SEBI Board approves amendments to REIT Regulations

By Shreya Routh, (finserv@vinodkothari.com)

Introduction

The SEBI in its Board Meeting on 18th September, 2017[1]approved several changes to the regulations issued for REITs. Before we start discussing the changes approved, let us quickly recap the way in which a REIT operates. REIT is a form of alternative investment vehicle. The working mechanism of a REIT involves purchase of commercial properties and then providing them on rent to tenants. The funding is done through issuance of units to public which are tradable on stock exchanges. The main advantage of a REIT structure is grounded on the tax exemptions that it receives.

Since, REITs mechanism observed a complete downfall and the fact that till date no REIT has been listed with SEBI, the proposed amendments come as a saviour intending to gear up the market for REITs. Read more

RBI’s P2P Regulations: A step forward or backward?

The Reserve Bank of India issued a Master Directions – Non Banking Financial Company – Peer to Peer Lending Platform (Reserve Bank) Directions, 2017 (hereinafter referred to as “Directions”) on 4th October, 2017[1], which is an extensive statement outlining in detail the various rules and regulations that all existing and prospective entities carrying on or intending to carry on the business of Peer-to-Peer (P2P) lending (hereby known as NBFC-P2P) will have to comply with. These Directions shall come in force with immediate effect and shall apply to all NBFC-P2Ps, i.e. with effect from the date of issuance of the Master Directions, mentioned above.

1. Registration

1.1. Eligibility criteria

The basic eligibility criteria for carrying on the business of setting up a P2P lending platform are as follows:

  • Only a Non-Banking Financial company shall undertake the business of P2P lending platform.
  • All NBFC-P2Ps that are either commencing or carrying on the business of Peer-to-peer lending platform must obtain a Certificate of Registration (CoR) from the bank.
  • Every existing and prospective NBFC-P2P must make an application for registration to the Department of Non-Banking Regulation, Mumbai of RBI.
  • Any company seeking registration as an NBFC-P2P must have Net Owned Funds of at least Rs. 2 Crores or higher as RBI may specify.
  • The RBI has imposed the condition that the company seeking registration must be incorporated in India and must have a robust IT system in place. The management must act in public interest and the directors and promoters must be fit and proper.

While the eligibility criteria remains same for those already into business and prospective ones, however, there is a slight difference in the way the application process of these two categories will be dealt with by the RBI.

1.2. Prospective P2Ps

An entity intending to set up a P2P lending platform will have to make an application to the RBI and at the time of making the application, it should achieve net-owned funds of Rs. 2 crores which must be parked into Fixed Deposit.

Upon submission of the application, if the RBI is of the view that the aforesaid conditions have been fulfilled, it will grant an in-principle approval for setting up of a P2P lending platform, subject to such conditions which it may consider fit to impose. This approval will be valid for a maximum of 12 months from the date of granting of the approval. Within this period of 12 months, the company must put in place the technology platform, enter into all other legal documentations required. We are of the view that during this period, the entity will be allowed to break the fixed deposit and utilize that money to incur capital expenditure as the ones mentioned above. The entity will have to report position of compliance with the terms of grant of in-principle approval to the RBI.

Once the systems are in place and the RBI is satisfied that the entity is ready to commence operations, it shall grant the Certificate of Registration as an NBFC–P2P.

This high NOF requirements and the long gestation can deter prospective players from entering into the market.

1.3. Existing P2Ps

The situation will be different for entities who are already into the business. Any entity carrying out the business of Peer-to-peer lending platform as on the effective date of these Directions, can continue to do so provided that they apply for registration as an NBFC-P2P to the RBI  within 3 months from the date of effect of these Directions. This will however, not hamper their business, as the RBI allows them to carry on the business, during the pendency of the application and until the application for issuance of CoR is rejected. If the application is rejected, the applicant will have to wind up its business.

2. Scope of Activities

The Master Directions, next, discuss about the Dos and Don’ts of the P2P lending platforms. Let us first discuss about the Dos.

2.1. Dos

An NBFC-P2P can only act as an intermediary that provides an online platform to the participants, i.e., borrowers and lenders, involved in P2P lending. It should ensure adherence to legal requirements applicable to the participants as prescribed under relevant laws, which means this includes the KYC Directions prescribed by RBI.  It is also required to store and process all data relating to its activities and participants on hardware located within India. It is permitted to invest in instruments specified by RBI provided they are not traded in.

Another important function that has been added to the scope of the NBFC-P2P credit assessment and risk profiling of the borrowers, the findings of which must be disclosed to the prospective lenders. Earlier, only few of the platforms carried out underwriting on behalf of the lenders, but, henceforth, this is something that a platform will have to carry out mandatorily.

In addition to the above, NBFC-P2Ps will have to get themselves registered with all the Credit Information Companies (CICs) in the country and file the credit information (relating to borrowers), and update them regularly on a monthly basis or at such shorter intervals as may be mutually agreed upon between the NBFC-P2P and the CICs.

NBFC-P2Ps shall also ensure that appropriate agreements are executed between the participants and the platform, which should categorically specify the terms and conditions agreed between the borrower, lender and the platform. The interest rates to be charged on the loans must be displayed in Annualized Percentage Rate (APR) format on the website of the platform.

2.2. Don’ts

Despite being an NBFC, NBFC-P2Ps are prohibited from lending on its own. It shall ONLY act as an intermediary and nothing more. It should not provide or arrange any credit enhancement or credit guarantee and also all loans intermediated must be purely unsecured in nature. It is required to maintain an escrow account to transfer funds and should not hold on its own balance sheet any funds received from lenders for lending, or from borrowers for repayment. It is prohibited from cross-selling any product on its platform except for loan specific insurance products. International flow of funds is also not permitted for NBFC-P2Ps.

During surveys we have observed that some P2Ps have been engaged in lending through their own platforms. This will have to be stopped now. P2Ps are not allowed to carry on any other activity other than P2P loan intermediation. This is much stricter regulation than for any other type of NBFC.  Mortgage guarantee companies are allowed to take up any other activity up to 10% of its total assets. All other NBFCs must in general satisfy the principality requirements- at least 50% of its total assets must be financial assets and at least 50% of its total income must be from these assets. This is far more lenient than that being allowed for P2Ps.

 

 

3. Prudential Norms

Like all other Directions issued by the RBI for NBFCs, these Directions also lay down the prudential regulations for this class of entities. They are as follows:

  1. Leverage: The outside liabilities of a platform must not exceed 2 times of its owned funds;
  2. Concentration limits: The Directions provide for several concentration limits, which are:
    1. Maximum that a single lender can lend across all P2P platforms – Rs. 10 lakhs;
    2. Maximum that a single borrower can borrow across all P2P platforms – Rs. 10 lakhs;
  • Maximum that a single lender can lend to a single borrower across all P2P platforms – Rs. 50,000;

One apparent concerns that we can point out in this regard is as follows:

Say for instance, a borrower requires a funding of Rs. 5 lakhs, in such case, the platform will have require at least 20 lenders empanelled with itself to meet the requirements of the borrower. Thus, the platforms will have to have large lender base to survive and be able to satisfy loan requirements of borrowers. Therefore, the success of the platforms will be directly related to the scalability of their business.

