RBI/2022-23/128
DoR.SIG.FIN.REC.75/26.03.001/2022-23

October 11, 2022

All Asset Reconstruction Companies

Dear Sir/ Madam,

Review of Regulatory Framework for Asset Reconstruction Companies (ARCs)

ARCs play a vital role in the management of distressed financial assets of banks and financial institutions. Considering their critical role, a need was felt to review their functioning and operating framework. Accordingly, as part of the Statement on Developmental and Regulatory Policies released along with the Monetary Policy Statement on April 7, 2021, the Reserve Bank of India had set up a Committee to undertake a comprehensive review of the working of ARCs and recommend suitable measures for enabling them to function in a more transparent and efficient manner.

2. Based on the Committee’s recommendations and feedback from the stakeholders, the extant regulatory framework for ARCs has been amended as detailed in the Annex.

3. These guidelines shall be effective immediately or as indicated otherwise in the Annex.

Yours faithfully,

(J.P. Sharma)
Chief General Manager

Annex

Section I: Corporate Governance Framework

With a view to strengthen transparency in the ARC sector and to improve the corporate governance standards in ARCs, the following measures are being introduced:

1. Measures to Enhance Governance of ARCs

(i) Chair and Meetings of the Board of Directors: The Chair of the Board shall be an independent director. In the absence of the Chair of the Board, meetings of the Board shall be chaired by an independent director. The quorum for the Board meetings shall be one-third of the total strength of the Board or three directors, whichever is higher. Further, at least half of the directors attending the meetings of the Board shall be independent directors.

(ii) Tenure of Managing Director (MD)/ Chief Executive Officer (CEO) and Whole -time Directors (WTDs): Tenure of MD/ CEO or WTD shall not be for a period of more than five years at a time and the individual shall be eligible for re-appointment. However, the post of the MD/ CEO or WTD shall not be held by the same incumbent for more than fifteen years continuously. Thereafter, the individual shall be eligible for re-appointment as MD/ CEO or WTD in the same ARC, if considered necessary and desirable by the Board, after a minimum gap of three years, subject to meeting other conditions. During this three-year cooling period, the individual shall not be appointed or associated with the ARC in any capacity, either directly or indirectly. The ARCs shall put in place appropriate measures to ensure succession planning.

(iii) Age of the MD/ CEO and WTDs: No person shall continue as MD/ CEO or WTD beyond the age of 70 years. Within the overall limit of 70 years, as part of their internal policy, ARCs’ Boards are free to prescribe a lower retirement age.

(iv) Performance Review: The performance of MD/ CEO and WTD shall be reviewed by the Board annually.

2. Committees of the Board

In order to strengthen the oversight by the Board, all ARCs shall constitute the following committees of the Board:

(i) Audit Committee: ARCs shall constitute an Audit Committee of the Board, which shall comprise of non-executive directors only. The Chair of the Board shall not be a member of the Audit Committee. The Audit Committee shall meet at least once in a quarter with a quorum of three members. The meetings of the Audit Committee shall be chaired by an independent director who shall not chair any other committee of the Board. Each of the members of the Audit Committee should have the ability to understand the financial statements as well as the notes/ reports attached thereto and at least one member should have requisite professional expertise/ qualification in financial accounting or financial management. The Audit Committee shall have the same powers, functions and duties as laid down in Section 177 of the Companies Act, 2013. In addition, the Audit Committee shall periodically review and assess the effectiveness of internal control systems, especially with respect to the asset acquisition procedures and asset reconstruction measures followed by the ARC and matters related thereto. The Audit Committee shall also ensure that accounting of management fee/ incentives/ expenses is in compliance with the applicable regulations.

(ii) Nomination and Remuneration Committee: ARCs shall constitute a Nomination and Remuneration Committee of the Board, which shall have the same powers, functions and duties as laid down in Section 178 of the Companies Act, 2013. In addition, the Committee shall ensure 'fit and proper' status of proposed/ existing directors and sponsors.

3. Transition Period

ARCs that currently do not comply with the guidelines prescribed at paragraphs 1 and 2 above, are required to comply with these guidelines within six months from the date of this circular.

