Informist, Tuesday, Apr 20, 2021
By Alekh Archana and T. Bijoy Idicheriah
MUMBAI – The bidding under insolvency resolution is unfairly tilted towards asset reconstruction companies as they can use security receipts to buy assets, says Kotak Investment Advisors Managing Director S. Sriniwasan.
"They use security receipts as currency," says Sriniwasan in an interview to Informist. "If they are participating in IBC (Insolvency and Bankruptcy Code) process and competing with funds like ours, then they should not be permitted to pay through security receipts."
Asset reconstruction companies are the only set of entities that are allowed to issue security receipts. When banks sell their bad loans, asset reconstruction companies buy partly in security receipts, which are then redeemed as and when a resolution takes place. Similarly, asset reconstruction companies can use such security receipts to buy assets under the IBC.
"They cannot have a unique advantage over the rest of the world and compete with others," says Sriniwasan.
Kotak Investment Advisors, a wholly-owned subsidiary of Kotak Mahindra Bank, manages assets worth about $4.7 bln across asset classes, including private equity, real estate funds, and special situations fund. The company plans to launch an infrastructure credit fund to invest in stressed projects.
According to Reserve Bank of India regulations, an alternate investment fund cannot invest in an ARC if both entities are in the same group, but foreign investors can own 100% equity and pump money from their FII book, he said. This is a specific disadvantage to home-grown asset managers such as the Kotak Group, Edelweiss, and Piramal Group.
"Some of the present regulations are completely out of sync and do not offer a level-playing field," Sriniwasan said.
Sriniwasan said Kotak Investment Advisors' special situations fund is in an advanced stage of closing a $100 mln transaction to take over a defaulting company.
Following are edited excerpts of the interview with Sriniwasan:
Q. Kotak Group has been an active player in the distressed asset space for many years. With the proposed setting up of the National ARC, will there be any change in strategy for the group?
A. Kotak Group's strategy in the stressed asset space remains intact. We have a minority interest in Phoenix ARC that is buying more of small and medium enterprises and retail portfolio and then we have a $1 bln Kotak Special Situation Fund that looks at large distressed opportunities through third party capital.
Our understanding is that the proposed National ARC will primarily function as a debt consolidator. Our experience shows that if there is a single party, decision and outcomes are far better. Today, the purchase and aggregation of loans is worse than land aggregation in this country.
Q. Should we expect more activity in the special situations fund vis-a-vis IBC? Former SBI chairman Rajnish Kumar has been roped in as an advisor and the fund closed its first deal under the IBC.
A. There are a number of opportunities in the special situation fund. We are keeping a close watch, especially with regard to pre-pack solutions. We are seeing situations where banks are willing to accept one-time settlements and change of management. We are in an advanced stage of closing a transaction, which we hope to formally announce in a few weeks.
Q. Could you share any details of the transaction?
A. It is potentially a $100 mln transaction. The company is not in IBC but tagged as a defaulter with banks. We are offering a one-time settlement in cash. The banks have accepted the proposal. As part of the plan, we will also be taking controlling interest in the company.
Q. What are the regulatory changes would you like see from the RBI-constituted committee on ARCs?
A. In the past, the ARC model has been used for sweeping the problem under the carpet. Now, lenders have freedom to sell at whatever pricing structure as long as they make adequate provisions. This forces banks to seek full cash. Hence, the ARCs must get well capitalised and be prepared to pay in full cash. Otherwise, it is just an AMC game and that is not the purpose of the ARC.
ARCs have a very unique advantage over others, the ability to issue security receipts. They use security receipts as currency. If they are participating in IBC process and competing with funds like ours, then they should not be permitted to pay through security receipts. Otherwise, there is no level-playing field. My view is take away that advantage of issuing security receipts during the bidding process. They cannot have a unique advantage over the rest of the world and compete with others.
Some of the present regulations are completely out of sync and do not offer a level playing field. As per RBI regulations, an alternate investment fund cannot invest in an ARC if both entities are in the same group. This is a specific disadvantage to home-grown asset managers such as Kotak Group, Edelweiss and Piramal Group.
On the other hand, foreign investors can own 100% of equity of ARC and pump money from their FII book in the form of both debt and equity. Alternate investment funds managed by these Indian firms have also raised more than US $3 bln dedicated India funds from global investors.
Why these managers and their investors should be denied this facility?
Q. Do you think there is a moral hazard in selling assets to National ARC, an entity with some different regulations and their security receipts potentially backed by sovereign guarantee?
A. If they are providing sovereign guarantee, there will be no incentive to work towards resolution.
We had suggested if the National ARC pays through security receipts, then after a year, fee payment on security receipts must be removed. It will then force ARCs to take some action.
Q. Do you think there is a need for changes in taxation for the alternate investment funds, which will buy assets from National ARC?
A. Alternate investment funds are structured as trusts. According to law, the return on stressed assets investment are categorised as business income. Let's say I have a fund, which has 10 equity investments and one investment in a stressed asset. Because of that one investment, all my other equity investments are treated as business income and the entire fund will be taxed at 40%.
It is for the revenue department to make a clarification on the language. I don't know what is holding them back. The common argument all these years has been on loss of revenue. In any case, we are asking for pass through, not tax breaks. Ultimately the investor pays the tax.
Q. What is your sweet spot in terms of ticket size of investment?
A. Our sweet spot is $50-75 mln. In some cases, we stretch up to $100 mln, but we don't do too many $100 mln transactions. There is a fair amount of opportunity in the $50-75 mln range. We don't like to be part of a consortium of lenders. Typically, we position ourselves as sole lender and shoot for majority equity. End
US$1 = 74.83 rupees
Edited by Subham Mitra
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