The Reserve Bank of India (‘RBI’) constituted a task force on the Development of Secondary Market for Corporate Loans (‘Task Force’) on May 29, 2019.

Bahram N Vakil, AZB’s founding Partner was a member of this Task Force and other lawyers from AZB participated in its deliberations.

The Task Force submitted its report to the Governor of the RBI on August 31, 2019 and the RBI has invited comments from stakeholders and the public via email to cgmicdbr@rbi.org.in  (see https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=48054 ).

The Task Force acknowledges the current impediments to the growth of the secondary loan trading market, including the need for more market participants, inadequate diligence and price discovery mechanisms, lack of standardized documents and regulatory hurdles and restrictions. It also identifies the various benefits of an active secondary market – for lenders, borrowers, the government and other stakeholders. Certain key recommendations of the Task Force are set out below, some of which when implemented will be the first of their kind for loan trading anywhere in the world.

1.       Self-Regulatory Body

A Self-Regulatory Body (‘SRB’) is proposed to be established within three months. The SRB will inter alia (i) develop standardized documentation for primary loans and loan trading; (ii) periodically review such templates; (iii) determine the detailed modalities of secondary trading including the trading processes, transfer structures and related protocols; (iv) provide guidelines and accreditation standards for market participants and service providers including facility agents and market makers; (v) help design the structure and processes of the central loan registry and loan sale platform; and (vi) provide training and standardize practices.

2.       Central Loan Contract Registry and Sale Platform

The Task Force has proposed a loan registry and a platform for auction and sale of loan assets. Such a platform would improve access for purchasers, which would likely result in increased participation and therefore enable better price discovery. The Central Loan Contract Registry (‘CLCR’) is to serve as a single online platform for (i) storing all relevant information in relation to loans; (ii) inviting expressions of interest for loans; (iii) communicating such interest and entering into preliminary (standardised) documentation between prospective purchasers and sellers; (iv) enabling an online diligence process followed by a bid/auction process; (v) entering into (standardised) transfer documentation; and (vi) enabling settlement. For counterparties that renege on their obligations, penalties are to be prescribed with public disclosure of such behavior to serve as a disincentive for such acts.

3.       New Market Participants and Investment Routes

The Task Force has recommended that new players with varied risk appetites, investment approaches, capital pools and horizons should be permitted to participate in the market to provide liquidity and to match the status and cycle stage of the underlying asset with such differing investor requirements. These include insurance companies, pension funds, mutual funds and a separate category of alternate investment funds. Keeping in mind the needs to have market makers for the secondary market, it has been recommended that ARCs be specifically permitted to perform this role.

Additionally, the Task Force has recommended easing of the route for Foreign Portfolio Investors (‘FPIs’) to invest in distressed loans. Currently, FPIs invest through acquisition of security receipts issued by ARCs to participate in the distressed loan market. The Task Force has recommended permitting the use of securitization trusts by FPIs for acquisition of non-performing assets (enabling the FPI to bid for assets independently, invest 100% and retain full control with nominal trustee fees) and also eventually permit the purchase of any kind of distressed loan directly from financial institutions within permissible annual prudential limits defined by RBI.

4.       Standardization

Once the SRB specifies template documentation, all new corporate loans and existing loans due for refinancing or renewal will need to adopt these templates and all other existing loans must do so within a specified time. Any deviations to the standard documentation should be included in the separate confirmations or schedules while the main body of the documentation is to remain unchanged. This will enable diligence of documentation prior to loan trading to be done with less effort and more certainty.

Lenders are to appoint a facility agent to administer loan related activities (such as managing voting processes, waivers and consent requests), monitor payments and compliance with covenants and maintain a record of the transactions. This would also assist loan trading by reducing information and other asymmetries between lenders and allowing borrowers to have a single point of contact.

The Task Force has also recommended that security for loans be created only in favour of the security trustee to avoid additional processes for transfer of security interest following trading of a loan and requested for certain regulatory relaxations to avoid any registry or other updates in relation to security following trading of a loan.

5.       Relaxation from Regulatory Requirements

The Task Force has also sought relaxations and clarifications under applicable stamp duty related laws for simplifying the due diligence, record keeping and storage processes (for e.g., lenders should be allowed to provide documents on the loan sales platform without bearing the risk of attracting stamp duty for the disclosure). It has also sought exemption from payment of stamp duty for loan sales to improve the ease of conducting this business. The Task Force has also suggested changes and clarifications to minimum retention and minimum holding requirements by selling financial institutions, securitisation guidelines and insider trading guidelines to reduce complications and hurdles for loan trading by domestic and overseas participants.