Real Estate Regulatory Bill

Real Estate Regulatory and Development Bill – Step in right direction, but just 1st hurdle cleared

Union Cabinet of India passes the Real Estate Regulatory and Development Bill which intends to project consumers of house space in the country by implementing best practices. The Bill proposes a regulator in each state / union territory which will address the industry issue and a tribunal for fasten the process of the disputes.

The bill would next be tabled in both the house of Parliament and then to standing committee before it becomes an Act. The Bill has just cleared the first hurdle and may take longer to be implemented at ground level.

Reasons for delay in project completion are addressed, but amending the ‘70% customer advance’ clause will lead to low uniformity

The Bill main intention is consumer protection in real estate space wherein project delay is major area of concern. The Bill addresses this concern by two proposed clauses – 1) the developer cannot launch a project before all approvals in place and 2) 70% & lower Customer advances, as stipulated by the state regulator, would be utilised only for development of project which is monetized. The second point here is been diluted from 70% to 70% & lower and also has given power to decide the share in the hands of state regulator. This amendment has diluted the effect of the point and would lead to higher red tapism in the sector.

The current Bill requires a lot of Clarity and doesn’t address many Loopholes in the proposals

The amended RE Bill has many points which needs clarifications or which has loopholes. Firstly, it doesn’t state that the state regulator will have to follow whose law when it comes to the State Bill and Centre’s Bill are at crossroads. The bill doesn’t provide clear demarcation in definition of a project and its phases as well as common amenities for assigning customer advances lock-in.

The bill implemented in the current form affects marginally to developers; lowering the churn of capital is the only concern

The current form of the Bill is diluted from the draft published in 2012. No pre-launches officially & registration of real estate agent would curb investor money in the sector when combined with 1% TDS clause introduced in Union Budget. But there are means to these issues which may lower the impact of the intent of the Bill. Hence, there would be some impact on the churn of capital as usage of customer advances would be restricted. Also, some cost of the company would increase in getting stipulated approvals from the state regulatory.

Interpretation of Key Clauses which may affect Real Estate Companies Clause Intent Current Practice Impact Clarity / Loophole

Clause:

A Real Estate Regulator in each state who will implement and address set regulations in that particular state

Intent:

To streamline best practices in the industry which is reeling under lot of issues pertaining to consumer

Current Practice

There is no single body who regulates the industry and its growing issues

Impact:

A lot of developers would have to streamline their operations to best of industry practices

Clarity/loophole:

Will the state regulator adhere to state level bill or this bill overwrites it

Clause:

The developer cannot launch the projects till all the approvals are in place and the project is registered with the regulator along with project plan

Intent:

To ensure timely completion of projects by making capital available

Current Practice:

A lot of developers would pre-launch the project and utilise the advance from sale towards getting approvals as well as other means

Impact:

The developer cannot do any pre-launch before getting project approvals and registering the same with the government authority. Hence they will have to deploy capital from other source then customer advances

Clarity/loophole:

The Company can always pre-launch and take advances and show it as short term debt. Later convert the same in customer advances at the time of launch. All the pre launches are done on understanding and trust between the parties

Clause:

Compulsory deposit 70% or lower funds received from allotees in a separate bank account. (The same was changed from 70% in 2012 bill to 70% or Lower in 2013 bill)

Intent:

To ensure timely completion of projects by making capital available

Current Practice:

A lot of projects completions are delayed because the developer utilise the customer advances for other means and assign approvals delayed as the reason.

Impact:

The developer cannot utilise the capital generated from one project, unless it is completed, to finance the capital requirement of other projects. This will lead to lower availability of the liquidity.

Clarity/loophole:

There is missing clarity on the definition of the project, as the industry phases out a single project. Can the developer utilise advances of phase 1 towards approvals of phase 2 and not deliver the common amenities, is not clear.

Clause:

Mandatory registration of real estate agents with the regulator

Intent:

To infuse professionalism in the intermediary role To curb money laundering

Current Practice:

With absence of any regulatory authority, there is no registration. Also, with no registration the agents launder the money through their account for a client.

