Author Name:   Deepti Bajpai

The project of developing International Financial Services Centre in the State is an innovative and a unique project being the first of its kind in the country which does not involve either grant of largesse

 Analysis of Regulations Governing IFSCs in India

Written by: Shaurya Joshi & Deepti Bajpai

The project of developing International Financial Services Centre (“IFSC”) in the State is an innovative and a unique project being the first of its kind in the country which does not involve either grant of largesse or the sale of land or undertaking an commercial venture but it is the State's own project, conceived with a socio-economic objective for the empowerment of the State in terms of creation of jobs, development of the infrastructure, integrated township, quality of the life standard and generation of revenue, based on a detailed study and reports of experts. Through this article the authors have tried to highlight the various guidelines as framed by these the Securities and Exchange Board of India (“SEBI”), the Reserve Bank of India (“RBI”) and the Insurance Regulatory Development Authority (“IRDA”) ,in section 18(2) of the Special Economic Zones Act (“SEZ Act”), 2005, which govern the procedure for setting up of units in the IFSC.

A. SEBI regulations on IFSCs

In its board meeting in New Delhi on March 22nd, 2015, the SEBI took various decisions in relating to IFSCs. The guidelines laid down by SEBI are that:
I. Itallowed thesubsidiaries of domestic and foreign stock exchange intermediaries and clearing corporations of stock exchanges to undertake business atthe IFSC. The guidelines permit issuance of depository receipts and debt securities by domestic and foreign companies under the ‘ForeignCurrency Depository Receipt’ Scheme.

II. The guidelines provide for listing and trading of shares and other derivatives of foreign companies in India. All investors eligible underForeign Exchange Management Act, 1999(“FEMA”)(which includes non-resident Indian, foreign investors, institutional investors, resident Indians) are allowed to invest in IFSC.

III. Mutual funds and alternative investment funds set-up in IFSC are allowed to invest in securities listed in IFSC.

Pursuant to this, through a press release dated March 27th, 2013, SEBI announced the guidelines pertaining to IFSC. The guidelines came into force on April 1st, 2015. The norms are designed to be less stringent than the regular ones, as they aim to bring the international market for Indian financial products onshore and to raise the foreign participation in Indian capital markets. Ownership and net worth requirement norms for stock exchanges and related entities have been relaxed by SEBI.

The key features of the guidelines are as follows:
I. Operation by entities
Any entity which needs to operate in an IFSC needs prior approvals from the SEBI and has to adhere to regulations prescribed by SEBI in this regard. The Board has allowed stock exchanges to deal in securities like equity shares of a company incorporated outside India, depository receipts, debt securities issued by eligible issuers, inter alia, others, in any currency other than Indian rupee.

II. Stock Exchanges, Clearing Corporations And Depositories
Any recognized stock exchange(domestic or foreign)or any clearing housecan establish its subsidiary in an IFSC subject to the condition that it shall hold 51% of the paid-up share capital and the rest can be offered to other recognized stock exchanges or clearing houses. The eligibility of depositories remains the same as stock exchanges and clearing houses.

These norms are relaxed as compared to the ownership requirements under the Securities Contracts (Regulation) (Stock Exchanges And Clearing Corporations) Regulations, 2012 for stock exchanges and clearing houses. Regulation 17 mandates that in a stock exchange, 51% of the equity shares shall be held by the public. Also, no single entity can hold more than 5% of the shareholding. Not only this, but there are restrictions on holding of equity shares in the stock exchanges by resident outside India. Clearing houses are barred from holding shares in the stock exchanges.

With respect to ownership of clearing houses, regulation 18 provides certain restrictions like only stock exchanges are permitted to hold 51% of the shareholding. Not only this, a single stock exchange cannot hold more than 15% in a clearing house. The regulations place restrictions similar to those on stock exchanges on investments by single entities in India and residents outside India. The regulations also provide restrictions of acquiring of shares and also, provide directions for appointment of directors among other requirements.

The 2015 regulations for IFSCs, thus provide less stringent ownership patterns as compared to the regulations applicable on other stock exchanges and clearing houses. Any entity desirous of operating in IFSC can simply form a company to provide such financial services relating to securities market, as permitted by the Board.