The P2Ps are also required to obtain a certificate from the borrower and lender, as applicable, that the aforementioned limits are being adhered to.

  1. Tenure: The tenure of the loans extended through the platforms cannot exceed 36 months.

4. Operational Guidelines

An NBFC-P2P is required to have a Board approved policy in place specifying the eligibility criteria, pricing of services and rules for matching participants on its platform.

The Directions explicitly state that the obligation of an NBFC-P2P does not diminish towards those activities that it has outsourced. It will be held responsible for the actions of its service providers including recovery agents and the confidentiality of information pertaining to the participant that is available with the service provider.

5. Transparency

The Directions has provided for one way transparency. On one hand, it states that the NBFC-P2Ps must disclose to the lender details about the borrower including:

  • personal identity;
  • required amount;
  • interest rate sought; and credit score as per the P2P’s credit rating mechanism;
  • terms and conditions of the loan, including
    • likely return; and
    • fees and taxes associated with the loan.

On the other hand it requires the NBFC-P2Ps to make the following disclosures to the borrowers:

  • amount of loan proposed by the lender
  • the interest rate offered by the lender etc.

However, it restricts the platform to give out the personal identity and contact details of the lender to the borrower.

Therefore, the Directions provide for full transparency with respect to borrower’s information but partial transparency with respect to lender’s information.

Apart from information of the participants, the Directions require the platforms to provide the following information on its website:

  1. overview of credit assessment/score methodology and factors considered;
  2. disclosures on usage/protection of data;
  3. grievance redressal mechanism;
  4. portfolio performance including share of non-performing assets on a monthly basis and segregation by age; and
  5. its broad business model.

6. Signing of the loan terms

One of the requirements of the Direction is that no loan shall be disbursed unless the individual lender has approved the individual recipient of loan and all the concerned parties have signed the loan contract.

Here it is important to take a note that while signing the terms of loan, sufficient measures must be taken by the platform to ensure that the personal and contact details of the lender continues are not revealed to the borrower, owing to the restrictions imposed by the Directions on the platform with respect to transparency.

7. Fund Transfer Mechanism

RBI has put a lot of focus on implementing an efficient fund transfer mechanism in order to eliminate any fears of money laundering or usage by the company for its benefit. The Directions stipulate that Fund transfer between the participants on the Peer-to-peer lending platform must take place through escrow accounts which will be operated by a trustee, who must mandatorily be promoted by the bank maintaining the escrow accounts. At least 2 escrows accounts must be maintained – one comprising funds received from lenders and pending disbursal, and the other for collection from borrowers as repayment of loans. All forms of transfer of funds must take place through bank accounts ONLY and cash transactions are prohibited. The graphical representation of the proposed mechanism was included in the Directions, the same has been reproduced below for your reference.

 

The graphic provided on the Directions for the funds transfer mechanism is somewhat ambiguous as it shows only one escrow account, and also shows direct flow of instructions between the lender/borrower and the Trust, which is odd, as it is the platform who should control the flow of information to the Trust.

8. Fair Practices Code

NBFC-P2Ps are required to follow the usual NBFC related Fair Practices Code (FPC) with the approval of its board. They are further required to disclose the same on their website for the information of various stakeholders.

The NBFC-P2Ps are prohibited from providing any assurances on the recovery of loans.
The platform is required to post the following disclaimer on its website –

“Reserve Bank of India does not accept any responsibility for the correctness of any of the statements or representations made or opinions expressed by the NBFC-P2P, and does not provide any assurance for repayment of the loans lent on it”

The Board of Directors shall also provide for periodic review of the compliance of the Fair Practices Code and the functioning of the grievances redressal mechanism at various levels of management. A consolidated report of such reviews shall be submitted to the Board at regular intervals, as may be prescribed by it.

9.Information Technology Framework

Given the fact that the core operation of P2P lending platforms depends on a robust IT framework, the Directions state that the technology must be scalable in nature to handle growth in business. The Directions also stipulate that there should be adequate safeguards built in its IT systems to ensure that it is protected against unauthorized access, alteration, destruction, disclosure or dissemination of records and data. The RBI also reserves the right to, from time to time, prescribe technical specifications, as deemed fit. The rest of the IT laws are same as those issued to NBFC-SIs in general.

10.Fit and Proper Criteria

An NBFC-P2P must ensure that a policy is put in place with the approval of Board of Directors, setting out the ‘Fit and Proper’ criteria to be met by its directors and also obtain a Deed of Covenants signed by the Directors. RBI may, if it deems fit and in public interest, may independently assess the directors and have the power to remove the concerned directors.

The guidelines have, surprisingly, been kept at par with NBFC-SI. The Deed of Covenants, regular reporting requirements etc. are all observed by NBFCs which are systemically important i.e. NBFCs having asset size of over 500 crores. For P2P platforms to have to observe these is perhaps over-regulation.

11.Requirement to obtain prior approval of the Bank for allotment of shares, acquisition or transfer of control of NBFC-P2P

Given the fact that most P2P lending platforms are start-ups in nature, the requirements are very restrictive in nature. The Directions stipulate that prior approval from the banks will be required in case of:

  1. any allotment of shares which will take the aggregate holding of an individual or group to equivalent of 26 per cent and more of the paid up capital of the NBFC-P2P;
  2. any takeover or acquisition of control of an NBFC-P2P, which may or may not result in change of management;
  3. any change in the shareholding of an NBFC-P2P, including progressive increases over time, which would result in acquisition by/ transfer of shareholding to, any entity, of 26 per cent or more of the paid up equity capital of the NBFC-P2P;
  4. any change in the management of the NBFC-P2P which would result in change in more than 30 per cent of the Directors, excluding independent Directors;
  5. any change in shareholding that will give the acquirer a right to nominate a Director

A public notice of at least 30 days shall be given before effecting the sale or transfer of the ownership.

The format for application for prior approval is the same as for other NBFCs.

This is quite unprecedented level of regulation and will seriously increase the bureaucracy PE/VC investors and startups have to go through before a funding round can be closed.  Even a 1% allotment which takes one’s shareholding past 26%, then prior permission will be required. Again, should an investor want the right to nominate a Director, then prior approval will be required. This level of regulation is higher than for regular NBFCs and would slow down the process of investments in P2P platforms in India.

12. Reporting Requirements

NBFC-P2Ps must submit a statement showing number and amount of loans during, at the closing of and outstanding at the beginning and end of quarter, including the number of lenders and borrowers outstanding as at the end of quarter to RBI regional office within 15 days after the quarter to which they relate.

They must also disclose the amount of funds held in the Escrow Account, with credit and debit summations for the quarter. Further, number of complaints outstanding at the beginning and end of quarter and disposed of during the quarter, bifurcated between the lenders and borrowers must also be disclosed in order to constantly improve the state of the industry.

13. Conclusion

The regulations on P2P platform was much awaited, but the way the Directions have been crafted, this could cause serious damage to these platforms. To start with, the requirement of maintaining NOF of Rs. 2 crores is not justified since the business is not a capital intensive one. Next, we also feel that RBI has taken a very cautious approach with respect to the credit concentration, however, we feel that this may be enhanced in the future looking at the performance of the sector. Next, the time required for registration of new P2P platforms also seems to be on the higher side. Further, the list of instances for which prior approval will have to be sought from RBI by the platform, may act as a deterrent for the investors who may interested in investing in P2P platforms.

