RBI Registration

RBI Review of Regulatory Framework on Asset Reconstruction Company

An Asset Reconstruction Company is a financial institution that buys Non-performing Asset from financial institution and banks. In other words, the ARC buys bad assets from the banks so that the banks’ balance sheet does not show any long outstanding dues. This enables the banks to perform their other banking activities rather than putting effort into recovering bad assets. Henceforth, they play a pivotal role in reducing the number of bad assets from banks all over the country.

To provide a better framework for the functioning ARCs, the RBI issued a circular on “Review of Regulatory Framework for Asset Reconstruction Company” on 11^th October 2022 and suggested suitable measures, which are discussed below.

A. Corporate Governance

Governance Structure of Asset Reconstruction Company

The current framework has reviewed the framework for governance structure in the different categories, which is discussed below:

1. Chair and Meetings of the Board of Directors
2. Chair: Thechair shall be presided over by the independent director, and in his absence, the meetings shall be chaired by only the Independent director.
3. Quorum: The quorum of the meeting shall be 1/3^rd of the total strength of the board or 3 directors, whichever is higher.
4.  Number of Independent Directors: It is required that half the directors attending the meeting shall be Independent directors.
5. Tenure of Key Managerial Persons
6. Managing Director or CEO OR Whole-time director: The tenure of MD/CEO/WTD shall not be more than 5 years at a time, after which the individuals may be eligible for re-appointment.
7. Continuous Tenure: The post of MD/CEO/WTD shall not be held by an individual continuously for more than 15 years.
8. Re-appointment in the same ARC: After a period of continuously holding the post for 15 years, the individuals may be elected by the board after a gap of 3 years in the same Asset Reconstruction Company, provided that it is considered by the board necessary. However, during 3 years, it is required that the individual shall not associate himself with the ARC in any manner.
9. Age: The individuals cannot hold the post beyond the age of 70years. However, the Asset Reconstruction Company can prescribe lower age within the overall limit of 70 years.

• Performance Review

The performance of the MD/CEO/WTD shall be reviewed by the board annually.

Committees of the board

The board shall establish the following committees to strengthen the board’s oversight.

1. Audit Committee
2. Composition: The Asset reconstruction company shall establish an Audit Committee of the board, which shall be presided over by non-executive directors.
3. Meeting and Quorum: They shall meet at least once in every quarter with a quorum of 3 Members.
4. Audit Committee Chair: The audit committee shall be chaired by an Independent Director who will not chair any other board meeting.
5. Knowledge and Qualifications: The board member shall have the requisite knowledge to understand financial statements and possess professional expertise in financial accounting and financial management.
6. Powers: The powers and functions of the audit committee shall be the same as mentioned in Section 177 of the Companies Act 2013.
7. Periodical Assessment: The committee shall be responsible for periodically reviewing and assessing the internal control systems.
8. Nomination and Remuneration Committee

The Asset Reconstruction Company shall form a nomination and remuneration committee that shall possess the powers mentioned under Section 178 of Companies Act 2013.

Time period for compliance with the circular

The Asset Reconstruction companies are required to comply with the circular within 6 months from the date of the circular.

RBI’s Approval for Change in Shareholding

The Asset Reconstruction Companies must obtain approval from RBI if there is any change in shareholding due to the transfer of shares. Moreover, any change in the sponsors of Asset Reconstruction Company on account of a fresh issue of shares shall require prior approval from RBI.

Fit and Proper Criteria for Directors and CEO

The Asset Reconstruction Company shall take due diligence in determining the individual’s suitability for the position. The ARC shall base its judgement on the previous track record and other “fit and proper” criteria. The Asset Reconstruction Company shall obtain necessary information and declaration from the appointed or existing directors and MD/CEO so that nomination and remuneration committee can scrutinise the supplied information.

Further, the declaration of updated information shall be supplied by the directors on an annual basis. In case if there is a change in the information, then the said change shall be communicated to the Department of Regulation of RBI.

The directors must sign a covenant in the prescribed format at the time of joining ARC, which shall act as an agreement to perform their responsibilities.

Enhanced Disclosure

The following additional disclosures are required to be made by the Asset Reconstruction Companyin the offer document:

1. Summary of financial statement for the last 5 years or since the commencement of business of the ARC, whichever is shorter.
2. Records of returns generated from Security Receipts investors on schemes floated in the last 8 years.
3. Record of recovery rating migration and engagement with rating agency on the schemes floated in last 8 years.

Credit Rating Agencies and rating of Security receipts

The asset Reconstruction Company is required to gather recovery ratings of Security Receipts from Credit Rating Agencies for at least 6 rating cycles. In case if there is a change in the rating between these 6 cycles, the said change shall be disclosed by Asset Reconstruction Company along with proper reasoning.