III. Net worth requirement of a permitted stock exchange, clearing corporation and depository:
Stock exchanges are required to have minimum net worth of Rs. 25 crore to initiate the business in an IFSC. Such entities need to raise the net worth to Rs. 100 crores within 3 years of operations. Clearing corporations are required to have a minimum net worth of Rs. 50 crore. This needs to be raised to Rs. 300 Crore from three years of start of operations. Depositories has been prescribed the same limits as stock exchanges.
This is a move welcomed by the players in the economy as the minimum net worth requirement of a stock exchange under the Securities Contracts (Regulation) (Stock Exchanges And ClearingCorporations) Regulations, 2012 is belowRs. 100 Crore at all times.Under the said regulations, clearing corporations also require a minimum net worth or Rs. 100 Crore and they are required to achieve a minimum net worth of Rs. 300 Crore within three years of functioning.

IV. Exemptions to entities
Under the Securities Contract Regulation Act, 1956 a stock exchange has to credit twenty five% of its profits every year to the Fund, of the recognised clearing corporation(s) which clears and settles trades executed on that stock exchange. This shall not be applicable to the stock exchanges as well as depositories operating in IFSC.

V. Issue of Capital
Domestic company can raise capital, in currency other than Indian Rupee in accordance with the Foreign Currency Depository Rules, 2014. Companies of foreign jurisdiction are required to comply with the provisions of the Companies Act, 2013 and relevant provisions of Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009.

VI. Issue of Debt Securities
Debt instruments can be issued by the entities operating in an IFSC after adhering to the certain conditions. The minimum subscription amount in case of private placement per investor must not be less than US$100,000. An issuer shall make an application for listing of such debt securities to one or more stock exchanges set up in IFSC.
 
VII. Investments: Mutual Funds and Alternate Investment Funds
The funds can invest in securities which are listed in IFSC, issued by companies incorporated in IFSC and issued by companies belonging to foreign jurisdiction.The guidelines also require that anasset management company of a mutual fund operating in IFSC shall have a net worth of not less thanUS$ 2 million which shall be increased to US$ 10 million within three years of commencement of business in IFSC.

B. RBI notifications and schemes for banks in IFSCs:
RBI in its notification dated March 2nd, 2015, provided regulations for financial institutions set up in IFSCs. The regulations are called Foreign Exchange Management (International Financial ServicesCentre) Regulations, 2015 (“Regulations”).

The Regulations provide that any branch of any recognized financial institution set up in an IFSC will be treated as a resident outside India. Therefore, their transaction with a person resident in India shall be treated as a transaction between a resident and non- resident and shall be subject to the provisions of FEMA.

The RBI issued another notification dated March 31st, 2015 termed as “Operational Guidelines on IFSC” and thus formulated a scheme for the setting up of IFSC Banking Units (“IBUs”) by banks in IFSCs. The said scheme is less stringent as compared to the guidelines for licensing of new banks in the private sector issued by the RBI.

The permissible activities of the banking units under the scheme are enumerated as follows:
a. IBUs are allowed to enter into transactions with non-resident entities other than individual or retail customers or high net worth individuals. IBU’s, however are allowed to deal with the Wholly Owned Subsidiaries or Joint Ventures of Indian companies registered abroad.

b. All transactions are to take place in any currency other than Indian Rupees.

c. IBUs are allowed to have liabilities including borrowing in foreign currency only with original maturity period greater than one year. They can however raise short term liabilities from banks subject to limits prescribed by RBI.

d. IBUs are barred from opening any current or savings accounts and are not allowed to issue bearer instruments or cheques. All transactions are permitted to take place through bank transfers.

e. IBUs are permitted to undertake factoring or forfaiting of export receivables.

f. IBUs are also allowed to enter into transactions involving all types of derivatives and structured products \aftertheapproval of their Board of Directors.

The important provisions can be summarized as follows:
I. Eligibility:
Indian banks in the public sector and the private sector and foreign banks already having presence in India are permitted to set up IBUs. Foreign banksare required to take permissions from regulators in parent countries. Each of the eligible banks is allowed to set up only one IBU in each IFSC.

II. Licenses for operations:
Banks need to take prior permission of the RBI for setting up an IBU under Section 23 (1)(a) of the Banking Regulation Act, 1949. The applications of foreign banks will be taken into consideration only after parent country regulator/s confirmation in writing of their regulatory comfort for the bank’s presence in the IFSC among other restrictions.

