Core Investment Companies and their Regulation in India
Written by Aditya Vaish
Fifth Year, BBA LLB. Symbiosis Law School, Pune
Disclaimer: Please note that the views expressed below represent the opinions of the article's author. The following does not necessarily represent the views of Law & Order.
Companies registered under the Companies Act, 2013 that carry out financial activities such as providing loans and advances as well as investment in shares, bonds, debentures etc. are classified as Non-Banking Financial Companies (NBFCs). The Reserve Bank of India has the power to regulate the said companies. ‘Financial activity’ is a wide term and encompasses a variety of business activities like loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities of a like nature, leasing, hire-purchase, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construction of immovable property.
RBI has further classified companies based on the principal business activity they carry out. There are certain financial companies whose principal business activity is acquiring securities. Such companies have been classified as Investment Companies. These companies however, have to be compulsorily registered with the RBI and comply with complex and cumbersome regulations and norms due to their exposure and ability to raise funds from the public as well.
As businesses evolved, the structure of companies became more and more complex. Several companies in the same group have become common. As there are multiple companies in one group, the ownership of all is given to one company. Such companies are incorporated only for the purpose of holding the shares of all other companies in the group and not for purposes of trading. Although these companies were investment companies by its definition and were classified under NBFCs, it was recognised that such companies have limited exposure as they do not perform any trading activities or any other financial activity. Hence, it was decided to give these companies a differential treatment for the above mentioned reasons.
Accordingly, RBI came up with a separate framework for such companies in 2011 and classified them as Core Investment Companies (CICs). The RBI notification defined CIC as a company where:
● not less than 90% of its assets are investments in shares, debt, loans in group companies for the purpose of holding stake in the investee companies
● At least 60% of its net assets is in the form of equity in group companies
● Not trading in these shares, except for block sale for purposes of diluting or divesting holding.
● It is not carrying on any other financial activities
● It is not holding / accepting public deposits
Scope And Objective
While investment is usually seen only as a financial activity, CICs invest in other companies only for the purposes of holding the ownership stake of that company. As business models have evolved and become more complex, the role of CICs has also evolved.
The author through this article aims to discuss the systemic importance, implications and risks posed by CICs in a group. It also aims to discuss how the structure of group companies has evolved which has further led to changes in the role of CICs. The article discusses the regulatory framework established by the RBI and how it has changed from when it was first introduced in 2010 as part of RBI’s annual policy. The article analyses all the changes brought to the regulatory framework and their implications thereof. It further analyses the loopholes and issues in the current system and what changes are required.
Need for Core Investment Companies
There are various commercial reasons which led to corporates opting to incorporate a separate holding company for the purposes of holding the shares of other companies of the group. A single holding company becomes a separate legal entity which has in it the concentrated ownership of other companies in the group. This led to ease in controlling assets and mitigating risks. Succession planning of huge groups also became more manageable. The most significant benefit a CIC has is that by investing in a group company it provides leverage to that company as the group can further borrow funds on the investment made by the CIC in its capital. Further, if a subsidiary or group company goes bankrupt the CIC cannot be held liable for those losses. Hence, a lot of big corporate groups such as Reliance, Larsen and Toubro, GMR etc. have CICs holding the stake of all the group companies.
Need For Regulations
The Infrastructure Leasing and Financial Services (IL&FS)company faced a debacle in 2018 which has proved that CICs can have a great impact on financial stability of the whole group. IL&FS, a core investment company in a group of 40 companies had several cross holdings in the group. The balance sheet did not show the actual state of affairs due to the leveraging and the company got crushed under heavy debt. The debt-equity ratio of the company at one point stood at 18:7.
The structures of businesses have only gotten more complex. Certain groups have various vertical chains of different businesses and each vertical chain has its own CIC. The situation becomes more complex in case of mixed conglomerates. Therefore, regulation of CICs in a group becomes necessary.
