Securitisation 2024 Comparisons

The financial assets most commonly securitised in India via pass-through certificates ("PTCs") include vehicle loans, two-wheeler loans, microfinance loans and mortgage-backed loans. Revolving credit facilities such as credit card receivables and synthetic securitisations (ie, securitisations through the use of credit derivatives or credit guarantees for hedging the credit risk of the loan portfolio, which remains on the lender's balance sheet) are not permitted in India.

The current framework for securitisation is for standard assets only (i.e., assets with a delinquency of up to 89 days) and securitisation of non-performing assets ("NPAs") through the special purpose entity ("SPE") route is under consideration by the Reserve Bank of India ("RBI").

Typically, in relation to NPAs, banks/non-banking financial companies transfer their NPAs to asset reconstruction companies (ie, entities regulated by the RBI) ("ARCs"), and subsequently, an ARC issues security receipts to eligible investors both onshore and cross-border basis, which is a different framework and not typically viewed as securitisation in industry parlance.

There are two broad structures for assignment of loans:

Securitisation

Securitisation of standard assets (which are not NPAs) are typically securitised as follows:

• The originator (the original lender) pools the assets in one or more homogenous tranches and transfers them on a 'true sale' basis to an SPE (typically set up as a trust in India), the purchaser of the underlying assets.
• The SPE issues PTCs to the investors, and the proceeds received from the investors are utilised as purchase consideration by the SPE to purchase the pooled assets from the originator. 
• The SPE utilises the cash flows received from the borrowers of the underlying pooled assets to make periodic payments to the investors.
• The SPE appoints the servicer (typically the originator) to provide collection and payout services in relation to the receivables payable to the investors.
• Most PTC transactions are credit-enhanced through cash collateral or investment in the subordinate tranche by the originator.

In certain transactions, an arranger (typically an investment bank) will structure and put together the transaction.

Direct Assignment

Regulated entities in India, such as banks, non-banking finance companies and housing finance companies, are permitted to transfer (standard) loans from their books to similar regulated entities through novation, assignment, or loan participation. Under this structure, credit enhancement by originators is not permitted, and there is no requirement for setting up an SPE or issuing PTCs, as the (standard) loans are simply transferred from one entity to the other. However, regulated entities (such as bank/non-banking finance companies/housing finance companies) can transfer 'NPAs' by way of direct assignment only to an ARC, pursuant to which ARCs may float a scheme for issuing security receipts to qualified institutional buyers against such loans.

The direct assignment structure is usually not considered as securitisation in industry parlance. However, various market research platforms tend to club them with securitisations while discussing industry data on such activities in view of the transfer of loans from the originator's balance sheet and the common objective of providing capital relief to the originator. Based on market feedback, the RBI has recently released a discussion paper to enable the securitisation of NPAs through the SPE route.

The principal applicable laws and regulations include:

• Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI Act”);
• Master Direction – Reserve Bank of India (Securitisation of Standard Assets) Directions, dated September 24, 2021, issued by the RBI (“Securitisation Directions”);
• Master Direction – Reserve Bank of India (Transfer of Loan Exposures) Directions, September 24, 2021, issued by the RBI (“Transfer of Loans Directions”);
• Master Circular on Asset Reconstruction Companies (dated February 20, 2022), issued by the RBI; and
• Securities and Exchange Board of India (Issue and Listing of Securitised Debt Instruments and Security Receipts) Regulations, 2008 ("SEBI Regulations”).

Additionally, there are various other laws which impact the securitisation structures, such as:

• The Indian Trust Act, 1882;
• Banking Regulation Act, 1949;
• Income Tax Act, 1961;
• The Indian Contract Act, 1872;
• The Indian Stamp Act, 1899; and
• Foreign Exchange Management Act, 1999 and the rules and regulations thereunder ("Exchange Control Regulations").

SPEs are incorporated in India for securitisation of loans originated domestically by Indian entities without any particular priority being given to any State or Union Territory in India, specifically on account of making such securitisation transactions attractive. However, certain states in India have lower stamp duty rates on the assignment of loans for the purpose of undertaking securitisation, which can often be a consideration when choosing a place for undertaking such securitisation transactions.

SPEs are not incorporated outside India in relation to loans originated in India as Exchange Control Regulations do not permit Indian originators to assign loans to SPEs outside India for the purpose of securitisation.

Lenders and other facility providers (which must be regulated by at least one financial sector regulator, such as the RBI, Securities and Exchange Board of India, Insurance Regulatory and Development Authority, etc) can provide supporting credit enhancement facilities and liquidity facilities to SPEs for securitisation transactions. However, the originator's exposure cannot exceed 20% of the securitised pool.

In India, credit enhancement is of two types:

• internal credit enhancement, which includes over-collateralisation, investment by the originator in subordinated tranches, excess spreads and credit-enhancing interest-only strips (subordinated in nature); and
• external credit enhancement, which creates exposure to entities other than the underlying borrowers. It primarily includes cash collaterals (ie, in the nature of fixed deposits) or first/second loss guarantees.

Credit enhancement can be provided only at the initiation of the securitisation transaction, and the same should be available to the SPE during the entire life of the securitisation notes. The Securitisation Directions also contain guidelines for reset and release of credit enhancement.

Liquidity facilities are provided to support the SPE in case of temporary cash flow mismatches faced by the SPE, between the receipt of cash flows from the underlying assets and the payments to be made to the investors. The purpose of liquidity facilities is not to:

• cover losses of the SPE;
• serve as permanent revolving funding; or
• to fund the final scheduled repayment of investors.

A liquidity facility provider will have priority of claim over the future cash flows from the underlying assets and thus will be senior to the senior tranche.

Role and business of an Issuer (ie, SPE): the issuer is created for the specific purpose to acquire the pooled loan assets from an originator out of the funds collected by it from the issuance of PTCs to the investors. The structure of an issuer could be a trust or a company (if PTCs are unlisted), although issuers are commonly formed as trusts under the Indian Trusts Act, 1882.

Issuers are not commonly incorporated as a company because of regulatory, taxation and insolvency law considerations.

