At its outset, the process of Securitisation involves a few key players and a few key instruments which are discussed in this post. In India, Securitisation concerns are classified into that of non-performing assets and of performing assets. While securitization of performing assets in India is governed mainly by RBI Guidelines on ‘Securitisation of Standard Assets’ and ‘Securities transactions’, the securitisation of non-performing assets is mainly governed by SARFAESI, RBI Guidelines on Securitisation Companies (SC) and Reconstruction Companies (RC).
Pass-Through and Pay Through Structures in Securitisation
The nature of the investors’ interest in the underlying assets determines whether a securitisation structure is a ‘Pass-Through’ or ‘Pay Through’ structure.
In a pass-through structure, the SPV issues ‘Pass-Through Certificates’ which are in the nature of participation certificates that enable the investors to take a direct exposure on the performance of the securitised assets. [RBI]
Pay through structure, on the other hand, gives investors only a charge against the securitised assets, while the assets themselves are owned by the SPV. The SPV issues regular secured debt instruments. [RBI]
Pay through structures permit de-synchronization of servicing of the securities from the underlying cash flows. In the pay through structure, the SPV is given discretion (albeit to a limited extent) to re-invest short term surpluses - a power that is not available to the SPV in the case of the pass through structure. In the pass through structure, investors are serviced as and when cash is actually generated by the underlying assets. Delay in cash flows is, of course, shielded to the extent of credit enhancement. Prepayments are, however, passed on to the investors who then have to tackle re-investment risk. A further advantage of the payment through the structure is that different issues of securities can be ranked and hence priced differentially.
A Broad Overview
Typically an SC or an RC purchases the financial assets from a Bank or a Financial Institution by the issue of Bond/ Debentures. After the acquisition, SC/ RC can offer Security Receipts (SR) to QIBs for subscription in accordance with provisions contained in the Companies Law, SCRA, SEBI Act and other regulations in this regard.
The SARFAESI defines Securitisation to mean the acquisition of financial assets by any securitization company or reconstruction company from any originator whether by raising of funds by such securitization company or reconstruction company from QIB by the issue of security receipts representing an undivided interest in such financial assets or otherwise.
Originator refers to the owner of a financial asset which is acquired by Securitization Company or Reconstruction Company for securitization or asset reconstruction [SARFAESI]
A Securitisation company is any company formed and registered under the Companies Act 1956 for the purpose of securitisation [SARFAESI] In order to conduct activities of a Securitisation Company, RBI approval in that regard is compulsory.
A Reconstruction Company is a company formed and registered under the Companies Act 1956 for the purpose of asset reconstruction [SARFAESI]. In order to conduct activities of a Reconstruction Company, RBI approval is compulsory.
Security receipt (SR) is a receipt or other security issued by Securitization Company or Reconstruction Company to any QIB pursuant to a scheme, evidencing the purchase or acquisition by the holder thereof, an undivided right, title or interest in the financial asset involved in securitization. [SARFAESI] Security Receipts typically need to be registered unless it satisfies requirements under Section 8 of SARFAESI which exempts certain SRs from compulsory registration. Securities Receipts are now permitted to be listed on Stock Exchanges, thus have better liquidity than before. [RBI]
An Obligor is a person liable to the originator, whether under a contract or otherwise, to pay a financial asset or to discharge any obligation in respect to a financial asset, whether existing, future, conditional or contingent and includes the borrower. [SARFAESI]
SPV
An SPV or a special purpose entity (SPE), is a legal entity created by a firm (known as the sponsor or originator) by transferring assets to the SPV, to carry out some specific purpose, or circumscribed activity, or a series of such transactions.[1] SPVs have no purpose other than the transaction(s) for which they were created, and they can make no substantive decisions; the rules governing them are set down in advance and carefully circumscribe their activities.[2]
SPV must be capable of acquiring, holding and disposing of assets. An SPV for Securitisation purposes has to be bankruptcy remote and in this regard S&P has developed criteria to be satisfied such as Restrictions on its object and powers, restriction from issuing other debt except in circumstances those are consistent with rated issuance, appointment of independent directors, Separation Covenants to ensure the S PV holds itself out to the world as an independent entity. Further, a debt security interest opinion is required that SPV can grant a security interest over its asset to holders of rated securities. Finally, while rated securities are outstanding, the bankruptcy remoteness of the SPV must not be undermined by a merger or consolidation with non-SPV or reorganization, dissolution, liquidation or asset sale. It also must be bankruptcy proof in the sense that it should not be capable of being taken into bankruptcy in event of inability to service the securitized paper issued by it. SPV should be tax neutral and have the capability of housing multiple securitisations while also ensuring that co-mingling of assets of such multiple securitisations are avoided.