Impact:

This clause along with TDS clause introduces in Union Budget 2013-14 will lead to curbing the transactions routed through multiple parties.

May curb investors from using RE as a medium for money laundering

Clarity/loophole:

The bill states the role of the agent but fails to address the repercussion of the falsification of information by him / her Also, there is no differentiation between a role of agent or a consumer played by the same person.

Charges for putting out misleading advertisements related to the projects carrying photographs of actual site.

Removed in 2013 Bill.  Was part of 2012 Bill

Written Agreement with the buyer needs to be registered before taking more than 10% of advances

Removed in 2013 Bill. Was part of 2012 Bill

Source: Emkay Research, Housing Ministry 

Challenges faced by SMEs in India

Small and Medium Enterprises (SMEs) contribute to economic development in various ways such as creating employment opportunities for rural and urban population, providing goods & services at affordable costs by offering innovative solutions and sustainable development to the economy as a whole. SMEs in India face a number of problems - absence of adequate and timely banking finance, non-availability of suitable technology, ineffective marketing due to limited resources and non availability of skilled manpower.

Small and Medium Enterprises (SME) play an important role in the development of a country. There are around 26 million MSME units in India, of which 13 million are SMEs. SMEs contribute nearly 45% share of manufactured output, accounting for 40% in overall exports of the country and providing employment to about 32 million people.

The performance of SMEs in India though impressive comes next to China where this sector provides employment to 94 million people with a network of 37 million units.

India has registered a high economic growth (6-9%) consistently over the last one decade. For the sustainability of this kind of growth proper nurturing of SME sector is imperative. The need of the hour is to empower the SME Sector so that it is able to take its rightful place as the growth engine of the economy.

Small and Medium Enterprises (SMEs) are often confronted with problems that is uncommon to the larger companies and multi-national corporations. These problems include the following:

Lack of IT Support

IT personnel are in high demand and are often attracted to bigger companies and MNCs. It is very difficult for SMEs to attract good IT personnel. It is even more difficult to retain them. Moreover, good IT personnel are expensive and may not be affordable by most SMEs. The current scenario offers scope for enterprises to offer standard (and customized) IT infrastructure services to SMEs on an ASP/cloud computing basis. This would ensure that individual SME does not have to commit large amount of capital to have benefits of technology. In fact, the service provider – if sufficiently innovative- can structure their own costs of services to be paid be the SME around the cash flows of the SME concerned.

Lack of IT Literacy

Many of the employees in SMEs started from the ground up after working with the company for many years. Some of them are often holding supervisory and managerial positions. These employees may not be IT literate and often have high resistance to the changes in the working process that they are comfortable with after many years. This again offers a great opportunity for institutes like the NIIT etc. basic training of the SME entrepreneurs for making them technologically literate.

Lack of Formal Procedure and Discipline

Most SMEs do not have formal procedure or often these are not documented. Furthermore, there is tendency for these procedures to change frequently. This makes it difficult for third party and newcomer to understand the existing business practices and match them with the IT process.

Management Skills:

As in case if technology, there are opportunities for service providers to train entrepreneurs on issues like internal organization structure, control and delegation, emerging opportunities and review of internal skill sets.

Lack of Financial Resources

Indian entrepreneurial effort has always been substantially debt funded. With growing globalization and sustained tight money regime over last four/five years, the debit equity ratio levels need to be brought down by SMEs. SMEs today minimum 35% to 40% owned funds as against 20% to 25% in the 1980’s and 1990’s. The lack of venture and private equity funds which meet capital fund requirements for SMEs particularly in amount below Rs.100 crores has not helped. There is a dire need to supplement the efforts of SIDBI through establishment of multiple such entities under an institutional frame work in this area since the need is very large.

As a SME/SMI, financial resources are often limited. This often forces company to select a solution, which appear to be cheap initially. However, the hidden costs will start to emerge during implementation. This sometime causes the project to be abandoned or sometime sent the company into further financial crisis.