Responsibilities of the issuer:

• The trustee(s) of the issuer can only perform trusteeship functions in relation to the issuer and should not undertake any other business.
• The transaction between the originator and the issuer should not be a related party transaction and should be at arm's length.
• The issuer should be bankruptcy remote and non-discretionary.
• The issuer should make it clear to the investors in the issued securitisation notes that the securitisation notes are not insured and do not represent deposit liabilities of the originator, servicer or trustee(s).
• The issuer to ensure that the receivables acquired by it are duly assigned in its name, are legally realisable and are a genuine transaction amounting to a true sale.
• The SPE to ensure timely payment of interest and redemption amounts to the investors in terms of the offer document.
• If it is a listed issuance, the issuer must abide by the code of conduct provided in the SEBI Regulations.

Role and business of sponsor: The SEBI Regulations define a sponsor as (a) a person who promotes an issuer for the purpose of issuance of securitised debt instruments or (b) an ARC who promotes a trust which has issued security receipts.

Responsibilities of a sponsor: A sponsor should ensure that the securitisation transaction is structured to minimise the risk of the asset pool being consolidated with the sponsor's assets in the event of the sponsor's insolvency.

Role and business of an originator: The originator pools its assets into different homogenous classes/tranches, taking into account the types of loans, maturity and interest rate risk, and transfers the pool of assets to the SPE for the purpose of securitisation and provides credit enhancement to the investors.

Originators under the Securitisation Directions are financial entities regulated by the RBI and may be scheduled commercial banks, all India term financial institutions (such as National Housing Bank and Export Import Bank of India), small finance banks, non-banking financial companies (including housing finance companies).

In respect of public issuance or listing of PTCs, the SEBI Regulations permit any person to be the assignor of debt or receivables to an SPE (which SPE shall mandatorily be a trust).

Underwriter:

• The underwriter agrees to buy the securitised notes from the SPE in order to ensure adequate subscription. Underwriting is exercisable only when the SPE cannot issue the securitised notes at a price equal to or above the benchmark price determined and is permitted in the case of publicly listed issues of securitised debt instruments.
• In India, the originator or any third-party service provider can act as an underwriter. For listed securities, the underwriter can be any person registered as an underwriter with the SEBI and is typically involved in listed transactions.
• An originator may underwrite only investment grade senior notes issued by the SPE, subject to other conditions. 

Placement agent: The involvement of a placement agent in securitisation is rare in India.

A servicer is responsible for managing or collecting the asset pool or making distributions to the holders of the PTCs.  Commonly, the originator itself is appointed as the servicer by the SPE. No special permission or authorisation is required to service the financial assets.

The servicer must hold the cash generated from the securitised assets for the investors and avoid mixing it with its own assets.

Role and businesses of the investors: Investors are the purchasers or subscribers of the PTCs issued by the SPE. The investors can be any Indian citizen or an entity such as insurance companies, NBFCs, mutual funds, or banks incorporated in India. Foreign portfolio investors are also permitted to invest in securitised debt instruments which are listed in the Indian securitisation market.

Responsibilities of investors:

• Since the investors will bear the risks on the PTCs held by them, they are required to conduct proper due diligence of the securitised assets and the entities involved in the securitisation process like the originator, the SPE and other third parties.
• The investors should also check whether the SPE and the originator are in compliance with the laws related to securitisation.

Under Indian securitisations, conventional securitisation structures usually involve two trustee roles:

• trustees responsible for holding the advantages of the covenants and rights associated with the securitised assets on behalf of the investors; and
• trustees tasked with holding security established over the assets and related rights in favour of the secured investors.

Typically, the same trustee performs both roles. In a broad sense, the trustee's primary responsibility is to ensure that collections are remitted to the SPE and that investors receive their allocated share of these amounts according to the agreed-upon contractual priority.

Please refer to our response at 2.7 Bond/Note Trustees above.

To ensure bankruptcy remoteness, the securitisation documents, listed in 3.8 Bonds/Notes/Securities, should ensure the following:

• The assignment/transfer of the assets should be on an absolute ("true sale") basis to the SPE.
• The originator should provide representations and warranties concerning the nature, tenure, and security interest relating to the pool of transferred assets.
• The SPE should represent that it is a distinct legal entity capable of holding/owning assets and carrying on the securitisation business.
• The originator should covenant that:
1. the title of the transferred assets will vest completely with the issuer for the benefit of the investors;
2. the issuer will have the right to enforce the security interest available in respect of the pooled assets;
3. it will comply with the MRR and credit enhancement regulations, etc.
• The assignment agreement should contain covenants/conditions regarding the perfection of the assignment by way of payment of applicable stamp duty and registration.
• The documentation should ensure that:
1. the originator should not have any claims over the securitised assets, indicating that the transfer is not made on a true sale basis;
2. the intention of the parties to undertake a complete, valid, and absolute transfer of the legal ownership of the assets should be clear;
3. the rights and obligations of the parties pursuant to the transfer should be expressly documented;
4. the originator should not retain unusually high risk in the securitised assets;
5. the assignment agreement should not allow for an increase in the credit enhancement positions after inception;
• The rights and control of the investors must be documented to account for all circumstances, including insolvency of all entities involved in securitisation, such as the originator SPE, etc.
• An independent legal opinion is obtained regarding the validity and legality of the securitisation transaction and the bankruptcy remoteness of the securitised assets.

Originators typically provide warranties regarding certain aspects of the securitised assets and the transaction structure. If there is a breach of warranties, the investor or the SPE may have the right to seek remedies, such as indemnity claims and compensation for losses incurred due to a breach of warranties. While the specific warranties can vary based on the transaction structure and the preferences of the parties involved, the following are some principal warranties commonly found under securitisation documents in India:

• Validity of transfer: the originator warrants that the transfer of the securitised assets to the SPE is valid, legally effective and in compliance with all applicable laws.
• Title and ownership: the originator warrants that it has good and marketable title to the securitised assets and that the assets are free from any encumbrances.
• Conformity with representations: the originator warrants that the securitised assets conform to the representations and warranties made in the transaction documents.
• Regulatory compliance: the originator warrants that the securitisation transaction complies with all applicable laws and regulations, including those issued by the RBI.
• Quality of assets: the originator may warrant that the securitised assets meet certain quality standards, such as credit quality, performance and other specified criteria.
• No undisclosed liabilities: the originator may warrant that the servicing of the securitised assets will adhere to specified standards and practices.

