Companies under IBC-quarantine, get GST-rebirth

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-Vinod Kothari 

[vinod@vinodkothari.com]

Resolution is not a re-birth of an entity – it is simply like nursing a sick entity back to health. It is almost akin to putting the company under a quarantine – immune from onslaught of creditor actions, while the debtor and/or the creditors prepare a revival plan. The objective is that the entity revives – in which case, it is out of the isolation, and is back as a healthy entity once again.

This process is not unknown in insolvency laws world-over. However, in India, revival under insolvency framework has taken a completely unique trajectory. First was section 29A, cutting the company from its promoter-lineage for all time to come. The next was section 32A – redeeming the company from the past burden of civil as well as criminal wrongs, thereby giving it a new avatar, with a new management.

Now, the initiation of a CIRP proceeding will be akin to a new birth to the company, at least for GST purposes. Therefore, irrespective of whether the revival process succeeds or not, at least for GST purposes, the entity becomes clean-slate entity. This is the result of the new GST rule announced on 21st March, 2020. However, the new rules do not seem to have envisaged several eventualities, and we opine the intent of giving an immunity from past liabilities might have better been carried out by appropriate administrative instructions, rather than the new registration process.

Read more →

SEBI relaxes timelines at the time of disruption caused by COVID-19

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Vinod Kothari & Company

corplaw@vinodkothari.com

Below is a short snippet of the relaxed timelines issued by the securities market regulator in the wake of the disruption caused by COVID-19.

Is capital relief allowed for on-balance sheet securitisations?

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Timothy Lopes, Executive, Vinod Kothari Consultants

finserv@vinodkothari.com

Non-Banking Financial Companies (NBFCs) have been actively involved in the securitisation market, being one of its major participants at the originating as well as investing front. One of the key motivation of a securitisation transaction is its ability to take the loans off the books of the originator, thereby extending capital relief.

Until the implementation of IFRS or Ind AS in the Indian financial sector, the de-recognition of financial assets from the books of financial institutions was pretty simple; however, with complex conditions for de-recognition under Ind AS 109, almost all securitisation transactions now fail to qualify for de-recognition.

This leads to the key question of whether capital relief will still be available, despite the transactions failing de-recognition test under Ind AS. Through this write-up we intend to explore and address this question.

Situation prior to Ind-AS

Prior to the implementation of Ind-AS, there was no accounting guidance with respect to de-recognition of the financial assets from the books of the financial institutions. However, it was a generally accepted accounting principle that if the transaction fulfilled the true sale condition, then the assets were eligible to go off the books.

The true sale condition came from the RBI Guidelines on Securitisation[1]. The off-balance sheet treatment of the assets led to capital relief for the financial institutions. However, the Guidelines requires knock off, to the extent of credit enhancement provided, from the capital (Tier 1 and Tier 2) of the financial institution.

Post Ind-AS scenario

One of the key highlights of the IFRS 9 or Ind AS 109 is the introduction of the de-recognition criteria for financial instruments. Under Ind AS, a financial asset can be put off the books, only when there is a transfer of substantially all risks and rewards arising out of the assets. This, however, is difficult to prove for the transactions that take place in India because most of the structures practiced in India have high level of first loss credit support from the originators, therefore, evidencing high level of risk retention in the hands of the originator.

As a result, the transactions fail to satisfy the de-recognition test and the financial assets do not go off the books of the financial institutions.

This raises another concern with respect to maintenance of regulatory capital, since the assets are not de-recognized as per accounting standards, although backed by a legal true sale opinion. The apprehension here is whether capital relief would still be available in case the assets are retained on the books as per accounting norms. Capital relief would mean not having to assign any risk weight to or maintain capital for these assets.

RBI guidance on implementation

In the absence of any clarity on the question of capital relief to be availed by NBFCs, the whole idea for securitization was getting frustrated. However, RBI has on March 13, 2020 issued guidance for NBFCs and Asset Reconstruction Companies for implementation of Ind-AS[2].

It has now been clarified by RBI that securitised assets not qualifying for de-recognition under Ind-AS due to credit enhancement given by the originating NBFC on such assets shall be risk weighted at zero percent. This implies that the originating NBFC will not be required to maintain any capital against the securitised portfolio of assets. However, the originator shall still be required to make 50% deduction from Tier 1 and 50% from Tier 2 capital.

The relevant extract of RBI notification states as follows-

vii) Securitised assets not qualifying for de-recognition under Ind AS due to credit enhancement given by the originating NBFC on such assets shall be risk weighted at zero percent. However, the NBFC shall reduce 50 per cent of the amount of credit enhancement given from Tier I capital and the balance from Tier II capital.

Accordingly, the fact that a transaction does not qualify for off-balance sheet treatment shall not be relevant for capital adequacy computation. As long as a securitisation transaction satisfies the conditions laid down in the relevant Securitsation Guidelines the fact that whether it has been de-recognised or not for accounting purposes will not make a difference.

