RBI Revamps ARC Governance and Capital Rules

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 transfer 1 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 guidelines 2 , 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: Current Minimum NOF

Reproduced for reference with acknowledgment — Source: Reserve Bank of India · RBI/2022-23/128 · issued 11 Oct 2022. The plain-English explanation above is BankPulse’s own independent summary.

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