Having said that, the attempt of giving a regulatory shape to the P2P businesses in India, itself must be applauded.


[1] https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=11137

APPLICATION UNDER SARFAESI- A Liberal Approach by the Supreme Court

By Richa Saraf, (legal@vinodkothari.com)

 

In the case of M.D. Frozen Foods Exports Pvt. Ltd. v. Hero Fincorp Ltd.[1], the Hon’ble Supreme Court held that there was no illegality in an Non-Banking Financial Company (NBFC) invoking SARFAESI Act for recovery of loan arrears with respect to an account classified as Non-Performing Asset (NPA) before the NBFC got notified under the Act. It also clarified that NBFC is entitled to initiate both arbitration proceedings and SARFAESI proceedings with respect to a loan account, and that the ‘doctrine of election’ was not attracted in such a scenario. There was a cleavage of judicial opinions inter se the High Courts, while the Full Bench of the Orissa High Court, as also the Delhi High Court and the Allahabad High Court have taken a view favourable in terms of the simultaneous legal processes under the SARFAESI Act and arbitration recovery proceedings, the Andhra Pradesh High Court has taken a divergent view and after careful scrutiny of the rival contentions and the judicial precedents cited, the Apex Court has finally settled the law on the point. Below, we discuss the same.  Read more

P2P lending comes under the ambit of RBI

By Mayank Agarwal & Anita Baid (finserv@vinodkothari.com)

 

Peer to Peer lending (P2P Lending) is a virtual marketplace which connects borrowers and lenders online by providing quick funds to borrowers and high returns to lenders. The borrower can raise fund by borrowing from a single lender or a group of lenders. The accelerated growth in P2P Lending platforms was recognized for the first time by the Reserve Bank of India (RBI) in its First Bi-monthly Monetary Policy Statement, 2016-17[1]. Read more

The Financial Resolution and Deposit Insurance Bill, 2017: Key Highlights

By Nidhi Bothra, (nidhi@vinodkothari.com)

 

In March, 2016 a committee was constituted under the Chairmanship of Mr. Ajay Tyagi to draft and submit a bill on resolution of financial firms. In September, 2016, the Committee submitted its report and bill which was titled as “The Financial Resolution and Deposit Insurance Bill, 2016”[1] (Bill 2016). The objective of the Bill, 2016 was to provide for a framework for safeguarding the stability and viability of financial services providers and to protect the interest of the depositors, as the name of the bill also suggests[2].

The Financial Resolution and Deposit Insurance Bill, 2017[3] (Bill, 2017) is formulated to provide resolution to certain categories of financial service providers in distress; the deposit insurance to consumers of certain categories of financial services; designation of systemically important financial institutions; and establishment of a Resolution Corporation for protection of consumers of specified service providers and of public funds for ensuring the stability and resilience of the financial system and for matters connected therewith or incidental thereto.

The proposed legislation together with the Insolvency and Bankruptcy Code, 2016 is expected to provide a comprehensive resolution mechanism for the economy.

The existing draft of the Bill, 2017 has been referred to a Joint Parliamentary Committee of both the Houses, under the Chairpersonship of Shri Bhupender Yadav, for examination and presenting a Report to the Parliament.

The Bill is divided into several chapters, which deal with establishment of a Resolution Corporation, its powers, management and functioning which is broadly to function along with the appropriate regulator[4] of financial services provider, classification of persons as systematically important financial institutions, deposit insurance, restoration and resolution plan, method of resolution, liquidation etc.

Highlights of the Bill, 2017

The brief highlights of the Bill[5], 2017 are as follows:

  1. Establishing the Resolution Corporation – A resolution corporation would be formulated broadly with the objective of
    1. monitoring certain financial services provider[6];
    2. providing deposit insurance to banking institutions;
    3. classifying certain persons as specified service provider [7] into one of the categories of risks to viability;
    4. acting as an administrator or liquidator for such service provider or resolve a specified service provider which has been classified into critical risk category;
    5. set up funds including Corporation Insurance Fund, set up for deposit insurance provided by the Corporation to the insured service providers[8] and other funds such as Corporation Resolution Fund for meeting the expenses of carrying out resolution of specified service providers and Corporation General Fund for all other functions of the Corporation.
  2. Deposit Insurance – Chapter IV of the Bill, 2017 discusses about deposit insurance and largely deals with
    1. Determination of amount payable by the Corporation, to a depositor on account of deposit insured;
    2. Amount payable to an insured service provider[9] on account of resolution but not bail-out or eligible co-operative bank on account of merger or amalgamation;
    3. If the Resolution Corporation is dealing with the resolution of an insured service provider, then the Corporation may decide to invite offers from other insured service providers to take over the liabilities, deposits or realisable assets of the insured service provider.
  3. Categorisation as SIFIs[10] – Certain persons can be classified as SIFIs by the Central Government in consultation with the appropriate regulator, as per Section 25 of the Bill, 2017, if it meets the criteria prescribed by the Central Government in this regard. Once categorised as an SIFI, then are deemed to be specified service provider and the provisions of being a specified service provider under the Bill, 2017 become applicable to them. It is important to mention that any financial service provider or domestic systematically important banks can be classified as SIFIs. Once classified as SIFIs, the Central Government may designate, its holding, subsidiary, associate company or any other body corporate related to it as financial service provider and falling into the ambit of being SIFI.
  4. Registration of specified service provider – Chapter V of the Bill, 2017 talks about registration of specified service providers and states that if a person classified as a specified service provider or deemed to be a service provider, it shall be deemed to be registered under the Act, from the date of classification. If the appropriate regulator has issued a license in favour of a specified service provider, such license shall be deemed to be registration for the purpose of this Act as well.
  5. Risk to viability categories – The Bill, 2017 specifies 5 categories[11] of risk to viability under Section 36 (5) and are as follows —
    1. low, where the probability of failure of a specified service provider is substantially below the acceptable probability of failure;
    2. moderate, where the probability of failure of a specified service provider is marginally below or equal to acceptable probability of failure;
    3. material, where the probability of failure of a specified service provider is marginally above acceptable probability of failure;
    4. imminent, where the probability of failure of a specified service provider is substantially above the acceptable probability of failure;
    5. critical, where the probability of failure of a specified service provider is substantially above the acceptable probability of failure, and the specified service provider is on the verge of failing to meet its obligations to its consumers

The classification of a specified service provider into any of the categories of risk to viability except the category of critical risk to viability under section 45, shall be kept confidential by the appropriate regulator, the Corporation and by all relevant parties.

6.   Categorisation of specified service providers under risk to viability categories

  1. The Resolution Corporation in consultation with the appropriate regulator categorise specified service providers under risk to viability categories.
  2. The Resolution Corporation shall have no power to classify a specified service provider into the category of low or moderate risk to viability.
  3. While classifying under risk categories, they can assess, evaluate and classify the holding or non-regulated operational entity within the group of the specified service provider as deemed to be a specified service provider.