Read our related write ups here –

Securitisation accounting under Ind-AS

Securitisation accounting: disconnects between RBI Guidelines and Ind-AS

Accounting for DA under Ind-AS

[1] https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=2723

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11818&Mode=0#AN1

CSR funds may be used for COVID-19 relief, clarifies MCA

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Team Vinod Kothari & Company | corplaw@vinodkothari.com

Updated on 29th March, 2020

Like all other public agencies, MCA has been taking a series of steps in the wake of the rapidly spreading COVID-19 and issued clarification[1] on spending of CSR funds for COVID 19 stating that the amount spent on COVID-19 by companies will count towards CSR spending. The activities falling under item nos. (i) & (xii) of Schedule VII of Companies Act, 2013 undertaken due to COVID 19 shall qualify as CSR activity which covers the following:

  • Eradicating hunger, poverty and malnutrition, promoting health care including preventive health care and sanitation including contribution to the Swach Bharat Kosh set-up by the Central Government for the promotion of sanitation and making available safe drinking water.
  • Disaster management, including relief, rehabilitation and reconstruction activities.

Subsequently, the Ministry on 28th March, 2020 has also clarified by way of an office memorandum, that companies contributing towards recently formed Prime Minister’s Citizen Assistance and Relief in Emergency Situations Fund (‘PM CARES Fund’) shall also qualify as CSR expenditure under item (viii) of Schedule VII of Companies Act, 2013.

Hence, this is the right occasion, and unarguably, one of the noblest causes, to use CSR funds in whatever way, one may think of for the welfare of society.

Notably, substantial CSR money remains unspent, very often for want of appropriate CSR projects. Many companies have to explain the same by finding some reason or the other. Currently the country is passing through an epidemic that has affected the whole world. Hence, companies may come forward and spend their unspent CSR budgets. Indeed companies are also welcome to over-spend this year’s budget pursuant to a proposal in the Companies Amendment Bill which permits carry forward of excess spending as well.

Questions are often being asked – can the company include the expenditure incurred for COVID-19 preparedness for its own employees and workmen – say, giving of masks, sanitizers, or similar expense, as a part of its CSR spending?

Our answer to this question is the same as what we have continuously answered as a part of our FAQs[2] on CSR that CSR is spending on a social cause. An employer spending for the well being, safety or welfare of employees is performing the employer’s legal or moral obligation. That cannot be regarded as CSR. However, if the company spends on COVID-19 preparedness, either by itself or through implementing agencies, for a wider section of public, and its employees or their families are also the beneficiaries of such an exercise, there is no denial as to eligibility of the same as CSR spending.

Our detailed write ups on CSR may be viewed here:

Proposed changes in CSR Rules

Draft CSR Rules Make CSR More Prescriptive

CAB, 2020: Bunch of Proposals for revamping CSR Framework

[1]http://www.mca.gov.in/Ministry/pdf/Covid_23032020.pdf

[2]http://vinodkothari.com/2019/11/faqs-on-corporate-social-responsibility/

Reckoning banks’ loans to NBFCs for on-lending to priority sectors for PSL targets

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-Financial Services Division (finserv@vinodkothari.com)

 

The Master Direction – Priority Sector Lending – Targets and Classification[1] issued by the Reserve Bank of India (RBI) mandates Scheduled Commercial Banks (SCBs) to lend a specified percentage of their Adjusted Net Bank Credit (ANBC) to the specified ‘needy’ sectors called the Priority Sectors. Further, in order to assist the banks in meeting their Priority Sector Lending targets (PSL Targets) and to extend the reach of credit to these sectors, the RBI has allowed various modes of collaboration between banks and NBFCs. One such mode is lending by banks to NBFCs and HFCs for on-lending to priority sector.

Additionally, through a notification[2] issued in 2019 the RBI provided that the loans extended by the banks to NBFCs on or before March 31, 2020 and which are on-lent to priority sector, shall be eligible to be classified as priority sector lending by the bank. However, notification imposed a cap on the ticket size of the loans originated by NBFCs and they are:

Sector Maximum ticket size of loans
Agriculture ₹ 10 lakh per borrower
Micro & Small enterprises ₹ 20 lakh per borrower
Housing (for on-lending by HFCs) ₹ 20 lakh per borrower

The maximum PSL Target that can be fulfilled by a bank using this mode is 5% of banks’ total PSL. For this purpose, on-lending done by NBFC (except MFIs) and HFCs shall be reckoned.

Considering the credit demand by these sectors classified as ‘priority’ and the outreach of NBFCs, the RBI has issued another notification dated March 23, 2020[3], extending the above mentioned time limit to cover originations during FY 2020-21. Accordingly, the loans originated by banks on or before March 31, 2021 and extended to NBFCs for on-lending to Priority Sectors shall be eligible to be classified under Priority Sector Lending of such bank.