Under the Securitisation Directions, originators are required to hold capital against such representations and warranties if any of the following conditions are not satisfied:

• Any representation or warranty is provided only by way of a formal written agreement.
• The originator undertakes appropriate due diligence before providing or accepting any representation or warranty.
• The representation or warranty refers to an existing state of facts that is capable of being verified by the originator at the time the assets are sold.
• The representation or warranty is not open-ended and, in particular, does not relate to the future creditworthiness of the assets, the performance of the SPE and/or the securitisation notes the SPE issues.

Further, any exercise of a representation or warranty requiring an originator to replace assets (or any parts of them) sold to an SPE must be:

• undertaken within 120 days of the transfer of assets to the SPE; and
• conducted on the same terms and conditions as the original sale.

An originator that is required to pay damages for breach of representation or warranties can do so provided the agreement to pay damages meets the following conditions:

• The onus of proof for breach of representation or warranty remains at all times with the party so alleging,
• The party alleging the breach serves a written notice of claim specifying the basis for the claim.
• Damages are limited to losses directly incurred as a result of the breach.

Securitisation Directions require originators to notify the RBI of all instances when an originator has agreed to replace assets sold to SPE or pay damages arising from any representation or warranty.

When perfecting under securitisation transactions, the following formalities need to be complied with:

• if any immovable property secures the underlying assets, then the instrument evidencing the underlying assets and the underlying security interest needs to be registered with the relevant sub-registrar of assurances; and
• if the underlying assets are due from a company incorporated in India, and any charge has been created over assets of any company to secure the underlying assets, the transfer of the underlying assets would amount to a modification of charge and will have to be filed with the relevant registrar of companies.

Apart from the above, stamp duty and registration fees also need to be paid, which is dealt with in the responses to questions 4.14 Other Principal Laws and Regulations and 6.3 Transfer of Financial Assets.

Specific terms may vary based on the transaction structure, although some of the principal covenants are set out below:

• True sale and insolvency covenant: the originator usually covenants that the transfer of assets to the SPE shall be on a true sale basis and not as a secured loan and that it shall ensure that the originator will not file for bankruptcy against the SPE.
• Maintenance of assets: the originator may agree to maintain the quality of assets and take necessary steps to recover defaulted assets.
• Cash reserve account: specific requirements for establishing and maintaining a cash reserve account to cover potential shortfalls in cash flows.
• Rating agency requirements: compliance with conditions set by rating agencies to maintain the credit rating of the securitised instruments.
• Change of control provisions: restrictions or requirements in the event of a change in control of the originator or the SPE.
• Reporting and information covenants: obligations related to regular reporting and disclosure of information to investors and other transaction parties.
• Regulatory compliance: covenants on compliance with applicable laws and regulations governing securitisation transactions in India.

Servicing provisions in securitisation documents in India outline the responsibilities and obligations of the servicer in managing and administering the underlying assets. The provisions are critical for the smooth operations of the securitisation transaction. Below are some of the commonly found provisions in servicing agreements:

• Servicing standards: specifies the standard of care and diligence the servicer must adhere to in managing and servicing the securitised assets.
• Collections and remittances: outline procedures for collecting payments from the underlying assets and remitting them to the designated accounts (such as the payment waterfall).
• Custody of documents: addresses the custody and safekeeping of important documents related to securitised assets (such as loan agreements, titles, and insurance policies).
• Defaulted assets and recoveries: defines the process for identifying and managing defaulted assets, including steps to be taken for recovery and rehabilitation.
• Reports and disclosures: specifies the frequency and content of reports the servicer must provide to various parties, including investors, trustees and rating agencies.
• Recordkeeping: requires the servicer to maintain accurate and complete records related to the securitised assets to protect against various risks.
• Change of servicer: outlines the process and conditions under which a change of servicer may occur, including the responsibilities for the transition.
• Servicer compensation: specifies the fees and expenses that the servicer is entitled to receive for its services, including any incentive structures tied to performance.
• Audit rights: grants the trustee(s) or other designated parties the right to audit the servicer's books and records to ensure compliance with the servicing standards.
• Regulatory compliance: ensures that the servicer complies with all applicable laws and regulations related to servicing the securitised assets.

Enforcement of these servicing provisions typically involves a combination of contractual mechanisms, legal remedies (pursued through courts or alternative dispute resolution mechanisms), and oversight by third-party entities. The SPE, acting on behalf of the investors, plays a crucial role in monitoring and enforcing compliance with servicing provisions. In the event of a breach, the SPE may take actions such as issuing notices, demanding cures, or even replacing the servicer in terms of the securitised documents.

Below are some of the principal default covenants commonly included in securitisation documents:

• Non-payment of principal or interest: Generally, a default occurs when the underlying obligors fail to make payments of the principal or interest as required. In such cases, the SPE may trigger its enforcement rights by issuing notices, demanding payments and, in severe cases, accelerating the repayment of the outstanding principal.
• Breach of representations and warranties: Default may occur if any party, such as the originator or servicer, breaches specific covenants in the transaction documents. In such cases, enforcement actions often involve indemnification by the originator for losses suffered by the investors, and the SPE may take legal action to remedy such breach.
• Breach of covenants: Defaults can occur if any party, such as the originator or servicer, breaches specific covenants outlined in the assignment agreement or the servicing agreement. In case of such violations, the SPE generally issues notices demanding cures and takes legal action to compel compliance.
• Bankruptcy and insolvency:  Any insolvency event concerning any party to the transaction, such as the originator, servicer, or liquidity provider, may trigger a default under the transaction documents. In such cases, the enforcement measures would be in the form of appointing a receiver, acceleration of repayment or other protective measures to safeguard the interests of the investors.
• Failure to maintain credit enhancement: A failure to maintain the required credit enhancement levels results in a default, and the enforcement typically involves the SPE taking corrective actions, such as replacing the servicer or demanding remedies specified in the servicing agreement.

