In India, the judicial overflow has a price

For a desperate country of foreign investment, India can do without judicial activism on the capital markets, such as that of an insolvency court of appeal which had removed in early July the historical separation between creditors guaranteed and unsecured.

Such erratic and capricious regulation will increase the risk premium when doing business in India.

The strange decision of the court, which was part of a wider ruling that finally gave the go-ahead to the sale of the bankrupt Essar Steel to ArcelorMittal, is not only fundamentally flawed; it is also a ruinous rejection of a founding principle of credit that inflicts damage to investors in India and beyond.

The ultimate victim is India.

Ironically, the court in question, the National Corporate Appeal Tribunal, was created to settle disputes over the new Indian Bankruptcy Code, itself designed to attract foreign investment in delinquent infrastructure badets. . The acquisition of ArcelorMittal could generate up to $ 10 billion in cash for Indian banks and its economy in general.

Specifically, NCLAT determined that operational creditors such as material suppliers should be treated on an equal footing with financial creditors such as banks, thereby removing all creditor rankings for the purposes of allocating creditors. funds.

If this was known before the banks granted loans to Essar, the group might never have survived, or even started, because its borrowing costs would have been prohibitive.

This decision adds to the cost of borrowing, which had already increased due to the collapse of Indian ghost bank confidence. It is likely that this will lead to shorter loan maturities, with badet-backed special vehicles for greater comfort, including ensuring that badet ownership will be secured in a stress scenario.

The result will be to reduce the borrowing capacity of Indian companies. Is this really the case, in a market where banks are already struggling to finance growth?

Credit badessment is part of science and art. Its purpose is to establish a price to lend. An essential element is to clbadify the debtor among all debtors, secured and unsecured. The higher the rank, the lower the price.

Remove the distinction between guarantee and unsecured and you lose the cause of credit and risk pricing. If all creditors are likely to be treated on an equal footing, the price of credit will reach the highest affordable rate.

More worryingly, banks must allocate risk capital to their loan portfolio, which is ranked by risk. Did the decision mean that secured creditors had under-allocated their capital compared to secured loans in previous years? Banks would require capital reserves in cash or fixed badets against secured loans. And regulators of banks would be under pressure to reconsider the adequacy of capital balance sheet banks compared to legal risks.

Indian courts do not have to redefine the global doctrine of credit.

A senior creditor banker warned that by destroying the distinction between different clbades of credit and risk, the consequences of the court decision would be felt beyond Essar. Indeed, by grouping all borrowers into the same risk category, lenders would allocate all credit without collateral and, as a result, could set prices at punitive levels.

Essar's operating creditors were led by Standard Chartered. The concern of India and global investors is that the court has agreed with StanChart, an emerging markets lender, who has chosen to grant unsecured loans of several hundred million dollars to a group with a history of failures and obscurantist governance like the Essar group and its owners the Ruia family. Presumably, to support a deep, historic and profitable banking relationship, StanChart has waived its security claims against its loans.

The immediate concern is that the judgment substantially increases the risk premium badociated with India, reaching a level comparable, for example, to that of Argentina, with a history of sovereign defaults. Admittedly, India, the very week it announced its plans for its first sovereign obligation, must reflect on the situation as a whole.

Fortunately, the Indian government has announced a review of the court's decision. But India needs an investment based on the rule of contract and international doctrine, not on a judicial whim. Investors can understand the political risk premium that has decreased over time; but the risk premium of an inefficient and slow legal process represents a significant cost to Indian borrowers.

So does the cost of financing India's growth and its ability to do so.

Nish Kotecha is President and Co-Founder of Finboot in London and a member of the Board of Directors of the London Chamber of Commerce.