Securitisation 2020

Last Updated January 13, 2020

India

Law and Practice

Authors



Jerome Merchant + Partners has a primary office located in Mumbai, with associate offices in New Delhi and Bangalore. Its lawyers advise financial institutions and corporates on various aspects related to securitisation and the assignment of different portfolios of receivables, including housing, credit card, operational and loan portfolio receivables. The securitisation practice works closely with the M&A and disputes practices in structuring securitisation transactions. Many large portfolio assignment transactions are undertaken by way of a business transfer of the portfolio, associated assets (including employees and technology) and are advised by the firm's financing/securitisation and M&A lawyers. Given the rising levels of distressed assets in the Indian economy, Jerome Merchant's securitisation lawyers increasingly work with its disputes and insolvency teams in advising on the structure for sale and acquisition of debt portfolios which are non-performing and are under different stages of restructuring or insolvency.

Introduction

Securitisation of performing financial assets in India is mainly governed by the Guidelines on Securitisation Transactions dated 7 May 2012 and 21 August 2012 (as applicable to all scheduled commercial banks, all India term-lending and refinancing institutions and non-banking financial companies), as amended by the master directions of the Reserve Bank of India (RBI) – collectively referred to as the RBI Guidelines – from time to time.

Securitisation of non-performing financial assets is governed by the:

  • Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI);
  • RBI regulation in the Securitisation Companies and Reconstruction Companies (Reserve Bank) Guidelines and Directions 2003, as amended; and
  • RBI notifications on the sale of non-performing assets, issued from time to time (banks purchasing/selling non-performing financial assets from/to other banks are required to formulate internal procedures for such purchase/sale, and comply with prudential norms and disclosure requirements stipulated by the RBI under the Guidelines on Purchase/Sale of Non-Performing Assets, dated 13 July 2005.

Securitisation by way of issuance of listed securitised debt instruments is, in addition, governed by the Securities and Exchange Board of India (Issue and Listing of Securitised Debt Instruments and Security Receipts) Regulations 2008 (SDI Regulations).

While undertaking a securitisation transaction, a practitioner must also consider and ensure compliance with the Companies Act, 2013, the Transfer of Property Act, 1881, the Income Tax Act, 1960, the Trusts Act, 1882, the Contract Act, 1872 and state stamp duty laws.

Securitisation in India is mostly undertaken as follows: (i) direct assignment by banks or financial institutions to other banks or financial institutions; and (ii) a pass-through structure where securitised paper in the form of pass-through certificates (PTCs), which represent the financial assets transferred to the special purpose vehicle, are issued to investors.

Insolvency Laws and Issues

Securitisation, "true sale" and risk insulation

There should be a “true sale” of financial assets in order to insulate them from the financial risk of the originator. In order to effectively achieve a true sale, the originator must have no further risk, liability or rights in the transferred financial assets. The consideration for the transfer should not be deferred and must take place simultaneously with the payment of consideration and execution of the transfer documents.

Section 36 of the Insolvency and Bankruptcy Code, 2016 (IBC) provides that any asset over which a debtor has ownership rights – as evidenced in its balance sheet or on the records of a registry or information utility – form part of the liquidation estate of the insolvent corporate. Hence, it is essential that the securitisation structure results in the removal of the financial assets from the books of the corporate debtor.

The securitisation transaction should also not qualify as a “preferential transaction” or an “undervalued transaction”, as such transfers would be void under the IBC.

Characteristics of true sale v secured loan

On a secured loan transaction, the debtor whose assets are offered as security to the lender to secure the repayment of the dues and performance by the borrower of its obligations, ordinarily remains the legal owner of those assets. Section 36 of the IBC provides that encumbered assets of the debtor form part of the liquidation estate of the debtor. Accordingly, the secured creditors are entitled to enforce their security interest, or relinquish it and receive the proceeds from the sale of the secured assets on par with all other secured creditors of the debtor.

In the case of a true sale, the debtor who has transferred the assets ordinarily has no legal or beneficial interest in the assets and hence they do not form part of the liquidation estate of the transferor/debtor.

In the case of a true sale, the transferred assets transfer on to the books of the assignee without any recourse to the originator or transferor.

Opinion of counsel

In India, parties customarily obtain opinions from legal counsel confirming that the tests of a true sale have been satisfied.

The opinions ordinarily confirm the following:

  • all rights, titles, interests and benefits in the transferred assets, including underlying security, have been transferred to the assignee;
  • creditors of the assignor do not have any right in any way with regard to the transferred assets, even in case of the bankruptcy of the assignor;
  • the assignment documentation does not interfere with the assignee’s rights and rewards associated with the transferred assets to the extent transferred by it;
  • the assignor does not retain any risk or reward associated with the transferred assets;
  • all acts necessary for the assignment and/or transfer of the transferred assets have been duly completed, including obtaining the necessary corporate authorisations;
  • it is confirmed that the assignment documents have been duly stamped as per the applicable stamp duty laws of India; and
  • save and except the filing of certain forms with the applicable registry, if any, in respect of any underlying security, no other filing or registration is required for the assignment and/or transfer of the transferred assets.

In cases where banks and financial institutions are the transferee and the transferor, the following assumptions are included:

  • that the assignor has owned the transferred assets for the required time period and retained such amounts of the portfolio giving rise to the transferred assets, in the manner stipulated in the RBI Guidelines;
  • that the assignee has undertaken a due diligence on the quality of the transferred assets, has confirmed that the assignee has and will continue to comply with minimum retention and holding periods, and has otherwise complied with the provisions of the RBI Guidelines.

Under Indian law, where banks and financial institutions are the assignor and assignee of the transferred assets, it is mandatory under applicable Indian laws to obtain a legal counsel opinion that the transfer is a true sale and in accordance with the provisions of the RBI Guidelines.

Other relevant insolvency-law aspects of a bankruptcy remote transfer

Under Indian law, it is important that the securitisation practitioner expressly establishes a special purpose vehicle (SPV) – also known as a special purpose entity (SPE) – with a distinct set of objects clearly and expressly related only to the transferred assets. The beneficiaries of the transferred assets should be identified in the documentation setting up the securitisation vehicle.

