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 INR 94,000 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.
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.
Anand Shah, Senior Partner
Hufriz Wadia, Partner
Moitreyee Banerjee, Senior Associate