rbi guidelines on direct assignment

RBI's Framework for Transfer of Loan Assets

Aditya Bhardwaj

ARTICLE 28 September 2021

As an anticipated measure for the banking and financial sector, the Reserve Bank of India (RBI) has, towards the close of past week, issued the comprehensive framework for the sale or transfer of loan assets. Taking immediate effect from the date of its issuance, the framework titled ‘ Master Directions - Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 ’ issued vide circular DOR.STR.REC.52/21.04.048/2021-22 dated September 24, 2021 (the ‘ Master Directions ’) is being seen as a pivotal move by the Regulator towards introducing an efficient secondary market for loans and ensuring proper credit-risk pricing, besides improving transparency in the identification of embryonic stress in the banking system as well as resolution of stressed loan exposures.

The Master Directions owes its genesis to the ‘ Draft Framework for Sale of Loan Exposures ’ which was released by RBI in course of the first COVID-19 induced lockdown in the Country. The draft had taken into consideration the recommendations of the ‘ Task Force on Development of Secondary Market for Corporate Loans ’ constituted by RBI under the chairmanship of Mr. T.N. Manoharan in May, 2019 and comments from the stakeholders were invited. One of the key components of the Task Force’s recommendation was to separate the regulatory guidelines for direct assignment transactions from the securitisation guidelines and treat it as a sale of loan exposure. The RBI had, accordingly, reviewed the recommendations and thought it prudent to comprehensively revisit the guidelines for sale of loan exposures, both standard as well as stressed, which were earlier spread across various circulars. The erstwhile guidelines or circulars on sale of loan exposures were particular to the asset classification of the loan exposure being transferred and / or the nature of the entity to which such loan exposure is transferred as well as the mode of transfer of the loan exposures. The need for a review also stemmed from the necessity to dovetail the guidelines on sale of loan exposures with the Insolvency and Bankruptcy Code, 2016 (‘ IBC ’) and the Prudential Framework for Resolution of Stressed Assets dated June 7, 2019 (“ Prudential Framework ”), which has witnessed substantial traction and developments towards building a robust resolution paradigm in India in the recent past.

The consolidation by RBI of a self-contained, comprehensive, and independent set of regulatory guidelines on transfer/sale of loan exposures is being seen as a laudable step in the direction of putting together a ‘ robust secondary market in loans which can be an important mechanism for management of credit exposures by lending institutions and also create additional avenues for raising liquidity ’. This write-up attempts to briefly summarize some key components of the Master Directions.

The Master Directions whilst superseding a host of existing circulars/directions (or a portion thereof) in relation of transfer of loan exposures (Chapter VI), has put forth a unified and singular framework for the sale of loan exposures by banks and other financial institutions. The exhaustive breadth of the framework is quite evident from the Chapters under the Master Directions which not only provide for ‘ General Conditions applicable to all Loan transfers ’ (Chapter II), but also cater specifically to transfer of loan exposures of standard assets (Chapter III) as well as stressed loan exposures (Chapter IV), including their respective and intrinsic modalities. The framework concludes with the imperative of ‘ Disclosures and Reporting ’ (Chapter V) and stipulates the mechanism for the stakeholders in that regard.

Applicability

On expected lines, nearly all constituents of the Financial sector regulated by RBI are mandated to ensure compliance to the Master Directions, both as a transferor as well as transferee of the loan exposures – Scheduled Commercial Banks, all NBFCs (including HFCs), Regional Rural Banks, Co-operative Banks, All India Financial Institutions and Small Finance Banks. In addition, the Master Directions also permits asset reconstruction companies (ARCs) and companies (save a financial service provider) to be ‘transferees’ of the loan exposures only if the same is pursuant to the resolution plan under the Prudential Framework and if they are permitted to take on loan exposures in terms of a statutory provision or under the regulations issued by a financial sector regulator.

It would be pertinent to take note that though all lenders permitted to acquire loans are required to ensure compliance to the extant Master Directions; yet, the acquisition of loans pursuant to securitisation are required to be independently dealt under the provisions of RBI’s ‘ Master Directions – RBI (Securitisation of Standard Assets) Directions, 2021 ’ dated September 24, 2021 (the ‘Securitisation Guidelines’). The coverage of the Master Directions includes transfer of loan exposures through novation, assignment, or risk participation. In cases of loan transfers other than loan participation, legal ownership of the loan shall be mandatorily transferred to the Transferee to the extent of economic interest transferred under the loan exposures.

For the Transferees which are financial sector entities (not falling under clause 3 of the Master Directions) and the ARCs, the prudential norms (asset classification, provisioning norms etc) of their respective sectoral regulators (SEBI, IRDA, PFRDA etc) shall be applicable post-acquisition of loan exposure under the Master Directions.

Basic Ingredients

Before venturing into the other nuances, it is an imperative that one accounts for the understanding of some key ‘constructs’ which cut across the Master Directions:

• Transfer : Quite apparently, the expression denotes the process of transfer of the economic interest in a loan exposure by the transferor and acquisition of the same by the transferee. The subject matter of transfer being the ‘ economic interest ’ of the transferor in the loan exposure, it is important that the risks and rewards associated with loans are clearly demarcated and separated in favour of the transferee; especially when some portion of the economic interest in the loan exposure is retained by the transferor.
• Transferor : Often referred as ‘assignor’ (in assignment transactions) or ‘grantor’ (for risk participation), transferor under the Master Directions would include Clause 3 entities which transfer their economic interest in the loan exposures.  
• Transferees : These refer to entities in whose favour the economic interest in the loans are transferred and would include Clause 3 entities as well as the ARCs/companies to the extent permitted under the Master Directions. It is clarified that the transferee should neither be a person disqualified under the IBC nor, in cases of loan exposures where frauds have been identified, belong to an existing promoter group of the borrower or its subsidiary / associate / related party etc. (domestic as well as overseas).
• Minimum Holding Period (MHP) : As the expression suggests, the MHP refers to a threshold period for which the transferor should hold the loan exposures, along with its risks and rewards, before the economic interest in respect thereto is transferred. The intent of having a MHP is to ensure that the loan has been seasoned in the books of the originator (or the transferor) for a certain specified time period. The MHP for loans with tenor upto 2 years and more than 2 years, as per the Master Directions, have been capped at 3 months and 6 months, respectively.
• Permitted Transferees : These include (i) Scheduled Commercial Banks, (ii) NBFCs (including HFCs), (iii) All India Financial Institutions and (iv) Small Finance Banks. The significance of carving out the foregoing financial sector entities from Clause 3 of the Master Directions lies in the fact that the transferor is permitted to transfer its loans (which are not in default) to permitted transferees only through novation, assignment, or loan participation. For the stressed exposures, the transfer is mandated only to such permitted transferees and ARCs and singularly through assignment or novation of such loan exposures.

Underlying Elements

The finer nuances of the Master Directions would certainly surface once the provisions have been widely given effect to by the stakeholders; however, as it stands, the framework undoubtedly promises to streamline the procedures and requirements for the stakeholders considering transfer of their loan exposures – standard as well as stressed. Some fundamental provisions of the Master Directions have been summarized as below:

• Overarching Transfer conditions : Quite categorically, the Master Directions stresses on the necessity of delineation of Transferor’s ‘risks and rewards’ associated with the loan exposures to the extent of the transfer. In fact, it is stated that not only should the transferee have the unrestrained and unconditional entitlement to transfer or dispose of the loans to the extent of economic interest acquired by it, but also in the event of any economic interest in the loan exposure is retained by the transferor, the loan transfer agreement should demarcate the distribution of the principal and interest income from the transferred loan between the transferor and the transferee. The Master Directions also caution against any modification of terms of the underlying financing agreement and require that any change, in course of such transfer, should withstand the test of not being categorised as ‘Restructuring’ under the Prudential Framework. It would be significant to take note that the transfer of loan exposures under the Master Directions not only should be without recourse to the Transferor, but also the transferor or transferee should not be constrained to obtain consent from the transferee/ transferor, as the case may be, in the event of resolution or recovery in respect of the beneficial economic interest retained by or transferred to the respective entity. In addition to the foregoing, the Master Directions also prescribe for the enumerated conditions applicable to all transfers of loan exposures:
• The Transferor shall have no obligation to re-acquire or fund the re-payment of the loans or any part of it or substitute loans held by the Transferee or provide additional loans at any time;
• If the security interest is held by the Transferor in trust with the Transferee as the beneficiaries, the Transferee shall ensure that a mutually agreed and binding mechanism for timely invocation of such security interest is put in place;
• Any rescheduling, restructuring or re-negotiation of the terms of the underlying agreement attempted by Permitted Transferee, after the transfer of assets to the transferee, shall be as per the Prudential Framework;
• The Clause 3 entities, regardless of whether they are transferors or otherwise, should not offer credit enhancements or liquidity facilities in any form in the case of loan transfers.
• Board-approved Policy : The Transferors are mandated to put in place a comprehensive Board-approved policy for transfer and acquisition of loan exposures under the Master Directions. These guidelines must, inter alia , lay down the minimum quantitative and qualitative standards relating to due diligence, valuation, requisite IT systems for capture, storage and management of data, risk management, periodic Board level oversight, etc. Further, the policy must also ensure the independence of functioning and reporting responsibilities of the units and personnel involved in the transfer/acquisition of loans from that of personnel involved in originating the loans.
• Transfer of Standard Assets : The transfer of loan exposures classified as ‘standard’ can be undertaken through the mechanisms of assignment or novation or a loan participation. The transfer of such loan exposures should be only on a cash basis to be received at the time of transfer of loans; besides, the requirement of the transfer consideration being arrived at in a transparent manner on an arm's length basis. The Master Directions require the Transferees to monitor, on an ongoing basis and in a timely manner, the performance information on the loans acquired, including through conducting periodic stress tests and sensitivity analyses, and take appropriate action required, if any. Further, the Transferor’s retention of economic interest, if any, in the loans transferred should be supported by legally valid documentation supported by a legal opinion.

The requirements of Chapter III of the Master Directions are, however, not applicable to certain identified loan transfers, as below:

• transfer of loan accounts of borrowers by a lender to other lenders, at the request/instance of borrower;
• inter-bank participations as per the RBI’s circulars;
• sale of entire portfolio of loans consequent upon a decision to exit the line of business completely;
• sale of stressed loans; and
• any other arrangement/transactions, specifically exempted by the RBI.
• Minimum Risk Retention : The Master Directions are explicit in their requirement of the requisite due diligence in respect of the loans exposures and mention that the said exercise cannot be outsourced or delegated by the Transferee. In order to ensure a systemic departure from the conventional practice of placing solitary reliance on the due diligence of the originator (or the Transferor), the Master Directions mandate the Transferee to undertake the due diligence of the loan exposures through its own staff, at the level of each loan, and as per the same policies as would have been done had the Transferee been the originator of the loan. In case the due diligence of entire portfolio is undertaken by the Transferee, the requirement of a minimum retention requirement (MRR) of the Transferor can be dispensed with.