The buyer of the transferred assets will need to show that the assignment/transfer has resulted in a bankruptcy-remote structure with no recourse or liability in respect of the seller. Accordingly, the documentation will need to reflect that the transfer of assets should result in the complete legal separation of the assets from the seller after its transfer. There should be no restriction on the buyer’s right to deal with the transferred assets, and it should be free to encumber, sell or deal with the transferred assets in any manner it may deem fit.

There should be no obligation on the seller or assignor to repurchase the assets or any part thereof, fund the repayment of the assets or part thereof, substitute or provide additional assets.

The transfer of the financial assets for securitisation should be from the originator to a bankruptcy-remote SPV, established for the purposes of creating a bankruptcy-remote vehicle.

Required or Desirable Aspects of an SPE

The SPE is ordinarily set up as a trust. The trustees are independent from the originator and the beneficiary, whose sole role is to manage and operate the SPE.

The SPE should not conduct any business other than the function of collecting the proceeds of the receivables from the transferred assets, taking steps to protect those assets or enforce their rights in them.

The object of the SPE in its constitutional documents should expressly relate only to the management of the transferred assets.

The SPE should not be able to be subjected to insolvency proceedings if it is not able to service the payments of instruments issued against the transferred assets.

The investors in an SPE must have an undivided interest in the transferred assets as against any ownership interest in the SPE.

Ideally, an SPE should be a “tax pass-through” vehicle.

The SPE should be restricted from raising or issuing any other debt.

Ideally, the SPE should not hold multiple assets. However, if the SPE does hold multiple assets, then the constitutional documentation should clearly state that each of the assets are held in trust for the specified beneficiaries who are entitled to it and therefore, no commingling of the assets will be possible.

The trustees/board of managers or directors should be independent from its sponsor/settlor, and therefore there should be no common persons who are trustees of the SPE and also serve as directors or are in control of the promoters/sponsor of the SPE.

In India, it is difficult for any entity other than a trust to actually satisfy the conditions set out in this section, and therefore a trust is the most commonly used vehicle for structuring securitisation and assignment transactions.

Risks of Consolidation That Endanger the Bankruptcy Remoteness of the SPE

Firstly, as discussed above, the parties need to ensure that the principles of a true sale have been satisfied. Ordinarily, if the true-sale conditions are satisfied Indian courts would not consolidate the SPE with the originator in an insolvency proceeding or otherwise.

However, it is important to ensure that the assignment is undertaken on an arm’s length basis, and that the transaction cannot be challenged on the basis of being undervalued or a preferential transaction.

Furthermore, it is important to ensure that the assignor has obtained the necessary contractual consents and corporate authorisations to effect the assignment so as to avoid any challenge being posed at the time of an insolvency of the originator.

Opinion of Counsel

One ordinarily obtains a legal opinion on the bankruptcy remoteness of the SPE entity so that investors may be able to at least review the opinion, and in certain privately placed transactions even rely on the opinion.

The opinion confirms the valid execution of the constitutional document of the SPE, that the constitutional documents expressly state that the assets of the SPE will be held for the express benefit of the investors/beneficiaries who are identified upfront individually or as a class, or who will be identified at the time of the transfer of assets to the SPE.

The opinion also examines the valid execution of the transfer documentation, so as to ensure that the true-sale conditions are met.

The qualifications are customary in nature and assume that the transfer has occurred on an arm’s length basis and is not an undervalued or a preferential transaction.

Other than the legal conditions set out in 1.1 Insolvency Laws and 1.2 Special Purpose Entities, the following requirements need to be undertaken to ensure a valid transfer of the financial assets.

Execution of the Assignment Agreement/Deed

The assignment agreement/deed will have to be stamped as per the stamp duty rates prevailing in the state in which the document is executed.

In India, the creation of a security interest on an asset of a corporate entity or on immovable property is generally registered with the Registrar of Companies (RoC), applicable land registry or the Central Registry of Securitisation and Asset Reconstruction in India, and to "information utility" companies as prescribed by the IBC. Therefore, if there is any underlying security which is being transferred along with the financial asset, then the parties will need to verify whether the security interest has been registered in the name of the assignor or a trustee for the benefit of all holders of the financial asset. If the registration has been made in the name of the assignor only, then the registrations will need to be modified to reflect the interest of the assignee in that asset.

Please note that, subject to any contract to the contrary, the consent of the debtors is not required for the assignment/transfer of the financial asset. Furthermore, while not obtaining a contractual consent for the transfer may not invalidate the transfer, it is advisable that such consents, if required, are obtained prior to effecting the transfer.

Rights and Requirements

Under Indian law, if the assignment document is not adequately stamped, the transfer may still be valid, but the document will not be admitted into evidence in a court of law, until such time as the stamp duty, along with the penalty, is paid.

Under the Companies Act, 2013, if a charge created by a company is not validly registered with the RoC, then that charge will not be considered by a liquidator or by any other creditor. Therefore, it is essential that the assignee verifies the entity in whose favour the charge has been registered so that modifications, if necessary, may be made to such registrations.

Similarly, a transfer of interest in immovable property is not valid if the instrument of transfer is not duly registered within the applicable land registry. Therefore, in the case of a transfer of an underlying mortgage or charge on immovable property, which has been made only in favour of the assignor and not a trustee on behalf of all persons who hold interest the debt being secured by the immovable property, the assignee will also have to register the assignment deed and make the necessary modifications in the records of the land registry.

Other than the pass-through and the direct assignment structures as outlined in 1.1 Insolvency Laws, other methods of securitisation and creation of bankruptcy-remote structures in the securitisation space are not common. Transactions involving synthetics or other means of securitisation do take place offshore for Indian assets.

The transfer of the financial asset from the originator/intermediary will be taxed, in the hands of the originator, as income tax. Corporate income tax rates in India are generally 22–30%.

Most securitisation vehicles are structured as pass-through vehicles, and hence the income of the trust vehicle is typically taxed only in the hands of the ultimate investor/transferee.

The Indian government has recently permitted complete pass-through of income tax to certain regulated securitisation trusts. Therefore, the tax incidence on the trustee is not in the nature of a distribution/dividend tax, but a tax deducted at source (TDS).

