FEMA

Guidelines on ECB Hedging

ECB Hedging

External Commercial Borrowings are commercial loans that are utilized by Indian Companies. These instruments are borrowed from foreign institutional investors. The framework related to ECB has to confirm with specific parameters related to end use of the ECB, ECB Hedging requirements, minimum average maturity period, and all-in costs ceiling requirement of the ECB. 

Indian borrowers prefer utilizing external commercial borrowings for the following reasons:

  • Borrowers get an opportunity to borrow a large amount of sums;
  • Funds are available for a longer period;
  • Foreign banks offer lower interest rates on comparison to Indian Banks;
  • Indian Companies prefer using ECBs as they are raised in the form of foreign currency; and
  • ECB’s will help the Indian Company to raise foreign exchange reserves.

Meaning of ECB Hedging

Hedging can be understood as a risk mechanism which is commonly used in finance. It is a mechanism in which the price movements of a particular asset can be controlled. Hedging is known as adjusting a particular risk or an investment against the adverse price movement in the market. Therefore an investor using the hedging mechanism would not concentrate on the amount of money made from the investment, but concentrate on reducing the loss. Therefore ECB hedging is understood as a mechanism where the borrowing would be used to offset the adverse price changes in the market.

Framework related to ECB Hedging

The Reserve Bank of India in their Master Direction No.5 dated January 1, 2016 brought out the regulatory framework for External Commercial Borrowings, Trade Credit, Borrowing, and Lending in Foreign Currency by Authorised Dealers. In this direction-specific parameters were required to be followed by borrowers.

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The following were the parameters brought out by the RBI:

MAMP (Minimum Average Maturity Period) –

  • Track I- for borrowers using up to USD 50 the minimum amount of maturity period varies between 3 to 5 years.
  • Track II- the minimum average maturity period is 10 years. This is irrespective of the amount of investment offered.
  • Track III- the minimum average maturity period for this track is similar to track II.

The Master Direction provided a list of eligible borrowers who can utilize ECB. The amount of investment borrowed by an entity would ultimately depend on the end-use requirements. End-use is the main purpose for which the investment was borrowed.

However, Track I and Track II ECB  borrowers would include companies, shipping companies, SEZ companies, NBFC, financial institutions, SIDBI ( Small Industries Development Bank of India), and trusts set up for infrastructural purposes.

ECB borrowings are subject to certain end-user requirements by the borrower.

ECB Hedging Report

Companies that prefer utilizing external commercial borrowings must get approval from the Board of Directors. Apart from this, the company has to have a board-approved risk management policy related to ECB hedging requirements. The exposure of the ECB hedge has to be at a minimum of 100% for the company at all times.  This would be applicable for an ECB having a MAMP of 5 years or less.

Category-I Authorised Banks have to verify that compliance has been met by the borrower while using the ECB. A report has to be published to the RBI in Form ECB 2 Returns. Companies that are raising ECB under track I and track II are required to follow specific guidelines issued by the concerned authority or prudential regulator of foreign exchange reserves.

Is ECB Hedging Mandatory?

As per the RBI 2016 master direction, wherever ECB hedging is compulsory the following guidelines have to be followed:

  • The borrower using ECB should cover the principal as well as coupon through the financial hedges. Hedging against the amount of investment i.e. the financial hedging on the ECB should start from the date of the exposure. This means that the exposure would start from the date on which the liability is created on the books.
  • For a financial hedge a minimum tenure of one year is required. This would include the periodic rollover to make sure that the ECB is not hedged at any point during the operation of the ECB.
  • Natural financial hedge would be only considered for offsetting projected cash flows in currencies which match the net of all other cash flows. ECB hedging would be considered to be natural if the offsetting exposure has the amount of maturity within the same year. Other expenditures or payments would not be considered as a natural hedge.

New Guidelines as per the circular on ECB Hedging

The RBI in a circular issued in 2018-19 brought out specific changes related to certain parameters.

The changes brought were as follows:

  • Amendment to the MAMP (Minimum Average Maturity Period)
  • Amendment of the ECB hedging framework

The changes related to MAMP for borrowers utilizing ECBs for the development of infrastructural spaces. The maturity period has reduced from 5 years to 3 years for this.

Another relaxation was brought out by the RBI on the mandatory requirement for ECB hedging. Previously, ECB hedging requirements were made compulsory. The average maturity period for ECBs has reduced from 10 years to 5 years.

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Furthermore, the RBI has clarified that ECBs having a maturity period for 3 to 5 years in the infrastructural space will have to meet the 100% hedging requirements. External commercial borrowings raised before this amendment would not require rolling over their existing hedges.

How will it affect companies that rely on ECB?

Further to the above circular, the RBI has further relaxed the mandatory requirement of ECB Hedging from 100% to 70%. Due to the liquidity crisis, faced by NBFCs the RBI has taken this step to further improve borrowings. Companies that have borrowed ECBs before this notification would require to compulsorily rollover their existing edge to 70%. Companies that rely on ECBs previously would only have to hedge 70% of the ECB.

Conclusion

RBI framework has brought out rules related to ECB hedging. These rules require companies to hedge against the borrowing. This creates a risk avenue for the companies to manage the risk.  The relaxation for 100% hedging to 70% hedging has improved the amount of borrowings by borrowers in Category I.

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