7.   Restoration and Resolution Plan — Any specified service provider, classified in the category of material or imminent risk to viability shall submit a restoration plan to the appropriate regulator and a resolution plan to the Corporation within ninety days of such classification. Every restoration plan will prescribe for the details of restoring category to low moderate and resolution plan on who resolution will be achieved.

Where a systemically important financial institution is classified in the category of low or moderate risk to viability, it shall submit the information required under this subsection assuming that it is classified in the category of material or imminent risk to viability.

Where the Resolution Corporation determines that liquidation is the most appropriate method for the resolution of a specified service provider, notwithstanding anything in any other law for the time being in force relating to liquidation and winding up, the Corporation shall make an application to the Tribunal for an order of liquidation in respect of such specified service provider.

The detailed actions as prescribed under the Bill for various categories of risks is tabulated in Annexure I to this note.

Changes from the Bill, 2016

The Bill, 2016 aimed at including all NBFCs its foray. Bill, 2017 only intends to cover such NBFCs and other entities in the group, if such NBFC is classified on high risks to viability categories. This was an important and a necessary change from the Bill, 2016.

All the NBFCs, big and small will be continued to be monitored by the appropriate regulators, however, matters will get escalated only if they are on the risks to viability meter. Similar would be the case with other financial services providers as well.

Some key issues

Some key issues that the Bill, 2017 does not address or overlook are as follows:

  1. Definition of financial services provider – The Bill does not provide for a definition of financial services providers. The specified services provider will be deduced from the financial services providers, by and large. However the Bill, 2017 does not expressly provide for the universe of which the monitoring will be carried out. The Bill, 2017 indicates, NBFCs, insurance companies and banking institutions will fall in the ambit of discussion.
  2. NBFC-Ds – While the concept continues to be theoretical for all practical purposes, but the Bill, 2017 does not make a mention at all of this category of entities.
  3. Resolution and restoration plan — Chapter VII provides for resolution plan and restoration plan to be submitted to appropriate regulator and resolution corporation for material and imminent risk category specified service providers. The plans are to be submitted with 90 days. The brief contents of the plans to be provided to the authorities is prescribed in the Bill, 2017. However, are both plans to be provided within 90 days from the date of categorisation and for both categories?

For both categories of risks to viability, there can be strong intervention of the authorities in running of the business itself. One may find it difficult to find the distinction between the two categories of the risks to viability as the action taken by the authorities and from the specified service providers seems to be almost similar.

In case an entity is categorised as critical risk to viability, the turnaround of the resolution plan is to be carried out within one year, else the Resolution Corporation may require the liquidation of the entity. The entities, in determination here have an element of systemic risks and therefore liquidation of such entities can have daunting consequences on the economy. The provision for triggering liquidation should be well defined or determined in consultation with the Central Government.

4.   Rule-making – The devil, as they say, lies in the details. A lot of actions to be taken in each of the risks categorisation will come by way of rule-making. This will determine the effectiveness of the resolution plans and restoration plans prescribed in the Bill, 2017.

5.  Existing resolution mechanisms – The appropriate regulators have introduced several policy initiatives and resolution guidance and schemes for restructuring of stressed assets, special restructuring norms, strategic restructuring norms, corporate debt restructuring wherein the entities were required to submit resolution/ restructuring/ restoration plans within certain timeframes. The experience with these guidelines have indicated the failure of these guidelines and schemes to provide for a resolution plan within the dedicated time frame and also restoring the position of the entities.Therefore, appropriate learnings from those guidelines should also be reflected in the Bill,2017.

Annexure I

SL no. Category of risk to viability (Section 36) Categorised by ** Immediate action to be taken by the specified service provider Continued Action required by the specified service provider Action taken by appropriate regulator and/ or corporation
 
1 Low Appropriate Regulator No Action taken, regular monitoring of the activities of the entity may be conducted.

Where a SIFI is classified in the category of low or moderate risk to viability, it shall submit the information required under section 39 (2) assuming that it is classified in the category of material or imminent risk to viability.

2 Moderate Appropriate Regulator No Action taken, regular monitoring of the activities of the entity may be conducted.

Where a SIFI is classified in the category of low or moderate risk to viability, it shall submit the information required under section 39 (2) assuming that it is classified in the category of material or imminent risk to viability.

3 Material Resolution Corporation or Appropriate Regulator Submit a restoration plan[12] to the appropriate regulator and a resolution plan[13] to the resolution corporation within 90 days of such classification.

A copy of the restoration plan and resolution plan to be submitted to the resolution corporation and appropriate regulator respectively, within 15 days of the first submission, thereof.

Every systemically important financial institution shall submit a restoration plan to the appropriate regulator and a resolution plan to the Corporation within ninety days of its designation under section 25.

Every restoration plan or resolution plan shall be revised annually and the appropriate regulator and the Corporation shall be informed of such revised restoration plan, within seven days of the revision.

Every material change shall be immediately informed to the appropriate regulator and the Corporation.

Additional inspection may be carried out to monitor the risk to viability.

Appropriate regulator may prevent entity from taking certain business decisions including declaration of dividend, establishing new business or acquiring new clients, undertaking related party transactions, increasing liabilities etc.

Appropriate regulator may require the entity to increase capital, sell assets etc.

4 Imminent Resolution Corporation or Appropriate Regulator

 

Or

If the specified service provider has not submitted the restoration plan or resolution plan within prescribed time frame.

Submit a restoration plan to the appropriate regulator and a resolution plan to the resolution corporation within 90 days of such classification.

A copy of the restoration plan and resolution plan to be submitted to the resolution corporation and appropriate regulator respectively, within 15 days of the first submission, thereof.

Every systemically important financial institution shall submit a restoration plan to the appropriate regulator and a resolution plan to the Corporation within ninety days of its designation under section 25.

Every restoration plan or resolution plan shall be revised annually and the appropriate regulator and the Corporation shall be informed of such revised restoration plan, within seven days of the revision.

Every material change shall be immediately informed to the appropriate regulator and the Corporation.

The resolution corporation may appoint an officer to inspect the functioning of the entity and act as an observer.

The corporation may prevent the entity from accepting funds, declaring dividend, acquiring new businesses or new clients, undertake related party transactions etc.

The corporation may require the entity to infuse new capital or sell identified assets etc.

 

A specified service provider classified in the category of imminent risk to viability shall, if it is not a SIFI, submit a resolution plan to the Corporation within 90 days.

 

5 Critical Resolution Corporation or Appropriate Regulator – effective from the date of publication in official gazette N.A. N.A. Corporation shall be deemed to be the administrator[14] and may take the following actions:

a.       resolve the issue through a scheme or merger or amalgamation or bail-in instrument.

b.      Transfer whole or part of assets/ liabilities to another person

c.       Create a bridge service provider

d.      Cause liquidation of the entity

e.       No legal action or proceeding including arbitration shall commence or continue until conclusion of resolution.

f.       No repayment or acceptance of deposit shall be made or liabilities incurred.

g.      temporarily prohibit (not exceeding 2 business days) by an order in writing, the exercise of such termination rights of any party to such specified contract with the relevant specified service provider or its associate company or subsidiary

License granted to the entity by the appropriate regulator may be withdrawn or modified.

