RBI redefines the Grievance Redress Mechanism in Banks

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To improve the efficacy and provide better customer service

– CS Burhanuddin Dohadwala | finserv@vinodkothari.com

What is Grievance Redress Mechanism (‘GRM’)

GRM means the receipt and processing of complaints from the customer and taking necessary actions to address the same. The GRM of any organization is the gauge to measure its efficiency and effectiveness and provides a picture on how the banks value its customer.

Background:

Banks are in service organization. Customer satisfaction and loyalty is prime focus of any bank. Customer complaints are the part and parcel of day to day functioning of banks in India. To address this Reserve Bank of India (‘RBI’) had taken various initiatives over the years for improving customer service and GRM in banks which are as follows:

  •          The Banking Ombudsman Scheme was introduced in 1995 to serve as an alternate GRM for customer complaints against banks;
  •       In 2019, RBI introduced the Complaint Management System (‘CMS’)[1], a fully automated process-flow based platform, available 24×7 for customers to lodge their complaints with the Banking Ombudsman (‘BO’);
  •          As a part of the disclosure initiative, banks were advised to disclose in their annual reports, summary information regarding the complaints handled by them and certain disclosures were also being made in the annual report of the Ombudsman Schemes published by the RBI;
  •       Banks were mandated to appoint an Internal Ombudsman (‘IO’) to function as an independent and objective authority at the apex of their GRM;

It is evident from the increasing number of complaints received in the Offices of Banking Ombudsman (‘OBOs’)[2] as per Annexure-1, that greater attention by banks to this area is warranted. More focused attention to customer service and grievance redress was required to ensure satisfactory customer outcomes and greater customer confidence.

Hence, with a view to strengthen and improve the efficacy of the internal GRM of the banks and to provide better customer service RBI vide its press release dated December 04, 2020 w.r.t Statement on Developmental and Regulatory Policies[3] decided:

  •        To put in place a comprehensive framework comprising inter alia of enhanced disclosures on customer complaints by the banks;
  •       A monetary disincentive in the form of recovery of cost of redress of complaints from banks when maintainable complaints are comparatively high; and
  •          Undertaking intensive review of GRM and supervisory action against banks that fail to improve their redress mechanism in a time bound manner.

The aforesaid framework was introduced by RBI on January 27, 2021 vide its notification w.r.t Strengthening of GRM in Banks[4]. The same shall be effective from January 27, 2021 and applicable to all scheduled commercial banks (excluding regional rural banks).

 The write-up below shall discuss the framework introduced by RBI and actionables required at the end of the banks.

Framework for GRM:

RBI proposes to strengthen GRM in the following areas:

        I.         Enhanced disclosure on complaints:

Currently, banks were required to make disclosure regarding customer complaints and grievance redress in their annual report in terms of Para 16.4 w.r.t Analysis and Disclosure of complaints – Disclosure of complaints / unimplemented awards of Banking Ombudsmen along with Financial Results of the Master Circular on ‘Customer Service in Banks’ dated July 01, 2015[5] which are as follows:

A. Customer Complaints

(a) No. of complaints pending at the beginning of the year;

(b) No. of complaints received during the year;

(c) No. of complaints redressed during the year;

(d) No. of complaints pending at the end of the year;

B. Awards passed by the Banking Ombudsman

(a) No. of unimplemented Awards at the beginning of the year;

(b) No. of Awards passed by the Banking Ombudsmen during the year;

(c) No. of Awards implemented during the year;

(d) No. of unimplemented Awards at the end of the year.

The same is now replaced by the set of granular disclosures to be made by banks in their annual reports as per Annexure 2. These disclosures are intended to provide to the customers of banks and members of public greater insight into the volume and nature of complaints received by the banks from their customers and the complaints received by banks from the OBOs, as also the quality and turnaround time of redress. 

      II.         Recovery of cost of redress of complaints from banks

Presently, redress of complaints under BO Scheme, 2006[6] (‘BOS’) is cost-free for banks as well as their customers. With a view to ensure that banks discharge this responsibility effectively, the cost of redress of complaints will be recovered from those banks against whom the maintainable complaints[7] in the OBOs exceed their peer group average as provided below. However, grievance redressal under BOS for customers will continue to remain cost-free.

The cost-recovery framework for banks, peer groups based on the asset size of banks as on March 31 of the previous year will be identified, and peer group averages of maintainable complaints received in OBOs would be computed on the following three parameters: 

The cost of redressing complaints in excess of the peer group average will be recovered from the banks as follows:

·        Excess in any one parameter: 30% of the cost of redressing a complaint[8] (in the OBO) for the number of complaints in excess of the peer group average;

·        Excess in any two parameters: 60% of the cost of redressing a complaint for the number of complaints exceeding the peer group average in the parameter with the higher excess;

·       Excess in all the three parameters: 100% of the cost of redressing a complaint for the number of complaints exceeding the peer group average in the parameter with the highest excess.

   III.            Intensive Review of GRM

RBI will undertake, as a part of its supervisory mechanism, annual assessments of customer service and grievance redressal in banks based on the data and information available through the CMS, and other sources and interactions.

Banks who are identified as having persisting issues in grievance redress will be subjected to an intensive review of their GRM to better identify the underlying systemic issues and initiate corrective measures. The intensive review shall include but not limited to the following area:

  1.           Adequacy of the customer service and customer grievance redress related policies;
  2.              Functioning of the Customer Service Committee of the Board;
  3.         Level of involvement of the Top Management in customer service and customer grievance related issues;
  4.         Effectiveness of the GRM of banks.

Based on the review, a remedial action plan will be formulated and formally communicated to the banks for implementation within a specific time frame. In case no improvement is observed in the GRM within the prescribed timelines despite the measures undertaken, the banks will be subjected to corrective actions through appropriate regulatory and supervisory measures.

Actionable required at the end of the Banks:

To provide disclosure in the revised format on complaints received by the bank from customers and from the OBOs in the annual report from FY 20-21;

Conclusion:

RBI with a view to strengthen and protect the consumers has laid down the aforesaid framework. This will make banks more vigilant to avoid any levy of the cost and supervisory action by RBI.

Annexure A: Chart representing number of complaints received by OBOs

Annexure 2: Part A w.r.t Summary information on complaints received by the bank from customers and from the OBOs

Sr. No   Particulars Previous Year Current Year
  Complaints received by the bank from its customers    
1.           Number of complaints pending at beginning of the year;    
2.           Number of complaints received during the year;    
3.           Number of complaints disposed during the year;    
  3.1 Of which, number of complaints rejected by the bank; (Newly Inserted)    
4.           Number of complaints pending at the end of the year;    
  Maintainable complaints received by the bank from OBOs    
5.           Number of maintainable complaints received by the bank from OBOs; (Newly Inserted)    
  5.1 Of 5, number of complaints resolved in favour of the bank by BOs; (Newly Inserted)    
  5.2 Of 5, number of complaints resolved through conciliation/mediation/advisories issued by BOs; (Newly Inserted)    
  5.3 Of 5, number of complaints resolved after passing of Awards by BOs against the bank; (Newly Inserted)    
6.         Number of Awards unimplemented within the stipulated time (other than those appealed)    
Note: Maintainable complaints refer to complaints on the grounds specifically mentioned in BO Scheme 2006 and covered within the ambit of the Scheme.

Annexure 2: Part B w.r.t Top five grounds of complaints received by the bank from customers (Newly Inserted)

Grounds of complaints, (i.e. complaints relating to) Number of complaints pending at the beginning of the year Number of complaints received during the year % increase/ decrease in the number of complaints received over the previous year Number of complaints pending at the end of the year Of 5, number of complaints pending beyond 30 days
1. 2. 3. 4. 5. 6.
Current Year
Ground-1
Ground-2
Ground-3
Ground-4
Ground-5
Others
Total
Previous Year
Ground-1
Ground-2
Ground-3
Ground-4
Ground-5
Others
Total
Note: The master list for identifying the grounds of complaints is as follows:

·         ATM/Debit Cards;

·         Credit Cards;

·         Internet/Mobile/Electronic Banking;

·         Account opening/difficulty in operation of accounts;

·         Mis-selling/Para-banking;

·         Recovery Agents/Direct Sales Agents;

·         Pension and facilities for senior citizens/differently abled;

·         Loans and advances;

·         Levy of charges without prior notice/excessive charges/foreclosure charges;

·         Cheques/drafts/bills;

·         Non-observance of Fair Practices Code;

·         Exchange of coins, issuance/acceptance of small denomination notes and coins;

·         Bank Guarantees/Letter of Credit and documentary credits;

·         Staff behavior;

·         Facilities for customers visiting the branch/adherence to prescribed working hours by the branch, etc.;

·         Others.


