There should be a “true sale” of financial assets in order to insulate the financial assets 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 – forms 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 assignor.
The securitisation transaction should also not qualify as a “preferential transaction” or an “undervalued transaction”, as such transfers would be void under the IBC.
The transfer of the financial assets for securitisation should be from the originator to a bankruptcy-remote special-purpose entity (SPE), established for the purposes of creating a bankruptcy-remote vehicle.
Required or Desirable Aspects of an SPE
One ordinarily obtains a legal opinion on the bankruptcy remoteness of the SPE so that investors may at least be able to 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.
The conditions set out in 1.2 Special-Purpose Entities will need to be satisfied to ensure effective transfer of the financial assets.
Furthermore, 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. In addition, the assignment deed will have to be stamped adequately for it to be admissible in court.
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 they therefore do not form part of the liquidation estate of the transferor/debtor. Also, in a true sale, the transferred assets transfer on to the books of the assignee, without any recourse to the originator or transferor. In India, parties customarily obtain opinions from legal counsel confirming that the tests of a true sale have been satisfied.
Under Indian law, it is important that the securitisation practitioner expressly establishes an 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 their 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, or substitute or provide additional assets.
Other than the pass-through and the direct assignment structures outlined above, 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. In India, parties customarily obtain opinions from legal counsel confirming that the tests of a true sale have been satisfied.
The transfer of the financial assets 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 no further TDS is charged to the investor.
The income payable to a resident investor by a securitisation trust is subject to TDS at a rate of 22–30%.
The income payable to a non-resident investor by a securitisation trust is subject to TDS at a rate of approximately 30% (subject to treaty benefits).
Any fees paid to the originator for any collection or servicing role played by them, would be subject to goods and services tax at a rate of 12–18%.
See 2.1 Taxes and Tax Avoidance.
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 special-purpose vehicle (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 being 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 with the assignor not bearing any further risk in relation to the assigned asset. Other than in limited exceptions – such as representations with respect to title – the asset being assigned/securitised is taken off the books of the assignor and is therefore accounted for, in the books of the assignor, as a sale and not a financing.
As regards the SPE to which 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 assets have 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 Securities and Exchange Board of India (Issue and Listing of Securitised Debt Instruments and Security Receipts) Regulations 2008 (SDI Regulations) and 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) from time to time and collectively referred to as 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:
Disclosures under the RBI Guidelines:
Other characteristics of the loan pool – industry break-up, LTV distribution, geographical distribution, etc.
See 4.1 Specific Disclosure Laws or Regulations.
The RBI Guidelines stipulate a minimum holding period and the minimum retention requirement that banks and financial institutions are required to comply with while undertaking 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 a licence.
There are reporting requirements in relation to securitisation transactions in both the SDI Regulations as well as the RBI Guidelines.
The material reporting requirements under the SDI Regulations include the trustee being obliged to:
The material reporting requirements under the RBI Guidelines are as follows:
The material reporting requirements under the RBI Guidelines on Securitisation of Standard Assets are as follows:
The RBI is the principal regulator and enforcer for the securitisation of assets and direct assignment of assets, while SEBI 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 on the part of the originator, issuer or market intermediary which is found to be in violation of any provision of the SDI Regulations.
The securitisation activities of credit rating agencies (RAs) are not separately regulated in India. 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 under 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 into 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 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.
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:
Please also refer to the offer document and disclosures that are listed in 4.1 Specific Disclosure Laws or Regulations.
The material terms of the RBI Guidelines that provide for investor protection include:
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 from accessing the securities market by the originator, issuer or market intermediary which is found to be in violation of any provision of the SDI Regulations.
Securitisation of performing financial assets in India is mainly governed by the RBI Guidelines.
Securitisation of non-performing financial assets is governed by the:
Securitisation by way of issuance of listed securitised debt instruments is, in addition, governed by the 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.
It is important to note that in June 2020, the RBI released two drafts, namely, a framework for securitisation of standard assets and a framework for sale of loan exposures. The drafts are intended to bring securitisation transactions in line with Basel III requirements and to ensure a more rationalised allocation of risk between sellers and buyers of debt. The draft guidelines propose to remove the distinction between standard and bad loans and to do away with minimum retention requirements. Other important changes include: allowing a single asset to be securitised, as against the current regime of allowing a pool of assets to be securitised; permitting loans taken from other lenders to be securitised; and relaxations in holding periods of mortgage-backed debt so as to provide a fillip to securitisation in the housing finance sector. No date has as yet been provided for bringing the new regulations into force.
It should be noted that recent loan moratoria announced by the RBI in light of COVID-19 do not strictly appear to apply to payables under securitisation transactions.
See 1.2 Special-Purpose Entities.
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:
Insurance policies and letters of credit are not common in securitisations in India. As a general principle, all security including insurance policies, if available, is transferred along with the underlying asset pool when entering into an underlying transaction.
Government-sponsored entities do participate in securitisation transactions, essentially to de-leverage 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.
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, participation by such investors is still muted.
Foreign portfolio investors are eligible to purchase securitised receipts/pass-through certificates satisfying the following criteria:
The following is the standard documentation used in securitisation transactions.
A trust deed for the settlement of the SPV 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 SPV through the trustee. Such rights include the right to cause the trustee to enforce rights arising 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 SPV. The deed of assignment is therefore the principal document which provides the SPV 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 SPV 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 SPV. Therefore, it is pursuant to the deed of assignment that the SPV 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 require a true sale of the assets to the SPV, 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.
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 SPV 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 SPV from the transferred pool of underlying assets. See 4.1 Specific Disclosure Laws or Regulations for a description of the terms set out in the information memorandum or offer document.
See 4.1 Specific Disclosure Laws or Regulations.
In India, all banks, NBFCs and Indian financial institutions are required to register creation of security interest over an asset with the Central Registry of Securitisation Asset Reconstruction and Security Interest of India (CERSAI). As per Section 23 of the SARFAESI Act, all transactions of securitisation and asset reconstruction and creation of security interest are required to be registered with the CERSAI.
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 an interest in 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.
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 that form part of the receivables, 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 obligations. Typically, there would be no indemnity against the trustee except for in the case of any gross negligence or misconduct. These indemnities are enforced as a result of breach of a contract.
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.
The sponsor is the entity or person who is in control of the issuer/SPV entity or the originator of the securitised assets, and provides representations and warranties in respect of the securitised assets.
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. The 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 the payment on to the SPV or the security holder as the case may be, follows up with delinquent borrowers, and pursues the legal remedies available against the defaulting borrowers. Since it receives the instalments and passes the payment on 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:
See 4.14 Entities Investing in Securitisation.
See 4.1 Specific Disclosure Laws or Regulations.
As per the RBI Guidelines, synthetic securitisations are not permitted for banks in India or their overseas branches, as well as NBFCs.
The most common classes of financial assets securitised in India are:
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 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 (FDI), under the automatic route (without regulator approval) in ARCs, has given rise to increased interest on the part of foreign distressed funds and investors in the Indian securitisation market.
In 2016, the RBI also announced regulations related to priority sector lending certificates (PSLCs). These are certificates representing a certain amount of priority sector lending (PSL) credit to the buyer of such instrument. Banks which do not meet PSL requirements can purchase PSLCs from other banks without having to undertake securitisation/direct assignment transactions.
The common structures are described in the responses given elsewhere in this chapter.