SARFAESI and Securitisation of non-performing assets
Central Government constituted Narasimham Committee I and II and Andhyarujina Committee to examine banking sector reforms. The Need for changes in the legal system in the area was recognized by them and the Committees, inter alia, suggested enactment of new legislation for securitization and empowering banks and financial institutions to take possession of securities and to sell them without court intervention. As a result, SARFAESI was enacted. SARFAESI prescribes the norms to be followed for securitization of non-performing assets.
RBI defined NPA as:
“a) Interest or principal (or instalment thereof) is overdue for a period of 180 days or more from the date of acquisition or the due date as per contract between the borrower and the originator, whichever is later;
b) interest or principal (or instalment thereof) is overdue for a period of 180 days or more from the date fixed for receipt thereof in the plan formulated for realisation of the assets referred to in paragraph 7(1)(6) herein;
c) interest or principal (or instalment thereof) is overdue on expiry of the planning period, where no plan is formulated for realisation of the assets referred to in paragraph 7(1)(6) herein; or
d) any other receivable, if it is overdue for a period of 180 days or more in the books of the SC / RC.”[3]
Per SARFAESI, when a bank or financial institution is a lender in relation to any financial assets acquired by the SC or RC, then such SC or RC would be deemed to be a lender and all the rights of such bank or financial institution shall vest in such company in relation to such financial assets and also that all agreements, contracts, deeds, bonds, agreements, power of attorney, grants of legal representation, permissions, approvals, consents or no-objections under any law or otherwise and other instruments of whatever nature which relate to the said financial asset subsisting or having effect immediately before the acquisition of financial assets and to which the concerned bank or financial institution is a party or which are in favour of such bank or financial institution, shall, after the acquisition of the financial assets shall pass on fully to the SC or RC. Litigation is also treated to not abate or discontinued to prejudicially affect the SC or RC.
An SC/RC can raise funds from QIBs by formulating schemes for acquiring financial assets and are required to maintain separate and distinct accounts in respect of each such scheme for every financial asset acquired from investments made by QIB. It has to be ensured that realisations of such financial asset are held and applied towards redemption of investment and payment of returns assured on such investments under the relevant scheme. This scheme for offering SR or raising funds is in nature of trust (in accordance of the Indian Trust Act 1882 so far as the provisions are consistent with SARFEASI) to be managed by SC or RC who holds the assets so acquired or funds so raised in trust with QIBs holding SRs are the beneficiaries. Section 5 also provides remedial measures for QIBs in the event of non-realisation of financial assets.
Activities of an RC/SC involves ‘a proper management of the business of the borrower, by change in, or takeover of the management of the business of the borrower, rescheduling of payment of debts payable by the borrower, enforcement of security interest in accordance with the provisions of the Act, settlement of dues payable by the borrower, taking possession of secured assets in accordance with the provisions of the Act. Besides this, it may act as an agent for any bank or financial institution for recovering their dues from the borrower, or it may act as a manager, both on payment of mutually agreed fees or charges.
[1] NBER WORKING PAPER SERIES SPECIAL PURPOSE VEHICLES AND SECURITIZATION Gary Gorton Nicholas S. Souleles https://www.nber.org/papers/w11190.pdf
[2] NBER WORKING PAPER SERIES SPECIAL PURPOSE VEHICLES AND SECURITIZATION Gary Gorton Nicholas S. Souleles https://www.nber.org/papers/w11190.pdf
[3] https://www.rbi.org.in/Scripts/BS_ViewMasCirculardetails.aspx?id=9901
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