 

 

Our link to YouTube video and other articles can be accessed below:

1. YouTube: https://www.youtube.com/channel/UCgzB-ZviIMcuA_1uv6jATbg;

2. Other articles w.r.t Financial Sector: http://vinodkothari.com/category/financial-services/

 

[2] As per RBI Annual Report of the Banking Ombudsman Scheme and Ombudsman Scheme for Non-Banking Financial Companies for the year 2018-19:

https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/AR201820190FB8B9072F984910A9FC7BA568B634D8.PDF

[7] Maintainable complaints refer to complaints on the grounds specifically mentioned in BOS 2006 and are covered 1301within the ambit of the Scheme.

[8] Average cost of handling a complaint at the OBOs during the year.

About time to unfreeze NPA classification and reporting

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-Siddarth Goel (finserv@vinodkothari.com)

Introduction

The COVID pandemic last year was surely one such rare occurrence that brought unimaginable suffering to all sections of the economy. Various relief measures granted or actions taken by the respective governments, across the globe, may not be adequate compensation against the actual misery suffered by the people. One of the earliest relief that was granted by the Indian government in the financial sector, sensing the urgency and nature of the pandemic, was the moratorium scheme, followed by Emergency Credit Line Guarantee Scheme (ECLGS). Another crucial move was the allowance of restructuring of stressed accounts due to covid related stress. However, every relief provided is not always considered as a blessing and is at times also cursed for its side effects.

Amid the various schemes, one of the controversial matter at the helm of the issue was charging of interest on interest on the accounts which have availed payment deferment under the moratorium scheme. The Supreme Court (SC) in the writ petition No 825/2020 (Gajendra Sharma Vs Union of India & Anr) took up this issue. In this regard, we have also earlier argued that government is in the best position to bear the burden of interest on interest on the accounts granted moratorium under the scheme owing to systemic risk implications.[1] The burden of the same was taken over by the government under its Ex-gratia payment on interest over interest scheme.[2]

However, there were several other issues about the adequacy of actions taken by the government and the RBI, filed through several writ petitions by different stakeholders. One of the most common concern was the reporting of the loan accounts as NPA, in case of non-payment post the moratorium period. The borrowers sought an extended relief in terms of relaxation in reporting the NPA status to the credit bureaus. Looking at the commonality, the SC took the issues collectively under various writ petitions with the petition of Gajendra Sharma Vs Union of India & Anr. While dealing with the writ petitions, the SC granted stay on NPA classification in its order dated September 03, 2020[3]. The said order stated that:

“In view of the above, the accounts which were not declared NPA till 31.08.2020 shall not be declared NPA till further orders.”

The intent of granting such a stay was to provide interim relief to the borrowers who have been adversely affected by the pandemic, by not classifying and reporting their accounts as NA and thereby impacting their credit score.

The legal ambiguity

The aforesaid order dated September 03, 2020, has also led to the creation of certain ambiguities amongst banks and NBFCs. One of them being that whether post disposal of WP No. 825/2020 Gajendra Sharma (Supra), the order dated September 03, 2020, should also nullify. While another ambiguity being that whether the stay is only for those accounts that have availed the benefit under moratorium scheme or does it apply to all borrowers.

It is pertinent to note that the SC was dealing with the entire batch of writ petitions while it passed the common order dated September 03, 2020. Hence, the ‘stay on NPA classification’ by the SC was a common order in response to all the writ petitions jointly taken up by the court. Thus, the stay order on NPA classification has to be interpreted broadly and cannot be restricted to only accounts of the petitioners or the accounts that have availed the benefit under the moratorium scheme. As per the order, the SC held that accounts that have not been declared/classified NPA till August 31, 2020, shall not be downgraded further until further orders. This relaxation should not just be restricted to accounts that have availed moratorium benefit and must be applied across the entire borrower segment.

The WP No. 825/2020 Gajendra Sharma (Supra) was disposed of by the SC in its judgment dated November 27, 2020[4], whereby in the petition, the petitioner had prayed for direction like mandamus; to declare moratorium scheme notification dated 27.03.2020 issued by Respondent No.2 (RBI) as ultra vires to the extent it charges interest on the loan amount during the moratorium period and to direct the Respondents (UOI and RBI) to provide relief in repayment of the loan by not charging interest during the moratorium period.

The aforesaid contentions were resolved to the satisfaction of the petitioner vide the Ex-gratia Scheme dated October 23, 2020. However, there has been no express lifting of the stay on NPA classification by the SC in its judgment. Hence, there arose a concern relating to the nullity of the order dated September 03, 2020.

The other writ petitions were listed for hearing on December 02, 2020, by the SC via another order dated November 27, 2020[5]. Since then the case has been heard on dates 02, 03, 08, 09, 14, 16, and 17 of December 2020. The arguments were concluded and the judgment has been reserved by the SC (Order dated Dec 17, 2020[6]).

As per the live media coverage of the hearing by Bar and Bench on the subject matter, at the SC hearing dated December 16, 2020[7], the advocate on behalf of the Indian Bank Association had argued that:

“It is undeniable that because of number of times Supreme Court has heard the matter things have progressed. But how far can we go?

I submit this matter must now be closed. Your directions have been followed. People who have no hope of restructuring are benefitting from your ‘ don’t declare NPA’ order.“

Therefore, from the foregoing discussion, it could be understood that the final judgment of the SC is still awaited for lifting the stay on NPA classification order dated September 03, 2020.

Interim Dilemma

While the judgment of the SC is awaited, and various issues under the pending writ petitions are yet to be dealt with by the SC in its judgment, it must be reckoned that banking is a sensitive business since it is linked to the wider economic system. The delay in NPA classification of accounts intermittently owing to the SC order would mean less capital provisioning for banks. It may be argued that mere stopping of asset classification downgrade, neither helps a stressed borrower in any manner nor does it helps in presenting the true picture of a bank’s balance sheet. There is a risk of greater future NPA rebound on bank’s balance sheets if the NPA classification is deferred any further. It must be ensured that the cure to be granted by the court while dealing with the respective set of petitions cannot be worse than the disease itself.

The only benefit to the borrower whose account is not classified NPA is the temporary relief from its rating downgrade, while on the contrary, this creates opacity on the actual condition of banking assets. Therefore, it is expected that the SC would do away with the freeze on NPA classification through its pending judgment. Further, it is always open for the government to provide any benefits to the desired sector of the economy either through its upcoming budget or under a separate scheme or arrangement.

THE VERDICT

[Updated on March 24, 2021]

The SC puts the final nail to almost a ten months long legal tussle that started with the plea on waiver of interest on interest charged by the lenders from the borrowers, during the moratorium period under COVID 19 relief package.  From the misfortunes suffered by the people at the hands of the pandemic to economic strangulation of people- the battle with the pandemic is still ongoing and challenging. Nevertheless, the court realised the economic limitation of any Government, even in a welfare state. The apex court of the country acknowledged in the judgment dated March 23, 2020[8], that the economic and fiscal regulatory measures are fields where judges should encroach upon very warily as judges are not experts in these matters. What is best for the economy, and in what manner and to what extent the financial reliefs/packages be formulated, offered and implemented is ultimately to be decided by the Government and RBI on the aid and advice of the experts.

Thus, in concluding part of the judgment while dismissing all the petitions, the court lifted the interim relief granted earlier- not to declare the accounts of respective borrowers as NPA. The last slice of relief in the judgement came for the large borrowers that had loans outstanding/sanctioned as on 29.02.2020 greater than Rs.2 crores. The court did not find any rationale in the two crore limit imposed by the Government for eligibility of borrowers, while granting relief of interest-on-interest (under ex-gratia scheme) to the borrowers.[9] Thus, the court directed that there shall not be any charge of interest on interest/penal interest for the period during moratorium for any borrower, irrespective of the quantum of loan. Since the NPA stay has been uplifted by the SC, NBFCs/banks shall accordingly start classification and reporting of the defaulted loan accounts as NPA, as per the applicable asset classification norms and guidelines.

