With the new government in place, the full budget for FY2024-25 is likely to be placed in parliament next month. This is therefore a good time to revisit some of the long pending reforms necessary for improving the financial sector. In a speech last month, RBI Deputy Governor M. Rajeshwar Rao emphasized that the thrust of RBI regulations going forward will be on developing a market for distressed assets. This has been long pending especially on account of direct participation for FPIs and other foreign distressed players in the Indian distressed debt space being limited by the regulatory framework.
While the IBC will remain a crucial pillar in this journey, the SARFAESI Act must also do some of the heavy lifting. Among the multiple channels through which banks resolve stressed assets, the SARFAESI Act has been the second most dominant mode of recovery after IBC. Yet, its share in total amount recovered fell from 30.5% in 2021-22 to 24.6% in 2022-23. To ensure its continued relevance, policymakers should consider expanding the user base of SARFAESI Act. Alternative Investment Funds (AIFs) and Mutual Funds (MFs) which are mainly active in the unlisted debt space, are currently not allowed to use the enforcement rights under the SARFAESI Act. This is in stark contrast to debenture trustees appointed for listed secured debt securities, banks and NBFCs, all of whom enjoy such enforcement rights. Most importantly, this legal position creates a wholly unjustified disparity in the enforcement mechanisms for unlisted bonds (held mainly by MFs and AIFs) as against listed bonds (through debenture trustees). Policymakers should be genuinely concerned about this issue. As of May 2024, MFs have deployed 14.03% of their total debt investments in corporate debt (excluding PSU bonds/debt). Similarly, Category I and II AIFs, which invest primarily in unlisted securities, have deployed 35.86% of their total investments in debt securities as on March 31, 2024.
Given such staggering amounts of investments in debt securities by MFs and AIFs, excluding them from the enforcement mechanism under SARFAESI Act seriously compromises the objective of investor protection. It also limits the utility of the SARFAESI Act by unnecessarily restricting its user base. Policymakers should urgently remedy this situation by simply adding AIFs and MFs to the definition of ‘financial institution’ in the SARFAESI Act. Another long pending issue for the financial sector has been the need for time-bound approvals. Way back in 2013, the Financial Sector Legislative Reforms Commission (FSLRC) had recommended that financial regulators should ensure that all applications are accepted or rejected within a specified time. In 2014, RBI had announced a list of indicative timelines for various regulatory approvals. If these timelines are made mandatory, it would boost private investment. To appreciate the practical challenges, consider a transaction involving change in control, ownership or management of a listed NBFC. This requires prior written permission from the RBI. As per RBI’s own indicative timelines, this should take 45 days. In practice, it takes longer and the clock resets with RBI queries. Change of control in a listed NBFC also triggers open offer requirements under SEBI’s Takeover Regulations.
If RBI’s approval gets unduly delayed, the price of the transaction goes up. This could significantly increase the cost of acquisition and impact the commercials of the deal itself. Such uncertainties are anathema not just for PE funds which have pre-defined investment cycles, but also for strategic investors where the time value of money is probably more critical. Mandatory time-bound regulatory approvals could help curb such uncertainties and boost investor confidence. Another aspect requiring immediate consideration is access to fresh financing for entities which have long come out of insolvency / stressed situations. The RBI regulatory framework remains silent on this, but in practice, lenders are wary of lending to entities / group with whom they have taken a haircut or exited the exposure by selling the loan to an ARC. This is also the reason why private credit is the buzz word and bank credit is decreasing. If the borrowing entity has come out of stress, it is imperative that they are judged on merits without any baggage and the market participants need to move way beyond the principle of ‘once a defaulter, always a red flag.’ Bank finance, which is most competitive in pricing, is a necessity for the corporates and hence this aspect also requires clarification from RBI. With the major insolvencies behind us and the need for credit being ever increasing, India is probably well positioned at present to implement these pathbreaking reforms. Views are personal. The authors are with Shardul Amarchand Mangaldas & Co.