In addition, any income of a securitisation trust from securitisation is exempt from income tax in the hands of the trust and is only subject to TDS on distribution of income to the ultimate investors. Also, if the TDS has been applied by the borrower at the time of repayment of the dues in respect of the financial asset, then there is no further TDS charged to the investor.

The income payable to a resident investor by a securitisation trust is subject to tax deduction at source at the rate of 22–30%.

The income payable to a non-resident investor by a securitisation trust is subject to tax deduction at source at the rate of approximately 30% (subject to treaty benefits).

For any collection or servicing agent role played by the originator, any fees paid to the originator for such services would be subject to goods and services tax at the rate of 12–18%.

Please see 2.1 Taxes and Tax Avoidance.

Please see 2.1 Taxes and Tax Avoidance.

In relation to possible tax issues arising in connection with securitisation transactions, the key is to ensure that the SPV is merely a passive pass-through entity so that the monies received by the SPV are not taxed as income in the hands of the SPV.

Tax counsel opinions are normally obtained in securitisation transactions. The qualification for the opinion is that the counsel assumes that the SPV is not involved in any other business activity.

Under applicable Indian regulations, securitisation in India generally involves a complete sale of the asset/receivable and the assignor not bearing any further risk in relation to that assigned asset. Other than for limited exceptions – such as representations with respect to title – the asset being assigned/securitised is taken off the books of the assignor and hence is accounted for, in the books of the assignor, as a sale and not a financing.

As regards the SPE to whom the asset is assigned, the receivables are treated as an asset in its books and the receipt or unit issued to the investors is treated as a contribution payable to the investor in accordance with the terms of the relevant transaction.

In order to provide an opinion that the asset has been assigned on a true-sale basis, legal practitioners ordinarily ensure through the documentation that the assignor bears no risk for the due realisation of the assigned assets and that representations and warranties are limited to title. To the extent that the assignor provides any undertaking to ensure realisation of any of the assets or part thereof, the opinion is qualified to state that the true sale has not occurred to that extent. Hence, the receivables/assets which have not been subject to a true sale will continue to be accounted in the books of the assignor as a receivable.

The material laws and regulations governing disclosures in respect of securitisation transactions are the SDI Regulations and the RBI Guidelines.

The SDI Regulations govern the issuance of private and publicly placed "securitised debt instruments" (SDIs). An SDI is defined as any certificate or instrument issued to an investor by a special purpose distinct vehicle, which possesses any debt or receivable, including mortgage debt assigned to such an entity, and acknowledging the beneficial interest of the investor in that debt or receivable.

Disclosures for Public Placement of SDIs:

  • The issuer is required to obtain a credit rating from at least two credit rating agencies and disclose the same in the offer document – all unaccepted credit ratings are also to be disclosed.
  • Description of the instruments being offered.
  • Description of the asset pool, including transaction type (ie, cash, synthetic, balance sheet repackaging, etc).
  • Criteria for selection of asset pool, rate of return, recourse to the originator, delinquency information of the originator’s asset pool for the preceding five years.
  • Names of all principal parties to the transaction – originator, issuer, credit enhancement provider, liquidity facility provider, underwriter, servicer, depository, collection and payment bank, etc.
  • Interest and redemption premium.
  • Credit enhancement details.
  • Expected interest and principal repayment dates.
  • Expected maturity.
  • Expected prepayments.
  • Expected pre-mature winding up of the issuer on account of prepayments.
  • Terms of payment, including distinction between revenue and principal receipts.
  • Contribution of the issuer/sponsor.
  • Nature of the receivables – LTV-based, tenure-based, ticket-size based distribution.
  • Collection period.
  • Servicer and fees.
  • Description of swaps, if any.
  • Portfolio audit.
  • Minimum holding and retention period.
  • Waterfall mechanism.
  • Risk factors – description of assets and debtors, default/credit risk, delinquency risk, dilution risk (ie, deterioration in the credit pool), servicing risk, prepayment risk, liquidity risk, currency, interest and other risks, geographic concentration risk, and any other risk associated with the specific receivables pool.
  • Sponsors and persons who control the issuer.
  • Financial information of the originator’s assets and liabilities, financial position, profit and losses for the past three years, including unaudited statements 120 days preceding the application for the asset-backed securities becoming effective.
  • Transaction structure and cash flows.
  • Details of non-performing loans held by the issuer.
  • Declaration of net asset value of the issuer within 15 days of the end of each quarter.

Disclosures Under the RBI Guidelines:

  • For disclosures to be made for securitisation of standard assets, the originator has to disclose to the investors the weighted average holding period of the assets securitised and the level of their minimum retention in the securitisation.
  • The originating banks should ensure that prospective investors have readily available access to all materially relevant data on the credit quality and performance of the individual underlying exposures, cash flows and collateral supporting a securitisation exposure as well as information necessary to conduct comprehensive and well-informed stress tests on the cash flows and collateral values supporting the underlying exposures; this information should be made publicly available.
  • Minimum holding and actual holding period.
  • Minimum retention and actual retention amount.
  • Types of retained exposures.
  • Credit enhancement and liquidity support.
  • Credit quality of underlying loans.
  • Extent of security cover available.
  • Rating-wise distribution of the assets.
  • Default rates of similar portfolios in the past five years and one year.
  • Upgradation/recovery/loss rates of similar portfolios.
  • Other characteristics of the loan pool – industry break up, LTV distribution, geographical distribution, etc.

Principal Regulators, Violations and Penalties of Required Disclosure

The Reserve Bank of India is the principal regulator for the securitisation of assets and direct assignment of assets, while the Securities and Exchange Board of India is the principal regulator for the listing of SDIs.

Banks and non-banking financial institutions are regulated by the Reserve Bank of India. In case of any violation of the guidelines, penalties could involve a fine or even cancellation of licence.

Violations of regulations governing the listing of SDIs could entail fines and suspension from trading or accessing the securities market by the originator, issuer or market intermediary which is found in violation of any provision of the SDI Regulations.

Public Market v Private Market

Please note that despite efforts to boost the public market in securitisation, the listing of SDIs remains muted. A significant number of transactions occur on the private market between banks and financial institutions and asset reconstruction companies. The types of investors in the private market are generally banks and financial institutions as well as, in certain instances, corporate players who look to transfer their receivables off their books.

