I finally got time to go through the regulations under the Bankruptcy Code. They look very good in theory. Well thought out with clear processes, mandatory timelines, incentive compatibility and so on. It is a paradigm shift in moving from "debtor in possession" to "creditor in control" once bankruptcy proceedings begin. I think we should all agree that we have a state-of-art regulation.
But this is no guarantee that it will work as anticipated. In fact, I shall put my head on the block and say that we can be rest assured that it will fall short of the (inflated) expectations, at least in the foreseeable future. Though India's bankruptcy eco-system would have moved into a superior equilibrium, resolution and liquidation is unlikely to disappear as a major pain point while doing business in India. And I shall hold myself accountable five and ten years down the line and revisit this blog post to make hindsight assessments.
I foresee some critical challenges.
1. How good will be the Insolvency Resolution Professionals (IRPs)? How good will be the valuation agencies? How fast can we develop a supply-side of sufficient quality in these services? How confident can we be that the ICSI and the ICAI, the two registered Insolvency Professional Agency (IPA), maintain high standards of certifying IRPs? How can we ensure that they (the median IRP or valuer) will not be captured? The four assurance/advisory firms will be dominant, but we have seen several instances in recent years of all of them being compromised. And the stakes here are much higher than those cases.
2. How can we be sure that the asset sale/transfer does not lead to round-tripping back to the promoter though complex set of transactions? The ARC resolution process was seriously compromised by this. In fact, as Vijay Mallaya's Goa property auction shows, after multiple tenders, it required the presence of public sector purchasers to get a private bidder to break "ranks" and bid.
3. The volume of NPAs are so huge that the depth of the market will be severely tested. This means the likelihood of low returns on sales/liquidation etc. Will the different stakeholders accept it? Will the limited depth also make gaming or cartelisation or collusion easier?
4. Since the vast majority of creditors losses will be taken by public sector banks and the decisions will be taken elsewhere, will it engender a moral hazard in so far as the individual bankers (being public servants) now have less incentive to maximise the recoveries? Especially so since the haircut decisions now delve on the NCLT - so easy to take cover.
5. How long can we keep the honourable courts out of this process? The vast majority of losses are likely to be taken by public sector banks. PILs will follow. The promoters too will not be lying down and taking losses. Will the promoters of Bhushan Steel calmly accept the sale of their steel assets to say, Jindal or POSCO? They will explore all avenues to litigate. The Courts will have to exercise a level of restraint that has eluded them till now.
6. Finally, the maturity and the integrity of the NCLT bench itself becomes critical to the success of such transactions. After all, in some ways, they have the decision rights on very high stakes decisions. If this works well, we should have the NCLT added to the pantheon of the handful of credible public institutions in India.
Answers to all these are judgement calls. It can turn out either way or meander along to some equilibrium (good or bad) over time. In fact, it is difficult to control the dynamics that lead to these sub-optimal outcomes.
In the circumstances, the only factor that can be controlled is for the Ministry of Corporate Affairs (MCA) and the Insolvency and Bankruptcy Board (IBB) to be under constant vigilance to emerging trends in the implementation, especially in the initial years, and respond quickly with modifications to the regulations to address serious concerns.
We have seen numerous examples of state of art regulations in sectors like capital markets, both in India and across developing countries (especially Latin America) fail to deliver anything close to their expected outcomes. There is nothing that prevents the same outcome from happening.
The purpose of this post is not to cynically dismiss the Code. As I said, it is state-of-art and possibly the best that could have been done. But while it may be a necessary condition for the successful evolution of a good bankruptcy regime in India, it is hardly a sufficient condition. In fact, we have only got to the starting line. Now comes the real challenges.
Instead the purpose is to interrogate the challenges likely and highlight how many of these are not only due to government inefficiencies or weaknesses, but deficiencies that reflect our stage of socio-economic development, corporate ethics and governance standards, institutional maturity, and so on.
Now these are big bang structural reforms. But most such big bang reforms require diligent and long-drawn work to achieve the desired "bang"! Unfortunately, mainstream debates, even in very informed circles, all too often miss these nuances and blame governments for everything that goes wrong with such reforms.