October 10, 2023

A Guide to External Commercial Borrowings (“ECB”) under FEMA-Part-1

Business financing is an integral part of business. To meet funding requirements, business entities resort to various sources of financing such as Equity funding, Debentures, borrowing from banks, etc. For raising finance, the domestic market is not the only option. Now, businesses are looking towards the international market also for raising finances.

As per Statistics, foreign debt has more than doubled in less than two years, as domestic lenders remained cautious in the aftermath of a liquidity crisis and India’s Central Bank relaxed regulations for using offshore borrowings.

Every financial transaction from the international market comes under purview of Foreign Exchange Management Act and is regulated by the RBI. Such borrowings are referred to as External Commercial Borrowings (ECB). The RBI laws governing ECBs are outlined in the Master Direction – External Commercial Borrowings, Trade Credits, and Structured Obligations (Master Direction) and the Foreign Exchange Management Act, 1999 (FEMA) (“ECB Master Circular”).

In this article a detailed analysis is carried out of External Commercial Borrowings:

1. What is External Commercial Borrowings (ECB)

In common parallence, External Commercial borrowings means commercial loans granted by non-resident entities to Indian Resident entities. ECBs are raised for business purpose only.

As defined under ECB Master Circular, External Commercial Borrowings,, are commercial loans raised by eligible resident entities from recognised non-resident entities and should conform to parameters such as minimum maturity, permitted and non-permitted end-uses, maximum all-in-cost ceiling, etc. The parameters given below apply in totality and not on a standalone basis.

2. Advantages of ECB

Borrowing from the international market makes borrowing more economical for business as Interest rates on ECBs are less as compared to domestic funds. For example, there are many economies with lower interest rates; accordingly, Indian enterprises and organizations would undoubtedly gain if they could borrow at more economical interest rates from the Eurozone and the United States.
In the domestic market, a business organization may need to approach more than one lender to meet its requirement of large funds. However, Foreign players are available with plenty of funds. ECB gives an option to borrow funds in large volume.
In the International market, funds are provided for a relatively longer period. Therefore, businesses may focus on their initial setups and not need in hurry about repayment of loans.
Unlike equity funding, no intervention of lender in business operations and stake. ECBs are, at their most basic level, just loans. The company’s stakes will not be diluted because they do not have to be of an equity kind. Lenders would have no voting rights in the corporation.
ECBs can be availed in foreign currency. Therefore, ECBs provide entities with foreign currency with which they can meet their import requirements like import cost of goods, machinery etc.

3. External Commercial Borrowings under FEMA

Provisions governing ECB are outlined under Part-I- External Commercial Borrowing Framework of RBI/FED/2018-19/67 FED Master Direction No.5/2018-19 dated 26th March, 2019.
ECB Master Circular is issued in suppression of earlier issued Master Directions dated 1st January, 2016.
Gist of ECB Master Circular is given below:

3.1 Currency of Borrowings

ECB can be borrowed either in Any freely convertible Foreing Currency (ECB Denominated in FYC) or Indian Currency (ECB Denominated in INR).
ECB borrowed in foreign currency can be freely converted into any other freely convertible Foreign Currency or Indian Rupee. However, ECB borrowed in INR is not permitted to convert into any other currency.
For the purpose of conversion from ECB FYC to ECB INR, exchange rate prevailing on the date of the agreement for such change between the parties concerned or at an exchange rate, which is less than the rate prevailing on the date of the agreement, if consented to by the ECB lender.

3.2 Form of ECB

Different forms of Loans are permitted by RBI based on denomination of ECB. FYC ECB can be borrowed in any of the following form:
- Banks Loans
- Floating/ fixed rate notes/ bonds/ debentures (other than fully and compulsorily convertible instruments)
- Trade credits beyond 3 years
- FCCBs (Foreign Currency Convertible Bond)
- FCEBs (Foreign Currency Exchangeable Bond)
- Financial Lease

ECB borrowed in INR can be of following forms:
- bank loans;
- floating/ fixed rate notes/bonds/ debentures/ preference shares (other than fully and compulsorily convertible instruments);
- Trade credits beyond 3 years; and
- Financial Lease.
- plain vanilla Rupee denominated bonds issued overseas, which can be either placed privately or listed on exchanges as per host country regulations.