It is noteworthy that since lending to HFCs and NBFC-MFIs by banks for on-lending was already covered under the Master Directions on Priority Sector Lending and there was no time limit provided for such loans under the Master Directions, the provisions of the aforesaid notification relating to the time limit of eligibility shall not be applicable on such bank credit. The time limit applies only for on-lending to agriculture sector and micro & small enterprises.

 

[1] https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=10497&Mode=0

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11659&Mode=0

[3] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11828&Mode=0

 

Our related write-ups:

http://vinodkothari.com/2016/02/priority-sector-lending-certificates-permitting-trades-between-haves-and-have-nots

http://vinodkothari.com/wp-content/uploads/2019/09/Modes-of-Collaboration-between-Banks-NBFCs.pdf

GST on Priority Sector Lending Certificates

COVID-19 preparedness: some questions on MCA Form CAR-2020

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Vinod Kothari and Company; corplaw@vinodkothari.com

Updated as on 23rd March, 2020

All companies and LLPs must have, by now, got mailers from the Ministry of Company Affairs about COVID-19 preparedness, and the need to file a web based form CAR 2020 i.e. Company Affirmation of Readiness towards COVID 19.

The MCA circular is nothing but a disaster management step from the Ministry, imploring upon all companies and LLPs to get sensitised to the need for handling this colossal challenge to humanity, India included. It will be an ironical travesty if the filing of the form is taken as a compliance requirement.

Therefore, in our view, what matters is the preparedness itself, not so much the task of having the so-called policy or the filing of the form itself.

However, the country has a few lakhs of companies, and the affirmation of preparedness by filing this form will be expected from all the companies. Hence, there is understandably a barrage of questions from clients and others.

We at Vinod Kothari & Company will be happy to contribute in our own little way; hence, if companies/LLPs have questions around this Form, we have thought it apt to put them down into this small guidance. We wish and pray that all of you stay safe during this challenging time.

1.     Whether the Advisory has any statutory backing?

Let us not even think of this as emanating from some power under the law. Neither do we have to search for such a power, nor question it. As human beings, not every action of ours arises out of legal obligations. It is a simple step by the Ministry towards sensitisation of the corporate sector, towards fulfilling an urgent social and human obligation.

2.     What are the steps being suggested through the Advisory?

Companies and LLPs are being advised to put in place an immediate plan to implement a ‘work from home’ policy as a temporary measure.

3.     What is the object of having such a plan?

The object of having such a plan is to ensure social distancing as advised by WHO and other public health authorities in the recent outbreak of COVID-19 which is required for preventing the rapid spread and transmission of the disease at community level.

4.     My company does not have any permanent employees. Am I still required to adhere to this policy?

If there are no permanent employees, it is all peace as far as your company is concerned. Go and file the form and say you have taken necessary steps.

5.     Whether the companies and LLPs will have to frame a written ‘work from home’ policy?

The Advisory suggests to have a plan to implement the work from home policy for the employees. In our view, the same is not required to be a written or formal policy. The word “policy” here should mean the steps to be taken by the organisation to provide the facility of working from home to its employees and the manner/ procedure to be followed to ensure the same. If there is a policy, typically, the policy is applied to all employees covered by it without discrimination. Further, the process and manner to be followed shall be different from organisation to organisation. Accordingly, in case of companies, the decision may be taken at management level, while in case of others, by the head of the organisation.

6.     What all does a work from home policy include?

As we said above, we are not envisaging this to be a formal document. However, please do consider the following:

  • Who all can be permitted to work from home – for those who have to be present, whether there is rotational or staggered presence?
  • What will be the weekly and daily working hours?
  • Whether necessary equipment or software is in place for working from home?
  • Whether there will be any revision in compensation and benefits paid to the employees?
  • Whether employees have adequate internet connection required for the job?
  • What level of dedication and concentration is expected from employees during working hours?
  • What will be the method of marking attendance or absence?
  • Who will review work of whom and how?
  • Revision in employees code of conduct
  • How to maintain and ensure confidentiality of information
  • Installation of necessary software for group discussions or meetings
  • To educate remote employees on basic security policies as for example use of VPN is a secure channel and better than public network
  • Establishment of virtual employee allowance or reimbursements for expenses such as internet, phone, electricity and other utilities
  • Strict adherence to do’s and don’ts issued by public health authorities from time to time
  • Date of implementation of this policy- with immediate effect till 31st March, 2020 (tentative date, maybe extended depending upon the situation)

7.     The circulars are being addressed to CEOs/directors. Is the action required to be taken at board/CEO level?

First of all, the actions expected are urgent – therefore, please do not wait for any formal processes or board resolutions. Whoever is in charge of putting administrative allocations may take such steps. Looking at the seriousness, it is expected that senior management is involved. However, it does not matter if there is any formal ratification or issue of circular, unless the organisation expects such formal internal documents.

8.     Till what time the work from home policy to be adopted?

Till 31st March, 2020. The same shall be reviewed by the appropriate authorities based on the evolving situation.

