Winds of change in the stressed asset market

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The stressed loan market in India is changing. The government, the RBI as well as the SEBI have triggered a series of reforms in what appears to be a well-coordinated strategy to deal with the NPA (non-performing assets) crisis. State intervention in the form of a new failed bank is complemented by broader structural reforms aimed at facilitating the development of a dynamic market for distressed assets.

North Block’s political mandarins deliberated on managing stressed assets at the Financial Stability and Development Board (FSDC) in early September. In mid-September, Cabinet approved the creation of the National Asset Reconstruction Company Ltd. (NARCL) to buy back nearly 2 lakh crore of postcode from the banking sector.

A week later, the RBI followed and liberalized its standards on the transfer of distressed loans. Banks, NBFCs and all Indian Financial Institutions (AIFIs) are now allowed to use the resolution process under the RBI Circular of June 7, 2019 to sell their stressed loans for cash directly to a new set of players , including companies as well as industry entities authorized to take such loan exposures by their respective regulatory authorities.

At the same time, SEBI Chairman Ajay Tyagi announced at a recent CII event that the regulator is considering a new sub-category of alternative investment funds (AIFs) to invest in distressed loans from banks and NBFCs. . This reform was originally suggested in 2019 by the RBI’s Business Loan Secondary Market Development Task Force. Given the larger context, this new category of AIF might be allowed to purchase NPAs directly from banks, NBFCs and cash AIFIs under the new RBI standards.

These reforms are indeed going in the right direction. They should help unlock the capital of banks and financial institutions, enabling them to extend new loans to spur post-pandemic economic recovery. To achieve this broader goal, policymakers should consider the following legal changes to complement these structural reforms.

Suggested changes

First, any financial entity authorized to purchase distressed loans from banks and financial institutions should also be granted enforcement rights under SARFAESI, which only identified banks and financial institutions traditionally enjoyed. Foreign portfolio investors who play a major role in financing the non-bank sectors in India by investing in unlisted securities should also benefit from similar access (access is currently restricted to listed securities). This legal privilege may be limited to financial investors and does not need to be extended to strategic investors who are otherwise eligible to purchase distressed debt under recent changes introduced by the RBI.

Second, SEBI should allow Category II AIFs to also invest in distressed loans from banks and financial institutions. Category II AIFs already enjoy pass-through status under the Income Tax Act 1961. In addition, they are already in use as debt funds and have the potential capacities required for debt funds. assets in difficulty. Given the nature of their establishment, they can offer healthy competition to existing participants in the stressed asset market.

Finally, the acquisition of control of a listed company by converting debt into shares by financial sector entities authorized under the new RBI guidelines should be exempted from the open offer obligation under the 2011 Takeover Code. Currently, acquisitions under SARFAESI as well as under RBI’s restructuring programs are exempt from these open bid requirements.

The same treatment should be extended to acquisitions by authorized financial sector entities under the new RBI standards. This measure would make it relatively easier for authorized financial sector entities to take control of a troubled, highly leveraged listed company, turn it around and then make a profitable exit by selling the business.

The government, RBI and SEBI are on track to reform India’s stressed asset market. Recent structural reforms coupled with reforms planned for RCAs as a sector, if complemented by the legal measures suggested above, could make the stressed asset market more attractive and lucrative for potential investors, including offshore investors, providing the best possible exit to banks and financial institutions. Dynamic change in this space is hopefully soon to be a reality.

Veena Sivaramakrishnan is a partner and Pratik Datta is a senior researcher at Shardul Amarchand Mangaldas & Co.


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