3.3 Eligible Borrowers

Blanket permission is not given to every person to borrow through External Commercial Borrowings. Only following persons are allowed to borrow through ECB:

All entities eligible to receive FDI.
Port Trusts;
Units in SEZ;
SIDBI (Small Industry and Development Bank of India); and
EXIM (Export Import) Bank of India.
Further, Registered entities engaged in micro-finance activities, viz., registered Not for Profit companies, registered societies/trusts/ cooperatives and Non-Government Organisations are allowed to raise only through ECB denominated in INR.

3.4 Recognised Lenders

Various lenders are prevailing in the international market. Only those lenders are permitted to provide money through ECBs which are resident of FATF (Financial Action Task Force) or IOSCO ( International Organization of Securities Commissions) compliant country, including on transfer of ECB. Further, following persons are also allowed for providing funds on ECB:

Multilateral and Regional Financial Institutions where India is a member country
Individuals only if they are foreign equity holders or for subscription to bonds/debentures listed abroad; and
Foreign branches/subsidiaries of Indian banks are permitted as recognised lenders only for FCY ECB (except FCCBs and FCEBs).
Further, Foreign branches / subsidiaries of Indian banks can also participate as arrangers/ underwriters/ market-makers/ traders for Rupee denominated Bonds issued overseas . However, underwriting by foreign branches/subsidiaries of Indian banks for issuances by Indian banks will not be allowed.

3.5 Minimum Average Maturity period (“MAMP”) of ECB:

MAMP of ECB will be 3 years.
Call and put option, if any, shall not be exercised prior to completion of minimum average maturity.
For following category of ECBs, MAMP shall be as follows:

Category of ECB	MAMP
ECB raised by manufacturing companies up to USD 50 million or its equivalent per financial year.	1 year
ECB raised from foreign equity holder for working capital purposes, general corporate purposes or for repayment of Rupee loans	5 years
ECB raised forworking capital purposes or general corporate purposeson-lending by NBFCs for working capital purposes or general corporate purposes	10 years
ECB raised forrepayment of Rupee loans availed domestically for capital expenditureon-lending by NBFCs for the same purpose	7 Years
ECB raised forrepayment of Rupee loans availed domestically for purposes other than capital expenditureon-lending by NBFCs for the same purpose	10 Years

3.6 All-in-Cost ceiling Per Annum

All in cost specifies total cost of borrowing funds through ECB.
All in cost includes rate of interest, other fees, expenses, charges, guarantee fees, ECA charges, whether paid in foreign currency or INR but does not include commitment fees and withholding tax payable in INR.
As per master instructions, All in cost shall be as follows:
- For FCY ECB:
  - For existing ECBs linked to LIBOR whose benchmarks are changed to ARR: Benchmark Rate plus 550 bps spread
  - For new ECBs: Benchmark rate plus 500 bps spread
- For INR ECB: Benchmark rate plus 450 bps spread.

Further, Penal interest, if any, for default or breach of covenants, should not be more than 2 % over and above the contracted rate of interest on the outstanding principal amount.
Penal Interest will be outside the all-in-cost ceiling.

3.7 Prohibited used of ECB Proceeds

ECB proceeds should be utilised for the purpose it is borrowed. However, RBI has provided a following list of activities for which ECB proceeds can’t be utilised all together:

Real estate activities.
Investment in capital market.
Equity investment.
Working capital purposes, except when ECB is borrowed for working capital purpose.
General corporate purposes, except when ECB is borrowed for general corporate purpose.
Repayment of Rupee loans, except when ECB is borrowed specifically for this purpose.
On-lending to entities for the above activities, except in case of ECB raised by NBFCs for such purpose.