The SPE typically carries out enforcement on behalf of the investors. The SPE has a fiduciary duty to act in the best interest of the investors and is empowered to take various actions to enforce default provisions. Legal remedies may include the initiation of legal proceedings, such as filing a lawsuit or seeking specific performance, depending on the nature of the default itself.

Indemnity provisions in India are contractual arrangements designed to protect one party from losses or liabilities potentially arising from certain specified events or breaches. Below are some common types of principal indemnities prevalent in the Indian context:

• Representation and warranty indemnity: The originator typically indemnifies the investors against losses arising from breaches of representations and warranties regarding the securitised assets' quality, legality and enforceability. The enforcement mechanics involve the investors notifying the originator of a violation, and the originator is then obligated to compensate the investors for resulting losses.
• Tax indemnity: The originator may provide indemnity to the investor for any adverse tax consequences arising from the securitisation transaction. Enforcement will typically involve the investors notifying the originator of any adverse tax claim and the originator reimbursing the investor for any resulting tax liabilities.
• Servicer indemnity: The servicer may indemnify the investors and other transaction parties against losses arising from the servicer's failure to perform its obligations. Enforcement involves the SPE or the investors notifying the servicer of a breach and the servicer being obligated to remedy the breach or compensate for resulting losses.
• Title and ownership indemnity: The originator may indemnify the investors against losses arising from defects in title or ownership of the securitised assets. Enforcement involves the investors notifying the originator of a title defect and the originator compensating the investors for any resulting losses.
• Regulatory compliance indemnity: The originator may indemnify the investors against losses arising from failing to comply with applicable laws and regulations related to the underlying assets and the securitisation transaction. Enforcement typically involves the investors notifying the originator of a regulatory breach and the originator compensating the investors for any resulting losses.
• Third-party indemnity claims indemnity: The originator may indemnify the investors against losses resulting from third-party claims related to the securitised assets. In such cases, the investor will also notify the indemnifying party of a third-party claim, and the indemnifying party will have to compensate the investor for any resulting losses.

As stated above, enforcement of indemnities often involves a notice and cure process. The party seeking indemnification notifies the indemnifying party of a claim or loss, thus allowing the indemnifying party to cure the breach or provide compensation. Legal remedies may be pursued if the indemnifying party fails to fulfil its indemnity obligations. These can include filing a lawsuit or initiating alternative dispute resolution processes to seek damages.

Securitisation transactions in India involve a comprehensive set of documentation to establish the terms and conditions governing the issuance of bonds, notes or other securities. The principal documents in a securitisation transaction typically include:

• Assignment agreement: An assignment agreement is typically executed between the originator and the trustee(s) under which the underlying assets are assigned to the SPE. This central document outlines the rights, obligations, and responsibilities of various parties involved in the securitisation transaction, including the originator, servicer, trustee(s), and investors. It covers issues such as cash flows, servicing standards and default scenarios.
• Trust deed: This document establishes the trust and outlines the terms under which the trustee(s) holds the securitised assets on behalf of the investors; it also sets out the rights and duties of the trustee(s).
• Offering circular or Information Memorandum: This document provides potential investors detailed information about the securitisation transaction. It includes information about the originator, the securitised assets, the transaction structure, risk factors and terms of the securities being offered.
• Servicing agreement: This document outlines the servicer's (typically, the originator) responsibilities, including collecting payments from the underlying assets, managing defaults, and providing regular reports to investors and other parties.
• Power of attorney: A power of attorney is executed by the originator to appoint the trustee as its attorney to perfect the trustee's title over the assets and take action against obligors/borrowers.
• Legal opinions: Legal opinions are provided by legal counsels involved in the transaction. They may cover various legal aspects, such as the validity of the transaction, enforceability of the documents and compliance with applicable laws.
• Rating agency documents: Documents related to the rating process (including rating agency reports and agreements) may be included to address the credit rating of the securities.

The principal subject matters covered in these documents include:

• Asset pool characteristics: description of the securitised assets (including their nature, quality and characteristics).
• Cash flow waterfall: the order in which cash flows from the securitised assets are distributed among different classes of securities and transaction parties.
• Conditions precedent and closing conditions: the conditions that must be satisfied before closing the securitisation transaction.
• Representation and warranties: statements by the originator regarding the assets being securitised and the transaction structure,
• Events of default and remedies: events that, if they occur, may lead to default and the remedies available to the trustee(s) or investors in case of default.
• Payment terms: terms related to the payment of principal and interest on the securities, including interest rates, payment dates and methods.
• Governing law and dispute resolution: the jurisdiction governing the transaction and the mechanisms for resolving disputes among the parties.
• Termination provisions: conditions under which the securitisation transaction can be terminated or unwound.

In securitisation transactions in India, derivatives may be used only for genuine hedging of asset and liability mismatches of interest rate and/or currency.

• Interest rate swaps: Interest rate swaps are used to convert fixed-rate cash flows into floating-rate cash flows, or vice-versa, depending on the interest rate exposure of the securitisation transaction.
• Currency swaps: Currency swaps help mitigate exchange rate fluctuation and reduce the impact of currency risk on cash flows. Currency swaps are primarily used to manage currency risk in transactions involving assets or liabilities denominated in foreign currencies.

The offering memorandum is required when the issuer wants to invite investors to subscribe to the PTCs/securitised notes. It can be in the form of an electronic document issued as an offer document or a prospectus. It can also be in the form of an initial offer document, any offering circular, notice, advertisement, or any other document that purports to invite a subscription from a specified category of investors or the public. It may also be a document issued for inviting subscriptions for the security notes/receipts from qualified buyers on a private placement basis.

In general, the RBI Directions apply to the offering memorandum. However, the issuer also has to ensure compliance with the SEBI Regulations for a listed issuance.

In India, the following are the major laws which directly govern securitisation-specific disclosures in India:

• the SARFAESI Act;
• Directions issued by the RBI, such as the Securitisation Directions and Transfer of Loans Directions; and
• Regulations issued by the SEBI, such as the SEBI Regulations.

