The SARFAESI framework establishes how securitisation and asset reconstruction companies (ARCs) are licensed, governed, and supervised, and how financial assets are acquired, managed, and resolved, with clear roles for obligors, investors, and the Reserve Bank of India. This article synthesizes the operational touchpoints a banking audience needs: licensing and cancellation, asset acquisition mechanics, obligor notices and discharge, security receipt issuance and exemptions, permissible reconstruction measures, dispute resolution, and RBI’s supervisory powers.
ARC registration
- ARCs must be incorporated as companies with the primary objective of securitisation or asset reconstruction, and obtain a certificate of registration from the Reserve Bank after meeting fit-and-proper, owned-fund, governance, and business plan thresholds.
- Registration conditions typically cover minimum capital, sponsor caps, board composition (including independent directors), risk management and recovery policies, and compliance systems.
Cancellation of registration
- The Reserve Bank may cancel registration for breaches such as non-compliance with conditions, inadequate capital, unsafe practices, misreporting, or failure to conduct business in public interest.
- Before cancellation, due process usually includes notice, opportunity to be heard, and the ability to rectify; post-cancellation, ARCs must cease new business and follow prescribed wind-down/transfer protocols.
Acquisition of financial assets
- ARCs may acquire banks’ and financial institutions’ financial assets (including NPAs) through assignment, novation, or similar transfer, with transaction documentation capturing true sale, representations/warranties, and servicing arrangements.
- Post-acquisition, the ARC steps into the shoes of the assignor as secured creditor, with concomitant enforcement and recovery rights under the loan and security documents.
Notices to obligor and discharge
- After acquisition, obligors must be notified of the transfer and the address/means for valid discharge; payments made in good faith to the transferor before notice remain a valid discharge.
- Following notice, obligors must discharge obligations only to the ARC or its authorized servicer/agent as specified.
Security receipts and fundraising
- ARCs issue security receipts (SRs) to qualified buyers representing undivided interests in securitised assets, with schemes laying down investment objectives, fees, valuation, credit enhancement, and payout waterfalls.
- Fundraising may include SR issuance, debt lines, and sponsor contributions, subject to capital structure norms, minimum skin-in-the-game requirements, and concentration limits.
Exemption from SR registration
- Security receipts are typically exempt from certain registration/filing requirements otherwise applicable to securities transfers, recognizing their special status and closed investor base.
- Even with exemptions, ARCs must maintain investor registers, scheme documents, valuation records, and periodic disclosures to investors and the regulator.
Measures for asset reconstruction
- Standard reconstruction measures include: restructuring/rescheduling principal and interest; settlement/OTS; change in or takeover of management; conversion of debt to equity or quasi-equity; sale/lease of business or assets; enforcement and sale of secured assets; and infusion of fresh funding to revive viability.
- Choice of measure should be backed by a resolution plan with viability assessment, independent valuation, documented recovery strategy, and governance approvals.
Other permissible functions
- ARCs may act as recovery agents for lenders, act as manager/receiver of secured assets post-possession, and provide ancillary resolution and servicing functions consistent with their license.
- Non-core activities are restricted, and any outsourcing must comply with board-approved policies, confidentiality, and consumer protection standards.
Dispute resolution
- Debtor challenges to enforcement/recovery typically lie before the DRT/DRAT framework; contractual disputes may go to arbitration if agreed, or civil courts where applicable exclusions do not apply.
- Investor-side disputes (e.g., on valuation or payouts) are addressed through scheme terms, trustee oversight, and applicable securities/contract law, with recourse to courts/arbitration as stipulated.
RBI supervisory powers
- The Reserve Bank prescribes prudential norms (capital adequacy, provisioning, concentration), governance standards (board oversight, audit, risk, valuation), disclosure and reporting, and fair recovery practices.
- It may conduct inspections, issue directions, require corrective action, impose penalties, restrict activities, or cancel registration for persistent or material non-compliance.
Operational checkpoints for banks and ARCs
- For sellers: ensure clean loan files, enforceability of security, complete assignment packs, borrower/guarantor notifications, and servicing transition plans.
- For ARCs: adopt robust onboarding due diligence, independent valuation, scheme governance, quarterly SR valuation by eligible valuers, and transparent investor reporting.
- For obligors: honor revised payment instructions post-notice; engage promptly on restructuring options to preserve enterprise value.
- For investors: review scheme IMs, valuation methodologies, recovery track record, fee structures, and conflict-of-interest controls.
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