They cannot, thus, be strictly classified as non-banking finance companies (NBFCs). Why? Any NBFC must fulfil the dual criteria of assets and income: its financial assets must be more than 50% of its total assets (netted off by intangible assets), and its income from financial assets has to be over 50% of gross income. A company which meets both the conditions is classified as an NBFC. The principal business criteria (PBC), used to identify a company as NBFC, was set by the RBI in April 1999.
Nonetheless, the central bank (in its master direction issued last month) has categorised these investment entities as Core Investment Companies (CICs)-thereby putting them in the same list with other holding companies.
And, herein lies the hurdle: a holding company, above a certain size, has to register as a CIC and follow a string of dos and don’ts which corporate groups do not want to be burdened with.
What’s their argument? A CIC is a special kind of NBFC having more than 90% of net assets (including debt and equity) in group companies and over 60% of net assets shares of group entities, Also, such an NBFC must refrain from trading in securities as all its investments are strategic in nature. So, corporates, confused by the RBI’s December directive, argue that while they breach the CIC asset threshold (of 90% exposure to group companies), their income composition does not make them NBFCs – and therefore they should not be required to register with RBI as CIC.
According to Moin Ladha, partner at the law firm Khaitan & Co, “A CIC is essentially a category of NBFC that primarily holds investments in group entities, subject to prescribed group exposure thresholds. Ordinarily, NBFC classification is linked to meeting the principal business test, which establishes that financial activity is the entity’s primary business. Against this backdrop, recent regulatory language suggesting that an entity could be treated as a CIC even without meeting the principal business test may benefit from further clarification, particularly since the CIC framework was originally intended to provide regulatory ease for entities investing solely within their group.” From a practical standpoint, this interpretation has implications for a number of holding companies within mid-sized corporate groups, said Ladha.
The regulatory challenge brings to the fore the manner in which corporate groups are structured. “Sometimes operating companies are unlisted and may not be declaring dividend, or the loans to them from the holding company may be at a very low interest bearing, resulting in the holding company not fulfilling the PBC with regard to the income test,” said Bhavesh Vora, director, Basilstone Consulting.
However, RBI is of the view that since these companies borrow from the public and have financial assets they should be registered as they may pose some risk to the system. A CIC with asset size over ₹100 crore and public borrowings are expected to meet a string of norms: independent directors, audit committee, risk management committee, minimum capital adequacy, leverage limits, income recognition, asset classification and provisioning norms, asset-liability mismatch management, and dividend payout limits.However, it’s also important to recognise transitional situations where an operating company may temporarily deploy surplus funds within group entities, such as following a divestment or during a restructuring, while intending to resume its core operating business, said Ladha, “Limited, well-defined flexibility for such cases would help align regulatory intent with commercial realities, without diluting the underlying framework,” he said.
The last few decades witnessed major restructuring in multiple business groups, with some opting for a single holding company while others preferring a layered structure with industry specific HoldCos under the main HoldCo. Thanks to consolidated borrowings posing a risk, a separate class of NBFC, known as Core Investment Company, was carved out to regulate such HoldCos.