STEERING COMMITTEE REPORT ON DIGITAL LENDING: ISSUES AND SOLUTIONS

– Richa Saraf (legal@vinodkothari.com)

The Department of Economic Affairs has recently shared the report of the Steering Committee[1] which discusses the various issues faced by fintech companies. This write up tries to focus on the issues in relation to online lending, and the recommendations given by the Steering Committee on the same.

Verifying the Authenticity of User:

RBI already provides for guidelines pertaining to Know Your Customer (KYC), specifying Originally Seen and Verified (OSV) norms, laying down conditions for non-face to face KYC, and in fact the e- KYC process was simplified with the advent of Aadhaar. However, the Aadhaar verdict by the Apex Court has adversely affected the fintech industry, and the Steering Committee has observed that there is need to explore alternatives for physical KYC. The following are the key recommendations in this regard:

  • Offline Authentication Process: These days smartphones are equipped with biometric enabled multi-factor authentication, therefore, technology may be put to use for the purpose of KYC and authentication of the user. Some fintech companies have already come up with various unconventional mode of KYC, such as video based KYC, obtaining validated electronic versions of KYC related documents through DigiLocker, etc., as an additional layer of protection, authentication of the user can also be done by sending an OTP at the registered mobile number of the user, or by using geo location, which indicates the IP address of the user. The Committee has also recognised some of these options in its Discussion Paper, provided the same is subject to prior customer consent.
  • Central Data Registry: In the light of representations made by various stakeholders, the Committee has expressed that e-KYC has the potential to reduce customer on-boarding and servicing costs significantly, and has, therefore, recommended that all financial sector regulators fix deadlines for on boarding existing KYC data to the Central KYC registry, making KYC a complete digital and paperless process.
  • Other non- traditional way of data exchange: The Discussion Paper also mentions about the usage of the Application Programme Interface (API), for facilitating real time information sharing; India Stack[2] being one such API, where digital records move with an individual’s digital identity, eliminating the need for massive amount of paper collection and storage.

Determination of Borrower’s creditworthiness:

The Steering Committee has noted how the poor and the unbanked are often unable to access credit due to the lack of formal credit history and/ or non-availability of significant information/ document. The following are the key recommendations in this regard:

  • Data sharing in the finance industry: The Committee believes that APIs must be used for cloud storing of data, and the same should be open, to ensure equal access to all those who wish to build on or rely on this data. For instance, an India Agri Stack can be built, such that lenders can evaluate the creditworthiness of agricultural borrowers. This stack can include a farmer’s borrowing history, land ownership data, income data, among other information. Additional APIs to facilitate research and the creation of applications may include: Government departments and local government bodies unified stack; land registry and state land records; ownership/fitness/loan/mortgage/enforcement records to provide transparency to transactions; and so on. Further, India MSME Stack may be built for MSME financing related data.
  • Digitisation of land records: The Digital India- Land Records Modernisation Program[3] is aimed at national integration of all land related data across the country in order to provide conclusive titles, including details such as characteristics of the land, mortgages, encumbrances, ownership and other rights, etc., enabling financial services companies to make informed decisions about lending.
  • Reliance on Informal Modes: Fintech companies are using a variety of sources for collecting customer information and advanced data analytics to access customer credibility, for instance obtaining data from social media usage, web browser history, financial transaction behaviour, product purchase behaviour, etc. from the mobile phones of prospective borrowers. Some companies are also resorting to psychometric tests to build the customer’s profile.

For agri- loans specifically, to access the credit score of a borrower, it is suggested that companies use permutation and combination of the alternate data which may be available, such as weather forecasts and records, agronomic surveys, accessing the demographic, geographic, financial and social information of the customer, farmer progressiveness and such like. Referring to a Chinese agricultural fintech company Nongfenqi, which generates credit scores on the basis of interaction with customers’ business partners, fellow customers and villagers, the Committee has observed that the default rate in such model is merely 0.1%. In order to increase access to credit and to stabilise the growth of such practices, the Committee has recommended that Ministry of Economics and Information Technology (MEITY) and TRAI to formulate a policy to enable such practices through a formal, consent-based mechanism.

  • Usage of Artificial Intelligence (AI): AIs afford an opportunity to gain insight into customer behaviour pattern, thereby aiding in determination of their creditworthiness. Equifax[4] is one credit information agency, which gives potential lenders an overall insight on the borrower’s credit health through Neuro Decision Technology. It claims to predict the likelihood of a business incurring severe delinquency, charge-off or bankruptcy on financial accounts within the next 12 months. Vantage Score Solution[5], which claims to predict the likelihood of the borrower repaying the borrowed money, also used AI to develop a model for people with thinner credit profiles.

 The Steering Committee has also recognised AI for modernising the credit scoring methodology and approach.

