Securitisation 2022

Last Updated January 13, 2022

India

Law and Practice

Authors



TT&A is a young and dynamic firm headquartered in Mumbai, India providing advice to Indian and overseas clients. The firm works with clients across a host of sectors including financial services, infrastructure, insurance, energy and healthcare, as well as on its core areas of expertise: banking and finance, capital markets, corporate, competition law, data protection, fintech and financial regulatory work. The team comprises 50 lawyers across Mumbai and Delhi. The firm’s securitisation practice works with onshore and offshore investors on various aspects related to securitisation and the assignment of different portfolios of receivables. TT&A is a member of INSOL and the APLMA.

Securitisation in India involves a sale of assets to bankruptcy remote entities thereby insulating such assets from any insolvency risk of the originator. The special purpose entity (typically a trust) itself has no credit exposure and does not engage in any other economic activity. The transfer of assets is carried out such that the legal title of the assets along with the financial risk and reward from such assets is transferred to the SPE while the originator of the assets is allowed to retain a limited amount of exposure (including any exposure on account of credit enhancements). Accordingly, in the case of the insolvency of the originator, the underlying assets and the receivables therefrom are not a part of the insolvency estate.

Securitisation transactions by banks and non-banking financial entities (NBFI) are regulated by the Reserve Bank of India (RBI) under the Reserve Bank of India (Securitisation of Standard Assets) Master Direction, 2021 (RBI SSA Directions). These directions were recently introduced to replace the existing regime, and are required to be complied with by banks and NBFIs securitising their loans. Under the RBI SSA Directions, the SPE can be organised as a company, a trust or any other legal entity. Typically, in India, SPEs are organised as non-discretionary private trusts settled by trusteeship companies (engaged for the purpose of the transaction) in favour of themselves as the trustee. Investors, as beneficiaries of such a trust, have an undivided interest in its assets (on account of being holders of securitisation notes issued by the trust). The required and desirable aspects of an SPE are as follows:

  • the name of the SPE should be distinct and unconnected with the name of the originator;
  • the originator should not have any economic or proprietary interest in the SPE – the beneficial interest of originator should be restricted to permitted exposures (see 4.12 Material Forms of Credit Enhancement for more details);
  • the originator should not be permitted to have more than one representative without a veto power in a board of at least four members (with independent members forming the majority);
  • the originator should not be permitted to exercise direct or indirect control over the SPE or its trustees;
  • the constituting document (being the trust settlement deed) should set out the specific purpose of the trust, the rights and duties of the trustee and the voting mechanism for decision making;
  • the trustee should not have any discretionary power, and the investors should be permitted to substitute the trustee at any point in time;
  • the SPE should disclose, specifically to the investors, that the securitisation notes are not in the nature of a deposit obligation of the originator; and
  • all transactions between the originator of the assets and the SPE should be on an arm’s length basis.

Instrument of Transfer

To transfer the legal title of the underlying assets, the originator enters into a deed of assignment in favour of the SPE. Applicable stamp taxes are required to be paid on such a deed of assignment. In the event that consent from/notice to the underlying obligors is required, the same will have to be obtained/completed prior to the assignment. However, underlying documents typically allow for assignment without the need for an intimation to or consent from the underlying obligors.

Taxes on Transfer

While transfer of receivables by way of assignment is treated at par with any conveyance and certain states in India have an uncapped stamp duty (typically in the range of 2% to 5%), some of the other states have provided a specific concession for transfer of loan receivables and capped the stamp taxes to INR100,000 (for example, in the States of Maharashtra and Delhi).

Formalities

In the event the underlying loan assets have the benefit of security from a company and the security interest is created and registered in favour of the originator (and not a trustee holding it for any holder of the financial asset), the same will have to be registered in the name of the SPE in the records of the relevant Registrar of Companies. This process is completed by filing an online form for modification of charge registration by the security provider.

In the event the underlying loan assets have the benefit of security over immoveable property and the security interest is created and registered in favour of the originator (and not a trustee holding it for any holder of the financial asset), the assignment deed transferring such a security interest will have to be registered at the office of the relevant sub-registrar of assurances and additional stamp taxes may be applicable based on the jurisdiction of such an asset.

Separately, in terms of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI), all banks and secured creditors (being certain NBFIs and financial institutions) are required to register their security interest with the Central Registry of Securitisation Asset Reconstruction and Security Interest of India (CERSAI).

Derecognition under RBI SSA Directions

Under the RBI SSA Directions, upon satisfaction of the following conditions, the transferred assets are derecognised as exposures of the originator and therefore the originator will not be required to maintain capital against the transferred assets.