4. Prior Approval for Change in Shareholding

In terms of circular no. DNBR(PD)CC.No.01/SCRC/26.03.001/2014-2015 dated February 24, 2015 on ‘Bank’s prior approval for change in shareholding’, ARCs are required to obtain prior approval of the Reserve Bank of India for change in shareholding on account of transfer¹ of shares. In addition to these requirements, any change in the sponsor/s of an ARC due to fresh issuance of shares shall also require prior approval of the Reserve Bank of India.

5. Fit and Proper Criteria for Directors and CEO

(i) In terms of the provisions of the SARFAESI Act, prior approval of the Reserve Bank of India is required for appointment/ re-appointment of a director or MD/ CEO. ARCs shall undertake due diligence to determine the suitability of the person for the post, based upon track record, integrity and other ‘fit and proper’ criteria. For this purpose, ARCs shall obtain necessary information and declaration from the appointed/ existing directors and MD/ CEO in the format enclosed in Appendix I. The Nomination and Remuneration Committee shall scrutinise the declarations for this purpose.

(ii) The declaration in Appendix I with updated information shall be obtained from the directors/ MD/ CEO on an annual basis, as on March 31 of each year. Any change in position with reference to items in paragraphs 3 and 4 of Appendix I shall be communicated to the Department of Regulation of the Reserve Bank of India for its consideration.

(iii) The ARC shall require the directors to execute a covenant in the format enclosed at Appendix II, at the time of their joining the ARC, binding them to discharge their responsibilities to the best of their abilities, individually and collectively. This deed shall be preserved by the ARC and should be made available to the Reserve Bank of India as and when called for.

6. Enhanced Disclosures

In order to enable ARCs to garner investments from a broader set of Qualified Buyers (QBs) and foster healthy competition among ARCs, the following additional disclosures shall be made in the offer document:

(i) Summary of financial information of the ARC for last 5 years or since commencement of business of the ARC, whichever is shorter.

(ii) Track record of returns generated for all Security Receipt (SR) investors on the schemes floated in the last 8 years.

(iii) Track record of recovery rating migration and engagement with rating agency of schemes floated in the last 8 years.

7. Engagement with Credit Rating Agencies (CRAs) and Rating of SRs

(i) ARCs shall mandatorily obtain recovery rating of the SRs from CRAs and disclose the assumptions and rationale behind such rating to SR holders.

(ii) ARCs shall retain a CRA for at least 6 rating cycles (of half year each). If a CRA is changed mid-way through these 6 rating cycles, the ARC shall disclose the reason for such change.

Section II: Other Measures

8. Settlement of Dues Payable by the Borrowers under One-time Settlement

(i) Under earlier guidelines², each ARC was required to frame a Board-approved policy laying down the broad parameters for settlement of debts due from the borrowers. Further, the Board was permitted to delegate powers to a committee comprising any director and/ or any functionaries of the ARC for taking decisions on the proposals for settlement of dues. On a review, the guidelines for the reconstruction of financial assets through settlement of dues payable by the borrowers have been modified as follows:

a) Settlement of dues with the borrower shall be done only after the proposal is examined by an Independent Advisory Committee (IAC)³ which shall consist of professionals having technical/ finance/ legal background. IAC, after assessing the financial position of the borrower, the time frame available for recovery of the dues from the borrower, projected earnings & cash flows of the borrower and other relevant aspects, shall give its recommendations to the ARC regarding settlement of dues with the borrower.

b) The Board of Directors including at least two independent directors shall deliberate on the recommendations of IAC and consider the various options available for recovery of dues before deciding whether the option of settlement of dues with the borrower is the best option available under the existing circumstances and the decision, along with detailed rationale, shall be specifically recorded in the minutes of the Board meeting.

c) Settlement with the borrower should be done only after all possible steps to recover the dues have been taken and there are no further prospects of recovering the debt.

d) The Net Present Value (NPV) of the settlement amount should generally be not less than the realizable value of securities. If there is a significant variation between the valuation of securities recorded at the time of acquisition of financial assets and the realisable value assessed at the time of entering into a settlement, reasons thereof shall be duly recorded.

e) The settlement amount should preferably be paid in lump sum. In cases where the borrower is unable to pay the entire amount in lump sum, IAC shall make specific recommendations about minimum upfront lump-sum payment and maximum repayment period.

f) ARCs shall frame a Board-approved policy based on the above-mentioned framework.