Execution of agreements online:

Fintech entities have been vigorously using e- mode for entering into transactions; for instance, providing app- based loan, on a click. While one may contend that click- wrap agreements are prone to fraud, since the user is not known, and thus, cannot be relied upon, such may the case in any mode of execution. Most of the time in litigations, it is not uncommon for parties to challenge the authenticity of agreement, claiming that the acceptance by mail was not sent by him, that the signature is forged, etc. While physical signatures may be examined by way of forensic, it is difficult to verify whether a click- wrap agreement was actually entered into by the parties or was a mere mistake on the part of either of the parties.

While e-agreements are generally held as valid and enforceable in the courts, for high stake transactions, parties have apprehensions on the enforceability in case of default of loan or non- compliance of any of the terms, and therefore, they still insist on wet signatures on physical agreements. The Steering Committee has discussed about re-engineering of legal processes for the digital world. The Committee suggests that insistence on wet signatures on physical loan agreements be replaced by paperless legal alternatives, as these can enable cutting costs and time in access to finance, repayment, recovery, etc., for businesses and financial service companies. To achieve the goal of paperless economy also the requirement of physical loan agreements are unwanted. The Committee has, therefore, recommended that the Department of Legal Affairs should review all such legal processes that have a bearing on financial services and consider amendments permitting digital alternatives in cases such as power-of-attorney, trust deeds, wills, negotiable instrument, other than a cheque, any other testamentary disposition, any contract for the sale or conveyance of immovable property or any interest in such property, etc., (where IT Act is not applicable), compatible with electronic service delivery by financial service providers.

Other recommendations w.r.t. lending industry:

(a) Enhancing competition by way of referral pool:

The Committee recommends that all financial sector regulators may study the potential of open data access among their respective regulated entities, for enabling competition in the provision of financial services; RBI may encourage banks to make available databases of rejected credit applications available on a consent-basis to a neutral marketplace of alternate lenders. In line with the Open Data Regulations in the UK banking sector, the Committee further recommends that RBI may consider making available bank data (such as transaction and account history data) to fintech firms through APIs.

(b) Data privacy risks:

The Committee notes that the data sharing between entities is also subject to privacy laws, and while the Ministry of Science and Technology has already formulated the National Data Sharing and Accessibility Policy[6], and MEITY is the nodal Ministry to implement the policy, the same needs wider acceptance and implementation. The Committee has further recommended that a taskforce in the Ministry of Finance may be set up with the participation of the regulators and suitable recommendations may be made to safeguard the interests of consumers.

The Committee has expressed that the provisions of the Data Protection Bill, 2018[7] may have far-reaching implications on the growth of fintech sector, and has therefore, recommended that regulators should urgently review the existing regulatory framework with respect to data protection and privacy concerns, in keeping with emerging data privacy legislation in India.

 

[1]https://dea.gov.in/sites/default/files/Report%20of%20the%20Steering%20Committee%20on%20Fintech_2.pdf

[2] https://indiastack.org/

[3] http://dilrmp.gov.in/#

[4] https://www.equifax.co.in/

[5] https://www.vantagescore.com/

[6] https://dst.gov.in/sites/default/files/nsdi_gazette_0.pdf

[7] https://meity.gov.in/writereaddata/files/Personal_Data_Protection_Bill,2018.pdf

Our related write-ups can be viewed here:

 

Please find below the link for other write-ups relating to Fintechs.

http://vinodkothari.com/category/financial-services/fintech/

Moving towards digital India: Are e-agreements valid?

     –Anita Baid and Richa Saraf (legal@vinodkothari.com)

Introduction

With the evolution of technology, the way of executing documents have also evolved. With the increasing demand for modern, convenient methods for entering into binding transactions, electronic agreements and electronic signature have gained a lot of momentum in recent years. Technological developments have not only changed the ways in which these transactions are entered into but the execution process has also revolutionised significantly.

Speaking about e- agreements, while there has been various case laws, wherein email between parties has also been accepted as a binding contract, the validity and enforceability of click- wrap agreements still continues to be a cause of concern. The recent report of the Steering Committee on Fintech Issues[1] has also discussed about re-engineering of legal processes for the digital world. The Committee suggests that insistence on wet signatures on physical loan agreements be replaced by paperless legal alternatives, as these can enable cutting costs and time in access to finance, repayment, recovery, etc., for businesses and financial service companies. To achieve the goal of paperless economy also the requirement of physical loan agreements are unwanted. The Committee has, therefore, recommended that the Department of Legal Affairs should review all such legal processes that have a bearing on financial services and consider amendments permitting digital alternatives in cases such as power-of-attorney, trust deeds, wills, negotiable instrument, other than a cheque, any other testamentary disposition, any contract for the sale or conveyance of immovable property or any interest in such property, etc., (where IT Act is not applicable), compatible with electronic service delivery by financial service providers.

In this article, we have discussed the legal validity of electronic agreements and electronic signatures.

Validity of E- Agreement as per the Contract Act, 1872[2]

Section 10 of the Contract Act lays down as to what agreements are contracts. It states:

All agreements are contracts if they are made by the free consent of parties competent to contract, for a lawful consideration and with a lawful object, and are not hereby expressly declared to be void.”

