Published on Mon, Apr 14,2014 | 20:09, Updated at Mon, Apr 14 at 20:09Source : CNBC-TV18 | Watch Video : 
India Inc is in general pain as it comes to terms with a half notified new Company Law with only half the Rules out, that too at the last minute. Cost accountants are fearful of losing their jobs under the new Act. And now NBFCs are a troubled lot. Several provisions in the Companies Act and the accompanying Rules might make it tougher for NBFCs to raise funds via debenture issues. The shortlist of those issues includes;
- The debenture definition – which may now also encompass commercial paper
- New conditions on private placements
- The need for a debenture to create a charge on specific assets
- And enhanced 50% allocation to the debenture redemption reserve & 15% of yearly redemptions to be invested at the start of the year
Does the Companies Act, 2013 make it tougher for NBFCs to raise funds? To answer that CNBC-TV18's Menaka Doshi spoke to V Ravi, CFO, Mahindra & Mahindra Financial Services and Vishwanath Venkatramanan, Partner, KPMG India
Doshi: I have listed the issues briefly and I am going to start with the very first issue on my list which is the definition of debenture, the opinion is spilt. Ravi do you think that this definition now includes commercial paper as well?
NBFCs IN TROUBLE?
Companies Act, 2013
Definitions
"debenture" includes debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not;
Ravi: The confusion comes because the debenture definition says that any other instrument, evidencing debt but debenture being- our interpretation is that - debenture being a security under the Securities Contracts (Regulation) Act and commercial paper is a money market instrument defined under Negotiable Instruments Act, it cannot be the same. So, we feel that the Act's intention is that by calling it a name other than debenture and if it is raised by a way of instrument which is evidencing debt- that was intended to be covered there and not commercial paper; that's our reading.
Doshi: I suspect Venkatramanan disagrees with you.
Venkatramanan: It is not that I disagree but if you reference the earlier definition that existed in the Companies Act, 1956 that spoke about securities and there has been a conscious change in the definition to move as Ravi said to any other instrument and the challenge is how do you prove at least on principles the commercial paper is not any other instrument that evidences debt.
NBFCs IN TROUBLE?
Debenture
- Companies Act, 1956
"debenture" includes debenture stock, bonds and any other securities of a company, whether constituting a charge on the assets of the company or not;
- Companies Act, 2013
"debenture" includes debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not;
Doshi: The reason why this is important is and this is how I understood it is that if commercial paper were to be included in the category of debenture, then there would be certain things applicable to debenture; especially the private placement of debentures that would now become applicable to commercial paper as well. Would this mean that the restriction that you can't do a new debenture issue without the previous one having closed would apply therefore to the issue of commercial paper as well? Venkatramanan I will let you go first on this.
NBFCs IN TROUBLE?
Companies Act, 2013
Section 42: Private Placement
(3) No fresh offer or invitation under this section shall be made unless the allotments with respect to any offer or invitation made earlier have been completed or that offer or invitation has been withdrawn or abandoned by the company.
Venkatramanan: This may be an unintended consequence of the drafting. So, slightly different from how Ravi reads it, I suddenly see commercial papers potentially being covered within the definition but for all the consequences that you speak of, that was probably not the intent. I think based on feedbacks that we are getting at the moment, it's possible that there maybe a further clarification on this.
Ravi: In commercial paper, generally speaking in practice, the issue is not kept open for a long time; there could be some exceptions here and there but generally speaking what happens is that the issue closes and ends on the same day. So, you get subscribed, the allotment is done and technically speaking, in one or two days everything will be completed and you can go on to the next issue.
Doshi: There is one problem I want to add to this list - this need to create a charge on specific assets underlying a debenture issue - can you tell me how this is a shift versus the earlier Act and how you read into this and what it means for the NBFC industry?
NBFCs IN TROUBLE?
Companies Act, 2013
Rules: Ch 4
(i) any specific movable property of the company (not being in the nature of pledge); or (ii) any specific immovable property wherever situate, or any interest therein.
Venkatramanan: So, the requirement that is there in the revised Act, as you said requires a creation of a charge specific to an asset.