Some of the disclosures required to be made are as follows:

• The disclosures are to be made in the offer document (such as maturity, characteristics of the underlying assets, credit quality, etc).
• Data on credit quality, the performance of individual underlying exposures, cash flows and collateral supporting a securitisation exposure, and information required to conduct comprehensive stress tests should be disclosed by the originator to the investor.
• Disclosure on fulfilment of the minimum holding period and minimum retention requirement should be made publicly available by the originator and appropriately documented. The rating and the rating rationale are to be publicly available.
• If it is a simple, transparent and comparable securitisation under the Securitisation Directions, the originator should demonstrate that it satisfies the applicable criteria.
• The originator's notes to annual accounts of the originators should indicate the outstanding amount of securitised assets as per books of the SPE and the total amount of exposures retained by the originator.
• Quarterly report to the RBI by the originator with details of the securitisation transactions and the issued securitisation notes.

The originators, which are regulated entities, may be subject to other disclosure requirements applicable to them. If the PTCs are listed, the issuance will be subject to the listing regulations issued by the SEBI.

Minimum Retention Requirement (MRR)

The Securitisation Directions in India require the originator to retain a continuing stake in the performance of the securitised assets to ensure that the originators carry out proper due diligence of loans to be securitised. The MRR cannot change during the life of securitisation, and proper documentation is required to be executed:

• The prescribed MRR limits for securitising loans (other than residential mortgage-backed securities) are as follows:
1. MRR of 5% of the book value of the loans being securitised for underlying loans with an original maturity of two years or less; and
2. MRR of 10% of the book value of the loans being securitised for underlying loans with an original maturity of more than two years, as well as loans with bullet repayments.

• MRR of 5% of the book value of the loans being securitised,  for residential mortgage-backed securities, irrespective of the original maturity.

The manner in which the MRR should be maintained is prescribed under the Securitisation Directions:

• Up to 5% of the book value of loans being securitised:
1. First loss facility, if available.
2. If first loss facility is not available or, if retaining the entire first loss facility adds up to less than 5%, then balance it out by retaining the equity tranche.
3. If retaining the first loss facility and equity tranche does not sum up to 5%, balance it proportionately in the remaining tranches sold to investors.
• Greater than 5% of the book value of loans being securitised:
1. First loss facility, equity tranche or any other tranche sold to investors, in any combination thereof.

In the case of direct assignment of loans, an MRR of 10% is required if investors do not conduct due diligence on each of the loans in the pool assigned.

Minimum holding period (MHP): The originator can transfer loans only after completion of the following MHP (applicable to individual loans in the underlying pool of securitised loans):

• three months for loans with original tenures of less than two years;
• six months for all other loans; and
• six months for loans acquired from other entities by a transferor.

Regulator: The Reserve Bank of India regulates compliance with these requirements by conducting audits and investigations. In case of non-compliance, the RBI has the power to undertake supervisory scrutiny and take suitable action as it may deem fit under the relevant statutes and directions issued by the RBI.

In India, the RBI primarily governs periodic reporting of securitisation transactions. The reporting requirements are outlined in the Securitisation Directions, and compliance is essential to ensure transparency, monitoring and regulatory oversight of securitisation transactions.

Material Requirements

Periodic reporting: Originators, sponsors and securitisation entities are required to submit periodic reports to the RBI. These reports intend to cover various aspects of the securitisation transaction, including the performance of securitised assets, compliance with regulatory guidelines and other relevant details.

Asset-level reporting: Detailed information about individual assets within the securitised pool may be required (including data on asset characteristics and performance metrics).

Credit rating reports: Reporting may include submitting credit rating reports and updates, especially if credit ratings are involved in the securitisation transaction.

Penalties for Non-compliance

Penalties for non-compliance with reporting requirements can vary and are at the discretion of the RBI. Potential penalties may include monetary fines, restrictions on specific activities, or other regulatory actions to address non-compliance. The specific penalties are generally outlined in the regulatory framework, and the severity may depend on the nature and extent of the non-compliance.

Credit rating agencies (including the ones involved in assessing securitisation transactions) are regulated by SEBI. SEBI is the primary regulatory authority overseeing the securities market in India, and it has issued the Securities and Exchange Board of India (Credit Rating Agencies) Regulations, 1999 ("Credit Rating Regulations") and other guidelines governing the activities of credit rating agencies. The Credit Rating Regulations aim to ensure transparency, accountability and integrity of the credit rating process.

The material requirements of Credit Rating Regulations include the following:

• Registration: Credit rating agencies must be registered with SEBI to conduct rating activities. SEBI issues certificates of registration to credit rating agencies meeting the specified criteria.
• Code of conduct: Credit rating agencies are required to adhere to a code of conduct prescribed by SEBI (ie, maintain independence, avoid conflict of interest and ensure fair and transparent rating processes).
• Rating process: The regulations outline the processes and methodologies that credit rating agencies must follow in assigning credit ratings (such as the disclosure of credit rating methodologies, rating symbols, and factors considered in the rating process).
• Rating committees: Credit rating agencies are required to establish rating committees responsible for assigning and reviewing credit ratings. SEBI regulates the composition and functioning of these committees.
• Disclosure requirements: The rating agencies must disclose information about their rating processes, methodologies, and any material changes. They are also required to disclose their rating track record periodically.
• Confidentiality and non-discrimination: Credit rating agencies are obligated to maintain confidentiality of non-public information and avoid discrimination in the treatment of different issuers and instruments.

SEBI monitors the activities of credit rating agencies through periodic inspections and reviews aiming to assess compliance with regulatory requirements. SEBI has the authority to conduct investigations into the affairs of the credit rating agencies in case of any suspected violations or irregularities.

Further, SEBI has the authority to impose monetary penalties on credit rating agencies for non-compliance with regulatory requirements. The penalty amount may depend on the nature and severity of the violation. In case of serious non-compliance, SEBI may suspend or cancel the registration of a credit rating agency's certificate.

Holdings in securitisation transactions are subject to capital and liquidity rules that apply to banks, insurance companies and other regulated financial entities. The regulatory framework, including guidelines issued by the RBI, outlines specific requirements regarding the capital treatment of securitisation exposures.