 


[1] http://dea.gov.in/sites/default/files/FRDI%20Bill-27092016_1.pdf

[2] See our article titled – Financial Resolution and Deposit Insurance Bill: Implications for NBFCs, by Vinod Kothari and Niddhi Parmar, here http://vinodkothari.com/blog/financial-resolution-and-deposit-insurance-bill-implications-for-nbfcs-by-niddhi-parmar/

[3] http://164.100.47.4/BillsTexts/LSBillTexts/Asintroduced/165_2017_LS_Eng.pdf

[4] Appropriate Regulator is defined in First Schedule to the Bill, 2017 to include a) RBI, b) IRDA, c) SEBI, d) Pension Fund Regulatory Development Authority or any other regulator as notified by the Central Government.

[5] http://164.100.47.4/BillsTexts/LSBillTexts/Asintroduced/165_2017_LS_Eng.pdf

[6] Financial services provider categorised as specified service providers and SIFIs fall within the purview of the Resolution Corporation. The detailed mechanism of monitoring is discussed further in the highlights.

[7] A specified service provider is a person as defined in Second Schedule to Bill, 2017 and includes

  1. A banking institution, , other than eligible co-operative bank including an insured service provider;
  2. Any insurance company
  3. Any Financial Market Infrastructure
  4. Any payment system, as defined under the Payment and Settlement Systems Act, 2007 (51 of 2007), not notified under section 227 of the Insolvency and Bankruptcy Code, 2016 (31 of 2016)
  5. Any non-banking financial company, not notified under section 227 of the Insolvency and Bankruptcy Code, 2016 (31 of 2016)
  6. Any systemically important financial institution
  7. Any other financial service provider (excluding individuals and partnership firms), not notified under section 227 of the Insolvency and Bankruptcy Code, 2016 (31 of 2016)
  8. A holding company of any specified service provider enumerated under items 1 to 7, registered in India which is not notified under section 227 of the Insolvency and Bankruptcy Code, 2016 (31 of 2016), subject to the determination by the Corporation under the proviso to sub-section (1) of section 33
  9. Non-regulated operational entities within a financial group or conglomerate of a specified service provider enumerated under items 1 to 7 subject to the determination by the Corporation under the proviso to sub-section (1) of section 33.
  10. Branch offices of body corporates incorporated outside India, carrying on the business of providing financial service in India.
  11. Any other entity or fund which may be notified by the Central Government

[8] As defined in Section 2 (19) of the Bill, 2017 — means any banking institution, that has obtained deposit insurance under sub-section (3) of section 33. Section 33 (3) states that every banking institution that has been granted a banking license by the appropriate regulator shall be deemed to be categorised as insured service provider for obtaining deposit insurance under the Act.

[9] Insured service provider is a banking institution that has obtained deposit insurance

[10] To qualify as an SIFI, the Central Government will consider the size, complexity of the financial service provider, the nature and volume of transactions undertaken, interconnectedness with other financial service providers and nature of services offered and possibility of substitution such business.

[11] The categorisation are based on assessment of the following parameters:

(a) adequacy of capital, assets and liability; (b) asset quality; (c) capability of management; (d) earnings sufficiency; (e) leverage ratio; (f) liquidity of the specified service provider; (g) sensitivity of the specified service provider to adverse market conditions; (h) compliance with applicable laws; (i) risk of failure of a holding company of a specified service provider or a connected body corporate in India or abroad; and (j) any other attributes as the Corporation deems necessary

[12] A restoration plan as per the provisions of Section 39, will contain details of assets and liabilities of the entity, including contingent liabilities, steps to be taken by the entity to move to moderate classification at least, time frame within which such restoration plan will be executed and other information relevant for the appropriate regulator to assess the plan.

[13] A resolution plan, as per the provisions of Section 40, will contain details of assets and liabilities of the entity, identification of critical functions of the specified service provider, access to financial market infrastructure services, either directly or indirectly, strategy plans on exiting the resolution process and any other relevant information.

[14] The resolution plan must be completed within one year from the date of classification into critical risk to viability. Where the plan is completed within one year and the Corporation deems necessary, it shall require liquidation of the entity.

FAQs on Ind AS 116: The New Lease Accounting Standard

By Vijaylakshmi Agarwal (finserv@vinodkothari.com)

Understanding Impact

  1. What is this new Standard all about, in brief?

The standard provides a new method for lease accounting. Ind AS 116 is largely converged with IFRS 16 Leases. Ind AS is expected to replace Ind AS 17 WEF from its proposed effective date being for annual periods beginning on or after 1st April, 2019. Essentially, lessee accounting undergoes major change, while lessor accounting largely remains unchanged. As for lessee, the existing distinction between financial and operating leases (whereby the former was on the balance sheet, and the latter was off-balance sheet) goes away, and in case of every lease (other than exceptions, discussed below), the lease comes on the balance sheet as a right-to-use (RTU) asset and a corresponding lease liability representing its obligation to make lease payments.

  1. Who will be more affected by the standard – lessors or lessees?

While the standard is primarily meant for lessee accounting, lessors are also likely be impacted, to the extent the potential demand from lessees for an off-balance sheet solution gets impacted.

  1. Is a lease completely on balance sheet now, for the lessee?

Not really. What comes on the balance sheet is an RTU asset, and not the cost of the asset. The RTU asset is to be measured at the present value of the minimum lease payments (“MLPs”) (see below). Therefore, the more the residual value component, the less will be the value of the RTU asset. Hence, the off-balance sheet portion of the leased asset is directly proportionate to the residual exposure of the lessor.

Scope and applicability

  1. When is the standard applicable from?

Ind AS 116 is proposed to be effective from annual periods beginning on or after 1st April, 2019.

  1. Is there any grandfathering of existing lease transactions?

Yes, there is a grandfathering provision in respect of existing lease transaction in respect of existing lease transactions. On the date of initial application of IND AS 116, an entity is not required to reassess whether a contract is, or contains, a lease. The entity is permitted to do the following:

  1. Apply IND AS 116 to contracts that were previously identified as leases applying IND AS 17 Leases. Transition requirements as listed under C5 – C18 of IND AS 116 need to be applied to those leases.
  2. Not to apply IND AS 116 to contracts that were not previously identified as containing a lease basis IND AS 17.

6.  Are there any property types excepted from the Standard?

Para 3 and 4 of IND AS 116 lays down the situations where entities will not be required to apply IND AS 116. The same has been explained as under:

  • leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources – IND AS 106 Exploration for and Evaluation of Mineral Resources lay down the accounting principles in respect of rights to explore for and evaluate mineral resources and hence the same has been excluded from the purview of IND AS 116.
  • leases of  biological  assets  within  the  scope  of  Ind  AS  41 Agriculture, held by a lessee – As per IND AS 41 Agriculture, a biological asset is a living animal or plant. However IND AS 41 applies only to produce from bearer plants while biological assets that are bearer plants are covered by IND AS 16 Property, Plant and Equipment.
  • service concession  arrangements  within  the  scope  of  Appendix  D, Service  Concession  Arrangements,  of  Ind  AS  115,  Revenue  from Contracts with Customer.
  • licences of intellectual property granted by a lessor within the scope of Ind AS 115, Revenue from Contracts with Customers; and
  • rights held by a lessee under licensing agreements within the scope of Ind  AS  38,  Intangible  Assets,  for  such  items  as  motion  picture films, video recordings, plays, manuscripts, patents and copyrights.
  • A lessee  may,  but  is  not  required  to,  apply  this  Standard  to  leases  of intangible assets other than those discussed above.
  1. Are there any de-minimis exceptions?

