By Falak Dutta, (firstname.lastname@example.org)
Yet another year went by and Indian securitization market certainly had a year to rejoice. Starting from the volume of transactions to innovative structures, the market has everything to boast about. Before we discuss each of these at length, let us take stock of the highlights first: Read more
By Dibisha Mishra (email@example.com)
Reserve Bank of India (RBI), in its Statement on Development and Regulatory Policies dated April 04, 2019, stated its intention to extend the same to the remaining notified classes of NBFCs as well, by the end of April, 2019.
Ombudsman Scheme for Non-Banking Financial Companies, 2018 (Scheme) on 23rd February, 2018 was introduced with the intent of curbing down the time, costs and complexities involved in complaint redressal mechanism for certain services rendered by non-banking financial companies (NBFC). The salient features of the Scheme worth taking note of has been explained in our previous article. The Scheme covered within its ambit, all NBFCs registered with RBI, who are:
- authorized to accept deposits; or
- having customer interface, with assets size of Rs. 100 Crores or above, as on the date of the audited balance sheet of the previous financial year,
(hereinafter referred to as “notified classes of NBFCs”) Read more
Financial Services Division
The Ministry of Corporate Affairs (MCA) has put a small announcement on its website that the new lease accounting standard, IndAS 116 will get implemented from 1st April 2019. The new Standard, globally implemented in several countries from 1st Jan 2019, is called IFRS 16. The Standard eliminates the 6-decade old distinction between financial and operating leases, from lessee accounting perspective, thereby putting all leases on the balance sheet. The phenomenon of off-balance sheet lease transactions was one of the burning analyses after bankruptcy of Enron in 2001, and since then, had been erupting off and on, until the global standard setter decides to push the new standard on the rule book in Jan 2016, effective 1st Jan 2019.
After the introduction of IFRS 16, the ICAI came out with an exposure draft on the new standard in 2017 and kept it open for comments for some days. However, nothing further was heard about it thereafter.
The exposure draft and the final published Ind AS 116 are same except for the below mentioned change which has been incorporated in the final published Ind AS 116:
|Para 47 dealing with presentation in books of lessee:|
|In Exposure Draft||Text of published Ind AS 116|
|Para 47 A lessee shall either present in the balance sheet, or disclose in the notes:||Para 47: A lessee shall either present in the balance sheet, or disclose in the notes:|
|(a) right-of-use assets separately from other assets.||(a) right-of-use assets separately from other assets. If a lessee does not present right-of-use assets separately in the balance sheet, the lessee shall:|
|(i) include right-of-use assets within the same line item as that within which the corresponding underlying assets would be presented if they were owned; and|
|(ii) disclose which line items in the balance sheet include those right-of-use assets.|
|(b) lease liabilities separately from other liabilities.||(b) lease liabilities separately from other liabilities. If a lessee does not present lease liabilities separately in the balance sheet, the lessee shall disclose which line items in the balance sheet include those liabilities.|
(above para is same as para 47 IFRS 16, thereby making IFRS 16 and Ind AS 116 exactly same now, except for the fair value option for investment property- ref para 1 of comparison with IFRS 16 )
Giving the above option makes it clear how the lessee is going to show the asset in books.
For example, if A takes Aircraft-1 on lease and owns Aircraft-2, A can either include both of them in PPE or can show Aircraft-1 in PPE and Aircraft-2 just below PPE under the head ROU.
Correspondingly, a lease liability can be disclosed separately, if not disclosed separately, then disclose which line item in BS includes the lease liability.
Globally, several jurisdictions have implemented the Standard with effect from 1st January, 2019. A list of jurisdictions which have already adopted can be viewed here.
Some of the key takeaways from the implementation of this Standard are:
- Currently, there are two accounting standards for lease transactions, first, Ind AS 17, which is applicable to the Ind AS compliant companies and second, AS 19, which is applicable to the remaining classes of companies. Ind AS 116 proposes to replace Ind AS 17, therefore, the companies which are not covered by Ind AS shall continue to follow old accounting standard.