As mentioned earlier, CICs were previously considered only as investment companies which were solely incorporated for the purpose of holding stakes in the other group companies and not for trading. However, it was later observed that more often these shares were sold or more shares were purchased, for varied reasons. To clear the position, in 2010 RBI for the first time mentioned CIC as a separate category of company having assets of ₹ 100 crore and above, which would be investing with the sole purpose of holding stakes in group concerns and not trading. The CICs were not allowed to receive bank funding in the form of loans and advances for on-lending to group entities. Banks, however, were not disallowed from investing in Commercial Papers (CPs) and Non-Convertible Debentures (NCDs) floated by the CICs.
It was understood that the exposure of a CIC would be limited to its group companies and therefore, its risk would also be limited. In light of this, a “Light Touch” regulation was brought in 2011 which classified CIC as a separate category under the NBFCs. Therein, CIC was defined as a non-banking financial company carrying on the business of acquisition of shares and securities and where not less than 90% of its assets are in investments in shares, debt, loans in group companies for the purpose of holding stake in the investee companies, at least 60% of its net assets is in the form of equity in group companies.; it is not trading in these shares, except for purposes of diluting or divesting holding and it is not carrying on any other financial activities. This regulation provided some exemptions to CICs as their structure and purpose would not allow them to comply with all the traditional compliances of an NBFC. The CICs were given certain relaxations with respect to registration, annual net worth and net owned funds. For the first time, group companies were properly defined. The regulation expanded the scope of the definition of group companies provided in the Companies Act, 1956.
1. Systemically Important CIC: A CIC that has asset size of more than 100 Crore Rupees and that accesses public funds has been termed as Systemically Important CIC. The regulations make registration of such CICs with RBI mandatory. It must be noted that in case of multiple CICs the aggregate asset size of all CICs is considered.
2. Principal Business: CICs are required to hold not less than 90% of their net assets in group companies and their investment in equity shares in group companies should not be less than 60% of their net assets (not for trading), but only for the purpose of holding stake on a long term basis. The net assets are defined as total assets excluding cash and bank balances, investment in money market instruments, money market mutual funds, advance payments of taxes and deferred tax payment.
CICs are prohibited to perform financial business activities, however, they are permitted to invest in bank deposits, money market instruments, government securities, and bonds or debentures issued by group companies. They are also allowed to give loans to group companies and issue guarantees on behalf of group companies.
3. Capital Requirement: Adjusted Net Worth of a CIC shall at no point of time be less than 30% of its aggregate risk weighted assets on balance sheet and risk adjusted value of off-balance sheet items as on the date of the last audited balance sheet as at the end of the financial year.
4. Leverage Ratio: Leverage ratio is the ratio of the debt of a company to its adjusted net worth. The leverage ratio of a CIC must not exceed 2.5:1 at any time.
5. Asset Classification: Every CIC shall, after taking into account the degree of well-defined credit weaknesses and extent of dependence on collateral security for realisation, classify its lease/hire purchase assets, loans and advances and any other forms of credit into Standard assets, sub-standard assets, doubtful assets and loss assets.
1. Asset Liability Mismatch: While the regulation on CIC provides the 90:60 principle regarding the asset side of the balance sheet, there is no regulated pattern for the liabilities. While the operational companies of a group have various sources of funds, CICs only have limited options to tap into. While the CIC invests on a long term basis, these long term investments are funded by short term borrowings. This leads to asset liability mismatch in the Balance Sheet.
2. Gearing of Leverage: A CIC can borrow 2.5 times of its adjusted net worth. It uses this borrowing to invest in other companies in the group. The investee company can make further borrowings leveraged on the amount invested in it by the CIC. Therefore, the same capital borrowed in the start can be invested further layer by layer causing multifold increase in the borrowing capacity of the group companies. Apart from getting capital from the multiple CICs in a group, the group companies also have other sources of funds like banks and the market. Thus keeping a track of the leverage ratio at group level becomes next to impossible.