  • The originator should not have direct or indirect control over the transferred exposures including by way of an obligation to repurchase or any other contractual undertaking to retain the risk. Clean up call options under the following conditions are allowed:
    1. the option should be voluntary and exercisable at arm’s length, and only when less than 10% of the obligations under the securitisation notes are due;
    2. exercise of the option should be subject to internal review processes of the originator; and
    3. the option should not be structured to avoid allocating risk to the senior tranche holders or the credit enhancement.
  • The exposures should be legally transferred from the originator (see requirements above).
  • The originator should not have any obligation under the securitisation notes (other than permitted credit enhancement, see 4.12 Material Forms of Credit Enhancement).
  • Securitisation notes should be freely transferable and the investors should be able to encumber the same without any restriction.
  • In structures where the originator is permitted to replenish assets, there should be no requirement to replenish so as to improve the credit quality of the underlying assets.
  • There should be no additional yield payable on account of deterioration of credit quality of assets.
  • Termination of securitisation is permitted only in case of an early amortisation in a replenishment structure or on account of regulatory changes or exercise of clean-up call option.
  • The originator is required to obtain a legal opinion certifying the satisfaction of the aforesaid conditions to achieve derecognition.

Please refer to 1.3 Transfer of Financial Assets.

The income arising from the transfer of assets is taxable in the hands of originator under Income Tax Act, 1961 (IT Act). Income tax for corporate entities under the IT Act ranges from 25% to 42% inclusive of the applicable surcharges payable.

In India, an SPE set up for securitisation under the RBI SSA Directions will be considered as a pass-through entity for taxation and any income arising or accruing to it will be taxed in the hands of the investor of the securitisation notes as if the income were directly received by it. SPEs are required to make a deduction of tax at source before distributing any income to the investors, whether resident or non-resident (other than the investors whose income is exempt from being taxed for securitisation transactions) at the following rates:

  • 25% on income distributed to any person being a resident individual or a resident Hindu Undivided Family;
  • 30% on income distributed to any other resident person; and
  • at rates in force applicable to the foreign investor (determined based on applicable regime to the foreign investor and the double taxation avoidance agreement (DTAA) with the respective jurisdiction).

Furthermore, Section 197 of the IT Act stipulates that if an investor is able to obtain a certificate from the assessing officer, for deduction at source at a percentage lesser than the percentages stipulated above or for nil deduction, the securitisation trust will have to deduct tax at such lower rates or will not be required to deduct any tax, as the case may be.

Foreign investors will be taxed at the applicable rates in force determined based on the type of payment (whether interest or redemption proceeds), their jurisdiction, and applicable DTAA.

This section reflects the general understanding of tax implications in securitisation and specific tax advice will have to be obtained by originators and investors based on their type, constitution and jurisdiction.

See 2.1 Taxes and Tax Avoidance.

See 2.1 Taxes and Tax Avoidance.

The key tax issues have been set out in 2.1 Taxes and Tax Avoidance. Furthermore, depending on (i) the structure of underlying asset pool and return parameters, (ii) the type of credit enhancement, (iii) the treatment of excess interest spread, and (iv) the constitution of the investor (including form, jurisdiction and type of investor), additional issues around tax treatment of the cash-flows may arise from time to time. Investors and originators should obtain specific tax advice in respect of these issues.

Tax opinions are obtained by originators and investors at the time of structuring the transaction. These opinions typically assume the factual aspects of the transaction and that the transaction will be a securitisation transaction which is subject to the specific regime set out in the IT Act. For this purpose, in the case of standard assets, the transaction will have to comply with the RBI SSA Directions.

The RBI SSA Directions prescribe for minimum criteria to be met for derecognition of assets for maintaining capital exposures. Derecognition of assets from an accounting purpose can be achieved only if the requirements under the applicable accounting standards are met (which may not always be the case, even though the requirements under the RBI SSA Directions are met, as the accounting standards provide for stricter requirements for derecognition and non-consolidation of the SPE).

In India, securitisation transactions are undertaken by banks and NBFIs primarily to achieve relief from maintaining capital exposures, and they may or may not achieve an off-balance sheet treatment for the transferred assets in all cases. In cases where off-balance sheet treatment is the principal driver for the transaction, specific structuring advise will be required from accounting practitioners.

One of the legal issues arising from this dichotomy is that under the Insolvency and Bankruptcy Code, 2016 (IBC), if the securitisation transaction does not lead to an off-balance sheet treatment for the assets, the insolvency professional/liquidator of the originator, may, in the case of the originator’s insolvency make a preliminary determination that the assets form a part of the originator’s estate which finding will then have to be challenged before the adjudicating authority. Given that the deed of assignment achieves a full legal transfer of the title over the assets, the challenge is very likely to succeed.