- The applicability of this standard shall have to be examined separately for the lessor and the lessee, that is, if the lessor is Ind AS compliant and lessee is not Ind AS compliant, then lessor will follow Ind AS 116 whereas lessee will follow AS 19.
- The new standard changes treatment of operating leases in the books of the lessees significantly. Earlier, operating leases remained completely off the balance sheet of the lessee, however, vide this standard, lessees will have to recognise a right-to-use asset on their balance sheet and correspondingly a lease liability will be created in the liability side.
- Lease of low value assets and short tenure leases (up to 12 months) have been carved out from the requirement of recognition of RTU asset in the books of the lessee.
- No change in the accounting treatment in case of financial leases.
- No change in the lessor’s’ accounting.
While leasing has not been greatly popular in India compared to the world, there has been a substantial pick up in interest over recent years. Therefore, a question comes – will the new standard put a death knell to the feeble leasing industry in India? To the extent the demand for leasing comes from off balance sheet perspective for a lessee, the standard may have some impact. However, there are many economic drivers for lease transactions – such as the ease of usage, tax benefits, better residual realisation, etc. Those factors remain unaffected, and in fact, the focus of lease attractiveness will shift to real economic factors rather than balance sheet cosmetics.
The apparent question that arises here is whether the new standard unsettle the taxation framework for lease transactions in India, especially direct taxes – the answer to this question is negative. The tax treatment of lease transaction does not depend on the treatment of the transaction in books of accounts. Instead, it depends on whether the transaction is case a true lease or is merely a disguised financial transaction. There will be no impact on the indirect taxation framework as well.
- Monetary Authority of Singapore (MAS) Guidelines on Securitisation (The guidelines were finalized in 2000)
- Amendment in 2018
- Amendment in 2007
- News on Securitisation
- Rules on Securitisation
- 15 U.S. Code § 78o–11. Credit risk retention:
- Dodd-Frank Wall Street Reform and Consumer Protection Act [Public Law 111–203] [As Amended Through P.L. 115–174, Enacted May 24, 2018]
- Securitisation Market
- Laws on Securitisation
- Australian Prudential Standard (APS) 120 made under section 11AF of the Banking Act 1959 (the Banking Act) By Australian Prudential Regulation Authority
- Covered Bonds issued under Part II, Division 3A of the Banking Act 1959 (Cth)
- Laws on Securitisation
- Securitisation Market
- Bank Indonesia Regulation No. 7/4/PBI/2005 Prudential Principles in Asset Securitisation for Commercial Banks
- Securitisation Market
- Hong Kong:
- There is no specific legislative regime for securitisation. Securitisation is subject to various Hong Kong laws, depending on the transaction structure, transaction parties, underlying assets, and the nature of the offering of the securities
- Securitisation Market
- Office of the Superintendent of Financial Institutions, Government of Canada
- Securitisation Market
- European Union:(UK, Germany, France,Italy, Sweden, Poland, Spain, Greece, Finland, Malta)
- Regulation(EU) 2017/2402 (the Securitisation Regulation) as on December 12,2017
- Regulation (EU) 2017/2402 of the European Parliament and of the Council of September 30, 2015
- Securitisation Market:
- UK: http://vinodkothari.com/secuk/
- GERMANY: http://vinodkothari.com/germany/
- SWEDEN: http://vinodkothari.com/secswede/
- POLAND: http://vinodkothari.com/secpolan/
- SPAIN: http://vinodkothari.com/secspain/
- FINLAND: http://vinodkothari.com/secfinla/
- Law 130 of 30 April 1999, Italian securitisation law
- Securitistion Market
- GREEK LAW 3156/2003
- Order No. 2017-1432 of October 4, 2017 , Modernizing the Legal Framework for Asset Management and Debt Financing (Initial Version)
Version in force on 26/03/2019
- Securitisation Market:
- Japan: Securitisation in Japan is governed by laws and regulations applicable to specific types of transactions such as the Civil Code (Law No. 89, 1896), the Trust Act (Law No. 108, 2006) and the Financial Instruments and Exchange Law (Law No. 25, 1948) (FIEL).