Contracts executed electronically are also governed by the basic principles provided in the Contract Act, which mandates that a valid contract should have been entered with a free consent and for a lawful consideration between two majors. The intent of the parties is, therefore, relevant.

In case of click wrap agreements also, if the terms and conditions are provided to the user (offer) and he confirms to the same by ticking on “I Agree” (acceptance), then he shall be held liable to honour the obligations under the contract.

Recognition of E- Agreement and Digital Signature under the Information Technology Act, 2000[3]

Section 10A of the IT Act expressly provides for validity of contracts formed through electronic means and states that-

“Where in a contract formation, the communication of proposals, the acceptance of proposals, the revocation of proposals and acceptances, as the case may be, are expressed in electronic form or by means of an electronic record, such contract shall not be deemed to be unenforceable solely on the ground that such electronic form or means was used for that purpose.”

An e-agreement subsequent to its execution is stored/recorded with the executing parties in electronic form, and is considered as an electronic record under the IT Act. In this regard, it is relevant to refer to Section 2(1)(t) of the IT Act, which defines an electronic record as “data, record or data generated, image or sound stored, received or sent in an electronic form or micro film or computer generated micro fiche”.

The terms electronic signature and digital signature have been defined under the IT Act.

In fact, the IT Act quite comprehensively covers the legalities of digital signature certificates (DSCs). Section 5 of the IT Act gives electronic signatures their legal character.

“5. Legal recognition of electronic signatures: Where any law provides that information or any other matter shall be authenticated by affixing the signature or any document shall be signed or bear the signature of any person, then, notwithstanding anything contained in such law, such requirement shall be deemed to have been satisfied, if such information or matter is authenticated by means of electronic signature affixed in such manner as may be prescribed by the Central Government. “

Considering that the IT Act has recognised e-signatures as legal and binding, the same may also form a strong basis for initiating litigation before a court of law.

Recognition of E- Agreement and E- Signature under Stamp Acts

While a majority of state stamp laws do not specifically include electronic records within their ambit, some state stamp duty laws do recognise “electronic records” within the purview of “instrument”. For instance, Section 2(l) of the Maharashtra Stamp Act, 1958[4] specifically refers to electronic records in the definition of the term “instrument” as under:

instrument includes every document by which any right or liability is, or purports to be, created, transferred, limited, extended, extinguished or recorded, but does not include a bill of exchange, cheque, promissory note, bill of lading, letter of credit, policy of insurance, transfer of share, debenture, proxy and receipt;

Explanation. – The term “document” also includes any electronic record as defined in clause (t) of sub-section (1) of section 2 of the Information Technology Act, 2000.

The Maharashtra E-Registration and E-Filing Rules, 2013[5] also make appending of electronic signature or biometric thumb print mandatory, thereby further giving recognition and legal validity to e-contract and e- signature. The Indian Penal Code, the Banker’s Book of Evidence Act 1891 and the Reserve Bank of India Act, 1934 also contain provisions in relation to such electronic contracts which contain digital signature.

Admissibility of E- agreements as evidence?

Under the Evidence Act, 1872[6], an e-agreement has the same legal effect as a paper based agreement. The definition of “evidence” as provided under Section 3 of the Evidence Act includes “all documents including electronic records produced for the inspection of the court.” Section 65B(1) of the Evidence Act provides that any information contained in an electronic record which is printed on a paper, stored, recorded or copied in optical or magnetic media produced by a computer shall be deemed to be also a document and shall be admissible in any proceedings, without further proof or production of the original, as evidence of any contents of the original or of any fact stated therein of which direct evidence would be admissible”.

Further, Section 47A of the Evidence Act stipulates that when the Court has to form an opinion as to the electronic signature of any person, the opinion of the Certifying Authority which has issued the electronic Signature Certificate is a relevant fact, and Section 85B of the Evidence Act stipulates that unless the contrary is proved, the Court shall presume that-

  • the secure electronic record has not been altered since the specific point of time to which the secure status relates;
  • the secure digital signature is affixed by subscriber with the intention of signing or approving the electronic record.

Global Laws

UNCITRAL Model Law on Electronic Signatures[7]

In 1996, the United Nations Commission on International Trade Law (UNCITRAL) adopted the Model Law on Electronic Commerce to bring uniformity in the law in different countries. Based on which, India enacted the Information Technology Act, 2000. Subsequently, in 2001, as an addition to the existing Model Law, a Model Law on Electronic Signatures was adopted by the General Assembly of UNICTRAL.

Article 2 (a) of the Model Law defines electronic signatures as below:

“Electronic signature” means data in electronic form in, affixed to or logically associated with, a data message, which may be used to identify the signatory in relation to the data message and to indicate the signatory’s approval of the information contained in the data message;”

The Model Law has further examined various electronic signature techniques being used, and has broadly recognised two categories of electronic signatures-

  • Digital Signatures relying on public-key cryptography; and
  • Electronic Signatures relying on techniques other than public-key cryptography.

