Promoters of listed companies may have cause both for some
relief and some worry with the recent and almost quiet notification of the
directions relating to Core Investment Companies (CICs) by the Reserve Bank of
India. Essentially, investment companies fulfilling certain conditions of size
and outside borrowings are now specifically required to be registered as
non-banking financial companies (NBFCs).
It is worth discussing first a short background here.
Promoters of listed companies (and even others) often hold shares of such listed
companies through investment companies for various reasons. In 1997, the Reserve
Bank of India Act was amended and it was required that NBFCs, as defined, should
be registered. There have been two views whether pure investment companies,
which just hold securities and do not deal in them, were also required to be
registered. Thus, several such companies did not register on this ground.
Further, on a case-to-case basis, several such companies were even exempted by
the Reserve Bank of India. On the other hand, numerous investment companies, it
appears, just neglected or defaulted in applying for registration. Now, the
Reserve Bank of India has defined such investment companies as Core Investment
Companies, and requires them to be registered even if they were earlier granted
exemption by the Reserve Bank of India.
The Core Investment Companies (Reserve Bank) Directions, 2011
were notified on 5th January 2011. Certain related notifications were also
issued. Important provisions of these Directions are discussed in the following
paragraphs.
What are CICs ?
The Directions define CICs. CICs are essentially companies
that carry on the business of acquiring securities and further satisfy certain
conditions. Firstly, at least 90% of their total assets should consist of
shares, debentures, loans, etc., in ‘group companies’. Secondly of the total
assets, at least 60% should consist of either equity shares or debentures,
compulsorily convertible into equity shares within 10 years of issue, of ‘group
companies’. Thirdly such companies should not trade in securities except through
block sales of securities in the specified manner. Finally, they should not
carry on any other financial activity except investment in bank deposits, money
market instruments, etc.
Which CICs are required to be registered ?
A CIC is required to be registered if, firstly, it has total
assets of at least Rs. 100 crores. Secondly, it should have raised or should be
holding ‘public funds’. Public funds are inclusively defined and particularly
include debentures, public deposits, inter-corporate deposits and bank finance.
However, debentures compulsorily convertible into equity shares within 10 years
of issue are not included. Such CICs are called systemically important CICs
(referred to herein as CICs only).
It is important to note that even the separate assets of
other ‘companies in the group’, as defined, are to be considered while
determining whether the CIC has the required minimum Rs.100 crores of total
assets or not. Thus, effectively, the aggregate assets of group companies are to
be counted to determine whether the concerned investment company is a CIC or
not.
Separate category of such CICs:
Such CICs are known by a separate category now, viz.,
CIC-ND-SI.
When is application for such registration required to be made ?
Existing CICs are required to apply within a period of six
months from the date of notification of the Directions. Till their applications
are disposed of by the Reserve Bank of India, they can continue to carry on
their business as CIC. Companies that become CICs after the date of the
Directions are required to apply within three months of becoming a CIC.
Minimum net owned funds :
NBFCs are required to have and maintain a minimum amount of
net owned funds as defined in the Reserve Bank of India Act. However, the
formula for calculation of net owned funds (NOF) is such that for holding
investment companies, the NOF often cannot be attained. This is particularly
because of an inherent feature of such investment companies that they, by
definition, invest in ‘group companies’, while the formula for calculating net
owned funds require deduction of most part of such group investments from the
‘net owned funds’. In fact, it is often found that by this calculation, even a
high positive net worth company has negative ‘net owned funds’. It is now
notified and clarified that such CICs shall not be required to have the NOF.
Minimum capital requirements :
An important reason for bringing even
non-deposit-accepting large NBFCs into the requirement of registration and
supervision is that such companies should not leverage too much and put
themselves and perhaps the market at risk. Thus, a minimum capital adequacy
requirement has been prescribed. As regards CICs, it is required that they
should have a minimum adjusted net worth that is at least 30% of the
risk-weighted on-balance sheet and specified off-balance sheet assets.
