mandatory central clearing,bilateral margining requirements, and the creation of an LEI, all meant to guarantee the securityof these transactions. RBI has appointed CCIL for the purpose of providing entities with an LEI.
The local operating units (LOU), are the local implementers of the LEI system and provide theprimary interface for entities wishing to register for LEI. CCIL has been designated as the pre- LOU
in India. CCIL has also been registered as a pre- LOU by the Regulatory Oversight Committee.
In the current context, it may be relevant to note that on 1st June 2017, RBI mandated theimplementation of the LEI system for all participants in the OTC markets for INR interest rate
derivatives, foreign currency derivatives and credit derivatives in India, in a phased manner(ending March 2018).
c. Futures Market
SEBI, in consultation with the RBI, introduced exchange traded cash settled IRF on a range ofunderlying G-Sec maturities.
To further protect the interest of the investor and bring transparency, SEBI has mandated stock
exchanges in India to provide information regarding aggregate gross long position in futures
markets taken together at end of the day to the depositories National Securities Depository Ltd
and the Central Depository Services India Ltd.
The depositories are required to publish the data on their website.
With such initiatives in the repo, swaps and future market, we expect the markets to maintainpace in the coming years and see the development of a more viable bond market.
A number of other steps have also been taken to make the investment environment more attractive.

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3. Concrete Steps for Attracting Foreign Investment
The role of foreign investments in the bond market cannot be emphasized enough. Recent benefits
given to the FPIs show the commitment of the Indian regulators towards attracting foreign
investments in the Indian bond market.
a. FPI limits for investment in government securities has been enhanced to INR 1877bn; andb. In February 2017, SEBI finally permitted FPIs to invest in unlisted corporate debt securities in
the form of non-convertible debentures/bonds issued by public or private Indian companies
This is subject to minimum residual maturity of three years and end-user restriction on
investment in real estate business, capital market and purchase of land.
c. SEBI has released a consultation paper dated 28th June 2017 for easing of access norms forinvestments by FPIs. SEBI vide this consultation paper inter alia proposes to rationalize theforeign portfolio investment route by untangling the procedures to attract more funds.
4. Protection of Investors ‘a must’
For the development of the bond market, confidence of the investors is sine qua non. Realizing theimportance, the Indian regulators have taken concrete steps to instill the faith of investors in the bondmarket.
a. Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements)
Regulations, 2015 (“LODR Regulations”)
In September 2015, SEBI notified the LODR Regulations providing for disclosures to be made by alisted entity if it has outstanding listed debt . Chapter V of the LODR Regulations contains detailed
provisions with respect to compliances for listed debt securities. These provisions aim to increasetransparency in the market and enable investors to make informed decisions.
b. NettingWith increasing multiplicity and complexity of transactions, the concept of netting has gained
tremendous momentum.
Netting gives the investors a right to off-set giving them more confidence to remain in the market.
This affirmation is particularly relevant for banks and investment managers who are significantly
exposed to counterparty risk if exposures are grossed up and not netted. Thus, these types of
institutional investors set limits to reduce the level of exposure in the market, hampering liquidity
even further in the secondary market.
In the recent past, enforceability of netting has been doubted by certain segments of the markets
as regards sovereign owned entities. Concrete steps have been taken under the new Insolvency
framework to give formal recognition to the concept of netting in India.
i.

The Insolvency and Bankruptcy Code, 2016 (“IB Code”)
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The IB Code is the Government of India’s response to resolve the growing crisis faced by banksin India as regards impaired debt and low recovery rates. The inimitable feature of the IB Codeis that it has an overriding effect over all other legislations – Central or State. This is a first for
any Indian legislation.
The concern as regards netting has been partly addressed by the enactment of the IB Code.
Section 36 of the IB Code stipulates that any assets of the corporate debtor that could be
subject to mutual dealings and set-off would not form part of liquidation estate of thecorporate debtor.
Further, the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016
states that “where there are mutual dealings between the corporate debtor and another party,
the sums due from one party shall be set-off against the sums due from the other to arrive at
the net amount payable to the corporate debtor or to the other party”.
ii.

Financial Resolution and Deposit Insurance Bill, 2017 (FRDI Bill)

The MOF introduced the draft FRDI Bill in September 2016. After taking feedback from key
stakeholders, a revised draft is to be placed before the Indian Parliament in the monsoon
session of 2017. It proposes to establish a special resolution regime to be administered by
Resolution Corporation. This will cover financial service providers such as banks, insurancecompanies, financial market infrastructure entities, payment systems.
As regards netting of financial entities, the FRDI Bill proposes to establish a special resolution
regime for financial service providers. The FRDI Bill will be amending the Reserve Bank of India
Act, 1934 and providing a statutory basis to netting for all classes of counterparties. It is
expected that the Resolution Corporation will protect the stability and ensure the resilienceof the financial system.
Once implemented, the FRDI Bill together with the IB Code will go a long way in giving comfort
to the investors by unambiguously implementing the principle of netting, ultimately leading
to a flourishing bond market.
5. Indian Bond Market: The Road Map Ahead
SEBI has been making ongoing efforts in strengthening the Indian bond market. Through its various
initiatives, SEBI, intends to create a more transparent and liquid bond market in India.
a. Re-issuance and Consolidation of Bonds
SEBI vide its circular dated 30 June 2017 has made provisions for re-issuance and consolidationof debt securities issued on private placement basis. As per the circular, an issuing company will
be permitted a maximum of 17 International Securities Identification Numbers (ISINs) maturing
per financial year that shall include 12 ISINs for plain vanilla debt securities and 5 ISINs forstructured debt/market linked debentures. An issuer issuing only structured/market linked debt
securities has been permitted 12 ISINs in a financial year.

Page 37This may however, cause some practical difficulties to issuers who are used to doing multiple
issuances in a year. Same ISIN may be granted to only those debt securities having a common
maturity and coupon. This may limit the number of issuances an issuer can make in a financial
year. While the proposed amendments are expected to increase liquidity in the market, this willneed to be weighed with the clubbing of liabilities for the issuer.
b. Electronic Book Provider (EBP) Mechanism
The use of the EBP mechanism is currently mandatory for all private placements of debt securities
with an issue size of INR 5bn. With its consultation paper dated 22nd May, 2017, SEBI has
expressed its intention of making EBP mechanism mandatory for all private placement of debt
securities with an issue size of INR 500mn. SEBI proposes to provide an option of direct bidding
to non-institutional investors. Currently, only institutional investors have a choice of either
participating through an arranger or entering bids on proprietary basis on their own.
Though the purpose of SEBI for introducing the consultation paper is achieving better andtransparent price discovery through the bidding process, having a threshold as low as INR 500mn
shall increase the cost of fund raising for small and medium size issuers and may thereby
discourage small issuers from the corporate bond market.

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D. Settlement & Operations – Recommendations
1. Uniform Settlement Cycle for Government Debt Securities
BackgroundAt present the settlement cycle for FPIs trading in government debt via the OTC route is T+2 withdifferent cutoff time for reporting / confirmation of sale and purchase trades. While the sale trades
are required to be reported on day T (‘T’ being the trade date) the purchase trades can be reported
until 1 pm on day T+1. For trades executed on NDS-OM Web the settlement cycle is T+1. The challenge
for investors is to manage different reporting dates for purchase/ sale. Global custodians and FPIs
prefer not to have differential treatment of reporting / confirmation of purchase and sale trades as it
requires considerable changes in systems and bespoke procedures at their end. Also, for certain FPIs,
reporting of trades on day T is a challenge as the necessary instructions to the local custodian via the
global custodian may not flow on day T before the reporting / confirmation deadline.
Recommendation
We suggest moving the settlement cycle to T+1 with custodian reporting/confirmation in the first halfof T+1, uniformly for purchases and sales, allowing FPIs across time zones sufficient time to send
instructions to the local custodian via the global custodian overnight and to make necessary
arrangements for margin and settlement funding.
2. Rationalization of Debt Limit Rules
Backgrounda. The existing debt limit rules have multiple nuances making the process of pre-trade due
diligence and limit monitoring of available limits quite complex for the foreign investors. The
monitoring of limits is particularly complex on account of multiple categories and subcategories of limits and nuances pertaining to reinvestment eligibility. The practice of auctionof limits when overall FPI utilization is more than 90% of the total limit under the generalcategory (non long term) also adds to the complexity.
b. The custodians are required to ensure that the cumulative value of the purchase trades of
their respective clients in a given day does not exceed the threshold of 90% utilization (90-N)
and 100% utilization (100-N) for General Category limits and Long Term Category limits
respectively. This results in uncertainty and potential commercial impact to FPIs whenutilization approaches the thresholds, as ‘in flight’ trades that fail the (100-N) & (90-N) are notreported on NDS-OM by the custodian. Also, this check performed by the custodians is error
prone due to the manual nature of such monitoring.
c. The utilization of reinvestment eligibility is calculated by FPIs and Custodians manually and isreported daily to NSDL. NSDL consolidates the positions based on reporting by the custodiansand hosts the cumulative utilization on its website daily. The multiple legs in the process andPage 39

the manual intervention in the process heighten the risk of incorrect calculation of cumulative
utilization.
d. Recently, FPIs have been allowed to access real time anonymous order matching platform NDS
OM-Web Module for trading in government debt. However for FPI trades executed on thisplatform custodians cannot perform checks such as the monitoring of (100-N) and (90-N)
threshold and adherence to residual maturity, restrictions applicable to FPIs.
e. There is also an ask from FPIs to increase the time window available to avail of reinvestment
facility upon sale or maturity of their debt holdings.
Recommendation
Automated monitoring of debt limits on the NDS–OM platform eliminates complex monitoring andtracking procedures described above. As a practical matter, to prevent commercial impact to the FPIs
whose ‘in flight’ purchase trades are not reported due to intraday breach of the ceiling due toautomated monitoring by NDS-OM, it is recommended that such trades be allowed to settle and thisincremental utilization be adjusted against the subsequent quarterly infusion of fresh limits. Finally,
we recommend that reinvestment period available to FPIs, especially for the reinvestment of free
limits for government debt and auction limits for corporate debt may be increased.
3. Introduction of Early Pay-In
Background
CCIL applies initial margin on both the sale and purchase legs of the government debt trades andcustodian banks advise the clients to make the necessary funding arrangement for the margin prior toreporting the trade on NDS-OM platform. The margin collected by the custodians is credited back intoclients’ account once the underlying trade is settled. The debit on account of margin and subsequent
refund upon settlement of trade also increases the load on reconciliation process at the FPIs’ end.
Recommendation
Allow FPIs flexibility to ‘Early Pay-in’ their entire settlement obligation on trade day (T) itself for saletrades to eliminate the margin requirement. This flexibility will not only simplify operational
procedures but will also reduce transaction cost for FPIs.
4. Other Recommendations
a. There are multiple circulars / notifications pertaining to FPI investment in debt. The issuanceof a comprehensive consolidated set of guidelines for FPI investments in government debt andcorporate bonds would be beneficial for FPIs as well as market intermediaries.
b. The Union Budget 2014-15 proposed allowing settlement of debt instruments through ICSDs
like Euroclear and Clearstream. Operationalization of this initiative will provide foreign
investors additional avenue to invest in Indian debt market.