As set out in 1.3 Transfer of Financial Assets, the originator is required to obtain a legal opinion in respect of the derecognition criteria in order to write off the capital exposure to the assets under the RBI SSA Directions. These opinions carry the same qualifications as would any other closing opinions issued in India for a debt transaction with the exception that the qualification on applicability of insolvency laws to enforcement is limited to voidable transactions such as preferential transfers to creditors, undervalued transactions and fraudulent transfers, which affect enforceability instead of generally qualifying the opinion as subject to bankruptcy laws.

In relation to any other facilities being provided by any person including the originator, the service provider is required to obtain a legal opinion that the terms of its engagement protect it from any liability to the investors or to the SPE save to the extent of its contractual obligations.

The general disclosure requirements in relation to securitisation transactions are stipulated in the RBI SSA Directions. Separately, listing of securitisation notes is governed by the Securities and Exchange Board of India (SEBI) under the and Securities and Exchange Board of India (Public Offer and Listing of Securitised Debt Instruments) Regulations, 2008, as amended from time to time (SEBI SDI Regulations) which provides for additional disclosure requirements if the notes are proposed to be listed.

Disclosures under RBI SSA Directions

The RBI SSA Directions stipulate the disclosures required to be made by parties to the securitisation such as originator, servicer, etc. Some of the key disclosure requirements are listed below:

  • weighted average holding period of the assets securitised;
  • the level of minimum retention requirement stipulated in RBI SSA Directions and actual retention;
  • material data on cash flows, collateral supporting a securitisation exposure and information necessary to conduct stress tests on the cash flows and collateral value supporting the underlying exposure;
  • maturity characteristics of the underlying assets such as weighted average maturity, maturity wise distribution, etc;
  • credit quality of the underlying loans such as distribution of overdue loans, rating wise distribution of the underlying loans, prepayment rules, etc; and
  • other characteristics of the loan pool such as industry wise break-up of the loans in case of mixed pools, geographical distribution of the loan pool, etc.

Disclosure under SEBI SDI Regulations

The disclosure requirements in relation to listing of securitised debt instruments and public issue of such instruments are stipulated in the SEBI SDI Regulations. Some of the key disclosures under SEBI SDI Regulations are listed below:

  • description of the structure of the transaction;
  • credit enhancement and liquidity support;
  • excess spread and the treatment thereof;
  • important structural triggers in the transaction such as early amortisation, trapping of excess spreads, etc;
  • priority of distributions and allocation of funds;
  • material features of the asset pool such as default rate, recovery rate, prepayment rate, etc;
  • major representations and warranties contained in the document whereby the asset has been assigned;
  • details of the servicer such as name of the servicer, its organisational form, experience, its fees, its duties, etc;
  • details of the originator such as name, principal business activities, market presence, financial information concerning originator’s assets and liabilities, etc;
  • details of the trustees such as name, organisational form, management, its duties, powers, procedure for appointment, etc; and
  • details of the issuer such as description, the management and persons in control of the issuer, persons holding residual beneficial interest in the issuer, financial information concerning its assets and liabilities, etc.

See 4.1 Specific Disclosure Laws or Regulations.

The RBI SSA Directions stipulate seasoning and minimum credit risk retention requirements for banks and financial institutions.

The RBI has prescribed the following minimum holding periods (MHP):

  • three months for loans with tenor of up to two years and six months for other loans from the date of registration of the underlying security interest (or date of first repayment, where there is no security);
  • in the case of project loans, six months from date of commencement of commercial operations; and
  • for loans acquired from other entities, six months from the date of transfer.

The RBI SSA Directions provide for the following minimum retention requirement (MRR) by the originator of the assets which are being securitised to ensure that originators continue to have exposure to the loans being securitised and therefore carry out proper due diligence at the time of originating such loans:

  • an MRR of 5% for loans with original maturity of up to 24 months and 10% for loans with longer maturity or with bullet repayments; and
  • an MRR of 5% for residential mortgage-backed securities.

Both RBI SSA Directions and SEBI SDI Regulations specify the periodic reporting obligations for the various parties involved in a securitisation.

Reporting Requirements under SEBI SDI Regulations

The originator is required to provide periodic reports (such as cash flow reports and payment reports) on a quarterly basis to the SPE which in turn provides the same to the investors.

The servicer is required to confirm to the investors as to its compliance with its obligations on a quarterly basis.

The originator is required to provide a quarterly certificate from its auditor regarding the disclosures made by the originator to the SPE in respect of the underlying pool.

The information, reports and auditor’s certificates, as received from the originator or its auditors, are required to be made available to the credit rating agency.

Reporting Requirements under RBI SSA Directions

In the event the originator changes its originating standards between the time of loan origination and the time that all the claims associated with the securitisation notes are paid off, such changes must be disposed to investors in the securitisation notes.