UK Law Commission- Consultation Paper on Making a Will[8]

The Law Commission has considered various forms of e- signatures such as typed names and digital images of handwritten signatures, passwords and PINs, biometrics, and digital signatures. The following are the key discussions in the Consultation Paper with respect to alternative modes of signature:

  • A rudimentary electronic signature may consist of a typed name in an electronic document, or a digital image of a handwritten signature. Such digital images may be produced by a scan or a photograph of the signature. However, there is a high risk of fraud in these forms of e- signature, as any person can copy the signature of any other person.
  • A biometric signature is a type of electronic signature that measures a unique physical attribute of the signatory in order to authenticate a document. For instance, fingerprints, retina scan, voice recognition, facial recognition. A biodynamic manuscript signature is also a type of biometric signature that is increasingly being used, where the unique way by which a person signs is recorded by way of various parameters including speed, pressure, and even the angle of the stylus, however, the reliability of biodynamic signatures varies on the systems used to record and analyse them.

Conclusion

On a combined reading of the national and international laws, it can be said that e-agreements are valid and enforceable in the courts, however, since the risk associated with e-signatures are high, for high stake transactions, parties still insist on wet signatures on physical agreements. For fintech entities, who have been vigorously using e- mode of documentation and execution, in order to avoid fraud or forgery, e- signatures can be used with an additional layer of security, for instance, by verifying the electronic signature via sending an OTP at the registered mobile number, or by using geo location, to capture the IP address, or such other mechanism to track the detail of the electronic device from where the e-signature has been affixed. Such two-tier verification process shall also ensure authenticity of the signatory.

 

[1] https://dea.gov.in/sites/default/files/Report%20of%20the%20Steering%20Committee%20on%20Fintech_2.pdf

[2] https://indiacode.nic.in/bitstream/123456789/2187/3/a1872___9pdf.pdf

[3] https://indiacode.nic.in/bitstream/123456789/1999/3/A2000-21.pdf

[4]https://indiacode.nic.in/bitstream/123456789/6916/1/maharashtra_stamp_act_%28lx_of_1958%29_%28modified_upto_05.12.2018%29.pdf

[5] http://igrmaharashtra.gov.in/writedata/PDF/e-Registration%20and%20e-Filing%20Rules%202013.pdf

[6] http://legislative.gov.in/sites/default/files/A1872-01.pdf

[7] https://www.uncitral.org/pdf/english/texts/electcom/ml-elecsig-e.pdf

[8] https://s3-eu-west-2.amazonaws.com/lawcom-prod-storage-11jsxou24uy7q/uploads/2017/07/Making-a-will-consultation.pdf

 

Our other write-ups on e-agreements and fintech lending can be referred here:

  • http://vinodkothari.com/wp-content/uploads/2019/03/Single-point-collection-of-stamp-duty.pdf
  • http://vinodkothari.com/articles-fintech-startups/

 

Resurgence of synthetic securitisations: Capital-relief driven transactions scale new peaks

Personal revolving lines of credit by NBFCs: nuances and issues

By Kanakprabha Jethani | Executive

Vinod Kothari Consultants P. Ltd.

(kanak@vinodkothari.com)

Personal loans by NBFCs are mostly extended as revolving lines of credit. Most of these facilities are originated by use of online apps. The lender will be quite keen, if there were no regulatory obstacles, to provide this line of credit by way of a credit card, or virtual credit card. However, there are regulatory barriers to NBFCs issuing credit cards. Therefore, NBFCs end up giving revolving lines of credit. However, the lurking issue is – if a credit card is also an instance of a revolving line of credit, is revolving line of credit an alternative to a card or virtual card, and if so, are there regulatory issues in NBFCs giving personal revolving lines of credit?

The issue is not whether the credit is personal, or for business purposes, for instance, a working capital line of credit. There is a general notion that NBFCs cannot extend working capital lines of credit, while they may give working capital loans.

It is important to examine this issue at length – as is done in this article.

Revolving line of credit: explained

A revolving line of credit is a mode of lending wherein the lender agrees to lend an amount equal to or less than a pre-determined credit limit, as approved for the borrower. The parameters for fixing the limit may be the credit appraisal of the borrower, or, as in case of working capital, the asset liability gap. The borrower may continue to use the line of credit – he may keep repaying, in which case the drawn amount comes down, and then he may re-draw, when the drawn amount goes up. The credit limit gets restored on repayment being made by the borrower. Such line of credit maybe secured or unsecured, depending on the agreement between lender and the borrower. The line of credit is essentially governed by the agreement between the parties. The term “revolving” does not imply that the line of credit is not subject to a review, or repayment. Each line of credit has a review period. If the lender decides not to revolve the line of credit, then the line of credit becomes a term loan, and has to be paid down as per the terms of agreement between the lender and the borrower.

For certain types of facilities, a revolving line of credit is aptly suitable. While, in case of businesses, working capital is best financed by a line of credit, in case of personal finance also, the ability to draw based on a line of credit extends the finances of the borrower, and allows him the flexibility to tap into the funding when needed, and pay it off when not needed. There is, of course, a standing commitment on the part of the lender to provide the facility amount the amount of the limit, for which lenders may charge a continuing commitment charge.