Doshi: The wording seems to indicate that if you read the Rules
Venkatramanan: That's right; there are some areas where this is slightly confusing. As some part of this reading seems to indicate that you have got to create this on existing assets before you can deploy funds. But, the form in the Act where you report for example, the creation of charge talks about creation of charge not only on existing assets but also future assets. So, some part of the challenge is that there seems to be some degree of incompatibility between the main Section and the form around this.
Doshi: How would you read this Ravi because in the NBFC industry, the assets are customer loans- how do you create a specific charge on a specific customer loan where you may have a pool of loans underlying a debenture issue? What is the impact of this?
Ravi: What we do is, say, I am just giving a vehicle loan or a tractor loan. The vehicle or tractor does not belong to us, we give a loan and we have a charge on the asset and the receivable along with the charge is pledged to the lending institution who in turn gives money against that security. Now, the thing is that these are repaid monthly, quarterly, or yearly depending on the customer arrangement that we have- terms and conditions of repayment- the amounts keep on getting liquidated every month. So, technically speaking the so-called specific charge that is created then, not again on the immovable property, it is on the receivables; that also gets liquidated. So, today what we do is that we keep on replacing it but now it is specific.
Doshi: So now it is linked to a specific loan.
Ravi: Yes. So, suddenly it will become unsecure.
Venkatramanan: The other aspect which is kind of worth noting is that most of these provisions, the reason why we are having all these challenges with regards to NBFCs is clearly when these provisions were conceptualized, they were conceptualized perhaps for more general industrial manufacturing type companies where there is creation of a charge on a specific fixed asset and actually would also protect the lender so to speak. But the dynamics of this industry is slightly different and unfortunately this Act is not written to deal with industry specifics.
Doshi: I get that. I just want to ask one more additional question to the specific charge issue which is that if commercial paper is included in debenture, then the need to create a specific charge would apply to commercial paper as well. How are you going to get around that?
Ravi: See the commercial paper by nature is an unsecured instrument. So, probably one has to take a view, if at all it is going to be included - it will be an unsecured debenture where I will have to keep the liquidity reserve. So, I may not be in a position to create any charge because the lender himself is saying I don't want your charge and so whom I am going to create for if the lender says I don't want it. But, I have to create a liquidity reserve- that is another challenge which we will discuss as we go on.
Doshi: Which are the next two points- the debenture redemption reserve and the need to put 50 percent of the money you raised through a debenture issue into that reserve ahead of redemptions and the 15 percent liquidity requirement that you need to have at the beginning of every year, 15 percent of the total redemptions for that year. Now, earlier private placement of debentures- so the debentures raised through private- were exempt from this debenture redemption reserve (DRR) and this 15 percent was the exemption given via a circular issued by the Ministry of Corporate Affairs- that exemption has not been maintained in the new Act, nor has it been brought in the Rules in any fashion which means that even privately placed debentures will now have to have a DRR and a 15 percent liquidity reserve as you call it--big hit to profitability and how do you hope this will get resolved? Is it that you hope that the notification will get extended?
NBFCs IN TROUBLE?
Companies Act, 2013
Rules: Ch 4
NBFCs IN TROUBLE?
Companies Act, 2013
Rules: Ch 4
MCA 2002 Circular: No DRR required in case of privately placed debentures
Ravi: One is that the liquidity reserve will affect the profit. I will explain in a minute how, but DRR will not affect technically the profit but it will affect the dividend paying capacity of the company. Let's discuss about DRR, you interpretation, I am sure Venkatramanan will agree with us, it is a must now - the private placed debentures, the exemption which was enjoyed earlier…(Interrupted)
Doshi: Unless a Circular comes in and it exempts you but as of today, it's a must.
Ravi: It says that if debentures issued under this Section and debenture are issued under Section 71. So, we have taken a view that debentures taken under 1956 Act that is the existing debentures- I have a stock of something like about Rs 15,000 crore of debentures…(Interrupted)
Venkatramanan: Certainly that is one view that is out there. The only point which would have been helpful is that if there had been a specific saving Section which said that clearly that this was grandfathered, I think it would have been helpful to avoid any confusion. Now, everyone is latching on to the fact that there is wording to say that these are debentures issued under this Section and this Section did not exist till April 1.