However, in case of loans proposed to be acquired as a portfolio, if a transferee is unable to perform due diligence at the individual loan level for the entire portfolio, the Transferor shall retain at least 10% of economic interest in the transferred loans as MRR. In such a case as well, the Transferee is required to undertake due diligence at the individual loan level for not less than one-third (1/3 rd ) of the portfolio by value and number of loans in the portfolio. As per the Master Directions, in case of multiple Transferees, the MRR would still be on the entire amount of transferred loan, even if any one of the transferee is unable to perform the due diligence at an individual level.

• Transfer of Stressed Assets : Chapter IV of the Master Directions deals specifically with the transfer of stressed loan exposures to ARCs and other Permitted Transferees. It is specifically stated that the mechanism for transfer of such stressed accounts can be consummated only through assignment or novation. Besides the requirement of a Board-approved policy for transfer as well as acquisition of stressed loan exposures and the parameters thereof, the Master Directions mandate such transfers to ARCs and other Permitted Transferees only. Importantly, the Transferor is necessarily required to undertake an auction through a ‘ Swiss Challenge method ’ both in cases where (i) the aggregate loan exposure to be transferred is Rs. 100 crore or more after bilateral negotiations; and even under (ii) a transfer pursuant to the Resolution Plan approved in terms of the Prudential Framework (irrespective of the monetary threshold).
• Accounting : In the event the transfer of loan exposures results in loss or profit, which is realised, the same should be accounted for and, accordingly, reflected in the P&L account of the Transferor for the accounting period during which the Transfer is consummated. However, the unrealised profits (if any) arising out of such Transfers, shall be deducted from the Common Equity Tier 1 (CET 1) capital or net owned funds of the Transferor for meeting regulatory capital adequacy requirements till the maturity of such transferred exposures. The Master Directions prescribe maintenance of borrower-specific accounts both by the Transferor as well as the Transferee of the retained and transferred loan exposures, respectively. It has been further clarified that the extant requirements of RBI for ‘income recognition, asset classification, and provisioning’ shall, accordingly, be ensured by the transferor and the transferee with respect to their respective shares of holding in the underlying loan exposures.

Though it would be quite nascent to present an analysis of the Master Directions even before it has been actually implemented, yet there are indeed some crucial aspects which underline the significance of the Master Directions issued by RBI which can be summarized as follows:

• Identification and Resolution of Stressed Exposures : Though quite a premature assessment, yet it is felt that the framework under Master Directions could facilitate the development of a robust distressed asset ecosystem and speed-up the resolution of various stressed exposures, which could be driven by the ensuing characteristics of the Master Directions:
• Early Identification and Resolution of Stressed Exposures : The framework has expanded the definition of stressed exposures (‘stressed loans’) to include both non-performing assets (NPAs) and special mention accounts (SMAs). Also, the deregulation of the price discovery process will enable faster and more efficient pricing of exposures – especially when coupled with a wider range of eligible investors.
• Enhanced Viability of Stressed Asset Takeover Structures :   More importantly, the Master Directions allow investors in stressed assets to classify the exposure as standard, although subject to any other exposure to the same entity on the investor’s books not being sub-standard on the date of the acquisition of the asset. This could significantly lower capital charge and provisioning requirements for the acquirer/investor of the stressed assets. Given that most stressed assets are restructured as well – often including a complete management overhaul, the rationalisation of the capital charge and provisions could make such assets more attractive to prospective acquirers.
• Impetus to Long-Term Funding structures : The Indian credit markets have for long been bereft of avenues for mobilising capital through long-term debt instruments. As a result, liability structures for corporate borrowers in sectors such as power generation and roads front load cash outflows during the project life. This, at least in part, reflects the non-availability of long-dated liabilities for the financial sector. Therefore, an ecosystem which allows lenders to off-load long-dated exposures after a certain time period with reasonable foresightedness could enable borrowers to raise long-term debt instruments from the financial system in a cost-efficient manner.
• Independent Credit Evaluations Could Prove Critical : The Master Directions mentions that transferees may have the loan pools rated before acquisition so as to have a third-party view of their credit quality in addition to their own due diligence; though, the latter is a mandatory requirement and cannot substitute for the due diligence that the transferee(s) are required to perform. Also, in case of transfer of stressed assets, it becomes critical to ensure that the valuation of the exposure and associated risk capital allocation are based on an assessment of the asset to meet its contractual debt obligations. Even restructured accounts have subsequently come under stress in some cases due to fundamental weaknesses in the business profile, heightened management risk/weak governance structures and unsustainable debt levels even after restructuring. Though not prescribed as a mandatory requirement under the Master Directions, yet a third-party evaluation by a credit rating agency could provide an added layer of assessment and valuations for such exposures along with subsequent capital charge and provisioning norms could be linked to the outcome of such evaluation.

The contents of this article are for general information and discussion only and is not intended for any solicitation of work. This article should not be relied upon as a legal advice or opinion.

New Directives on Securitisation of Standard Assets – Revamping the Securitisation Landscape?

February 1, 2022 > India > Finance

Juris Corp | View firm profile

The Reserve Bank of India (“RBI”) on 24 th September 2021, issued the Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021 (“Master Directions”). These Master Directions repeal the existing RBI guidelines on securitisation of standard assets. The Master Directions apply to the following entities:

• all Scheduled Commercial Banks (including Small Finance Banks but excluding Regional Rural Banks);
• all all-India Term Financial Institutions (NABARD, NHB, EXIM Bank and SIDBI); and
• all Non-Banking Financial Companies (“NBFCs”) including Housing Finance Companies (“HFCs”).

