India: Securitisation and Structured Finance

Last Updated: 8 December 2003
Article by Rajkumar Dubey

Securitisation, per se is a transaction in "instruments", which represents cluster of assets / receivables of identical nature, having steady flow of income, thereby giving greater liquidity to the instrument representing it. Historically, it has been developed as a "mechanism", to club smaller stream of incomes, regular and steady in nature and represent it through "instrument(s)", which then could be placed in the market either for public at large or to institutions, to raise funds at a higher level.

Securitisation is primarily a "structured finance instrument" that balances the risk-return needs of the investors. Therefore, the terms ‘securitisation’ and ‘structured finance’ are almost used interchangeably in practice. Securitisation as commercial activity has already attained maturity in markets like the US, the UK and several other European countries. However, in Indian market, where experimentation with different philosophies of economic theories and mechanism for the market regulations have been going on for quite some time, it is yet to gain ground as "matured commercial transaction".

India has been trying hard to catch up with the latest economic developments. That said, securitisation and structured finance has only been a recent phenomenon, with the regulatory provisions only recently being introduced. There is however increasing acceptance of this mechanism in Indian market and it has a great future in the growing Indian economy.

The recent introduction of "Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002" (also known as Securitisation Act) has for the first time introduced directly a regulatory mechanism for securitisations in India. The Securitisation Act aims to fulfill the following ideas and objectives:

  1. to provide greater control to the banks and financial institutions (secured creditors) over the assets of defaulting borrowers,
  2. transfer of non-performing assets to Asset Reconstruction Companies, for management, dealing or disposal and realisation of proceeds,
  3. legal and regulatory provisions relating to Securitisation of assets.

The Indian market for securitisations is still in developing stage. Most of the transactions are structured around the "beneficial interest in the return of the asset base". The ownership pattern in the securitisation deals has yet to evolve. The control generally is done through the escrow mechanism – through originator – which ensures that the direction of flow of income is rightly maintained.

The Securitisation Act has primarily focussed and tried to provide a mechanism for controlling of non-performing assets and securitisation of the same through special purpose vehicles, namely, securitisation/reconstruction companies. Some of the salient features of the Securitisation Act have been outlined below:

To provide greater control to secured creditors

The Act provides greater control to secured creditors in case of ‘default’ by the borrowers by giving them the right to enforce their security interest. ‘Default’ has been defined to mean: the non-payment of any principal debt or interest thereon or any other amount payable by a borrower to any secured creditor, consequent upon which the account of such a borrower is classified as a non-performing asset in the books of account of the secured creditor in accordance with the directions or guidelines issued by the Reserve Bank of India (RBI).

Once the default is committed and the asset becomes a non-performing asset, a secured creditor can enforce the security against such defaulting borrower, without intervention of any Court or Tribunal, after giving 60 days notice to the borrower. If the borrower does not pay the principal and interest as specified in the notice – within 60 days, the secured creditor may take recourse to one or more of the following measures to recover his secured debt, namely: take possession of assets, take over management of assets or appoint any person to manage the assets.

After taking possession, the secured creditor could also sell and transfer the assets to recover its dues. In case the dues are not fully satisfied with the sale proceeds, it could file an application with the Debt Recovery Tribunal (DRT) having jurisdiction or a competent court for the recovery of the balance amount. The creditor shall also be entitled to proceed against the guarantors or sell the pledged assets directly.

A secured creditor could also transfer/sell the assets to securitisation/reconstruction company constituted under the Securitisation Act, which shall thereupon step into the shoes of the secured creditor.

In cases where the borrower feels aggrieved, the Act provides that an appeal with the DRT within 45 days from the date on which the assets or management had been taken over and not at the stage of receiving notice from the secured creditor. Appeal to DRT order lies with Debt Recovery Appellate Tribunal (DRAT). Jurisdiction of Civil Courts has been barred in respect of any matter, which a Debt Recovery Tribunal is empowered by or under this Act to determine and also no injunction shall be granted in respect of such matters. However, the Courts in India have been granting injunctions under exceptional circumstances. It is to be noted that in case a borrower succeeds in appeal at DRT or DRAT, he shall be entitled to get back possession of asset plus compensation and costs as may be fixed by DRT or DRAT.

Transfer of Non-Performing Assets to Securitisation / Reconstruction Companies

The Act defines ‘securitisation’ as the acquisition of financial asset by any securitisation company or reconstruction company from any ‘originator’. This can either be by the raising of funds by such securitisation company or reconstruction company from a ‘qualified institutional buyer’ or by issuance of security receipts representing undivided interests in such financial assets or otherwise.

A securitisation company/reconstruction company – or a special purpose vehicle – duly incorporated under the Companies Act, 1956, shall be compulsorily registered with the Reserve Bank of India. It can acquire any ‘financial asset’ (which is in the nature of debt or receivable) from a secured creditor by issuing debentures, bonds or by entering into any arrangement with a secured creditor. Once the securitisation company or reconstruction company takes over ‘financial asset’, that company shall be treated as lender and secured creditor for all the purposes.

A Securitisation or reconstruction company may raise funds from the qualified institutional buyers by formulating schemes for acquiring financial assets. It does this by issuing security receipts to said buyers (other than by offer to public) for subscription to said schemes.

Further, any securitisation/asset reconstruction company is allowed to take following steps (apart from taking possession of the assets) pertaining to asset reconstruction, namely: taking over the management, sale or lease of a part or whole of the business of the borrower, rescheduling of payment of debts payable by the borrower and the settlement of dues payable by the borrower.

Legal and regulatory provisions relating to securitisation of assets

The Act clearly lays down the manner in which the securitisation transactions shall take place and its applicability on the parties involved in such transactions. The Securitisation Act is applicable upon the secured creditors. This means any bank or financial institution or any consortium or group of banks or financial institutions. This includes debenture trustees appointed by any bank or financial institution, securitisation companies or reconstruction companies or any other trustee holding securities on behalf of a bank or a financial institution in whose favour security interest is created for due repayment by any borrower of any financial assistance.

Further, under the Act, only the qualified institutional buyers are eligible to subscribe to the schemes floated by any securitisation/reconstruction company. Qualified institutional buyer means a financial institution, insurance company, bank, state financial corporation, state industrial development corporation, trustee or any asset management company making investment on behalf of mutual fund, provident fund, gratuity fund or pension fund or a foreign institutional investor registered with Securities and Exchange Control Board of India (SEBI) or any other body corporate as may be specified by SEBI.

Interpretation of the Act

The Securitisation Act, being a recent enactment, has certain ambiguous and anomalous provisions. The Supreme Court of India is in the process of interpreting and clarifying such provisions. The matters pending with the various High Courts have also been referred to the Supreme Court. The Supreme Court has asked for suggestions from both borrowers and lenders so as to plug the loopholes. Considering the economic realities and the purpose behind the enactment of the Act, it is expected that the matter will be sorted out soon.

Future of Securitisation in India

Securitisation in an emerging market like India has huge growth potential. The introduction of Securitisation Act is a step towards the development and regulation of an efficient securitisation and structured finance market. Further, India’s market offers great potential to the foreign players to explore and create niche for themselves.

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