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Loan Restructuring: ‘Stress’ing On Coordinated Resolutions

The current loan restructuring mechanism is subject to selective application and piecemeal solutions, writes Abizer Diwanji.

The shadow of pedestrians are seen on the ground of a crosswalk. (Photographer: Brent Lewin/Bloomberg)
The shadow of pedestrians are seen on the ground of a crosswalk. (Photographer: Brent Lewin/Bloomberg)

India’s financial system is currently facing the resolution of an estimated Rs 16 lakh crore of stressed assets. Time is of the essence and yet the resolutions are few and far between. This despite pressure from both ends – a June circular from the Reserve Bank of India that lays down a resolution framework and an effective Insolvency and Bankruptcy Code, 2016, that serves as a real and effective threat or deterrent for those assets that fail to find a solution.

The problems, as this piece details, are three.

Banks Are The Only Holders Of Debt, A Myth

All of RBI’s stressed asset resolution regulations so far, be it the Strategic Debt Restructuring, Scheme for Sustainable Structuring of Stressed Assets, the Feb. 12, 2018, circular or the June 7, 2019, circular, are in response to the stress in the banking and non-banking finance sector that it regulates.

But all debt doesn’t fall in the banking regulator’s jurisdiction.

A look at many of the largest stressed asset cases makes clear that the companies have borrowed from banks and non-banking financial companies, both of which are regulated by RBI, but also from mutual funds via bonds and loans against shares, and life insurance or pension funds via bonds or other debt instruments.

And yet, none of the other regulators, Securities and Exchange Board of India in the case of MFs or Insurance Regulatory and Development Authority of India and Pension Fund Regulatory and Development Authority for insurance and pension have issued similar resolution guidelines. Recently, SEBI and IRDAI allowed MFs and insurance companies to participate in the signing of inter-creditor agreements under the RBI regulations. But as the participation is voluntary, and in the absence of overarching guidelines that apply to all classes of creditors, the RBI’s June 7 circular is subject to selective application and piecemeal solutions.

Also, each of these lenders have peculiar issues, separate from the concerns of banks or NBFCs. For instance, MFs face immediate liquidity concerns (due to redemptions or scheme closures) which are more important than just mark to market revaluations of the loan portfolio. For insurance and pension companies, mandated to hold paper rated AA and above, a sudden drop in rating poses difficulty in an illiquid and shallow corporate bond market.

It’s clear that the issuance of listed bonds and their restructuring consequences need to be thought through and appropriate dispensations built into the guidelines to enable clarity and hence timely resolutions.
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June 7 RBI Circular And Its Effectiveness For Timely And Collective Resolution

Even on those institutions that the RBI’s June 7 circular does apply, there are gaps that afflict the process.

Due to the legal challenge its predecessor faced, this circular does not mandate a lender to admit the asset to insolvency if the resolution is not achieved within the stipulated 210 days - 30 days to reach a path and 180 days of execution. Instead, it mandates punitive provisioning if a restructuring fails.

The circular requires that financial institutions agree to a restructuring by signing an ICA within 30 days and then evolve a plan. Amongst other things, the ICA requires that its signatories cannot invoke IBC if they sign.

There is also a process of an oversight committee, a forensic review and a valuation (both fair value and liquidation value) apart from a minimum investment grade rating of the proposed plan.

Thereafter, 75 percent by value and 60 percent by number need to approve the plan. Dissenting lenders will get liquidation value upfront.

While many of the features are similar to IBC, there is no real negative if institutions fail to sign an ICA or don’t sign it within time – except for the additional provisioning. This takes away some of the time urgency.

To improve compliance with the ICA, RBI should require lenders to put those assets not resolved under the circular on every lender’s assets-for-sale list as defined in its Sept. 1, 2016 circular. With an amendment that should a bid be received, the asset must be sold via a Swiss auction process. This would make it more imperative for lenders to sign the ICA.

Also, as explained, the circular only applies to entities governed by the RBI and does not cover lenders other than those regulated by the RBI.

Accordingly, the ICA timelines, as well as SEBI-related issues like conversion price to equity which is at the lower of book value or market averages, do not apply to entities not covered by RBI. This too has created issues of parity, especially where similar instruments are held by say a bank, a mutual fund, and an insurance company.

To provide parity, other equalisation methods, such as differential interest rates are adopted, which only make a restructuring more complicated.

For example, as per the June 7 circular, RBI-regulated entities are allocated equity based on the lower of book value, two-weeks average or two- months average, whilst others are issued equity at the higher of the two- weeks or two-months average. Further, the RBI controlled entities are exempt from an open offer process while other lenders are not.

The Great Cultural Divide

Running parallel with the lack of a uniform lender resolution architecture is the lack of a uniform stakeholder approach. A much needed ‘paradigm shift’ in the minds of the stakeholders is yet to happen.

The number of insolvency resolution professionals grew at a fast pace but their individual capacity to take on inter-personal issues, deal with hostile situations, maintain integrity and run insolvent companies in difficult situations has not yet gained the confidence of other stakeholders.

Creditors themselves, empowered with appointing RPs, also did not have much exposure in dealing with stress asset resolution and hence are unable to fully contribute to positioning companies for a change in control.

Prospective investors, though sophisticated, are yet to fully understand the Indian financial and legal dynamic and hence struggle to accumulate, structure and close distressed deals.

Courts, inexperienced and faced with a sudden flood of cases, have faced innumerable challenges ranging from multiple overlapping litigation to interpreting law in its infancy.

Owner-managers of the corporate debtor too, are yet to fully come to terms with the IBC or RBI’s regulations, resulting in endless litigation in order to maintain the status quo.

Dealing with stressed assets and insolvencies requires deeper stakeholder capacity to ensure sustained success.

Conclusion

In conclusion, I would reiterate that while substantial progress has been made with the introduction of IBC, and there has been an imminent change in promoter behaviour towards repayments, the alternative mechanism for resolution should be developed and guided well by regulation and capacity building to enable the lender community to settle debts outside of an IBC process. This way, the threat of IBC would remain real and there would be alternative revival options available to the lenders. Investors too would find better and timely deals enabling the much-needed flow of capital to revive distressed assets.

Abizer Diwanji, Partner and Head – Financial Services, EY India.

He is involved in several active restructurings as well as insolvency cases.

The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its Editorial team.