In the event there is a breach, the status in respect of the expected cash flows to the note holders, the ability for the breach to be reversed and the consequences of the breach should be clearly identified in the investor report.

The originator is required to notify the RBI of all the instances where it has agreed to replace assets sold to the SPE or pay damages arising out of any representation or warranty.

Wherever a third-party servicer is appointed, the originator is required to ensure that there are robust and legally binding information-sharing arrangements in place to comply with stipulated reporting requirements with requisite frequency and rigour. In cases where data is obtained from third party entities, the originator must get information duly certified by the respective third-party auditors, preferably at least once a calendar year.

The disclosure in relation to the originator’s fulfilment of MHP and MRR should be made at the origination of the transaction and is required to be confirmed thereafter, at a minimum, biannually (by the end of September and March) and at any point where the requirement is breached. The aforesaid periodical disclosure is required to be made for each securitisation separately throughout its life, in the servicer report, investor report, trustee report or any similar document published.

Originators are required to disclose the details of the securitisation transactions to the RBI on quarterly basis.

Enforcement and Penalties

The RBI is the primary regulator for securitisation transactions by banks and NBFIs and is the enforcement agency in relation to RBI SSA Directions. Under the securitisation regime prior to the RBI SSA Directions, securitisation transactions which did not comply with the criteria set out under the regulations were not expressly prohibited and therefore the general market position was that such transactions could be undertaken provided the originator continued to maintain capital exposure in respect of the transferred assets.

Under the RBI SSA Directions and the RBI TLE Directions, any assignment transaction that does not comply with the requirements under the said directions not only leads to the originators having to maintain capital exposures but is also expressly prohibited.

Enforcement and regulation in relation to listed securitised debt instruments is governed by SEBI. In the event of a breach of the SEBI SDI Regulations, the registration of relevant trustee can be cancelled.

Credit rating agencies (RAs) in India are governed by the SEBI (Credit Rating Agencies) Regulations, 1999 (SEBI CRA Regulations). The SEBI CRA Regulations govern RAs in respect of all securities and there is no specific law in India that governs RAs in relation to securitisation.

The SEBI CRA Regulations specify the minimum conditions required to be met by an entity to get itself registered as an RA in India. Furthermore, SEBI CRA Regulations require RAs to enter into a written agreement with the client whose securities it proposes to review, to continuously monitor the rating of the securities rated by it, to carry out periodic reviews of all published ratings, etc.

The RBI SSA Directions also provide for credit assessment of the securitisation notes by external credit rating agency subject to compliance with following conditions.

  • The external credit assessment has to be from an eligible external credit rating agency as provided in paragraph 6 of the Master Circular – Basel III Capital Regulations dated 1 July 2015; the rating is required to be published on a publicly accessible platform and should also be included in the RA’s transition matrix.
  • Eligible RAs must demonstrate expertise in assessing securitisations.
  • The external credit assessment must take into account and reflect the entire amount of credit risk exposure the lender has with regard to all payments owed to it.   
  • A lender is not permitted to use any external credit assessment for risk weighting purposes where the assessment is at least partly based on unfunded support provided by the lender.

The SEBI CRA Regulations stipulate that in the event that an RA fails to comply with the provisions of the SEBI Act, any rules made thereunder or with the provisions of SEBI CRA Regulations, it shall be liable for inquiry and penal action (leading to payment of penalties or cancellation of licence) by the SEBI.

Lenders are required to maintain capital against their entire securitisation exposure as per the applicable directions of the RBI. The RBI has provided for separate mechanisms for computing risk weights in the case of unrated and rated securitisation notes.

In the case of securitisation transactions which satisfy the criteria prescribed by the RBI for simple, transparent and comparable securitisation transaction (based on the prescriptions of the Basel Committee on Banking Supervision) (STC Transaction), alternative and more favourable capital treatment has been made available to investors (being banks, NBFIs and other institutions regulated by the RBI) in such notes. The originator is required to disclose necessary information to allow investors to determine if the transaction is an STC Transaction before applying the alternative treatment.

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

Over-the-counter (OTC) interest rate and foreign currency derivatives in India are regulated by the RBI and governed by the Comprehensive Guidelines on Derivatives dated 20 April 2007 (which will be repealed by the Reserve Bank of India (Market-makers in OTC Derivatives) Directions, 2021 with effect from 3 January 2022). Both the existing guidelines and the new directions permit eligible users (including banks and financial institutions) that have a genuine underlying risk to enter into derivative contracts.

Exchange-traded interest rate and foreign currency derivatives are regulated by the RBI and SEBI.

