The Imperative for a distinct framework for the resolution of financial firms
The financial sector is facing a combination of liquidity, governance and business issues, on account of which certain Non Banking Financial Companies ("NBFCs") are facing solvency concerns.
The severe liquidity crunch for NBFCs was caused as banks and other financial institutions have curtailed refinancing the loans of NBFCs on account of which several NBFCs and other financial institutions faced debt servicing and solvency issues. These have sought to be resolved through the Stressed Asset Directions issued by the Reserve Bank of India ("RBI") on June 7, 2019. This was fraught with complexities given the diverse sets creditor, including market borrowings each of whom were governed by different financial regulators.
The resolution of financial firms globally is undertaken in a manner distinct from those of other corporate debtors on account of three primary reasons: (i) systemic financial stability concerns (ii) consumer protection (particularly the protection of retail depositors) and the continuation of critical financial services to consumers (iii) the diverse and disaggregated creditor base which makes collective, coordinated creditor action difficult. Further, the resolution of financial firms is part of a continuum of the macroprudential regulation and supervision, where stabilization and resolution are prioritized and in rare instances liquidation is undertaken. Accordingly, the involvement of a separate resolution corporation or of the relevant financial sector regulator is usually central.
In this regard, the Financial Stability Board established under the aegis of the G 20 released Key Attributes of Effective Resolution Regimes for Financial Institutions ("FSB Key Attributes") on October 14, 2014 which set out the core elements necessary for any effective resolution regime being inter alia ensuring continuity of systemically important financial services, and payment, clearing and settlement functions; protect, where a depositors, insurance policy holders; introducing a moratorium on payments and legal proceedings; avoid unnecessary destruction of value, and provide for speed and transparency and as much predictability as possible through legal and procedural clarity and advanced planning for orderly resolution. All G 20 member countries are required to have in place a framework for the resolution of financial firms that include the FSB Key Attributes.
In India, the Insolvency and Bankruptcy Code, 2016 ("IBC") applies to corporate debtors other than financial services providers ("FSPs")1. However, in terms of Section 227 of the IBC, the Central Government is empowered to notify, in consultation with the relevant financial sector regulators, either individual FSPs or which categories of FSPs should be included for the purpose of insolvency and liquidation proceedings under the terms of the IBC.
The Financial Resolution and Deposit Insurance Bill, 2017 (FRDI Bill) was tabled in the Lok Sabha on 10 August 2018 specifically for the purposes of resolution of the financial institutions (including NBFCs) incorporating provisions of the FSB Key Attributes.
The Finance Bill, 2019 amended the Reserve Bank of India Act, 2019 to introduce Section 45 MBA in respect of NBFCs empowering the RBI with a range of tools for resolution of NBFCs include the power to frame schemes to :
- Amalgamate troubled NBFCs with other NBFCs;
- Reconstruct NBFCs;
- Split the NBFCs into different units or institutions and vesting viable and non-viable businesses in separate units or institutions to preserve the continuity of the activities of such NBFCs that are critical to the functioning of the financial system and for such purpose establish temporary bridge institutions
- Sale of any of the assets of the NBFC.
The scope of Section 45 MBA is limited to NBFCs and not other kinds of FSPs such as insurance companies and pension funds.
Given the challenges faced by the financial sector and the creditors and customers in the absence of a resolution framework applicable to all FSPs, the Central Government introduced rules on November 15, 2019.
The Insolvency and Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application to Adjudicating Authority Rules), 2016 ("FSP Rules") issued under Section 227 of the IBC were notified in the official gazette by the Ministry of Corporate Affairs on November 15, 2019 and came into effect the same day. The FSP Rules extend the applicability of the IBC to such FSPs, with certain modifications as specified by way of the FSP Rules. FSPs will therefore be resolved through a combination of the IBC principles and processes and the distinct processes set out in the FSP Rules.
In terms of the Press Release issued by the Central Government on the notification of the FSP Rules, the FSP Rules constitute a special mechanism aimed at serving the interim function of dealing with the insolvency and liquidation of systematically important FSPs until a full-fledged framework is enacted in this regard.