Henceforth, the CIC reporting of the defaulted loan accounts (NPA) must also be done. Surely, the said directions of the court would be applicable only to the loan accounts that were eligible and have availed moratorium under the COVID 19 package. [10]

The lenders should give credit/adjustment in the next instalment of the loan account or in case the account has been closed, return any amount already recovered, to the concerned borrowers.

Given that the timelines for filing claims under the ex-gratia scheme have expired, it is expected that the Government would be releasing extended/updated operational guidelines in this regard for adjustment/ refund of the interest in interest charged by the lenders from the borrowers.

 

 

[1] http://vinodkothari.com/2020/09/moratorium-scheme-conundrum-of-interest-on-interest/

[2] http://vinodkothari.com/2020/10/interest-on-interest-burden-taken-over-by-the-government/#:~:text=Blog%20%2D%20Latest%20News-,Compound%20interest%20burden%20taken%20over%20by%20the%20Central%20Government%3A%20Lenders,pass%20on%20benefit%20to%20borrowers&text=Of%20course%2C%20the%20scheme%2C%20called,2020%20to%2031.8.

[3] https://main.sci.gov.in/supremecourt/2020/11127/11127_2020_34_16_23763_Order_03-Sep-2020.pdf

[4] https://main.sci.gov.in/supremecourt/2020/11127/11127_2020_34_1_24859_Judgement_27-Nov-2020.pdf

[5] https://main.sci.gov.in/supremecourt/2020/11127/11127_2020_34_1_24859_Order_27-Nov-2020.pdf

[6] https://main.sci.gov.in/supremecourt/2020/11162/11162_2020_37_40_25111_Order_17-Dec-2020.pdf

[7] https://www.barandbench.com/news/litigation/rbi-loan-moratorium-hearings-live-from-supreme-court-december-16

[8] https://main.sci.gov.in/supremecourt/2020/11162/11162_2020_35_1501_27212_Judgement_23-Mar-2021.pdf

[9] Compound interest burden taken over by the Central Government: Lenders required to pass on benefit to borrowers – Vinod Kothari Consultants

[10] Moratorium on loans due to Covid-19 disruption – Vinod Kothari Consultants; also see Moratorium 2.0 on term loans and working capital – Vinod Kothari Consultants

 

 

Tailoring still to fit: CSR Law continues to evolve with contemporary needs

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Vinod Kothari and Smriti Wadhera

corplaw@vinodkothari.com

As the CSR framework moves from ‘comply or explain’ principle to the rule of ‘comply or pay penalty’, we see how the CSR provisions in India have uniquely evolved over the years. On one side while there is penalty, on the other side, there is motivation – prominently in the form of an extended list of activities which can qualify for CSR. The article covering CSR in detail was published in the November 2020 edition of Chartered Secretary of the Institute of Company Secretaries of India.

 

Our other related material on CSR can be accessed through below link:

Knowledge Centre for Corporate Social Responsibility (CSR)

 

FAQs on CSR 2021 Amendments

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FAQs on CSR 2021 Amendments

[These FAQs pertain to the amendments made vide the Companies (Amendment) Act, 2020 and the Companies (Corporate Social Responsibility Policy) Amendment Rules, 2021. These FAQs need to be read with our FAQs on CSR]

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PPT on Corporate Social Responsibility 2021- Amendments

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Updated as on 2nd May, 2022

Our other related content:

  1. CSR –“comply or suffer” provisions made effective:http://vinodkothari.com/2021/01/csr-comply-or-suffer-provisions-made-effective/
  2. Snapshot of CSR Amendment Rules, 2021:http://vinodkothari.com/2021/01/32315/
  3. Enforcement Status of Companies (Amendment) Act, 2020:http://vinodkothari.com/2020/12/enforcement-status-of-companies-amendment-act-2020/
  4. Presentation on Unspent CSR & role of implementing agencies:https://vinodkothari.com/2021/09/35882/

IBC Passes Another Test of Constitutionality

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SC upholds the IBC Amendment Act, 2020

-Megha Mittal

Ishika Basu 

(resolution@vinodkothari.com)

In view of the rising need to fill critical gaps in the corporate insolvency framework like last-mile funding and safeguarding the interests of resolution applicants, certain amendments were introduced by way of the Ordinance dated 28.12.2019[1], which were later on incorporated in the Insolvency Bankruptcy Code (Amendment) Act, 2020 (“Amendment Act”). The amendments inter-alia introduction of threshold for filing of application by Real-Estate Creditors, colloquially ‘Home-Buyers’ and section 32A for ablution of past offences of the corporate debtor, were made effective from 28.12.19 i.e. the date of Ordinance.

While the Ordinance introduced several amendments[2], clarificatory as well as in principles, apprehensions were raised against proviso to section 7 (1), that is, threshold for filing of application by Home-Buyers, the ablution provision introduced by way of section 32A, and clarification under section 11 dealing with the rights of a corporate debtor against another company. As such, various writ petitions were filed under Article 32 of the Constitution, alleging that the aforesaid amendments were in contravention of the fundamental rights viz.  Article 14 which deals with the equality before law and equal protection of law; Article 19(1)(g) deals with fundamental right to trade, occupation, and business; and Article 21 deals with the right to life and personal liberty.

Now, after a year of its effect, the Hon’ble Supreme Court vide it order dated 19.01.2021, in Manish Kumar V/s Union of India, upheld the constitutional validity of the third proviso to section 7(1) and section 32A, setting aside all apprehensions against their insertion.

In this article, the Authors analyses the order of the Hon’ble Supreme Court, with respect to the threshold on filing of application by real-estate creditors, and section 32A.

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CSR –“comply or suffer” provisions made effective

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CSR Policy Amendment Rules, 2021 brings plethora of other changes

PCS Nitu Poddar, Senior Associate, Vinod Kothari & Company

Introduction

The long pending amendment brought in the provisions of section 135 of Companies Act, 2013 dealing with Corporate Social Responsibility (“CSR”), implementation of which was pending for want of respective amendment in the Rules, has finally been made effective on and from January 22, 2021[1] along with amendment in the CSR Policy Rules, 2021[2].

With the coming into force of this amendment, the penal provisions for non-compliance CSR provisions have also come into force, changing the very nature of the CSR provisions from “comply or explain” to “comply or suffer”. Pursuant to the amendment, the companies are now required to do either of the following: (i) spend the required amount for CSR activities as prescribed under schedule VII or (ii) park the unspent amount of ongoing projects in a separate account within 30 days of the end of financial year or (iii) transfer unspent amount to such funds as mentioned in Schedule VII viz. Clean Ganga Fund or PMNRF or like within 6 months of the end of financial year.

Further, the amendment in the Rules are not just limited to the changes made in the section, rather, it extends to make substantial changes in the implementation of the entire CSR activity. Infact, couple of fresh concepts have also been introduced in the Rules like registering of implementing agencies by filing e-form CSR-1 with the MCA, CFO certificate, mandatory impact assessment.

In this write up, we discuss the impact of the significant changes made in the CSR Rules by the MCA.

Negative attributes of what will not be considered as “CSR”

A list of 6 items have been mentioned in the negative attributes of what would not include to be a CSR expenditure. This includes:

  1. Activities undertaken in normal course of business;
    1. [3]Exclusion for three year till FY 2022-23, in case companies do expense for R&D activity of vaccine/ drugs/ medical devices related to covid-19, to such companies which are engaged in R&D activity of new vaccine, drugs and medical devices in their normal course of business. This exclusion will be allowed only in case the companies are doing such R&D in collaboration with organisations as mentioned in item (ix) of schedule VII and disclose the same in their board’s report.
  2. Activity undertaken outside India;
    • Excluded – training of Indian sports personnel representing any State or Union territory at national level or India at international level
  3. Contribution to political party under section 182;
  4. Activities benefitting the employees[4] only;
    • In case the activity is intended to provide generic benefit to the public and large and the employees also get benefited in the process, the Rule does not intend to discard such activity as a CSR activity. The idea is that the companies should not come out with activities where the employees are the only intended beneficiaries.
    • It should also be noted that the definition of employee has been referred from Code on Wages which is quite wide.
    • In the draft rules, it was proposed that the activities which have less than 25% employees shall be deemed to be CSR activity. This proposal has been dropped in the final Rules.
  5. Sponsorship activities which help the company in deriving marketing benefits;
    • This was always deemed, however, now have been made absolutely clear that sponsorship / marketing activities cannot be classified as CSR expenditure.
  6. Activities carried out for fulfiling statutory obligation[5].