Banks and financial institutions are entitled to enter into OTC derivatives and exchange-traded derivatives. The typical derivative products entered into in respect of securitisation transactions are OTC derivatives such as interest rate swaps and forward rate agreements (with interest rate options also available) and exchange traded derivatives such as interest rate futures.

Both RBI SSA Directions and SEBI SDI Regulations specify requirements aimed at investor protection. Some of the key requirements are as follows.

Requirements under RBI SSA Directions

The originator is required to retain a certain portion of credit risk in the securitised pool by complying with MRR requirements as detailed in section 4.3 Credit Risk Retention.

Underwriting standards for securitised exposures are required to be the same and as stringent as those applied to the retained exposures of the originator. In case of securitised exposures which are acquired by originators from other lenders, the originator is required to apply the same standards of due diligence as its own.

The originator is required to disclose sufficient loan-level data to investors to ensure that the investors are able to conduct appropriate due diligence prior to investment.

In order to protect investors from being subjected to unexpected repayment profiles during the life of a securitisation, the documents should clearly specify the priorities of payments for all liabilities in all circumstances and appropriate legal comfort should be provided regarding their enforceability.

All triggers affecting the cashflow waterfall, payment profile or priority of payments should be clearly documented and disclosed in the offer document in order to provide investors with transparency.

The trust deed should empower the investors to change the trustee at any point of time.

The originator is required to ensure that prospective investors have access to information on the credit quality, cash flows and collateral supporting a securitisation exposure and information necessary to conduct stress tests on the cash flows and collateral value supporting the underlying exposure.

Where investors are banks, NBFIs and financial institutions regulated by the RBI the RBI has stipulated additional criteria for assessment and diligence to be followed by them prior to investment in securitised notes.

Requirements under SEBI SDI Regulations

Please refer to the disclosure and periodic reporting requirements in 4.1 Specific Disclosure Laws or Regulations and 4.4 Periodic Reporting. Additionally:

  • the trustee is required to take adequate steps for redressal of grievances of the investors within one month of the date of the receipt of the complaint and to keep SEBI informed about the number, nature and other particulars of the complaints received;
  • the instrument of trust should not contain any clause which limits or extinguishes 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;
  • the trustee is required to take appropriate measures for protecting the interest of the investors including informing SEBI about any action, legal proceeding, etc, initiated against it in respect of any material breach or non-compliance by it, of any law, rules, regulations, directions of SEBI or of any other regulatory body;
  • the terms of the issue of securitised debt instruments cannot be adversely changed without the consent of the investors; and
  • SEBI has the right to inquire into the complaints received from investors and to look into the affairs of the SPE of its own accord in the interest of investor protection.

Securitisation of loan receivables, as a structure, is governed under the following statutes:

  • the Indian Contract Act, 1872, governing the general law of contracts in India;
  • the Transfer of Property Act, 1881 governing transfer of actionable claims (being loan receivables) in India;
  • the Indian Trusts Act, 1882, governing private trust arrangements in India; and
  • the Income Tax Act, 1960, governing direct taxation on income in India.

The RBI is the principal regulator for banks in India. The following specific regulations have been prescribed by the RBI:

  • transfer of loan exposures by banks (acquisition and sale) are governed by the Reserve Bank of India (Transfer of Loan Exposures) Master Direction, 2021 (RBI TLE Directions);
  • the RBI SSA Directions, which are also applicable to other financial institutions;
  • securitisation of non-performing assets by asset reconstruction companies will be governed by the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) and the Securitisation Companies and Reconstruction Companies (Reserve Bank) Guidelines and Directions 2003; and
  • the RBI issues additional notifications from time to time which govern securitisation of loan exposures by banks in India.

In the case of listed securitisation notes, disclosure and reporting requirements under the SEBI SDI Regulations will also become applicable.

Please refer to 1.2 Special-Purpose Entities (SPEs).

The trustees of the SPE are not permitted to undertake any business with the SPE. While there are no separate restrictions on the ability of the SPE to engage in other activities; typically, the SPE will not enter into any economic activity other than the securitisation transaction itself or any other contracts or activities which are ancillary to the transaction.

In India, any arrangement that absorbs losses for the investors in a securitisation transaction is considered as a credit enhancement.

Credit enhancements may be provided by the originator or any third party

Credit enhancements are offered either as internal enhancements – by way of subscription to an equity tranche, over collateralisation, excess interest spreads and credit enhancing interest-only strips – or as external enhancements – by way of cash collateral and first/second loss guarantees are also provided.

The RBI SSA Directions prescribe that the originator must not retain more than 20% of the total securitisation exposure under a scheme, including by way of credit enhancements (though subordinated excess interest spread does not count towards the same). Increase in exposure on account of amortisation of the securitisation notes is not considered breach of these limits and credit enhancements may be reset at specified intervals subject to satisfaction of certain prescribed requirements.