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E. Offshore Issuance by Indian Issuers – Structures &Legal Framework*
Indian issuers, or "credits", typically access internal G3 currency markets through the avenues of highyield issuance, off investment-grade or so-called "cross-over credit" style medium term note
programme platforms, and more recently, through the Rupee-denominated bond (or "Masala bond")framework introduced by the RBI. This chapter seeks to summarise the essential features of thestructures and legal framework of those product types, and introduce both a comparison to theregulatory and commercial approach of other Asian markets, as well as consider refinements which
could make Indian credit more competitive when seeking to attract capital in the international
currency markets.
1. High Yield Issuance
From first principles, high yield bonds are typified by their covenant package: as high yield bonds areusually issued by sub-investment grade issuers (or by issuers with either or both of a substantial
amount of debt, or incurring new debt which is subordinated to other senior debt), the covenant
package is designed to mitigate this inherent credit risk by putting in place a set of incurrence
covenants around a restricted group of subsidiaries, regulating and controlling elements of the credit
such as total indebtedness, restricted payments and the ability to grant security over assets in thegroup.
There were 13 New York-style covenant high yield issuances in India in 2016 and 2017 (to date).
Unlike Chinese high yield offerings (where real estate predominates), there is no dominant industry,and Indian high yield issuers have come from a broad cross-section of industries, including thetransportation, manufacturing, internet, pharmaceutical, energy, real estate and agricultural sectors.
Similarly, the types of covenant packages seen from Indian issuers are not as standardized as one sees
for comparable Chinese high yield offerings. Covenant packages in Indian offerings usually include
covenants that are customized to the company's specific business needs and credit risk profile.
The following table gives a general overview of the range of covenant ratios recently seen in Indianhigh yield offerings:
Issuer
HPCL-Mittal Energy
Glenmark Pharmaceuticals
Samvardhana Motherson Auto
Greenko Investments

Ratio Debt
Leverage Ratio (ratio of long-term debt totangible net worth) 3.0x
Fixed Charge Coverage Ratio: 3.0x
Consolidated Priority Debt Leverage Ratio: 0.4x
Fixed Charge Coverage Ratio: 2.0x
Senior Secured Leverage Ratio: 3.5x
Combined Leverage Ratio: 5.5x

Page 41

In addition, the following table gives a general overview of the range of credit enhancement (whether
by way of guarantees or collateral) structures seen from Indian issuers and credits:
Issuer
HPCL-Mittal Energy and Delhi International
AirportCredit Enhancement
No guarantees; no security
Parent guarantee; no upstream guarantees fromoperating subsidiaries
Upstream guarantees from various subsidiaryguarantors
Shares and partnership interests, certain bankaccount and substantially all material assets of
the issuer and certain restricted subsidiaries

Jain Irrigation

Samvardhana Motherson Auto

Traditionally, due to local regulations, non-investment grade Indian issuers tapped the international
debt capital markets only when the issuer had an entity incorporated offshore, and it could use thebond proceeds outside India. For example, Indiabulls used an offshore subsidiary as the issuer ofbonds and used the proceeds for projects in London (i.e. without bringing funds onshore into India):
Indiabulls Real EstateOnshore Parent Guarantor

Onshore Subsidiary
Guarantors

Onshore Non-Guarantor
Subsidiaries

Partial repayment of share
application money used inconnection with a UK realestate acquisition

Offshore Issuer

HY
Bond

Repayment of an offshore loan
Offshore Non-Guarantor
Subsidiaries= Notes Issuer= Guarantors= Restricted Group= Bond Proceeds

Recently, Indian companies have used Masala bonds to inject the proceeds of international bonds into
India. For example, ReNew Power used an orphan SPV incorporated in Mauritius (Neerg Energy) toissue bonds in the international capital market and moved the proceeds onshore using Masala bonds.
This was the first orphan issuer structure that was used in a live deal in Asia.

Page 42

Neerg Energy
HY
Bond

Offshore Issuer

Masala Bonds
ParentGuarantor

OnshoreSubsidiary
Masala Bond
IssuerOnshoreSubsidiary
Masala Bond
IssuerOnshoreSubsidiary
Masala Bond
IssuerOnshoreSubsidiary= Notes Issuer= Guarantors= Restricted Group= Bond Proceeds /Rupee Bonds Subscription

However, the recent release by the RBI of A.P. (DIR) Series Circular No. 47, the newly introduced
requirement that entities which are permitted investors under the Rupee bond guidelines should not
be "related parties" within the meaning of the applicable Indian accounting standard has effectively
meant that the Neerg Energy structure is unlikely to be replicated.
These structures are different from what is typically seen in other jurisdictions in the region. For
example, PRC companies may directly issue bonds in the international market or directly guarantee
bonds issued by an offshore subsidiary. Both, direct issuance by a PRC issuer and PRC onshore parent
guarantee require NDRC Circular (2015) No. 2044 registration compliance, and a PRC onshore parent
guarantee also requires post-issue filing and registration with State Administration of Foreign
Exchange (SAFE).
If PRC companies cannot or do not want to obtain approval from, or make registration with, theauthorities but needed credit support from PRC on-shore entities, they use a keepwell structure,sometimes supplemented by equity interest purchase undertakings (EIPUs) or standby facilities, which
are fundamentally not "guarantees" within the meaning of PRC regulation or English or New York law.1
Whereas a typical guarantee (under either New York or English law)2 is, legally, a conditional payment

1 A keepwell deed is essentially an undertaking, usually from a holding company to a subsidiary, in terms of which the parent company undertakes to keep theissuer as a subsidiary; to ensure the issuer maintains a positive net worth at all times; and to ensure that the issuer is in sufficient funds to meet its
obligations under the bonds, and to do so on time. An EIPU is similar in the nature of obligations it creates, but includes an undertaking by the parent toinject equity capital should the issuer not have sufficient funds to meet its obligations under the notes.
2 The two most prevalent governing law regimes for international bond offerings.

Page 43obligation allowing a creditor (in our case, a bondholder) to claim directly against a guarantor for an
unpaid obligation of a debtor (i.e. an issuer) – essentially, a liquidated sum – a keepwell or EIPU ismore in the nature of a "pure guarantee", any breach of which does not entitle the bondholder to aclaim for a liquidated sum against the provider, but rather, a simple claim for damages for breach ofcontract (with a duty to mitigate losses that does not exist in a conditional payment guarantee).

PRC Onshore
Parent Company
PRC
OnshoreKeepwell Agreement/Purchase
Undertaking/Standby Facility

PRC
Offshore(Cayman or BVI or
Hong Kong) Issuer

TrusteeInvestor

A crucial comparative difference, therefore, between India and competitor markets such as China or
issuers in the ASEAN region is an effective "negative" regulatory arbitrage: in our understanding, theRBI will treat any keepwell or EIPU structures as 'guarantees' of payment obligations requiring priorapproval, when as a matter of legal reality, they are not, and are not so treated in other markets.
Accordingly, lower grade issuers in other markets do appear to have greater flexibility in the design of
their credit structure, by using such non-guarantee credit devices, than Indian issuers are able to use,
thereby limiting the scope for financial innovation that may otherwise be available in other markets.
While covenant packages may go some way to imposing a degree of credit quality control on Indianissuers, the inherent subordination in a given credit structure means that this is not a universal salve
to the credit quality conundrum that non-investment grade Indian credits would otherwise findthemselves in.
In addition, in most high yield issuances out of China, the issuer is the Cayman Islands or BVI entitythat is listed on HK Stock Exchange, and the bonds are guaranteed by offshore subsidiaries only, i.e.,the on-shore operating PRC subsidiaries will be within the restricted group but will not provide a
subsidiary guarantee.
2. Masala Bonds
The issue of A.P. (DIR Series) Circular No.171 by the RBI, commonly referred to as the “RupeeDenominated Bond Guidelines” (“RDB Guidelines”), initially paved the way for Indian issuers to quickly
and efficiently issue Indian Rupee-denominated bonds in the international debt capital markets
pursuant to the RBI’s overarching Master Circular on External Commercial Borrowings and Trade
Credits (the “ECB Guidelines”), without having to seek prior approval from the RBI.
The introduction of the “RDB Guidelines” was pursuant to the robust demand made by theInternational Finance Corporation (“IFC”) and the Asian Development Bank. IFC was the first to issue
RDBs outside India.

Page 44The RDB Guidelines permits banks, corporates, non-banking finance companies, infrastructure
investment trusts and real estate investment trusts to issue RDBs overseas. The introduction of the
RDB Guidelines has ushered a new era for debt-raising by Indian entities.
Initially, the Rupee Bond Guidelines have relaxed a number of the requirements for Indian credits toaccess foreign funding and, in the process, opened up a potentially flexible form of funding for Indiancompanies through the issuance of so-called ‘Masala bonds’, which are bonds denominated in Indian
Rupees but settled in a foreign currency (for example, U.S. dollars). This synthetic settlement featureof Masala bonds means that issuers enjoy the benefits of raising capital in their home currency, withcurrency fluctuation risk shifting to investors, while at the same giving them an opportunity to tap aninternational investor base in the G3 markets. Similarly, the Rupee Bond Guidelines present foreign
fixed income investors with the first real opportunity to gain portfolio exposure to the Indian Rupee –a currency that, at the time of the introduction of the Rupee Bond Guidelines, enjoyed significantly
lower implied volatility compared to its Asian peers and other emerging market currencies in the wakeof the RBI’s inflation targeting policies. In addition, the Indian Finance Ministry has reduced thewithholding tax on interest income of such bonds to 5 per cent from 20 per cent and capital gains fromrupee appreciation have been exempted from tax, thus providing an additional source of attraction toforegin investors.
While Masala bonds did not introduce any regulatory flexibility insofar as credit enhancement
elements, covenant packages and related structural techniques are concerned, the effective passingof currency risk to an investor base that was seemingly happy to assume it led to an initial spate ofissuance, especially following the reduction of the minimum average maturity period from five years
to three years – thereby ensuring that fixed income investors had access to a U.S. dollar-Indian Rupee
currency swap market that was sufficiently deep to hedge their currency exposure (a market which
did not otherwise exist with a minimum average maturity of five years and over). It was thus widely
expected that Masala bonds would provide an opportunity for mid-size Indian corporate issuers, who
would otherwise not meet the ECB Guidelines requirements in order to access foreign investors, toaccess an international fixed income investment base. This was especially the case for non-bankfinancial companies, such as Indiabulls Housing Finance Limited and HDFC, who did not have thebenefit of a deposit base: Masala bonds essentially provided them with an entirely new source offunding. In Indiabulls Housing Finance's case, a reduction in the cost of funding was achieved further
by securing the bonds against its loan portfolio, on a pari passu basis with the rest of its loans.
However, since the introduction of the Rupee Bond Guidelines, the requirements for issuers to be able
to use them as an instrument have become increasingly stricter, with the most recent A.P. (DIR Series)
Circular No.47 effectively increasing the average maturity back to five years (for issues above USD 50
million); including an all-in cost ceiling limited of 300 basis points above the prevailing yield of Indiansovereign securities of equivalent maturity, and – as indicated in the discussion on high yield bonds
above – excluding the use of Masala bonds as part of a broader structure by requiring investors not tobe related parties.
It is our view that these recent changes to the regulatory framework represent an obstacle to thefurther development of the Indian capital markets – the imposition of “pricing caps” fails to distinguish
Page 45

higher-rated issuers from lower rated ones and it is our view that this is best left to the market todecide pricing levels – the information possessed by both ratings agencies and investors are in ourview sufficient for all market participants to make informed decisions with respect to individual Masalabond issues.
Yet another restriction that is in place is that domestic investors are not allowed to invest in Masalabonds in the secondary markets. We recommend that domestic investors should be allowed to buy
Masala bonds in the secondary market, as this would substantially improve liquidity and increase themarketability of Masala bonds among foreign investors.
The technology underlying the synthetic settlement of Masala bonds is not new, with Chinese issuerssuch as Shui-On Land and Evergrande having issued synthetic RMB bonds in the past. However, thesynthetic settlement on those offerings were designed to take the capital raising exercise outside of
the regulatory perimeter of Chinese capital controls, whereas for Masala bonds, that perimeterremains carefully circumscribed.
INR Denominated External Commercial Borrowings
In November 2015, the Reserve Bank of India liberalized the External Commercial Borrowings
framework. The Revised Guidelines enabled INR denominated bilateral lending to Indian corporates
by Recognized Lenders/ Investors.
Masala Bonds and INR ECBs provide a new avenue of funding Indian entities. Both routes have largely
similar features, the key being FX hedging transferred to offshore Lenders/Investors. Transfer of FX
hedging requirement to offshore Lenders/Investors would systemically reduce the complexity for
Indian borrowers in managing FX risks to their Balance Sheets.
From a tax policy perspective however, there is a lack of parity between the two products. Based on
our experience and advice from Indian tax advisers, while the Withholding Tax (WHT) rate on interest
income from Masala Bonds is 5%, there is no concessionary WHT rate applicable to interest on INR
ECBs which means that the applicable WHT rate defaults to the normal rate of 40% (subject toapplicable tax treaty relief, if any). This is also significantly higher than the concessional rate of 5%
given under section 194LC of the Income Tax Act, 1961 which is applicable to Foreign Currency
denominated ECB.
3. Medium Term Note Programmes
Medium Term Note Programmes, or "MTNs", are essentially no different to any other bond issue (withno significant legal or structural difference arising from the use of the phrase, "medium-term"). Theiressential feature is that all underlying bond documentation, including a prospectus or offering circular,
is agreed in advance (including in-principal regulatory approval from the stock exchange on which thebonds to be issued are to be listed), meaning that issuers can quickly, efficiently and comparatively(to "stand-alone" issuances, which are documented from scratch for each issue) cheaply accessinternational bond markets on the basis of the framework documents agreed on establishment ofPage 46