9.     What is the form CAR all about?

It is a web form deployed on 23rd March, 2020 by the Ministry. The same is a simple web based form requiring only an OTP based verification and does not require any digital signature for affirming or denying the adoption of work from home policy.

10. Is there a fee for filing form CAR?

There is no fee for filing the form. Seriously, we don’t even imagine there can be a fee.

11. Who will require to file the said form?

All companies and LLPs are expected to file the said form. There is no exclusion or exemption for OPCs, private companies or small companies. However, looking at the language of the applicability, partnership firms and proprietorship concerns have been kept outside the purview of filing CAR, 2020.

12. What is the timeline to file?

The web form CAR, 2020 is deployed on the MCA portal on 23rd March, 2020. Initially, the advice suggested to file it on the same day, however, later it was clarified that the same can be filed till 30th March, 2020.

13. What kind of information/ data to be reported?

As per the twitter handle of the Hon’ble Minister of Finance and Corporate Affairs the possible format of the form shall contain the following:

  1. CIN/ FCRN/ LLPIN/ FLLPIN
  2. Name of the company/ foreign company/ LLP/ Foreign LLP
  3. Whether the company/ LLP is in compliance of COVID 19 Guidelines?
  4. Authorised Signatory of the company/ LLP
  5. DIN/ PAN/ Membership No. of the Authorised Signatory
  6. Mobile No.
  7. OTP

The step to step guide on filing CAR 2020 has been issued by MCA on 22nd March, 2020. The same can be viewed here.

14. Whether foreign company/ LLPs are also required to follow the Advisory?

The Advisory suggests all companies/ LLPs to file the form. The intent seems to include all the companies/ LLPs incorporated in India or companies/ LLPs not incorporated in India but having operations/ physical presence in India. The contents of the Form as provided in Query 9 above suggest the same.

15. What do the COVID 19 Guidelines mean?

There is no definition as such. However, it should mean the Advisory itself issued by the Govt. from time to time. One may refer to pages such as https://www.mygov.in/covid-19/?cbps=1.

16. Who is the Authorised Signatory of the company/ LLP for authenticating the form?

As referred to above, it seems that the authorised signatory may be a director, CS, CFO or any other person authorised to file the form. However, who is eligible to give such authority is not clear. In our view, in case of companies which have given general authority to the CS/ any director/ CFO to file necessary forms with the regulatory authorities from time to time, such authorised persons may file the form. In case of others, the same may be filed by the MD/ head of the organisation who looks after the day to day affairs or any person authorised by such MD/ head of the organisation.  Once again, we suggest there need not be a formal flow of authorisation, such as a resolution, for filing the form.

17. Whether the mobile no. has to be a registered mobile no.?

Since the form is an OTP verified form, the OTP is sent on the mobile no of the person who is authenticating the form and the same is prefilled on providing details of the authorised person.

18. What are the consequences of non- filing?

There is no penalty for non-filing of the form. Further the Advisory is not coming from any statutory requirement but out of a social obligation only, non- filing of the same may not lead to any penal consequences.

19. The Authorised Signatory may be the compliance officer. But how does the compliance officer certify the preparedness across the company, with so many locations?

The authorised signatory is not taking the burden upon himself. The signatory may, in turn, get confirmations from those who are involved, say, the HR head or similar positions.

20. In view of the lockdown/ shutdowns announced by the state governments for various places in India, does it mean lockout of operations by the corporate houses and giving leaves altogether?

Please note that shutdown does not mean shutdown of operation. Therefore, it still means work from home. The whole intent of shutdown is to control movement and not to control work.

21. Are the companies mandatorily required to file form CAR?

As per the information uploaded on MCA’s website, the filing of the form is on voluntary basis. Therefore, the company/ LLP (s) may take a call on filing. However, if one throws a question on whether they are required to take steps to combat COVID-19 by following government guidelines, please note that we have no doubt on answering this is positive. Everyone including the companies and LLPs are mandatorily required to take steps during this health emergency.

Remunerating NEDs and IDs in low-profit or no-profit years

/1 Comment/in , /by

Ambika Mehrotra

corplaw@vinodkothari.com

The role of non-executives (NEDs) and independent directors (IDs) in an organization in bringing their unbiased views, transparency and good governance in the corporate culture has already been recognized globally. The NEDs including IDs are not typically engaged in the day-to-day management but their responsibilities inter-alia include monitoring of the functioning of executive directors. This is quite essential in order to ensure that the decision making in the company is not dominated by individual choices.

As stated by Sir Vincent Powell-Smith in his book ‘Law and Practice Relating to Company Directors’, “apart from the working or executive directors, that is persons who are full-time executives, it is sometimes desirable to take in ” outside ” directors who have no association with the company other than as a director.”

It is to be noted that the unique role of such directors is evaluated by their ‘positive contribution’, in the board, as stated in the Report by Cadbury Committee[1], which is irrespective of the profits generated by the day to day business and working, However, the compensation for their contribution has always been linked to the profitability of the company by virtue of the provisions of Section 309 of the Companies Act, 1956 or corresponding Section 197 in the Companies Act, 2013.