The forms of disclosure and regulatory issues governing the private and public market are set out above. In particular, the emphasis for the private market, which is governed by the Reserve Bank of India, is to ensure that the assets being transferred or securitised are not defaulted assets and, through rules governing minimum retention and minimum holding, that the transferor is not offloading bad assets. The assignee is also responsible for conducting a proper diligence on the assets being transferred so as to ensure that undue risk is not being assumed by the bank.

The public market looks at more institutional investors taking positions in the securitisation receipts and, therefore, who are required to inform themselves of the quality of the assets in the pool based on the information and disclosures provided pursuant to the SDI Regulations.

In order to enhance securitisation transactions, the RBI has reduced the minimum holding period for non-bank financial companies and SEBI has eased the route for asset reconstruction companies (ARCs) to list their securitised loans.

Obtaining Legal Opinions as to Compliance

Please refer to 1.1 Insolvency Laws.

See 4.1 Specific Disclosure Laws or Regulations.

The RBI Guidelines stipulate a minimum holding period and minimum retention requirement that banks and financial institutions are required to comply with while undertaking their securitisation and assignment transactions.

Banks and non-banking financial institutions are regulated by the Reserve Bank of India. In case of any violation of the guidelines, penalties could involve a fine or even cancellation of licence

For the necessity or advisability of obtaining legal opinions as to such rules, please refer to 1.1 Insolvency Laws.

Reporting requirements in relation to securitisation transactions are present in the SDI Regulations as well as the RBI Guidelines dated 7 May 2012 and 21 August 2012, and the RBI’s Guidelines on Securitisation of Standard Assets, February 2006 (as applicable to all scheduled commercial banks, all Indian term-lending and refinancing institutions and non-banking financial companies).

The material reporting requirements under the SDI Regulations include the trustee being obliged to:

  • call for periodic reports from the originator regarding the performance of the underlying asset pool, at least on a quarterly basis;
  • share reports and auditors’ certificate, as received from the originator/auditor(s), with the credit rating agency that is rating the SDI;
  • collect information and reports from the servicers/originators;
  • generate cash flow reports, payment reports and meet all reporting requirements required under the guidelines/circulars of the Security and Exchange Board of India (SEBI) or the Reserve Bank of India;
  • the Special Purpose Distinct Entity (SPDE) is required to file such reports or furnish certain information to SEBI as directed by SEBI from time to time.

The material reporting requirements under the RBI Guidelines are as follows:

  • Disclosures by the originating banks should be made separately for each securitisation transaction in the servicer report, investor report, trustee report or similar published document, and are required to be made at the origin of the transaction, and confirmed thereafter at a minimum half-yearly interval (end of September and end of March), and at any point when the requirement is breached.
  • The bank’s audit reports need to be made available for verification by the inspecting officials of the RBI during the annual financial inspections of the purchasing banks.

The material reporting requirements under the RBI Guidelines on Securitisation of Standard Assets are as follows:

  • The SPV/trustee is required to publish a periodical report on any rescheduling, restructuring or renegotiation of the terms of agreement effected after the transfer of assets to the SPV, as a part of disclosures to all the participants at quarterly/half-yearly intervals – the authorisation of investors to this effect may be obtained at the time of issuance of securitised paper.
  • Originating banks of the securitisation transaction are required to report on a quarterly basis to the audit sub-committee of SEBI.

The RBI is the principal regulator and enforcer for the securitisation of assets and direct assignment of assets, while the Securities and Exchange Board of India is the principal regulator and enforcer for the listing of SDIs. In case of violation of the RBI Guidelines on Securitisation Transactions, penalties could involve a fine, or a cancellation of licence. In case of violation of the SDI Regulations, penalties could entail fines and suspension from trading or accessing the securities market by the originator, issuer or market intermediary which is found in violation of any provision of the SDI Regulations.

The securitisation activities of credit rating agencies are not separately regulated in India. Credit rating agencies (RAs) in respect of all forms of securities are regulated by SEBI through the Securities and Exchange Board of India (Credit Rating Agencies) Regulations, 1999 (CRA Regulations).

The CRA Regulations require RAs to maintain and disclose their ratings in a specific manner, and that RAs maintain copies of their rating notes, ratings issued, terms of engagement, records of decisions of rating committees and fees charged for rating for at least five years. The CRA Regulations require that RAs should have an internal audit, submit information to SEBI whenever required, and be open to inspection and investigation by SEBI.

The CRA Regulations also specify that RAs may be held liable for any contravention under the SEBI Act, or any of the rules and regulations as specified in them, by way of fines, issuance of warnings, suspension of registration certificates and disgorgement of unlawful gains or loss averted by RAs.

Basel III norms have been adopted in India and are being implemented in phases by Indian banks.

In India, there are no specific rules on giving capital or liquidity benefit for any transaction if that transaction complies with any specific rules on the substantive quality of the transaction, such as "single, transparent and comparable".

There is no specific regulation governing the use of derivatives in relation to securitisation transactions.

The use and issuance of derivatives in India is governed by the Comprehensive Guidelines on Derivatives dated 20 April 2007. These regulations permit banks and financial institutions which have a genuine underlying risk to be able to enter into derivative contracts.

The type of derivative products which a bank or financial institution may enter in respect of securitisation transactions is significantly limited. Banks and financial institutions are entitled to enter into "over-the-counter" derivatives and "exchange-traded" derivatives. The typical derivative products entered into in relation to securitisation transactions are interest rate swaps, forward rate agreements and interest rate futures.

The regulations governing derivatives in India are regulated by the RBI Exchange traded derivatives and are further regulated by SEBI. However, in the context of securitisation transactions, derivatives are typically over-the-counter products.

Accurate information regarding specific accounting rules requires obtaining appropriate advice from a licensed accounting firm.

The provisions governing the protection of investors in relation to securitisation transactions are the SDI Regulations and The RBI Guidelines (as applicable to all scheduled commercial banks, all Indian term-lending and refinancing institutions and non-banking financial companies).