The definition of terms such as ‘adjusted net worth’ and the
formula for calculation of risk-weighted assets have been prescribed.
Essentially, the adjusted net worth includes the ‘owned funds’ but adjusted by
100% of unrealised depreciation/50% of unrealised appreciation in the book value
of quoted investments calculated in the specified manner.
Maximum debt-equity ratio :
CICs are required to have and maintain a maximum debt-equity
ratio of 2.5 as calculated in the specified manner. Essentially stated, this is
the ratio of outside liabilities to adjusted net worth, both terms as
elaborately defined in the Directions.
Outside liabilities for this purpose mean the total
liabilities appearing on the liabilities side of the balance sheet, but exclude
the following :
(i) Paid up capital
(ii) Reserves and surplus
(iii) Instruments compulsorily convertible into equity
shares within a period not exceeding 10 years from the date of issue.
However, it is to be noted that all forms of debt and
obligations having the characteristics of debt are included. In particular,
guarantees issued, whether appearing on the balance sheet or not, are also
included.
This term is thus to be contrasted with the other similar
term, though used for a different purpose, and that is ‘public funds’.
Annual auditors’ compliance certificate :
CICs are required to submit annually a certificate from their
statutory auditors of compliance with the Directions. This certificate has to be
submitted within one month of the finalisation of the balance sheet of the CIC.
What are group companies?
As stated earlier, the assets of companies in the group are also to be considered for determining whether the minimum size of total assets of Rs. 100 crores has been reached or not. The term ‘companies in the group’ has been very widely defined and thus includes the following:
i) Subsidiary-parent (defined in terms of AS-21)
ii) Joint ventures (defined in terms of AS-27)
iii) Associates (defined in terms of AS-23)
iv) Promoter-promotee [as provided in the SEBI (Acquisition of Shares and Takeover) Regulations, 1997] for listed companies,
v) related parties (defined in terms of AS-18)
vi) Companies having common brand name
vii) Having investment in equity shares of 20% and above.
Some areas requiring clarity:
There are several questions that need clearer answers and some of these are as follows:
1. What is the status of a holding investment company that does not have the minimum assets, calculated in the prescribed manner, of Rs.100 crores??
Whether such company, if not yet registered, is not required to be registered?
The Reserve Bank of India has issued simultaneous notifications giving certain exemptions, but a more express and clear exemption would clarify such issues with greater finality.
2. What would be the implications if a CIC is not in complying with the various requirements such as minimum capital adequacy, debt-equity ratio, etc. of these newly notified Directions?? By what time will it be required to be in compliance with such conditions?
3. A question related to the earlier one is whether the requirements relating to, say, having minimum 90% investments in group companies mandatory for registration or mandatory conditions after registration. The intention appears to be that if a CIC is required to be registered, then they should ensure that their asset profile consists investments in group companies only as per the specified formula. One will have to see in practiced, how the Reserve Bank of India deals with such matter.
4. It is seen that many of the related directions, circulars, etc., are presently prescribed, keeping in mind the regular categories of NBFCs such as loan, investment, etc. The CIC-ND-SI is clearly a separate category of NBFCs and hence these other directions would have to be amended to ensure coverage of such CICs as well, of course with suitable modifications where required. For example, the Directions to Auditors of 2008 would need appropriate amendments to cover such CICs.
5. Can existing registered holding companies shift to this new category? As discussed earlier, many existing holding investment companies may be finding it difficult to maintain capital adequacy and other ratios. However, they may be already registered as investment companies, but surely they would like to obtain the benefit of the diluted requirements if they otherwise qualify for being registered as CICs. The Directions do not provide for shifting of registration from being an ordinary registered investment company to a CIC. It is hoped that in keeping with the spirit of these Directions, the Reserve Bank of India allows shifting of such registration.
Conclusion:
These new Directions will require several promoter groups, particularly of listed companies, to check whether their holding companies need compliance of these Directions in the form for registration. Further, they will need to make a plan of restructuring the capital and finances of such companies to ensure that they fall within the framework of the new Directions.