Doshi: But let's assume that's a small problem - maybe the MCA will fix that and say look that this Act is meant to apply prospectively.
Venkatramanan: It isn't a small problem actually; it is a large problem.
Doshi: I didn't mean in amount. What I meant is given that most of this Act applies prospectively and they have extended grandfathering to structures etc as well that they will extend it to this as well and say okay, earlier pool of debentures raised, DRR does not apply because you were specifically exempted. Fresh pools of debentures raised, DRR and 15 percent will apply. How big a hit this is going to be for the NBFC industry Venkatramanan?
Over 30% of funds raised by NBFCs via Debentures & Bonds. In 2013 NBFCs raised approx…
Debentures: Rs 2.4 trillion, CP: Rs 460 bn.
Venkatramanan: It is very significant because of the sheer quantum of the debentures that are issued and also practically given the tenure of the debentures that are issued, the requirement to start creating DRR will happen pretty soon and if you look at, again I will go back to this difference between a financial services entity and a manufacturing type entity. The size of the balance sheet vis-à-vis the size of the profit and loss (P&L), in a financial services entity balance sheet is just huge as compared to the P&L because of the leverage that's there. So, if you start needing to create 50 percent of these amounts of borrowings, the distributable profits really come under a lot of pressure. In some cases actually, they may just completely disappear. The practical challenge is that can you find a way in which either to get extension of the previous exemption that existed or come up with some more creative way of structuring such instruments.
Ravi: On this DRR only one point I would like to add just to supplement what Venkatramanan has said. I am just extending his point - unlike a manufacturing company; a manufacturing company will pay the principal of the debentures out of the profits because assets will generate sales, sales will generate profit and out of it. For a finance company and a bank, the principal or the debenture will not be paid out of the profit; it will be paid out of our lending assets. Our asset itself is self liquidating unlike a plant and machinery which is immovable or which will be for 20-25 years. My asset which is created out of debenture which is loan receivable is self liquidating on a monthly basis, quarterly basis. So, out of that asset, I will repay the principal. When I am paying the debenture interest, it is serviced out of the profit. So, what the Act requires 50 percent of the principals I have to create out of the profit which is a fundamental fallacy. That is why this problem will be perennial if it is allowed to exist.
Doshi: And that is why you are hopeful that they exemption that existed will be extended to privately placed debentures and within the definition of debentures privately placed commercial paper as well, if at all a DRR applies to commercial paper. Would it apply to commercial paper as well - if commercial paper came under the definition of debenture?
Ravi: Yes
Doshi: You spoke of a creative option, a way out if the exemption extension doesn't come through
Venkatramanan: I am not sure it's creative, but some of the alternatives that are being currently discussed- for instance, the requirement to create debenture redemption reserve and allocate separate assets for redemption proceeds is all based on the year in which redemption is going to begin or before the redemption process begins. So, in terms of structures, some of the structures that may deal with this challenge are let's say for instance a company wanted to raise money for three years. But they issued and instrument which was, let's say, with a term maturity of five years but had a call option for the issuer at the end of three years. Technically the requirement to set out or create this debenture redemption reserve would really only trigger off in the year four or the end of year four and the beginning of the year five is when you would need to actually set aside cash. But, if an entity were then in a position to early redeeming this instrument at the end of the third year, it would have at least achieved its business purpose of raising those funds.
Doshi: And then having redeemed the instrument in the third year, the need to create a DRR or this 15 percent redemption reserve or redemption liquidity fund or however you want to call it would then fall off, right?
Venkatramanan: The practical issue with such structures is that they seem to fit in very much with the letter of the law and not the spirit.
Doshi: How would you describe the impact on the NBFC industry if this is not fixed in time?
Ravi: The NBFCs will be forced to go to the banks for borrowings. So, in a way borrowing will be crippled. Typically for an NBFC today if you take their fund mix by category of institutions, the banks are already occupying something like about 50-70 percent of the NBFCs requirements. Now, that concentration is going to be driven further up.