- Laws on Securitisation
- Securitisation Market
- Administrative Rules for Pilot Securitization of Credit Assets(the Administrative Rules) on April 2005
- Securitisation Market
- European Union (General Framework For Securitisation And Specific Framework For Simple, Transparent And Standardised Securitisation) Regulations 2018 (Central Bank of Ireland)
- South Africa:
- In South Africa, securitisations are regulated according to the securitisation regulations issued under the Banks Act 94 of 1990 (the Banks Act)
- Government Gazette 30628 of 1 January 2008 (Securitisation Regulations)
- Laws on Securitisation
- Securitisation Market
- Law No. 33-06 on Securitization
- Draft amendment of Law on Securitization
With the backdrop of revision of various frameworks for raising funds outside India (other than by way of equity participation), RBI has issued the Master Direction – External Commercial Borrowings, Trade Credits and Structured Obligations on 26th March, 2019, in supersession of the existing Master Direction – External Commercial Borrowings, Trade Credit, Borrowing and Lending in Foreign Currency by Authorised Dealers and Persons other than Authorised Dealers dated 1st January, 2016 (last updated on 22nd November, 2018).
The new Master Direction seeks to consolidate all applicable circulars and notifications in respect of the following:
- External Commercial Borrowing framework (ECB framework) covered in the Master Direction as Part I
- Trade Credit framework covered as Part II
- Structured Obligations covered as Part III.
The first set of changes was introduced through the Foreign Exchange Management (Borrowing and Lending) Regulations, 2018 on 17th December, 2018. Thereafter, the New ECB framework was issued on 16th January, 2019 and the Trade Credit Policy on 13th March, 2019.
New Master Direction
The erstwhile Master Direction included provisions pertaining to borrowing and lending in foreign currency, which has now been removed and is solely dealt with by Foreign Exchange Management (Borrowing and Lending) Regulations, 2018. Further, it replaces the erstwhile ECB framework and Trade Credit framework with the recently issued frameworks, separately.
The revised ECB policy and Trade Credit Policy were issued, coinciding with Foreign Exchange Management (Borrowing and Lending) Regulations, 2018.
The changes introduced pursuant to new ECB policy and Trade Credit policy have been covered by our colleagues extensively in the following write ups:
- RBI revises ECB framework – aligns with FEM (Borrowing and Lending) Regulations, 2018
- RBI revises Trade Credit Policy Framework.
Few important additions in the revised frameworks, now consolidated under the Master Directions include Standard Operating Procedure for Untraceable Entities for Ad Banks, ECB for entities under resolution under IBC, ECB for resolution applicants, Late Submission Fee for late submission of returns.
The revision of the Master Direction which was originally issued in 2016 was quite anticipated in light of the recent changes made by RBI. Although the new Master Direction does not introduce any additional change in the ECB and Trade Credit framework, it unifies all the applicable policy frameworks, thereby giving more clarity.
Vinod Kothari (firstname.lastname@example.org); Abhirup Ghosh (email@example.com)
On 22 March, 2019, just days before the onset of the new financial year, when banks were supposed to be moving into IFRS, the RBI issued a notification, giving Indian banks indefinite time for moving into IFRS. Most global banks have moved into IFRS; a survey of implementation for financial institutions shows that there are few countries, especially which are less developed, where banks are still adopting traditional GAAPs. However, whether the Notification of the RBI is giving the banks a break that they badly needed, or is just giving them today’s gain for tomorrow’s pain, remains to be analysed.
The RBI notifications lays it on the legislative changes which, as it says, are required to implement IFRS. It refers to the First Bi-monthly Monetary Policy 2018-19, wherein there was reference to legislative changes, and preparedness. There is no mention in the present notification for preparedness – it merely points to the required legislative changes. The legislative change in the BR Act would have mostly been to the format of financial statements – which is something that may be brought by way of notification. That is how it has been done in case of the Companies Act.
This article analyses the major ways in which IFRS would have affected Indian banks, and what does the notification mean to the banking sector.