Capital treatment for banks:

• Capital requirements: Banks are required to maintain capital against all securitisation exposure amounts, including those arising from the provisions of credit risk mitigants to a securitisation transaction, investments in asset-backed or mortgage-backed securities, retention of a subordinate tranche and extension of a liquidity facility or credit enhancement.
• MHP: The Securitisation Directions require banks to satisfy the requirements of a an MHP during which the bank is required to retain the economic interest in the securitised assets.
• Risk-weighted assets: Banks are required to assign risk weights to their assets based on the credit risk associated with them. Securitisation exposures are subject to risk weighting, and the risk weights depend on factors such as the credit rating of the securitised instruments and whether the securitisation meets certain criteria.
• Credit enhancement: Securitisation Directions regulate credit enhancement mechanisms, such as over-collateralisation or guarantees that may impact risk-weighted assets.

The regulations governing use of over the counter (OTC) derivatives include the Securitisation Directions, Guidelines for computing exposure for counterparty credit risk arising from derivative transactions dated November 10, 2016, Master Direction - Risk Management and Inter-Bank Dealings dated July 1, 2016, Rupee Interest Rate Derivatives (Reserve Bank) Directions, 2019 and Foreign Exchange Management (Foreign Exchange Derivative Contracts) Regulations, 2000 and require that such derivatives must be entered into with authorised dealer banks for hedging genuine underlying risks and should be co-terminus with the underlying arrangement. Further, naked derivatives are not allowed, and the exposure must be equal to the underlying value.

Any person guilty of contravention of the above-mentioned regulations shall be punishable with a fine, which may extend to INR100,000 and where a contravention or default is a continuing one, with a further fine which may extend to INR10,000 or every day after the first, during which the contravention or default continues. Further, applicable penalties under Exchange Control Regulations may also apply.

The Securitisation Directions and prudential guidelines issued by the RBI and SEBI Regulations protect investor interest in securitisation transactions. The regulatory framework is designed to ensure transparency and fairness and safeguard investor interests. The regulations aim to protect investors from various risks arising from securitisation transactions (such as credit, counterparty, legal, and market risks).

Banks engaging in securitisation transactions are subject to various laws and regulations to ensure prudential norms, risk management and regulatory compliance. The principal laws and regulations impacting banks involved in securitisation include the Securitisation Directions, SARFAESI Act, Prudential Norms on Income Recognition, Asset Classification and Provisioning and other guidelines issued by the RBI.

The material content and impact of such legislation(s) include the following:

• Capital conditions: This requires banks to maintain capital against all securitisation exposure amounts, including those arising from the provision of credit risk mitigants to a securitisation transaction.
• Derecognition conditions: These conditions set out the framework to determine whether a sale results in the assets being de-recognised from the bank's books.
• Servicing conditions: These set out the parameters of servicing when banks perform servicing facilities with respect to the transferred assets. For example, in their capacity as servicers, banks should not have any obligations to support any losses incurred by the SPE (except to the extent contractually provided in the servicing agreement).
• Due diligence requirements: Banks can invest in securitised notes only if the originator has explicitly disclosed to the purchasing banks that it has adhered to the MRR and MHP requirements and will adhere to MRR on an ongoing basis.
• Credit monitoring and valuation: Banks are required to have board-approved policies detailing the valuation of the securitisation notes in which they have invested.
• Permitted securitisation structures: The RBI specifies the forms and structures of permitted securitisation structures.

SPEs

Please refer to our response at 2.1 Issuers.

Originators

The RBI Directions and the SEBI Regulations are the major legislations applicable to determine the form of the originators. Please refer to our response at 2.3 Originators/Sellers for further details on who can be originators.

Servicer

Please refer to our response at 2.5 Servicers.

SPEs are formed only for the limited purpose of implementing the securitisation structure in relation to the specific receivables assigned to the SPE by the originator. Such SPEs do not engage in activities such as lending, investment banking, private equity, etc, which the RBI or SEBI would otherwise regulate. However, the trustee(s) may be permitted to invest proceeds in certain permitted investments to maintain liquidity management.

The RBI is the supervisory and regulatory body that will determine any non-compliance with the Securitisation Directions. In case of non-compliance, the RBI has the power to undertake supervisory scrutiny and take suitable action as it may deem fit. Additionally, in case of a listed issuance of PTCs, SEBI will also have supervisory and regulatory powers.

The banks and NBFCs in India owned or controlled by the government also participate in securitisation transactions, especially to meet the priority sector norms promulgated by the RBI, as banks and NBFCs in India must allocate a percentage of their lending to priority sectors such as agriculture, small and medium enterprises, education, housing, social infrastructure.

The regular participants in securitisation transactions in India are also banks and NBFCs, which are subject to the same regulations.

A diverse range of entities invest in securitisation, including financial institutions, banks, non-banking financial companies, mutual funds, insurance companies and other qualified institutional buyers.

The material rules for investments in securitisations for the abovementioned entities include:

• Prudential norms and risk management: The RBI and SEBI prescribe prudential norms and risk management guidelines for entities investing in securitisations. These norms address issues such as exposure limits, credit enhancement and due diligence.
• Credit rating requirements: Investments in securitisation often require credit ratings. Regulatory guidelines often mandate a minimum credit rating for the instruments to ensure a certain level of credit quality.
• Asset liability management norms: Banks and financial institutions are subject to asset liability management norms prescribed by the RBI to ensure prudent risk management.