Herein, it is pertinent to note that, while the role if NEDS/IDs demands them to bring independence to the board, the performance/profit based remuneration for non-executive directors has significant potential to conflict with their primary role in the organization. Accordingly, considering various stakeholder representations received by the Government regarding this inconsistency, the Company Law Committee (“CLC/Committee”) which was set up under the Chairmanship of Shri Injeti Srinivas in November, 2019[2] considered the need to have adequate compensation for such directors.

In line with same, the Central Government (CG) has recently laid down another set of amendments before the Lok Sabha on 17th March, 2020 by way of Companies (Amendment) Bill, 2020[3] (“CAB, 2020”). In this article we intend to discuss the said amendment along with the rationale behind the same.

Analysis of the amendments

The board is a mix of executives and non- executives, while the executives are being paid remuneration, the non- executives are only eligible for sitting fee and commission out of profits. Where the difference between the work domain is only as regards the day to day management of the company. Here, it is to be noted that although the non-executives do not involve in the everyday working of any organization, they carry the vintage of their experience in the company. It is interesting to note that while both the kind of directors bring in their bit of value in the company, however during a financial disrupt in a company, maybe through losses or inadequacy of profits, when there is a conflict in the minimum remuneration being paid, where the executive still receive the prescribed remuneration, the non-executives get to sacrifice their commission, which they were otherwise entitled to and they have to satisfy themselves with the sitting fee only.

In order to curb the said conflict, the CAB, 2020 has introduced provisions for allowing payment of adequate remuneration to NEDs in case of inadequacy of profits, by aligning the same with the provisions for remuneration to executive directors in such cases. This is backdrop of the discussion in the CLC Report which considered that the existing provisions in the CA, 2013, do not recognise payment of remuneration to non-executive directors, in case of losses or inadequate profits as it does for the managerial personnels in terms of Section 197 read with Schedule V.

Notably, the concept of minimum compensation to independent directors had also been incorporated in the Uday Kotak Committee report on Corporate Governance issued on October 5, 2017[4]. However, the above requirement of minimum remuneration did not extend to the case of inadequacy of profits.

While the Calcutta High Court in the matter of Hind Ceramics Ltd. vs Company Law Board And Ors[5] discussed that the minimum remuneration paid to the executives and non executives equally might severely impact the financial strength of the loss making entity in recovering the same for an uncertain term. However, on taking a close look at the active involvement of the non-executives in the company by virtue of their enhanced role and liabilities, it is required to re-consider the fact that the inconsistency in the payment of such non-executives as compared to the executives would not only de-incentivise the latter but also affect the retention of talented resources in a company.

Global Precedents

Considering the above, it may also be inferred that the limitation in the provisions of CA, 2013 w.r.t the payment of remuneration to IDs in case of losses or inadequacy of profits frustrates the whole intent of their unique role on the board. Even globally, various  countries have recognised that the level of remuneration for non-executive directors should reflect their time commitment and responsibilities of the role and not be linked to the performance of the company.

UK Corporate Governance Code

As per the UK Corporate Governance Code dated July 2018[6], which clearly provides that,

“Remuneration for all non-executive directors should not include share options or other performance-related element.”

The remuneration of non-executive directors is determined in accordance with the Articles of Association of the company or, alternatively, by the board.

OECD Report on Corporate Governance 

Similar provisions have been recommended in the Portuguese code of corporate governance, as referred in the report of the Organisation for Economic Co-operation and Development (OECD) based on Corporate Governance on Board Practices[7], which provides that the remuneration of the NEDs on the Board should not include a part depending on the performance or the value of the company.

ICGN’s Guidance on NED Remuneration

In addition to the above, the International Corporate Governance Network (ICGN) in its Guidance on Non-executive Director Remuneration[8] explains that the performance-based remuneration in any organisation has significant potential to conflict with a non-executive director’s primary role as an independent representative of shareholders. Although, ICGN is a strong advocate of performance-based concepts in executive remuneration, they do not uphold the same in case of remuneration to non- executives.

Conclusion

In view of the global stand in determining the remuneration to non-executives on  the basis of their value in the organisation without linking the same to the profits of the company, the amendments to be introduced vide the CAB, 2020 appear to be a boon for the IDs. At the same time, we cannot disregard the fact that, the concept of adequate compensation mentioned above applies to the companies facing losses or inadequacy of profits and it may be possible that this might increase the financial distress of the loss making company.  However, the positive aspect of the same still appears to be beneficial as regards the retention of experienced resources who shall remain motivated by being adequately remunerated.

