Close at the heels of the announcement made in the Union Budget in February 2016, the Government released Press Note 4 of 2016 dated 6 May 2016 (Press Note 4) liberalising foreign entry norms in asset reconstruction companies registered with the Reserve Bank of India (RBI) (ARCs) by allowing 100% foreign direct investment (FDI) under the automatic route in ARCs. It has also proposed amendments to bring the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) in sync with the dispensations provided under Press Note 4 by introducing the Enforcement of Security Interest and Recovery of Debt Laws and Miscellaneous Provisions (Amendment) Bill, 2016 (Proposed Amendment) in the Lower House of Parliament. In this note, we briefly analyse the changes brought out by Press Note 4 and the impact of the Proposed Amendment in liberalising the regime on foreign investment in ARCs.
Press Note 4 purports to amend the currently existing FDI regime in respect of ARCs as follows:
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Perhaps as a counterbalance to this liberalisation or as a result of the increased importance of ARCs in this day and age, the Proposed Amendment proposes greater RBI oversight on ARCs. Some key proposals include:
- RBI approval to be required for appointing any director on the board of directors of the ARC (in addition to the existing requirement where there is substantial change in management).
- RBI to be empowered to carry out periodic audits and inspection and take necessary action where it determines that the business of the ARC is being conducted in a manner detrimental to the interests of either investors or the public.
- Failure to comply with the directions of RBI can incur a financial liability of the higher of INR 1 Crore or twice the amount involved in such a failure (payable within 30 days of issue of notice to such effect by RBI).
With the current levels of distress, the importance of ARCs and their capital needs is well known. Despite the significantly high level of bad debts in the banking system the valuation mismatch between banks and ARCs has been holding-up the sale of non-performing loans to ARCs. Perhaps the greater capital flow arising out of Press Note 4 will help address this mismatch, at least to some extent.
It also remains to be seen whether RBI would completely remove the minimum investment requirement applicable to ARCs as that may result in a change in character of an ARC from a reconstruction company to an asset manager acting purely under the instructions of its investors.
Foreign investors and new sponsors, in weighing opportunities in the ARC sector, should consult their advisors on the corporate governance norms and greater RBI oversight. Learnings from other similarly regulated sectors like insurance would also be helpful.