(ii) Instructions given under paragraph 2(B)⁴ of the circular DNBS.(PD).CC.No.37/ SCRC/ 26.03.001/ 2013-2014 dated March 19, 2014 on ‘Buyback of assets from ARCs by the defaulters and acquisition of assets by ARCs from sponsor banks’ are hereby withdrawn and ARCs shall ensure compliance with Section 29A of Insolvency and Bankruptcy Code, 2016 in dealing with the prospective buyers.

9. Policy on Management Fees

The circular DOR.NBFC(ARC) CC. No. 9/26.03.001/2020-21 dated July 16, 2020 on Fair Practices Code (FPC) requires ARCs to put in place a Board-approved policy on the management fee, expenses and incentives. In order to ensure that management fee/ incentives charged by ARCs are reasonable and transparent, the following additional measures shall be adopted:

(i) Any management fee/ incentives charged towards the asset reconstruction or securitisation activity shall come only from the recovery effected from the underlying financial assets.

(ii) The Board-approved policy shall indicate the quantitative cap/ limit on the management fee/ incentives under various scenarios, any deviation from which shall require approval of the Board.

10. Minimum Net Owned Fund (NOF) Requirement

The minimum NOF (as required under para 4 of the circular DNBR. PD (ARC) CC. No. 03/26.03.001/2016-17 dated April 28, 2017 on Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002- Section 3(1)(b) - Requirement of NOF for ARCs) is hereby increased to ₹300 crore on an ongoing basis from the existing requirement of ₹100 crore. Consequently, any ARC obtaining the certificate of registration on or after the date of this circular shall not commence the business of securitisation or asset reconstruction without having minimum NOF of ₹300 crore. The following glide path is provided for the existing ARCs to achieve the minimum required NOF of ₹300 crore:

In case of non-compliance at any of the above stages, the non-complying ARC shall be subject to supervisory action, including prohibition on undertaking incremental business till it reaches the required minimum NOF applicable at that time.

11. Deployment of Surplus Funds

Para (e) of the circular DNBS(PD) CC.No.18/SCRC/26.03.001/2009-2010 dated April 21, 2010 on the subject has been amended. In order to allow ARCs to manage their surplus funds efficiently, in addition to the avenues already permitted, they are now permitted to deploy the available surplus funds in short-term instruments viz., money market mutual funds, certificates of deposit and corporate bonds/ commercial papers which have a short-term rating equivalent to the long-term rating of AA- or above by an eligible CRA, subject to the following conditions:

(i) Maximum investment in such instruments is capped at 10% of the NOF of the ARC.

(ii) The ARC shall have a Board-approved policy in this regard.

12. Investment in SRs issued by the ARCs

Para 2(a) of circular DNBS.(PD).CC.No.41/ SCRC/26.03.001/2014-2015 dated August 05, 2014 on ‘Regulatory Framework for ARCs – Certain Amendments’ has been modified. Henceforth, ARCs shall, by transferring funds, invest in the SRs at a minimum of either 15% of the transferors’ investment in the SRs or 2.5% of the total SRs issued, whichever is higher, of each class of SRs issued by them under each scheme on an ongoing basis till the redemption of all the SRs issued under such scheme.

13. Allowing ARCs to act as Resolution Applicant under Insolvency and Bankruptcy Code, 2016 (IBC)

ARCs are currently not permitted to commence or carry on any business other than that of securitisation or asset reconstruction or the business referred to in Section 10(1) of the SARFAESI Act without prior approval of the Reserve Bank of India. It has now been decided under the provision of Section 10(2) of the SARFAESI Act to permit ARCs to undertake those activities as a Resolution Applicant (RA) under IBC which are not specifically allowed under the SARFAESI Act. This permission shall be subject to the following conditions:

(i) The ARC has a minimum NOF of ₹1,000 crore.