A line of credit implies a commitment to disburse. To the extent of the amount already disbursed, there is a funded facility. To the extent of the limit sanctioned but not yet availed, there is an unfunded commitment to disburse. Undisbursed or partly disbursed loans are common in case of term loans as well – for example, a home loan may take a substantial time to get disbursed.

Similarities between a credit card and revolving line of credit

A credit card is a payment card which the borrower may use for making payments at point of sale. The lender makes payment on behalf of the borrower and then recovers the same from the borrower. A detailed explanation of features of credit cards maybe referred to in one of our write-ups[1].

A revolving line of credit shares some of its features with a credit card, due to which they are seen as equivalents. The similarities between both the modes are as follows:

  • Borrowers can take the disbursement as and when needed.
  • The lender, in both cases, always reserves the right to reduce the credit limit.
  • The lender has to maintain optimum amount of working capital to meet the disbursement demands of the borrowers.
  • The credit limit is restored on repayment being made.

Disparity between credit card and revolving line of credit

Based on usual practice of the market, the following are the key points:

  • Security: A revolving line of credit maybe secured or unsecured, whereas, a credit card is always unsecured.
  • End-use restrictions: There are no restrictions on end use of funds in case of a credit card. However, in a line of credit, the end use is restricted by mentioning the purpose for availing the loan in the loan agreement. Of course, the purpose may be generic – for example, personal use or general business use.
  • Restriction w.r.t. withdrawal of fund: A revolving line of credit does not require a purchase to be made in order to get the funds disbursed. It allows money to be transferred into bank account for any reason without requiring an actual transaction. Whereas, in case of a credit card, payments can be made at Point of Sale (PoS) only and thus, it requires an actual transaction for the disbursement to be made..
  • Interest Period: In case of credit card, if repayment is made within a specified term, no interest is usually charged. However, after the specified period, a high rate of interest is charged. While on the other hand, in case of a revolving line of credit, the interest is calculated from the day of disbursement being made at a comparatively lower rate.
  • Credit Limit: As a market practice, revolving line of credit maybe availed for business purposes or personal purposes and thus, has higher credit limits as compared to a credit card which is generally used for personal purposes only.
  • Manner of Repayment: In case of credit card, funds once availed have to be repaid within a specified period of time, in lump sum. On the other hand, when credit is availed from a revolving line of credit, the same is repaid by the borrower in instalments.
  • Risks: Credit cards come with the risk of theft, misuse etc. However, the same maybe done away with, in case of virtual credit cards.

The fundamental difference

The abovementioned differences are, in essence, surficial. They are based on practices of the market, which may easily be reshaped suiting the needs of the parties. What is the key difference between a card, virtual card and a revolving line of credit? ​

A logical difference that one finds is that while in case of a credit card, the borrower uses it to make payments to third parties, in case of a revolving line of credit, the disbursements are made to the account of the borrower from where the borrower may use it for the required purpose. A credit card is an instrument: it can be used to settle payments, and therefore, becomes a part of the payment and settlement system. A straight line of credit may be tapped by the borrower. After tapping the line, the borrower may use it for making payments and settlements. But the line of credit itself is not an instrument of settling payments.

Therefore, fundamentally, while a revolving line of credit is a promise by lender to the borrower, a credit card is a promise by the lender to the world at large. A lender in case of a line of credit is obliged to make disbursement to the borrower, and only the borrower has a recourse against the lender. However, in case of issue of credit cards, the issuer or the lender is obliged to make payments to any authorized merchant who supplies goods and services against the card.

The burning question- Can NBFCs extend revolving line of credit?

Logical answer

The distinction between a revolving line of credit and credit card has already been highlighted above. Further, it is also quite evident from the above discussion that a credit card has wider risks than that of a revolving line of credit. In case of a revolving line of credit, the failure on the part of the lender to disburse the sanctioned amount impacts the borrower. However, if a card issuer defaults, it may affect all those merchants who might have used the card to supply goods and services. There may be a contagion impact, and therefore, the failure of a card issuer has systemic implications. Thus, capital adequacy, solvency and liquidity are far greater issues for a card issuer, than in case of a plain lender against revolving line of credit.

The above discussion leads one to conclude that there are no specific concerns in case of granting of a revolving line of credit. The only concern may be the exposure on account of the sanctioned but undisbursed amount, for which off-balance sheet credit conversion factors exist.

Regulatory support

The above logic may further be supported by the provisions of the Prudential Framework for Resolution of Stressed Assets[2], wherein the Reserve Bank of India (RBI) has recognized the practice of extending revolving line of credit by NBFCs. Following is the relevant extract from the said framework which is applicable on Scheduled Commercial Banks (excluding RRBs), All India Term Financial Institutions, Small Finance Banks, Deposit taking NBFCs and Systemically Important NBFCs (‘NBFC-SI’):

In the case of revolving credit facilities like cash credit, the SMA sub-categories will be as follows:

SMA Sub-categories Basis for classification – Outstanding balance remains continuously in excess of the sanctioned limit or drawing power, whichever is lower, for a period of:
SMA-1 31-60 days
SMA-2 61-90 days

So, firstly there are no express restrictions on extending revolving line of credit and secondly, the RBI recognizes such credit in its frameworks. Therefore, it is safe to take this recognition as a provenance to allowability of extending revolving line of credit by NBFCs.

