Ashika Jain and Lakshay Garg
Introduction
The Banking and Finance sector is all set to experience noteworthy changes in the subsequent months. The Reserve Bank of India has released the Draft Framework for Securitisation of Standard Assets and has solicited public opinion on the same. The guidelines were chalked out after much cogitation, to meet the recommendations made by Committee on Development of Housing Finance Securitisation Market in India and the Task Force on the Development of Secondary Market for Corporate Loans, with the ulterior objective of aligning the regulatory framework with the Basel Guidelines. The Draft has meticulously introduced certain novel concepts, while perpetuating and transmuting the existing ones. This piece scrutinises the major changes introduced by the Draft, and its likely impact on the stakeholders.
Single asset securitisation
One of the shortcomings of the 2012 guidelines was the absence of provision which permitted securitisation of single assets. The reason for its preclusion was primarily that it did not involve risk redistribution and credit trenching. The new draft encapsulates within itself this provision too. RBI too, on the precondition that the either the principle or interest be paid in instalments, authorised that bullet payment loans can be securitised.
This development will also enable the longer tenure loans to be securitised either in part or in whole. Among other benefits, this will enhance the ability to generate rated securities and benefit the investors to diversify their portfolios even in case of single asset loans. This alteration will also enable the eligible investors avail the credit tranched securities after the single loans lettered on the books of banks or NBFC are securitised. This also provides that without the express approval of the borrower, the existing lender will have to bear the burden of obligations pertaining to such loans.
Traditional Securitisation and Simple, Transparent and Compatible (STC) structures
Another addendum to the Draft Securitisation framework is that of the Simple, Transparent and Comparable (STC) securitisations. Clauses 112, 113, 114,127 and 128 give a blow-by-blow account of STC- compliant securitisations which may be subject to alternative capital treatment. STC framework also includes within its ambit all traditional securitisations which tick all the boxes as laid out in Annexure 13.
A traditional securitisation has been defined as a structure in which two or more stratifies risk positions or tranches are serviced by using cash flow from an underlying pool of exposures. Instead of being reasoned from the originator’s obligation, payment to the investors will depend upon the specified underlying exposures, which depict a varied strata of credit risks. For all traditional securitisation transactions which abide by the STC framework, the draft offers a lower risk weight. This is likely to benefit the banks to a great extent.
Replenishment
The Draft Plan has also introduced replenishment structures. These are likely to have the following benefits:
1. The investors will have better prospects for a good return.
2. They will of great assistance to package shorter tenor loan deals.
Replenishment is the process in which more eligible assets are acquired by making use of cash flow from the securitised assets. Until the pre-announced replenishment period, these eligible assets are to continue. Post this, the securitisation structure reverts to an amortising one.
The Reserve Bank of India has given a green signal to replenishment structure wherein an express identification of the replenishment period is premeditated, and the structure shall regress to an amortisation one after the expiry of such period. Provisions regarding appropriate and early amortisation events, triggers for the cession of the replenishment period are necessitated in the securitisation featuring a replenishment period.
Residential mortgage backed securities
Residential mortgage backed securities (RMBS) can be elucidated as “the securities issued by the special purpose entity against underlying exposures that are all residential mortgages”. The RBI, following the exhortations of the Development of Housing Finance Securitisation Market, has provided certain relaxations in relation to the RMBS.
According to the said framework, the minimum holding period for RMBS could be six months or six instalments (whichever is later). The MRR has been limited to 5% of the book value of the loans that have been securitised. If the value of exposure for an underlying an RMBS crosses INR 500 crore mark, the listing of the security has to be statutorily done.