B. Other Measures

Settlement of Dues under a one-time settlement

The guidelines have modified the framework for reconstructing financial assets through the settlement of dues. The Asset Reconstruction Companies shall be required to frame a policy approved by the board. Further, the process of settlement, as defined in the guidelines, is discussed below:

1. The settlement process shall be initiated only after the approval from the Independent Advisory Committee, which shall be presided over by a professional with sound knowledge in the finance, legal and technical fields.
2. The IAC shall, after assessing all the possibilities, including the time frame for recovery, projected earnings, and cash flow of the borrower, give its recommendations to the ARCs.
3. The recommendation shall be examined by the board of directors, which shall include at least 2 independent directors and decide the best option available for the settlement of dues from the borrower. The decision on the scheme shall be recorded in the minutes of the board meetings.

Moreover, the settlement amount shall be calculated as follows:

1. The Net present value of the settlement shall not be less than the Realisable value of securities. In case if there is a change in the valuation of securities and realisable value, then the reason for such change shall be recorded.
2. The amount shall be paid in lump sum.
3. If the borrower cannot pay in lump sum, then IAC shall evolve a plan about minimum payment from the lump sum amount and total period for repayment.

Further, the Asset Reconstruction Company shall ensure compliance under Section 29A of IBC 2016^[1] while dealing with prospective buyers as previous instructions given under para 2(B) of circular no. DNBS (PD) CC.No. 37/SCRC/26.03.001/2013-2014 shall stand withdrawn.

Policy on Management Fees

The circular has modified the policy on management fees and introduced new measures, which are:

1. The management fee or incentive shall be recovered from the recovery of underlying financial assets.
2. The policy approved by the board shall include the quantitative limit on management fees, and the deviation on it shall require prior approval.

Minimum Net Owned fund (NOF) Requirement

The circular has changed the minimum net-owned fund requirements for ARC. The NOF requirement is now increased to 300 crores from the current requirement of 100 crores. Additionally, the Asset Reconstruction Company that obtained the registration certificate after the issuance of this circular shall have a minimum NOF of 300 core.

Deployment of Surplus Funds in Short term Instruments

The current guidelines have allowed the Asset Reconstruction Companies to deploy their surplus funds in short-term instruments, namely:

1. Money Market Mutual Funds
2. Certificate of Deposits
3. Corporate Bonds
4. Commercial papers

However, the funds can be deployed subject to the following conditions:

1. The maximum investment in the instrument is  10% of the NOF
2. There shall be board approved policy for dealing in short-term instruments.

Investment in Security Receipt

The Asset Reconstruction Companies can invest in the Security Receipts under one scheme and till the redemption of all security receipts issued under such scheme at a minimum of:

1. 15% of the transferor’s investment in the Security Receipts or
2. 2.5% of the total Security Receipt, whichever is higher

Allowing ARCs to act as Resolution Applicants under IBC 2016

The present guidelines have now allowed the Asset Reconstruction Companies to act as the resolution applicant under IBC, provided that the Asset Reconstruction Companyis subject to the following conditions:

1. There shall be a minimum NOF of Rs 1000 core.
2. There shall be a board-approved policy for taking up the role of Resolution Applicant.
3. There shall be a committee composed of a majority of Independent Directors who are responsible for deciding on the proposal of the resolution plan.
4. The ARC can explore the possibility of preparing sector-specific individuals with expertise in running firms or companies and can be considered for managing the firms or companies.
5. There shall be no retention of any control over the corporate debtor after 5 years from the approval date of the resolution plan. Any non-compliance with this condition will lead to a ban on the submission of any fresh resolution plan.
6. There shall be additional disclosures in the financial statements ofthe assets acquired under IBC, namely, type and value of assets, sector-wise etc.
7. There shall be a quarterly disclosure in the financial statement on the implementation status of the approved resolution plan.

Transfer of Stressed loans to Asset Reconstruction Company

Any stressed loans declared as default in the transferor’s books can now be transferred to the Asset Reconstruction Companies.

Conclusion

The Asset reconstruction Companies play a significant role in reducing the financial burden on the banks by eliminating the risk of recovery from bad assets. Henceforth, the current guidelines are issued to enable Asset Reconstruction Companies to function transparently and efficiently. The current guidelines have also mandated that the director and the key managerial person shall disclose certain information and shall meet the “fit and proper” criteria. Further, allowing ARC to act as a resolution applicant will diversify their business activities and help them earn more income. Therefore, the ARC must comply with the current framework within 6 months from the circular date.

Read our Article: Key Updates:RBI Master circular on Asset Reconstruction Company