RBI’s guidelines on Step Down Subsidiary

Ashish M. Shaji

21 May, 2020

Over the years, the Indian industry has been building up its presence successfully abroad with increasing overseas acquisitions, and thereby the exposure of banks to such financing is rising. As the overseas market is expected to offer better opportunities for growth and is supposed to bring in higher revenues and volumes, the RBI has therefore decided to allow banks in India to extend funded and or non-funded credit facilities to wholly-owned step down subsidiary or subsidiaries of Indian companies (where the holding by the Indian Company is higher than 51%) abroad.

The circular issued by the RBI dated 10 May 2007 have been reviewed and modified. It says that:

• The banks may extend funded and or non-funded credit facilities to the step down subsidiary of Indian companies, including to those beyond the first level in order to finance the projects that are undertaken abroad.
• The immediate overseas subsidiary of the Indian company should be directly controlled by the Indian parent company through any of the medium of control recognized under the Indian Accounting Standards. In addition to it, the Indian parent company must hold a minimum of 51% of its shareholding directly.
• The entire step down subsidiaries, including the intermediate ones, should be wholly owned subsidiaries of the immediate parent company, or all its shares shall be jointly held by the immediate parent company and the Indian parent company and or its wholly-owned subsidiary. The immediate parent must wholly or jointly with an Indian parent company and or its wholly-owned subsidiary have control over the step down subsidiary.
• The banks will make additional provision of 2% (in addition to the country risk provision that is applicable on all overseas exposures) against standard assets representing all exposures to the step down subsidiaries in order to cover the additional risk accruing from the complexity in the structure, location of different intermediary entities in various jurisdictions exposing the Indian company and the bank to considerable political or regulatory risk.

The aforementioned modifications will apply to the credit facilities sanctioned after the date of the circular and further to existing facilities as and when they are renewed afterward.

All other terms and conditions specified above in the circular as amended from time to time will remain applicable.

Is the Indian party permitted to issue a corporate guarantee on behalf of its second generation subsidiary abroad?

Under the approval route, the Indian party can issue corporate guarantee on behalf of its second generation or subsequent level step down operating subsidiaries, provided the Indian Party indirectly holds 51% or more than 51% stake in the overseas second level step down operating subsidiary for which such a guarantee is proposed to be issued.

Can the rollover of guarantee that has been issued already on behalf of the overseas Joint venture/wholly owned subsidiaries/step down subsidiary, may be allowed under the automatic route where there is change in the end-use of the facility or the overseas lender or the coupon rate or the amount?

No, as on date a guarantee that that has been issued already on behalf of the overseas Joint venture/wholly owned subsidiaries/step down subsidiaries may be allowed to be rolled over under the automatic route without subjecting the rollover to FEMA compliance afresh, provided that only the validity period of the extant guarantee is undergoing change.

Is there any restriction for setting up a second-generation company? Can such step down subsidiaries be put in place under the Automatic Route?

 There are no restrictions on entities having Joint ventures / wholly-owned subsidiaries abroad setting up second-generation operating companies (Step down subsidiaries) within the overall limits that are applicable under the automatic route. However, it may be noted that companies wishing to set up step down operating subsidiaries to undertake financial sector activities shall have to comply with the additional requirements for direct investment in the financial services sector.

Can an Indian party fund directly such a step down subsidiary?

Where a Joint venture / wholly-owned subsidiary has been established through a Special Purpose Vehicle, all funding to the operating step down subsidiaries should be routed through the Special Purpose Vehicle only. In case of guarantees to be given on behalf of the first level step down operating subsidiary, these can be given directly by the Indian Party (IP) provided such exposures are within the permitted financial commitment of the IP.

Can an Indian party set up a Step Down Subsidiary (SDS)/ Joint Venture in India through its foreign entity (JV/WOS) directly or indirectly through SDS of the foreign entity?

No, as per the provisions contained in the notification number FEMA 120/RB-2004 of 7 July 2004, as amended from time to time, which deals with the transfer and issue of any foreign security to the residents do not permit an Indian party to set up a step down subsidiary/ Joint Venture in India nor does the provisions permit or allow an Indian party to acquire a WOS or invest in JV that already has a direct or indirect investment in India under the automatic route. However, it may be noted Indian parties can approach the Reserve Bank for prior approval through their AD banks which shall be considered on a case to case basis depending upon the merits of the case.

Conclusion

While referring queries by the Authorised Dealer banks in the conference of the Authorised dealers on FEMA, one of the questions were raised by the Authorized dealer bank stating whether it is permitted for an Indian Company to acquire an overseas company and that such overseas company has an Indian subsidiary as well. The RBI responded that it was not envisaged under the extant guidelines at the point of time.