The Master Directions have evolved from the ‘ Draft Framework for Securitisation of Standard Assets ’ which was released by the RBI on 8 th June 2020, wherein the aim was to align the regulatory framework surrounding the securitisation regime with Basel III requirements and deepen the secondary loan trading market. The Master Directions have also taken into account the recommendations of the Committee on Development of Housing Finance Securitisation Market in India (Chair: Dr. Harsh Vardhan) and the Task Force on the Development of Secondary Market for Corporate Loans (Chair: Shri T.N. Manoharan) ( “Task Force” ) which were set up by the RBI in May 2019. One of the key components of the Task Force’s recommendation was to separate the regulatory guidelines for direct assignment transactions from the securitisation guidelines and treat it as a sale of loan exposure. To that effect, the guidelines for direct assignment transactions, which formed part of the repealed securitisation guidelines, have been separated from the securitisation guidelines and subsumed under a separate set of guidelines on transfer of loan exposures including stressed loans or loan exposures classified as fraud.

This article aims to briefly summarise and highlight key components of the Master Directions and its subsequent implication on the banking and financial sector.

Basic Deviations:

• The Master Directions permit single asset securitisation which was prohibited under the erstwhile guidelines. It is interesting to note that securitisation of single assets was common prior to the 2012 Guidelines pursuant to which it was not allowed. However, exposures to other lending institutions can no longer be securitised.
• In a major deviation from the repealed guidelines, the Master Directions have now revised the minimum holding period ( “MHP” ) and minimum retention requirement ( “MRR” ) for the assets being securitised. While a 12-month MHP is no longer required for residential mortgage-backed securitisations and the MHP is no more linked to repayment frequency but to the tenor of the loan, the percentage of MRR to be maintained has not undergone any revision. However, an exception has been carved out for residential mortgage-backed securitisation wherein only a 5% MRR is required to be maintained irrespective of the original maturity.

In addition to the above, overcollateralization is no longer considered as a form of MRR.

Accordingly, MRR may be achieved by issuance of equity tranches or pari passu investment in senior tranches.

• The timelines for credit enhancement reset for residential mortgage-backed securities have also been reduced.
• The risk weights for high rated senior tranches have been reduced while the risk weights of junior tranches are higher.

New Inclusions:

• Investment threshold for securitisation notes will be at a minimum of INR 10 million. If the securitisation notes are offered to more than 50 persons, it will have to be listed as per the terms of the Securities and Exchange Board of India (Issue and Listing of Securitised Debt Instruments and Security Receipts) Regulations, 2008 (as amended).
• Simple, transparent, and comparable securitisation (“STC”)

Under the Master Directions, two methods of securitisation have been introduced:

• STC securitisations; and
• non-STC securitisations.

STC compliance permits alternative capital treatment and the compliance itself is primarily linked to enhanced transparency requirements. STC transactions enable lower risk weights effectively leading to higher yields. Hence originators undertaking securitisation on an ongoing basis may consider securitisation that is STC compliant.

• The provision relating to credit monitoring and valuation has been revised under the Master Directions. Board approved policies for the valuation of securitisation notes need to be put in place. Lenders need to now put in place formal procedures to assess the risk profile of the underlying assets. They also need to monitor on an ongoing basis and in a timely manner, performance information on the exposures underlying their securitisation positions and take appropriate action, if any, required.
• Under the provisions of the Master Directions, holders of securitisation notes can now pledge or trade their holding without any restriction unless the restriction is imposed by a statutory or regulatory risk retention requirement.
• Further, assets purchased from other lenders can now also be securitised including securitisation of trade receivables is now specifically provided for. Assets purchased from other lenders can now be securitised. This inclusion can help in repackaging and risk diversification. In this regard it has also been clarified that the conditions of separation from the transferred asset applicable to the originator shall apply to such lender from whom the asset is purchased although only either of such lender or originator can have a representative on the board of the special purpose entity.
• The Master Directions envisage a new requirement that there should not be a gap of more than 30 days between transfer of the assets and the issuance of securitisation notes .
• The Master Directions have expressly provided for :
• mortgage-backed securitisation;
• replenishment structures; and
• securitisation of trade receivables.

It should be noted that while securitisation for the above structures were being undertaken in the past, an express provision has now been included.

In a nutshell:

Following in the footsteps of the global market, the securitisation market in India has steadily evolved over the years. The Master Directions is a step in this direction. While certain provisions thereunder remain ambiguous and curtail otherwise emerging structures, undoubtedly, the changes introduced will result in more transparent securitisation structures and give an impetus to the Indian financial sector. In this backdrop, we anticipate innovative structures, specifically in relation to mortgage-backed securitisation, replenishment structures, single asset securitisation to name a few.

All in all, the Master Directions are a nod from the regulator towards a more developed structured finance market, hopefully resulting in a steady increase of securitisation deals in the Indian market.

Ankit Sinha Partner, Juris Corp Email: [email protected]

Teza Jose Principal Associate, Juris Corp Email: [email protected]

Disha Saxena Associate, Juris Corp Email: [email protected]

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RBI'S Framework For Transfer Of Loan Assets

Contributor.

As an anticipated measure for the banking and financial sector, the Reserve Bank of India (RBI) has, towards the close of past week, issued the comprehensive framework for the sale or transfer of loan assets. Taking immediate effect from the date of its issuance, the framework titled ' Master Directions - Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 ' issued vide circular DOR.STR.REC.52/21.04.048/2021-22 dated September 24, 2021 (the ' Master Directions ') is being seen as a pivotal move by the Regulator towards introducing an efficient secondary market for loans and ensuring proper credit-risk pricing, besides improving transparency in the identification of embryonic stress in the banking system as well as resolution of stressed loan exposures.