programme. The use of programmes is, therefore, largely analogous to that of facility agreements
and "drawdowns" in the syndicated loan market.
The cost inherent in establishing the programme in the first instance was typically viewed as making
MTNs more suitable to frequent issuers with high credit quality. In addition, given the dynamic natureof high yield covenants and the disclosure obligations attendant on high yield issuers, programmes
are not seen as being suitable to high yield issuers, as covenants would need to be assessed in detailprior to each issuance, and disclosure updated in detail – an exercise which would largely negate thetime and cost benefits associated with programme establishments and drawdowns.
This profile is no different in India compared to other markets, with only established bank credits (forexample, Axis Bank) and quasi-sovereign or public sector undertakings (such as the Export-Import
Bank of India) establishing programmes, and which had little in the way of credit enhancement
features or covenant packages (as these are not needed, in light of the credit quality of the issuer).
However, in light of the fact that no regulatory approvals are required from Indian regulators toestablish MTN programmes (as there is no incurrence or issuance of debt on a pure establishment),
and in the context of a fast-changing regulatory landscape in India, MTN programmes could provide
Indian issuers with a means to be able to quickly and efficiently access international debt capital
markets as and when regulations and market dynamics permit. The establishment of a multi-currency
programme well in advance of any issuances may therefore provide Indian issuers with the flexibility
to go to market quickly, as opposed to suffering the time-lags – and therewith, the potential prejudice
to a successful transaction – of execution that would otherwise be the case on a typical four-to-six
week execution timetable.
4. Green Bonds
There is no formal or statutory definition of a green or climate bond, nor are they always easily
identifiable by a green moniker or a “green bond” title. Essentially a green bond or climate bond is a
fixed income product the proceeds of which are used for projects which have environmental benefits
and typically promote a low carbon economy. Green bonds are popular amongst issuers for various
reasons, although at the moment improved pricing on issue does not seem to be one of them.
Corporate green bonds are currently pricing flat on issuance with the issuer’s other debt. There is logic
to this as the credit is the same. Interestingly however, many of the green bond issuances are creating
demand from a wider range of investors, and in some cases investors who are new to the particularissuer. For example, on the GDF Suez issuance it was reported that 64% of investors were sustainable
investors, many of whom were investing in GDF bonds for the first time. Increased investor demandand diversification may eventually translate to a pricing differential. A recent report by Barclays
indicates that green bonds trade at a premium in the secondary market, up to 17 basis points tighter
than conventional bonds, attributed in part to demand from environmentally-focused funds. In
addition, issuers benefit from positive publicity resulting from green bond issuance – green bonds
present an opportunity to align corporate strategy with fund raising.

Page 47

Although multilateral investment institutions such as the European Investment Bank and the WorldBank have been issuing green bonds since 2007, the first corporate green bonds were only issued in
November 2013 (with Indian's first certificated green bond in international markets being raised by
Axis Bank Limited in 2016, listing on the London Stock Exchange).
In India, green bonds have also been issued by other Indian entities such as Yes Bank Ltd., Exim Bank,IDBI Bank Ltd. and have received positive response in the market. Keeping in mind the potential ofgreen bonds, SEBI, in May 2017, notified disclosure requirements for issuance and listing of green
bonds (“Green bonds Circular”).
As per the Green bonds Circular, green bonds can be issued inter alia for projects and/or assets
relating to renewable sources of energy, waste management and climate change adaption. To ensurebona fide utilization of funds, SEBI has placed the issuing company under an obligation to utilize theproceeds for the stated environment purpose, and ensure that the projects/assets meet the eligibility
criteria. SEBI has prescribed additional disclosure requirements for issue of green bonds.
Since 2013, the global market has seen exponential growth, from USD 11bn in 2013 to approximately
USD 93bn in 2016 (Reuters data), and the number and range of issuers entering the green bond market
continues to expand. The emergence of the green bonds market has been recognised by the United
Nations in its “Trends in Private Sector Climate Finance” on 9 October 2015 as representing “one of
the most significant developments in the financing of low-carbon, climate-resilient investment
opportunities”.
There is no legal definition of a “green bond”: it is effectively issuers themselves who determine if
their bonds are green and market them as such. Similarly, the ongoing commitments of green bondissuers, such as ensuring that the proceeds are used for the green purposes described in the bondoffering documentation and complying with any reporting obligations that they have agreed to adhere
to, are not generally included as contractual covenants enforceable by investors – investors must rely
on market reprobation to ensure issuer compliance. The key players in the green bond market see
benefit in self-regulation by the market, but also recognise that minimum standards and criteria giveconfidence to investors, enable better and quicker execution and trading and improve comparability
across bonds. To address the lack of uniform standards the Green Bond Principles (GBP) and the
Climate Bonds Initiative (CBI), amongst others, have sought to develop general principles andcertification programmes. In conjunction with these initiatives there is an increased focus across thesector on standardising the provision of assurance, verification and reporting.
While the introduction of green bonds, and their adoption by Indian issuers, are seen as being a
positive development in the world of sustainable finance, the commercial reality remains that green
bonds are ultimately no different – from a credit profile and credit analysis perspective – than any
other corporate bond issuance. Accordingly, the issues and challenges faced by Indian companies
seeking to engage a broader "green" investor base, and enhance its access to sustainable financing,will be subject to the same obstacles surrounding pricing parameters and the lack of viable credit
enhancement, synthetic settlement and pricing alternatives attendant on any other issuance of debt
securities.

Page 48

* PLEASE NOTE THE INDIAN REGULATIONS DO NOT PERMIT FOREIGN LAW FIRMS TO ADVISE ON
INDIAN LAW. THE PRECEDING CHAPTER WAS PREPARED WITH INPUT FROM INDIAN COUNSEL,REFLECTS CLIFFORD CHANCE'S UNDERSTANDING OF THE INDIAN REGULATIONS AND ITS EXPERIENCE
ON TRANSACTIONS IN INDIA. IN THE CASE OF ANY QUESTIONS OR CLARIFICATIONS ON INDIAN LAW,
THE VIEWS OF INDIAN COUNSEL SHOULD BE OBTAINED.

Page 49

F. Access Channels and Taxation of Debt Instruments
1. Access Channels for Debt Investments
The Indian Government in recent years, has taken several steps to revamp the Indian debt market andencourage greater foreign participation. Some of these include steps to increase the breadth of thedebt markets by introducing new investment products such as rupee denominated bonds issued
outside India (Masala Bonds) and the depth of the markets by increase in investment limits, allowing
FPIs to re-invest their coupons in Government securities and allowing them to trade directly in thecorporate bond market.
“Access channels” with respect to Indian debt markets can broadly be divided into “offshore funding”
routes such as investment by FPIs and other non-resident investors in Indian debt instruments and“onshore funding” routes such as an Alternative Investment Fund, Non-Banking Financial Company(NBFC), etc. to lend or invest in Indian companies. This paper largely focusses on the offshore funding
route for debt investments in India. In this context, “access channels” available to foreign investors,
divided across borrower categories, are tabulated below:
IssuerName of the Instruments

Government Dated Government Securities

Non-Convertible Debentures(NCDs)/Bonds

Perpetual Debt Instruments(Tier I and Tier II)
Corporates

Credit Enhanced Bonds

Description
Dated Government securities are long term
securities and carry a fixed or floating coupon
payable, at fixed time periods (usually halfyearly). The tenor of dated securities can be up
to 30 years. In India, the Central Government
issues dated securities while the State
Governments issues bonds or dated securities,
which are called the State Development Loans(SDLs).
NCDs are rupee denominated debt securities
issued by Indian companies which evidence a
debt due to the NCD holder and entitle suchholder to the principal amount with a preagreed interest and/or premium.
Perpetual Debt Instruments, which are
popularly known as a ‘perpetual’ or ‘perp’, aredebt instruments with no maturity date. The
issuer pays coupon on perpetual debt
instrument throughout the life of the bond.
These bonds are generally not redeemed.
Credit enhancement refers to a method
whereby a company attempts to improve its
debt or credit worthiness. Through credit
enhancement, the lender is provided withreassurance that the borrower will honor the
obligation through additional collateral,
insurance, or a third party guarantee.

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Zero Coupon Bonds (ZCBs),
Deep Discount Bonds (DDBs)
and Discounted Bonds (DBs)

Masala Bonds

Indian Rupee DenominatedExternal Commercial Borrowing(ECB)

Foreign Currency DenominatedBonds (FCB)

Units of Debt Oriented Mutual
Funds

Infrastructure Debt Fund (IDF)
Others(Trusts,
SPVs, etc.)

Security Receipts Issued by
Asset Reconstruction
Companies (ARCs)

ZCBs means a bond in respect of which no
payment and benefit is received or receivable
before maturity or redemption from
infrastructure capital company or infrastructure
capital fund or public sector company.
DDB and DBs are generally issued at a pricelower than its face value and the face value isrepaid to the investor at the time of thematurity of the bond. These bonds do not carrycoupon during their lifetime.
Masala Bonds are generally coupon bearing
bonds issued by Indian corporates outside
India. These bonds are denominated in Indianrupees and are either placed privately or listed
on overseas exchanges as per host country
regulations.
ECBs are borrowings raised by permitted
resident entities from recognised non resident
entities. ECBs can be denominated in either
foreign currency or Indian rupees.
These bonds are issued by Indian companies
overseas. They are denominated in foreign
currency, generally listed on an overseas stock
exchange and carry a fixed coupon rate.
Issuance of these bonds by Indian companies
are governed by the External Commercial
Borrowing (ECB) framework of the RBI.
Debt oriented mutual fund schemes are mutualfund schemes which allocate major part of thefunds in government securities, corporate
bonds, debentures and at times fixed deposits.
IDFs are investment vehicles which can besponsored by commercial banks and NBFCs in
India in which investors can invest through units
and bonds issued by the IDFs. IDFs essentiallyact as vehicles for refinancing existing debt ofinfrastructure companies, thereby creating
fresh headroom for banks to lend to fresh
infrastructure projects.
Security receipt means a receipt or othersecurity, issued by a securitisation company orreconstruction company. It is issued to any
qualified institutional buyer pursuant to ascheme, evidencing the purchase or acquisitionby the holder thereof, of an undivided right,
title or interest in the financial asset involved insecuritisation.

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Securitised Debt Instruments

Units of Real Estate Investment
Trusts (REITs)/Infrastructure
Investment Trusts (InvITs)

Cash Settled IRFs

A securitised debt instrument is any certificate
or instrument (by whatever name called),
issued to an investor by any issuer being a
special purpose distinct entity which possesses
any debt or receivable, including mortgage
debt, assigned to such entity, andacknowledges the beneficial interest of suchinvestor in such debt or receivable, including
mortgage debt, as the case may be.
Securitisation involves the pooling of financial
assets and the issuance of securities that are repaid from the cash flows generated by theseassets.
A REIT is an investment vehicle that owns andoperates real estate-related assets, and allows
individual investors to earn income produced
through ownership of commercial real estate
without actually having to buy any assets. An
InvIT is like a mutual fund, which enables direct
investment of small amounts of money frompossible individual/institutional investors ininfrastructure projects to earn a small portionof the income as return.
An IRF is a futures contract with an underlying
instrument that pays interest. An IRF is acontract between the buyer and seller agreeing
to the future delivery of any interest bearing
asset. IRFs allow the buyer and seller to lock in
the price of the interest bearing asset for a
future date.