3.8 Hedging Provision for ECB

FCY ECB:
- The entities raising ECB should follow the hedging guidelines issued by the concerned sectoral or prudential regulator in respect of foreign currency exposure.
- Further, Infrastructure space companies shall have a Board approved risk management policy.
- Also, such companies are required to mandatorily hedge 70 % of their ECB exposure in case the average maturity of the ECB is less than 5 years. Such requirements shall be verified by RBI through a report in Form ECB-2.
- The following operational aspects with respect to hedging should be ensured:
  - Coverage: The ECB borrower will be required to cover the principal as well as the coupon through financial hedges. The financial hedge for all exposures on account of ECB should start from the time of each such exposure (i.e. the day the liability is created in the books of the borrower).
  - Tenor and rollover: A minimum tenor of one year for the financial hedge would be required with periodic rollover. Borrower should ensure that exposure on account of ECB is not unhedged at any point during the currency of the ECB.
  - Natural Hedge: Natural hedge, in lieu of financial hedge, will be considered only to the extent of offsetting projected cash flows / revenues in matching currency, net of all other projected outflows. For this purpose, an ECB may be considered naturally hedged if the offsetting exposure has the maturity/cash flow within the same accounting year. Any other arrangements/ structures, where revenues are indexed to foreign currency will not be considered as a natural hedge.

INR ECB:
- Overseas investors are eligible to hedge their exposure in Rupee through permitted derivative products with AD Category I banks in India.
- The investors can access the domestic market through branches / subsidiaries of Indian banks abroad or branches of foreign banks with Indian presence on a back to back basis.

3.9 Limit and Leverage

All eligible borrowers can raise ECB up to USD 750 million or equivalent per financial year under the automatic route.
Further, in case of FCY ECB raised from direct foreign equity holder, ECB liability-equity ratio for ECB raised under the automatic route cannot exceed 7:1. However, this ratio will not be applicable if the outstanding amount of all ECB, including the proposed one, is up to USD 5 million or its equivalent.
Also, the borrowing entities will also be governed by the debt equity ratio guidelines, if any, issued by the sectoral or prudential regulator concerned.

3.10 Guarantee, etc. by Indian banks and Financial Institutions against ECB:

Indian banks, All India Financial Institutions and NBFCs shall not issue any kind of Guarantee relating to ECB.
Further, financial intermediaries (viz., Indian banks, All India Financial Institutions, or NBFCs) shall not invest in FCCBs/ FCEBs in any manner whatsoever.

4. Frequently Asked Questions

4.1 For repayment of ECB, how Average Maturity Period is calculated?

Ans: Computation of Average Maturity Period can be understood by following example:

Loans Taken: 2 Million USD

Date	Loan Disbursed/ taken	Loan Repayment	Loan Balance Amount	Number of days balance	*Product (de)**
a	b	c	d	e	f
1/1/2021	0.5	–	0.5	31 Days	15.50
2/1/2021	0.5	–	1	28 Days	28.00
3/1/2021	0.5	–	1.5	31 Days	46.50
4/1/2021	0.5	–	2	44 Days	88.00
5/15/2021	–	0.25	1.75	31 Days	54.25
6/15/2021	–	0.2	1.55	16 Days	24.80
7/1/2021	–	0.75	0.8	31 Days	24.80
8/1/2021	–	0.25	0.55	14 Days	7.70
8/15/2021	–	0.4	0.15	17 Days	2.55
9/1/2021	–	0.05	0.1	61 Days	6.10
11/1/2021	–	0.1	0	–	–
	2 Days				298.20

*Average Maturity period (f/(Total Loan365 days))**					0.408493

4.2 What is the meaning of Hedging and Natural Hedging?

Hedging:

Hedging is an investment which is made to reduce or mitigate the risk of adverse price movement of any financial asset.
It is generally done by taking an opposite position in related assets.
Hedging helps to reduce risk but likewise it also results in reduction of potential profit.
Hedging strategies generally involve derivatives such as futures and options.

Natural Hedging:

A natural hedge is a management strategy wherein risk of financial loss is mitigated by making investment in those assets which are inherently negatively correlated.
For instance, a natural hedge against owning financial stocks is to hold bonds. Therefore, decrease in interest income of financial stock will get mitigated by decrease in interest cost of bonds.
In case of ECB, natural hedging can be done by arranging cash inflows in the same currency.

Read remaning provisions related to ECB in part-2.

DISCLAIMER: The views expressed are strictly of the author and VJM & Associates LLP. The contents of this article are solely for informational purpose. It does not constitute professional advice or recommendation of firm. Neither the author nor firm and its affiliates accepts any liabilities for any loss or damage of any kind arising out of any information in this article nor for any actions taken in reliance thereon.

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