Credit enhancement may be provided only at the initiation of the transaction and must be available to the investors throughout the tenor of the notes.

Any drawdown of credit enhancement is required to be written off as a loss by the facility provider.       

Government-owned entities and public utility companies in India have entered into transactions to leverage their cash flows. There has been a strong push from the government to securitise infrastructure and power utility receivables to deleverage their balance sheets. To quote a few, the Karnataka Electricity Board, IFCI Limited and the Indian Rail Finance Corporation have securitised their receivables in the past. The applicable principles governing securitisation structures will be similar for these transactions as well.

Securitisation notes are typically subscribed to by banks, NBFIs, mutual funds, and insurance companies. While banks and NBFIs are regulated by the RBI, mutual funds are required to follow specific directions issued by SEBI and specifically the Securities and Exchange Board of India (Mutual Fund) Regulations, 1996. Insurance companies are required to follow specific investment guidelines issued by the Insurance Regulatory and Development Authority of India.

Foreign portfolio investors (FPIs) have also been permitted to invest in securitised debt instruments including securitisation notes which are issued by SPEs where banks, NBFIs or financial institutions are the originators. FPIs are regulated under the Securities and Exchange Board of India (Foreign Portfolio Investors) Regulations, 2019 and by the RBI under the Foreign Exchange Management Act, 1999 and specific guidelines issued for investments in debt instruments by FPIs from time to time.

The following documentation is typically entered into in respect of securitisation transactions.

Trust Settlement Deed

The SPE is settled as a private trust by a trustee company in favour of itself with the note holders as the underlying beneficiaries. The trust deed sets out the roles and responsibilities of the trustees, their rights and liabilities, the terms of the securitisation notes, the manner in which the trust assets (being the assigned receivables) are to be dealt with, such as the waterfall of payments, appointment of facility providers, etc, and the decision-making process (such as voting thresholds and manner of conducting meetings)

Deed of Assignment

The deed of assignment is entered into between the originator and the trustee of the SPE to legally transfer the right, title and interest of the originator in the underlying assets to the SPE. The deed of assignment assigns the right to claim payment and enforce security in respect of the underlying assets to the SPE. It is accompanied by a power of attorney to authorise the SPE to use its agency, if required, to recover under the assets. Typically, the waterfall of payments from the underlying pool are enshrined in the deed of assignment. All representations, covenants and indemnities from the originator are captured in this document.

Credit Enhancement Documents

External forms of credit enhancements (such as a guarantee or cash collateral) may be documented separately though in some cases they may be recorded in the deed of assignment with the originator also singing as the credit enhancement provider.

Servicing Agreement

Typically, the originator is appointed as the servicer at the time of the transaction in terms of the servicing agreement. The document captures the roles and responsibilities of the originator and is coupled with a power of attorney to allow the servicer to act on behalf of the SPE to collect and pass on the receivables.

Offering document

The offering document or the information memorandum is issued by the SPE to the investors. It sets out the terms and conditions of the securitisation notes and all of the disclosures and risk factors associated with the notes.

Typically, originators make representations and warranties by way of a written agreement in relation to the assets (after undertaking appropriate due diligence) as on the date of transfer and do not make any ongoing representations and warranties about the credit quality of the assets. The following additional requirements are also applicable in respect of the representations that may be made, failing which the originator will be required to hold capital.

  • representation must not be open ended;
  • any representation requiring the originator to replace an asset must be exercisable no later than 120 days from transfer and such replacement must be on the same terms as the original transfer; and
  • payment of damages is permitted provided that (i) onus of proof is on the party alleging the breach, (ii) a written claim notice is served, and (iii) damages relate only to direct losses.

Any instances with respect to replacement and damages are required to be reported to the RBI.

Originators typically make representations in relation to the following:

  • legal and beneficial ownership of the assets being with the originator;
  • clear and marketable title of the originator over the assets;
  • absolute right of the originator to sell, transfer and assign the assets;
  • compliance by the originator with all applicable law including “know your customer” requirements in relation to underlying loans;
  • compliance by the originator with all applicable law and the regulatory requirements for securitisation of loans including but not limited to the MHP requirements and the requirements pertaining to the accounting of profit/ loss on the securitisation of loans as stipulated in the RBI SSA Directions; and
  • confirmation that the underlying borrower is not entitled to any right of set-off, any counterclaim, deduction, recoupment, recovery or recission in terms of the underlying loan agreement or any other agreement between the originator and the underlying borrower.

Please refer to 1.3 Transfer of Financial Assets.

The covenants which have a material bearing on a securitisation transaction are generally set out under the trust deed and the assignment agreement. Some of the key covenants as listed below.