The material terms of the SDI Regulations that provide for investor protection include:

  • a certificate of registration to make a public offer of securitised debt instruments or to seek listing of such securitised debt instruments would be granted only on the condition that the trustee shall take adequate steps for redressal of grievances of the investors within one month of the date of the receipt of the complaint and keep the Board informed about the number, nature and other particulars of the complaints received;
  • the instrument of trust for the Special Purpose Distinct Entity (SPDE) shall contain such clauses as have been mentioned in Schedule IV of the SDI Regulation and such other clauses as would be necessary to protect the interest of the investor in the SDI;
  • clauses in the instrument cannot have the effect of limiting or extinguishing the obligations and liabilities of the trustees or the special purpose distinct entity in relation to any scheme or the rights or interests of investors or indemnifying the trustees or the special purpose distinct entity for loss or damage caused to the investors by their act of negligence or commission or omission;
  • a trustee is expected to do such acts as are necessary in the event the security becomes enforceable and supervise the enforcement of the security in the interest of the investors;
  • the trustee shall take appropriate measures for protecting the interest of the investors including informing the board about any action, legal proceeding, etc, initiated against it in respect of any material breach or noncompliance by it, of any law, rules, regulations, directions of the Board or of any other regulatory body and ensure that the securitised debt instruments have been repaid or redeemed in accordance with the provisions and conditions under which they were offered to the investors;
  • the trustee shall communicate on a quarterly basis to the investors regarding the compliance by the servicer with its obligations and actions taken thereof;
  • the trustee shall call a meeting of all the investors on a requisition, in writing and signed by at least one-tenth of investors in value currently outstanding or at the occurrence of an event, which constitutes a servicer default or which in the opinion of the trustees affects the interest of the investors;
  • the trustee shall ensure that changes in registration status or any administrative, civil or penal action taken by the Board or any material change in financial position that could adversely affect the interest of the investors be promptly informed to the investors;
  • the trustee and the SPDE shall ensure timely payment of interest and redemption amounts to the investors;
  • the SPDE shall give investors the option of receiving the SDIs either in physical or dematerialised form;
  • the credit rating agency rating the SDI is to include reference to the risks and concerns for the investors as well as mitigating factors;
  • the offer document of the SPDE or trustee is to contain all material information which is true, fair and adequate for an investor to make an informed investment decision, and disclose the matters specified in Schedule V of the SDI Regulations;
  • the SDI Regulations also specify the manner in which the SDI is to be allotted to the investors;
  • in case of a private placement of securitised debt instruments, shall make the application to the recognised stock exchange along with such information as may be necessary for the investor to make an informed decision regarding the SDI;
  • SEBI may inquire into affairs of the SPDE suo moto in the interest of investor protection and, if need be, can order in writing that an inspection of the SPDE or person be taken up without notice;
  • SEBI may, in the interest of the investor appoint a valuer, if required for the proper valuation of asset pools acquired or held by an SPDE;
  • in the interest of the investors SEBI may also direct refund of money collected under an issue, direct persons associated with securitisation or regulated activity to not engage in such activity or to not access the capital market or deal in securities or SDIs for a particular period, direct the recognised stock exchange to not permit trade in the SDIs or suspend trading in SDIs, or any other direction that the Board deems fit and proper; and
  • the Trustee is also obligated to obey the Code of Conduct prescribed under Schedule III of the SDI Regulations.

The material terms of the RBI Guidelines that provide for investor protection include:

  • that the determination of the minimum holding period (MHP) for assets needs to ensure that the project implementation risk is not passed on to the investors;
  • that the originating banks have to disclose to their investors the weighted average holding period of the assets securitised and the level of their minimum retention in the securitisation; and
  • that the originating banks should ensure that prospective investors have readily available access to all materially relevant data on the credit quantity and performance of the individual, underlying exposures, cash flows, and collateral supporting a securitisation exposure as well as such information that is necessary to conduct comprehensive and well-informed stress tests on the cash flows and collateral values supporting the underlying exposures – this information should be made publicly available.

The RBI is the principal regulator for the securitisation of assets and direct assignment of assets, while SEBI is the principal regulator for listing of SDIs.

In case of violation of the RBI Guidelines, penalties could involve a fine, or a cancellation of licence.

In case of violation of the SDI Regulations, penalties could entail fines and suspension from trading or accessing the securities market by the originator, issuer or market intermediary which is found in violation of any provision of the SDI Regulations.

Please refer to 1.1 Insolvency Laws.

Please refer to 1.2 Special Purpose Vehicles.

This is not applicable under Indian legislation.

Credit enhancements in India usually take the form of bank guarantees and cash collaterals. Certain other forms of enhancement also include:

  • investments in subordinated tranches;
  • overcollateralisation;
  • excess spreads; and
  • credit enhancing interest-only strips.

Insurance policies and letters of credit are not common in securitisations in India. As a general principle, all security including insurance policies, if available, are transferred along with the underlying asset pool when entering into the underlying transaction.

Government sponsored entities do participate in securitisation transactions, essentially to deleverage receivable positions, enhance cash flows and for balance sheet restructuring. The Indian Railways Corporation and state utilities companies are examples of government sponsored institutions which participate in the securitisation market.

The applicable laws governing securitisation transactions do not differ for such entities.

As discussed earlier, the Indian securitisation market is growing, but is still largely confined to investments by banks and financial institutions. While foreign portfolio investors are allowed to participate in the purchase of securitised receipts/pass-through certificates, under certain conditions, investor participation by such investors is still muted. Foreign portfolio investors are eligible to purchase securitised receipts/pass-through certificates satisfying the following criteria:

  • receipts/certificates issued by a special purpose vehicle (SPV) set up for securitisation of assets where banks, financial institutions and non-banking financial companies (NBFCs) are originators; and/or
  • any certificate or instrument issued and listed in terms of the SDI Regulations.

As set out in earlier sections, the following is the standard documentation used in securitisation transactions.

Trust Deed

A trust deed for the settlement of the special purpose vehicle will hold the transferred pool of underlying assets. The trust is ordinarily settled by an independent trustee company. The trust deed will set out the manner in which investors may enforce their rights in the special purpose vehicle through the trustee. Such rights include the right to cause the trustee to enforce rights which arise from the underlying asset against the originator or the original debtors.

