[Sanya Purohit and Kushal Agarwal are 4th year students at Hidayatullah National Law University, Raipur in the B.A., LL.B. (Hons.) course]
Six years after the Reserve Bank of India (‘RBI’) overhauled its Master Direction on External Commercial Borrowings, Trade Credits, and Structured Obligations (‘ECB Directions’) in 2019, the scope and application of end-use restrictions remain ambiguous, with no formal definitions provided. Although these restrictions are absolute in principle—specifying the uses for which the borrowed funds can and cannot be deployed— their application becomes complex in borderlinecases. A transaction that appears permissible may be prohibited because it constitutes the borrower’s core business activity, while another that seems restricted may be allowed if it is merely incidental to the borrower’s legitimate operations.
Among the various restrictions, the ECB Directions impose three primarily ‘universal end-use’ prohibitions that apply to all borrowers: (a) real estate activities, (b) investment in capital market, and (c) equity investment. While these restrictions are absolute, their application reflects nuanced regulatory practice that goes beyond literal interpretation. The challenge arises when transactions fall into grey areas, where the same activity may be permissible for one borrower but prohibited for another, depending on the character of their core business.
This post examines these restrictions and how regulators navigate such ambiguities by applying a ‘core business lens’, a principle interpreted through two informal guidance letters issued by the Securities and Exchange Board of India (‘SEBI’)that consider not just the transaction itself but the fundamental nature of the borrower’s business.
The Interpretive Lens: Core Business Activity
The foundational precedent arises from SEBI’s informal guidance to Puranik Buildcon Private Limited (‘Puranik’), a real estate company that issued listed non-convertible debentures (‘NCDs’) to foreign portfolio investors (‘FPI’). When regulatory changes permitted FPIs to invest in unlisted NCDs, Puranik sought informal guidance on delisting its NCDs and asked whether FPIs could hold such delisted debentures.
In response, SEBI opined that delisting was permissible, subject to the end-use restrictions. Crucially, SEBI did not scrutinize how Puranik would deploy the proceeds, but assumed that the proceeds will be utilized solely for the real estate business. Even though the funds could have been earmarked for any other permissible use, SEBI’s entity-based assessment led to a prohibitive outcome. Because Puranik’s core business aligns with a restricted end-use—i.e., real estate—SEBI applied increased scrutiny, effectively creating a presumption that any proceeds would ultimately be used for aprohibited purpose.
The Puranik precedent gets complemented by an equally significant SEBI’s informal guidance to Genpact India Private Limited (‘Genpact’), a provider of finance and accounting services. Genpact had issued listed NCDs to its Luxembourg-based group entity, a registered FPI. The proceeds from these NCDs were utilized for meeting funding requirements for day-to-day operations, downstream investment in acquiring shares of private companies of the Genpact group, and general corporate purposes. Similar to Puranik, when regulatory changes permitted FPIs to invest in unlisted NCDs,Genpact sought SEBI’s informal guidance on whether it could delist its existing NCDs, given that the proceeds had been used for downstream investment in private group companies.
Genpact argued that such downstream investments should not be considered as prohibited “investment in capital market”, because the investments were in shares of private and unlisted companies—not freely tradable in primary or secondary markets—and therefore did not constitute “capital funds” in the sense of publicly traded securities. Rather than engaging with the technical investment argument, SEBI opined that there was no violation of the end-use restrictions because Genpact was engaged in the business of providing finance and accounting services.
Together, the Puranik and Genpact precedents illustrate how regulators navigate the ‘universal end-use’ rules in ambiguous cases. While the negative list provides a baseline of absolute prohibitions, these guidance letters show that in grey areas, regulators apply a ‘core business lens’ to determine compliance. This lens evaluates whether the borrower’s fundamental operations support a legitimate, non-speculative use, as in Genpact, or warrant heightened scrutiny and a presumption of non-compliance, as in Puranik. It offers a robust analytical framework capable of cutting through the complexities of the three end-use prohibitions, providing clarity amid regulatory ambiguity.