3. Group Structure: CICs are usually part of complex groups of companies and are conglomerated with several companies. The groups further have different structure of company chains divided on the basis of line of business. There can be several CICs in the group. A parent CIC can have multiple step-down CICs that have cross-holdings. While there is a limit on the number of subsidiaries for NBFCs provided in the Companies Act, 2013, there is no such limit on the number of CICs. A large number of layers in the group can decrease transparency of operations.
4. Corporate Governance: The Corporate regime in India has the principles of good corporate governance at its heart. It aims at maintaining transparency and accountability. Public money is invested into companies and therefore, it is important that their interest is protected. Moreover, it aims at maintaining the financial stability of the market. While the Company Law regime in India as well as the regulatory framework laid down by the RBI provides for a lot of regulatory compliances for companies, CICs were mostly exempted from this framework keeping in mind their structure and their purpose.
Unlike NBFCs, which are required to constitute Committees of the Board like Audit Committee, Risk Management Committee, Nomination Committee and Asset Liability Management Committee etc., no such corporate governance standards are mandated for CICs. The same director could be part of boards of multiple companies in a group, including CICs. In a few cases, for instance, it has been observed that the CIC had lent funds to group companies at zero percent rate of interest with bullet repayment of 3-5 years and without any credit appraisal.
The concept of CICs was brought in to give official recognition to holding companies in a group and therefore have some sort of regulation for them. At the same time, it was a welcome move as it allowed consolidation of ownership of various group companies at one place without going through the hassles of facing the elaborate compliance regime faced by other companies. However, as business structures have become complex, multiple layers of CICs and cross-holdings have led to opacity of functions.
The multifold increase in ability to borrow just by an initial capital inflow at the top layer, poses excessive risk at the group level. While the regulatory framework for CICs was aimed at being an easier way for holding companies, however, since the beginning the industry has been unable to get a clear picture of the framework.
It has led to derogation of the corporate governance standards. The IL&FS debacle in 2018 is a proof of this. The CICs which are regulated by RBI are also only the ‘Systemically Important CICs’ which are mandatory to register. The criteria to be a ‘Systemically Important CIC’ are so narrow that a lot of other companies are left out of the purview of regulation.
The RBI in the aftermath of the IL&FS crisis constituted a Working Group to Review Regulatory and Supervisory Framework for CICs, on July 03, 2019. The WG has submitted its report on November 06, 2019. It is expected that RBI will incorporate the recommendations made by the Working Group and issue a revised framework. However, it still must be made sure that a balance between risk elimination and excessive regulation is maintained.
 RBI, NBFC FAQ’s. https://www.rbi.org.in/Scripts/FAQView.aspx?Id=92  RBI Circular no. DNBS (PD) CC.No. 206 /03.10.001/2010-11 dated January 5, 2011.  ET Online. IL&FS: The crisis that has India in panic mode, Oct 03, 2018, 11:37 AM IST. https://economictimes.indiatimes.com/industry/banking/finance/banking/everything-about-the-ilfs-crisis-that-has-india-in-panic-mode/articleshow/66026024.cms?from=mdr  RBI notification DNBS(PD)CC.No. 197/03.10.001/2010-11 dated August 12, 2010.  See Supra at note 2.  Section 372(11), Companies Act, 1956.  Section 45-IA, RBI Act, 1934. Notification No. DNBS.PD.221/CGM (US) 2011 dated January 5, 2011.  3.1.xvii, Master Direction - Core Investment Companies (Reserve Bank) Directions, 2016.  Notification No. DNBS.PD.221/CGM (US) 2011 dated January 5, 2011.  Regulation 9, CIC Master Direction, 2016.  Regulation16.1 , CIC Master Direction, 2016.  RBI, Report of the ‘Working Group on Core Investment Companies’, dated 06 Nov 2019 BIBLIOGRAPHY
Reserve Bank of India, FAQs, Core Investment Companies, 20 Dec. 2016, www.rbi.org.in/Scripts/FAQView.aspx?Id=92
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The Companies Act, 1956
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