Deed of Assignment

Also required is a deed of assignment of the underlying pool of assets being transferred, executed between the originator and the special purpose vehicle. The deed of assignment is therefore the principal document which provides the special purpose vehicle with the rights to enforce legal remedies against the originator. In the event of any defect in title, or misrepresentation as to the nature of the asset, it is under the deed of assignment that the special purpose vehicle will be able to recover its dues or damages from the originator. It is also under the deed of assignment that all rights in the underlying pool of assets, such as security interests, are transferred to the special purpose vehicle. Therefore, it is pursuant to the deed of assignment that the special purpose vehicle becomes a beneficiary of the security interest and can enforce the security created in its favour under the underlying security documents. Since the regulations governing securitisation transactions requires a true sale of the assets to the special purpose vehicle, the covenants and representations and warranties are limited to the quality of the assets, that the originator has valid legal title to the assets (free from any encumbrances) and that each party has complied with the laws regulating securitisation in India (as elaborated above).

Information Memorandum or Offer Document

The information memorandum or offer document sets out the terms and conditions of the pass-through certificate/receipt issued by the special purpose vehicle to the investors. Primarily, it forms the basis for issuing an instrument to the investor covenanting to pay the investor the dues received by the special purpose vehicle from the transferred pool of underlying assets. Please refer to 4.1 Specific Disclosure Laws or Regulations for the description of the terms set out in the information memorandum or offer document.

Please refer to 4.1 Specific Disclosure Laws or Regulations.

Please refer to 1.2 Special Purpose Entities.

See 4.1 Specific Disclosure Laws or Regulations.

Typically, in private securitisation transactions the originator undertakes the obligation of acting as a collection and servicing agent. In the case of public securitisation transactions, an independent third party will act as the servicing agent.

The principal defaults against the originator are breaches in the representations and warranties which have been provided in respect of the assets. In the case of the trust/trustee, the investors would have the right to require enforcement action against the debtors which form a part of the receivables would arise typically on a payment default or potential insolvencies.

The principal indemnities against the originator would be against a breach of the representations and warranties and any servicing obligation. Typically, there would be no indemnity against the trustee except for any gross negligence or misconduct. 

The rights available to the investor in a securitisation transaction are pursued through the special purpose vehicle instituting a suit for recovery against the original debtor, enforcing the security interest created in its favour, instituting insolvency proceedings against the original debtor or exercising rights available under the SARFAESI and taking possession of the underlying secured assets or the management of the secured assets of the original debtor (including the right to transfer by way of lease, assignment or sale and realise the secured asset).

Each of the remedies available to the investor requires the intervention of courts in India and all are therefore subject to prolonged delays for effective enforcement and recovery.

While the provisions of the IBC are intended to expedite resolution/recovery of dues, the actual implementation of the IBC is still in its nascent stage and it is not altogether certain, at this stage, whether in practice the time bound enforcement procedures will be adhered to.

A significant change under the IBC is that upon an insolvency petition being filed by an operational creditor, a financial creditor or a corporate debtor – and until the tribunal determines whether an insolvency resolution plan can be implemented for the debtor or the debtor placed in liquidation – there is a moratorium on the institution or continuation of any suits and any action to foreclose or enforce any security interest created by the corporate debtor, including under the SARFAESI. The management of the corporate debtor is suspended and placed in the hands of resolution professionals and a committee of financial creditors. The moratorium – which may extend to a period of up to 330 days – can greatly prejudice the rights of the secured lenders to protect their security interest and secure its value prior to the debtor being placed under severe stress, if it is actually subjected to liquidation.

Please see 5.8 Other Principal Matters.

No information provided.

The issuer of the securities is the SPV entity. A securitisation SPV is usually in the form of a trust. It has independent directors or trustees. The assets to be securitised are bought by the SPV from the originator. The interest and payment collection is the responsibility of the SPV.

Please refer to 1 Structurally Embedded Laws of General Application.

Pursuant to the RBI Guidelines, securitisation transactions are typically not underwritten. The SDI Regulations permit underwriters registered under the Securities and Exchange Board of India (Underwriters) Regulations 1993 to underwrite the public issues of SDIs. However, since the SDI market is still at a nascent stage in India, the underwriting of such public issues is not common.

Placement agents or arrangers for large syndicated transactions are appointed from time to time. Such an agent merely plays the role of an arranger and does not have significant fiduciary obligations to the investor; such an agent earns fees from commissions payable by the issuer.

The servicer – who is, in most cases, the originator – collects the payment due on the underlying assets, and after retaining a service fee passes it on to the SPV or the security holder as the case may be, follows up with delinquent borrowers and pursues legal remedies available against the defaulting borrowers. Since it receives the instalments and pays it to the SPV, it is also called the "receiving and paying agent". The servicer could also be the collection agent. A servicer appointed by an SPDE has the following obligations under the SDI Regulations:

  • to co-ordinate with the obligors, manage the asset pool and collections therefrom;
  • to administer the cash flows of the asset pool, distributions to investors, and reinvestment (if any), in accordance with the scheme; and
  • to manage incidental matters.

Please refer to 4.15 Entities Investing in Securitisation.

Please refer to 4.1 Specific Disclosure Laws or Regulations.

As per the RBI’s Guidelines, synthetic securitisations are not permitted for banks in India, including their overseas branches, as well as NBFCs.

Please refer to 8.1 Synthetic Securitisation.

Please refer to 8.1 Synthetic Securitisation.

Please refer to 8.1 Synthetic Securitisation.

Please refer to 8.1 Synthetic Securitisation.

Please refer to 8.1 Synthetic Securitisation.

The most common classes of financial assets securitised in India are:

  • home loans;
  • commercial vehicle loans;
  • microfinance loans; and
  • credit card receivables.

There is also a growing interest in the securitisation of project receivables in the infrastructure sector and strengthening the securitisation of receivables arising out of distressed assets. In 2019, the RBI permitted banks in India to assign stressed and defaulted Indian rupee loans provided for capital expenditure in the manufacturing and infrastructure sector to foreign banks, thereby opening up a further avenue for the growth in the securitisation and assignment market. The sale of distressed assets is permitted to be made between banks, asset reconstruction companies and other financial institutions and is typically undertaken by way of a Swiss challenge bid method.

Liberalisation in allowing foreign portfolio investors (FPIs) to invest in securitised debt instruments and 100% Foreign Direct Investment (under the automatic route (without regulator approval) in ARCs, has given rise to an increased interest by foreign distressed funds and investors in the Indian securitisation market.