As per para 5, Ind AS 116 provides recognition exemptions to lessees for the following and specifies alternative requirements for the same:

  • Short term leases – A lease which has a lease term of not more than twelve months on the date of commencement is regarded as a short term lease.
  • Leases for which underlying asset is of low value
  1. In considering the exception for small value assets, assuming several assets (say laptops) are given on lease under a single contract, shall we take them as one asset (bunched together), or as several assets?

As per para 8 of Ind AS 116, the election  for  leases  for  which  the  underlying  asset  is  of  low  value  can  be made on a lease-by-lease basis. Hence where several assets of low value are given on lease under a single contract, each of the asset qualifies to be a low value asset and the entity can elect to apply the low value asset exemption to all of the assets under the contract. It is relevant to refer to para B5 of Ind AS 116 here which lay down the situation as to when the underlying asset can be of low value. As per para B5 an underlying asset can be of low value only if:

  • the lessee can benefit from use of the underlying asset on its own or together with other resources that are readily available to the lessee; and
  • the underlying  asset  is  not  highly  dependent  on,  or  highly interrelated with, other assets.
  1. Is the Standard applicable to land leases?

    Yes, Ind AS 116 covers long term leases of land.

  2. Is the Standard applicable to short tenure transactions?

Para 5 of Ind AS 116 provides a recognition exemption to lessees in regard to short term leases (a lease which has a lease term of not more than twelve months on the date of commencement) according to which the lease payments in those cases are recognized as expense over the lease term.

What, after all, is a lease?

  1. Does the standard make any significant differences to the definition of a lease?

Yes the standard makes significant differences to the definition of a lease.

Appendix A to Ind AS 116 defines the term lease as “a contract, or part of a contract, that conveys the right  to  use  an  asset  (the  underlying  asset)  for  a period of time in exchange for consideration.”

The new definition of lease captures IFRIC 4 Determining whether an Arrangement contains a Lease, IFRIC 17 Distribution of Non-cash Assets to Owners, SIC 15 Operating Leases Incentives and SIC 27 Evaluating the Substance of Transactions Involving the Legal Form of a Lease.

  1. Can a contract containing a lease and provision of other services be split into (a) lease and (b) other services?

As per para 12 of Ind AS 116, where a contract containing lease comprises a lease and a non-lease component, both of the components need to be accounted for separately unless the entity opts for the practical expedient as per para 15.

The practical expedient permits a lessee to opt for not to separate lease and non-lease components in the contract and instead account for each lease component and any associated non-lease components as a single lease component. This option needs to be exercised by the lessee by class of underlying asset.

When the lessee elects the practical expedient, the lessee is required to account for the combined lease and non-lease component as a lease and not as a service.

Good old financial leases

  1. Does the standard alter the meaning of a financial lease, as opposed to IAS 17/IndAS 17/ AS 19?

Ind AS 116 does not alters the meaning of finance lease as compared to IAS 17, Ind AS 17 or AS 19. A comparative of the definition has been provided as under:

 

AS 19 Ind AS 17 IAS 17 IFRS 16 Ind AS 116
A finance lease is a lease that transfers substantially all the risks and rewards incident to ownership of an asset. A finance lease is a lease that transfers substantially all the risks and rewards

Incidental to ownership of an asset.  Title may or may not  eventually  be transferred.

A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership. A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership of an underlying asset. A lease is classified as a finance lease if it transfers substantially all the

risks  and  rewards  incidental  to  ownership  of  an  underlying  asset.

 

  1. Does the standard lead to any major difference in accounting for a financial lease in the books of the lessee?

Ind AS 116 does not lead to any major differences in accounting for a financial lease in the books of the lessee. The treatment of financial lease in the books of lessee under AS 19, Ind AS 17 and Ind AS 116 could be summarized as under:

Particulars AS 19 Ind AS 17 Ind AS 116
Initial recognition At the inception of a finance lease, the lessee should recognize the lease as an asset and a liability.  Such recognition should be at an amount equal to the fair value of the leased asset at the inception of the lease. However, if the fair value of the leased asset exceeds the present value of the minimum lease payments from the standpoint of the lessee, the amount recorded as an asset and a liability should be the present value of the minimum lease payments from the standpoint of the lessee. At the commencement of the lease term, lessees shall  recognise finance leases as  assets  and  liabilities  in  their  balance  sheets  at  amounts  equal  to  the  fair value  of the leased property or, if lower, the present value of the  minimum lease payments, each determined at the  inception of the lease. At the commencement date, a lessee shall recognise a right-of-use asset and a lease liability. The right of use asset need to be measured at cost which comprises of the following:

·         the  amount  of  the  initial  measurement  of  the  lease  liability

·         any lease payments made at or before the commencement  date, less any lease incentives received

·         any initial direct costs incurred by the lessee

·         an estimate of costs to be incurred by the lessee in dismantling and removing  the  underlying  asset,  restoring  the  site  on  which  it  is located or restoring the underlying asset to the condition required by the terms and conditions of the lease, unless those costs are incurred to  produce  inventories.

At the commencement date, a lessee shall measure the lease liability at the present value of the lease payments that are not paid at that date.

Subsequent measurement Lease payments is apportioned between the finance charge and the reduction of the outstanding liability. The finance charge is allocated to periods during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability for each period.

Finance lease also give rise to depreciation expense for the asset. The depreciation policy for the leased asset should be consistent with that of the depreciable assets which are owned and the depreciation recognized should be calculated on the basis set out in AS 10 Property, Plant and Equipment.

Minimum  lease  payments  is apportioned  between  the  finance  charge and  the  reduction  of  the  outstanding  liability.  The  finance  charge  shall  be allocated  to  each  period  during  the  lease  term  so  as  to  produce  a  constant periodic rate  of interest on the remaining balance of the liability.  Contingent rents are charged as expenses in the periods in which they are incurred.

The depreciable amount of a leased asset is allocated to each accounting period during  the  period  of  expected  use  on  a  systematic  basis  consistent  with  the depreciation  policy  the  lessee  adopts  for  depreciable  assets  that  are  owned.  the depreciation recognised shall be calculated in accordance with  Ind  AS  16,  Property,  Plant and Equipment  and  Ind  AS  38, Intangible Assets. If there is reasonable certainty that the lessee will obtain ownership by the end of the lease term, the period of expected use is the useful life of the asset; otherwise the asset is depreciated over the shorter of the lease term and its useful life.

After the commencement date, the right-of-use asset should be measured using a cost model unless it applies either of the measurement models described in para 34 and 35 of IFRS 16. Under the cost model, the right-of-use asset is measured at cost:

·         less any accumulated depreciation and any accumulated impairment losses

·         adjusted for any re-measurement of the lease liability specified in para 36(c) of IFRS 16.