Further, the provisions relating to restructuring of accounts of borrowers by NBFCs as per the Master Directions also recognize extension of revolving cash credit. It recognizes that roll-over of short-term loans based on actual requirement of borrower and not as a concession considering the credit weakness of the borrower, shall not be considered as restructuring of accounts. For-this purpose, short-term loans shall not include properly assessed regular Working Capital Loans like revolving Cash Credit or Working Capital Demand Loans. The relevant extract is as follows:

“In the cases of roll-over of short-term loans, where proper pre-sanction assessment has been made, and the roll-over is allowed based on the actual requirement of the borrower and no concession has been provided due to credit weakness of the borrower, then these shall not be considered as restructured accounts.

**

Further, Short Term Loans for the purpose of this provision do not include properly assessed regular Working Capital Loans like revolving Cash Credit or Working Capital Demand Loans.”

Concerns on maintenance of capital

In case of line of credit, the disbursements are to be made as and when the borrower requires, therefore, the NBFC should maintain adequate capital and liquidity to meet such abrupt demands. The RBI Master Directions take care of the solvency concerns of the NBFCs extending revolving line of credit. Liquidity standards, internally set by the NBFC under the ALM process, also contain safeguards by taking the undisbursed amount of committed facilities as “required funding”.

The Master Directions for NBFC-SI[3] requires the NBFC-SIs to maintain a Capital to Risk Assets Ratio (CRAR) of 15%. It provides the detailed methodology of how the risk-weighting of assets is to be done to meet the CRAR requirement.

Following is the extract from the said methodology:

Instrument Credit Conversion Factor
Other commitments (e.g., formal standby facilities and credit lines) with an original maturity of:

 

up to one year

over one year

 

 

 

20

50

Similar commitments that are unconditionally cancellable at any time by the applicable NBFC without prior notice or that effectively provide for automatic cancellation due to deterioration in a borrower’s credit worthiness  

 

0

 

Thus, depending on the terms of the revolving line of credit, a credit conversion factor will be multiplied to the total amount of obligation and the capital will be maintained accordingly.

Further, the Master Directions for Non-Systemically Important NBFCs (NBFC-NSIs)[4] require the NBFC-NSIs to maintain a leverage ratio of 7. Leverage Ratio shall mean Total outside Liabilities/ Owned Funds.

The definition of Total Outside Liabilities can be derived from Master Directions for Core Investments Companies (CICs)[5] which is as follows:

“outside liabilities” means total liabilities as appearing on the liabilities side of the balance sheet excluding ‘paid up capital’ and ‘reserves and surplus’, instruments compulsorily convertible into equity shares within a period not exceeding 10 years from the date of issue but including all forms of debt and obligations having the characteristics of debt, whether created by issue of hybrid instruments or otherwise, and value of guarantees issued, whether appearing on the balance sheet or not.”

Due to the leverage restriction, NBFC-NSIs shall also automatically be restricted from lending more than its capacity.

Nuts and bolts to the structure of revolving line of credit

From the above discussion, it is clear that NBFCs may extend revolving line of credit. However, from the prudence perspective, following are certain essentials that must be kept in mind by the NBFCs while extending a revolving line of credit:

  • It is advisable for the lender to retain the right to unconditionally cancel the commitment of revolving line of credit. In such case, the credit conversion factor for such exposure shall be “0”.
  • The terms of the line of credit must provide for review and reset as the lender may deem fit.
  • The lender must ensure that it maintains liquidity to meet abrupt calls for disbursement by the borrower.
  • In case the tenure of revolving line of credit is pre-determined, the credit conversion factor shall accordingly be taken as 20 or 50.

Conclusion

Though there are similarities between features of a credit card and a revolving line of credit, but the differences are not skin-deep. Further, it may also be argued that the RBI Master Directions recognize NBFCs extending line of credit, by providing expressly for prudential framework for SMA classification for revolving line of credit.

 

[1] http://vinodkothari.com/2018/07/credit-cards-and-emi-cards-from-an-nbfc-viewpoint/

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11580&Mode=0

[3]https://rbidocs.rbi.org.in/rdocs/notification/PDFs/45MD01092016B52D6E12D49F411DB63F67F2344A4E09.PDF

[4] https://rbidocs.rbi.org.in/rdocs/notification/PDFs/MD44NSIND2E910DD1FBBB471D8CB2E6F4F424F8FF.PDF

[5] https://rbidocs.rbi.org.in/rdocs/notification/PDFs/39MD440D125D51C2451295A5CA7D45EF09B9.PDF

SEBI’s Framework for listing of Commercial Papers

Munmi Phukon | Principal Manager, Vinod Kothari & Company

corplaw@vinodkothari.com

Introduction

SEBI on 22nd October, 2019 came out with a Circular to provide for the Framework for listing of Commercial Papers (CPs). The Circular is based on the recommendations of the Corporate Bonds & Securitization Advisory Committee (CoBoSAC) chaired by Shri H. R. Khan which was set up for making recommendations to SEBI on developing the market for corporate bonds and securitized debt instruments.