Key Covenants under the Trust Deed

The trustee should ensure that all trust monies are kept segregated from the other assets of the trustee.

The trustee should exercise due diligence in carrying out its duties and should take all action necessary to protect the interests of the investors.

The trustee should ensure that all acts, deeds, matters or things to be undertaken by the trustee in terms of the transaction documents should be in compliance with the RBI guidelines.

The trustee should not amend the terms and conditions relating to the payments to be made by the underlying borrowers, if such amendment will adversely affect the receivables, without the express consent of the investors.

The trustee should maintain proper books of accounts, documents and records with respect to the trust fund to give a true and fair view of the affairs of the trust.

Key Covenants under the Assignment Agreement

The originator should, at all times, adhere to the MHP and MRR criteria as specified in the RBI SSA Directions and RBI TLE Regulations.

The originator should, if required by the trustee, lend its name as plaintiff or co-plaintiff to any legal proceedings that the trustee, acting on the instructions of the investors, may institute with respect to the underlying assets.

The originator should make proper disclosures as required by the applicable law.

The originator should not have any right to make any claim or exercise any right of deduction, lien (general or specific) or set-off on, over or in respect of any receivables, amounts, writings or things held by it or continued to be held by it or coming within its power or possession pursuant to or in connection with the securitisation and should, as soon as may be possible, hand over the same to the trustee or to the servicer, if so instructed by the trustee.

The originator should not provide any additional loan to the underlying borrower (or any other person) against the security of any of the underlying assets forming part of the pool for so long as the relevant loan assigned to the trustee is outstanding.

For disclosure and reporting-related covenants and conditions, please refer to 4.1 Specific Disclosure Laws or Regulations and 4.4 Periodic Reporting.

Typically, the originators themselves are appointed at the time of initiation of the transaction to act as servicer with the ability to the SPE to change the servicer. The following are some of the key stipulations governing servicing arrangements.

  • The servicer is required to hold all the amounts collected under a securitisation in trust until the said amounts are deposited with the trustee. The servicer should avoid co-mingling of these amounts.
  • The servicer should not be under any obligation to remit monies unless received by it.
  • The servicer should provide full access to its books of accounts and records relating to the underlying assets, as may be requested by the auditors appointed by the trustee and provide details and supporting documents of any information contained in a monthly report.
  • The servicer should monitor and enforce the duties and obligations of the underlying borrowers on behalf of the SPE in the same manner as the servicer would have performed such functions, duties and obligations if the right, title and interest vested in the servicer.
  • The servicer should initiate legal proceedings, including issuing of legal notices on behalf of the SPE, against the underlying borrowers or join as a party in legal proceedings initiated by the trustee to recover the receivables and enforce the underlying security, acting on behalf of the trustee, and the servicer should not refrain or refuse to take any such actions on the grounds that it would jeopardise the originator’s interest.

The principal default against the originator is the breach of representations and warranties which are provided by the originator in respect of the assets.

In the case of servicers, the following events are generally documented as events of default:

  • the servicer being prevented by a competent regulatory authority from carrying on its business;
  • insolvency proceedings in relation to servicer;
  • any underlying right of the investors being unenforceable by reason of the failure on the part of the servicer to obtain any licences or permits; and
  • any delay or default committed by the servicer in payment of any monies which were received by the servicer.

In relation to trustees, non-payment of receivables to investors, insolvency and winding up of the trustee company are typically provided as events of default. Failure to make required payments will allow the investors/SPE to access the credit enhancement facility.

The SPE has a right to be indemnified by the originator or to the have the assets forming part of the underlying pool replaced in the event of any breach of representation or warranty given by the originator to the SPE.

There are general indemnities against the trustee and the servicer for any actions done in gross negligence or a misconduct. 

Under the RBI SSA Directions, the issuer is required to be a special purpose entity. This special purpose entity is generally set up in the form of a private non-discretionary trust under the Indian Trusts Act, 1882 for the benefit of the note holders. The assets are sold and assigned by the originator to the SPE, settled under a trust deed for acquiring the assets as property of the SPE in trust for and for the benefit of the investors. Please refer to 1.2 Special-Purpose Entities for other details in respect of the issuer.

Typically, the SPE is settled by the trustee company itself. As such the originator does not act as a sponsor. Please refer to the rest of this chapter – particularly 4.4 Periodic Reporting, 5.2 Principal Warrantiesand 5.4 Principal Covenants – for further details of the role and functions of the originator.

