Curbs on CICs could limit fundraising abilities of big corporate groups

The proposed curbs on core investment companies will make it tough for large corporate groups to funnel capital as they did in the past

What hurts more than a bad hangover is the fact that you had to foot the bill for the party as well.

A working group (WG) of the Reserve Bank of India (RBI) on core investment companies (CICs) is of the view that the big boys of India Inc can’t have scores of such entities within a group —tiered many times over — to raise capital. It is not to be more than two CICs; and such a firm within a group is also not to make investments through more than two layers of CICs, including itself. If these suggestions were to come into play, the central bank would have effectively taken away the punchbowl — you can’t party with public funds, going ahead.

Ask Divyanshu Pandey, partner at J Sagar & Associates, what he makes of the emerging regulatory view on CICs: “What is clear is that we are in uncharted territory now. It may affect the ability of many groups to raise funds as they did in the past. It remains to be seen as to how resources are raised as the routes available so far may not be open to them anymore.”

Too fast, too soon

At end August 2019, there were 63 CICs registered with the banking regulator — their total assets amounted to Rs 2,63,864 crore with borrowings at approximately Rs 87,048 crore. The top five CICs accounted for around 60 per cent of the assets, and 69 per cent the borrowings. Considering that a CIC can borrow 2.5 times of its adjusted net worth, if there are two CICs in a group, then a capital of Rs 100 can be leveraged about 11.25 times. This is much more than what is allowed for non- banking financial companies (NBFCs). If the central bank were to have its way, big groups will have to unwind complex CIC structures crafted over decades in some cases — in just two years.

Suggestions of the WG is to be read along with the RBI’s discomfort with leverage through the pledge of shares also. It flagged its concerns in its Financial Stability Reports (FSRs) of December 2013 and December 2014; and again, in the FSR’s last edition — in June 2019. “It is highly unusual for the central bank to bring to attention an issue thrice over, pointing at the high levels of leverage, albeit via pledge of shares. The WG’s views on CICs falls into the same family of thought”, says an investment banker who had been involved in many such deals.

And had it not been for the blowout at the Infrastructure Leasing and Financial Company (IL&FS) last year, CICs would not have come to the regulatory radar this strong. IL&FS, was a CIC with over 300 subsidiaries — four levels of companies below the main CIC — which defaulted on over Rs 90,000 crore of debt. Then, given that Section 186 (1) of the Companies’ Act, 2013 (which restricts the group structure to a maximum of two layers) is not applicable to NBFCs (and CICs are a variant of them), the scope of complexity gets exacerbated. The Securities and Exchange Board of India also wanted listed entities to minimise such structures.

Points out Ashvin Parekh, managing partner at Ashvin Parekh Advisory Services: “The rules for pledging shares, tightening of norms for leverage, mandated fund raising from the market for listed entities and now the RBI’s intent to limit the layers of CICs are interlinked. They are ensuring that business houses do not leverage beyond a certain extent”.

There is already chatter that it would not be surprising if some of the big corporate houses make a plea to the Ministry of Finance that curbs on CICs may impede on their ability to make investments; that it will be tough to unwind structures built over time all too soon.

What now?

“It has the potential to bring in a new category of investors and foreign direct investment into some of these groups. You are anyway over leveraged… and now that this CIC route is to turn difficult, how do you raise funds assuming you have a need to do so”, asks Ananda Bhaumik, managing director and chief analytical officer at India Ratings.

Adds Manushree Saggar, vice-president and head-Financial Sector Ratings, at ICRA Ltd: “Investments would largely have to be done from equity capital only, rather than the two-and-half times leverage that was permitted earlier”, and appears to second Bhaumik when she says: “The role of equity investors (including private equity or PE) would become more important given its increased requirement”.

While the PE route is an option, it brings its own complexities. “Investments by PE firms may get a fillip. But it can work only if it is structured in such a way that the PE has an exposure to a specific operational company. Any investment by a PE firm in the CIC will give indirect equity holding to the PE firm in CIC’s investments across various operating companies”, says Pandey.

The WG also seems to be hinting on the current segregation of business within large groups, and what it may be considered as unhealthy practices. “The position of the board of CIC becomes more complex in mixed conglomerates which includes financial and non-financial entities in the group both in India and abroad. CICs have also been found to be providing loans to loss-making entities within the group as at times their interests can be secondary to the group’s requirements”, it noted. A secondary message in this observation could be that large groups with aspirations to be a significant player in financial services will have to get their acts right, and clean up the financial structures within.

Four other suggestions of the WG may prove to be impractical — that every group having a CIC should have a group risk management committee (GRMC); there should be audit, nomination and remuneration committees. That offsite returns may be designed by the central bank and may be prescribed for the CICs on the lines of other NBFCs; annual submission of statutory auditor’s certificates may also be mandated; and onsite inspection of CICs may be conducted periodically.

The WG’s suggestions for what are essentially private companies akin to mainline NBFCs is not desirable. ‘From where are these companies going to get qualified independent directors as suggested? Even the bigger ones are finding it difficult to get good hands. Then, the standard for independent directors is to be made stricter”, says a senior industry watcher. Another quips: “How I arrange the furniture in my house is none of the regulator’s business”.

It could be said that after the mess at IL&FS (and shadow banking in general), and the flak it has received, the central bank wants make it doubly sure that nothing is left to chance from its end. But what can’t be overlooked is also the fact that the regulator is as on date overburdened with the scale of oversight now needed – spanning banks, NBFCs, and urban co-operative banks. And CICs down the line.

The RBI’s current mood can be best summed up by a senior regulatory official’s riposte to the analogy on arranging furniture under one’s roof: ‘Yes, I have no business looking at how you arrange the furniture in your house. But if that furniture includes a bench from a public park, I will raise an issue!” It’s his way of saying that you can’t party on public funds anymore. Yes, the punchbowl is to be taken away.