In 2016, the RBI has also announced regulations related to priority sector lending certificates (PSLC); PSLCs are certificates representing a certain amount of priority sector lending (PSL) credit to the buyer of such instrument. PSLCs allow banks which do not meet PSL requirements to purchase them from other banks and not to have to undertake securitisation/direct assignment transactions.

The common structures are as described in the responses given elsewhere in this chapter.

Jerome Merchant & Partners

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Trends and Developments


Authors



AZB & Partners is a prominent law firm in India, providing reliable, practical and full-service advice to clients based on in-depth knowledge of the legal, regulatory and commercial environment within which clients operate and a full understanding of their overall business objectives. The firm now has six offices across Mumbai, Delhi, Bangalore and Pune, with a driven team of more than 450 lawyers. The firm has advised on mergers, acquisitions, joint ventures and general corporate, regulatory practice and securities laws, private equity, capital markets, funds, banking and finance, infrastructure and project finance, real estate, media and entertainment, employment, insurance, intellectual property, taxation, competition law, and litigation and arbitration.

The Development of Securitisation in India

When undertaken by banks, financial institutions and non-banking financial companies ("NBFCs"), securitisation in India is regulated and governed by the Reserve Bank of India ("RBI") under the provisions of the 2006 and 2012 Guidelines on Securitisation of Standard Assets ("RBI Guidelines") for standard assets and by the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 ("SARFAESI Act") for stressed financial assets.

While the term "securitisation" is defined under each of these regulatory regimes, both regimes envisage securitisation as a ring-fenced and bankruptcy-remote true sale of financial assets (or a pool of such assets) in return for immediate cash payment. Under the true sale mechanism, the assets move from the balance sheet of the originator to the balance sheet of a special purpose vehicle ("SPV") or asset reconstruction company, and are pooled, sub-divided, repackaged as tradeable securities backed by such pooled assets and sold to investors either as pass through certificates ("PTCs") or security receipts ("SRs"), which represent claims on incoming cash flows from such pooled assets.

Banks and financial institutions in India also often enter into direct assignments of non-stressed financial assets under the provisions of the RBI Guidelines. Such direct assignment structures would not involve an SPV, the pooling of assets or the issuance of PTCs, and are often preferred in the Indian market by banks and financial institutions when selling down to other banks or financial institutions.

Securitisation as a structured finance mechanism has several commercial advantages, including balance sheet and risk management, increased liquidity, cost-efficient financing, marketability of the resulting securities and an opportunity for portfolio diversification, which has remained an attractive option for banks, NBFCs and financial institutions in India.

India’s foray into securitisation can be traced back to 1991, when CRISIL rated the first securitisation programme in India, where Citibank securitised a pool from its auto loan portfolio and placed the paper with GIC Mutual Fund (source: RBI Report of the In-House Working Group on Asset Securitisation dated 29 December 1999).

The first significant legislation in this field in India was the SARFAESI Act, notified in 2002, which even today remains the principal legislation for the securitisation of non-performing loans and financial assets.

Under Indian stamp laws (which differ from state to state across India), securitisation and assignment transactions are subject to stamp duty, which would need to be factored into the cost of the securitisation. In several states, a deed of assignment attracts significant stamp duty, which is paid on an ad valorem basis, and in some states no distinction is made between conveyances of real estate and transfers or assignments of receivables, with both attracting similarly high stamp duties. To ensure that the stamp duty is not prohibitive and to render such transactions commercially viable and encourage securitisation, several states have issued notifications for the remission and/or reduction of stamp duties on debt assignment or securitisation transactions. Several states now have a cap on the stamp duty payable on instruments assigning loans or securitising debt with underlying security to INR100,000. A 2016 amendment to the SARFAESI Act also eased the pricing of securitisation transactions by exempting instruments securitising or assigning non-performing financial assets in favour of asset reconstruction companies. 

So far, the SARFAESI Act has provided for the securitisation of non-performing assets only. In 2006, the RBI introduced the RBI Guidelines to regulate the securitisation of standard assets (ie, non-stressed assets) by banks, NBFCs and financial institutions, to ensure the healthy development of the securitisation market in India (source: RBI notification dated 4 April 2005 releasing the draft RBI Guidelines). This was a further step towards opening up the Indian markets to securitisation transactions while providing a robust regulatory framework for such transactions. The RBI Guidelines also provide for the originator to act as servicing agent to the assignee or investors for the collection of payments due under the securitised assets on behalf of the assignee or investors.

In the wake of the global financial crisis of 2008 centred around sub-prime lending and securitisation, regulators across the globe put more robust mechanisms in place to regulate their markets. To insure against a misuse of securitisation in India, the RBI introduced revisions to the RBI Guidelines in 2012 mandating banks, NBFCs and financial institutions securitising their standard assets to retain "skin in the game" and have a continuing stake in the performance of the securitised assets, referred to as the minimum retention requirement ("MRR"). It was also mandated that such assets had to be held by the originating entity for a minimum length of time, being the minimum holding period ("MHP") that the loan or financial asset must stay on the books of an originator before it can become a part of the pool to be securitised. The MRR and MHP provided for a more effective screening of loans, requiring the originator to show a proven record of performance prior to the securitisation or assignment of such assets. Despite the stricter regulation, securitisation has remained of interest to banks and financial institutions through the years, for both securitisation and direct assignment.

In September 2018, the Indian NBFC sector suffered a setback with Infrastructure Leasing & Financial Services Limited ("IL&FS"), a large infrastructure and development finance company, defaulting on several of its debt obligations (amounting to approximately INR94,000 Crore). The resulting panic in the market saw traditional sources of funding disappear for other NBFCs, and raised concerns on debt servicing. With such a sudden drop in willing lenders, NBFCs looked to securitise their standard assets to finance their funding requirements, and the Indian market witnessed a growth in the volume of securitisation.