Under the RBI SSA Directions, an originator or any third-party may act as an underwriter for the issue of securitisation notes by an SPE and treat the facility as an underwriting facility for capital adequacy purposes subject to the fulfilment of some conditions specified thereunder. The underwriter is entitled to withhold payment and to terminate the facility upon occurrence of events such as material adverse changes or default on assets above a specified level. Furthermore, an originator can underwrite only investment grade senior notes issued by the SPE. In cases where the originator is the underwriter, the holdings of securitisation notes through underwriting will not be computed towards the 20% exposure limit referred to in 4.12 Material Forms of Credit Enhancement, provided that the notes are sold to third parties within a period of three months.   

The underwriting facility can be exercisable only when the SPE cannot issue securitisation notes into the market at a price equal to or above the benchmark predetermined in the underwriting agreement. The SEBI SDI Regulations permit the underwriters to underwrite the public issues of securitised debt instruments.

The originator or any third person may act as the servicer of the assets. The servicer is, inter alia, responsible for:

  • servicing of the receivables, collection of the payments from the borrowers and deposit of the same into the account of the SPE, safekeeping of the documents, amounts or any security in relation to the assets;
  • enforcement of the obligors’ obligations, including by way of enforcement of the underlying security; and
  • administration of the assets and related matters, including providing monthly reports in relation to the collection of the receivables and the enforcement actions related thereto.

The SPE is established as a non-discretionary trust; accordingly, all decisions of the SPE are decided upon the votes of the investors. Investors in India are typically entities involved in financial markets such as banks, NBFIs, financial institutions, mutual funds and insurance companies. As set out in 4.14 Entities Investing in Securitisation, the RBI has also permitted FPIs to invest in securitisation notes.

The trustee (typically a trustee company) establishes the trust. The trust deed sets out the functions, roles and responsibilities of the trustee, which are largely administrative in nature. All key decisions in relation to the transaction are required to be taken by the trustee on the vote of the investors.

Synthetic securitisation structures are not permitted in India.

Typically, the following asset types are commonly securitised in India:

  • vehicle loans;
  • micro-finance loans; and
  • residential mortgages.

The RBI has also permitted banks and NBFIs to securitise a single loan and there is therefore a possibility of securitisation of wholesale loans. Certain asset classes are specifically prohibited from securitisations. These include:

  • short term instruments such as commercial paper which is periodically rolled over against long term assets held by an SPE;
  • revolving credit facilities;
  • re-securitisation;
  • exposures to other lending institutions;
  • restructured loans and advances which are in the specified period; and
  • loans with bullet payment of principal and interest.

Standard structures involve the originator assigning assets to the SPE which has issued notes to the investors. The transaction documents record a waterfall of payments from the assets and the credit enhancement provided by the originator.

There could be variations where the excess interest spread is either paid to the originator in each payment cycle or alternatively applied towards repayment of the securitisation notes on priority.

More recently, structures allowing replenishment of the asset pool by the originator (by way of purchase of new assets by the SPE from the originator by utilising the cash flows from the assigned assets) during a fixed revolving period followed by amortisation is also being explored. This structure caters to those investors who intend to stay invested for a certain period of time on account of regulatory restrictions (such as FPIs investing under the voluntary retention route) or for commercial reasons.

The government amended the IBC to restrict filing any application for the initiation of a corporate insolvency resolution process against a corporate debtor for any default that arose from 25 March 2020 onwards for a period of one year. Furthermore, another provision was introduced to the effect that no application could ever be filed for the initiation of an insolvency resolution process against a corporate debtor for a default occurring during the aforesaid period of one year.

Separately, the RBI has allowed banks and non-banking finance companies to provide a moratorium to their customers on their loans during the period of the first lockdown and most borrowers availed themselves of this moratorium, thereby restricting any coercive or enforcement action. During this period, securitisation cash-flows also had to be rescheduled across deals.

The pandemic, as such did not cause any shift in the securitisation market for the issuers to focus on any new class of assets. For the financial assets most commonly securitised, please refer to 8.1 Common Financial Assets

The pandemic has not caused any material changes in the laws governing securitisation transaction.

TT&A

Kalpataru Heritage
3rd Floor, 127 M G Road
Fort, Mumbai
400001
India

+91 22 661 36 900

+91 22 661 36 901

sonali.mahapatra@tta.in www.tta.in
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Law and Practice

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TT&A is a young and dynamic firm headquartered in Mumbai, India providing advice to Indian and overseas clients. The firm works with clients across a host of sectors including financial services, infrastructure, insurance, energy and healthcare, as well as on its core areas of expertise: banking and finance, capital markets, corporate, competition law, data protection, fintech and financial regulatory work. The team comprises 50 lawyers across Mumbai and Delhi. The firm’s securitisation practice works with onshore and offshore investors on various aspects related to securitisation and the assignment of different portfolios of receivables. TT&A is a member of INSOL and the APLMA.

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