Why RBI Is Playing Gatekeeper On Resolution Plans From ARCs
The Reserve Bank of India remains unconvinced that asset reconstruction companies can act as resolution applicants as part of insolvency proceedings. The regulator, according to a person familiar with the matter, believes that several enabling conditions would need to be put in place before allowing ARCs to act as resolution applicants.
The view comes after several rounds of discussions between the regulator, ARCs and other stakeholders, which followed an attempt by UV ARC Ltd. to purchase 74% stake in Aircel Ltd. The deal, if it had gone through, would have made the ARC a promoter of a telecom company with over Rs 12,000 crore in debt.
The RBI first objected to the plan in August 2019. Despite that UV ARC went ahead with the resolution process and was named highest bidder by Aircel’s financial creditors. Later, on insistence from the National Company Law Tribunal, UV ARC again approached the RBI in June for approvals, when the regulator reiterated its stance.
The case has led to much discussion over the RBI’s stance. The RBI has received written representation from the ARC industry association, the Insolvency & Bankruptcy Board of India and the Ministry of Corporate Affairs to consider allowing ARCs to participate in insolvency proceedings as resolution applicants, according to the person quoted above. The regulator, however, remains unconvinced.
UV ARC declined to comment on the matter.
The SARFAESI View
ARCs as a set of companies came into existence in 2002, when the RBI allowed securitisation of bad debt owned by banks, under Section 3 of the Securities and Reconstruction of Financial Assets and Enforcement of Security Interest (Sarfaesi) Act.
As per the conditions laid down by the regulator, an ARC may only conduct the business of securitisation of bad debt and reconstruction of these assets.
Provisions under the SARFAESI Act are clear but the confusion arose because of Section 29A of the IBC.
That specifically excludes an ARC from the definition of a related party. If an entity is not a related party or have not been a defaulter for over a year, it can act as resolution applicant, a letter by the Association of ARCs In India, addressed to the RBI Governor on August 18 said. BloombergQuint has reviewed a copy of the letter.
But the RBI isn’t buying that argument. According to the person quoted above, the regulator believes that Section 29A merely exempts ARCs from certain disqualifications, but that does not equal a qualification for participation, this person said. According to the RBI, ARCs can participate in the resolution process as a financial creditor but not as a resolution applicant, the person said.
Abizer Diwanji, partner and head-financial services at EY says that the RBI is justified in its position.
“The RBI’s stance is that as the law stands today, ARCs cannot participate in the resolution process as sole bidders. The law clearly states that they can only accept equity in a stressed firm through conversion of debt and not through direct purchase,” said Diwanji. “Does the Sarfeasi Act need amendments? Of course. Especially since the resolution process has evolved so much in the last few years. But that is not the question here,” he added.
To be sure, in November 2017, the RBI had amended norms governing ARCs to allow certain reconstruction firms to hold more than 26% stake in a stressed company through conversion of debt. Such an exemption is only allowed for an ARC which has more than Rs 100 crore in net owned funds. Such an ARC must also have at least half of its board populated by independent directors. The shares acquired under this process should also be periodically marked to market, the RBI specified.
The guidelines, however, still do not permit a direct purchase of equity by the ARC.
Siby Antony, chairman, Association of ARCs in India believes that the RBI should seriously reconsider its stance.
“It is true that the current regulations do not allow an ARC to purchase equity in a stressed firm. The solution to that is to bring in suitable regulations to allow such purchases. IBC is meant for resolution of corporate stress and the aim of the code is in alignment with what ARCs do. Therefore the ARCs should be allowed to participate in the process of resolution,” Antony told BloombergQuint.
ARCs And Their Financial Position
While the regulator’s stance is based on the law, the financial position of ARCs is also a relevant factor in the debate.
According to information available in annual reports of large ARCs, most do not have an equity share capital of more than Rs 500 crore.
To purchase the equity of any large stressed firm, funds will have to be infused by the promoters of the concerned ARCs. If the stressed company requires additional equity infusions during the course of business, the ARCs might find it difficult to meet their needs, said the head of a large ARC, speaking on conditions of anonymity.
According to the senior ARC official quoted above, while the industry body has argued for the UV ARC proposal, not all are in favour. There is a view among the members that an ARC should continue to do what it was meant to do, aggregate debt and resolve stress, the official said. Becoming promoters of a specialised services company is not of any strategic interest to ARCs, the person said.
“One has to look at why the regulator is against letting ARCs purchase equity in these firms. The recovery track record of the ARC industry has been poor. Moreover they function on a very thin capital base. The model also does not penalise them if they do not achieve recovery. Without real skin in the game, you are just raising the moral hazard component,” said Ashvin Parekh, managing partner, Ashvin Parekh Advisory Services.
Satish Kumar Gupta, stressed assets professional and a long-term collaborator with ARCs, said that directly purchasing equity stakes is not the only option for ARCs or other long term investors to resolve stress in a corporate entity.
“To tap opportunities in various niches of stressed assets space, long term investors have multiple set-ups in their distressed asset platform such as AIF, ARC and NBFC that enable them to meet regulatory challenges faced,” Gupta said.
Queries sent to Edelweiss ARC, JM Financial ARC and Phoenix ARC on Friday remained unanswered.