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Business News/ Opinion / Online-views/  Real credit to India: Making insolvency reforms count
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Real credit to India: Making insolvency reforms count

Successful insolvency restructurings over this time will help establish localized templates for corporate rescue in India

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We have earlier argued that the supply of credit is vital to sustaining high growth in India, and further that current bankruptcy reforms—in turn essential in securing a steady supply—will prove inadequate.

Even as Prime Minister Narendra Modi and Reserve Bank of India (RBI) governor Raghuram Rajan reach into India’s future, the Bankruptcy Law Reform Committee’s (BLRC’s) effort remains preoccupied with the past. Its concomitant failure to prioritize—enumerating a laundry list of objectives, making piecemeal recommendations and deferring salient matters—is likely to create yet another bankruptcy regime doomed to fail.

While the battle is not lost, the ensuing phase will prove critical. With no shortage of defaulted corporate loans, India now faces a golden opportunity: it possesses a ready-made test-bed of insolvencies to work through. Their successful resolution can persuade prospective lenders of India’s intent, and its ability, to make a clean break with the past.

India thus needs to immediately reorient its reform effort, and expeditiously design and institute a unified bankruptcy regime—laws, tribunals, processes and their operative context—that will, finally, stand the test of time. For this, policymakers need to deploy a practitioner’s lens, prioritizing those fears and needs of credit investors that actually matter, and enabling an honest shot at new and workable templates for corporate rescue and debt recovery in India.

The touchstones that follow are simple—in the near term, attracting expertise and capital into several large Indian insolvencies; and, in the medium term, achieving successful restructurings so as to inspire confidence in India’s creditor jurisdiction and thus secure a steady supply of credit.

In sum, a pragmatic orientation is necessary for insolvency reforms to have a chance of success.

Responding to investor fears

Lenders are fearful of India’s corporate credit jurisdiction, albeit strongly attracted by its strategic promise. As policymakers design the new insolvency regime, a conscious focus on three important elements of the context may help in persuading investors to take a chance on an unproven new regime.

Firstly, lenders have a morbid fear of poor recoveries and delays based on India’s record. Even after the inordinate delays in its courts, secured lenders have historically recovered a mere 25% of their loans in Indian insolvencies under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI Act). This compares with approximately 70% in high-income Organisation for Economic Co-operation and Development nations, and 36%, 43% and 68% in China, Russia and Mexico, respectively.

Secondly, investors are concerned about the lack of bankruptcy expertise in, and the worrisome insolvency adjudication record of the Indian system. As Professor Kristen van Zwieten of Oxford University correctly observes, “The functionality of the new law will be heavily influenced by early decisions" of the new, and existing, courts. In the best of circumstances, India’s new insolvency adjudication forums will need time to gain credibility with investors.

Finally, investors find the prevalent attitude towards creditors, especially unsecured lenders, somewhat dismissive. This jibes with the virtual absence of a corporate bond market in India, and jars relative to the nation’s financing needs. The dissonance is also evident in BLRC’s report. An example is the proposed amendment of the Companies Act, instituting a 25% threshold for unsecured creditors to initiate rescue proceedings.

This may be valid for the approval of a scheme of rehabilitation from which the threshold is borrowed, and where it is applied in addition to a 75% threshold for secured creditors. However, applying it independently for the initiation of rescue proceedings is not logical, and will be a deal-breaker for most unsecured investors.

Delivering on core investor needs

Indian insolvency restructuring exercises in the near future will be the first real world test of the new corporate credit jurisdiction, and will have far-reaching consequences. Four important considerations must guide the design of the new insolvency regime that will significantly determine these outcomes.

First, given the relative lack of insolvency expertise in the system, a strong reliance must be placed on market-driven processes, especially for valuation and other similar matters.

Second, the power of the courts should be clearly defined and delimited, and their decisions time-bound. Vague laws, or ones that leave wide latitude to the courts before they have a chance to establish their insolvency credentials, will simply deter investment.

Third, all legal proceedings related to a particular insolvency must be effectively subsumed into an insolvency court, eliminating interference from competing legal forums.

Finally, BLRC must more carefully evaluate the practical consequences of its choices, and consult leading bankruptcy counsel from common law jurisdictions—especially the UK, the US and Australia, which have rich and easily applicable experience—to appropriately adapt suitable statutes and mechanisms.

Improvements in transfers

Policymakers will finally need to ensure substantive improvements in the transfer of distressed loans and assets. A few measures will reassure investors that they have a fair chance of attempting restructurings with the requisite control, and without undue distraction.

First, distressed loans or assets must be sold in wide, relatively transparent auctions. RBI has taken intelligent steps to incentivize banks to sell early. Additionally, any reasonable buyer should be welcomed. For large corporate loans, RBI should also mandate and monitor a high standard of disclosure, ideally on a standard global platform such as Intralinks, based on international market practice.

Second, transfers must be for real consideration, and for a substantial majority—think 75%, not 15%—of the purchase price. RBI increased the monetary component from 5% to 15% last year, initiating a shift away from the norm of “window-dressing" or nominal transfers. A further change is necessary to properly cure the mispricing of loan sales, and other related ills.

Third, in order to expedite and streamline transfers, all lenders should be required to transfer their loans to a buyer if a simple majority of lenders agree on a transfer price.

Finally, regulations and mechanisms—one set, and all at one time—must be put in place immediately to ensure that such transfers are fast, and unencumbered.

A cornerstone of India’s future

The ill-effects of a poor insolvency regime are widespread, even if they are not quite obvious. Finance minister Arun Jaitley told investors recently that “the next two-three years are going to be very critical" for reforms in land, labour and tax laws. The period is equally crucial for credit reform.

Successful insolvency restructurings over this time will help establish localized templates for corporate rescue in India. Even more importantly, they will inspire confidence in India’s new jurisdiction, channelling much needed credit for Indian enterprise. And some day, a domestic bond market may take root, providing cheaper credit to businesses, and an attractive investment avenue for India’s savers.

It is time for insolvency reforms that will count—so that Indian credit can finally come into its own, and feed the aspirations of an eager generation.

Anurag Das is managing partner of Rain Tree Capital, a Singapore-based investment manager specializing in Asia-Pacific credit, and distressed and special situations.

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Published: 04 Sep 2015, 12:44 AM IST
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