Eligibility for application of the FSP Rules
In terms of the press release announcing the FSP Rules, they are applicable to systemically important FSPs2. The Central Government is required to notify the FSPs or categories of FSPs who are systemically important to whom the FSP Rules will apply, as also the "appropriate regulator" of such FSPs, who have an important role in the resolution process. On November 18, a notification was issued for all systemically important NBFCs and for RBI to be the appropriate regulator in this regard. For all other FSPs, the IBC is required to apply in the same manner as that to all other corporate debtors.
The FSP Rules do not apply to banks presently, for whom the provisions of the Banking Regulation Act, 1949 which have enabling provisions for the resolution of banks continue to apply.
Triggering proceedings under the FSP Rules
In recognition of the centrality of the role of the regulator in resolution proceedings, FSP Rules, require the appropriate regulator to initiate resolution (as opposed to individual creditors initiating resolution) since the regulator would be aware of the systemic implications of triggering a resolution process for a large interconnected FSP. Such power being retained with regulators will also mitigate the disruption of critical financial services being provided by FSPs to consumers. Interim Moratorium and carve out for third party assets.
Upon the appropriate regulator filling for CIRP, a moratorium is immediately applicable, which applies until admission (at which stage the Section 14 moratorium would apply) or rejection (when there would no longer be a moratorium in place). This interim moratorium applies to actions contemplated under sub-sections (1), (2) and (3) of Section 14 of the IBC3. The institution of such an interim moratorium will obviate the multiplicity of proceedings in various fora during the initial filing stage. By way of example, there could be simultaneous proceedings initiated during this time by NCD holders who have certain remedies before the NCLT, certain specific categories of creditors who can approach the DRT and also by the many types of creditors that are eligible to approach the High Courts. The interim moratorium will prevent the initiation of such multiple conflicting proceedings, which can be value destructive.
The FSP Rules additionally clarify that the interim moratorium will not apply to any third party assets or properties in custody or possession of the FSP, including any funds, securities and other assets required to be held in trust for the benefit of third parties. The administrator appointed for the FSP is permitted to take control of all such third party assets in custody or possession of the FSP only for the purpose of dealing with them in the manner as may be notified by the Central Government under Section 227. This is in recognition of bona fide third party purchasers of assets from FSBs and similar contractual arrangements. The need for such clarity is underscored by recent legal proceedings where attempts have been made to reach assets not even owned by the FSP and assets validly sold to third parties for consideration.
Appointment of Administrator to take over control and management
The FSP rules contemplate the appointment of an administrator to take over the control and management of the FSP upon the admission of the insolvency application against it. The administrator is akin to an insolvency professional, interim resolution professional, resolution professional or liquidator (as the case may be) under the IBC, and is required to take on the same functions, duties, obligations, responsibilities, rights and powers of such statutory functionaries as prescribed under the IBC. Accordingly, the administrator will carry on the FSP as a going concern, which will ensure that critical functions of the FSP and the provision of services to consumers continue. The rules of conduct applicable to the resolution professional under the IBC will continue to apply to an Administrator under the FSP Rules. The administrator can be appointed or replaced only upon an application by the Appropriate Regulator.
Resolution Process and its interaction with IBC
The process for the resolution of FSPs shall align with the IBC process with the requisite amendments on account of the FSP Rules. The proof of claims to be filed with the interim resolution professional / resolution profession will be filed with the administrator.
The committee of creditors will be constituted with the same powers and responsibilities as that of a committee of creditors for all corporate debtors.
Resolution Plan:approvals and deemed no objection
In addition to compliances with all other provisions applicable to resolution plans under the IBC, the FSP Rules provide that a resolution plan submitted for an FSP must specifically include a statement about how it satisfies or intends to satisfy the requirements of engaging in the business of the financial service provider in accordance with applicable laws.