This is not a new provision added; this infact was anyway covered under Rule 4 and FAQ of CSR by MCA. from where it has been replaced in the definition clause.

Definition of CSR Policy

The definition of CSR Policy focuses on the role of board towards CSR Policy which has to be prepared taking into account the recommendation of the CSR Committee. It is clear from the amendments that unlike the current prevalent practice where several companies simply picks and choose any activity under schedule VII as a CSR activity, the government intends the Board of companies to have a more thoughtful approach towards undertaking CSR activity. The new definition seems to require the board to do a strategic planning with respect to CSR activity to be undertaken by the company. It requires the Policy to have approach and direction of Board along with guiding principles for selection, implementation and monitoring of the CSR activities undertaken by the companies. This apart, the Policy should also contain annual action plan.

This change may require the companies to revisit their existing CSR Policy soonest so that the same may be placed in the upcoming CSR and Board meeting.

Defining “ongoing projects”

As per the amendment in section 135, unspent amount, if any, for ongoing projects, may be parked in a separate bank account for three years and is not required to be transferred to the Fund. The definition of ongoing projects have been defined in the Rules. As per the definition:

  1. The ongoing project can be a program of maximum 4 years (including the first year of commencement); – mere one-time spending surely cannot be a “project”. It requires continued expenditure over time.
  2. “Year” would surely mean financial year. Therefore if say a project has been commenced in the month of February, 2020, the three FY therefrom, will be FY 2022-2023.
  3. Year wise allocation will have to be made
  4. Basis reasonable justification, a bullet program can also be converted to an ongoing project by the board of directors

While the timeline of 4 years at one go has been provided, the gaps seems to be two-fold:

  1. What about the projects which may take longer than 4 years; so as to keep a close check on India Inc., seems like the govt. intends the companies to make budgets for 4 years and either implement it or transfer amount to the National CSR account.
  2. Can such projects be extended after completion of the 4 years? – to our mind, the answer to this seems to be positive.

Modes of implementing CSR activities

So far, a section 8 company, trust, or a society, having track record of three years in carrying out similar activity were qualified to be an implementing agency. Several amendments have been brought in the provisions relating to implementing agencies:

  1. On and from April 1, 2021, companies can undertake CSR activity only through implementing agencies which are registered with MCA; – it seems that the MCA is intending to govern the third leg of the economy which consist of not for profit organization by requiring registration of these entities
  2. Registration has to be done by filing e-form CSR-1 with MCA, post which the implementing agencies will receive a unique CSR Registration Number. This e-form has to be verified by a practicing CA/ CS/ CWA;
  3. Following entities can only apply for such registration:
    • Established by the company either singly or jointly with other company – Section 8 company, registered public trust, registered public society (not private), registered under section 12A and 80G of the Income Tax Act, 1961;
    • Established by the Government – Section 8 company, registered trust (here both public and private), registered public society;
    • Established under an Act of Parliament or State Legislature – any entity;
    • Established by anyone – Section 8 company, registered public trust, registered public society (not private), registered under section 12A and 80G of the Income Tax Act, 1961; having track record of atleast three years in undertaking similar activities.

Mandatory registration of implementing agency with the MCA

As mentioned above, this is a fresh introduction. The template of the e-Form is present in the rules. Also, this would mean that, entities will not be hired as implementing agencies until they register themselves.

Role of International Organisation

The Rules prescribe that companies may engage international organisations for designing, monitoring and evaluation of the CSR projects or programmes as per its CSR policy as well as for capacity building of their own personnel for CSR. The provision, using the word “may”, is directory and not mandatory. Accordingly, companies can take a call to appoint any other entity to undertake the prescribed overhead jobs in respect of CSR. In any case, the threshold allowed as administrative overhead will be applicable,

In the draft rules, it was proposed that the companies may also undertake CSR activities through International Organisations, making them one of the implementing agencies, with the prior permission of the central government, however, this proposal has been dropped in the final rules.

Board responsibility and CFO certification

This is an extremely important amendment. In addition to the monitoring by the board, it requires the CFO or alike to give utilisation certificate of the disbursements made. This makes the role of monitoring all the more crucial. This apart the, CFO will also be required to sign the annual CSR report.

This clause makes the CFO apparently responsible for the entire CSR provision without him being part of the CSR committee or the board of directors. Probably, such certificate shall have to be placed before the CSR committee and / or the board – the draft rules are silent on this.

CSR Committee – responsibility to recommend annual action plan

This seems to be another immediate actionable on part of the Committee.  While annual budget and areas of activities was being recommended by the CSR Committee, however, the manner of execution was something that was currently being decided by the board. Also, practically speaking, there used to be one of meeting of CSR in several cases in which the allocating of budget for next FY and approving and signing of the report of last FY used to be done.

However, as per the amendment, the committee is required to draw a detailed annual action plan to undertake CSR program. The amendment rules are clear to indicate the intension of the government which is in full mood to get the management on their heels for effective implementation of the CSR provisions along with ensuring that such spent is making impact in the society.

Mandatory CSR impact assessment

The High Level Committee on CSR[6] highlighted importance of the need and impact assessment for projects with higher outlays. This will help in bringing forth the areas requiring more attention, for there development.

Companies having minimum 10 cr of average CSR obligation in last 3 years shall have to undertake mandatory impact assessment. Interestingly, the report of such assessment is required to be formed a part of the annual report.

There are several question around this:

  1. who does this assessment ? surely, the govt acknowledges that an outside entity can also be engaged for such assessment and therefore there is increased limits of allowed overhead expenditure for such companies who are mandatorily required to undertake such assessment
  2. also, it is to be noted that the CSR report as mentioned in the annexure, includes surplus from CSR in the total CSR obligation; – will this mean that where there is extraordinary surplus, compliance of this provision becomes applicable because of surplus ? it may in such cases prove to be waste of resources

Surplus out of CSR program

Though it may seem to be amendment in this provision, however, there is no effective change. The surplus out of CSR activity was anyway prohibited to form part of business profits of the Company. This is just an explicit clarification to say that it has to be used back for CSR purpose only – either the same program from which such surplus has been generated or any other project as per CSR policy of the company.

Such surplus is required to be transferred to the unspent account within 6 months from the end of financial year.

Title holder of CSR assets

This is another important proposal which says that any capital asset acquired / created for the purpose of CSR has to be in the name of only a section 8 company or a registered public trust or registered society having CSR registration Number and cannot be held in the name of the company itself. Considering the quantum of CSR spent being carried through in-house foundations, this is a very substantial change and will lead to revisit the plan of CSR activity.

180+90 days (extension with reasonable justification) time has been proposed for the compliance of this provision.

Unspent amount of ongoing projects to be transferred to Unspent CSR Account

Since the provisions are applicable from January 22, 2021, any amount that remains unspent on ongoing project in FY 2020-21 will have to be transferred to separate account within 30th April, 2020.

Additional disclosures on the website of the company

This is again an important proposal for the companies which have / are required to have a functional website. This requires the companies to inter alia mandatorily disclose the CSR projects approved by the board. So far, this was only known from the annual report much after the end of the FY. This proposal indicates that the board will have to make a thought-through plan on the recommendation of the CSR Committee as the same will be displayed on its website and therefore cannot be changed as per the whims and fancies of the board.

This will also put check on the random on-off / philanthropic acts of the promoters which currently is, in many cases, being converted to CSR spent.

Annual CSR Report

There are several additional details required in the report which is by and large in line with the additional requirement.

It may be noted that requirement of CIN of implementing agencies will be applicable for section 8 companies only.

Conclusion

While the amended rules are quite technical, considering the intent of CSR, it should be broadly principle based then laden with heavy rules and the CSR committee could be laden with the onus of compliance of the provisions in such case.

In any case, the mind of the government seems to be loud and clear that gone are those days when the companies used to take the CSR provisions lightly by putting cliché explanations in the annual report for all the gaps for unspent amount. One cannot ignore that, as per CARO-2020, the auditor is also required to comment on the CSR provisions specifically with respect to the amount unspent and whether transferred to the unspent account.