Our other write- ups on similar topics may be viewed at:

  1. http://vinodkothari.com/2019/11/the-injeti-srinivas-committee-report-18-11-2019/
  2. http://vinodkothari.com/2019/11/clc-report-moving-company-law-a-step-closer-to-ease-and-peace/
  3. https://www.moneylife.in/article/norms-for-disqualification-of-directors-may-undergo-change/58842.html
  4. http://vinodkothari.com/category/corporate-laws/

[1] https://ecgi.global/sites/default/files/codes/documents/cadbury.pdf

[2] http://mca.gov.in/Ministry/pdf/CLCReport_18112019.pdf

[3] http://164.100.47.4/BillsTexts/LSBillTexts/Asintroduced/88_2020_LS_Eng.pdf

[4] https://www.sebi.gov.in/reports/reports/oct-2017/report-of-the-committee-on-corporate-governance_36177.html

[5] https://indiankanoon.org/doc/445116/

[6] https://www.frc.org.uk/getattachment/88bd8c45-50ea-4841-95b0-d2f4f48069a2/2018-UK-Corporate-Governance-Code-FINAL.pdf

[7] https://www.oecd.org/daf/ca/49081438.pdf

[8] https://www.top1000funds.com/pdf/ICGN_NED_Rem_Guidelines.pdf

RBI to regulate operation of payment intermediaries

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Guidelines on regulation of Payment Aggregators and Payment Gateways issued

-Mridula Tripathi (finserv@vinodkothari.com)

Background

In this era of digitalisation, the role of intermediaries who facilitate the payments in an online transaction has become pivotal. These intermediaries are a connector between the merchants and customers, ensuring the collection and settlement of payment. In the absence of any direct guidelines and adequate governance practices regulating the operations of these intermediaries, there was a need to review the existing instructions issued in this regard by the RBI. Thus, the need of regulating these intermediaries has been considered cardinal by the regulator.

RBI had on September 17, 2019 issued a Discussion Paper on Guidelines for Payment Gateways and Payment Aggregators[1] covering the various facets of activities undertaken by Payment Gateways (PGs) and Payment Aggregators (PAs) (‘Discussion Paper’). The Discussion Paper further explored the avenues of regulating these intermediaries by proposing three options, that is, regulation with the extant instructions, limited regulation or full and direct regulation to supervise the intermediaries.

In this regard, the final guidelines have been issued by the RBI on March 17, 2020 which shall be effective from April 1, 2020[2], for regulating the activities of PAs and providing technology-related recommendations to PGs (‘Guidelines’).

In this article we shall discuss the concept of Payment Aggregator and Payment Gateway. Further, we intend to cover the applicability, eligibility norms, governance practices and reporting requirements provided in the aforesaid guidelines.

Concept of Payment Aggregators and Payment Gateways

In common parlance Payment Gateway can be understood as a software which enables online transactions. Whenever the e-interface is used to make online payments, the role of this software infrastructure comes into picture. Thinking of it as a gateway or channel that opens whenever an online transaction takes place, to traverse money from the payer’s credit cards/debit cards/ e-wallets etc to the intended receiver.

Further, the role of a Payment Aggregator can be understood as a service provider which includes all these Payment Gateways. The significance of the Payment Aggregators lies in the fact that Payment Gateway is a mere technological base which requires a back-end operator and this role is fulfilled by the Payment Aggregator.

A merchant (Seller) providing goods/services to its target customer would require a Merchant Account opened with the bank to accept e-payment. Payment Aggregator can provide the same services to several merchants through one escrow account without the need of opening multiple Merchant Accounts in the bank for each Merchant.

The concept of PA and PG as defined by the RBI is reproduced herein below:

PAYMENT AGGREGATORS (PAs) means the entities which enable e-commerce sites and merchants to meet their payment obligation by facilitating various payment options without creation of a separate payment integration system of their own. These PAs aggregate the funds received as payment from the customers and pass them to the merchants after a certain time period.

PAYMENT GATEWAYS (PGs) are entities that channelize and process an online payment transaction by providing the necessary infrastructure without actual handling of funds.

The Guidelines have also clearly distinguished Payment Gateways as providers of technological infrastructure and Payment Aggregators as the entities facilitating the payment. At present, the existing PAs and PGs have a variety of technological set-up and their infrastructure also keeps changing with time given the business objective for ensuring efficient processing and seamless customer experience. Some of the e-commerce market places have leveraged their market presence and started offering payment aggregation services as well. Though the primary business of an e-commerce marketplace does not come within the regulatory purview of RBI, however, with the introduction of regulatory provisions for PAs, the entities will end up being subjected to dual regulation. Hence, it is required to separate these two activities to enable regulatory supervision over the payment aggregation business.

The extant regulations[3] on opening and operation of accounts and settlement of payments for electronic payment transactions involving intermediarieswe were applicable to intermediaries who collect monies from customers for payment to merchants using any electronic / online payment mode. The Discussion Paper proposed a review of the said regulations and based on the feedback received from market participants, the Guidelines have been issued by RBI.