Some of the other principal laws and regulations relevant in securitisation transactions are:

• Transfer of Property Act, 1882 (ToPA): The transfer of actionable claims (which includes receivables arising out of unsecured debt) has to be effected only by the execution of an instrument in writing, in accordance with the provisions of ToPA. Further, the creation and registration of mortgages are also governed by the provisions of ToPA.
• Stamp laws: The securitisation documents should be adequately stamped to be admissible as court evidence. Further, a securitisation involving the transfer of mortgage-backed assets may attract an ad valorem stamp duty, which could range from 0.1%% to as high as 8.5% of the value of the transaction, depending on the stamp laws of the state in which the mortgaged property is situated. However, various States have issued notifications in this regard, capping the amount of the stamp duty payable on the assignment of loans in securitisation transactions.
• Registration Act, 1908: It requires certain documents to be compulsorily registered, such as any document pertaining to a transfer of immoveable property or interest in an immovable property has to be compulsorily registered with the relevant registrar of land records in the area where such property is located.
• Income Tax Act, 1961: Taxation laws may apply at various securitisation stages. Please see section 7 below on taxes.
• Companies Act, 2013: If the SPE is incorporated as a company, it must ensure compliance with the Companies Act, 2013 and its relevant rules. 
• Indian Trust Act, 1882: SPE incorporated as a trust will have to comply with the provisions of this act.
• Indian Contract Act, 1872: This act provides the criteria for a contract to be valid and enforceable, including the requirement of a lawful consideration. Any contract between the parties under a securitisation transaction should be valid and enforceable under the Indian Contract Act of 1872.
• Foreign exchange laws: The RBI regulates foreign investment in India; therefore, foreign portfolio investors investing in PTCs should comply with the the Exchange Control Regulations.
• SEBI regulations: Entities regulated by SEBI and listed issuance of PTCs should comply with the applicable regulations promulgated by the SEBI.

Synthetic securitisations, under which the credit risk of an underlying pool of exposures is transferred using credit derivatives or credit guarantees to hedge the credit risk of the pool of assets that remain on the lender's balance sheet, are not permitted in India.

Insolvency laws Affecting Originators

The Insolvency and Bankruptcy Code, 2016 ("IBC") governs the insolvency regime in India. However, the RBI governs the insolvency of originators, such as banks. In the case of an NBFC, the RBI can apply to the relevant authority to initiate insolvency of a particular NBFC.

The Securitisation Directions require the bankruptcy remoteness of the securitised assets from the originator's insolvency. As creditors of the originators may claim rights over the securitised assets in an insolvency proceeding initiated against the originators, the assets must be transferred to the SPE on a 'true sale' basis. Therefore, when the securitised assets are legally isolated from the originator, the securitised assets held by the SPE will not form part of the insolvency proceedings of the originator.

While bankruptcy remoteness of the securitised assets can be ensured in the aforesaid manner, under the IBC, if the originator is going insolvent, then the transfer of assets by the originator to the SPE can be set aside as a 'preferential transfer' or an 'undervalued transaction' if the transaction is executed during the look-back period (ie, two years prior to the admission of insolvency proceedings for related party transactions and one year for other transactions).

Insolvency laws Affecting SPEs

Under the IBC, insolvency proceedings will be initiated against the trustee(s) for the SPE's assets. When incorporated as a trust, the SPE does not enjoy the legal fiction of being a separate legal entity and will, therefore, be wound up as per the terms of the trust deed.

SPEs are typically structured in a form of trust. However, SPEs can also be structured in the form of a company (provided that the PTCs are proposed not to be listed). SPEs play a crucial role in achieving bankruptcy remoteness and isolating securitised assets from the risks associated with the originator's financial condition. The structure of the SPE is carefully designed to meet regulatory requirements and address potential risks, including those related to insolvency proceedings.

Some of the desirable aspects of a SPE include:

• Independent directors: If the SPE is structured as a company, having one or two independent directors is common. Independent directors bring an additional layer of oversight and governance to an SPE, contributing to its credibility and independence.
• No operations outside securitisation: The SPE is typically structured to have no operations outside securitisation transactions. This focuses on holding and managing the securitised assets without engaging in unrelated business activities or having any comingling interest.
• Debt structure: The SPE's capital structure is designed to align with the securitisation transaction. It may issue different classes of securities representing different risk tranches, with priority of payments based on each tranche.
• Bye-laws (Trust Deed / Articles of Association): The bye-laws, ie, the trust deed when the SPE is structured as a trust and articles of association when the SPE is structured as a company, outline the SPE's governance structure, decision-making process and powers. These documents often include provisions to ensure that the SPE operates in accordance with the securitisation transaction terms.
• Orphan SPE: An SPE is often structured as an 'orphan SPE', meaning it is legally and financially independent of the originator and its affiliates. This independence is critical for bankruptcy remoteness.

In relation to potential risks and bankruptcy remoteness, legal and structural protections are often put in place to mitigate the risk of substantive consolidation of the SPE's assets and liabilities with those of the originator or another affiliated entity. Clear legal separation, proper documentation and adherence to regulatory guidelines are critical in maintaining the independence of the SPE.

Further, ensuring that the securitisation transaction meets the 'true sale' criteria is essential. If the transfer of the assets to the SPE is not considered a true sale, there may be a higher risk of substantive consolidation in the event of the originator's insolvency. In this regard, legal opinions are often obtained to confirm the bankruptcy remoteness of the SPE. These opinions often address issues related to substantive consolidation and other risks.

Certain key considerations and steps are necessary to ensure that the transfer of financial assets from the originator to the SPE is valid and enforceable. The process typically involves the following:

• Drafting and execution of legal documentation: A comprehensive assignment agreement is drafted, detailing the terms of the transfer, representations, warranties and covenants of the parties involved.
• True sale criteria: The transfer must meet the 'true sale' criteria. A true sale involves complete ownership and control over the securitised assets from the originator to the SPE. Key considerations include:
1. Legal isolation of assets from the transferor's bankruptcy risk.
2. Absence of any recourse or buyback obligations by the originator.
3. Effective transfer of the economic benefits and risks associated with the assets.
• Legal due-diligence: Legal due diligence ensures that the transfer complies with all applicable laws and regulations (including review of the relevant transaction documents, perfection requirements and regulatory compliances).
• True sale opinions: Parties often obtain legal opinions, commonly referred to as 'true sale' opinions, from legal counsels. These opinions confirm that, in the legal counsel's view, the transfer constitutes a true sale and is enforceable against the transferor and its creditors.
• Stamp duty and registration: Parties to a securitisation transaction are also required to pay stamp duty and registration fees, which differ from state to state depending on each state's stamp duty and registration legislation. However, stamp duty is exempted if any bank or financial institution executes the assignment agreement in favour of an ARC acquiring financial assets for asset reconstruction or securitisation.