The financial sector faced another roadblock in mid 2019, when housing finance company Dewan Housing Finance Limited ("DHFL") failed to make interest payments of INR1,150 Crore to its bond holders, leading to its credit rating being downgraded to "D". Prior to such downgrade, DHFL had, as an originator, assigned some of its standard assets to certain other financial institutions under the RBI Guidelines. DHFL continued to service the assigned assets by collecting the receivables in respect of such assigned assets as a servicing agent for and on behalf of the assignees. On DHFL’s default in payments as mentioned above, some of its creditors obtained a court-imposed stay vide order dated 10 October 2019 of the High Court of Judicature at Bombay on DHFL making payments to any of its creditors (except for certain payments on a pro-rata basis to all its secured creditors). This order brought to the fore concerns about the efficacy of securitisation and assignment transactions and their true bankruptcy remoteness. Subsequently, the High Court of Judicature at Bombay vide order dated 13 November 2019 (in Reliance Nippon Life Asset Management Limited v/s Dewan Housing Finance Corporation Limited & Others) clarified that the stay would not apply in respect of assets assigned by DHFL under the assignment agreements, thereby reinforcing the well-settled principle of the bankruptcy remoteness of assets assigned under the RBI Guidelines.

The public backlash on the IL&FS cases, the increasing defaults by NBFCs and the lack of an insolvency regime to hold such NBFCs more accountable to their creditors prompted the government in November 2019 to extend the applicability of the Insolvency and Bankruptcy Code, 2016 ("IBC") to NBFCs with a minimum asset size of INR500 Crore. The notification by the Ministry of Corporate Affairs of the Insolvency and Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application to Adjudicating Authority) Rules, 2019 ("Rules") currently only lists such NBFCs as financial service providers ("FSP") under the ambit of the IBC, and provides a mechanism for the RBI to initiate an insolvency resolution process against such an NBFC in case of a default in payment of its debt. Smaller NBFCs, banks and other financial institutions currently continue to remain shielded from the IBC regime.

The RBI initiated insolvency proceedings against DHFL, which, on 3 December 2019, was admitted by the Mumbai bench of the National Company Law Tribunal against DHFL and a moratorium has been imposed inter alia on the transfer, alienation or disposal of any assets of DHFL. In order to ensure that such moratorium applies only to assets owned by the FSP, the Rules clarify that the moratorium will not apply to third party assets or property in the custody or possession of the FSP held in trust by the FSP for the benefit of third parties. It would therefore appear that the latest insolvency regime in India also adequately protects the rights of assignees or investors in assignment and securitisation transactions.

Securitisation Trends in India

The last few years especially have seen major developments in the area of securitisation and direct assignments, which are further augmented by commercially astute law and regulation, be it stamp duty relaxations, the RBI modifying its guidelines from time to time or the IBC and the Rules. Other measures that have fueled the securitisation market in India include the RBI temporarily relaxing the MHP requirements for NBFC originators/ assignors, which has, as of 31 December 2019, been further extended until 30 June 2020. The relaxation allows a larger asset pool to be eligible for securitisation by NBFCs.

The NBFC crisis has clearly led to a surge in securitisation and assignment transactions across the financial services sector in India. Over the years, there has been greater variation in the pool of assets being securitised or assigned – auto and vehicle loans, finance lease receivables, microfinance, retail and consumer durable loans, and education loans. As NBFCs continue to innovate new and varied products and portfolios, the securitisation market too will see an increased spread across asset classes and products.

Banks, NBFCs and financial institutions remain interested in securitisation to meet their minimum priority sector lending requirements. With better reach to these sectors, NBFCs remain by and large the originators, while banks with a smaller branch network often prefer to satisfy their priority sector lending commitments using the securitisation route as an investor instead of originating loans directly to this sector. Investors or assignees through securitisation have access to a broader asset base across sectors, enabling the diversification of risk. For NBFC originators, the securitisation option – especially after the IL&FS and DHFL crisis – provides access to alternative sources of funding where traditional sources may not be as easily available. The past year has also seen assignments and securitisation transactions by unregulated entities (ie, other than banks, financial institutions and NBFCs) falling outside the purview of the RBI Guidelines and the SARFAESI Act.

Closing Remarks

The RBI has constituted a committee to review the existing state of mortgage-backed securitisation in India and recommend specific measures to facilitate second market trading in such instruments. The report of the committee dated 5 September 2019 has been released and recommends various measures to improve the securitisation market in India. The legislative and regulatory clarity so far, especially on the IBC front, and the regulator’s willingness to further develop the market should bolster investor and assignee confidence and appetite for securitisation and assignments across asset segments.

In its press release dated 15 July 2019, ICRA Limited (a rating agency), announced that, in the first quarter of the financial year 2019-2020, the Indian securitisation market clocked the highest issuance volumes seen in the first quarter of any financial year (with 56% year-on-year growth over the same period in the previous fiscal year).

With the continuing need for liquidity by NBFCs, the growing appetite of investors and the developments on the regulatory front, securitisation is likely to remain on the upward curve in the near future.

AZB & Partners

AZB House
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Lower Parel
Mumbai 400 013

+91 22 4072 9999

+91 22 6639 6888

www.azbpartners.com
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Law and Practice

Authors



Jerome Merchant + Partners has a primary office located in Mumbai, with associate offices in New Delhi and Bangalore. Its lawyers advise financial institutions and corporates on various aspects related to securitisation and the assignment of different portfolios of receivables, including housing, credit card, operational and loan portfolio receivables. The securitisation practice works closely with the M&A and disputes practices in structuring securitisation transactions. Many large portfolio assignment transactions are undertaken by way of a business transfer of the portfolio, associated assets (including employees and technology) and are advised by the firm's financing/securitisation and M&A lawyers. Given the rising levels of distressed assets in the Indian economy, Jerome Merchant's securitisation lawyers increasingly work with its disputes and insolvency teams in advising on the structure for sale and acquisition of debt portfolios which are non-performing and are under different stages of restructuring or insolvency.

Trends and Development

Authors



AZB & Partners is a prominent law firm in India, providing reliable, practical and full-service advice to clients based on in-depth knowledge of the legal, regulatory and commercial environment within which clients operate and a full understanding of their overall business objectives. The firm now has six offices across Mumbai, Delhi, Bangalore and Pune, with a driven team of more than 450 lawyers. The firm has advised on mergers, acquisitions, joint ventures and general corporate, regulatory practice and securities laws, private equity, capital markets, funds, banking and finance, infrastructure and project finance, real estate, media and entertainment, employment, insurance, intellectual property, taxation, competition law, and litigation and arbitration.

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