III. Minimum Capital Requirements
The parent bank will be required to provide a minimum capital of US$ 20 million or equivalent in any foreign currency to its IBU. Additionally for foreign banks, the parent bank is required to provide a Letter of Comfort for extending financial assistance, as and when required, in the form of capital / liquidity support to IBU. The minimum capital requirement in this case for any private bank obtaining a license from RBI is 500 Crores. Thus, it makes IFSCs a lucrative option for setting up a new IBU.

IV. SLR and CRR requirements
The liabilities of the IBU are exempt from both CRR and SLR requirements of RBI, unlike any other financial institutions which have to strictly maintain such reserves as directed by the RBI. The requirements by other banks are that CRR has to be maintained in cash while SLR can be maintained either in cash or in assets that RBI suggests.

V. Resources and deployment
The sources for raising funds, including borrowing in foreign currency, will be persons not resident in India and deployment of the funds can be with both persons resident in India as well as persons not resident in India. However, the deployment of funds with persons resident in India shall be subject to the provisions of FEMA for both foreign and Indian banks.

VI. Prudential Norms:
The scheme provides prudential regulations for such banks which are less stringent as compared to the prudential norms prescribed for private banks obtaining licenses.It requires Indian banks to follow the same prudential norms applicable to overseas branches of Indian banks. It provides that foreign banks should also follow norms prescribed by the RBI.

VII. Priority Sector Lending:
The loans provided by such IBUs would not be considered as a portion of the Net Bank Credit of the parent bank for computing priority sector lending obligations. Thus, the IBUs have been exempted from lending to priority sectors giving greater freedom to the units to extend loans and advances. As per the requirements of the RBI, the parent bank would still require to extend loans and advances to such sectors as prescribed by the Regulatory Authority and meet the set targets for 2015 through branches outside IFSCs.

VIII. Others
The scheme provides for anti-money laundering measures and reporting requirements among other requirements. The scheme clearly specifies that the IBUs will be regulated and supervised by the RBI.

C. International Financial Services Centers (IFSC)) Guidelines, 2015 by Insurance Regulatory Development Authority of India (“IRDA”)
IRDA, on April 7th, 2015 has issued guidelines with regard to regulate the insurance offices set up in an IFSC. The guidelines state that domestic insurance companies have been allowed to set up IFSC Insurance Office (“IIO”). These insurance companies can carry on reinsurance business and foreign insurance companies can do the same if they meet the certain conditions and obtain prior approval of IRDA.

In the case of a reinsurance business, section 10 of the regulations shall be complied with, which states that the companies should“demonstrate an assigned capital of Rs.10 Crore which may be held in the form of Government Securities issued by the Government of India or held as deposits with scheduled banks in India and shall be maintained at all times during the subsistence and validity of its registration under these guidelines”. Further in case of a direct insurance, the Indian insurers (except a statutory body) may also establish an IIO to transact a specified direct insurance business within the SEZ.