Coverage of Guidelines

RBI has made its intention clear to directly regulate PAs (Bank & Non-Bank) and it has only provided an indicative baseline technology related recommendation. The Guidelines explicitly exclude Cash on Delivery (CoD) e-commerce model from its purview. Surprisingly, the Discussion Paper issued by RBI in this context intended on regulating both the PAs & PGs, however, since PGs are merely technology providers or outsourcing partners they have been kept out of the regulatory requirements.

The Guidelines come into effect from April 1, 2020, except for requirements for which a specific deadline has been prescribed, such as registration and capital requirements.

Registration requirement

Payment Aggregators are required to fulfil the requirements as provided under the Guidelines within the prescribed timelines. The Guidelines require non-bank entities providing PA services to be incorporated as a company under the Companies Act, 1956/2013 being able of carrying out the activity of operating as a PA, as per its charter documents such as the MoA. Such entities are mandatorily required to register themselves with RBI under the Payment and Settlement Systems Act, 2007 (‘PSSA, 2007’) in Form-A. However, a deadline of June 30, 2021 has been provided for existing non-bank PAs.

Capital requirement

RBI has further benchmarked the capital requirements to be adhered by existing and new PAs. According to which the new PAs at the time of making the application and existing PAs by March 31, 2021 must have a net worth of Rs 15 crore and Rs 25 crore by the end of third financial year i.e. March 31, 2023 and thereafter. Any non-compliance with the capital requirements shall lead to winding up of the business of PA.

As a matter of fact, the Discussion Paper issued by RBI, proposed a capital requirement of Rs 100 crore which seems to have been reduced considering the suggestion received from the market participants.

To supervise the implementation of these Guidelines, there is a certification to be obtained from the statutory auditor, to the effect certifying the compliance of the prescribed capital requirements.

Fit and proper criteria

The promoters of PAs are expected to fulfil fit and proper criteria prescribed by RBI and a declaration is also required to be submitted by the directors of the PAs. However, RBI shall also assess the ‘fit and proper’ status of the applicant entity and the management by obtaining inputs from various regulators.

Policy formulation

The Guidelines further require formulation and adoption of a board approved policy for the following:

  1. merchant on-boarding
  2. disposal of complaints, dispute resolution mechanism, timelines for processing refunds, etc., considering the RBI instructions on Turn Around Time (TAT)
  3. information security policy for the safety and security of the payment systems operated to implement security measures in accordance with this policy to mitigate identified risks
  4. IT policy(as per the Baseline Technology-related Recommendations)

Grievance redressal

The Guidelines have put in place mandatory appointment of a Nodal Officer to handle customer and regulator grievance whose details shall be prominently displayed on the website thus implying good governance in its very spirit. This is similar to the requirement for NBFCs who are required to appoint a Nodal Officer. Also, it is required that the dispute resolution mechanism must contain details on types of disputes, process of dealing with them, Turn Around Time (TAT) for each stage etc.

However, in this context, the Discussion Paper provided for a time period of 7 working days to promptly handle / dispose of complaints received by the customer and the merchant.

Merchant on boarding and KYC compliance

To avoid malicious intent of the merchants, PAs should undertake background and antecedent check of the merchants and are responsible to check Payment Card Industry-Data Security Standard (PCI-DSS) and Payment Application-Data Security Standard (PA-DSS) compliance of the infrastructure of the merchants on-boarded and carry a KYC of the merchants on boarded. It also provides for some mandatory clauses to be incorporated in the agreements to be executed with the merchants.

Risk Management

For the purposes of risk management, apart from adoption of an IS policy, the PAs shall also have a mechanism to monitor, handle and report cyber security incidents and breaches. They are also prohibited to allow online transactions with ATM pin and store customer card credentials on the servers accessed by the merchants and are required to comply with data storage requirements as applicable to Payment System Operators (PSOs).

Reporting Requirements

The Guidelines provide for monthly, quarterly and annual reporting requirement. The annual requirement comprises of certification from a CA and IS audit report and Cyber Security Audit report. The quarterly reporting again provides for certification requirement and the monthly requirement demand a transaction statistic. Also, there shall be reporting requirement in case of any change in management requiring intimation to RBI within 15 days along with ‘Declaration & Undertaking’ by the new directors. Apart from these mainstream reporting requirements there are non-periodic requirements as well.

Additionally, PAs are required to submit the System Audit Report, including cyber security audit conducted by CERTIn empanelled auditors, within two months of the close of their financial year to the respective Regional Office of DPSS, RBI

Escrow Account Mechanism

The Guidelines clearly state that the funds collected from the customers shall be kept in an escrow account opened with any Schedule Commercial Bank by the PAs. And to protect the funds collected from customers the Guidelines state that PA shall be deemed as a ‘Designated Payment System’[4] under section 23A of PSSA, 2007.