 

Read our other article on subject:

  1. Proposed changes in CSR Rules, click here
  2. Draft CSR Rules Make CSR More Prescriptive, click here
  3. CAB, 2020: Bunch of Proposals for revamping CSR Framework, click here

Our presentation on Unspent CSR & role of implementing agencies can be viewed here – https://vinodkothari.com/2021/09/35882/

To access various web-lectures, webinars and other useful resources useful for the Corporate and Financial sector, visit our Youtube channel: https://www.youtube.com/channel/UCgzB-ZviIMcuA_1uv6jATbg

 

[1] https://www.mca.gov.in/Ministry/pdf/CSRHLC_13092019.pdf

[1] Companies CSR Policy Amendment Rules, 2020. W.e.f 24.08.2020 – http://egazette.nic.in/WriteReadData/2020/221325.pdf

[2] “employee” means, any person (other than an apprentice engaged under the Apprentices Act, 1961), employed on wages by an establishment to do any skilled, semi-skilled or unskilled, manual, operational, supervisory, managerial, administrative, technical or clerical work for hire or reward, whether the terms of employment be express or implied, and also includes a person declared to be an employee by the appropriate Government, but does not include any member of the Armed Forces of the Union;

[3] MCA FAQ- Q3: http://www.mca.gov.in/Ministry/pdf/General_Circular_21_2014.pdf

[1] MCA Notification for effecting amendment brought vide Companies (Amendment) Act, 2019: http://egazette.nic.in/WriteReadData/2021/224636.pdf

MCA Notification for effecting amendment brought vide Companies (Amendment) Act, 2020: http://egazette.nic.in/WriteReadData/2021/224637.pdf

[2] CSR Policy Amendment Rules, 2021: http://mca.gov.in/Ministry/pdf/CSRAmendmentRules_22012021.pdf

Draft CSR Policy Amendment Rules, 2020 dated March 13, 2020: http://feedapp.mca.gov.in/csr/pdf/draftrules.pdf

 

Scalar regulatory framework for the NBFC sector

/0 Comments/in /by

-Financial Services Division (finserv@vinodkothari.com)

RBI has issued the Revised Regulatory Framework for NBFCs, effective from October 1, 2022. Highlights of prescribed framework can be accessed at this link.

Introduction

Systemic risk of NBFCs has been an issue for discussion, specifically in India as there have been some major NBFC failures, and the issue of inter-connectivity between NBFCs and the rest of the financial sector became clearly evident[1]. The issue is not limited to India -globally, an annual publication of the Financial Stability Board, called Global Monitoring Report on Non-banking Financial Intermediation[2] has been drawing attention to the increasing relevance of non-banking financial intermediaries and the risk they pose.

The RBI had, in its Statement on Development and Regulatory Policies dated December 4, 2020[3], highlighted a need to review the regulatory framework in line with the changing risk profile of NBFCs. The NBFC sector has witnessed various changes in the regulatory framework in the past few years, making it more comprehensive. However, the tremendous growth in the sector combined with regulatory arbitrage enjoyed by the NBFCs is now leading to a systemic risk. Hence, the regulators have thought it necessary to tighten the regulatory norms for NBFCs holding a major chunk of market share.

In line with the aforesaid announcement, the RBI released a Discussion Paper on January 22, 2021[4] seeking inputs from industry participants. The following write-up analyses the major propositions made by the RBI.

Highlights of the New Regulatory Framework

  • 4 layers of regulatory intensity – progressively from bottom – BL, ML, UL, and TL, Base layer (BL) to be systematically non-significant entities, with light touch regulation. Some entities like Type 1 NBFCs (those without public interface or public funds) will always remain in the Base layer, seemingly irrespective of size. ML to consist of the systemically important NBFCs. From ML, 20-25 entities to be selected for tighter supervision, based on indicia of higher systematic risk. TL is empty by default, but to be populated only on exercise of supervisory discretion for extreme risks.
  • Monetary threshold for systematic significance to be revised upwards from Rs 500 crores to Rs 1000 crores
  • Aims at eliminating regulatory arbitrage at Layer 2 (ML) and above; seeks to align regulatory framework at ML with banks.
  • Layer 3 (UL) is a new regulatory layer; regulations expected to be at par with banks.
  • UL classification is not something that would take the NBFC by surprise; the decision to be put into the category will be communicated in advance with an opportunity to manoeuvre and come out the classification
  • Entry-point requirement for new NBFC registrations to be increased 10 times, from Rs 2 crores to Rs 20 crores. Existing NBFCs to be given a timeframe, say, 5 years to measure up.
  • NPA norms for BL NBFCs (currently, the NSI category) to be made 90 days instead of 180 days as of now
  • At least one of the directors of the NBFCs to be a person with retail lending experience.
  • ICAAP to be applicable to NBFC-ML and above.
  • Auditor rotation after 3 years, appointment of a Chief Compliance Officer, managerial compensation controls, and several disclosure requirements to be imposed on ML entities.
  • Concentration limits: Board-imposed caps on sectoral exposure; IPO financing limits, self-imposed real estate exposure – proposed for ML entities
  • Core Banking Solution be adopted by NBFCs with 10 or more branches
  • Upper Layer to consist of 25-30 entities selected from a sample of about 50 entities, based on scoring methodology, indicating distinctive systemic risk. 9% Common Equity Tier to be prescribed for these entities. Additionally, leverage limits may also be imposed.
  • Differential provision for standard assets to prescribed for UL entities
  • Mandatory listing, managerial remuneration controls, etc to be prescribed for UL entities
  • Top layer to be similar to protective framework in case of banks: Higher capital charge, capital conservation buffer

Regulatory arbitrage: The concern behind present regulatory proposal

The operational flexibility provided to NBFCs has enabled them to assume a scale that would potentially impact systemic stability. In recent years, the regulator has identified structural arbitrage and prudential arbitrage between banks and NBFCs. While the former emanates from differences in legislative and licensing framework like net owned funds, branch approval requirements etc., the latter is concerning CRAR, prescribed leverage, liquidity guidelines etc.

There also exists some relaxation in corporate governance and disclosure norms for NBFCs in comparison to banks such as instructions on compensation policy for WTD/CEOs/Risk Control Staff and most of SCB being listed and thus abiding by the listing requirement.

NBFCs have become more interconnected with the financial system. Linkages are due to the substantial exposure that banks have in NBFCs. As per the Financial Stability Report of January 2021, NBFCs were the largest net borrowers of funds from the financial system. The  gross payables and receivables stood around ₹9.37 lakh crore and ₹0.93 lakh crore as at end-September 2020.[5] More than half of this funding was supported by scheduled commercial banks (SCBs) followed by Asset Management Companies-Mutual Funds (AMC-MF) and Insurance Companies. Further the Discussion Paper noted that there are seven NBFCs (including HFCs) each having asset size exceeding 1 lakh crore and above.

The unconstrained growth of the NBFC sector in addition to the lenient regulatory framework within an interconnected financial system may sow the seeds of systemic risk. In the present scenario, failure of any large and deeply interconnected NBFC is capable of transmitting shocks into the entire financial sector and causing disruption even to the operations of the small and mid-sized NBFCs.

Classification of NBFCs by scale of activities, risks and size

The proposed framework provides for the regulation on scale based approach. This essentially means that regulatory and supervisory resources are to be more focused on the entities which have become too-big-to-fail (TBTF) owing to their systemic interconnectedness with other financial market participants. The degree of regulation is to be based on ‘principle of proportionality’. The three triggers of scale based regulation are:

  • Risk perception: This parameter is based on size, leverage and interconnectedness of the NBFC with market participants in terms of prescribed threshold.
  • Size of operations: The size of the balance sheet of an NBFC beyond a certain prescribed high threshold would be an important independent factor in determination of regulation.
  • Nature of activity – Just by performing financial activity cannot give rise to systemic risk. Like Type 1 NBFCs which do not access public deposits and neither have customer interfaces are to be regulated with light touch. The essence of such form of NBFCs is that the financial activity is being carried out by net-owned funds. However some activities are regarded as high risk owing to their systemic connectivity and business model. The draft paper categorises NBFC-HFC, IFC, IDF, SPD and CIC as they are interconnected with other financial institutions while performing credit intermediation.

The RBI has proposed a scale-based four-layered structure regulatory framework–viz. Base Layer (NBFC-BL), Middle Layer (NBFC-ML), Upper Layer (NBFC-UL) and Top Layer. The classification of layers is made commensurate to the regulatory intervention required- i.e. the base layer having the least regulatory intervention and the intervention increasing as the one moves up the pyramid. The proposed categorisation/classification as provided in the discussion paper is summarized in the fig below.

