## Sunday, March 25, 2018

by Ajay Shah.

### The key idea of the IBC

The centrepiece of the bankruptcy process is the Insolvency Resolution Process (IRP). Because a firm after default is like a melting ice-cube, every day of delay destroys value. So the IBC provides for a limited time of 180 days for the IRP to work out. It is within this time limit that multiple external persons come up with proposals on resolution plans for the defaulted firm. These are evaluated by the Committee of Creditors and the best one is chosen. The chosen one takes control of the company and walks away into the sunset, and all others forever hold their peace.

This machinery must be understood and trusted by all. When there is certainty that this process will work as defined, all parties -- bidders, committee of creditors -- are incentivised to invest resources, and work within the defined procedures.

We need to be nuanced about the phrase "the best bid". The decision before the Committee of Creditors is more subtle than a simple auction of a commodity. There are many factors in the picture. Do we trust the promises of the bidder? If cash will come out to the creditors at a future date, then the creditors need to weigh the possibility of the new person becoming their borrower. In complex cases, each bidder may show a different restructuring strategy as his preferred one; the comparison between different bids is then not apples to apples. There is a great deal of judgment about the thought process of the Committee of Creditors. Sometimes, it's a simple question of the person who offers the highest number, but in most complex transactions, it's more complicated than that.

### Recent events

The bankruptcy process for Binani Cements has raised concerns about these concepts being disrupted. On February 27, the Committee of Creditors chose one bid (Dalmia) at Rs.6,700 crore. This was a near-100% recovery rate as the total liabilities were Rs.7,000 crore. A binding agreement was signed and sent to NCLT for ratification. In any reasonable bankrutpcy process, this should be a done deal that cannot be reopened.

A month later, Ultratech announced a deal with Binani's holding company to purchase the firm for Rs 7,300 crore, and petitioned the NCLT that it should not approve the Dalmia deal because Ultratech is really the highest bidder.

In a previous case of a similar nature, Liberty House failed to get a bid in time into the IRP for Bhushan Power. In the IRP, the Committee of Creditors chose Tata Steel. After the terms offered by Tata Steel were revealed, Liberty House has tried to go to the NCLT, saying that they had a better offer.

### Implications

Consider an auction for some listed shares. The market price is Rs.100 and the auction outcome is near Rs.100. Now half the time, the price of the shares on the public market goes up. Suppose we have a situation where a month later, they are worth Rs.110. Can a person now ask to reopen the auction because she is bidding Rs.105? This would be a ridiculous position to take, one that completely undermines the sanctity of the auction process. The auction is your opportunity to make a bid, and once it's over, you must forever hold your peace.

Agreeing with Ultratech or Liberty House would undermine the IBC-defined machinery of the Committee of Creditors. There is a trivial sense in which they are now claiming they have a superior bid. But going with their claims would disrupt the resolution timelines of 180/270 days. It would undermine all future IBC outcomes, setting a precedent of someone coming along, late, and reopening the matter. The lack of finality would, in turn, disrupt the trust of bidders in the process. Bidders who mistrust the IBC would tend to put in less resources in thinking about each case, and they would tend to put in lower bids because the outcome is not certain.

In the case of Binani, Ultratech was one of the participants in the IRP. They were not chosen there. This offers a natural response: Why did you not make a more attractive offer while the IRP was in process?. If they were not part of the IRP, a natural response would be: The forum where bids are analysed by the Commmittee of Creditors is the IRP; it is transparent and widely announced to enable a fair playing ground for everyone who is interested in resolving the firm. Why was your proposal not presented there?

I thank Josh Felman and Susan Thomas for useful discussions.

## Wednesday, March 21, 2018

### Financial regulation for the fintech world

by Ajay Shah.

In India, there is a confusing term non-bank financial company' (NBFC). This is an unfortunate phrase as the term, when taken literally, includes insurance companies, etc. In India, it denotes a $10 \times 2 \times 2$ classification of business models which are regulated by the RBI.