A lessee shall apply the depreciation requirements in Ind AS 16, Property, Plant  and  Equipment,  in  depreciating  the  right-of-use  asset.

After the commencement date, the lease liability is measured by:

·         increasing the carrying amount to reflect interest on the lease liability;

·         reducing the carrying amount to reflect the lease payments made; and

·         re-measuring the carrying amount to reflect any reassessment or lease modifications specified in para 39 to 46 of IFRS 16, or to reflect revised in-substance fixed lease payments.

Interest on the lease liability in each period during the lease term shall be the amount  that  produces  a  constant  periodic  rate  of  interest  on  the  remaining balance of the lease liability.

 

The asset side

  1. How is the RTU asset recognized?

At the date of commencement of lease, RTU asset is measured at cost. Cost of RTU asset will comprise of the following:

  • the amount of the initial measurement of the lease liability, as described in para 26 of Ind AS 116 i.e. on the date of commencement of lease, lease liability is to be measured at present value of the lease payments that are not paid at that date.
  • any lease payments made at or before the commencement date, less any lease incentives received i.e. if the lessee has made payment towards the RTU the underlying assets at any point of time, the same shall form a part of the cost of RTU.
  • any initial direct costs incurred by the lessee. Initial direct costs are the incremental costs of obtaining a lease that would not have been incurred if the lease had not been obtained.
  • an estimate of costs to be incurred by the lessee in dismantling and removing the  underlying  asset,  restoring  the  site  on  which  it  is located or restoring the underlying asset to the condition required by the terms and conditions of the lease, unless those costs are incurred to  produce    The lessee incurs the obligation for those costs either at the commencement date or as a consequence of having used the underlying asset during a particular period.

A lessee shall recognise the costs described in fourth bullet above as part of the cost of the right-of-use asset when it incurs an obligation for those costs. A lessee  applies  Ind  AS  2,  Inventories,  to  costs  that  are  incurred  during  a particular period as a consequence of having used the right-of-use asset to produce  inventories  during  that  period.  The  obligations  for  such  cost accounted  for  applying  this  Standard  or  Ind  AS  2  are  recognised  and measured  applying  Ind  AS  37,  Provisions,  Contingent  Liabilities  and Contingent Assets.

  1. How is the RTU asset depreciated?

RTU asset is to be depreciated as per the depreciation requirement of Ind AS 16 Property, Plant and Equipment subject to the following:

  • If the lease transfers ownership of the underlying asset to the lessee by the end of the lease term or if the cost of the right-of-use asset reflects that the lessee will exercise a purchase option, the lessee shall depreciate the right-of-use asset from the commencement date to the end of the useful life of the underlying asset.
  • Otherwise, the lessee shall depreciate the right-of-use asset from the commencement date to the earlier of the end of the useful life of the right-of-use asset or the end of the lease term.

The Liability side

  1. How is the lease liability recognized?

At the commencement date, a lessee shall measure the lease liability at the present value of the lease payments that are not paid at that date. The lease payments shall be discounted using the interest rate implicit in the lease, if that rate can be readily determined. If that rate cannot be readily determined, the lessee shall use the lessee’s incremental borrowing rate.

At the commencement date, the lease payments included in the measurement of the lease liability comprise the following payments for the right to use the  underlying  asset  during  the  lease  term  that  are  not  paid  at  the commencement date:

  • fixed payments (including in-substance fixed payments i.e. lease  payments  that  may,  in  form, contain  variability  but  that,  in  substance,  are  ), less any lease incentives receivable;
  • variable lease payments that depend on an index or a rate [these include, for example, payments linked to a consumer price index,  payments  linked  to  a  benchmark  interest  rate  (such  as  LIBOR)  or payments that vary to reflect changes in market rental rates.], initially measured  using  the  index  or  rate  as  at  the  commencement  date
  • amounts expected  to  be payable  by  the  lessee  under  residual  value guarantees [A guarantee made to a  lessor  by a party unrelated to the lessor  that the value (or part of the value) of an underlying asset at the end of a lease will be at least a specified amount.]
  • the exercise  price  of  a  purchase  option  if  the  lessee  is  reasonably certain  to  exercise  that  option
  • payments of  penalties  for  terminating  the  lease,  if  the  lease  term reflects the lessee exercising an option to terminate the lease.
  1. How is the liability amortised over time?

After the commencement date, a lessee shall measure the lease liability by:

  1. increasing the  carrying  amount  to  reflect  interest  on  the   lease liability;
  2. reducing the  carrying  amount  to  reflect  the  lease  payments made; and
  3. re-measuring the carrying amount to reflect any reassessment or lease modifications or to reflect revised in-substance fixed lease payments.

Interest on the lease liability in each period during the lease term shall be the amount  that  produces  a  constant  periodic  rate  of  interest  on  the  remaining balance of the lease liability. The periodic rate of interest is the interest rate implicit in the lease, if that rate can be readily determined. If that rate cannot be readily  determined,  the  lessee  shall  use  the  lessee’s  incremental borrowing rate,  or  if  applicable,  the  revised  discount  rate.

After  the  commencement  date,  a  lessee  shall  recognise  in  profit  or  loss, unless  the  costs  are  included  in  the  carrying  amount  of  another  asset applying other applicable Standards, both:

  1. interest on the lease liability; and
  2. variable lease payments not included in the measurement of the lease liability in  the  period  in  which  the  event  or  condition  that  triggers those payments occurs.

Balance sheet and Profit and loss impact for lessee

  1. How is the lessee’s balance sheet impacted by the Standard?

Ind AS 116 eliminates the requirement for a lease to be classified as either operating or finance lease for a lessee. All leases are to be treated in a similar way to finance leases applying Ind AS 17. The standard leads to more asset and liabilities being put on the lessee’s balance sheet.

  1. How is the profit and loss account of the lessee impacted by the standard?

The rental expense being debited in case of an operating lease is now replaced by (a) amoritisation of lease liability; and (b) depreciation of the RTU asset. The depreciation charge is even over the life of the asset while interest expense reduces over the lease period as the lease payments are made. The rental was an above-EBITDA item. The amortization of lease liability and depreciation of the RTU asset are now post EBIT items. Hence, the lessee’s EBIT also gets affected.

Minimum lease payments

  1. Is the definition of MLPs under the new standard materially different from the same under the existing lease accounting standards?

The definition of MLPs under the new standard is substantially the same as under the existing lease standards. The same could be shown with the help of the comparative table below:

AS 19 Ind AS 17 Ind AS 116
Minimum lease payments are the payments over the lease term that the lessee is, or can be required, to make excluding contingent rent, costs for services and taxes to be paid by and reimbursed to the lessor, together with:

a.       in the case of the lessee, any residual value guaranteed by or on behalf of the lessee; or

b.      in the case of the lessor, any residual value guaranteed to the lessor:

i.            by or on behalf of the lessee; or

ii.            by an independent third party financially capable of meeting this guarantee.

However, if the lessee has an option to purchase the asset at a price which is expected to be sufficiently lower than the fair value at the date the option becomes exercisable that, at the inception of the lease, is reasonably certain to be exercised, the minimum lease payments comprise minimum payments payable over the lease term and the payment required to exercise this purchase option.