An overview of the Indian tax and regulatory aspects relevant to above debt instruments has been
enclosed as Annexure A and B.
2. Emerging Tax Landscapea. Recent Treaty Developments
Traditionally, Mauritius, Singapore, Cyprus and Netherlands have been usually preferred for debt
investments into India. Often, concerns have been expressed over possible misuse of theseplatforms for avoiding Indian taxes. In a defining step, the Indian Government has renegotiatedits tax treaties with jurisdictions such as Mauritius, Singapore and Cyprus.
Hitherto, capital gains arising to Mauritius, Singapore and Cyprus tax residents from transfer ofIndian securities were generally not taxable in India. With effect from 1 April 2017, capital gains
earned by residents of these jurisdictions from alienation of shares of an Indian company
acquired on or after 1 April 2017 is now taxable in India. Investments in shares made before 1
April 2017 have been grandfathered and will generally continue to enjoy the benefits of the
Page 52

erstwhile tax treaty provisions. Capital gains arising on alienation of instruments other thanshares (bonds, debentures, derivatives, etc.) continue to be exempt from tax. This exemption, isof course, subject to application of Indian General Anti-Avoidance Rules which are discussed later.
As far as interest income is concerned, the amended India – Mauritius tax treaty now provide fora tax rate of 7.5% on interest income earned by a Mauritian tax resident. The taxation of interest
income under the amended India – Singapore and India – Cyprus tax treaties remain same as
earlier i.e. 15% under the India – Singapore tax treaty and 10% under the India – Cyprus tax treaty.
b. General Anti Avoidance Rules (GAAR)GAAR provisions have been codified in the Indian tax law to counter aggressive tax planningarrangements. These provisions are applicable to income arising on or after 1 April, 2017. GAAR
provisions empower the Indian Revenue Authorities (IRA) to declare certain transactions as“impermissible avoidance arrangements”.
The expression "impermissible avoidance arrangement" essentially means a step or an
arrangement, whose “main purpose” is to obtain a tax benefit and the arrangement, amongst
others, lacks or is deemed to lack commercial substance in whole or in part.
GAAR also makes a presumption in favour of the tax department where an arrangement that isentered into for the tax benefit alone (thus an impermissible avoidance agreement), unless thesame is rebutted by the taxpayer. The burden of proof has been shifted on to the taxpayer toestablish that obtaining a tax benefit was not the main purpose of the arrangement; else thearrangement shall be presumed to have been entered into, or carried out, for the main purposeof obtaining a tax benefit. Hence, GAAR is expected to bring a big change in the underlying tax
treatment including eligibility of foreign investors to claim tax treaty benefits.
Certain relaxations and clarifications have however been provided with respect to applicationand implementation of GAAR provisions. For example, these provisions are not applicable in thefollowing cases:• Where the tax benefit from an arrangement in a relevant tax year does not exceed INR
30mn (approx USD 450,000)• Where FPIs registered with the Indian market regulator do not avail any tax treaty
benefits• Investment made by a non-resident by way of offshore derivative instruments orotherwise, directly or indirectly, through an FPI• Gains arising from transfer of investments made up to 31 March 2017
• If the jurisdiction of FPI is finalised based on non-tax commercial considerations and themain purpose of the arrangement is not to obtain tax benefit

Page 53• If the arrangement is held as permissible by the Authority for Advance Ruling (AAR) or
where the Court has explicitly and adequately considered the tax implication while
sanctioning an arrangement
To limit application of GAAR provisions only to justifiable cases, it is clarified that GAAR provisions
will be invoked only after the arrangement is vetted by the Principal Commissioner /Commissioner of Income tax at the first stage and then by the Approving Panel headed by thejudge of a High Court at the second stage.
Once the arrangement is declared as impermissible avoidance arrangement, the IRA could
possibly, amongst others, deny tax treaty benefits, disregard, merge or re-characterise any stepin any arrangement, or re-characterise equity in to debt and vice versa, treat place of residence,situs of asset or transactions at different place.
c. Multilateral Instrument to Implement Tax Treaty Related Measures to Prevent Base Erosion
and Profit Shifting
Another global tax development is the introduction of the 'Multilateral Convention to Implement
Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting’ (MLI) by theOrganisation of Economic Co-operation and Development (OECD). The MLI aims, amongst others,
to implement tax treaty related measures to prevent Base Erosion and Profit Shifting'. The MLI is
new global tax avoidance agreement, that is signed by 68 countries (including India). Several
other countries are expected to sign the MLI in due course.
Once adopted, MLI will supplement/modify the existing tax treaties that India has with several
countries and incorporate anti-avoidance rules/Limitation of Benefits (LOB) conditions. These
rules/conditions are to be finalised based on positions adopted by signatories to the MLI.
The MLI, amongst others, includes a "principal purpose test" (PPT), wherein tax treaty benefits
can be denied if one of the principal purposes of an arrangement or a transaction was to, directly
or indirectly, obtain tax benefit, unless it is established that granting that benefit would be inaccordance with the object and purpose of the provisions of the relevant tax treaty. The PPT
appears to be wider than the India GAAR which is invoked if the “main purpose is to obtain tax
benefit”.
d. Thin Capitalisation Rules
Thin capitalisation rules have recently been introduced in the Indian tax law to curb companies
from claiming excessive interest deductions. These rules are an outcome of the Base Erosion andProfit Shifting (BEPS) Action Plan 4 adopted by the OECD which proposed a 10 to 30% of Earnings
Before Interest, Taxes, Depreciation and Amortisation (EBITDA) range for limit on interest
payments.
Under the Indian tax law, where an Indian company or Permanent Establishment (PE) of a foreigncompany makes interest payments (or similar consideration) exceeding INR 10mn which isPage 54deductible in computing income chargeable under the head “profits and gains of business or
profession” to its:
• Non-resident associated enterprise (AE); or• A third party lender (non AE) but where the AE provides implicit or explicit guarantee tosuch lender or deposits a corresponding and matching amount of funds with the lenderthen such interest shall not be deductible in the hands of the Indian company/ PE to the extent
of the “excess interest”. Excess interest means total interest in excess of 30% of the EBITDA of
the Indian company / PE. These provisions are not applicable to borrowers engaged in banking or
insurance businesses.
The above move could have a significant impact on investments into India through the debt route.
e. Income Computation and Disclosure Standard (ICDS) - Timing of Taxability
Interest income received from investment in debt securities is generally taxable under the head“income from other sources”. The timing of taxability of such interest income i.e., whether on
due basis or accrual basis has been subject matter of debate. The issue is more relevant withrespect to investment in discounted instruments where no coupon is generally paid.
f. Overseas Transfer Provisions
The Indian tax law incorporates provisions to tax overseas transfers i.e. transfers of shares orinterest in an offshore entity where the value of such shares or interest is substantially derived
from assets located in India (overseas transfer provisions). Certain debt securities owned byforeign investors in India could be regarded as assets located in India, and hence the provisions
are relevant.
The overseas transfer provisions are applicable if, on a specified date (which could be the latest
balance sheet date or transfer date, depending on facts of the case), fair market value of Indian
assets (without reduction of liabilities) (1) exceeds INR 100mn; and (2) represent at least 50% of
the value of all the assets owned by such foreign company or entity.
Certain relaxations have been provided with respect to applicability of overseas transfer
provisions. For example, these provisions are not applicable to shareholders not holding right ofmanagement or control or to small shareholders holding less than 5% of the voting power/sharecapital/interest in the offshore entity or on dividend pay-outs by the foreign company.
Further, the Indian Government recently amended the tax law to exclude Category I and Category
II FPIs from the ambit of overseas transfer provisions. It is expected that the Indian Government
will clarify that overseas transfer provisions shall not apply in case where redemption of sharesor interests outside India as a result of or arises out of redemption or sale of investment in India
which is chargeable to tax in India.

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g. Safe Harbour Provisions for Offshore Funds Investing in the Indian Capital Market
India has introduced safe harbour provisions in the Indian tax law to encourage offshore fundmanagers who are of Indian origin and managing offshore funds to relocate to India. These
provisions essentially provide that fund management activities carried out through an eligible
fund manager shall not constitute a ‘business connection’ of that fund in India. Also, an offshore
fund shall not be considered as being resident in India merely because the fund manager
undertaking the fund management activities is situated in India.
The above safe harbour benefits will be available to offshore funds and fund managers who fulfil
certain specified conditions. The key conditions specified in this regard include diversified
holdings at the offshore fund level and registration of the fund manager with the appropriate
authority in India.
h. International Financial Services Center (IFSC)
An IFSC is a designated area for providing financial services to non-residents and residents, incurrency other than Indian Rupees. The purpose for setting up an IFSC is to bring financial services
transactions, which are currently carried out outside India by overseas financial institutions andoverseas branches/subsidiaries of Indian financial institutions, to a designated center on Indiansoil, while being subject to the same financial ecosystem as their present offshore location.
India’s first IFSC is launched at Gujarat International Finance Tech-City (GIFT City). Amongst
others, the permissible securities traded in IFSC include debt securities issued by eligible issuers
and interest rate derivatives.
The Indian Government has extended certain regulatory and fiscal incentives to attract foreign
investors on the international stock exchange in IFSC, such as waiver of Securities Transaction Tax(STT) and commodities transaction tax on transactions, and no requirement of any additional
registration or approval for FPIs already registered with SEBI. IFSC could emerge as an important
destination in the Indian financial services sector.

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G. Annexure A
1. Overview of Taxability in India
a. Streams of Income
Foreign investors investing in debt securities would generally earn following types of income fromtheir India investments:• Long term capital gains or short term capital gains on transfer of debt securities• Interest income from investments in debt securities
b. Charge of Tax
The Indian tax law is contained in the Income-tax Act, 1961 and is administered by the Central
Board of Direct Taxes (CBDT). Income tax is levied on the total taxable income earned by a person
during the previous year. Total income has to be computed in accordance with the provisions of
the Indian tax law and the Income-Tax Rules, 1962.
The basis of charge of Indian income tax depends upon, amongst others:• the residential status of the tax payer during the year; and• the nature/source of the income earned.
c. Residential Status of the Tax Payer
Broadly, a non-corporate tax payer (other than individual) is treated as tax resident in India,
except in a case where during the year, the ‘control and management’ of its affairs is situatedwholly outside India. A company is considered as a tax resident in India if its Place of Effective
Management (POEM) is in India during that year. The term POEM is defined as “the place where
key management and commercial decisions that are necessary for the conduct of the business ofan entity as a whole are, in substance, made”.
A person who is regarded as an Indian tax resident is liable to taxation in India on worldwide
income, subject to tax exemptions, provided under the Indian tax law. A person who is regarded
as a non-resident for Indian income-tax purposes is generally subject to tax in India only on such
person’s Indian-sourced income or income received in India.
Income earned by foreign investors from investments made in India should generally be regarded
as Indian sourced income and should be taxable in India as per the provisions of the Indian tax
law.

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d. Accrual of Income
Income accruing or arising, whether directly or indirectly, through the transfer of a capital asset
situated in India shall be deemed to accrue or arise in India.
Interest income shall be deemed to accrue or arise in India where, it is payable by a person who
is an Indian tax resident, except where such interest is payable in respect of any debt incurred, ormoneys borrowed and used, for the purposes of a business or profession carried on by such
Indian tax resident outside India or for the purposes of making or earning any income from any
source outside India.
e. Characterisation of Income
In the absence of express provisions in the Indian tax law, characterisation of gains earned byforeign investors from transactions in securities has been the subject matter of debate. In orderto provide certainty, the Indian tax law was amended in 2014 to provide that any investment insecurities made by FPIs in accordance with SEBI FPI Regulations shall be regarded as a capital asset.
Accordingly, gains arising to FPIs on transfer of such Indian securities shall be characterised as“capital gains”.
Further, the CBDT has clarified that, gains arising from transfer of listed shares and securities(which were held for more than 12 months before sale) would be regarded as ‘capital gains’ asagainst ‘business income’, except where the tax payer itself treats such income as businessincome.
Characterisation of premium on redemption of debt securities (on face value in the context of
discounted debt securities), whether “interest income” or “capital gains”, is a vexed issue. Where
the debt securities carry coupon which is commensurate with the market rate, redemption
premium could be arguably, regarded as capital gains.
f. Minimum Alternate Tax (MAT)As per the Indian tax law, MAT is levied at the rate of 18.5% on the adjusted book profits ofcompanies whose tax payable under normal Indian tax law provisions is less than 18.5% of theiradjusted book profits.
The liability to pay a minimum tax of 18.5% on book profits is entrusted to Indian as well as foreigncompanies. However, a foreign company is not liable to pay MAT if India has entered a tax treaty
with the country in which the foreign company is a resident and it does not have a PE in India. In
cases where India has not entered a tax treaty with the country in which the foreign company is a
resident, the company will not be liable to pay MAT if it is not required to seek registration in India
under any law in force that relates to companies.
g. Tax Treaty Provisions
Under the Indian tax law, non-residents can generally avail benefits under tax treaties to theextent such tax treaties provide a more concessional treatment as compared to the Indian tax law.
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To avail tax treaty benefits, non-residents are required to obtain a Tax Residency Certificate (TRC)
containing prescribed particulars certifying their tax residence in their home country. Further,
non-residents are also required to maintain and furnish such other documents and informationthat may be required by the IRA.
The table below outlines taxation in accordance with tax treaties signed by India with some of the
key jurisdictions preferred for debt investments in India:
Tax Treaty between India
andCyprusJapan
Korea
Mauritius
Netherlands
Singapore

Capital Gains on Transfer of
Debt Securities
ExemptExemptExemptExemptExemptExemptTax Rate on Interest Income
10%
10%
15%
7.5%
10%
15%

h. Withholding Tax
As per the Indian tax law, any person responsible for paying to a non-resident any sum chargeableto tax is required to deduct tax thereon at the rates in force. However, no deduction of tax isrequired from any income by way of capital gains arising to FPIs from transfer of securities.