CPs are currently traded in OTC market though settled through the clearing corporations. Evidently, listing of CPs for trading in stock exchanges will enhance the investor participation which will in turn help the issuers to cope up with their short term fund requirements. SEBI’s current move in laying down the Framework is to ensure investor protection keeping in mind a prospective broader market for CPs. The Circular is mostly concerned about making elaborate disclosures at the time of submitting the application for listing and also some disclosures on a continuous basis post listing of the CPs.

As evident from the content of the Circular, some of the disclosure requirements proposed at the time of application for listing of the CPs are same as provided in the format of Letter of Offer as provided in the Operational Guidelines on CPs[1] (Operational Guidelines) prescribed by the Fixed Income Money Market and Derivatives Association of India (FIMMDA). However, there are certain additional requirements which are discussed in this article.

Disclosure requirements at the time of application for listing

Annexure I of the Circular provides for the disclosure requirements which the issuers are required to make at the time of submitting the application and the content of the same is quite elaborative which covers almost every aspect of an issuer. The broad segments of disclosures are as below:

General details of issuer
Under this heading, details such as, name, CIN, PAN, line of business group affiliation will be given. The issuer will also be required to give name of the managing director, CEO, CFO or president as chief executives. The disclosures are same as provided in the Operational Guidelines.

Details of directors
Details of current set of directors including inter alia their list of directorships and the details of any change in directors in the last 3 financial years and the current year shall be required to be disclosed.  Currently, the Operational Guidelines do not require these details.

Details of auditors
Details of current auditor and any change in directors in the last 3 financial years and the current year shall be required to be disclosed. Currently, the Operational Guidelines do not require these details.

Details of security holders
Under this category, the disclosure shall be made for top 10 equity shareholders, top 10 debt security holders and top 10 CP holders. However, the date of determination of the same has not been provided. Currently, the Operational Guidelines do not require these details.

Details of borrowings as at the end of latest quarter before filing of the application
Details of borrowings are divided into 3 parts-

a.      Details of debt securities and CPs. The Operational Guidelines require the details of CPs issued during last 15 months and also of the outstanding balance as on the date of offer letter.

b.      Details of other facilities such as secured/ unsecured loan facilities/bank fund based facilities, borrowings other than above, if any, including hybrid debt like foreign currency convertible bonds (FCCB), optionally convertible debentures / preference shares from banks or financial institutions or financial creditors. The details related to outstanding debt instruments and bank fund based facilities are same as provided in the Operational Guidelines however, it was silent on the hybrid instruments.

c.      Details of corporate guarantee or letter of comfort along with name of the counterparty on behalf of whom it has been issued, contingent liability including debt service reserve account (DSRA) guarantees/ any put option etc. Operational Guidelines do not require these details currently.

Information related to the concerned issue

The content is more or less similar to the details required to be provided in the Letter of Offer as provided in the Operational Guidelines. The additional requirements are as follows:

d.     Details of credit rating letter issued should not be older than one month on the date of opening of the issue and

e.      Copy of the executed guarantee.

Financial information
The stock exchanges shall be provided with the following financial information-

a.      Audited / Limited review of half yearly consolidated financial statements, if available;

b.      Financial statements along with auditor qualifications, if any, for last 3 years along with latest available financial results;

c.      Latest available quarterly financial results prepared under Regulation 33, if applicable;

d.     Latest audited financials not older than six months from the date of application. However, companies already complying with the Listing Regulations may submit unaudited financials with limited review.

The Operational Guidelines currently require the financial summary only of last 3 FYs to be provided in the letter of offer.

Material information
The following shall be disclosed-

a.      Details of all default/s and/or delay in payments of interest and principal of CPs, (including technical delay), debt securities, term loans, external commercial borrowings and other financial indebtedness including corporate guarantee issued in the past 5 financial years including in the current financial year.

b.      Ongoing and/or outstanding material litigation and regulatory strictures, if any.

c.      Any material event/ development having implications on the financials/credit quality including any material regulatory proceedings against the issuer/ promoters, tax litigations resulting in material liabilities, corporate restructuring event which may affect the issue or the investor’s decision to invest / continue to invest in the CP.

The disclosures in point (a) and (c) above are not required to be disclosed in the letter of offer as per Operational Guidelines.