Reinforcing the centrality of the Committee of Creditors, their approval is required for the resolution plan. Following such approval, the appropriate regulator is also required to provide a no-objection certificate. This no objection certificate is required to be provided by the Appropriate Regulator on the basis of 'fit and proper' criteria applicable to the business of the FSP, without prejudice to the applicability of the eligibility criteria prescribed under Section 29A of the IBC. Given that the resolution of financial firms must be undertaken swiftly, a concept of "deemed" no-objection has been built in following 45 days from the submission of the application to the appropriate regulator. In this regard, the Rules also provide for the constitution of an Advisory Committee which advises the Administrator in the operations of the FSP during the corporate insolvency resolution process. Further rules regarding the advisory committee are to be issued by appropriate regulators. The timelines for resolution appear to be aligned with the IBC i.e. a directory period of 330 days.
The resolution plan once approved by the NCLT will be binding on creditors, members and other stakeholders as set out in Section 31 (1) of the IBC.
In terms of the FSP Rules, the provisions of the IBC pertaining to liquidation are to apply in their entirety for purposes of the liquidation of FSPs, subject to the license or registration authorising the FSP continuing during the liquidation process and the regulator being given the opportunity to be heard prior to liquidation and resolution.
It is important to note that the liquidation waterfall prescribed under Section 53 of the IBC has not been will apply equally for FSPs.
The FSP Rules represent a crucial and timely first step in the resolution of financial firms in India and provide for an interplay between the IBC processes and the principles unique for financial firms and distinct but complementary roles for the regulator, the CoC and the adjudicating authority.
The FSP Rules will bring much needed respite for the stakeholders involved in FSP as they now have a clear path to implement a resolution plans. This press release provides that this is an interim measure and a comprehensive legislation in this regard will be crucial.
The implementation of this framework will need to continue to watched closely as it evolves with the resolution of FSPs being undertaken through these Rules.
1 Section 3 (15) of the IBC defines a financial services provider as a person engaged in the business of providing financial services in terms of authorisation issued or registration granted by a financial sector regulator", Section 3 (16) provides that “financial service” includes any of the following services, namely:—
(a) accepting of deposits;
(b) safeguarding and administering assets consisting of financial products,
belonging to another person, or agreeing to do so;
(c) effecting contracts of insurance;
(d) offering, managing or agreeing to manage assets consisting of financial
products belonging to another person;
(e) rendering or agreeing, for consideration, to render advice on or soliciting for the purposes of—
(i) buying, selling, or subscribing to, a financial product;
(ii) availing a financial service; or
(iii) exercising any right associated with a financial product or financial service;
(f) establishing or operating an investment scheme;
(g) maintaining or transferring records of ownership of a financial product;
(h) underwriting the issuance or subscription of a financial product; or
(i) selling, providing, or issuing stored value or payment instruments or providing payment services;
Section 3 (18) defines a “financial sector regulator” to mean an authority or body constituted under any law for the time being in force to regulate services or transactions of financial sector and includes the Reserve Bank of India, the Securities and Exchange Board of India, the Insurance Regulatory and Development Authority of India, the Pension Fund Regulatory Authority and such other regulatory authorities as may be notified by the Central Government
2 In this regard, the RBI defines systemically important NBFCs as those with assets in excess of INR 500 crore. IRDA and PFDRA do not have equivalent definitions of systemically important FSPs regulated by them.
3 The text of sub-sections (1), (2) and (3) of Section 14 of the IBC has been extracted below, for ease of reference:
"14. Moratorium. –
(1) Subject to provisions of sub-sections (2) and (3), on the insolvency commencement date, the Adjudicating Authority shall by order declare moratorium for prohibiting all of the following, namely: –
(a) the institution of suits or continuation of pending suits or proceedings against the corporate debtor including execution of any judgement, decree or order in any court of law, tribunal, arbitration panel or other authority;
(b) transferring, encumbering, alienating or disposing off by the corporate debtor any of its assets or any legal right or beneficial interest therein;
(c) any action to foreclose, recover or enforce any security interest created by the corporate debtor in respect of its property including any action under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (54 of 2002);
(d) the recovery of any property by an owner or lessor where such property is occupied by or in the possession of the corporate debtor.
(2) The supply of essential goods or services to the corporate debtor as may be specified shall not be terminated or suspended or interrupted during moratorium period.
(3) The provisions of sub-section (1) shall not apply to —
(a) such transaction as may be notified by the Central Government in consultation with any financial regulator;
(b) a surety in a contract of guarantee to a corporate debtor."
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