Price discovery in the times of NARCL

NARCL has a competitive advantage over private asset reconstruction companies, because it comes with deep pockets and a government guarantee

Policymakers have taken several steps to address the stressed assets problem. These include the setting up of the National Asset Reconstruction Company (NARCL) and the framing of new guidelines for sale of loan assets in the secondary market. The Reserve Bank of India’s (RBI’s) expert committee on reforms in the working of asset reconstruction companies (ARCs) has also recommended solutions in the legal and regulatory framework that governs ARCs. One of the crucial being, “there should be fair competition between NARCL and private ARCs to promote the objectives of true price discovery through the market mechanism”.

NARCL, during its first phase, is to acquire about 15 non-performing accounts (NPAs) of about Rs 50,000 crore. It is noteworthy that these (and the subsequent NPAs) are pre-determined assets which are likely to be sold at a pre-determined price. The sale of these NPAs will go through a “Swiss Challenge Auction”, which is anyway a regulatory requirement for sale of NPAs worth more than Rs 100 crore. Without commenting on the commercial intent of the ARCs which may want to throw their hat in the ring, it is obvious that NARCL has a competitive advantage over private ARCs, because it comes with deep pockets and is backed by government guarantee.

This guarantee is for covering any shortfall at the time of redemption in the value of security receipts (SRs) issued by NARCL, and the access to this pool of funds for NARCL is Rs 30,600 crore. This makes the SRs issued by NARCL more attractive to buyers and can be a major hindrance in ensuring fair competition and true price discovery, which is the recommendation of the RBI report.

The timeframe within which NARCL can purchase loan assets and the timeframe for its existence ought to have been limited. NARCL is not bound by a sunset clause. It can easily morph into a commercial entity, with support of taxpayer money. Global experience has specifically shown the benefits of a sunset clause for such entities.

There is also continuing noise in the NARCL-IDRCL (India Debt Resolution Company) structure. Simply put, NARCL (as a regulated entity) will purchase the NPAs, while IDRCL (which is not a regulated entity) will perform the role of resolution. While it has been recently clarified that the relationship between the two will be of principal and agent, how this will actually work in practical terms — especially in light of how the RBI views outsourcing by its regulated entities — will be of interest.

Global precedent on this is also that functions are housed in one entity. For instance, Securum (Sweden), Danaharta (Malaysia), National Asset Management Agency (Ireland), and Sociedad de Gestión de Activos Procedentes de la Reestructuración Bancaria (Spain) all perform both roles.

Institutions such as NARCL that are created for a larger public purpose are usually statutorily incorporated, such as state-run banks and development financial institutions. For instance, the National Bank for Financing Infrastructure and Development, as a statutory corporation, will soon boost infrastructure financing. Many jurisdictions which created entities for debt resolution set up new statutory corporations or converted existing entities into one. The advantage of having a law to create a special entity such as the NARCL is that the dispensations required for its functioning can be given by means of a law, as was done in case of other jurisdictions.

In the present structure, NARCL has a narrow focus on asset management, restructuring, and disposition, and this could pose practical challenges. In the absence of statutory recognition, the RBI is tasked with the responsibility of ensuring that the NARCL is able to serve the public interest and at the same time create a fair competitive market for stressed assets.   

The writer is Partner at Shardul Amarchand Mangaldas & Co. Sumant Prashant (Principal Associate) and Varun Marwah (Senior Associate), contributed to this article. The views are personal