In addition to strengthening them structurally with better governance, better disclosures, less funding requirements for asset acquisitions and strong balance sheets, the new regulatory guidelines for asset reconstruction companies (ARCs) will drive consolidation in the industry, according to a report.
Crisil Ratings analysis indicates that the new requirements for ARCs, which were announced by the Reserve Bank last Tuesday, will require them to increase their net funds by three times, to Rs300 crore from Rs100 crore, in a phased manner of by March 2026. This might be difficult for small ARCs.
However, two significant improvements to the legal framework – lower capital requirements for asset acquisitions and two – an opportunity to participate as a resolution seeker under the bankruptcy code – will favorably affect the business profiles of CRAs.
Under the new regulations, CRA investments in Security Receipts (SRs) must be at least 15% of the transferor’s investment in SRs or 2.5% of the total number of SRs issued, whichever is greater. high, in each asset class and for each plan on a continuous basis until the SRs are traded.
Previously, even in the presence of investors other than the selling lenders, CRAs could invest at least 15% of the SRs issued in each class of each regime.
The agency expects the momentum to continue as funding needs for cash transactions diminish. It is worth mentioning that the percentage of cash transactions in SRs increased gradually and reached 36% in February 2022 compared to 4-5% in February 2017.
The organization views RBI’s decision to let CRAs participate as resolution requesters in the IBC process as a positive step, as it will increase available business opportunities and potentially create a new revenue stream. However, only a number of the 28 ARCs may be able to muster the net funds of more than Rs 1,000 crore required to be a candidate for resolution.
The regulator has also put in place a number of measures to strengthen the governance structure of CRAs, including increasing the independence of their boards of directors, limiting the term of office of board members and creating a process board members to be evaluated on their performance.
According to the document, having stricter disclosure requirements for financial data, a history of yields produced and recovery ratings on SRs in offering documents should increase transparency and, therefore, the investor interest in CRAs.
Rules limiting management fees to money recovered through the sale of underlying assets should encourage CRAs to prioritize accelerated settlement.
Many CRAs may not be able to raise more capital as more than half of them have net funds below the revised Rs300 crore benchmark.
Additionally, new governance initiatives will likely increase compliance and operating costs, which could be difficult for smaller CRAs and potentially lead to consolidation.
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