Asset Liability Management (ALM) disclosures for NBFCs and HFCs

The Circular specifically provides for some additional disclosures for NBFCs and HFCs which are currently not required to be provided in the letter of offer prescribed by FIMMDA:

a.      NBFCs shall make disclosures as specified for NBFCs in SEBI Circular nos. CIR/IMD/DF/ 12 /2014[2], dated June 17, 2014 and CIR/IMD/DF/ 6 /2015, dated September 15, 2015. Further, “Total assets under management”, under the aforesaid Circular dated September 15, 2015 shall also include details of off balance sheet assets.

b.      HFCs shall make disclosures as specified for NBFCs in the said SEBI Circular no. CIR/IMD/DF/ 6 /2015, dated September 15, 2015, with appropriate modifications viz. retail housing loan, loan against property, wholesale loan – developer and others.

In terms of the SEBI Circular dated June 17, 2014, NBFCs are required to disclose the details with regards to the lending done by them, out of the issue proceeds of previous public issues, including details regarding the following:

a.      Lending policy;

b.      Classification of loans/advances given to associates, entities /person relating to Board, Senior Management, Promoters, Others, etc.;

c.      Classification of loans/advances given to according to type of loans, sectors, maturity profile, denomination, geographical classification of borrowers, etc.;

d.      Aggregated exposure to the top 20 borrowers with respect to the concentration of advances, exposures to be disclosed in the manner as prescribed by RBI in its guidelines on Corporate Governance for NBFCs, from time to time;

e.      Details of loans, overdue and classified as non-performing in accordance with RBI guidelines.

The Circular dated September 15, 2015 provides for the following additional disclosures:

a.      In case any of the borrower(s) of the NBFCs form part of the “Group” as defined by RBI, then appropriate disclosures shall be made as regards the name of the borrower, Amount of Advances /exposures to such borrower and Percentage of Exposure;

b.      A portfolio summary with regards to industries/ sectors to which borrowings have been made by NBFCs;

c.      Quantum and percentage of secured vis-à-vis unsecured borrowings made by NBFCs;

d.      Any change in promoter’s holdings in NBFCs during the last financial year beyond a particular threshold (RBI has prescribed such a threshold level at 26% at present).

Continuous disclosures after listing of CPs

Annexure II of the Circular provides for the disclosure requirements which shall be observed on a continuous basis. The details of such disclosures are broadly as below:

a.      Submission of financial results

i.          For issuers which are required to follow Chapter IV of SEBI LODR Regulations i.e. whose specified securities are listed, the financial results shall be in the format as prepared and submitted under Regulation 33. The issuers will also be required to disclose along with the financial results the additional line items as required under Regulation 52(4). This shall also apply to an issuer which is required to prepare financial results for the purpose of consolidated financial results in terms of Regulation 33;

·      The line items as provided under Regulation 52(4) are as below:

o  credit rating and change in credit rating (if any);

o  asset cover available, in case of non- convertible debt securities;

o  debt-equity ratio;

o  previous due date for the payment of interest/ dividend for non-convertible redeemable preference shares/ repayment of principal of non-convertible preference shares /non- convertible debt securities and whether the same has been paid or not; and,

o  next due date for the payment of interest/ dividend of non-convertible preference shares /principal along with the amount of interest/ dividend of non-convertible preference shares payable and the redemption amount;

o  debt service coverage ratio;

o  interest service coverage ratio;

o  outstanding redeemable preference shares (quantity and value);

o  capital redemption reserve/debenture redemption reserve;

o  net worth;

o  net profit after tax;

o  earnings per share:

 ii.          For issuers which are required to comply with provisions of Chapter V of the Regulations only i.e. whose NCDs/ NCPSs are only listed, the financial results shall be prepared and submitted as per regulation 52; and

iii.          Issuers who only have outstanding listed CPs shall prepare and submit financial results in terms of Regulation 52.

 

b.      Disclosure of material events

The issuers shall disclose the following details to the stock exchange(s) as soon as possible but not later than 24 hours from the occurrence of event (or) information:

i.          Details such as expected default/ delay/ default in timely fulfilment of its payment obligations for any of the debt instrument;

ii.          Any action that shall affect adversely, fulfilment of its payment obligations in respect of CPs;

iii.          Any revision in the credit rating;

iv.          A certificate confirming fulfilment of its payment obligations, within 2 days of payment becoming due.

c.      ALM Statements for issuers who are NBFCs/HFCs

NBFCs and HFCs will be required to simultaneously submit to the stock exchanges the latest ALM statements as and when they submit the same to respective regulator(s) viz RBI/NHB, as applicable.

d.     CEO/ CFO Certification

A certificate from the CEO/CFO shall be submitted by the issuers to the recognized stock exchange(s) on quarterly basis certifying that CP proceeds are used for disclosed purposes, and adherence to other listing conditions.

Conclusion

As mentioned above, the disclosure requirements as provided in the Circular are meant for assisting the investors in taking an informed decision. Since the requirements are new, it is expected that apart from the stock exchanges, FIMMDA/ RBI will also come out with the revised Operational Guidelines/ Directions in order to bring more clarity on this aspect.

 

 

 

 

 

 

 

 

 

 

 

[1] http://www.fimmda.org/modules/content/?p=1033
[2] https://www.sebi.gov.in/sebi_data/attachdocs/1403065620622.pdf