Difference Between Trust and Retention Account and Escrow Account*

Trust and Retention Account (TRA) mechanism

TRA mechanism has been a common feature in financing of infrastructure projects. It seeks to protect the project lenders against the credit risk (the risk of debt service default) by insulating the cash flows of the project company. This is done through shifting the control over future cash flows from the hands of the borrowers (project company) to an independent agent, called TRA agent, duly mandated by the lenders.

2. The infrastructure projects are executed through a separate company created for the purpose (called 'Special Purpose Vehicle' - SPV) and the shares of the SPV would normally be held, among others, by the sponsors of the project. The cash flows of the SPV (project company) are subjected to a TRA arrangement. Under this arrangement, the lenders, the borrower and the TRA agent enter into a tri-partite agreement, which provides for all revenues of the project to be directed into a single account, maintained with the designated TRA agent. The lenders, in consultation with the borrower, draw up a detailed mandate for the TRA agent as to periodic transfer and utilisation of funds available in the TRA. The mandate basically spells out the manner and purpose of various payments including the debt service to the lenders. The payment to the lenders is to be made directly by the TRA agent, as per its mandate, without any intervention by the borrower. For operational convenience, the TRA could be sub-divided into several sub-TRAs dedicated to separate heads of expenses / purposes. In case of multi currency cash flows, there could also be separate TRAs with the same agent or different TRA agents for handling the cash flows in various currencies. Thus, the TRA agent acts as a trustee on behalf of the lenders and ensures that the cash flows are accessible to the borrower / project company, strictly as per the mandate. Thus, the TRA mechanism could be viewed as a sophisticated version of the traditional 'No Lien' accounts, on which the concerned bank could not exercise its right of general lien.

3. Illustratively, the mandate to the TRA agent by the lenders for appropriation of cash flows could prescribe the following sequence for end use of funds:

● All operation and maintenance expenses of the project;

● Monthly dues / accruals of net principal and interest payments to lenders;

● A debt service reserve equal to, say, six months' dues - which could also be backed by a letter of credit to be arranged by the sponsors of the project company;

● A cash reserve equal to, say, four months' operating expenses;

After meeting all the foregoing obligations, either through L/C or out of project cash flows, the residual funds, if any, would be available to the project company for disposal as per their discretion or as pre-determined by the mandate given to the TRA agent. .

4. A Trust and Retention Account mechanism needs to be distinguished from an Escrow Account arrangement,though the two are somewhat similar. An Escrow Account is an arrangement for safeguarding the borrower against its customers from the payment risk for the goods or services sold by the former to the latter. This is achieved by removing the control over the cash flows from the hands of the customer to an independent agent, who in turn could ensure appropriation of cash flows as per the its mandate. The Escrow arrangement provides for directing a pre-determined payment stream from the customers of the borrower to a special account maintained with a designated agent. Payment / deposit by the user / buyer into such an account is assumed to be a valid discharge of his liability to the supplier of the goods / services. An Escrow arrangement involves parties different from the parties in a TRA mechanism. The Escrow arrangement would involve usually four parties: the lender, the borrower, the customers of the borrower and the Escrow Agent. The mandate to the Escrow Agent would normally be finalised by the lenders in consultation with the borrower and its customers.

5. Thus, for instance, in financing of a power plant which sells its power generated to a SEB, the Escrow arrangement would involve the power producer (borrower), the SEB concerned (customer), the bank / FI (lenders) and the Escrow Agent (a designated bank). The SEB would agree to direct its collection centres to deposit the electricity charges received from retail consumers, into a designated account with the designated bank (Escrow agent) and to direct its bulk consumers to deposit their payments directly with the Escrow Agent in the specified account. The Escrow Agent would then appropriate the funds in the Escrow account as per the priority laid down in the Escrow Agreement.

* extract from co-ordination between banks and financial institutions, BP. BC. 82 /21.04.048/00-01 dated February 26,2011, available at www.rbi.org.in