China; The Rough Guide

The report of the committee on Banking Sector Reforms (1998) acknowledged that non-performing assets of large magnitudes are a major impediment to the healthy performance of the banking sector.

NPAs have an adverse effect on the return on assets of a bank. They erode current profits, inter alia, through provisioning requirements, result in reduced interest income and limit recycling of funds.

To address the problem of accumulated NPAs, the first and second Narasimham Committee, suggested the setting up of an asset reconstruction company.

Separate institutional arrangements for taking over problem loans or NPAs have played a key part in bank restructuring in different countries with varying degrees of success.

A recent example is that of China, where NPAs amounting to approximately Renminbi 1.4 trillion were transferred to asset management companies in the ‘99 and ‘00.

Pursuant to these reports and the TR Andhyarjuna Committee recommendations for a new law granting statutory powers directly to banks and financial institutions for possession and sale of security, the President of India promulgated the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Ordinance, 2002 ( the Ordinance).

In the interest of time, instead of passing separate legislations regulating securitisation transactions; granting statutory power of possession and sale of security to banks and FIs; and for the creation of asset reconstruction companies (ARCs), the government has bundled the provisions of the Creation and Enforcement of Security Interest by Banks and Financial Institutions Bill, 2002 and the Securitisation Bill 2001 into a single legislation.

Unlike the Securitisation Bill, which vested power with the Securities and Exchange Board of India (Sebi) to regulate entities acting as SPVs in securitisation transactions and matters connected to it, under the Ordinance, the Reserve Bank of India has been empowered to license and regulate securitisation companies (Scos) and ARCs.

However, the Ordinance does not preclude the applicability of the Sebi Act and the rules and regulations made under it to such Scos and ARCs.

Consequently, a Sco or an ARC, in addition to fulfilling the registration and capitalisation requirements under the Ordinance may also be governed by the Sebi regulations, such as, the Collective Investment Scheme Regulations.

This overlap between the regulatory authorities may result in conflict and consequential confusion as to who will regulate a particular aspect of a securitisation/reconstruction transaction.

The Ordinance defines a Sco and an ARC and requires registration with the RBI as a precondition for a Sco or an ARC to carry on business. The Ordinance also prescribes an owned fund requirement for the Scos and the ARCs, which is a minimum of Rs2 crore.

Typically, the SPV is a thinly capitalised vehicle, for holding assets in trust for investors. As there are sufficient credit enhancements already built in by sponsors, there is no need to capitalise the SPV.

Thus, the owned fund requirement is an additional burden on the Sco. It is also envisaged that the RBI will prescribe norms, inter alia ,for making provisions for bad and doubtful debts, which goes against the concept of an ARC, specially created for recovering NPAs.

Under the Ordinance, the sponsors of a Sco or an ARC cannot hold controlling interest in the Sco or ARC and therefore, have an onerous obligation to broad base the shareholding of the Sco or the ARC.

Since most of the funds in a SPV are raised in the form of the pass through or debt securities issued to investors, such broad basing requirement would be difficult to achieve.

The Securitisation Bill gave freedom as to the choice of entity, for the purpose of securitisation transaction. This allowed the parties to choose entities, which gave them operational and structuring flexibility.

For instance, tax pass-through treatment by way of a trust structure. Though an ARC or a Sco has been defined to be a company, the Ordinance envisages floating of schemes by the Sco and the ARC.

However, there is a lack of clarity as to whether it may be possible to interpose an AMC- trustee structure in case of a Sco/ARC and whether the benefits available to the Sco and the ARC relating to speedy enforcement and recovery of assets would be available in case of a trust-AMC structure.

There is an exemption from registration requirement of a security receipt under the Indian Registration Act, 1908, in certain cases.

The Ordinance creates another layer of red tapisim by setting up a separate central registry where all securitisation transactions have to be registered.

In addition to the above, the stamp duty implications arising out of transfer of assets from the originator to the Sco/ARC have not been addressed in the Ordinance.

Stamp duty being a state subject, would require initiatives from the respective state governments for making securitisation and asset reconstruction more feasible.

The Ordinance envisages only qualified institution investors (which include banks, FIs, asset management companies et al) to be investing in the `security receipts’ issued by the Sco or the ARC, excluding the participation of public in such transaction.

Such exclusion will result in the continued involvement of existing big-ticket players in the market, and there will be no penetration in the retail markets.

The Ordinance has a non-obstante deeming clause, which mandates dispute resolution by way of arbitration. At the same time, the Ordinance states that the provisions of the Ordinance are not in derogation to other laws, including the Recovery of Debts due to Banks and FI Act.

Under this Act, all cases where there is a debt to banks and Fis, it has to be specifically referred to the debt recovery tribunal. This creates confusion as to whether the dispute should be referred to arbitration or it should be filed in the debt recovery tribunal.

The Ordinance has given sweeping powers to banks and FIs, including Scos and ARCs, whereby a secured creditor has various options to enforce its security without the intervention of courts, thereby substantially reducing the time required for enforcement of security.

In addition to the right to sell , it also gives a secured lender the power to take over management control of a borrower company upon default, without intervention of courts.

The Ordinance comes as a boon for banks and FIs saddled with NPAs, but, it creates roadblocks for securitisation transaction by modifying the concepts of a traditional securitisation transaction.

It is also not clear as whether the government intends this Ordinance to only regulate securitisation and reconstruction transactions to be carried out by banks and FIs and whether there will be a separate legislation for regulating securitisation transaction conducted by companies other than banks and FIs