There is a lot of confusion in the present regulatory treatment of these classes of firms. The existing levers of regulation are inappropriate, and it is not clear why RBI -- which should be about sound money and sound banking -- is doing all this work. These concerns are becoming particularly important in the context of the fintech revolution, where all kinds of new firms are being shoe-horned into NBFC regulation.

It's hence useful to take one step back and think about  financial regulation from first principles. Where and why is financial regulation required? Financial regulation is based on exactly four motivations:

1. Consumer protection. Financial firms generally require a layer of restrictions, that impact upon their dealings with customers, that improve fair play. These problems are heightened when the financial firm directly deals with unsophisticated individuals.
2. Micro-prudential regulation. When a financial firm makes a high intensity promise to a consumer, generally there is a need for restrictions upon the risk-taking by the firm, to curtail the probability of firm failure. Such micro-prudential regulation is  (in turn) motivated by consumer protection: we wish to improve how consumers are treated in their dealings with the financial firm. When a firm takes a deposit from a household, that requires micro-prudential regulation, but when the firm lends to a household, the household is quite comfortable with the prospect of firm default, and no micro-prudential regulation is required.
3. Resolution. When a financial firm makes promises to consumers, or when a financial firm is systemically important, the conventional bankruptcy process (of IBC) is inadequate. A specialised bankruptcy process is required, which is run by the Resolution Corporation.
4. Systemic risk regulation. The behaviour of firms needs to be restricted from the viewpoint of systemic risk. This is mostly about system thinking, and not looking at individual firms ("the woods and not the trees"). But one ("trees") element of this tends to be a reduced target failure probability for a few firms which are termed systemically important'.

FSLRC drafted the Indian Financial Code (version 1.1, 2015). The four components of financial regulation show up there as:

1. Part VII which does consumer protection (S.105 to S.151)
2. Part VIII does micro prudential regulation (S.152 to S.184)
3. Part XII does resolution (S.286 to S.310). This has morphed into the FRDI Bill.
4. Part XIII does systemic risk regulation (S.311 to S.341).

This treatment is non-sectoral. There is no special law which defines consumer protection for banks vs. consumer protection for mutual funds. All kinds of financial business is treated identically, within these four components. The advantage of  non-sectoral law is that the law does not have to be modified when new business models are invented, or when multiple kinds of activities are undertaken under one roof.

Now let's apply this thought process to what, in today's India, would be called an NBFC. To keep things simple, consider a company which finances itself using the bond market, has no unsophisticated consumers, and gives out loans to companies. How would we think about regulating this?

1. Consumer protection: As this firm has no unsophisticated customers, this simplifies the problem of consumer protection. See Table 5.5 in FSLRC Volume 1. The protections that would have to be enforced are: professional diligence, unfair contract terms, unfair conduct, privacy, fair disclosure and redress.
2. Micro prudential regulation: As this firm makes no promises to unsophisticated individuals, there is no need for micro-prudential regulation. The bond market is what will discipline the risk taking of this firm. This is similar to how the bond market shapes the leverage and access to debt capital of an ordinary non-financial firm.
3. Resolution: Ordinary IBC processes will suffice to deal with failure. The bond market will reward more resolvable businesses with a lower cost of capital.

#### Advantages Over The Laser Egg

• It costs about \$20, which is significantly cheaper.
• It is much lighter and smaller. It fits in a pocket.
• Doesn't have to be charged regularly since it takes power from a phone.
• The data is processed in a phone. Other sensors in the phone such as GPS can be collaborated.

### Instructions

1. Buy this sensor, e.g. from Aliexpress.
2. Buy an adapter to connect into micro USB or USB C , depending on what your phone requires.
3. Install my program Aqui from the Google play store or APK
4. Run the program, plug in the sensor.

### Future development

Aqui is built as an open source system on github. A lot of interesting work can and should be done here:

1. Send data to a central database
2. Maps display of my data juxtaposed with data from other Aqui users
3. Support for diverse sensors.

Ayush Patnaik is student of Physics and Mathematics at Australian National University.