A new lever for PE funds

Written by Punit Shah | Updated: Feb 18 2014, 09:45am hrs
In a significant move, RBI recently laid out a framework to identify an action plan for addressing the NPA issues in the financial system and for revitalising distressed assets. While, on one hand, these guidelines could be considered a warning about the magnitude of the NPA problem, on the other, this framework can be seen as significant change in the overall approach toward this issue.

The framework, effective from April 1, outlines a corrective action plan that will offer incentives for early identification of stressed assets by banks, timely revamp of accounts considered unviable, and prompt steps for recovery or sale of assets in the case of loans at the risk of turning bad.

Under this framework, lenders will need to carve out a special category of assets termed special mention accounts (SMAs) in which early signs of stress are visible and accounts within this category will be put under three sub-categories, based on the period of outstanding. The framework envisages formation of a joint lenders forum for early resolution of stress and it also lays down timelines within which the forum needs to arrive at a solution. There is also a provision under the new framework for independent evaluation of large-value restructuring. It is interesting to note that RBI has thought of some minute details as well in these recommendations. For example, the issue of priority in repayment for statutory dues against the rights of creditors has been a vexed issue. RBI proposes to discuss this with the government and try to fix a limit for the claims that can be made by such regulatory authorities.

One important aspect of this new development is that it now also covers NBFCs within its fold by requiring notified Systemically Important NBFCs and NBFC Factors to furnish information regarding credit information of their customers to the central repository to be created.

However, a very interesting facet of this whole framework is the recognition of private equity investors as part of the restructuring process. For the first time, the regulator seems to have officially recognised private equity as a separate class, although there is no formal definition for this class in the guidelines. The framework specifically lays down that private equity firms and large NBFCs will be allowed to participate in auctions of NPAs through explicit regulatory affirmation. Such firms would also be provided authority under the Sarfaesi Act on a selective basis. The framework highlights the fact that PE firms can be expected to not only bring in additional funds for restructuring but also bring in expertise for management of the troubled business. RBI has also mentioned that the biggest hurdle for buy-out investors, which is the restriction on leveraged buy-outs, would now be eased by permitting banks to lend to entities which acquire troubled companies. In the era of economic downturn, when several businesses are under huge stress, the need for large pool of funds in this important segment cannot be undermined. The buyout market in India is almost non-existent especially due to enabling regulatory framework. This is extremely significant move by RBI, as several PE funds were reluctant to set up asset financing business in India due to lack of effective protection to them in case of default by the Indian borrowers. Currently, it entails a long drawn litigation to enforce any security and recover dues. This move from RBI will certainly encourage the PE funds to pursue their strategy of participating in this significant market.

One would hope that the government would look at appropriately tweaking other regulations also to support this initiative. For example, the exchange control regulations would need amendment to permit leverage and permit acquisition of debt portfolios, the FDI/FPI sectoral caps in this activity need to be liberalised, the tax regime would need to be fine-tuned to permit continued set-off of losses of the troubled companies post such buy-outs, security enforcement laws would need support such transfers, etc. Nonetheless, this opens up a whole new vista for PE investors and is a welcome move on the part of the regulator. While one would need to wait and see how the regulatory framework is actually amended to permit this activity, this is quite a positive step and is likely to make investing in India attractive for investors.

The author is co-head of Tax, KPMG