One of the means of raising finances is by the absolute assignment of receivables (along with underlying securities) from an obligor to an assignor or originator, that are structured as bankruptcy remote from the originator, and any creditors of the originator. Where the assignee is a special purpose vehicle (SPV), it issues instruments in the form of pass through certificates (PTCs) to raise funds for the purchase of receivables.
For years this market remained unregulated, however, the guidelines on the assignment of standard assets issued on 1 February 2006 by the Reserve Bank of India (RBI) changed this. More recently the Securities and Exchange Board of India (SEBI) (Public Offer and Listing of Securitized Debt Instruments) Regulations, 2008, were notified by SEBI in relation to listed public and private placements of instruments relating to the raising of finances by assignment.
The RBI guidelines stipulated conditions to be fulfilled by banks, non-banking financial companies (NBFCs) and the trust in order to achieve a “true sale”, while also outlining the accounting treatment expected of such transactions.
The RBI guidelines were seen by most originators as being very regressive. This resulted in a sharp drop in the quantity of finance raised through securitization.
While the RBI guidelines do not regulate a direct assignment of receivables, they impose certain restrictions on the trust (i.e. the SPV structure), such as prohibiting embedded put options and forbidding the originator from subscribing to the primary issue of PTCs.
Unsurprisingly, thereafter the market witnessed a rise in the number of direct assignment transactions with tailor-made variations, to achieve what was not possible in trust structure transactions due to RBI restrictions.
Although the receivables are clubbed as a pool and assigned, issues arise with regard to the market practice of transferring payments to the assignee with a time lag and pooling them until then. As a result, the originator is invariably appointed as the servicer of the loans, with an obligation to transfer all amounts received from the pool of loans to the assignee’s account.
In order to make such assignments more attractive, credit ratings are obtained and a better credit rating sought, by providing higher credit enhancements in the form of cash collateral and/or bank guarantees, or corporate guarantees. Although an absolute assignment entails no recourse to the originator, such a practice is viewed only as a limited recourse arrangement.
However, issues often arise on account of what would amount to “limited recourse”, as there is no regulatory stipulation concerning the amount of credit enhancement that may be provided.
To avoid a moral hazard in this context, the originator should not dilute its own norms in terms of lending, because it plans to assign the receivables. This is a significant issue and has been the root cause of the sub-prime crisis and the current financial meltdown.
Most rating agencies in India require the originator to appoint an auditor to conduct a random sample of receivables due diligence, to ascertain compliance levels with the standard practices and documentation of the originator. The auditor thus becomes a crucial link in preventing this moral hazard. However, a chain is only as strong as its weakest link. Over the years, most rating agencies have been proactive while their standards have gradually become more stringent.
The accounting treatment of the originator’s business income from the assignment of receivables is required to follow the RBI guidelines and the guidance note issued by the Institute of Chartered Accountants of India. However, these rules are not adequate. Although accounting standards 30 broadly covers the relevant issues, it only becomes mandatory with effect from 2011.
Another hindrance is the requirement for stamp duties and registration fees in India. Documents for assignment (along with the underlying securities) attract high stamp duties in most states in India. Very few states have notified a significantly reduced (and capped) stamp duty rate on an assignment of receivables.
Further, the assignment of (or rather of the interest in) the underlying security, especially in the case of mortgaged property like home loans or property loans, entails high stamp duties in addition to registration requirements for transaction documents. Amendments of each loan document to reflect the transfer also attract a stamp duty.
SEBI recently notified the listing regulations, under which securitized debt instruments (which are either privately placed or offered to the public) may be listed on stock exchanges in India.
There are certain concerns in relation to these listing regulations, such as specific percentages for clean-up-call options, modes of disclosure of offer documents, and green shoe options, which are not provided for. Although the listing regulations appear to be stringent, they will definitely offer an exit mechanism and thereby a secondary market for investors. Since these regulations have been enforced only recently, some time may pass before the market for listed securitized instruments develops.
H Jayesh is the founder partner, Harsha Punjabi is a senior associate, and Maymoona Mandviwala is an associate at Juris Corp. The firm is a full-service law firm based in Mumbai and specializes in financial transactions including capital markets and securities, banking, corporate restructuring and derivatives.
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