 

Interestingly, CICs are poised to be put under greater scrutiny- this is possibly the regulatory reaction to a recent NBFC default. CICs are proposed to be regarded as Middle Layer NBFC (NBFC-ML) along with NBFCs currently classified as systemically important NBFCs (NBFC-ND-SI), deposit-taking NBFCs (NBFC-D), HFCs, IFCs, IDFs, SPDs. Though CICs and SPDs will fall in the Middle Layer of the regulatory pyramid, the existing regulations specifically applicable to them, will continue to apply. However, a pertinent question for discussion would be whether the activity-based classification of NBFC-AA, P2P, NOFHC in Lower Layer and NBFC-HFC, IFC, IDF, CIC and Standalone Primary Dealers in Middle Layer justified.

Increased NOF & harmonisation of NPA recognition

Further, NOF is proposed to be raised to Rs. 20 crores. Further, in order to ensure a smooth transition, a well-defined timeline will be prescribed by the RBI for existing NBFCs, spanning over a period of, say, five years. For new registrations, the higher NOF norms will get implemented immediately on the issue of instructions.

NPA recognition based on 90 DPD will be extended to all NBFCs including those which are not systemically important.

Recognition of NBFCs in Upper Layer

NBFC categorisation is based on annual review. The paper recognises two parameters; quantitative and qualitative:

  • The quantitative parameters will have 70% weightage.
  • The qualitative parameters will have 30% weightage.

The table below represents quantitative and qualitative parameters as proposed:

Parameter Sub-parameter Sub weight Weights
Quantitative Parameters (70%)
Size & Leverage Size: Total exposure (on-and off-balance sheet)

 

Leverage: total debt to total equity

 20+15 35
Interconnectedness i) Intra-financial system assets:

–        Lending to FIs

–        Securities of other FIs

–        Mark to market REPO

–        OTC derivatives

 

ii) Intra-financial system liabilities

 

–        Borrowings from FIs

–        Marketable securities issued by finance company to FI

–        Mark to market OTC derivative with FIs

iii) Securities outstanding (issued by NBFC)

 10

 

 

 

 

 

10

 

 

 

 

 

 

5

 25

 

 

 

 

 

 

 

 

 

 

 

 
Complexity i) Notional amount of OTC derivatives

–        CCP centrally

–        Bilateral OTC

 

ii) Trading and available for sale securities

 5

 

 

 

 

5

 10
Qualitative Parameters/Supervisory inputs (30%)
Nature and type of liabilities –        Degree of reliance on short term funding

–        Liquid asset ratios

–        Callable debts

–        Asset backed funding Vs. other funding

–        Asset liability duration and gap analysis

–        Borrowing split (secured debt, CCPS, CPs, unsecured debt)

 10 30

 

 

 

 

 

 

 

 

 
Group Structure –        Total number of entities

–        Total number of layers

–        Total intra-group exposure

 10
Segment Penetration Importance of NBFC as a source of credit in a specific segment or area 10

The scoring will be done on a sample basis, by dividing the individual NBFCs amount by the aggregate sum of all the indicators in the sample. The score for each category will be converted into basis points and the overall systemic significance score will be based on the relative importance of the NBFC compared with other NBFCs in the sample.

The sample criteria for the purpose of above parameter based measurement is to be as follows:

  • Excluding the top 10 NBFCs (based on asset size) as they will automatically fall in upper layer regulation.
  • The sample will include next 50 NBFCs based on total exposure (including off balance sheet)
  • NBFCs designated as NBFC-UL in previous year
  • NBFCs added to sample by supervisors judgement

For leverage calculation the individual score of NBFC is to be divided by average leverage of the sample. A NBFC-UL will be subjected to enhanced regulatory requirements similar to that of banks at least for a period of four years from its last appearance in the category, even where it does not meet the parametric criteria in the subsequent year.

NBFCs in Base Layer

The base layer would cover NBFCs with asset size upto Rs 1000 crores. The major propositions for this layer are provided in the table below:

Proposals for NBFCs in Base Layer
1. The current regulations require NPA classification of the asset having more than 180 DPDs the same is proposed to be reduced to 90 DPDs in order to bring it in sync with the regulatory guidelines for other classes of NBFCs
2. The board shall be required to have –

(i)  Adequate experience and educational qualification

(ii) At least one of the directors should have experience in retail lending in a bank/NBFC
3. For the Risk Management Committee-

(i)  Overall role and responsibilities to be laid out, and

(ii) Composition could be Board or Executive level as to be decided by the Board
4. The regulations for sale of stressed assets shall be made  at par with banks once guidelines are finalized
5. Additional disclosures on type of exposures, related party transactions, customer complaints shall be prescribed

 

NBFCs in Middle Layer

Several new regulatory requirements are proposed for this category in addition to the proposals for the base layer. There are no changes proposed in capital requirements for NBFC-ML.

Proposals for NBFCs in Middle Layer
1. Board approved policy taking into account all risks for Internal Capital Adequacy Assessment shall be required.
2. The extant credit concentration limits prescribed for NBFCs for lending and investment is proposed to be merged into a single exposure limit of 25% for single borrower and 40% for group of borrowers anchored to Tier 1 capital instead of Owned Funds
3. Compulsory Rotation of auditors shall be applicable- After completion of continuous audit tenure of three years, Auditors shall not be eligible for re-appointment for a period of six years (two tenures)
4. i) Appointment of a functionally independent Chief Compliance Officer.

ii) Additional Corporate Governance and Disclosure Requirements, including requirement for Secretarial Audit.
5. It has been proposed that no KMP of an NBFC shall be allowed  hold office in any other NBFC-ML or NBFC-UL or subsidiaries, further, an Independent Director cannot be director in more than two NBFCs (NBFC-ML and NBFC-UL) at the same time
6. Board approved internal limits and adequate disclosures would be required for exposure to sensitive exposures and Dynamic vulnerability assessment by NBFCs shall be required. Sub-limit within the commercial real estate exposure ceiling should be fixed internally for financing land acquisition

 
7. Restrictions on grant of loans and advances for/to the following:

(a)  buy back of shares/ securities

(b)  activities leading to Ozone Depleting Substances

(c)  Directors and relatives of directors

(d)  Officers and relatives of Senior Officers

(e) Real Estate – only where project approvals other permissions are in place.
8. The IPO financing by NBFCs shall be capped at Rs.1 crore. There is no limit prescribed for NBFCs at present, while there is a limit of Ts. 10 lakh for banks for IPO financing.
9. Mandatory for NBFCs with more than 10 branches to have Core Banking Solution for NBFCs

NBFCs in Upper layer

In addition to the regulations applicable to NBFC-ML, a set of additional regulations will apply to NBFC-UL, they are:

Proposals for NBFCs in Upper Layer
1. CET 1 may be prescribed at 9% within the Tier I capital

In addition to the CRAR requirements, NBFCs will also be subjected to a leverage requirement
2. Differential Provisioning being similar as banks for standard assets to be made applicable
3. For Concentration norms-

(i)   Large Exposure Framework (LEF) as applicable to banks with suitable modification will apply

(ii)  Transition time for implementation
4. Corporate Governance norms to be similar lines as applicable for Private Sector Banks. Additional governance regulations such as specifying qualification of board members, providing detailed disclosure on group companies including consolidated financial position and details of related party transactions.
5. Adequate phase-in-time for mandatory listing to be provided. However, disclosure requirements will kick in earlier than actual listing within the broad implementation plan for NBFC-UL
6. Removal of Independent Director shall require supervisory approval

 

NBFCs in Top Layer

The top layer is currently empty and will get populated in case RBI takes a view that there has been an unsustainable increase in the systemic risk spill-overs from specific NBFCs in the Upper Layer. NBFCs in this Layer will be subject to higher capital charge, including Capital Conservation Buffers. There will be enhanced and more intensive supervisory engagement with these NBFCs.

Monetary threshold for systemically important NBFCs

Asset size of Rs 500 crores was stipulated a long time back for distinguishing between SI and NSI NBFCs, that is on November 10, 2014. The limits were in line with recommendations made by the Working Group on Issues and Concerns in the NBFC Sector, chaired by Smt. Usha Thorat.

After more than 6 years, the RBI proposes to increase the threshold from Rs 500 crores to Rs 1000 crores.