Major changes that IFRS would have affected bank accounting:
- Expected Credit Loss – Currently, financial institutions in India follow an incurred credit loss model for providing for financial assets originated by them. Under the ECL model, financial assets will have to be classified into three different stages depending on credit risk in the asset and they are:
- Stage 1: Where the credit risk in the asset has not changed significantly as compared to the credit risk at the time of origination of the asset.
- Stage 2: Where the credit risk in the asset has increased significantly as compared to the credit risk at the time of origination of the asset.
- Stage 3: Where the asset is credit impaired.
While for stage 1 financial assets, ECL has to be provided for based on 12 months’ expected losses, for the remaining stages, ECL has to be provided for based on lifetime expected losses.
The ECL methodology prescribed is very subjective in nature, this implies that the model will vary based on the management estimates of each entity; this is in sharp contrast to the existing provisioning methodology where regulators prescribed for uniform provisioning requirements.
Also, since the provisioning requirements are pegged with the credit risk in the asset, this could give rise to a situation where the one single borrower can be classified into different stages in books of two different financial institutions. In fact, this could also lead to a situation where two different accounts of one single borrower can be classified into two different stages in the books of one financial entity.
- De-recognition rules – Like ECL provisioning requirements, another change that will hurt banks dearly is the criteria for derecognition of financial assets.
Currently, a significant amount of NPAs are currently been sold to ARCs. Normally, transactions are executed in a 15:85 structure, where 15% of sale consideration is discharged in cash and the remaining 85% is discharged by issuing SRs. Since, the originators continue to hold 85% of the SRs issued against the receivables even after the sell-off, there is a chance that the trusts floated by the ARCs can be deemed to be under the control of the originator. This will lead to the NPAs coming back on the balance sheet of banks by way of consolidation.
- Fair value accounting – Fair value accounting of financial assets is yet another change in the accounting treatment of financial assets in the books of the banks. Earlier, the unquoted investments were valued at carrying value, however, as per the new standards, all financial assets will have to be fair valued at the time of transitioning and an on-going basis.
It is expected that the new requirements will lead to capital erosion for most of the banks and for some the hit can be one-half or more, considering the current quality of assets the banks are holding. This deferment allows the banks to clean up their balance sheet before transitioning which will lead to less of an impact on the capital, as it is expected that the majority of the impact will be caused due to ECL provisioning.
World over most of the jurisdictions have already implemented IFRS in the banking sector. In fact, a study shows that major banks in Europe have been able to escape the transitory effects with small impact on their capital. The table below shows the impact of first time adoption of IFRS on some of the leading banking corporations in Europe:
Impact of this deferment on NBFCs
While RBI has been deferring its plan to implement IFRS in the banking sector for quite some time, this deferral was not considered for NBFCs at all, despite the same being admittedly less regulated than banks. The first phase of implementation among NBFCs was already done with effect from 1st April, 2018.
This early implementation of IFRS among NBFCs and deferral for banks leads to another issue especially for the NBFCs which are associates/ subsidiaries of banking companies and are having to follow Ind AS. While these NBFCs will have to prepare their own financials as per Ind AS, however, they will have to maintain separate financials as per IGAAP for the purpose of consolidation by banks.
What does this deferment mean for banks which have global listing?
As already stated, IFRS have been implemented in most of the jurisdictions worldwide, this would create issues for banks which are listed on global stock exchanges. This could lead to these banks maintaining two separate accounts – first, as per IGAAP for regulatory reporting requirements in India and second, as per IFRS for regulatory reporting requirements in the foreign jurisdictions.
India has been adopted International Financial Reporting Standards (IFRS) in the form of Indian Accounting Standards (Ind AS) in a phased manner since 2016. Different implementation schedules have been issued by different regulatory authorities for different classes of companies and they are:
- Ministry of Corporate Affairs –
- For non-banking non-financial companies – Implementation schedule started from 1st April, 2016
- For non-banking financial companies – Implementation schedule started from 1st April, 2018
- Reserve Bank of India –
- For banking companies – The original scheduled start date was 1st April, 2018, subsequently, it was shifted to 1st April, 2019. However, a recent notification from the RBI has shifted the implementation schedule indefinitely.