(ii) The ARC shall have a Board-approved policy regarding taking up the role of RA which may inter alia include the scope of activities, internal limit for sectoral exposures, etc.

(iii) A committee comprising of a majority of independent directors shall be constituted to take decisions on the proposals of submission of resolution plan under IBC.

(iv) The ARC shall explore the possibility of preparing a panel of sector-specific management firms/ individuals having expertise in running firms/ companies which may be considered for managing the firms/ companies, if needed.

(v) In respect of a specific corporate insolvency resolution process (CIRP), the ARCs shall not retain any significant influence or control over the corporate debtor after five years from the date of approval of the resolution plan by the Adjudicating Authority under IBC. In case of non-compliance with this condition, the ARCs shall not be allowed to submit any fresh resolution plans under IBC either as a resolution applicant or a resolution co-applicant.

(vi) The ARC shall make additional disclosures in the financial statements with respect to assets acquired under IBC in addition to the existing disclosure requirements. These would include the type and value of assets acquired under IBC, the sector-wise distribution based on business of the corporate debtor, etc.

(vii) The ARC shall disclose the implementation status of the resolution plans approved by the Adjudicating Authority on a quarterly basis in their financial statements.

14. Transfer of Stressed Loans to ARCs

Subject to the provisions of the circulars DNBR.PD (ARC) CC.No.07/26.03.001/2018-19 dated June 28, 2019 and DOR.NBFC(ARC) CC. No. 8/26.03.001/2019-20 dated December 6, 2019, stressed loans which are in default in the books of the transferors are permitted to be transferred to ARCs. The Master Direction – Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021, is being suitably updated.

¹ Any transfer of shares by which the transferee becomes a sponsor; any transfer of shares by which the transferor ceases to be a sponsor; an aggregate transfer of ten percent or more of the total paid up share capital of the ARC by a sponsor during the period of five years commencing from the date of certificate of registration.

² (a) Every ARC shall frame a policy duly approved by the Board of Directors laying down the broad parameters for settlement of debts due from borrowers; (b) The policy may, inter alia, cover aspects such as cut-off date, formula for computation of realisable amount and settlement of account, payment terms and conditions, and borrower's capability to pay the amount settled; (c) Where the settlement does not envisage payment of the entire amount agreed upon in one instalment, the proposals should be in line with and supported by an acceptable business plan, projected earnings and cash flows of the borrower; (d) The proposal should not materially affect the asset liability management of the ARC or the commitments given to investors; (e) The Board of Directors may delegate powers to a committee comprising any director and/ or any functionaries of the company for taking decisions on proposals for settlement of dues; (f) Deviation from the policy should be made only with the approval of the Board of Directors.

³ Under extant guidelines, an ARC is required to constitute an IAC for examining the proposals related to change in or takeover of management of business of the borrower. This IAC shall also now examine the proposals of settlement of dues with the borrower.

⁴ Promoters of the defaulting company/ borrowers or guarantors are allowed to buy back their assets from the ARCs provided the following conditions are met:
I. Such a settlement is considered helpful in (i) minimizing or eliminating the cost of litigation and the attendant loss of time;(ii) arresting the negative impact of diminution in the value of secured assets which are likely to rapidly lose value once a unit becomes non-operational;(iii) where the recovery/ resolution process would appear to be rather uncertain; and iv) where such settlement will be beneficial for restructuring purposes.
II. The valuation of the asset is worked out by the ARCs after factoring in the following components: The current value of the proposed settlement (valuation of the asset not more than six months old) vis-à-vis the net present value of the recoveries under the alternative mode of resolution taking into consideration the timelines involved therein; Likely positive or negative changes in the value of the secured asset on account of passage of time; Likely diminution in realisation due to accumulation of statutory dues, liability to employees, etc.; Other factors, if any, which may affect recoveries.
III. ARCs shall frame a Policy duly approved by the Board of Directors, which should include the above aspects besides those already contained in clause 7 (5) of the ARC (Reserve Bank) Guidelines and Directions, 2003, as updated from time to time.