With increasing levels of non-performing or stressed assets in the Indian financial services sector, reforming the debt recovery and bankruptcy framework has been a key focus area for the Indian government. Following the recent enactment of the Insolvency and Bankruptcy Code, 2016 (Bankruptcy Code), the Indian parliament has now passed the Enforcement of Security Interests and Recovery of Debt Laws and Miscellaneous Provisions (Amendment) Act, 2016 to improve the efficacy of Indian debt recovery laws.
The amendment act introduces a number of changes to the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interests Act, 2002 (SARFAESI Act) and the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (DRT Act). These changes will however come into effect as and when the government issues appropriate notifications in the Official Gazette to implement the relevant provisions of the amendment.
Changes to the ARC Framework
- Ownership and Control of ARCs:
Till now, ownership and control of an asset reconstruction company (ARC) had to be diversified and no sponsor could hold a controlling interest (more than 49%) in an ARC or appoint a majority of its board of directors. These restrictions have been removed and sponsors are now allowed to hold up to 100% equity in an ARC as well as exercise majority control over its board. Correspondingly, the Reserve Bank of India (RBI) has also been given greater powers of oversight over an ARC’s operations including, the right to appoint RBI officers as observers to the board of directors of an ARC and if required, change/ replace its directors.
- Eligible Purchasers of Security Receipts:
Until now, only ‘qualified institution buyers’ (i.e. banks, financial institutions, insurance companies, state finance corporations, mutual funds and foreign portfolio investors) were permitted to purchase security receipts issued by ARCs. With the amendment, the scope of eligible investors has been widened to include non-institutional investors as identified by RBI from time to time.
With non-performing assets (NPAs) and stressed assets of Indian banks exceeding INR 8 trillion (approx. USD 125 billion), these changes to the ARC framework could help remove distressed assets from the balance sheets of Indian banks by developing a robust secondary market for distressed debt in India. Removal of the sponsor ownership restrictions could incentivize more players to set up ARCs and allow existing ARCs to raise necessary capital to expand their portfolios. Further, the widening of the investor base for security receipts may possibly generate more interest in these instruments and allow banks to off-load their NPAs on an arms’ length basis, as opposed to self-funding securitization transactions to restructure their exposure.
Wider group of SARFAESI Eligible Lenders
Until recently, the benefits under the SARFAESI Act and the DRT Act were available to a limited group of lenders – i.e. scheduled commercial banks, International Finance Corporation, Asian Development Bank and identified Housing Finance Companies. The government has made two significant additions to this group:
NBFCs: On 5 August, 2016, the Ministry of Finance has specifically notified and named those non-banking financial companies (NBFCs) with an asset size of more than Rs. 500 crores, as SARFAESI eligible lenders.
Listed Debt Securities: The benefits of the SARFAESI Act and the DRT Act have been extended to the listed bond market in India. Debenture trustees appointed in respect of debt securities listed in accordance with applicable SEBI regulations have been specifically included as ‘secured creditors’ under the SARFAESI Act, and corresponding changes have been made to various provisions of both the SARFAESI Act and the DRT Act. These changes potentially allow lenders that do not independently have rights under the SARFAESI Act or the DRT Act (such as domestic funds, mutual funds, insurance companies, foreign portfolio investors and other investors in the corporate debt market) to benefit from such rights when acting through a debenture trustee in respect of listed bonds.
Central Registry for Security Interests
Once the amendments are notified, all secured creditors (including creditors who do not have enforcement privileges under the SARFAESI Act) will be required to register their security interests with the Central Registry of Securitization Asset Reconstruction and Security Interests of India (Central Registry). This will facilitate implementation of the Bankruptcy Code and will increase overall transparency in respect of security interests over a debtor’s assets.
Increasing efficacy of SARFAESI and DRT Proceedings
While the SARFAESI Act and DRT Act are intended to expedite recovery of secured debt, there have been various procedural issues which have limited the efficacy of these legislations. Accordingly, various modifications have been made to both the legislations to deal with this problem.
For instance, timelines for various steps in the adjudication process before the debt recovery tribunals such as filing of written statements, passing of orders, appeals, etc. have been reduced; and the cost on a borrower to delay recovery timelines through protracted appeals and proceedings has been increased. Borrowers will now be required to deposit at least 25% of the outstanding amounts with the debt recovery appellate tribunal (DRAT) under the DRT Act to prefer an appeal. Previously, (a) this floor of 25% on the deposit obligation applied only to appeals made under the SARFAESI Act, and (b) borrowers could request the DRAT for a waiver of the entire deposit obligation under the DRT Act.
The amendments are perhaps the most significant set of changes to the SARFAESI Act since its enactment in 2002. The Bankruptcy Code and the amendments to the SARFAESI Act together reflect a clear legislative intent to shift the needle in a distressed situation towards the creditors by plugging various loopholes available to borrowers.
We believe that the inclusion of listed bonds within the SARFAESI Act could significantly deepen the listed debt market in India by generating interest from a wider variety of investors – including retail investors, insurance companies, domestic funds and foreign portfolio investors. If sufficient liquidity is generated in the market, traditional lenders could also explore subscribing to listed debt in light of the simpler process and cheaper transaction costs associated with a transfer of these instruments.
While the amendments are a welcome move, they fall short of creating a level playing field for all participants in the Indian debt market. The entire external commercial borrowing (ECB) framework, which is comparatively more regulated than the listed bond framework, continues to remain outside the scope of the SARFAESI Act. In an environment where foreign companies, individuals and retail investors holding listed bonds would ultimately benefit from the self-help remedies under SARFAESI Act, it is unclear why regulated foreign banks, bilateral or multilateral financial institutions and other eligible ECB lenders should have to resort to traditional court-proceedings to recover their dues.