Page 59

H. Annexure B – Tax and Regulatory Overview of Different
Instruments
1. Dated Government Securities
Instrument
IssuerEligible foreign
investors

Key investment
conditions

Investment
limits**Exchange raterisk
Period of holding
for classification
as a long term
capital asset

Dated Government Securities
The Central Government of India through auctions conducted by the RBI.
• Long term FPI investors such as Sovereign Wealth Funds, Multilateral
Agencies, Pension/Insurance/Endowment Funds and Foreign Central
Banks (referred to as 'long term FPIs');• FPIs (other than the above);• Non-resident Indians (NRIs).
Dated Government securities can be bought in the primary market or thesecondary market [including Over the Counter (OTC), Negotiated Deal System- OM (NDS - OM)].
Key investment conditions:• FPIs are permitted to invest in Government securities having minimum
residual maturity period of 3 years;• There is no lock-in period and FPIs are free to sell the securities to thedomestic investors;• FPIs are permitted to invest in Government securities on tap till theoverall investment limit reaches 90% (tabulated below), after which an
auction mechanism is initiated for allocation of the balance limit;• Aggregate FPI investments capped at 20% of the outstanding stock ofeach Government security;• Increase in the limit of FPI investment in Government securities to beallocated in the ratio of 75% (for Long Term FPIs and 25% for the other
FPIs); and• FPIs are permitted to re-invest in Government securities bought on tap
and coupons on Government securities subject to certain conditions.
Limit in USD million Limit in INR
Type of Investors(approx.)million*Long term FPIs
8,354
543,000
FPIs (other than the above)
28,876
1,8,77,0o0
Re-investment of coupons in
42,670656
Government securities (For all FPIs)* The limit in dated Government securities are to be gradually increased byMarch 2018.
** as on 4 July, 2017
Since the investment is in INR, the exchange rate risk is borne by the foreign
investor
12 months or more

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Taxation ofcapital gains
under the Indian
tax law^^
Taxation ofinterest income
under the Indian
tax law^^
Withholding tax
rate on interest
income in India^• FPIs: Long-term capital gains - 10 %; and Short-term capital gains - 30 %• NRIs: Long-term capital gains - 10%/20%; and Short-term capital gains –30%• FPIs: 5%• NRIs: 20%/30%• FPIs: 5%• NRIs: 20%/30%^^

Treaty provisions where beneficial may be applied^As a practical matter, no tax is withheld by the Government#1 USD = 65 INR

2. State developmental Loans (SDLs)
Instrument
IssuerEligible foreign
investors

Key investment
conditions

Investment
limits**Exchange raterisk
Period of holding
for classification
as a long term
capital asset

State Developmental Loans (SDLs)
State Governments through auctions conducted by the RBI• Long term FPIs;• FPIs (other than the above);• NRIs.
SDLs can be bought in the primary market or the secondary market (including
OTC and NDS – OM)
Investment conditions for FPI investors:• FPIs are permitted to invest in SDLs having minimum residual maturity
period of 3 years;• There is no lock-in period and FPIs are free to sell the securities to thedomestic investors;• Increase in the limit of FPI investment in Government securities to beallocated in the ratio of 75% (for Long Term FPIs and 25% for the other
FPIs); and• Aggregate FPI investments capped at 20% of the outstanding stock ofeach SDL.
Limit in USD million
Type of Investors
Limit in INR million*(approx.)Long Term FPIs
707
46,000FPIs
4,385
285,000* The limit in SDLs are to be gradually increased by March 2018** as on 04 July, 2017
Since the investment is in INR, the exchange rate risk is borne by the foreign
investor.
12 months or more

Page 61Taxation ofcapital gains
under the Indian
tax law^^
Taxation ofinterest income
under the Indian
tax law^^
Withholding tax
rate on interest
income in India^• FPIs: Long-term capital gains - 10 %; and Short-term capital gains - 30 %• NRIs: Long-term capital gains - 10%/20%; and Short-term capital gains –30%• FPIs: 5%• NRIs: 20%/30%• FPIs: 5%• NRIs: 20%/30%^^ Treaty provisions where beneficial may be applied^As a practical matter, no tax is withheld by the Government#1 USD = 65 INR

3. Deep Discount Bonds (DDBs), Zero-Coupon Bonds (ZCBs) and Discount Bonds (DBs)
Instrument
IssuerEligible foreign
investors
Key investment
conditions

Investment
limits**Exchange raterisk
Period of holding
for classification
as a long term
capital asset
Taxation ofcapital gains
under the Indian
tax law^^

Deep Discount Bonds (DDBs)/ Zero Coupon Bonds (ZCBs)/ Discount Bonds(DBs)
Usually financial institutions, infrastructure capital fund, Government
undertakings, scheduled banks and large Indian companies including
infrastructure capital companies.
• FPIs• NRIsKey investment conditions:• FPIs are permitted to invest in DDBs, ZCBs and DBs having minimum
residual maturity period of 3 years; and• There is no lock-in period and FPIs are free to sell the securities to thedomestic investors.
Limit in USD million
Type of Investors
Limit in INR million*(approx.)
FPIs
37,5882,443,230* the overall limit of INR 2,443,230mn (USD 37,588mn) is earmarked for FPI
investment in corporate debt** as on 04 July, 2017
Since the investment is in INR, the exchange rate risk is borne by the foreign
investor.
• 12 months or more for listed securities• 36 months or more for unlisted securities• DDBs (as per a clarification issued by the Government)- Transfer before maturity - difference between sale price and the costof bond (value as on last valuation date) taxable as short term capitalgains.
• ZCBs (as per the Indian tax law)
- Transfer before maturity - difference between sale price and the costof bond taxable as capital gains;
Page 62-On maturity or redemption – difference between face value of bondand acquisition price taxable as capital gains.

• DBs- Transfer before maturity - difference between sale price and the costof bond taxable as capital gains;- Where the DBs carry coupon which is commensurate with the market
rate, redemption premium could be arguably, regarded as capitalgains.
FPIs: Long-term capital gains - 10%; and Short-term capital gains - 30 %NRIs: Long-term capital gains - 10%/20%; and Short-term capital gains – 30%

Taxation ofinterest income
under the Indian
tax law^^

Withholding tax
rate on interest
income in India• DDBs (as per a clarification issued by the Government)
Yearly accretion- Bonds to be marked to market at every year end;
- Accretion (difference between bid price/cost and market value at theyear end) generally taxable as interest income.
On maturity or redemption- Difference between redemption price and value as on the last
valuation date/cost is generally taxable as interest income.
• DBs
On maturity or redemption- Difference between face value of the bond and acquisition price isgenerally taxable as interest income.
FPIs: 5%/20%
Others: 20%/30%
Income in respect of investment in ZCB is not subject to withholding tax rate.
Interest in respect of investment in DDBs and DBs is subject to withholding
tax at the rates mentioned below:• FPIs: 5%/ 20%• NRIs: 20%/30%^^ Treaty provisions where beneficial may be applied# 1 USD = 65 INR

4. Perpetual Debt Instruments – Tier I and Debt Capital Instruments – Tier II
Instrument
IssuerEligible foreign
investors

Perpetual Debt Instruments – Tier I and Debt Capital Instruments – Tier
II
Indian Banks• Long term FPIs;• FPIs (other than the above); and• NRIs.

Key investment
conditions

No specific investment conditions apply

Investment limits• Investments by all FPI in Perpetual Debt Instruments (Tier I) should
not exceed an aggregate ceiling limit of 49% each issue;• Investments by an individual FPI in Perpetual Debt Instruments (Tier I)
should not exceed the limit of 10% of each issue;• Investments by all NRIs in Perpetual Debt Instruments (Tier I) should
not exceed aggregate ceiling limit of 24% of each issue;
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Exchange rate risk

• Investments by an individual NRI in Perpetual Debt Instruments (TierI) should not exceed the limit of 5% of each issue;• Investments by FPIs in Debt Capital Instruments (Tier II) should notexceed the overall limit of INR 2,443,230 million (USD 37,588 million)
earmarked for FPI investment in corporate debt; and• Investments by NRIs in Debt Capital Instruments (Tier II) should bewithin the limit prescribed for investments in other debt instruments
for NRIs.
Since the investment is in INR, the exchange rate risk is borne by theforeign investor.

Period of holding forclassification as a longterm capital asset• 12 months or more where listed• 36 months or more where unlisted

Taxation of capitalgains under the Indian
tax law^^• FPIs: Long-term capital gains - 10%; and Short-term capital gains 30%• NRIs: Long-term capital gains - 10%/20%; and Short-term capital gains– 30%

Taxation of interest
income under the
Indian tax law^^
Withholding tax rate
on interest income inIndia• FPIs: 5%/ 20%• NRIs: 20%/30%• FPIs: 5%/ 20%• NRIs: 20%/30%^^ Treaty provisions where beneficial may be applied# 1USD = 65 INR

5. Listed Non-Convertible Debentures (NCDs)/Bonds (including Credit Enhanced Bonds)
Instrument
IssuerEligible foreign
investors

Key Investment
conditions

Investment limits**

Listed NCDs/Bonds (including Credit Enhanced Bonds)
Indian companies• FPIs• NRIsKey investment conditions:• FPIs are permitted to invest in listed NCDs having minimum residual
maturity of 3 years;• There is no lock-in period and FPIs are free to sell the securities to thedomestic investors; and• NRIs can invest in listed NCD subject to certain prescribed conditions.
Type of
Nature ofLimit in USD
Limit in INR
Investors Instrument
million (approx.) million*
FPIs
Listed NCDs and37,5882,443,230
bonds issued by an
Indian company
FPIs
Credit enhanced
3,685
239,530bonds*the overall limit of INR 2,443,230mn (USD 37,588mn) is earmarked for FPI
investment in corporate debt.
** as on 04 July, 2017
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Exchange rate risk

Since the investment is in INR, the exchange rate risk is borne by theforeign investor.

Period of holding forclassification as a
12 months or morelong term capital
asset
Taxation of capital• FPIs: Long-term capital gains - 10%; and Short-term capital gains - 30%
gains under the• NRIs: Long-term capital gains - 10%/20%; and Short-term capital gains
Indian tax law^^– 30%
Taxation of interest• FPIs: 5%/ 20%
income under the• NRIs: 20%/30%
Indian tax law^^
Withholding tax rate
• FPIs: 5%/ 20%
on interest income in• NRIs: 20%/30%
India^^ Treaty provisions where beneficial may be applied# 1 USD = 65 INR

6. Unlisted Corporate Debt Securities
Instrument

Unlisted Corporate Debt Securities (Bonds and NCDs)

IssuerEligible foreign
investors

Indian companies• FPIs• NRIsKey investment conditions:• FPIs are permitted to invest in unlisted corporate debt securities
having minimum residual maturity of 3 years;• Indian company issuing unlisted corporate debt securities is subject
to end use restriction on investment in real estate business, capital
markets and purchase of land.
Type of Investors
Limit in USD million
Limit in INR million(approx.)
FPIs
5,385
350,000** Within the overall limit of INR 350,000mn (USD 5,385mn) earmarked
for FPI investments in unlisted corporate debt securities and securitised
debt instruments** as on 04 July, 2017
Since the investment is in INR, the exchange rate risk is borne by theforeign investor.

Key investment
conditions

Investment limits**

Exchange rate risk
Period of holding forclassification as a longterm capital asset

36 months or more

Taxation of capitalgains under the Indian
tax law^^• FPIs: Long-term capital gains - 10%; and Short-term capital gains 30%• NRIs: Long-term capital gains - 10%; and Short-term capital gains –30%

Page 65

Taxation of interest
income under the
Indian tax law^^
Withholding tax rate
on interest income inIndia• FPIs: 5%/ 20%• NRIs: 20%/30%• FPIs: 5%/ 20%• NRIs: 20%/30%^^ Treaty provisions where beneficial may be applied# 1USD =65 INR

7. Masala Bonds
Instrument
IssuerEligible foreign
investors

Key investment
conditions

Masala Bonds
Any Indian company, body corporate, Indian banks or REITs or InvITs
registered with the SEBI.
Masala Bonds can be issued in a country and can be subscribed by aresident of a country:• that is a member of Financial Action Task Force (FATF) / FATF-style
regional body and;• whose securities market regulator is a signatory to International
Organisation of Securities Commission’s (IOSCO) Multilateral
Memorandum of Understanding (MMOU) or a signatory to bilateral
Memorandum of Understanding with SEBI and;• should not be a country identified in the public statement of the
FATF as:- a jurisdiction having a strategic Anti-Money Laundering or
Combating the Financing of Terrorism deficiencies to whichcounter measures apply; or- a jurisdiction that has not made sufficient progress in addressing
the deficiencies or has not committed to an action plandeveloped with the FATF to address the deficiencies.
Masala bonds can be also be subscribed by Multilateral and Regional
Financial Institutions where India is a member country.
• Any proposal of borrowing by eligible Indian entities by issuance of
Masala Bonds will be examined by the RBI;
• End use restrictions on proceeds of Masala Bonds are as under:- Real estate activities other than for development of integrated
townships affordable housing projects;- Investing in capital market and using the proceeds for equity
investment domestically;- Activities prohibited as per the Foreign Direct Investment (FDI)
guidelines;- On-lending to other entities for any of the above objectives; and- Purchase of land.
• The minimum original maturity period for Masala Bonds raised up to
USD 50 million equivalent in INR per financial year should be 3 years.
For Masala Bonds raised above USD 50 million equivalent in INR per
financial year, minimum original maturity should be 5 years;

Page 66

Investment limits
Exchange rate risk

• The all-in-cost ceiling for Masala Bonds will be 300 basis points overthe prevailing yield of the Government of India securities ofcorresponding maturity;• Recognised investors should not be related parties of borrowers as
per Indian Accounting Standard 24 (IndAS-24; and• Non-resident investors are permitted to hedge their exposure
through permitted derivative products.
FPI investment in Masala Bonds to be within the aggregate limit of INR
2,443,230mn (USD 38,175mn approx.) which is earmarked for FPI
investment in corporate debt.
Since the investment is in INR, the exchange rate risk is borne by theforeign investor.

