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ARCs must be allowed to acquire bad assets of mutual funds, AIFs

As of August, India’s burgeoning mutual fund sector boasted Assets under Management totaling  ₹46.94 trillion (Photo: AFP)
As of August, India’s burgeoning mutual fund sector boasted Assets under Management totaling 46.94 trillion (Photo: AFP)

Summary

  • India undeniably requires a robust secondary market for distressed debt. Both ARCs and regulatory bodies share the responsibility to boost this market's efficiency.

Indian Asset Reconstruction Companies, or ARCs, have had existential issues to combat over the past few years. Hopes of a thriving distressed assets market remain unmet, and the recent significant bad debt clearances by Indian banks means that their challenge of boosting business is now even more severe.

Perhaps that may have also prompted the industry body representing Indian ARCs to lobby the Reserve Bank of India (RBI) for authorization to buy assets from local mutual funds and alternative investment funds (AIFs). ARCs say that their acquisition of bad assets of mutual funds or AIFs will ensure swifter recovery besides providing an exit option to these investment vehicles. That may not be a bad idea. For one, the ticket size of some of the assets which have gone sour for mutual funds in debt oriented schemes may not be significant compared to the big boys in the industry such as banks or other investment institutions. And many fund houses may not have the capacity unlike banks to engage and deal directly with buyers of distressed debt on their portfolios.

As of August, India’s burgeoning mutual fund sector boasted Assets under Management (AUM) totalling 46.94 trillion. Within this, debt schemes account for just under a fifth of the industry's entire asset pool. This segment is primarily driven by institutional investors such as banks, who significantly invest in liquid, money market, and debt schemes, highlighting them as seasoned investors.

However, before allowing ARCs to acquire these assets from mutual funds, it would be wise for both financial regulators – the RBI and the Securities and Exchange Board of India (Sebi), which supervises mutual funds – to establish clear guidelines. This would ensure transparency in such acquisitions and set recovery benchmarks, akin to the protocols for bank bad loan acquisitions. The existing framework used by banks, which includes board approvals, could serve as a model here, placing the responsibility on the trustees of asset management companies to sanction such distressed asset purchases. This approach might pave the way for a fresh revenue stream for ARCs, reminiscent of their recent endorsement to function as Resolution Professionals or IRPs.

It is likely that ARC’s will resist any possible stiff norms for such entry having been restricted for long to buying out bad loans of only banks and other financial institutions. But the shadow of the income tax raids on a few ARCs which had colluded with borrower groups involving dummy firms and funding by some promoter groups and the subsequent special audit by the RBI would mean that regulators are likely to tread far more cautiously. That too with the RBI having tightened corporate governance norms and their capital adequacy framework a while ago effectively crimping their operational efficiency.

Opening up the buyout of bad assets of mutual funds may be welcome but more than that small slice of business or revenue stream, it is the business models of Indian ARCs which is being put to test. Over the last few years, banks have preferred negotiated settlements unhappy with the pricing of assets put up for auctions by ARCs who have to reckon with higher cost of funds and capital needs when lenders insist on cash sale. Banks on the other hand are unwilling to take steep hair cuts given the over reach by Indian agencies over the past few years. There is also the fresh challenge in the form of the bad bank - the National Asset Reconstruction Company, or NARCL, which has the backing of the sovereign which guarantees the security receipts issued by the latest buy out company in the business.

India certainly needs a thriving and deep secondary market for distressed debt. ARCs have as much stake as the regulators and the government in enhancing the efficiency of this market.

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