The inherent sense of reservation in this measure is itself evident from the data that the RBI has shared – that the number of NSI companies will go up from 9133 to 9209. That is, merely 76 companies will be taken out of the SI classification and put into BL category.

10-fold jump in entry point net worth requirement

If some people familiar with the evolution of regulatory framework for NBFCs may recall, the NOF requirement for NBFCs was Rs 25 lacs in 1990s. Then, it was increased to Rs 2 crores. The regulator is now proposing to increase the same to Rs 20 crores – a 10 fold increase. The underlying rationale is to have a stronger entry barrier, and to ensure that NBFCs have the initial capital for investing in technology, manpower and establishment. However, this sharp hike in entry point requirement will keep smaller NBFCs out of the fray. Smaller NBFCs, particularly those with geographical or sectoral focus, have been doing a useful job in financial inclusion.

Conclusion

The regulatory frame is going for a complete overhaul. While the new regulatory framework should have been expected to to smaller NBFCs out of regulatory glare, it is notable that only 76 companies are sliding down from SI status to NSI status due to the proposed change. The whole principle of scalar regulation should have been lesser entities to regulate, so that there is more attention where attention is needed. Further, the principle of scalar regulation would intuitively have more regulation at higher levels, but lesser regulation at the bottom of the pyramid. There are no apparent signals of reduced regulation at the base level. On an overall assessment, the scalar regulatory frame is a new thought process, and should be appreciated.

The video on  “Round table discussion on RBI’s proposed regulatory framework for NBFCs” can be viewed here 

 

Our Presentation on the topic can be viewed here

 

[1] See an article by Vinod Kothari, tilted Shadow Banking in India – Creating an Opportunity out of a Crisis, at http://vinodkothari.com/2020/01/shadow-banking-in-india/

[2] The 2020 Report is here: https://www.fsb.org/wp-content/uploads/P161220.pdf

[3] https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=50748

[4] https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/DP220121630D1F9A2A51415B98D92B8CF4A54185.PDF

[5] Reserve Bank of India – Reports (rbi.org.in)

Snapshot of CSR Amendment Rules, 2021

/1 Comment/in , , /by

Vinod Kothari & Company

corplaw@vinodkothari.com

Below is a short snippet of the Companies (Corporate Social Responsibility Policy) Amendment Rules, 2021

Proposed changes under the LLP Act are much more than decriminalisation

/0 Comments/in /by

More regulation for LLPs including business limitation, accounting standards and more!

By Pammy Jaiswal and Megha Saraf

corplaw@vinodkothari.com

Background

A Limited Liability Partnership (LLP) being a hybrid form of an entity has always been seen with lesser regulatory burden as compared to a company and is regulated by the Limited Liability Partnership Act, 2008 (LLP Act). Having said that, it is imperative to note that currently there are various provisions under the LLP Act that provide for levying penalty, fine and also imprisonment. The offences have been bifurcated into compoundable and non-compoundable offences as in the case of companies under the Companies Act, 2013 (CA, 2013/Act).

Further, the fact that an LLP in the course of its business can undertake debt obligations cannot be argued, however, the mode of undertaking debt obligations in the case of instruments has not been dealt with under the Act.

Continuing with the policy and intent of the Government of India to decriminalise minor and procedural non-compliances, the Ministry of Corporate Affairs (MCA) has constituted a Company Law Committee (CLC/Committee) on 18th September, 2019 with a view to revamp the LLP Act, 2008 (LLP Act) and bring necessary amendments in line with the economic scenario. The Committee was chaired by Mr. Rajesh Verma and had eminent personalities from regulatory bodies like SEBI etc.

While the main agenda for the constitution of the CLC was decriminalisation, however, when we look at the Report[1] which has been presented on 18th January, 2021 and is open for public comments till 2nd February, 2021, it is seen that it is much more than just decriminalisation.

Highlights of the Report

The proposed reforms go wide enough to confining the business of LLPs to non-financial business, creating a structure for issuance of non-convertible debentures by LLPs, having a separate classification called small LLPs with lower filing or additional fees, extending accounting standards for LLPs and decriminalisation of offences.

We shall now critically discuss the proposed reforms in detail.

 

Raising of funds through issuance of secured Non-Convertible Debentures (NCDs)

Debentures are one of the widely used instruments for raising funds. It is not only a structured mode of raising funds as it is in form of a security but also more flexible as compared to loans. As per the Act, a company can raise borrowed funds both by way of loan or issuance of debentures. However, the LLP Act has always been silent on the same.

Having said that, it is observed that the Report recommends issuance of secured NCDs only to bodies corporate and trusts which are regulated by SEBI or RBI with certain fetters as given below:

  • The LLP agreement shall have a provision in this regard and the same should have been registered with the Registrar;
  • Maintain a register of NCDs so issued in such form and manner as may be prescribed;
  • Creation of debenture redemption reserve (DRR) out of the profits of the LLP for such quantum and in such manner as may be prescribed;
  • Offer or invitation to subscribe to the secured NCDs to not more than 200 person in a financial year;
  • Payment of interest and redemption to be made in accordance with the terms of issue;
  • Filing of prescribed details about the secured NCDs so issued with the Registrar;
  • In case of failure on the part of the LLP to pay interest or redeem the NCDs, the Tribunal may direct for doing so on the basis of the application made by any or all of the NCD holders;
  • Issuance shall be made on such terms and conditions as may be prescribed;
  • Any LLP who makes a default in compliance with the provisions of the proposed insertion of section 33A, will make the partners liable for punishment with imprisonment for a term which may extend to one year or with fine which shall not be less than Rs. 2 lacs and may extend upto Rs. 5 lacs or both.

International scenario

  1. United Kingdom

The Limited Liability Partnerships (Application of Companies Act 2006) Regulations, 2009[2] specifically lays down the provisions for issuance of debentures. The provisions broadly say the following:

  • Provision to issue perpetual debentures;
  • Registration of the allotment of debentures within 2 months after the date of allotment;
  • Debentures to bearer issued in Scotland are valid and binding according to the statue of Scots Parliament Act, 1696;
  • Maintenance of register of debenture holders;
  • Right to inspect register of debenture holders and take extracts of the same;
  • Time limit for claims arising from entry in register;
  • Providing for right to debenture holder to copy of deed;
  • Providing for the liability of trustees of debentures;
  • Power to re-issue redeemed debentures;
  • Priorities where debentures secured by floating charge;
  • Deposit of debentures to secure advances

FAQs on LLPs by United Kingdom[3]

As per the FAQs, LLPs can create a charge on its assets and issue debentures. Further, para 53A.80 of the same provides that “An LLP, as it has a separate legal identity, is able to create and issue debentures to secure its borrowing”. 

Hence, the LLP Act of United Kingdom provides for issuance of Debentures by an LLP.

  1. Singapore

As per para 11 of the Fourth Schedule of the Singapore LLP Act, 2005[4], “Where a receiver is appointed on behalf of the holders of any debentures of a limited liability partnership secured by a floating charge or possession is taken by or on behalf of debenture holders of any property comprised in or subject to a floating charge, then, if the limited liability partnership is not at the time in the course of being wound up, debts which in every winding up are preferential debts and are due by way of wages, salary, retrenchment benefit or ex gratia payment, vacation leave or superannuation or provident fund payments and any amount which in a winding up is payable in pursuance of paragraph 76(6) or (8) of the Fifth Schedule shall be paid out of any assets coming to the hands of the receiver or other person taking possession in priority to any claim for principal or interest in respect of the debentures and shall be paid in the same order of priority as is prescribed by that paragraph in respect of those debts and amounts.” 

This implies that the Singapore LLP Act also allows raising of funds by way of debentures.

Related Indian laws and guidance

  1. Banning of Unregulated Deposit Schemes Act, 2019 (BUDS Act)

The Ministry of Law and Justice has laid a comprehensive mechanism to ban any unregulated deposit schemes by introducing Banning of Unregulated Deposit Schemes Act 2019 (BUDS Act). Section 2(4)(e) of the said Act stated that where a capital contribution is received by an LLP, the same is an exempt deposit.

Further, the introductory paragraph as well as Section 41 of the BUDS Act states that the said Act shall not apply to deposits taken in the ‘ordinary course of business’. While ‘ordinary course of business’ has not been defined, however, the same should be construed as  funding raised in order to carry out business operations for which the LLP has been formed since every business requires funding to operate.