Period of holding forclassification as a longterm capital asset

36 months or more

Taxation of capitalgains under the Indian
tax law^^• Transfer of Masala Bonds outside India should be exempt from tax inIndia• Gains arising on account of fluctuation of currency between the dateof issue and the date of redemption should be exempt from capitalgains tax

Taxation of interest
income under the
Indian tax law^^
Withholding tax rate
on interest income inIndia• FPIs: 5%/ 20%• Others: 5%/20%/30%/40%• FPIs: 5%/ 20%• Others: 5%/20%/30%/40%^^ Treaty provisions where beneficial may be applied# 1 USD = 65 INR

8. Indian Rupee Denominated External Commercial Borrowings (ECBs)
Instrument

Eligible borrowers

Eligible lenders

Indian Rupee Denominated External Commercial Borrowings (ECBs)• Companies engaged in manufacturing, software development,
shipping, airlines, infrastructure sector and miscellaneous services
viz. companies engaged in R&D, training (other than educational
institutes), supporting infrastructure, logistics services• Holding companies and Core Investment Companies• REITs and InvITs coming under the regulatory framework of SEBI
• Non-Banking Financial Companies (NBFCs)• Small Industries Development Bank of India, Units in Special
Economic Zones (SEZs), Developers of SEZs/ National Manufacturing
and Investment Zones (NMIZs), Export Import Bank of India (onlyunder approval route)• NBFCs-MFIs, Not for Profit entities, NGOs engaged in micro financeand certain specified societies trusts and co-operatives• International banks, International capital markets, Multilateralfinancial institutions, overseas long term investors like Pension
funds, Insurance companies, Sovereign Wealth Funds, Foreign Equity
Page 67

Key conditions

Borrowing limits

Holders, Export Credit agencies, Suppliers of equipment. Overseas
branches / subsidiaries of Indian Bank cannot provide Indian Rupee
Denominated-ECBs
For NBFCs-MFIs, other eligible MFIs, not for profit companies and NGOs,
ECB can also be availed from overseas organisations and individuals.
End use prescriptions• NBFC's can use ECB proceeds for;- On-lending to the infrastructure sector- Providing hypothecated loans to domestic entities foracquisition of capital goods/equipments- Providing capital goods/equipments to domestic entities by wayof lease and hire-purchase• Developers of SEZs/NMIZs can raise ECB only for providing
infrastructure facilities within SEZ/ NMIZ;• NBFCs-MFI, other eligible MFIs, NGOs and not for profit companies
can raise ECB only for on-lending to self help groups or for
microcredit or for bonafide micro finance activity including capacity
building.
• For other borrowers, ECB proceeds can be used for any purposes
excluding the following:- Real estate activities- Investing in capital markets- Using the proceeds for equity investment domestically- On-lending to other entities for any of the above activities- Purchase of land
Minimum Average Maturity is as under• 3 years for ECB up to USD 50 million or its equivalent• 5 years for ECB beyond USD 50 million or its equivalentAll-in-cost ceiling• The all-in-cost ceiling for Indian Rupee Denominated ECBs should bein line with market conditions
Thin Capitalisation• ECBs (more than USD 5 million) from foreign equity holders should
not exceed 4 times the equity contributed by such holder (underautomatic route) and 7 times (under approval route).
• ECB can be raised by an eligible entity under the automatic route in afinancial year as under:- Up to USD 750mn or equivalent for the companies ininfrastructure and manufacturing sectors; NBFC-IFCs, NBFCAFCs, Holding Companies and Core Investment Companies- Up to USD 200mn or equivalent for companies in softwaredevelopment sector;- Up to USD 100mn or equivalent for entities engaged in microfinance activities; and- Up to 500mn or equivalent for remaining entities• ECB proposals beyond aforesaid limits require prior regulatory
approval.

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Exchange rate risk
Taxation of interest
income under the
Indian tax law*
Withholding tax rate
on interest income inIndia*For computation of INR limits, exchange rate prevailing on the date ofagreement should be taken into account.
Since the lending is in INR, the exchange rate risk is borne by the foreign
lender.
30%/40%30%/40%*Assuming ECBs are in form of loans and not securities*Treaty provisions where beneficial may be applied

9. Foreign Currency Bonds (FCBs)
Instrument

Foreign Currency Bonds (FCBs)

IssuerIndian companies
International banks, International capital markets, Multilateral financial
institutions, overseas long tem investors like Pension funds, Insurancecompanies, Sovereign Wealth Funds, etc.
Issue and subscription of FCBs is subject to ECB framework. The ECB
regulations prescribe eligible borrowers, eligible lenders, end use
restrictions and other parameters for investment.
Broadly, the ECB framework comprises the following:• Track I - Medium term foreign currency denominated ECB with
Minimum Average Maturity (MAM) of 3/5 years.
• Track II: Long term foreign currency denominated ECB with MAM of
10 years.
• ECB can be raised by an eligible entity under the automatic route in afinancial year as under:- Up to USD 750mn or equivalent for the companies ininfrastructure and manufacturing sectors;- Up to USD 200mn or equivalent for companies in softwaredevelopment sector;- Up to USD 100mn or equivalent for entities engaged in microfinance activities; and- Up to 500mn or equivalent for remaining entities• ECB proposals beyond aforesaid limits require prior regulatory
approval.
FCB shall be denominated in USD. Therefore, the exchange rate risk will
be borne by the Indian issuing company.

Eligible foreign
investors

Key investment
conditions

Investment limits

Exchange rate risk
Period of holding toconsidered forclassifying a long term
capital asset
Taxation of capitalgains under the Indian
tax law^^

36 months or more

• Transfer of any FCB outside India should be exempt from tax in India

Page 69• Gains arising on account of fluctuation of currency between the dateof issue and the date of redemption should be exempt from capitalgains tax
Taxation of interest
income under the
Indian tax law
Withholding tax rate
on interest income inIndia• FPIs: 0%/5%/20%• Others: 0%/5%/20%• FPIs: 0%/5%/20%• Others: 0%/5%/20%^^ Treaty provisions where beneficial may be applied

10.Cash Settled Interest Rate Futures (IRFs)
Instrument
Trading
Eligible foreign
investors

Key investment
conditions

Investment limits

Exchange rate risk
Period of holding toconsidered for

Cash Settled Interest Rate Futures (IRFs)
Traded on recognised Indian stock exchanges
FPIs• IRF contracts generally have Government bonds as underlying
securities;• Currently the available IRFs are as under:- 6 year Government of India security;- 10 year Government of India security;- 13 year Government of India security.
• Each futures contract shall represent 2000 underlying bonds of total
face value of INR 0.2mn; and• Futures contract to be cash settled in INR.
• At any exchange overall open interest on IRF contracts on eachunderlying shall not exceed 25% of the outstanding of underlying
bond;• Category I and II FPI - The gross open positions across all contracts
within the respective maturity bucket shall not exceed 10% of thetotal open interest in the respective maturity bucket or INR 6,000mn,
whichever is higher;• Category III FPI – The gross open positions across all contracts within
the respective maturity bucket shall not exceed 3% of the total open
interest in the respective maturity bucket or INR 2,000mn, whicheveris higher;
Additional restriction for FPIs
• The total gross short (sold) position of each FPI in IRFs, should notexceed their long position in the Government securities and in IRFs at
any point in time; and• The total gross long (bought) position in cash and IRF markets taken
together for all FPIs shall not exceed the aggregate permissible limit
for investment in Government securities for FPIs.
Since the investment is in INR, the exchange rate risk is borne by theforeign investor.
12 months or more for listed securities

Page 70

classifying a long term
capital asset
Taxation of capitalgains under the Indian
tax law^^
Taxation of interest
income under the
Indian tax law^^
Withholding tax rate
on income in India

FPIs: Long-term capital gains - 10%; and Short-term capital gains – 30%

Not applicableNot applicable^^ Treaty provisions where beneficial may be applied

11.Units of a Debt Oriented Mutual Fund
Instrument
IssuerEligible foreign
investors

Investment conditions

Key investment
conditions

Exchange rate risk

Units of a Debt Oriented Mutual Fund
Scheme of Debt Oriented Mutual Funds registered with SEBI• FPIs• NRIsKey investment conditions:• FPIs are restricted to invest in units of liquid mutual funds andmoney market mutual funds• No single investor can invest more than 25% of the corpus of the
Mutual FundType of Investors
Limit in USD million
Limit in INR million*(approx.)
FPIs
37,5882,443,230* the limit of INR 2,443,230mn (USD 37,588mn) is earmarked for FPI
investment in corporate debt** as on 04 July, 2017
Since the investment is in INR, the exchange rate risk is borne by theforeign investor.

Period of holding forclassification as a longterm capital asset• 12 months or more for listed securities• 36 months or more for unlisted securities

Taxation of capitalgains under the Indian
tax law^^• FPIs: Long-term capital gains - 10%; and Short-term capital gains 30%• NRIs: Long-term capital gains – 10%/20%; and Short-term capitalgains - 30%

Taxation of interest
income under the
Indian tax law^^
Withholding tax rate
on income in India

Dividend income earned from units of a debt oriented mutual fund shallbe exempt in the hands of the investor
Not applicable^^ Treaty provisions where beneficial may be applied# 1USD = 65 INR

Page 71

12.Infrastructure Debt Funds (IDF)
Instrument
IssuerEligible foreign
investors

Key investment
conditions

Investment limits**

Exchange rate risk

Period of holding forclassification as a longterm capital asset

Infrastructure Debt Funds (IDF)• IDF set up as a NBFC issues either rupee denominated bonds or FCBs
• IDF set up as mutual fund issues units• Long term FPIs
• FPIs (other than the above)• Multilateral financial institutions
IDF set up as a NBFC
• In case of a non-resident investor, the original or initial maturity ofbond, at time of first investment by such non-resident investor, shallbe a minimum of 5 years; and• Investment made by non-resident investor shall be subject to a lock inperiod of 3 years. However, the non-resident investor may transfer
the bond to another non-resident investor within such lock in period.
IDF set up as mutual fund
• An IDF scheme shall have minimum 5 investors and no single investor
shall hold more than 50% of net assets of the scheme;• No IDF scheme shall accept any investment from any investor whichis less than INR 10mn;• The minimum size of the unit shall be INR 1mn;
• Each scheme launched as an IDF scheme shall have firm commitment
from the long term FPIs (including multilateral financial institutions)for contribution of an amount of at least INR 250mn.
• Limits for investments in rupee denominated bonds issued by IDF set
up as NBFC and units issued by IDF set up as a mutual fund are as
under:
Type of Investors
Limit in USD million
Limit in INR million*(approx.)
FPIs
37,5882,443,230*the limit of INR 2,443,230mn (USD 37,588mn) is earmarked for FPI
investment in corporate debt** as on 04 July, 2017
• For limits for investments in FCBs issued by IDF set up as a NBFC,
please refer to investment limits applicable to FCBs mentioned atserial no. 9.
• In case of investments made in rupee denominated bonds issued by
IDF set up as a NBFC and units issued by IDF set up as mutual fund,the exchange rate risk is borne by the foreign investor, since theinvestment is made in INR.
• In case of investments made in FCBs issued by IDF set up as a NBFC,
the exchange rate risk is borne by the Indian issuing company, since
the issuance is in foreign currency.
• 12 months or more for listed securities• 36 months or more for unlisted securities

Page 72

Taxation of capital
FPIs: Long-term capital gains - 10%; and Short-term capital gains - 30%
gains under the Indian Others: Long-term capital gains - 10%/20%; and Short-term capital gains
tax law^^– 30%• Interest income earned from rupee denominated bonds issued by IDF
set up as NBFC - taxable at 5%
Taxation of interest
income under the• Interest income earned from FCBs issued by IDF set up as NBFC –Indian tax law^^taxable at 0%/5%• Income distributed by IDF set up as mutual fund – taxable at 5%• Interest income earned from rupee denominated bonds issued by IDF
set up as NBFC subject to withholding tax at the rate of 5%
Withholding tax rate
• Interest income earned from FCBs issued by IDF set up as NBFC
on interest income insubject to withholding tax at the rate of 0%/5%
India• Income distributed by IDF set up as mutual fund subject towithholding tax at the rate of 5%^^

Treaty provisions where beneficial may be applied# 1 USD = 65 INR

13.Security Receipts and Securitised Debt Instruments
Instrument
IssuerEligible foreign
investors

Key investment
conditions

Investment limits**

Security Receipts and Securitised Debt Instruments• Security Receipt – ARC Trust• Securitised Debt Instrument - Special purpose vehicles (SPV) set up asa trust for securitisation of assets• Security Receipt- Qualified Buyers i.e., ARCs, banks, FPIs, mutual funds, insurancecompanies, public financial institutions, state financial
corporation, state industrial development corporation,prescribed NBFCs, Alternative Investment Funds (AIFs),
prescribed non-institutional investors etc.
• Securitised Debt Instrument- Institutional investors• Securitised Debt Instrument
The certificate instrument may be issued by a SPV set up for
securitisation of assets where banks, financial institutions or NBFC are
originators and listed in terms with the prescribed regulations• Security Receipt- FPIs can invest up to 100% of security receipts of each tranche ofa scheme of an ARC trust- FPI investment in Security receipts to be within the aggregate
limit of INR 2,443,230mn (USD 38,175mn approx.) which isearmarked for FPI investment in corporate debt
• Securitised Debt Instrument- Within the limit of INR 35,000 crores (USD 5,385mn) earmarked
for FPI investments in unlisted corporate debt securities andSecuritised Debt Instruments** as on 04 July, 2017

Page 73

Exchange rate risk

Since the investment is in INR, the exchange rate risk is borne by theforeign investor.

