The Reserve Bank of India (RBI) on 7th May 2012 issued its revised guidelines on securitisation and assignment of standard assets (Revised Guidelines). These guidelines have been introduced in addition to the securitisation guidelines issued by RBI in February 2006 (Original Guidelines), which had introduced norms for the then unregulated securitisation market.Considering that the...
The Reserve Bank of India (RBI) on 7th May 2012 issued its revised guidelines on securitisation and assignment of standard assets (Revised Guidelines). These guidelines have been introduced in addition to the securitisation guidelines issued by RBI in February 2006 (Original Guidelines), which had introduced norms for the then unregulated securitisation market.
Considering that the draft guidelines issued by the RBI in 2010 and 2011 (Draft Guidelines) were more or less in line with the recently introduced Revised Guidelines, it can be said that the market players are not taken in by surprise as they were warned of the RBI's intention, especially as regards (a) ensuring 'skin-in-the game' by the originators, and (b) bringing direct assignment under its regulatory purview. The Revised Guidelines inter alia reflect the mind set of a vigilant regulator especially post the sub-prime crisis in the western countries.
It is pertinent to note that the Revised Guidelines apply only to banks and are not applicable where the investor or transferee of the loan portfolio is a corporate. With a view to streamline the existing framework and to curb banks from following the 'originate to sell' model, the RBI had introduced norms for minimum retention requirement (MRR) and the minimum holding period (MHP). However, it is relevant to note that, RBI has been more stringent in introducing the retention requirement and placing it at 10% for loans of certain tenor as opposed to most other global regulators that have restricted this to approximately 5%. The RBI has in its Revised Guidelines stipulated MRR and MHP on the basis of the different tenors of loans and corresponding repayment frequencies. This comes as a relief mainly to various microfinance institutions because typically, microfinance loans are shorter term loans and such arequirement for holding them for longer periods would have effectively quashed the fund flow required for the growth of such entities.
Securitisation, as defined in the Original Guidelines, is a transfer of loans to a special purpose vehicle (SPV), for further issue of securities (i.e., pass through certificates (PTC)) by such SPVs against the underlying loan portfolio, to various investors. A direct assignment (not defined in the Original Guidelines) would therefore imply assignment of loan portfolio to investors (usually a single investor) directly without the involvement of a SPV. Such direct assignment transactions, for which there was an active market earlier, though unregulated, has now been brought under the ambit of the RBI's watchful eye.
The common consensus in the market as regards the Revised Guidelines is that direct assignment transactions, which formed about 75% of the market space in previous years, will be significantly reduced. Given that credit enhancement is not permitted for these transactions, the ratings given to assignment of such loan/loan portfolios will deteriorate as the entire credit risk associated with such underlying assets will have to be transferred to the investing banks. Therefore, banks looking to sell their loan/loan portfolios would find it difficult to locate investors who are willing to buy such unenhanced loan(s). Having said that, RBI's stipulations as regards MRR reduce the risk transferred to the investor and the further requirement of a legal opinion to ensure the transferee's risk is protected, might in fact be sufficient protection for some investors, depending on their risk taking appetite.
Restrictions have been imposed on originators hedging their credit risk in the exposures constituting the MRR. Since the originating banks are required to meet the MRR and MHP requirements, the RBI should have considered permitting the Originators to hedge its risk, to better manage its balance sheet. Also, while the RBI has laid down accounting procedures for the recognition of the profits from sale of the loan portfolio, these may not be in-line with the accounting standards (including when International Financial Reporting Standards is made applicable) to be followed by banks.
Another factor for investors is the requirement to conduct a comprehensive due diligence prior to purchasing the loan(s), as the onus to assess the risk and credit worthiness associated with the loans being purchased is solely on the purchasing banks. This in fact increases the cost to the bank for undertaking these transactions, and would be factored in the purchase consideration, which may render such securitisation transactions commercially unviable. Apart from the high expenditure, banks may also not have the strength and ability to undertake such activities on their own.
Banks who have previously purchased a loan/loan portfolios from other banks/financial entities, including to meet their priority sector lending requirements, would not be eligible to re-assign such assets to another entity, as the RBI has strictly prohibited re-securitisation and further sell-down transactions. Also, banks investing in investment grade PTCs who may want to further securitise these PTCs, to free up their investment books, will not be permitted to do so because of the prohibitions laid down by the RBI. Further, since the RBI has disallowed 'clean-up call options' for direct assignment transactions, originating banks will not be able to exercise this option for any direct assignment transaction entered into prior to the Revised Guidelines, unless such an option is in fact explicitly provided for in the assignment agreement. It is unclear as to why the RBI has disallowed clean up call options, and this may be another factor to be considered while evaluating the commercial viability of a transaction.
The Revised Guidelines do not prohibit a single investor from purchasing securities or PTCs issued by an SPV, and this results in a direct assignment transaction, albeit indirectly. The Revised Guidelines are not applicable for assignment of a loan or portfolio of loans undertaken at the instance of the borrowers of the underlying loans. Thus, it can then be argued that issuing a notice to the borrower of such assignment coupled with a right to assign under the underlying contract, would also not be affected by the Revised Guidelines and originating banks can directly assign such loans along with providing credit enhancement. Another issue of great significance to the securitisation market, unassociated to the Revised Guidelines, is the impending issue of the Income Tax authorities' claim of taxing of the SPV involved in securitisation transactions as a separate entity.
Practically speaking, the securitisation market has been on a downward gradient ever since the Draft Guidelines. However with the restrictions imposed on direct assignments, the market would inevitably shift to PTC route transactions, which may have a positive impact on the secondary market for PTCs. Also with the onset of a more volatile PTC route securitisation market, the Securities and Exchange Board of India (SEBI) might be motivated to comprehensively overhaul the SEBI Public Offer and Listing of Securitised Debt Regulations, 2008 (Regulations). The restrictive nature of these Regulations is evident from the torpid market for issuances of listed PTCs since the inception of the Regulations. SEBI will have to keep in mind the twin aspects of sophisticated investors and compulsory rating, while amending the Regulations to ensure less comprehensive disclosure and due diligence requirements for listing of the PTCs.
As the saying goes - "The policy of being too cautious is the greatest risk of all". In this space, the market awaits and hopes that innovative structures despite stringent norms see the light of the day and the saying above does not hopefully hold good.
Disclaimer–Views of the author are personal and do not reflect the views of the firm.