Footnotes:
[1] Shaurya Joshi & Deepti Bajpai - Students, VIIth Semester, IV Year, B.A.LL.B. (Hons), Dr Ram Manohar Lohiya National Law University, Lucknow.
[2] Pathan Mohammed Suleman v State of Gujarat, 2013 SCC On Line Guj 5391.
[3] Section 2(zc) of the SEZ Act defines “Units” as:
“Unit set up by an entrepreneur in a Special Economic Zone and includes an existing Unit, an Offshore Banking Unit and a Unit in an International Financial Services Centre, whether established before or established after commencement of this Act”.
 [4] SEBI Board Meeting dated March 22nd,2015, PR No. 70/2015.
[5] http://203.199.247.102/cms/sebi_data/attachdocs/1427450911533.pdf(Last accessed on September 19th, 2015).
[6] Such guidelines have been announced in exercise of the powers conferred by section 11(1) of the SEBI Act, 1992 and sections 4 and 8A of the Securities Contracts (Regulation) Act, 1956 read with along with Section 18(2) of the Special Economic Zones Act, 2005.
[7] http://www.business-standard.com/article/markets/incentives-for-gift-city-profit-transfer-rule-eased-for-bourses-115032701076_1.html (Last accessed on September 19th, 2015).
[8] Regulation 17(1), Securities Contracts (Regulation) (Stock Exchanges And Clearing Corporations) Regulations, 2012.
[9] Regulation 17(2) and 17(3), Securities Contracts (Regulation) (Stock Exchanges And Clearing Corporations) Regulations, 2012.
[10] Regulation 17(4) Securities Contracts (Regulation) (Stock Exchanges And Clearing Corporations) Regulations, 2012.
[11] Regulation 17(5), Securities Contracts (Regulation) (Stock Exchanges And Clearing Corporations) Regulations, 2012.
[12] Regulation 18(1), Securities Contracts (Regulation) (Stock Exchanges And Clearing Corporations) Regulations, 2012.
[13] Regulation 5(1), Securities And Exchange Board Of India (International FinancialServices Centres) Guidelines, 2015.
[14] Regulation 5 (2), Securities And Exchange Board Of India (International FinancialServices Centres) Guidelines, 2015.
[15] Regulation 5 (3), Securities And Exchange Board Of India (International FinancialServices Centres) Guidelines, 2015.
[16] Regulation 14, Securities Contracts (Regulation) (Stock Exchanges And Clearing Corporations) Regulations, 2012.
[17] Regulation 6, Securities And Exchange Board Of India (International FinancialServices Centres) Guidelines, 2015.
[18] Chapter IV, Regulation 10, Regulation 11,Securities And Exchange Board Of India (International FinancialServices Centres) Guidelines, 2015.
[19] The regulations provide that the constitution of the entity must allow the issue of such instruments and that the entity should not be debarred by any regulatory authority in domestic or foreign jurisdiction. Along with these requirements, the entity must not have been held guilty of any financial offence in domestic or foreign jurisdiction.
[20] Chapter V,Securities And Exchange Board Of India (International FinancialServices Centres) Guidelines, 2015.
 
[21] Chapter VI, Securities And Exchange Board Of India (International FinancialServices Centres) Guidelines, 2015.
[22] Regulation 2(b) defines “financial institutions”to include banks, non-banking financial companies, insurance companies, brokerage firms, merchant banks, investment banks, inter alia, others. The term financial transaction by such financial institutions shall mean making or receiving payment, drawing, issuing or negotiating any bills of exchange or promissory note, transferring any security or acknowledging any debt. Similarly, RBI has defined financial service to mean any activity which a financial institution is permitted to carry on by the Respective Act of the Parliament or Government of India or any Regulatory Authority empowered to regulate the concerned financial institution.
[23] https://rbidocs.rbi.org.in/rdocs/content/pdfs/FEMANIFSC010415_AN.pdf(Last accessed on September 20th, 2015).
[24] https://rbi.org.in/scripts/NotificationUser.aspx?Id=9619&Mode=0(Last accessed on September 20th, 2015).
[25] Regulation 3, Foreign Exchange Management (International Financial Services Centre) Regulations, 2015.
[26] The regulations also clarify that the exchange of foreign currency in an IFSC shall be in accordance with the regulations provided by authorities and the said institutions shall be governed by the said regulations. Regulation 4 and 5.
[27] https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=9636&Mode=0(Last accessed on September 20th, 2015).
[28] https://rbi.org.in/scripts/bs_viewcontent.aspx?Id=2651(Last accessed on September 19th, 2015).
[29] https://rbi.org.in/scripts/bs_viewcontent.aspx?Id=2651 (Last accessed on September 19th, 2015).
 
[30] https://rbi.org.in/Scripts/BS_ViewMasCirculardetails.aspx?id=9857 (Last accessed on September 19th, 2015).
[31] https://rbi.org.in/Scripts/NotificationUser.aspx?Id=9688&Mode=0 (Last accessed on September 20th, 2015).
[32] https://www.irda.gov.in/admincms/cms/whatsNew_Layout.aspx?page=PageNo2465&flag=1 (Last accessed on September 20th, 2015).
[33] https://www.irda.gov.in/admincms/cms/whatsNew_Layout.aspx?page=PageNo2465&flag=1 (Last accessed on September 21st, 2015).
[34] The regulations provide the following conditions:
a. Insurance companies should be registered or licensed for insurance or reinsurance business in India or the country of incorporation.
b. Such companies should be authorized by the supervisory authority of that country to set up such office in India.
c. The company must be in continuous operation for at least five years or more.
d. The company must have a satisfactory track record in respect of regulatory or supervisory compliance with the laws governing such companies.
e. If should have net owned funds as specified in the Insurance Act, 1938.

The author can be reached at: shauryajoshi@legalserviceindia.com

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