This article has been published by Mondaq at Reassessing QIBs: Need for SEBI Clarification for NBFCs – Fund Finance – India.

The Securities and Exchange Board of India (“SEBI”) plays a pivotal role in regulating India’s capital markets ensuring transparency, efficiency and investor protection. In the current regulatory regime where rules and regulations are continuously evolving, a minor ambiguity in a regulatory framework can hinder compliance and operational clarity. One such area of concern lies with the definition of Qualified Institutional Buyers (“QIBs”) under the SEBI (Issue and Capital Disclosure of Requirements) Regulations, 2018 (“SEBI ICDR Regulations”) updated in May, 2024. This article explores the need for SEBI to revisit and clarify the definition of QIB to the extent it concerns non-banking financial companies (“NBFCs”), to ensure consistency across SEBI and RBI regulations, while addressing stakeholder concerns.

A. Background

SEBI under various regulations, allows QIBs to participate in wide a range of capital market activities from public issues to private placements. QIBs are large, sophisticated and informed investors who are considered suitable for making investments in the capital markets and have expertise in evaluating investment opportunities and in managing risks and are a major source of funding for issuers seeking to raise funds.

B. Definition under SEBI Regulation

 QIBs are defined under regulation 2 (1) (ss) of the SEBI ICDR Regulations as follows:

“(ss) qualified institutional buyer” means:

• a mutual fund, venture capital fund, alternative investment fund and foreign
  venture capital investor registered with the Board;
• foreign portfolio investor other than individuals, corporate bodies and family
  offices;
• …

(xiii) systemically important non-banking financial companies.”  [Emphasis Supplied]

As seen from the above definition, ‘systemically important non-banking financial companies’ under paragraph (xiii) qualify as QIBs.

C. Erstwhile RBI Definition

The term “systemically important non-deposit taking non-banking financial company”, was earlier defined by the Reserve Bank of India (“RBI”) under the following erstwhile Master Directions i.e.

(a.)  the Non-Banking Financial Company–Non-Systemically Important Non-Deposit taking (Reserve Bank) Directions, 2016; and

(b.)  Non-Banking Financial Company–Systemically Important Non-Deposit taking Company and Deposit taking Company (Reserve Bank) Directions, 2016 (“Erstwhile RBI Directions”).

The definition under the Erstwhile RBI Directions is set out below:

“systemically important non-deposit taking non-banking financial company” means a non-banking financial company not accepting / holding public deposits and having total assets of ₹500 crore and above as shown in the last audited balance sheet.

D. Current RBI Definition / classification

The Erstwhile RBI Directions were superseded on October 19, 2023 by the Master Direction – Reserve Bank of India (Non-Banking Financial Company – Scale Based Regulation) Directions, 2023 (“SBR Directions”), which no longer refer to ‘systemically important’ NBFCs. The RBI vide the SBR Directions has classified NBFCs into four layers (i.e. Base Layer, Middle Layer, Upper Layer and Top Layer) and has removed the earlier classification of systemically important and non-systemically important NBFC. This categorisation is made on the basis of the risk exposure, size and the business of the NBFC:

(a). Base Layer (NBFC – BL): The Base Layer comprise of (a) non-deposit taking NBFCs below the asset size of INR 1,000 crore and (b) NBFCs undertaking the following activities – (i) NBFC-Peer to Peer Lending Platform (NBFC-P2P), (ii) NBFC-Account Aggregator (NBFC-AA), (iii) Non Operative Financial Holding Company (NOFHC) and (iv) NBFC not availing public funds and not having any customer interface.

(b). Middle Layer (NBFC – ML): The Middle Layer consist of (a) all deposit taking NBFCs (NBFCs-D), irrespective of asset size, (b) non-deposit taking NBFCs with asset size of INR 1,000 crore and above and (c) NBFCs undertaking the following activities (i) Standalone Primary Dealer (SPD), (ii) Infrastructure Debt Fund-Non-Banking Financial Company (IDF-NBFC), (iii) Core Investment Company (CIC), (iv) Housing Finance Company (HFC) and (v) Non-Banking Financial Company-Infrastructure Finance Company (NBFC-IFC).

