RBI, Sebi ‘clash’ adds to defaulters’ resolution woes

Even if the bankers agree on a deal under the ICA, it is not binding on funds.

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Mumbai: Differences between Reserve Bank of India (RBI) and Securities and Exchange Board of India (Sebi) may delay or possibly even scupper resolution plans of defaulting firms such as DHFL, experts and industry insiders have warned.

While the RBI’s word is binding on banks, mutual funds, who are also prominent lenders to many firms, are regulated by Sebi. The market regulator’s views on certain aspects of the resolution proposed by banks are different from that of RBI and the clash may lead to delays as various lenders try and work out a common ground on the best way to rescue a defaulting firm.

Take for example the intercreditor agreement (ICA) which is binding on banks but not on insurers or mutual funds. In the case of DHFL, the mutual funds have decided not to be a part of the ICA. While banks can agree to a deal under the terms of the ICA, such an agreement is not binding on mutual funds who are free to approach the courts or the Debt Resolution Tribunal for relief. Two MFs — Edelweiss and Reliance AMC — have done exactly that.


The market regulator has stipulated that mutual funds side pocket their stressed investments before joining the ICA. Mutual funds, in the case of DHFL, have not done so and are therefore reluctant to join the ICA.

Even if the bankers agree on a deal under the ICA, it is not binding on funds and other lenders such as insurers.

The proposed resolution in case of DHFL says that all lenders acknowledge and agree that from time to time certain banks, NBFCs, other financial institutions and asset reconstruction companies may sign an agreement and shall be bound by the terms of this agreement as a ‘lender’ and shall acquire and assume the same rights and obligations.
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“Sebi’s reservation on conditionally allowing mutual funds to participate in ICA is primarily to protect the interest of investors,” said Ashish K Singh, partner, Capstone Legal. “However, the resolution process has to be seen from a broad perspective to include the liability of the entity comprehensively. Sebi should take a more liberal view while deciding on AMFI’s (Association of Mutual Funds in India’s) request for allowing mutual funds to be a part of ICA.”

After the IL&FS default, apart from banks, insurance and mutual funds are taking haircuts on their investments. AMFI has laid down norms on treatment of downgraded debt and suggested haircuts once a paper falls below investment grade.

The whole concept of mutual fund is that investors reap the benefits and bear the losses. The debate is on whether bondholders like mutual funds must sign the ICA. Mutual funds and insurance companies will also have to take a hit without having any say in the restructuring.

“This is one of the key reasons why the DHFL resolution plan is stuck as bankers want mutual funds on board because we want to ensure that no entity takes a unilateral decision,” said a banker involved in the DHFL process. “Since debt holders like mutual funds are also creditors, it is important that they are on board, otherwise the whole process could be stalled.”
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In cases like DHFL, the ICA involves taking an equity stake in the company because no one is ready to take over. So, lenders converting debt to equity is crucial for the resolution.

“Interest of different classes of lenders not being aligned is clearly a challenge,” said R Gurumurthy, head of risk and governance at RBL Bank. “The process is voluntary. The ability of the court to drive a process can be high and resolution process may run faster in such cases.”
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In some cases that have been resolved through NCLT, mutual funds have taken a cut. In case of Essel Group, some funds entered into standstill agreements which were against regulations. Other funds did not enter into such pacts, marked down NAVs and investors took the hit.

Data from the Insolvency and Bankruptcy Board of India (IBBI) shows that as much as 34 per cent of the 1,292 cases in the bankruptcy courts up to June 2019 are delayed beyond 270 days, up from 26 per cent a year ago and 31 per cent in the quarter ended March 2019, raising fears that delays could make the law redundant.

“We are still dealing with the list of companies which were admitted in the bankruptcy courts under the February 12 circular,” said Nishit Dhruva, managing partner, MDP & Partners. “The ICA was supposed to solve issues that arose after the Supreme Court order but these issues between regulators will create more problems and delay matters further.”
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