Shift from Nodal to Escrow

The Discussion Paper proposed registration, capital requirement, governance, risk management and such other regulations along with the maintenance of a nodal account to manage the funds of the merchants. Further, it acknowledged that in case of nodal accounts, there is no beneficial interest created on the part of the PAs; the fact that they do not form part of the PA’s balance sheet and no interest can be earned on the amount held in these account. The Guidelines are more specific about escrow accounts and do not provide for maintenance of nodal accounts, which seems to indicate a shift from nodal to escrow accounts with the same benefits as nodal accounts and additionally having an interest bearing ‘core portion’. These escrow account arrangements can be with or without a tripartite agreement, giving an option to the merchant to monitor the transactions occurring through the escrow. However, in practice it may not be possible to make each merchant a party to the escrow agreement.

Timelines for settlement to avoid unnecessary delay in payments to Merchants, various timelines have been provided as below:

  1. Amounts deducted from the customer’s account shall be remitted to the escrow account maintaining bank on Tp+0 / Tp+1 basis. (Tp is the date of debit to the customer’s account against good/services purchased)
  2. Final settlement with the merchant
  3. In cases where PA is responsible for delivery of goods / services, the payment to the merchant shall be made on Ts + 1 basis. (Ts is the date of intimation by merchant about shipment of goods)
  4. In cases where merchant is responsible for delivery, the payment to the merchant shall be on Td + 1 basis. (Td is the date of confirmation by the merchant about delivery of goods)
  5. In cases where the agreement with the merchant provides for keeping the amount by the PA till expiry of refund period, the payment to the merchant shall be on Tr + 1 basis. (Tr is the date of expiry of refund period)

Also, refund and reversed transactions must be routed back through the escrow account unless as per contract the refund is directly managed by the merchant and the customer has been made aware of the same. A minimum balance requirement equivalent to the amount already collected from customer as per ‘Tp’ or the amount due to the merchant at the end of the day is required to be maintained in the escrow account at any time of the day.

Permissible debits and credits

Similar to the extant regulations, the Guidelines provide a specific list of debits and credits permissible from the escrow account:

  • Credits that are permitted
  1. Payment from various customers towards purchase of goods / services.
  2. Pre-funding by merchants / PAs.
  3. Transfer representing refunds for failed / disputed / returned / cancelled transactions.
  4. Payment received for onward transfer to merchants under promotional activities, incentives, cashbacks etc.
  • Debits that are permitted
  1. Payment to various merchants / service providers.
  2. Payment to any other account on specific directions from the merchant.
  3. Transfer representing refunds for failed / disputed transactions.
  4. Payment of commission to the intermediaries. This amount shall be at pre-determined rates / frequency.
  5. Payment of amount received under promotional activities, incentives, cash-backs, etc.

The aforesaid list of permitted deposits and withdrawals into an account operated by an intermediary is wider than those allowed under the extant regulations. The facility to pay the amount held in escrow to any other account on the direction of the merchant would now enable cashflow trapping by third party lenders or financier. The merchant will have an option to provide instructions to the PA to directly transfer the funds to its creditors.

The Guidelines expressly state that the settlement of funds with merchants will in no case be co-mingled with other business of the PA, if any and no loans shall be available against such amounts.

No interest shall be payable by the bank on balances maintained in the escrow account, except in cases when the PA enters into an agreement with the bank with whom the escrow account is maintained, to transfer “core portion”[5] of the amount, in the escrow account, to a separate account on which interest is payable. Another certification requirement to be obtained from auditor(s) is for certifying that the PA has been maintaining balance in the escrow account.

Technology-related Recommendations

Several technology related recommendations have been separately provided in the Guidelines and are mandatory for PAs but recommendatory for PGs. These instructions provide for adherence to data security standards and timely reporting of security incidents in the course of operation of a PA. It proposes involvement of Board in formulating policy and a competent pool of staff for better operation along with other governance and security parameters.

Conclusion

With these Guidelines being enforced the online payment facilitated by intermediaries will be regulated and monitored by the RBI henceforth. The prescribed timeline of April 2020 may cause practical difficulties and act as a hurdle for the operations of existing PAs. However, the timelines provided for registration and capital requirements are considerably convenient for achieving the prescribed benchmarks. Since PAs are handling the funds, these Guidelines, which necessitate good governance, security and risk management norms on PAs, are expected to be favourable for the merchants and its customers.

 

[1] https://www.rbi.org.in/scripts/PublicationReportDetails.aspx?ID=943

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11822&Mode=0

[3] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=5379&Mode=0

[4] The Reserve Bank may designate a payment system if it considers that designating the system is in the public interest. The designation is to be by notice in writing published in the Gazette, as per Payment System Regulation Act, 1998

[5] This facility shall be permissible to entities who have been in business for 26 fortnights and whose accounts have been duly audited for the full accounting year. For this purpose, the period of 26 fortnights shall be calculated from the actual business operation in the account. ‘Core Portion’ shall be average of the lowest daily outstanding balance (LB) in the escrow account on a fortnightly (FN) basis, for fortnights from the preceding month 26.

 

 

Our other write ups on NBFCs to be referred here http://vinodkothari.com/nbfcs/

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