  1. SEBI’s Informal Guidance[5] in the matter of Vijay Suraksha Realty LLP

In the said case, the LLP intended to raise funds through listed NCDs under the SEBI (Issue and Listing of Debt Securities) Regulations, 2008 (ILDS Regulations) and list them in the wholesale debt market. While the definition of ‘debt securities’ as per ILDS Regulations covered such securities issued by an LLP by virtue of it being a body corporate, however, the definition of ‘Issuer’ specifically covered company, public sector undertaking or any statutory corporation.

While the said informal guidance discussed on the issue of listed NCDs, it nowhere discussed or stated regarding any restriction in the LLP Act to issue NCDs.

VKC Comments

The Report states that an LLP Act can contract debt, however, the LLP Act along with the allied Rules do not permit the LLPs to raise funds. While the Report talks about the restriction on issuance of NCDs, however, it is significant to note that the LLP Act and the rules are silent on the same. Accordingly, in the absence of any express restriction for the said matter, construing that the same tantamount to a restriction is not correct in our view.

The Report also focuses on the fact that it is important to boost the debt market in India and allow LLPs to raise funds by issuance of NCDs. Further, in order to protect investors’ interests and to prevent any fraudulent misuse of funds, such issuance will be allowed to be made only to SEBI or RBI regulated entities thereby prohibiting any issuance to retail investors. While this is a welcome move to insert an express provisions for enabling and at the same time regulating the issuance of NCDs by an LLP, however, the following things should also be considered at the time of bringing the final changes in the law:

  • Change to be prospective – This change in law is expected to be prospective and not retrospective considering the fact that the existing set of laws was silent on the same. If the same is made retrospective, it may have serious consequences to those LLPs which have actually raised funds in the form of NCDs based on the existing text of the LLP Act and allied rules.
  • Allowing issuance of NCDs to individuals – The intent of proposed change is very clear to allow issuance of NCDs by LLPs and at the same time protect the interest of the investors. Having said that, it can be noted that the Act allows issuance of NCDs to all categories of investors including the individuals along with certain conditions or fetters. Similarly, allowing LLPs to issue NCDs to retail investors with several safeguards should also be allowed considering that an LLP may not always have the outreach to the regulated investors. In the absence of such outreach, the proposed change may fall short of meeting its intent.


Introduction of Small LLPs

The CA, 2013 provides for the concept of small companies. Such small companies enjoy several privileges under the CA, 2013 such as reduced no. of board meetings, preparation of concise board’s report, lesser penalties, concise financial statements etc. The rationale behind such relaxations/ privileges is to promote ease of operations by small companies or MSMEs.

With similar intent, the CLC Report has proposed the introduction of small LLPs. Such a provision will facilitate lesser compliances, lesser fee or additional fees for small LLPs.

The proposed definition of small LLPs will be based on contribution and turnover not exceeding 25 lacs or 40 lacs respectively, or such higher amount as may be prescribed. Such small LLPs will be able to enjoy several privileges such as:

  • Reduced filing fees;
  • Lesser compliances;
  • Lesser additional fees;
  • Lesser penalties;
  • Accounting Standards for only certain class of LLPs mainly engaged in manufacturing LLPs

The same will reduce cost of compliances and will facilitate business by MSMEs/ small LLPs.

Confinement of business activities

The LLP Act does not prohibit an LLP from carrying out a particular business activity. However, it has been seen that RBI has raised concerns on an LLP carrying out non-banking financial activities. The Report has discussed that RBI is not the regulator of LLPs and hence, should not be regulating non-banking financial activities of an LLP.

Considering the same, the Report has proposed insertion of a new proviso wherein the definition of ‘business’ comes with a proviso. This proviso gives the power to the Central Government to include or exclude any business activities by way of a Notification.

Express restriction proposed for merger of LLPs with a company

The CLC Report has also placed a proposal to restrict any amalgamation of an LLP with a company by amending Section 62 of the LLP Act.

Since, an LLP is also a body corporate hence, putting such restriction on amalgamation of a body corporate with another body corporate does not seem to be a welcome move.

Decriminalisation of offences

The CLC has recommended various offences to be decriminalized and to be shifted to the In-house Adjudication Mechanism. Similar to the CA, 2013, where several provisions have been decriminalized both either by amending the CA, 2013 or by Companies (Amendment) Act, 2020. The motive behind the same is to de-clog the courts or the NCLTs thereby reducing their burden from non-serious matters. A list of the offences decriminalized are as follows:

  1. Section 9- Changes in Designated Partners
  2. Section 10- Punishment for contravention of section 7,8 and 9
  3. Section 13- Registered office of limited liability partnership and change therein
  4. Section 21- Publication of name and limited liability
  5. Section 25- Registration of changes in partners
  6. Section 34- Maintenance of books of account, other records and audit, etc.
  7. Section 35- Annual Return
  8. Section 60- Compromise, or arrangement or limited liability partnerships
  9. Section 62- Provisions for facilitating reconstruction or amalgamation of limited liability partnerships
  10. Section 74- General penalties

 

Introduction of In-house Adjudication Mechanism (IAM)

In order to ease out and de-clog the Courts, various offences have been proposed to be decriminalized and brought under the In-house Adjudication Mechanism (IAM), similar to the CA, 2013. The CLC Report has introduced Section 77A in the LLP Act thereby enabling the Central Government to appoint officers for adjudging penalty under the provisions of the LLP Act.

Reduction in filing fees

Section 69 of the LLP Act deals with the provisions of additional fee on delayed filings of documents/ returns of the LLPs. There are situations when the returns/ documents are not filed timely due to technical glitches. The Report also proposes reduced additional fees in cases of delayed filings which will facilitate ease of doing business. Further, the introduction of reduced additional fees in case of small LLPs will incentivize the operations of such LLPs.

Introduction of accounting standards

As per the extant provisions in the law, in absence of any specific provision, LLPs are required to comply with the Generally Accepted Accounting Principles (GAAP). It has been discussed that it is important to make accounting standards applicable on certain class of LLPs particularly LLPs engaged in manufacturing activities. Further, it is also proposed to lay down standards for auditing to certain classes of LLPs. Accordingly, it has been recommended to insert new sections 34A and 34AA in the LLP Act in respect of the same.

 

Alignment with the provisions of CA, 2013

Considering the enactment of the CA, 2013, it was prudent to align the references of the Companies Act, 1956 provided in the LLP Act with that of the CA, 2013. A list of the sections where the alignment of the sections has been made is as follows:

  1. Section 2(1)(c)- Definition of ‘Appellate Tribunal’
  2. Section 2(1)(d)- Definition of ‘’Body corporate’
  3. Section 2(1)(e)- Definition of ‘Business’
  4. Section 2(1)(s)- Definition of ‘Registrar’
  5. Section 2(1)(u)- Definition of ‘Tribunal’
  6. Section 2(2)- General definition of words and expressions under the CA, 2013
  7. Section 7(6)- Designated Partners
  8. Section 58- Registration and effect of conversion
  9. Section 59- Foreign limited liability partnerships
  10. Section 67(1)- Application of the provisions of the Companies Act

Introduction of a new Section 68A- Registration Offices

In alignment with the provisions of Section 396 of the CA, 2013, which enables Central Government to appoint officers to carry out or discharge functions bestowed upon the Central Government, the CLC Report has also proposed similar provisions by introduction of Section 68A in the LLP Act.

Conclusion

With the plethora of changes proposed, it seems that the LLP Act is set to be amended significantly. While the title of the Report suggested that decriminalisation is the main agenda, however, after looking into the same, we understand that the proposed changes are deep and wide.

Some of the proposed changes related to the issuance of NCDs and restriction on amalgamation with a company will surely attract market reaction. Since the Report is currently open for public comments, it will be interesting to see the final set of changes proposed.

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[1] http://www.mca.gov.in/Ministry/pdf/Report%20of%20the%20Company%20Law%20Committee%20on%20Decriminalization%20of%20The%20Limited%20Liability%20Partnership%20Act,%202008.pdf

[2] https://www.legislation.gov.uk/ukdsi/2009/9780111479612/part/6

[3] https://www.insolvencydirect.bis.gov.uk/technicalmanual/Ch49-60/Chapter%2053A/Ch53A%20FAQs.htm

[4] https://sso.agc.gov.sg/Act/LLPA2005?ProvIds=Sc4-#Sc4- 

[5] https://www.sebi.gov.in/sebi_data/commondocs/VijaySuraksha-SEBIRep_p.pdf