Minimum lease payments  are the payments over the lease term  that the lessee is or can be required to make,  excluding  contingent rent, costs for services and taxes to be paid by and reimbursed to the lessor, together with:

a.       for  a  lessee,  any  amounts  guaranteed  by  the  lessee  or  by  a  party related to the lessee; or

b.      for a lessor, any residual value guaranteed to the lessor by:

i.            the lessee

ii.            a party related to the lessee; or

iii.            a third party unrelated to the lessor that is financially capable  of discharging the obligations under the guarantee.

However, if the lessee has an option to purchase the asset at a price that is expected  to  be  sufficiently  lower  than  fair  value  at  the  date  the  option becomes  exercisable  for  it  to  be  reasonably  certain,  at  the  inception  of  the lease,  that  the  option  will  be  exercised,  the  minimum  lease  payments comprise the minimum payments payable over the lease term to the expected date of exercise of this purchase option and the payment required to exercise it.

As per Ind AS 116, the minimum lease payments is equivalent to the cost at which the RTU asset shall be initially recognized. For lessee the same shall comprise of the following components:

·         the amount of the initial measurement of the lease liability, as described in para 26 of Ind AS 116 i.e. on the date of commencement of lease, lease liability is to be measured at present value of the lease payments that are not paid at that date.

·         any lease payments made at or before the commencement  date, less any lease incentives received i.e. if the lessee has made payment towards the RTU the underlying assets at any point of time, the same shall form a part of the cost of RTU.

·         Any initial direct costs incurred by the lessee. Initial direct costs are the incremental costs of obtaining a lease that would not have been incurred if the lease had not been obtained.

·         an estimate of costs to be incurred by the lessee in dismantling and removing  the  underlying  asset,  restoring  the  site  on  which  it  is located or restoring the underlying asset to the condition required by the terms and conditions of the lease, unless those costs are incurred to  produce  inventories.  The lessee incurs the obligation for those costs either at the commencement date or as a consequence of having used the underlying asset during a particular period.

From the lessor’s point of view, the minimum lease payments comprise of the following:

·         fixed payments, less any lease incentives payable;

·         variable  lease  payments  that  depend  on  an  index  or  a  rate,  initially measured using the index or rate as at the commencement date;

·         any residual value guarantees provided to the lessor by the lessee, a party related to the lessee or a third party unrelated to the lessor that is  financially  capable  of  discharging  the  obligations  under  the guarantee;

·         the  exercise  price  of  a  purchase  option  if  the  lessee  is  reasonably certain  to  exercise  that  option ; and

·         payments  of  penalties  for  terminating  the  lease,  if  the  lease  term reflects the lessee exercising an option to terminate the lease.

Discounting rate

  1. What is the discounting rate to be taken for computing the present value of MLPs?

For computing the present value of MLPs, the following interest rates should be considered:

  1. the interest rate implicit in the lease [The rate of interest that causes the present value of(a) the lease  payments  and (b) the  unguaranteed residual  value  to  equal  the  sum  of  (i)  the  fair value  of the  underlying asset  and (ii) any  initial direct costs of the lessor]; or
  2. if the interest rate implicit in the lease cannot be readily determined, the lessee’s incremental borrowing rate [The rate of interest that a lessee would have to pay to borrow  over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use asset  in a similar economic environment].

 

  1. Is there a difference between the existing accounting standards and this standard, as regards the discounting rate?

There is no difference between the existing accounting standards and Ind AS 116 as regards the discounting rate. The same could be depicted with the help of the comparative table below:

 

AS 19 Ind AS 17 Ind AS 116
In calculating the present value of the minimum lease payments the discount rate is the:

a.       interest rate implicit in the lease [The interest rate implicit in the lease is the discount rate that, at the inception of the lease, causes the aggregate present value of

i.            the minimum  lease payments under a finance lease from the standpoint of the lessor; and

ii.            any unguaranteed residual value accruing to the lessor, to be equal to the fair value of the leased asset.],

if this is practicable to determine;

b.      if not, the lessee’s incremental borrowing rate [The lessee’s incremental borrowing rate of interest is the rate of interest the lessee would have to pay on a similar lease or, if that is not determinable, the rate that, at the inception of the lease, the lessee would incur to borrow over a similar term, and with a similar security, the funds necessary to purchase the asset] should be used.

The discount rate  to  be  used  in  calculating  the  present  value  of  the  minimum  lease payments  is  the:

a.       interest  rate  implicit  in  the  lease [The interest rate implicit in the lease  is the discount rate that, at the  inception of  the  lease,  causes  the  aggregate  present  value  of  (a)  the  minimum  lease payments  and (b) the  unguaranteed residual value  to be equal to the sum of (i)  the  fair  value  of  the  leased  asset  and  (ii)  any  initial  direct  costs  of  the lessor.],  if  this  is  practicable  to determine;

 

b.      if not, the lessee’s incremental borrowing rate [The lessee’s incremental borrowing rate of interest is the rate  of interest the lessee would have to pay on a similar  lease  or, if that is not determinable, the rate that, at the  inception of the lease, the lessee would incur to borrow over a similar term, and with a similar security, the funds necessary to purchase the asset. ] shall be used.

For computing the present value of MLPs, the following interest rates should be considered:

a.       the interest rate implicit in the lease [The rate of interest that causes the present value of(a) the  lease  payments  and (b) the  unguaranteed residual  value  to  equal  the  sum  of  (i)  the  fair value  of the  underlying asset  and (ii) any  initial direct costs of the lessor]; or

b.      if the interest rate implicit in the lease cannot be readily determined, the lessee’s incremental borrowing rate [The rate of interest that a lessee  would have to pay to borrow  over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use asset  in a similar economic environment].

 

 

SEBI requires disclosure by banks in case of NPA divergence

By Mayank Agarwal, (finserv@vinodkothari.com)

The banking sector is one of the pillars for economic development of any country, and any well balanced and healthy economy is largely dependent on a transparent and credible banking system. In recent years, the Indian economy has recognized the importance of a well-regulated and fundamentally strong banking framework and made it one of its priorities to clear out the vast amount of unhealthy practices and activities that tread on the fine line of regulation. A slew of new policies which led to clearer recognition norms, stricter disclosure requirements, more hands-on approach by the Reserve Bank of India (RBI) and an overall environment that is much more transparent than before are all testimony to the fact that the banking institutions are in for a major overhaul. The introduction of practices such as Asset Quality Review (AQR), restructuring norms and the introduction of Insolvency and Bankruptcy Code (IBC) by the RBI were steps aimed towards a fundamentally cleaner banking system. Read more

RESTRICTIVE REMEDY UNDER SECTION 14 OF SARFAESI ACT

By Richa Saraf , (legal@vinodkothari.com)

In a recent Calcutta High Court (“Hon’ble High Court”) ruling of Union Bank of India & Anr. v. State of West Bengal & Ors. (01.09.2017), the object and intention behind Section 14 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI Act”) was discussed. The issue for consideration before the Hon’ble High Court was whether the District Magistrate can consider and dispose of an application under Section 14, subsequent to sale of the immovable property, over which security interest was claimed and the Hon’ble High Court answered in negative. Below, we discuss the ruling. Read more