- Insurance Regulatory Development Authority of India –
- For insurance companies – The implementation schedule starts from 1st April, 2020.
Consequent upon implementation of IFRS, it is logical that the regulatory framework for financial institutions will also require modifications to bring it in line with the provisions requirements under the new standards.
Though the Ind AS already been implemented in the NBFC sector, no modifications in the existing regulations have been made. Consequently, this has led to the creation of several ambiguities; and one such is regarding treatment of the Other Comprehensive Income (OCI), as per Ind AS 109, for the purpose of computing Tier 1 capital.
This write up will solely focus on the issue relating to treatment of OCI for the purpose of Tier 1 capital.
Other Comprehensive Income (OCI)
Before delving further into specifics, let us have a quick recap of the concept of the OCI. The format of income reporting under Ind AS has undergone a significant change. Under Ind AS, the statement of profit or loss gives us Total Comprehensive Income which consists of a) profit or loss for the period and b) OCI. While the first component represents the profit or loss earned by the reporting entity during the financial year, OCI represents unrealized gains or losses from financial assets of the reporting entity.
The intention of showing OCI in the books of the accounts, is that it protects the gains/losses of companies from oscillation. As the fair values of assets and liabilities fluctuate with the market, parking the unrealized gains in the OCI and not in the P/L account provides stability. In addition to investment and pension plan gains and losses, OCI also captures that the hedging transactions undertaken by the company. By segregating OCI transactions from operating income, a financial statement reader can compare income between years and have more clarity about the sources of income.
While profit or loss earned during the year forms part of the surplus or other reserves in the balance sheet, OCI is shown separately under the Equity segment of the balance sheet.
Capital Risk Adequacy Ratio
Moving on to the meaning of capital risk adequacy ratio (CRAR), it is a measurement of a bank’s available capital expressed as a percentage of a bank’s risk-weighted credit exposures. The CRAR is used to protect creditors and promote the stability and efficiency of financial institutions. This in turn results in providing protection against insolvency. Two types of capital are measured: Tier-I capital, which can absorb losses without a bank being required to cease trading, and Tier-II capital, which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors.
The concept of CRAR comes from the Basel framework laid down by the Basel Committee on Banking Supervision (BCBS), a division of Bank of International Settlement. The latest framework being followed worldwide is Basel III framework.
RBI has also adopted the Basel framework, however, with modifications to suit the economic environment in the country. The CRAR requirements have been made applicable to banks as well as NBFCs, however, the requirements vary. While banks are required to maintain 9% CRAR, NBFCs are required to maintain 15% CRAR.
To understand whether OCI should form part of CRAR, it is important to understand the components of CRAR.
Components of Tier I and II Capital as per RBI Master Directions for NBFCs
For the purpose of this write-up, requirements have been examined only from the point of view of NBFCs, as Ind AS is yet to be implemented for banking companies.
CRAR comprises of two parts – Tier I capital and Tier II capital. Each of the two have been defined in the Master Directions issued by the RBI, in the following manner:
(xxxii) “Tier I Capital” means owned fund as reduced by investment in shares of other non-banking financial companies and in shares, debentures, bonds, outstanding loans and advances including hire purchase and lease finance made to and deposits with subsidiaries and companies in the same group exceeding, in the aggregate, ten percent of the owned fund; and perpetual debt instruments issued by a non-deposit taking non-banking financial company in each year to the extent it does not exceed 15% of the aggregate Tier I Capital of such companies as on March 31 of the previous accounting year;
The term “owned funds” have been defined as:
“owned fund” means paid up equity capital, preference shares which are 9 compulsorily convertible into equity, free reserves, balance in share premium account and capital reserves representing surplus arising out of sale proceeds of asset, excluding reserves created by revaluation of asset, as reduced by accumulated loss balance, book value of intangible assets and deferred revenue expenditure, if any;
Tier II capital has been defined as:
(xxxiii) “Tier II capital” includes the following:
- preference shares other than those which are compulsorily convertible into equity;
- revaluation reserves at discounted rate of fifty five percent;
- General provisions (including that for Standard Assets) and loss reserves to the extent these are not attributable to actual diminution in value or identifiable potential loss in any specific asset and are available to meet unexpected losses, to the extent of one and one fourth percent of risk weighted assets;
- hybrid debt capital instruments;
- subordinated debt; and
- perpetual debt instruments issued by a non-deposit taking non-banking financial company which is in excess of what qualifies for Tier I Capital, to the extent the aggregate does not exceed Tier I capital.