The Master Directions owes its genesis to the ' Draft Framework for Sale of Loan Exposures ' which was released by RBI in course of the first COVID-19 induced lockdown in the Country. The draft had taken into consideration the recommendations of the ' Task Force on Development of Secondary Market for Corporate Loans ' constituted by RBI under the chairmanship of Mr. T.N. Manoharan in May, 2019 and comments from the stakeholders were invited. One of the key components of the Task Force's recommendation was to separate the regulatory guidelines for direct assignment transactions from the securitisation guidelines and treat it as a sale of loan exposure. The RBI had, accordingly, reviewed the recommendations and thought it prudent to comprehensively revisit the guidelines for sale of loan exposures, both standard as well as stressed, which were earlier spread across various circulars. The erstwhile guidelines or circulars on sale of loan exposures were particular to the asset classification of the loan exposure being transferred and / or the nature of the entity to which such loan exposure is transferred as well as the mode of transfer of the loan exposures. The need for a review also stemmed from the necessity to dovetail the guidelines on sale of loan exposures with the Insolvency and Bankruptcy Code, 2016 (' IBC ') and the Prudential Framework for Resolution of Stressed Assets dated June 7, 2019 (" Prudential Framework "), which has witnessed substantial traction and developments towards building a robust resolution paradigm in India in the recent past.

The consolidation by RBI of a self-contained, comprehensive, and independent set of regulatory guidelines on transfer/sale of loan exposures is being seen as a laudable step in the direction of putting together a ' robust secondary market in loans which can be an important mechanism for management of credit exposures by lending institutions and also create additional avenues for raising liquidity '. This write-up attempts to briefly summarize some key components of the Master Directions.

The Master Directions whilst superseding a host of existing circulars/directions (or a portion thereof) in relation of transfer of loan exposures (Chapter VI), has put forth a unified and singular framework for the sale of loan exposures by banks and other financial institutions. The exhaustive breadth of the framework is quite evident from the Chapters under the Master Directions which not only provide for ' General Conditions applicable to all Loan transfers ' (Chapter II), but also cater specifically to transfer of loan exposures of standard assets (Chapter III) as well as stressed loan exposures (Chapter IV), including their respective and intrinsic modalities. The framework concludes with the imperative of ' Disclosures and Reporting ' (Chapter V) and stipulates the mechanism for the stakeholders in that regard.

Applicability

On expected lines, nearly all constituents of the Financial sector regulated by RBI are mandated to ensure compliance to the Master Directions, both as a transferor as well as transferee of the loan exposures – Scheduled Commercial Banks, all NBFCs (including HFCs), Regional Rural Banks, Co-operative Banks, All India Financial Institutions and Small Finance Banks. In addition, the Master Directions also permits asset reconstruction companies (ARCs) 1 and companies 2 (save a financial service provider 3 ) to be 'transferees' of the loan exposures only if the same is pursuant to the resolution plan under the Prudential Framework and if they are permitted to take on loan exposures in terms of a statutory provision or under the regulations issued by a financial sector regulator.

It would be pertinent to take note that though all lenders permitted to acquire loans are required to ensure compliance to the extant Master Directions; yet, the acquisition of loans pursuant to securitisation are required to be independently dealt under the provisions of RBI's ' Master Directions – RBI (Securitisation of Standard Assets) Directions, 2021 ' dated September 24, 2021 (the 'Securitisation Guidelines'). The coverage of the Master Directions includes transfer of loan exposures through novation, assignment, or risk participation. In cases of loan transfers other than loan participation, legal ownership of the loan shall be mandatorily transferred to the Transferee to the extent of economic interest transferred under the loan exposures.

For the Transferees which are financial sector entities (not falling under clause 3 of the Master Directions) and the ARCs, the prudential norms (asset classification, provisioning norms etc) of their respective sectoral regulators (SEBI, IRDA, PFRDA etc) shall be applicable post-acquisition of loan exposure under the Master Directions.

Basic Ingredients

Before venturing into the other nuances, it is an imperative that one accounts for the understanding of some key 'constructs' which cut across the Master Directions:

• Transfer : Quite apparently, the expression denotes the process of transfer of the economic interest in a loan exposure by the transferor and acquisition of the same by the transferee. The subject matter of transfer being the ' economic interest ' of the transferor in the loan exposure, it is important that the risks and rewards associated with loans are clearly demarcated and separated in favour of the transferee; especially when some portion of the economic interest in the loan exposure is retained by the transferor.

It is significant to take note that the transfer of the said economic interest can be with or without the transfer of underlying contract. Essentially, even loan participation transaction have also been recognised under the Master Directions (for transfer of standard loans) wherein the transferor transfers all or part of its economic interest in a loan exposure to transferee without the actual transfer of the loan contract, and the transferee(s) fund the transferor to the extent of the economic interest transferred which may be equal to the principal, interest, fees and other payments, if any, under the transfer agreement.

• Transferor : Often referred as 'assignor' (in assignment transactions) or 'grantor' (for risk participation), transferor under the Master Directions would include Clause 3 entities which transfer their economic interest in the loan exposures.
• Transferees : These refer to entities in whose favour the economic interest in the loans are transferred and would include Clause 3 entities as well as the ARCs/companies to the extent permitted under the Master Directions. It is clarified that the transferee should neither be a person disqualified under the IBC 4 nor, in cases of loan exposures where frauds have been identified, belong to an existing promoter group 5 of the borrower or its subsidiary / associate / related party 6 (domestic as well as overseas).
• Minimum Holding Period (MHP) : As the expression suggests, the MHP refers to a threshold period for which the transferor should hold the loan exposures, along with its risks and rewards, before the economic interest in respect thereto is transferred. The intent of having a MHP is to ensure that the loan has been seasoned in the books of the originator (or the transferor) for a certain specified time period. The MHP for loans with tenor upto 2 years and more than 2 years, as per the Master Directions, have been capped at 3 months and 6 months, respectively.