Period of holding forclassification as a longterm capital asset• 12 months or more where listed• 36 months or more where unlisted

Taxation of capitalgains under the Indian
tax law^^

Taxation of income
distributed by thetrust under the Indian
tax law^^

Withholding tax rate
on income distributedby the trust in India• FPIs: Long-term capital gains - 10%; and Short-term capital gains 30%• Others: Long-term capital gains - 10%/20%; and Short-term capitalgains - 30%/40%• ARC Trust/securitisation trust has been accorded tax pass throughstatus i.e. any income received by the ARC Trust shall be chargeableto tax as if the income were arising to, or received by an investor, had
the investments by the securitization trust been made directly bysuch investor;• Income from ARC Trust/securitisation trust can be characterised
either as ‘business income’ or ‘capital gains’ or ‘income from othersources’.
Income payable by the ARC trust/securitisation trust may be subject towithholding at the applicable rates in force.

^^ Treaty provisions where beneficial may be applied# 1USD = 65 INR

14.Units of Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs)
Instrument
IssuerEligible foreign
investors

Key Investment
conditions

Units of Real Estate Investment Trusts (REITs) and Infrastructure
Investment Trusts (InvITs)
REIT/ InvIT set up in the form a Trust
Person resident outside India including FPIs and NRIs may invest in unitsof a REIT or InvIT• REITA REIT is required to be publicly placed within 3 years of its date ofregistration.
From an investor perspective:- Minimum subscription amount - INR 0.2mn per investor; and- Minimum trading lot - INR 0.1mn per investor.
• InvIT
InvIT can raise funds through public or private placement. The units of
InvIT shall be mandatorily listed on the designated stock exchanges
within the prescribed period from the closure of initial public offer / dateof allotment.
From an investor perspective:
Public placement:- Minimum subscription amount - INR 1 million per investor; and- Minimum trading lot - INR 0.5 million per investor
Private placement:

Page 74

Minimum subscription amount - INR 10/250 million per investor;and- Minimum trading lot - INR 10 /20 million per investor
No investment limits apply
Since the investment is in INR, the exchange rate risk is borne by theforeign investor.
-

Investment limits
Exchange rate risk
Period of holding forclassification as a longterm capital asset
Taxation of capitalgains under the Indian
tax law^^

Taxation of income
distributed by the
REIT/InVIT under the
Indian tax law^^
Withholding tax rate
on income in India

36 months or more
• Long-term capital gains (where STT* is charged) - exempt
Short-term capital gains (where STT is charged) - 15 %• Long-term capital gains (other than above) - 20%
Short-term capital gains (other than the above) – 30%/40%*STT – Securities Transaction Tax• o Dividend income distributed by REIT/InvIT to its unitholders exempt in the hands of the investor;• o Interest income distributed by the REIT/InvIT – arguably taxable
at the rate of 5%; and• o Rental income distributed by the REIT - taxable at the applicablerates in force
Taxes to be withheld at the rates mentioned above^^ Treaty provisions where beneficial may be applied

Page 75

I. Annexure C – Recommendations
Topic

GeneralEconomyCapital Markets

Bond Markets

Specific Ask

Stabilization of theeconomy throughmore steady and lessvolatile economic
growth.

Indian capital
markets must be
further developed for
India to sustain its
economic growth andfund its social andinfrastructure
initiatives.

India must develop
deep, liquid andtransparent bondmarkets.

Recommendation
This transition can befacilitated andaccelerated through thedevelopment of robust
capital and bondmarkets.

Rationale

Alleviating poverty among
the population through alarger corporate sector
and new infrastructureneeds will require a more
Separately, thegovernment’s recent GST balanced and stable
initiative is a positive step growth model fueled byincreased spending.
in fostering steady andless volatile economic
growthGovernment policies areneeded to encourage thedevelopment of capital
markets in ways that will
support its widespread
economic and social
development initiatives,
including the further
stabilization of its
economy, increasing
access to credit, funding
municipal infrastructure
projects, developing
social safety nets andfostering its sweeping
urbanization program.
While considerable
progress has been madein developing both the
cash bond andderivatives markets,
there is still not enoughliquidity in off-the-run
issues.
The inclusion of Indianbonds in the global bondindices, in anenvironment where
passive investment tends
to dominate, would

The substantial
infrastructure still needed
to spread development,
extend social safety nets,
improve productivity andsustain high economic
growth requires theefficient mobilization ofprivate and public capitalthat only robust capital
markets can facilitate.

The expansion anddeepening of the bondmarket would better
serve the needs of boththe private and publicspheres in India,
especially given thetightened capitalrequirements under BaselIII. Further, robust bondmarkets are also
particularly important to
the evolution of the
Indian banking sector,
whereby capital is not
Page 76

encourage long-term
flows into India.

Interest-Rate
Liberalization

Benchmark Yield
Curve

Interest rates mustbe further liberalized.

Stronger and more
dependable
benchmark yield
curves must be
developed.

Interest rate
liberalization is the firststep toward creating
deeper, more liquid bondmarkets and can only beachieved througheliminating restrictions
on the all-in-cost ceiling
imposed on ExternalCommercial Borrowing(ECBs), and on the ability
to provide security overassets.

The 10-year, 5-year and2-year government
bonds are currently themost reliant benchmark
yield curves in Indian
markets for the mostactively traded bonds
across a range of given
maturities – called the“on-the-run” issues.
ASIFMA strongly urges
regulators to establish
benchmarks at every
level of the yield curve.
One positive
development is theintroduction of 13-15year
G-Secs and futures – butmore issuances out tolonger maturities – suchas the 40y issue
described in section 1
above, would be helpful.

available for the
corporate sector.
Further liberalization ofinterest rates and capital
controls will benefit the
Indian corporate sector
by allowing issuers to
issue at every level of theyield curve. Investors, inturn, will be more likely
to buy since the price andinterest rate of the bondwill match its real risk.
The creation of theMasala bond market is an
important step in theright direction, but pricecaps and the limiting ofstructures that permit
security on onshore
assets is counterproductive.

The existence of acommon benchmark yield
curve, grounded on aliquid government bondmarket, is critical to thefinancial sector’s ability toreach efficient capital
allocation and forgovernment policy
makers to gauge market
expectations, as much of
the analysis and pricing
activity that takes place inthe bond markets revolvearound the yield curve.

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SecondaryMarket Trading

Settlement &Debt Limit Issues

Indian regulators
must foster thedevelopment of asecondary market forgovernment bonds.

The reduction ofmultiple guidelines
and the complexity
and monitoring of FPI
limits & the need fora uniform settlement
cycle are specificrecommendations for
the Indian regulatory
authorities toconsider.

A number of steps, suchas the development oftrading platforms forcash and derivatives,
broadening the investor
base through the
granting of increased
access to FPIs – including
for shorter-dated
securities of less than 3years’ tenor - and thestrong growth of theasset management sector
in India have all helped tofoster growth in thesecondary markets. Yetanother step has been
the steep reduction in
the SLR. Even so, moreneeds to be done.

Different reporting dates
for the purchase/sale ofsecurities, based onwhether they are
executed OTC are on
central platforms like
NDS-OM pose a numberof challenges – thus, only
one reporting date isrecommended.
Settlement of G-Secs on
ICSDs such as Euroclear
and Clearstream shouldbe allowed.

The growth of asecondary market forgovernment bonds is
integral to the overall
development of the
Indian bond market andprovides several
important benefits tomarket participants of all
types, including: theestablishment of “riskfree” reference yield
curves and “risk free”
assets, like U.S. Treasury
Bonds; supports thedevelopment of soundcorporate debt andmoney markets; andenables the government
to borrow for longer
terms at lower funding
costs – allowing thegovernment to fundlarge, country-wide
infrastructure andurbanization programs.

Harmonizing India’s
settlement infrastructure
and other regulations
governing foreign
investment withinternational norms,
would help attract
considerably more
foreign investment into
the country.

On the issue of debt
limits for FPIs, themanual calculation ofutilization once theselimits approach between
90 and 100% makes the

Page 78

process cumbersome andunreliable and should
therefore be automated.
On the issue of re-use of
quota, FPIs should begiven sufficient time post
the sale or maturity of
their bond holdings, to einvest the proceeds
arising from suchsale/maturity.

Repo Market

India must develop aclassic repo market
that is aligned withinternational
standards.

A “classic” bond repo
market allows: (1) market
participants to use thebonds they hold for
additional purposes, suchas further repos, covering
short positions, securities
lending, and collateral (apledge repo system does
India’s current repo
not allow that as themarket (pledge repo
bond title is not
system) must betransferred); (2) allows
transitioned to a classic
market makers, who are
repo market
critical for developing(international standard).
liquidity in any market, toCertain recent steps, such ‘go short,’ which
as allowing for re-repoing enhances liquidity in thecertain transactions, thecash market and thereby
reporting of repo across a serves as a key
central platform and theprerequisite for thecreation of a framework
development of the bondfor tri-party repo havefutures market and thealigned the Indian
OTC derivatives market,
markets more closely towhich requires ainternational standards – sufficiently liquid cash
but more progress needs market; (3)allow primary
to be made.
dealers to hedge risk witha wider array of hedging
strategies; and (4)broaden funding markets
and serve as a critical link
between money markets,bond markets, futures
markets and OTC
derivatives markets.

Page 79

Futures Market

Interest-Rate &Currency Swaps

Once the cash
markets are
sufficiently liquid,
India should further
develop its
government bondfutures market –Significant steps havebeen taken in thisdirection.

It is imperative thatIndia develops aninterest-rate andcurrency swap
market.

India’s government bondfutures market has
shown substantial growthand development overthe past few years – Thefact that they are listed
on exchanges, arecentrally cleared andcash-settled, across a
range of maturities are allin line with international
practice – in addition,these are useful hedging
tools for market makers.
That said, contracts on awider range ofmaturities, coupled withincreased liquidity inexisting maturities, would
enhance the market’s
development.

While some progress has
been made through theintroduction of the
ASTROID platform on
CCIL for interest rate
swaps, the fact that OIS(Overnight Index Swaps)
volumes have fallen is aworrisome sign.
Nevertheless,considerable growth involume has been seen in
the OTC swaps markets(both interest rate &currency). Furthermore,
the introduction ofcentral clearing, bilateral
margining and thegovernment’s mandating
the use of LEIs align India
with G-20 market

An active, liquid, andclosely supervised
government bond futures
market would allow
participants to hedge
large-value positions
quickly and reduce risk
more effectively, while atthe same time deepening
the underlying bond andderivative markets. The
experience of othercountries shows thatbond futures enhance theliquidity of the underlying
cash markets as market
participants are able tomanage the risk of theirbond inventories more
effectively. Thus far, theevolution of the Indian
government securities
futures market isproceeding in the right
direction.

Interest-rate and currency
swaps are an integral partof the fixed-income
market. These derivative
contracts are an essential
tool for investors who
typically use them tohedge, speculate, andmanage risk, andgenerate greater liquidity
in fixed-income markets.
Importantly, interest-rate
and currency swaps allow
companies to keep undercontrol and revise theiroutstanding debt by
adjusting the interest rateaccording to current or
future market conditions.