The above definitions of Tier I and II capital do not talk about OCI. However, the Directions were prepared before the implementation of Ind AS 109 and no clarity on the subject has come from RBI post implementation of Ind AS 109.
Therefore, for determining whether OCI should be made a part of Tier I or Tier II capital, we can draw reference from Basel III framework.
Components of Tier I capital as per Basel III framework 
As per Para 52 of the framework, the Tier I capital consists of:
Common Equity Tier 1 capital consists of the sum of the following elements:
- Common shares issued by the bank that meet the criteria for classification as common shares for regulatory purposes (or the equivalent for non-joint stock companies);
- Stock surplus (share premium) resulting from the issue of instruments included Common Equity Tier 1;
- Retained earnings;
- Accumulated other comprehensive income and other disclosed reserves;
- Common shares issued by consolidated subsidiaries of the bank and held by third parties (ie minority interest) that meet the criteria for inclusion in Common Equity Tier 1 capital. See section 4 for the relevant criteria; and
- Regulatory adjustments applied in the calculation of Common Equity Tier 1
Retained earnings and other comprehensive income include interim profit or loss. National authorities may consider appropriate audit, verification or review procedures. Dividends are removed from Common Equity Tier 1 in accordance with applicable accounting standards. The treatment of minority interest and the regulatory adjustments applied in the calculation of Common Equity Tier 1 are addressed in separate sections.
The Basel III norms clearly states that accumulated other comprehensive income forms a part of the Tier I capital.
It is very interesting to note that RBI had also adopted Basel III framework on July 1, 2015, however, the framework adopted and introduced is silent on the treatment of the OCI, unlike the original Basel III framework. The reason for the omission of the concept of OCI is that the framework was adopted in India way before Ind AS implementation and under the erstwhile IGAAP, there was no concept of OCI or booking of unrealized gains or losses in the books of accounts.
It is well understood that due to the very recent implementation of IndAS 109, the guidelines have not been revised in line with the IndAS. However, going by the spirit of Basel III regulation, this leaves us very little doubt what the treatment of OCI for the purpose of CRAR computation should be. Therefore, one can safely conclude that the OCI should form part of Tier I capital, unless, anything contrary is issued by the RBI subsequently.
By Simran Jalan (firstname.lastname@example.org)
Supreme Court in the case of Justice K.S. Puttaswamy (Retd.) & Anr. V. Union of India, W.P. (Civil) 494/2012 dated September 26, 2018 (‘Aadhaar Verdict’) partially quashed section 57 of the Aadhaar Act, which dealt with use of Aadhaar by private companies or bodies corporate. Pursuant to the Aadhaar verdict, the private entities were not allowed to demand Aadhaar for establishing identity unless the same is pursuant to any law.
Consequently, it was proposed to amend the Aadhaar (Targeted Delivery of Financial and Other subsidies, Benefits and Services) Act, 2016 (‘Aadhaar Act’), Indian Telegraph Act, 1885 and the Prevention of Money Laundering Act, 2002 (‘PML Act’) in line with the Supreme Court directives. In order to ensure that personal data of Aadhaar holder remains protected against any misuse and Aadhaar scheme remains in conformity with the Constitution, the Aadhaar and Other Laws (Amendment) Ordinance, 2019 (Ordinance) was passed.
In this write-up we intend to discuss the outcome of the Ordinance.