Analysis of the Three Core End-Use Restrictions
Real Estate Activities
The ECB Directions define “real estate activities” broadly to include buying, selling, and renting property, as well as intermediary services. This definition is qualified by key carve-outs for productive asset creation, such as developing integrated townships, industrial parks, and projects under the Harmonized Master List of Infrastructure sub-sectors. This distinction separates prohibited speculative real estate trading from permissible, value-additive real estate development.
The Puranik precedent illustrates that, in ambiguous cases, regulators assess end-use compliance in relation to the borrower’s core business. Entities primarily engaged in real estate are presumed, by the nature of their operations, to ultimately invest in real estate transactions—prohibited end-uses—even if proceeds are earmarked for permissible purposes. In contrast, a manufacturing company acquiring land for a factory engages in permissible capital formation, as land is an incidental input to its core industrial business. For a real estate developer, the same activity is prohibited, as land acquisition forms the essence of its core business.
Investment in Capital Market
The ECB Directions do not formally define “capital market,” but its scope can be inferred from SEBI’s Frequently Asked Questions (‘FAQ’) and RBI orders. SEBI’s FAQ on Secondary Market Department defines ‘capital market’ in a broad manner as
“Capital market is a market for long-term debt and equity shares. In this market, the capital funds comprising of both equity and debt are issued and traded. This also includes private placement sources of debt and equity as well as organized markets like stock exchanges. Capital market can be further divided into primary and secondary markets”
This definition was adopted by SEBI in its informal guidance to Genpact.
This scope is further clarified by the RBI’s Order against Reliance Infrastructure Limited. When Reliance temporarily invested its ECB proceeds in domestic debt mutual funds, the RBI imposed a compounding fee of Rs. 125 crores. This order offered clarity in two aspects: first, investment in mutual funds, even debt-oriented schemes, constitutes capital market investment; and second, the restriction is absolute, disallowing any temporary deployment of funds in market instruments, even as a short-term treasury management strategy. The penalty imposed serves as a deterrent and a reaffirmation that ECB Funds cannot be used for the capital market, directly or indirectly.
Equity Investment
The ECB Directions do not define the term “equity investment” as well. Both Section 2(k) of Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 and RBI’s Master Direction on Foreign Investment in India define ‘equity instruments’ as “equity shares, convertible debentures, preference shares, and share warrants issued by an Indian company”. Furthermore, RBI’s FAQ on ECBs extends this prohibition to the purchase of goodwill and capital contributions to limited liability partnerships (‘LLPs’), with the aim to prevent circumvention through creative structuring, ensuring that foreign capital functions through its designated framework debt via ECB and equity via foreign direct investment (‘FDI’).
SEBI’s informal guidance to Genpact clarifies the practical scope. Genpact’s downstream investment in unlisted group companies initially appeared to fall under prohibited equity investment. However, SEBI did not consider it a violation because (i) the shares were private and unlisted, and (ii) the investment was an ordinary incident of Genpact’s business infinance and accounting services. This demonstrates that, in grey areas, regulators often analyze the broader business context rather than the transaction in isolation.
Concluding Thoughts
The ECB Directions reflect RBI’s intent to simplify compliance without compromising safeguards on the use of foreign borrowings. Yet, as the Puranik and Genpact precedents show, absolute textual prohibitions do not always produce absolute clarity. Regulators’ interpretive approach, centered on the borrower’s core business, provides a pragmatic framework for resolving ambiguities. This approach ensures that ECB funds are directed toward productive economic activity while preventing circumvention.
For corporates, the lesson is clear: compliance cannot rely solely on the form of a transaction. Borrowers should evaluate their business model carefully and, where cases are ambiguous, seek informal guidance from SEBI. India’s ECB regime continues to balance access to global capital with financial stability concerns, with interpretive guidance filling gaps in the legal text. It is therefore recommended that RBI or SEBI issue a clarifying circular reaffirming that end-use prohibitions apply universally to all ECB borrowers and that a borrower’s core business will be a primary factor in determining scrutiny and compliance interpretation in ambiguous cases.
– Sanya Purohit & Kushal Agarwal