New framework for ARCs perhaps a missed opportunity

By Sawant Singh and Aditya Bhargava, Phoenix Legal

The April 2021 statement on developmental and regulatory policies of the Reserve Bank of India (RBI) noted the growth of asset reconstruction companies (ARCs), mentioning that “their potential for resolving stressed assets is yet to be realised fully”. The statement proposed establishing a committee to review the regulatory framework for ARCs and recommend suitable measures enabling ARCs “to meet the growing requirements of the financial sector”. On 11 October 2022, the RBI issued a revised regulatory framework for ARCs, introducing measures “to strengthen transparency in the ARC sector and to improve the corporate governance standards in ARCs”.

Sawant Singh, Phoenix Legal, Forex inflows need open doors not small windows
Sawant Singh
Phoenix Legal

Previously, ARCs were required to invest a minimum amount of 15% in each scheme of security receipts (SRs). The revised regulatory framework now requires ARCs to invest a minimum of 15% of a transferor’s investment in SRs or 2.5% of the total SRs issued, whichever is higher. To encourage broader participation, an offer document for SRs must also disclose a summary of the financial information of the ARC over the previous five years or since its commencement of business, whichever is shorter, the track record of returns generated by SRs issued in the previous eight years, and the record of recovery rating migration and engagement with credit rating agencies in the previous eight years. ARCs are required to obtain a recovery rating for SRs and must also disclose the rating and the rating rationale to the holders of the SRs. An ARC must retain a credit rating agency for a minimum period of six rating cycles of six months each.

The previous regulatory framework permitted ARCs to frame board-approved policies for the settlement of debts and to delegate powers to a committee or identified officers to decide on proposals. Now, proposals for the settlement of debt must be examined by an independent advisory committee (IAC) composed of professionals with technical, legal or finance backgrounds. The IAC will make recommendations to the board of directors of the ARC after considering factors such as the financial position of the borrower, the time frame for recovery, and projected earnings and cash flows. The board, which must include at least two independent directors, will consider the recommendations of the ARC and then decide on proposals for the settlement of debt. Settlement of debt must be considered only after all other options for recovery have been taken and there are no further prospects of recovery of such debts. The revised regulatory framework prescribes that management fees can only be charged from amounts recovered from the assets managed by the ARC. Further, the board-approved policy on fees must also set out a cap on management fees and incentives, any deviations from which will require the approval of the board.

Forex inflows need open doors not small windows
Aditya Bhargava
Phoenix Legal

ARCs are now allowed to participate as resolution applicants in a resolution process under the Insolvency and Bankruptcy Code, 2016. Reports in the public domain indicate that the RBI had previously been disinclined to permit ARCs to act as resolution applicants on the grounds that such activities were not contemplated under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. To participate as a resolution applicant, an ARC must have a minimum net owned fund of INR10 billion (USD121 million), and must also fulfil other requirements such as having a board-approved policy on participation as a resolution applicant and having a committee with a majority of independent directors to take decisions on participating as a resolution applicant.

While the move to allow ARCs to participate as resolution applicants has been welcomed in some circles, its full impact can only be evaluated over time. The revised regulatory framework does not touch on operational aspects such as the aggregation of debt, measures to encourage the participation of debt capital markets in SRs, enhancing the tradability of SRs and improving resolution-friendly steps such as changing the management of a borrower or providing a shield to protect ARCs from routine proceedings that can delay the resolution process. In the absence of a complete overhaul of the statutory framework, these RBI measures can only be seen as nudging things forward and not spearheading progress.

Sawant Singh and Aditya Bhargava are partners at Phoenix Legal. Sristi Yadav is a senior associate.

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