(c). Upper Layer (NBFC – UL): The Upper Layer comprise of those NBFCs which are specifically identified by the RBI as warranting enhanced regulatory requirement based on a set of parameters and scoring methodology provided in the SBR Directions. The top ten eligible NBFCs in terms of their asset size shall always reside in the upper layer, irrespective of any other factor.

(d). Top Layer (NBFC – TL): The Top Layer is proposed to remain empty and will be populated if the RBI is of the opinion that there is a substantial increase in the potential systemic risk from specific NBFCs in the Upper Layer. Such NBFCs shall move to the Top Layer from the Upper Layer.

E. Repercussions of Reclassification

The SBR Directions under paragraph 2.7 state that, from October 01, 2022, all references to NBFC-ND (i.e., non-systemically important non-deposit taking NBFC) shall mean NBFC-BL and all references to NBFC-D (i.e., deposit taking NBFC) and NBFC-ND-SI (systemically important non-deposit taking NBFC) shall mean NBFC-ML or NBFC-UL, as the case may be. The footnote to Paragraph 2.7 further clarifies that existing NBFC-ND-SIs having asset size of INR 500 crore and above but below INR 1000 crore (except those that otherwise necessarily feature in the Middle Layer) will be classified as NBFC-BL. Therefore, the RBI has clarified that an existing systemically important NBFC may fall within its new classification as either (i) an NBFC-BL if its asset size is more than INR 500 crore but less than INR 1000 crore or (ii) an NBFC-ML if its asset size is more than INR 1000 crore.

The erstwhile references to ‘systemically important’ NBFCs can therefore no longer be easily identified merely by their current RBI categorization (i.e. NMBF-BL, NBFC-ML, etc.).

Under the RBI’s discussion paper dated January 22, 2021 in respect of the SBR Directions, titled ‘Discussion paper on revised regulatory framework for NBFCs – a scale based approach’, the RBI had noted that the threshold for systemic importance was INR 500 crore, which needed recalibration, taking into account increase in general price levels as well as increase in real GDP since 2014. Accordingly, the threshold was proposed to be revised to INR 1000 crore.

It is unclear whether the RBI retained this intent to increase the threshold for systemic importance when they finally notified the SBR Directions over two years later, i.e. in October 2023.

While basis the above reference in the Discussion Paper, one may take the view that the RBI now classifies all NBFC-BLs as non-systemically important, one cannot completely set aside the clarification in the SBR Directions that an existing systemically important NBFC having assets of more than INR 500 crore but less than INR 1000 crore would be classified as an NBFC-BL.

F. Need for SEBI Clarification – Harmonious Construction

From a SEBI standpoint, given that there is no longer any definition of a systemically important NBFC either under RBI or SEBI regulation, there is a need to amend the existing reference to systemically important NBFCs in the definition of QIBs at regulation 2 (1) (ss) (xiii) of the SEBI ICDR Regulations to provide clarity on NBFCs that would qualify as a QIB.

SEBI may consider either (i) replacing the current reference to NBFCs in the definition of QIBs with a reference to the new classification of NBFCs as per the SBR Directions (i.e. NBFC-ML, NBFC-UL, etc.) or (ii) clarifying that the reference to NBFCs in the definition of QIBs refers to all NBFCs having an asset size of INR 500 crore and above, irrespective of the RBI classification of such NBFC.

The former proposition to bring the SEBI definition in line with the new classification made by RBI, would, since restricted to only NBFCs qualifying as NBFC-ML and above, result in all NBFCs with an asset size between INR 500 crore to INR 1000 crore being no longer qualified as a QIB, as they would as per the RBI, be classified as NBFC-BLs. It would mean that such NBFC-BLs with an asset size of more than INR 500 crore would not be in a position to subscribe to further securities as a QIB.

In order to protect the QIB status of NBFCs that in the recent past, squarely met the criteria of systemic importance under the Erstwhile RBI Directions and to grant issuers access to a larger pool of funds within its regulatory regime, SEBI may instead prefer to opt for the latter proposition clarifying that all NBFCs meeting the 500 crore asset size criteria would continue to qualify as a QIB.

G. Conclusion

As markets in India continue to mature, it is imperative for the regulatory framework governing them to also evolve consistently across the board. SEBI’s clarification to the definition of QIB for NBFCs will not only resolve the existing ambiguity but also enhance regulatory coherence, aligning with SEBI’s ethos to promote the development of the securities market.