Page 80

practice and is a positive
development.

Close-Out
Netting

Corporate &Quasi-Sovereign
Bond Market

The Insolvency &Bankruptcy Code, 2016
and the Financial
Resolution & Deposit
Insurance Bill, 2017 havegone a long way towards
The rules governing
recognizing the concept
creditors’ rights,
of netting. This will give amore specificallysignificant boost to
close-out netting, andcreditor rights. While thean efficient recovery
2016 Bill is already law,mechanism must be
the 2017 Bill needs to bestrengthened andenacted – moreover, theclarified in order to2017 Bill is more relevant
ensure confidence inin the context of setting
the enforceability of
up a netting-friendly
transactions andregime for financial
contracts.
institutions’ recovery andresolution. Thus, there’s
still some distance to be
travelled before “closeout netting” is fullyrecognized in India.

India must develop a
more well-rounded
corporate debt
market.

The liberalization of FPI
limits for corporate bondinvestment, the creationof a framework for realestate and infrastructure
trusts, the permission
granted to banks toprovide increased levelsof credit enhancement,
the growth in lower rated
issuance and the setting
up of more efficient
settlement and clearing
frameworks (such as DvP
for OTC trades) andpermission being granted
to banks for lower-rated
issuance (such as Basel-3

Close-out netting reduces
credit risk by allowing aparty to calculate its
exposure to a particularcounterparty on a net
basis. Close-out netting
will also result in cost
reduction, allowing
parties to use credit lines
more efficiently and tomaintain lower reservesto cover exposure. With
the increased cost ofcapital under Basel III, theimpact on risk-weighted
assets is much greater forsuch non-netted trades,
driving up costs
considerably.
The reduction of theuncertainty related to“Close-out” netting inIndia will also help
develop repo andderivatives markets,
going forward.
In India, a well-developed
corporate bond market
would serve several
functions: (1) it would
enable companies to raise
funds even if they are notfavored customers of thelarge, domestic
commercial banks; (2) itwould allow companies tomatch the durations of
their assets with thematurity of their
liabilities; (3) with the riseof pension funds, social
security funds, andinsurance funds, thecombination of aPage 81compliant AT1 securities)
are positive steps.

Municipal &Local Authority
Bond Market

India must develop arobust municipal
bond market.

The introduction by SEBIof regulations in 2015 forMunicipal Bond Issuance– both revenue andgeneral obligation bonds- is a welcome first step.
Also, the designation ofcertain municipal bonds
as tax-free (if they meetcertain conditions) is
another positive. Finally,
the adoption of amunicipal bonds ratings
framework by the major
Indian ratings agencies isanother step forward.
That said, the market isstill small and more
incentives/disseminationof information regarding
the benefits of municipal
bond issuance to help
support the further
development of themarket is essential.

Masala Bonds

The development ofan “offshore INR” of“Masala” bondmarket should be
fostered, as it eases
foreign investor
access go thedomestic bondmarkets

We believe that the
recently announced
restrictions on the“Masala” bond market
are counterproductive:a) Caps on all-in
funding costs

government andcorporate bond market is
key to ensuring that thesefunds can match their
future payment
obligations; and (4)promote greatertransparency andimproved corporate
governance throughincreased disclosure.

The creation of amunicipal bond market
would allow a
combination of domestic
and foreign private capital
to finance municipal
infrastructure projects,
significantly easing local
municipal dependence on
Indian central
government, andsignificantly increasing
the amount of longerterm capital available forlarge-scale infrastructuredevelopment.

There is the need for an
active and liquid offshore
INR bond market, which
can only occur with active
FPI and domestic investor
participation. Recently
announced restrictions
stand in the way of thedevelopment of thismarket.

Page 82b) Minimum issuancetenors based on
size thresholds andc) The ban on the useof “related party”
structures
These conditions shouldbe eased.

Removal of the 5%
withholding tax on
Masala bonds would be
beneficial for both issuers(lower all-in funding
costs, since there would
be no need to gross up
for tax purposes) andinvestors.

In addition, domestic
investors should beallowed to buy “Masalabonds” in the secondary
bond markets.
Finally, the elimination of
the 5% Withholding tax
on Masala bonds could
be considered.

Securitisation

India needs toexpand and increase
access to its existing
securitization
markets.

The removal of tax at the
SPV level and thepermission granted to
FPIs to invest in “passthrough certificates(PTCs)” and unlisted debt
securities are positive
developments. Bank
balance sheet stress,
coupled with the needfor infrastructure
financing and enhanced
credit ratings should be
supportive of further
growth and development
in Indian securitisation.

Securitisation allows
banks to move illiquid
assets, like long-termloans, off their balance
sheets, reducing thebuild-up of risky assets
and providing banks withthe ability to continue
lending. In India,
securitisation will
increase banks’ flexibility
to tap additional sourcesof cash and liquidity,
significantly broadening
their ability to support
economic growth.
Additionally, it will
provide companies with acheaper source of capital,
lowering the excessive
reliance on banks forlending. It will also
provide government andlocal municipalities withcheaper capital to financethemselves.

Page 83

Importantly,
securitisation also
allocates risk with capital,
avoiding middlemaninefficiencies and canenable companies toaccess capital markets
directly, in most cases atlower cost than the costof issuing direct debt
(such as bonds orcommercial paper), as it iscollateralized, decreasing
investor risk.
A well-supervised andestablished credit rating
industry will provide
investors with aguarantee of the type of
securities they are
trading, ensuring a matchof bond price, coupon
and risk.

Ratings & Credit
MarketInfrastructure

There is a clear needto further develop
the credit rating
industry in India,
creating an accessible
and attractive market
for investors.

Broadening theInvestor Base

India must foster abroad investor base,which allows foreign

In a system with stableinterest rates, banks may
recognize mark-to-market
losses, trading securities
and investing in
corporate bond sector. By
so doing, banks willdevelop their own risk
management
department, better
assessing credit
exposure.

The growth of debt
mutual funds, theWith the growth of thehomegrown credit-rating
industry and international
ratings agencies investingin India, the groundwork
is in place for the further
development of the
Indian credit ratingsindustry. Over time, thiswill attract more domestic
and foreign investors. The
growing participation ofboth domestic andforeign credit rating
agencies would provide
healthy competition fordomestic rating agencies
and help improve overall
standards of analysis andtransparency.
A broad investor basewith different time
horizons, risk preferences
Page 84

and domestic
financial institutions(ranging fromcommercial banks toinsurance companies,
pension funds, hedge
funds, as well as
individual investors)
to compete on an
equal playing field.

Market participants
need more clarity on
the implementationof, GAAR, PPT under
BEPS MLI andoverseas transfer tax.
Taxation (1)Further, domestic
withholding Tax inrespect of similar
products should bealigned.

liberalization of FPI limits
and the granting of
permission to FPIs toinvest in a wider range ofassets are key first steps
in broadening theinvestor base. The
creation of real estateand infrastructure
investment trusts will
also help foster longterm investment in the
country.

and trading motives isvital for stimulating active
trading and high liquidity,
enabling the government,
corporates or financial
institutions to execute
their funding strategies
under a wide range ofmarket conditions. Morespecifically, a broad
investor base provides animportant source ofstability and liquidity tofinancial markets, aids inthe efficiency of pricediscovery, reduces
market volatility, andstimulates economic
growth.

Deferral of GAAR to FY
2017-18 is a welcome
development. However,the lack of adequate
guidance on
implementation of GAAR
continues to be negative.

Providing clarification
with respect to theimplementation of GAAR
(including PPT) is
recommended to allay
apprehensions andincrease transparency inthe market to draw moreinvestors.

Further, implementationof PPT in India should bealigned thematically andprocedurally with thechecks and balances
established for invoking
GAAR.
The exclusion of Category
I and Category II FPIs
from the ambit ofoverseas transfer
provisions is a welcome
move. Additionally, aclarification that overseas
transfer provisions shallnot apply in case ofredemption of shares orinterest outside India as aresult of or arising out ofredemption or sale of

The Indian Finance
Minister while presenting
the Union Budget 201718 had announced that it
will be clarified thatoverseas transfer
provisions shall not apply
in case where redemptionof shares or interests
outside India as a resultof or arises out ofredemption or sale ofinvestment in India which
is chargeable to tax inIndia. A clarification tothis effect is awaited.
Not only are WHT tax
rates higher for INR ECBs,

Page 85investment in India which
is chargeable to tax inIndia should be issued at
the earliest.
We further recommendthat India extend
concessionary WHT of 5%
regime towards INR ECBs
as done with similar
products (e.g., Masala
Bonds).

Taxation (2)Rationalisation of
period of holding ofunlisted debt
securities and units of
REITs/InvITs (together
referred to as abusiness trust)

The period of holding ofunlisted debt securities
to qualify as "long term
capital asset" should be
reduced from 36 months
to 24 months, while forunits of business trusts,
this should be 12 months

the fact that INR ECB
coupons are generally
higher than FCY ECB
coupons further
exacerbate theunattractiveness of INR
ECB. Unless a levelplaying field isestablished, key policy
objectives of launching
INR ECBs such as transfer
of foreign exchange risk
to foreign investors anddiversification of thelender base would notmaterialise. Extending
the 5% concessionary
WHT would help broaden
the offshore lender basefor Indian borrowers.
Under the domestic tax
law, long term capitalgains on transfer ofunlisted and listed
securities are generally
taxable at a lower rate(sometimes nil for listed
securities) than the shortterm capital gains.
Currently, gains fromtransfer of unlisted sharesare characterised as longterm if they are held for aperiod of more than 24
months. However, forunlisted debt securities,
the corresponding
holding period is 36
months. The holding
period of unlisted debt
securities to qualify as"long-term" should bealigned to the holding
period for unlisted sharesi.e. if held for more than

Page 86

24 months, then regarded
as long-term capital asset.
As for listed securities,
gains from the transfer ofthese instruments arecharacterized as longterm if they are held formore than 12 months.
Since units of businesstrusts are required to belisted, gains on thetransfer of these shouldbe treated as long-term ifthey are held for morethan 12 months, downfrom 36 months.
Currently, FPIs aregoverned by a special tax
regime under thedomestic tax laws
wherein income inrespect of securities istaxable at a beneficial tax
rate of 20%.

Taxation (3)Provide clarity on
taxability of income
distributed by an
Asset Reconstruction
Company (ARC) trust
to an FPI investor

In case where the FPI
holds security receipts
It should be clarified that issued by an ARC Trust,income distributed by the the FPI shall be
ARC Trust to an FPI
chargeable to tax ininvestor will be regarded respect of income
as 'income in respect of
distributed by the ARC
securities' under Section
Trust in a manner as if the115AD of the Income tax FPI has invested directly
Act, 1961 (the Act)in the underlying assets
held be the ARC Trust.
This results in the tax passthrough.
There is lack of clarity as
to whether such income
can be regarded as'income in respect of
securities' and can be
granted beneficial tax
rate of 20% under the

Page 87

special tax regime
applicable to FPI.
Hence, for the purposesof determining the tax
rate applicable to FPI, its
income from the ARC
Trust should beconsidered to be received
in respect of security
receipts of the ARC Trust.

Taxation (4)Clarity on taxability ofinterest income
distributed bybusiness trusts to
FPIs

Section 115AD of the Act
which provides fortaxation of FPIs, should
be amended to
specifically clarify thatinterest income
distributed by businesstrusts referred to in
Section 194LBA of theAct, to FPIs should bechargeable to tax at therate of 5%.

Section 194LBA of the Act
provides for withholdingof tax of 5% on interest
income distributed bybusiness trusts to nonresidents. Section 115A of
the Act which applies to
non-residents in general,
has been amended toprovide for taxability ofinterest income
distributed by businesstrusts at the rate of 5%.
However, Section 115ADof the Act which governs
taxability of income
earned by FPIs fromvarious securities,
provides for taxability ofinterest income fromsecurities at the rate of
20% (except for intereston certain rupee
denominated bonds
which are taxable at therate of 5%) Accordingly,
an additional clarification
shall be provided by wayof an amendment to
Section 115AD of the Act
which would provide fortaxation of interest
income from businesstrust at the rate of 5%.
This would ensure that
FPIs are not worse-off

Page 88than other non-resident
investors investing inbusiness trusts.

Regulation of
FinancialMarkets

India’s financial
regulatory authorities
must become moretransparent whendrafting andimplementing new
regulations.

Indian regulators
implement bylaws that
foster greater regulatorytransparency andconsistency, genuine
market consultation
processes, ample
notification of new
regulations and sufficient
time for public comment.

Regulatory transparency
and consistency, market
consultation processes,
sufficient notification of
new rules and time forpublic comment are vitalto well-functioning
financial markets.

Page 89

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