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RBI committee suggests ARCs be allowed as resolution applicants with AIFs
Photo Credit: Reuters

Asset Reconstruction Companies (ARCs) will now be allowed to participate as resolution applicants in the bankruptcy and insolvency process, a committee of Reserve Bank of India (RBI) has recommended.

In a report released on Tuesday, the committee said that ARCs can act as resolution applicants only in the role as security receipt (SR) trustees or through alternate investment funds (AIFs) promoted by them.

"In order to enhance ARCs’ ability to be a prime vehicle for resolution, they may be allowed to participate in IBC (Insolvency and Bankruptcy Code) as a Resolution Applicant either through their SR trust or through the AIF sponsored by them. This is subject to the condition that AUM (assets under management) by the ARC acquired through AIF and IBC should not together exceed the AUM acquired via SR issuance at any time," the report said.
 
It added, "In order to broaden the investor base of SRs, the list of eligible qualified buyers may be further expanded to include HNIs with minimum investment of Rs 1 crore, corporates (Net Worth: Rs 10 crore & above), NBFCs/ HFCs which are not yet notified as FIs, trusts, family offices, pension funds, distressed asset funds with the condition that (a) defaulting promoters should not be gaining access to secured assets through SRs and (b) corporates cannot invest in SRs issued by ARCs which are related parties as per SEBI definition."

Several players such as Aditya Birla ARC, SSG-backed ACRE, Blackstone-backed IARC are already investing through this route.

An ARC acquires stressed or non-performing assets (NPAs) from banks and financial institutions at a discounted price against cash and security receipts (SRs). The ARCs help turnaround the assets for a management fee and the banks can then redeem the SRs at market value.

The Committee recommends that SEBI may extend the exemption from open offer requirements, for invocation of pledge, to ARCs in line with by banks  or public financial institutions.

Further, SEBI may also modify the explanation of ‘lenders’ to include ARCs.

It also recommended that the Government of India may look into the matters of tax provision where The concessional tax regime of 5% existing for taxability of income arising to FPIs and other non-residents (on Government securities, corporate bonds, ECB, etc.), may be also provided for interest income earned by FPIs from investment in SRs.

Also, it may be clarified that any upside arising as business income may be taxed at the rate of 20%, RBI said.

Other key recommendations are mentioned below in the report.

Under the chairmanship of former RBI Executive Director Sudarshan Sen, in April this year, the central bank has set up a six-member committee to review the working and business models of ARCs. https://www.vccircle.com/central-bank-sets-up-committee-to-review-arcs-role/

Since then, the Committee has submitted its report and the same is being placed on the RBI website for comments of stakeholders and members of the public by December 15.

The committee was set up against the backdrop of the government-backed National Asset Reconstruction Company Ltd (NARCL) which will purchase large stressed assets of Rs 500 crore and above.

It also came after the resolution of distressed assets under the Insolvency and Bankruptcy Code (IBC) hit a stumbling block in August 2020 with the central bank rejecting UV Asset Reconstruction Company Ltd’s bid to acquire Aircel Ltd’s assets.

The RBI had nixed the Delhi-based ARC’s resolution plan on the grounds that the SARFAESI Act doesn’t allow an ARC to acquire another company. SARFAESI is short for Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest. The 2002 law allows banks to auction defaulters’ assets to recover loans.

Some of the other recommendations are as below:

  1. RBI may suitably amend the participating conditions governing AIF and FPI (foreign portfolio investors) investment in SRs to create a level playing field.
  2. If an ARC sponsors an AIF, at least half the members of its Board should be independent directors
  3. For all transactions, minimum investment in SRs by an ARC, should be 15% of the lenders’ investment in SRs or 2.5% of the
  4. total SRs issued, whichever is higher. The minimum required investment may be held by the ARC only so long as it is a manager/ trustee of the underlying assets in any scheme. Any investment in excess of the required minimum may be divested at any time.
  5. In any acquisition of assets by ARCs from lenders, RBI may provide a dispensation to lenders on an ongoing basis for amortising the loss on sale of NPAs to ARCs, over a period of two years.
  6. Sale of fraud accounts to ARCs may be permitted subject to appropriate safeguards to ensure that fixing of accountability at lender level and criminal inquiry by competent authorities are not affected by this sale.
  7. In the interest of debt aggregation, ARCs may be allowed to also acquire stressed loans to domestic borrowers from regulated overseas banks and financial institutions
  8. Via a regulation, SLMA may provide lenders with a suitable comprehensive checklist on necessary information to be given to ARCs at pre-deal stage for due diligence and deal evaluation. Further, data room should be open for a minimum of 30 days after all information is furnished. (RBI, SLMA)
  9. the IBA may provide a model process document to lenders for ensuring certainty and transparency of auctions conducted by them. Also, for the purpose of ensuring transparency and uniformity of processes in sale of stressed assets, a separate online platform may be established. Infrastructure created by SLMA may be utilised for this purpose. (RBI, IBA, SLMA)
  10. In the bidding process followed by banks/ FIs, for all financial assets of Rs.500 crore and above, two bank-approved external valuers should carry out the valuation exercise of liquidation value and fair market value. For financial assets between Rs.100 crore to Rs.500 crore, one valuer may be engaged. The determination of the Reserve Price should be influenced by the external valuations. Further, the final approval of the Reserve Price should be given by a high-level committee that has the power to write off the loan.
  11. The scope of Section 5 of the Act, and other related provisions, may be expanded to allow ARCs to acquire ‘financial assets’ as defined in the Act, for the purpose
  12. of reconstruction, not only from banks and ‘financial institutions’ but also from such entities as may be notified by the Reserve Bank. Under these proposed powers, Reserve Bank may consider permitting ARCs to acquire financial assets from all regulated entities, including AIFs, FPIs, AMCs making investment on behalf of MFs, all NBFCs (including HFCs) irrespective of asset size and from retail investors (RBI and Govt)
  13. Further, when substantial investment in SRs (say 51% or more) is by investors other than the lenders, provisioning on SRs held by the lenders may be done based on net asset value declared by the ARC. The threshold of 51% may be applicable for two years and increased to 76% thereafter, it said.
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