The holding period for the Transferor, in case of secured exposures, is to be computed from the date of registration of the underlying security interests; unless, of course, the loan is unsecured in which case the MHP runs from the date of first repayment under such unsecured exposure. However, in case of project loans, the foregoing months of MHP is required to be calculated from the date of commencement of commercial operations of the project being financed. Besides, the loans acquired by the Transferor itself are required to have a MHP of atleast 6 months from the date of acquisition of the loan on the books of the Transferor, irrespective of the tenor of the loan exposures.

It would be of significance to note that the MHP criteria prescribed under the Master Directions do not apply for loans transferred by an arranging bank under a syndication arrangement.

• Permitted Transferees : These include (i) Scheduled Commercial Banks, (ii) NBFCs (including HFCs), (iii) All India Financial Institutions and (iv) Small Finance Banks. The significance of carving out the foregoing financial sector entities from Clause 3 of the Master Directions lies in the fact that the transferor is permitted to transfer its loans (which are not in default) to permitted transferees only through novation, assignment, or loan participation. For the stressed exposures, the transfer is mandated only to such permitted transferees and ARCs and singularly through assignment or novation of such loan exposures.

Underlying Elements

The finer nuances of the Master Directions would certainly surface once the provisions have been widely given effect to by the stakeholders; however, as it stands, the framework undoubtedly promises to streamline the procedures and requirements for the stakeholders considering transfer of their loan exposures – standard as well as stressed. Some fundamental provisions of the Master Directions have been summarized as below:

• Overarching Transfer conditions : Quite categorically, the Master Directions stresses on the necessity of delineation of Transferor's 'risks and rewards' associated with the loan exposures to the extent of the transfer. In fact, it is stated that not only should the transferee have the unrestrained and unconditional entitlement to transfer or dispose of the loans to the extent of economic interest acquired by it, but also in the event of any economic interest in the loan exposure is retained by the transferor, the loan transfer agreement should demarcate the distribution of the principal and interest income from the transferred loan between the transferor and the transferee. The Master Directions also caution against any modification of terms of the underlying financing agreement and require that any change, in course of such transfer, should withstand the test of not being categorised as 'Restructuring' under the Prudential Framework. It would be significant to take note that the transfer of loan exposures under the Master Directions not only should be without recourse to the Transferor, but also the transferor or transferee should not be constrained to obtain consent from the transferee/ transferor, as the case may be, in the event of resolution or recovery in respect of the beneficial economic interest retained by or transferred to the respective entity. In addition to the foregoing, the Master Directions also prescribe for the enumerated conditions applicable to all transfers of loan exposures:
• The Transferor shall have no obligation to re-acquire or fund the re-payment of the loans or any part of it or substitute loans held by the Transferee or provide additional loans at any time;
• If the security interest is held by the Transferor in trust with the Transferee as the beneficiaries, the Transferee shall ensure that a mutually agreed and binding mechanism for timely invocation of such security interest is put in place;
• Any rescheduling, restructuring or re-negotiation of the terms of the underlying agreement attempted by Permitted Transferee, after the transfer of assets to the transferee, shall be as per the Prudential Framework;
• The Clause 3 entities, regardless of whether they are transferors or otherwise, should not offer credit enhancements or liquidity facilities in any form in the case of loan transfers.

In case the transfer of loan exposures which are not compliant with the requirements mentioned in the Master Directions, the onus is on the Transferee to maintain capital charge equal to the actual exposure acquired and the Transferor is required to treat the transferred loan in its entirety, as if it was not transferred at all in the first place, and the consideration received by it shall be recognised as an advance.

• Board-approved Policy : The Transferors are mandated to put in place a comprehensive Board-approved policy for transfer and acquisition of loan exposures under the Master Directions. These guidelines must, inter alia , lay down the minimum quantitative and qualitative standards relating to due diligence, valuation, requisite IT systems for capture, storage and management of data, risk management, periodic Board level oversight, etc. Further, the policy must also ensure the independence of functioning and reporting responsibilities of the units and personnel involved in the transfer/acquisition of loans from that of personnel involved in originating the loans.
• Transfer of Standard Assets : The transfer of loan exposures classified as 'standard' can be undertaken through the mechanisms of assignment or novation or a loan participation. The transfer of such loan exposures should be only on a cash basis to be received at the time of transfer of loans; besides, the requirement of the transfer consideration being arrived at in a transparent manner on an arm's length basis. The Master Directions require the Transferees to monitor, on an ongoing basis and in a timely manner, the performance information on the loans acquired, including through conducting periodic stress tests and sensitivity analyses, and take appropriate action required, if any. Further, the Transferor's retention of economic interest, if any, in the loans transferred should be supported by legally valid documentation supported by a legal opinion.

The requirements of Chapter III of the Master Directions are, however, not applicable to certain identified loan transfers, as below:

• transfer of loan accounts of borrowers by a lender to other lenders, at the request/instance of borrower;
• inter-bank participations as per the RBI's circulars;
• sale of entire portfolio of loans consequent upon a decision to exit the line of business completely;
• sale of stressed loans; and
• any other arrangement/transactions, specifically exempted by the RBI.
• Minimum Risk Retention : The Master Directions are explicit in their requirement of the requisite due diligence in respect of the loans exposures and mention that the said exercise cannot be outsourced or delegated by the Transferee. In order to ensure a systemic departure from the conventional practice of placing solitary reliance on the due diligence of the originator (or the Transferor), the Master Directions mandate the Transferee to undertake the due diligence of the loan exposures through its own staff, at the level of each loan, and as per the same policies as would have been done had the Transferee been the originator of the loan. In case the due diligence of entire portfolio is undertaken by the Transferee, the requirement of a minimum retention requirement (MRR) of the Transferor can be dispensed with.