Lack of Human Resources

Implementations of some bigger scale IT project especially those that involve business process across different departments or require large amount of initial data entries require human resource during the implementation. Some SMEs are often in the stage of frequent fire fighting and shortage of manpower. This makes it very difficult for them to allocate time to carry out implementation. Furthermore, there is always a conflict between getting the daily routing work going and to do the "Extra" IT implementation. Equally important is the need to understand that as the organization grows the skill sets needed at senior level will change.

Lack of Experience of Using Consultants

A good consultant often save time and effort, and help to prevent pitfalls during the IT projects. However, most SMEs are lacked of experience in working with consultants. The lack of knowledge in the field of IT makes them difficult in identifying good consultant for the projects. They often feel that the consultant costs are too high and they can handle it with their own staff. If the company has no staff that are experience and knowledgeable in t he IT project, avoiding external help often costs more to the company eventually.

Small and Medium Enterprises significantly contribute to industrial, economic, technological and regional developments in all economies, developed and developing, though the definitions of SMEs may vary. In India, it is estimated that there are over 1.4 million small industries, out of which about 30 per cent may relate to manufacturing. SSI sector account for about 40% of total industrial production, 35 to 40% of total exports and a significant share in employment (close to 2.5 million) and close to 8% of GDP. However SMEs or SSI sector (now called as micro, small and medium enterprises, MSMEs) are going through a transition phase including restructuring of strategies and facilities since the announcement of new policies in 1991 and thereafter progressive adoption of liberalized and globalizing policies in India. We will however continue to use 'SME' nomenclature as it is more popular, and widely accepted.

SMEs need to be vitalized for competitiveness and sustainable growth under new world trade rules and faster technological changes, including wider use of ICT (Information and Communication Technology) besides new business models. Several initiatives have been taken by the government from time to time to promote and support MSMEs, including new support measures, financing mechanisms, and gradual de-reservation of items for production. Innovations and technologies are becoming more crucial for competitiveness and sustainability of SMEs, in the emerging international trade regime. MSMEs (or SMEs) need to adopt internationalization strategies in tune with objectives and strategies and global supply chain management of transnational corporations (TNCs) or large companies

Securitisation and India

Securitisation is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations and selling said consolidated debt as bonds, pass-through securities, or collateralized mortgage obligation (CMOs), to various investors. The principal and interest on the debt, underlying the security, is paid back to the various investors regularly. Securities backed by mortgage receivables are called mortgage-backed securities (MBS), while those backed by other types of receivables are asset-backed securities (ABS).

In India, securitisation has been for while now, the route to achieving the mandatory priority sector targets for banks both domestic and multinational. Securitisation as a market itself has evolved from being mere sale of portfolio from one organization to another to becoming complex structures in itself. This market has been in existence since the early 1990s, though has matured significantly only post-2000 with an established narrow band of investor community and regular issuers. In the early 1990s, securitisation was essentially a device of bilateral acquisitions of portfolios of finance companies. There were quasi-securitisations for sometime, where creation of any form of security was rare and the portfolios simply got transferred from the balance sheet of the originator to that of another entity. In recent years, loan sales have become common through the direct assignment route, which is structured using the true sale concept. Europe and United States has one of the most complex and developed securitisation market. India is still a small market where securitisation grew 15% over previous year in value terms. The number of transactions was also 32% higher in FY2012 than in the previous fiscal. The number and volume of retail loan securitisation (both ABS – Asset Backed Securitisation and RMBS – Residential Mortgage Backed Securitisation together), was the highest in FY2012 compared to previous fiscals, while the LSO (Securitisation of individual corporate loans or loan sell-off) issuance was the lowest ever. This in reality is an increase in volume—following a continuous decline for three years and was on account of a 26% rise in securitisation of retail loans.

In India, issuers have typically been private sector banks, foreign banks and non-banking financial companies (NBFCs) with their underlying assets being mostly retail and corporate loans.

The key objectives for Indian banks include:

·       Liquidity: Securitisation is an easy route than raising deposits that are subject to reserve requirements

·       Regulatory issues: Constrains arising out of Provisions, priority sector norms, etc.