While the steps outlined above are designed to achieve a true sale, risks such as characterisation of the transaction of the transfer, regulatory changes or unexpected legal developments should be continually assessed.

Achieving bankruptcy remoteness in securitisation transactions involves careful structuring to isolate the financial aspects to be financed from the insolvency risk of the originator. While obtaining insolvency opinions is not as common in India as in other jurisdictions, various legal and structural mechanisms are employed to enhance bankruptcy remoteness. Some of the means and considerations for achieving bankruptcy-remote transactions in India include:

• Structuring the SPE: The creation of the SPE is a fundamental step in securitisation transactions. The SPE is designed to hold and manage the securitised assets independently of the originator. The SPE's legal and financial separation helps mitigate the impact of the originator's insolvency on the securitised assets.
• True sale criteria: Meeting the 'true sale' criteria is critical. A true sale involves a genuine transfer of ownership and control over the securitised assets from the originator to the SPE.
• Non-recourse and non-bankruptcy remoteness provisions: Drafting contractual provisions that explicitly limit the recourse of the investors or the SPE to the securitised assets is essential. Non-recourse provisions prevent investors from seeking recovery from the originator’s general assets in the event of default.
• Bankruptcy remote provisions: Including bankruptcy remote provisions in the transaction documents helps to isolate the securitised assets further. These provisions may restrict the SPE from filing for bankruptcy or limit the liability of the creditors of the originator to reach the securitised assets in the event of the originator's insolvency.
• Regulatory compliance: Adhering to regulatory guidelines issued by the RBI and SEBI is critical. Compliances ensure that the securitisation structure aligns with the regulatory expectations, contributing to its legitimacy and effectiveness.

Given that most SPEs are typically structured as a trust, specific provisions are included in the trust deed to address the bankruptcy remoteness and protection of the investor. In this context, limited recourse and non-petition provisions are applied within the framework of a trust. These provisions are typically framed as below:

• Limited recourse provisions: Limited recourse provisions limit the recourse available to the investor to the specific assets that have been securitised. In other words, investors have recourse only to the cash flows and assets in the securitised pool. This is achieved by the trust deed defining the specific assets that form part of the trust estate, typically representing the securitised assets. Limited recourse provisions would then restrict the investors' recourse to only those trust assets. By restricting the recourse to the securitised assets, limited recourse provisions mitigate the risk of the SPE's bankruptcy affecting assets outside the securitised pool. This becomes crucial for maintaining the bankruptcy remoteness of the transaction.
• Non-petition provisions: Non-petition provisions in the trust deed would typically prohibit the SPE or the investors from filing for bankruptcy or insolvency proceedings against the trust. Such provisions help maintain the bankruptcy remoteness status of the SPE.
• Trustee's role and independence: The trust deed designates a trustee responsible for managing the trust estate. Ensuring the trustee's independence from the originator is crucial for maintaining the autonomy of the SPE and preventing a conflict of interest.

Any income arising from an SPE from, inter alia, on the acquisition of a financial asset from the originator is tax-exempt under Indian tax laws. Please note that the securitisation should be in accordance with the SEBI Regulations.

Indian tax laws provide for a complete tax pass status on all the income arising to SPE from the activity of securitisation, meaning that any income earned from underlying financial assets is tax-exempt in the hands of the SPE and taxed directly in the hands of the investor as if such income arises directly in the hands of the investor.

The income distributed by the SPE to its Indian tax-resident investors is subject to tax withholding as per the rates set out below:

• 25% in case of individuals or Hindu undivided families; and
• 30% for other categories (such as companies, partnerships, etc).

In the case of non-resident investors, taxes are required to be withheld as per applicable tax rates in force, depending on the nature of income distributed by the SPE.

For instance, if the SPE receives dividends from an investee company and, onwards, pays dividends to non-resident investors, taxes may be withheld at the rate of 20% (plus applicable surcharge and cess) under domestic tax law. Similarly, interest from notes or loans will be taxed at the rate of 20% or 40% plus applicable surcharge and cess, depending on the currency in which the borrowing was made under domestic tax law. Such tax rates will be subject to benefits under the relevant tax treaty, if any. As such, if the rates specified in the relevant tax treaty are lower than the domestic tax rates on such India-sourced income, the lower tax rate under the tax treaty will apply. 

The investors can claim a credit of the taxes withheld by the SPE on the income they earn, which can be adjusted against the taxes due on their total income subject to taxes in India.

Securitisation transactions will not attract Goods and Service Tax ("GST") under the applicable laws, as it is beyond the ambit of "supply" under such laws.

However, any service fee charged for collection, for payment as a servicing agent, will be liable to GST in the hands of the service provider. Further, any service between related parties, even if it is free of cost, for example, management fees by trusts floated by ARCs to such ARC(s), will be liable to GST on any fee in the hands of the service provider.

A reasonable open market value should be ascribed to paying GST for free-of-cost transactions. If the receiver is eligible for full input credit of the GST paid, then any value can be ascribed to the transaction.

Practitioners commonly give tax opinions covering the following aspects:

• Tax treatment of income on transfer of assets/property (subject to securitisation).
• Tax treatment of securitisation transactions, such as receipt of financial assets by the SPE.
• Tax treatment of the income from underlying assets in the hands of the SPE.
• Tax withholding obligations in the hands of the SPE.
• Tax treatment of returns in the hands of the investor.

The material conclusions in such tax opinions will be similar to the discussion on tax treatment of such transactions, as discussed above (see sections 7.1 Transfer Taxes to 7.4 Other Taxes above).

Typically, such tax opinions carry qualifications regarding accounting matters related to securitisation transactions.

The following legal issues may arise in connection with accounting rules that apply to securitisations in India:

• the treatment of the transfer of underlying financial assets as a "true sale" for accounting purposes; and
• whether the SPE is consolidated into the originator's group for accounting purposes.

Legal and tax opinions in this regard do not generally cover accounting matters. However, legal opinions may be provided on true sale and compliance with Securitisation Directions, such as compliance with MRR and credit enhancement compliances, but may include certain qualifications or assumptions.