This emendation will directly benefit HFCs and NBFCs by accrediting them with the required exposure to RMBS to package such portfolios in order to issue securities of different credit tranches and list them. Risk averse investors can be issued with senior tranches while the subscribers of such instruments can be issued with junior tranches. These will help the market in three-fold ways:
– It will provide the much-needed liquidity to HFCs
– With due course of time, it will deepen the RMBS market
– It will ensure that the products are available to wider spectrum of investors
Prohibitions and exemptions:
Although the new draft provides for the provision whereby the assets purchased from other entities will be securitised, there is no such provision for re-securitisation exposures, synthetic securitisation and securitization with revolving credit facilities. The rating of certain kind of pools will definitely increase owing to the fact that existing portfolios will now be pooled with the purchased loans.The Draft Securitisation framework still exempts the transactions involving Revolving Credit Facilities, loans with bullet repayments of both principal and interest and securitisation exposures
Securitisation exposures and the related requirement for capital
The draft also provides for the conditions that have to be met by lenders for the maintenance of the capital. With an immediate effect, these conditions will be applicable on the existing securitisation exposures as well. These include:
- The underlying exposures of the securitiesissues by the special purpose entity and the significant credit risk associated with it while a transfer takes place to the third parties. In such case, it will be deemed to be transferred if:
- There are at least three tranches along-with the fact that risk weighted exposure amounts of the mezzanine securitisation positions held by originator do not exceed 50% of what is present in the whole mezzanine securitization positions existing in the securitisation; and
- If the originator does not hold more than 20% of the exposure values of securitisation positions that ae first lost portions combined with the fact that there should be no mezzanine securitisation positions in this case.
- The transferred exposures will be legally isolated in a way that they will be put beyond the reach of the originator and its creditor.
- There will no obligation on the originator of the securities issued by the SPE
- There is no provision under securitisation where replenishment or replacement of the underlying exposure is required in the event of deterioration in the underlying credit quality.
Capital measurement approaches
The banks have been given two choices in the form of capital management approaches namely, Securitization External Ratings Based Approach (SEC-ERBA) and Securitisation Standardised Approach (SEC-SA). The above-mentioned scheme has been introduced keeping in mind the Basel III guidelines, whereby banks are free to adopt any of the two schemes but the non-banking financial companies have to go with the former one.
Comments/analysis
The Draft Securitisation Framework recognises the challenges faced by the market in certain aspects and has tried to get to the grips with the same. It eliminatesplenty of ambiguities and anomalies in the earlier framework. It also enlarges the ambit of securitisation whereby certain loansthat were impermissible have been made into a reality. It is a bold move with an aim to develop more robust and sophisticated market.
However, there are certain ambiguities regarding the draft and RBI has asked for the comments/ public opinion on the same. The areas that have to be thought upon and need to be resolved are:
- Whether the two available approaches that have been specified by the MRR requirements need to be considered as alternatives or there lies a clear advantage of one over the other?
- In case of investments in the field of securitisation notes, is there any requirement of regulatory prescriptions for the valuation by the investors in order to ensure uniformity in recognition of the notes.
- Is there a need to set threshold above which the notes have to be listed? If there lies such requirement, what could be the possible cost-benefit analysis for the same.
- The RBI provided banks with choice where they can choose one between SEC-ERBA and SEC-SA. The reason for doing so is still not clear and there can be possible estimates of the scenario where one approach clearly overpowers other. If that is the case, does it make one approach preferred over the other?
- There still lies a doubt as to whether there lies any type of possible assignment transaction which might not be possible under the new set of guidelines.
The RBI has asked for the comments and the responses to the discussions by June 30, 2020.
Authors:
Ashika Jain | 2nd Year| B.B.A. LLB | Gujarat National Law University, Gandhinagar, Gujarat
Lakshay Garg | 3rd Year| B.Com.LLB | Gujarat National Law University, Gandhinagar, Gujarat
Author Bio
Thanks for this technical article. Highly appreciable. This has to be corelated with transfer of loans directions by RBI. I would prefer th not to be British, simplify the language , stipulate punishment for RBI when scam happen s due to failure of monitoring at RBI levels
Again congratulations
Subramanian
CPA USA