·       Capital Relief: Major investors are mostly mutual funds (money market/liquid schemes), close-ended debt schemes and banks. Long term investors like insurance companies and provident funds are currently not active due to regulatory constraints. Foreign institutional investors are also missing due to regulatory ambiguity. As per guidelines, mutual funds are required to declare their NAV’s on a daily basis due to which they prefer the structure/asset classes which involve low pre-payment rates. The lack of domestic non-traditional hedge fund style investors to participate in equity and mezzanine tranches has led to originators holding them.

Some examples of securitisation in the Indian context are:

·       First securitisation deal in India between Citibank and GIC Mutual Fund in 1991 for Rs 160 mn

·       India’s first securitisation of personal loan by Citibank in 1999 for Rs 2,841 mn.

·       India’s largest securitisation deal by ICICI bank of Rs 19,299 mn in 2007. The underlying asset pool was auto loan receivables.

·       India’s first mortgage backed securities issue (MBS) of Rs 597 mn by NHB and HDFC in 2001.

·       Securitisation of aircraft receivables by Jet Airways for Rs 16,000 mn in 2001 through offshore SPV.

·       India’s first floating rate securitisation issuance by Citigroup of Rs 2,810 mn in 2003. The fixed rate auto loan receivables of Citibank and Citicorp Finance India included in the securitisation

·       India’s first securitisation of sovereign lease receivables by Indian Railway Finance Corporation (IRFC) of Rs 1,960 mn in 2005. The receivables consist of lease amounts payable by the ministry of railways to IRFC

·       L&T raised Rs 4,090 mn through the securitisation of future lease rentals to raise capital for its power plant in 1999.

An important change negating lot of banks from lending to NBFCs was what we observed in the ‘Master Circular by the RBI for Lending to Priority Sector’ released in July 2011, where loans by banks to NBFCs no longer qualify as Priority Sector Lending (PSL). With this change in regulation there was only one major way in which banks could meet their shortfall in priority sector lending targets, viz., acquisition of compliant portfolios from NBFCs. For the Originators’ (or NBFCs) motive in entering into these transactions was a pricing, capital relief and tenure-matched funding, apart from having an alternate fund-raising channel. This saw a neat rise in transactions involving bilateral assignment of retail loan pools of mainly including loans to Small and Medium Enterprises (SMEs) or Small Road Transport Operators (SRTOs) and micro credit.

These Bilateral assignments which account for around 75% of ABS and RMBS volume in India—continued to be the preferred route relative to conventional securitisation, given that these transactions were not covered by RBI’s guidelines of Feb 2006 on securitisation, thus making them less restrictive for originators.

That no longer is the case according to our internal estimates given that the RBI Guidelines on Securitisation issued in May 2012 that prohibit stipulation of credit enhancement for assignment transactions, thus exposing the purchasing banks to the entire credit risk on the assigned portfolio.

Priority Sector Lending targets however continue to exist and continue to get stricter and larger (MNCs with greater than 20 branches now are treated similar to domestic banks with 40% of their lending portfolio to be to the Priority Sector. And these could going forward be met at-least partly through the securitisation route, wherein credit enhancement is permitted.

Securitisation too is has its own deterrents which are high capital charge for Originators and impact of mark-to-market for the Investing Banks. Another key constraint presently is the ambiguity on the taxation of PTCs (or Pass Through Certificates), a matter which is presently sub-judice. Pending clarity on the issue, Mutual Funds—as well as several banks—are staying away from making fresh investments in PTC instruments. The microfinance industry saw 13% rise in deals involving sale of portfolio through securitisation and other bilateral transactions last financial year.

Last year, sailing through rough waters, the MFI industry managed to strike deals worth Rs 3700 crore (securitisation and direct assignments). This year, the industry is expected to have sold portfolios worth Rs 4,200 crore to banks and other financial institutions, according to data from MFIN (microfinance institutions network).

Additionally, RBI’s expected adoption of the proposals of the Nair committee on Priority Sector Lending (report submitted in February 2012) would be a key regulatory guideline which could further affect the securitization market in India.

We await further guidelines this year from the regulator – this will in addition to the changes in Priority Sector Norms affect the market in totality.