However, in case of loans proposed to be acquired as a portfolio, if a transferee is unable to perform due diligence at the individual loan level for the entire portfolio, the Transferor shall retain at least 10% of economic interest in the transferred loans as MRR. In such a case as well, the Transferee is required to undertake due diligence at the individual loan level for not less than one-third (1/3 rd ) of the portfolio by value and number of loans in the portfolio. As per the Master Directions, in case of multiple Transferees, the MRR would still be on the entire amount of transferred loan, even if any one of the transferee is unable to perform the due diligence at an individual level.

• Transfer of Stressed Assets : Chapter IV of the Master Directions deals specifically with the transfer of stressed loan exposures to ARCs and other Permitted Transferees. It is specifically stated that the mechanism for transfer of such stressed accounts can be consummated only through assignment or novation. Besides the requirement of a Board-approved policy for transfer as well as acquisition of stressed loan exposures and the parameters thereof, the Master Directions mandate such transfers to ARCs and other Permitted Transferees only. Importantly, the Transferor is necessarily required to undertake an auction through a ' Swiss Challenge method ' both in cases where (i) the aggregate loan exposure to be transferred is Rs. 100 crore or more after bilateral negotiations; and even under (ii) a transfer pursuant to the Resolution Plan approved in terms of the Prudential Framework (irrespective of the monetary threshold).

The transfer of such stressed loan exposures, as per the Master Directions, should be bereft of any operational, legal or any other type of risks relating to the transferred loans including additional funding or commitments to the borrower / transferee. In fact, it is specifically required for the transferor to ensure that no transfer of a stressed loan is made at a contingent price whereby in the event of shortfall in the realization of the agreed price, the Transferor would have to bear a part of the shortfall.

In addition, the Transferor is required transfer the stressed loans to transferee(s) other than ARCs only on cash basis and the entire transfer consideration should be received not later than at the time of transfer of loans. The stressed exposure can be taken out of the books of the Transferor only on receipt of the entire transfer consideration.

Quite significantly, the Master Directions prescribed that if the Transferee of such stressed loan exposure (except ARCs) have no existing exposure to the borrower whose stressed loan account is acquired, the acquired stressed loan shall be classified as "Standard" by the transferee. However, in case the Transferee has an existing exposure to such borrower, the asset classification of the acquired exposure shall be the same as the existing asset classification of the borrower with the Transferee, irrespective of whether such acquisition is pursuant to the transferee being a successful resolution applicant under the IBC.

Further, the Master Directions require the Transferee to hold the acquired stressed loans in their books for a period of at least 6 months before transferring to other lenders; however, such holding period is not applicable in case the transfer of stressed loan exposure is to an ARC or is pursuant to a resolution plan approved in terms of the Prudential Framework.

As regards the mandate of undertaking the 'Swiss Challenge method' is concerned, the Master Directions require the lenders put in place a Board-approved policy which should, interalia , specify the minimum mark-up over the base-bid required for the challenger bid to be considered by the lender(s), which in any case, shall not be less than 5% and shall not be more than 15%. However, for transfer of stressed exposure under the Prudential Framework, the minimum mark-up over the base-bid required for the challenger bid is to be decided with the approval of signatories to the ICA representing 75% by value of total outstanding credit facilities and 60% of signatories by number.

Additionally, the Master Directions provide for sharing of surplus between the ARC and the Transferor, in case of specific stressed loans; though, the clarity in respect of such specific stressed loans is not mentioned. The repurchase of stressed loan exposures is also stipulated from the ARCs in cases where the resolution plan has been successfully implemented

• Accounting : In the event the transfer of loan exposures results in loss or profit, which is realised, the same should be accounted for and, accordingly, reflected in the P&L account of the Transferor for the accounting period during which the Transfer is consummated. However, the unrealised profits (if any) arising out of such Transfers, shall be deducted from the Common Equity Tier 1 (CET 1) capital or net owned funds of the Transferor for meeting regulatory capital adequacy requirements till the maturity of such transferred exposures. The Master Directions prescribe maintenance of borrower-specific accounts both by the Transferor as well as the Transferee of the retained and transferred loan exposures, respectively. It has been further clarified that the extant requirements of RBI for 'income recognition, asset classification, and provisioning' shall, accordingly, be ensured by the transferor and the transferee with respect to their respective shares of holding in the underlying loan exposures.

Though it would be quite nascent to present an analysis of the Master Directions even before it has been actually implemented, yet there are indeed some crucial aspects which underline the significance of the Master Directions issued by RBI which can be summarized as follows:

• Identification and Resolution of Stressed Exposures : Though quite a premature assessment, yet it is felt that the framework under Master Directions could facilitate the development of a robust distressed asset ecosystem and speed-up the resolution of various stressed exposures, which could be driven by the ensuing characteristics of the Master Directions:
• Early Identification and Resolution of Stressed Exposures : The framework has expanded the definition of stressed exposures ('stressed loans') to include both non-performing assets (NPAs) and special mention accounts (SMAs). Also, the deregulation of the price discovery process will enable faster and more efficient pricing of exposures – especially when coupled with a wider range of eligible investors.
• Enhanced Viability of Stressed Asset Takeover Structures :More importantly, the Master Directions allow investors in stressed assets to classify the exposure as standard, although subject to any other exposure to the same entity on the investor's books not being sub-standard on the date of the acquisition of the asset. This could significantly lower capital charge and provisioning requirements for the acquirer/investor of the stressed assets. Given that most stressed assets are restructured as well – often including a complete management overhaul, the rationalisation of the capital charge and provisions could make such assets more attractive to prospective acquirers.
• Impetus to Long-Term Funding structures : The Indian credit markets have for long been bereft of avenues for mobilising capital through long-term debt instruments. As a result, liability structures for corporate borrowers in sectors such as power generation and roads front load cash outflows during the project life. This, at least in part, reflects the non-availability of long-dated liabilities for the financial sector. Therefore, an ecosystem which allows lenders to off-load long-dated exposures after a certain time period with reasonable foresightedness could enable borrowers to raise long-term debt instruments from the financial system in a cost-efficient manner.
• Independent Credit Evaluations Could Prove Critical : The Master Directions mentions that transferees may have the loan pools rated before acquisition so as to have a third-party view of their credit quality in addition to their own due diligence; though, the latter is a mandatory requirement and cannot substitute for the due diligence that the transferee(s) are required to perform. Also, in case of transfer of stressed assets, it becomes critical to ensure that the valuation of the exposure and associated risk capital allocation are based on an assessment of the asset to meet its contractual debt obligations. Even restructured accounts have subsequently come under stress in some cases due to fundamental weaknesses in the business profile, heightened management risk/weak governance structures and unsustainable debt levels even after restructuring. Though not prescribed as a mandatory requirement under the Master Directions, yet a third-party evaluation by a credit rating agency could provide an added layer of assessment and valuations for such exposures along with subsequent capital charge and provisioning norms could be linked to the outcome of such evaluation.

1. Registered with the Reserve Bank of India under Section 3 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002

2. Sub-section (20) of Section 2 of the Companies Act, 2013

3. Sub-section (17) of Section 3 of the Insolvency and Bankruptcy Code, 2016

4. Section 29A of the Insolvency and Bankruptcy Code, 2016

5. As defined under SEBI (ICDR) Regulations, 2018

6. As defined under the Insolvency and Bankruptcy Code, 2016

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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India Corporate Law

Rbi’s move to revamp loan transfers in india.

On June 08, 2020, the Reserve Bank of India ( RBI ) released two draft frameworks — one for securitisation of standard assets ( Draft Securitisation Framework ) and the other on sale of loan exposures ( Draft Sale Framework ). In our previous article (available here ), we had dealt with key revisions introduced by the RBI under the Draft Securitisation Framework. This article contains a brief summary of the Draft Sale Framework.

The Draft Sale Framework is addressed to the same constituents as the Draft Securitisation Framework and is expected to operate as an umbrella framework, which will govern all loan transfers (standard and stressed assets).

The Draft Sale Framework is broadly divided into three parts viz., (i) general conditions applicable to all loan transfers; (ii) provisions dealing with sale and purchase of standard assets; and (iii) provisions dealing with sale and transfer of stressed assets (including purchase by ARCs).

The core principles of transfer appear like the previous guidelines on direct assignment. However, the scope of transfer has now been expanded to include various kinds of economic transfers of loan assets, including participation arrangements and transactions in which the loan exposure remains on the books of the transferor even after the said transactions.

Three types of transfers that have been recognised under the Draft Sale Framework viz., (i) assignment; (ii) novation; and (iii) loan participation (which includes both risk participation and funded participation). Whilst loans can be transferred via any of the aforesaid transfer methods, (a) revolver loans and loans with bullet payments of principal and interest can only be transferred through novation and loan participation; and (b) stressed assets can only be transferred through assignment and novation. Transfer by way of novation is exempt from the applicability of the guidelines, except for a diktat that approval of all parties, including the borrower, is required for novation.

RBI has indicated that all these transfers are required to result in immediate legal separation of the transferor from the assets, which are transferred and put beyond the reach of the transferor as well as the creditors of the transferor. RBI has also suggested that these should be bankruptcy remote and a legal opinion should be obtained in this regard.

In line with the position in the 2012 guidelines, transferors are not permitted to offer any credit enhancement or liquidity facility for loan transfers. Diligence requirements continue to be strict and the purchasing lender is required to apply the same standard of care while assessing the asset, as if it were originating the asset directly and cannot outsource its due diligence.

The RBI has also permitted transfer of a single loan asset or part of a single asset to a financial entity through novation or loan participation. Only financial entities carrying on business in India will be eligible to participate. Loans acquired from other entities can also be assigned.

Participation Agreements

The Draft Sale Framework also seeks to permit and regulate participation arrangements. Participation arrangements though popular in certain other jurisdictions were not common here, except inter alia , in accordance with the guidelines issued by the RBI on December 31, 1998. The1998 guidelines permitted two types of participations, inter-bank participations with risk sharing and inter-bank participations without risk sharing. While the assignment agreements that were entered into earlier were akin to participation agreements in spirit, the permissibility of participation is an interesting development and a regulatory headway made in the growth of the loan market. The Draft Sale Framework seeks to allow both risk participation and funded participation in loans. Participation agreements in respect of stressed assets has not been specifically permitted.

The Draft Sale Framework specifically recognizes transfer of external commercial borrowings by ‘eligible lenders’ (as defined under the Master Direction on External Commercial Borrowings, Trade Credits and Structured Obligations), subject to any loss or hair cut being to the account of the transferor.

It is expected that the RBI will provide further clarity on whether all lenders (i.e. overseas branches, onshore branches, etc.) can purchase such assets and whether the exposure must continue to remain in foreign currency, both for standard and stressed assets

The RBI has not stipulated the requirement for a transferor to maintain minimum risk retention for loan transfers. This will enable the transferee to deal with the loan independently. However, transferors will have to comply with the ‘minimum holding period’ requirement.

Transfer of loan accounts at the instance of the borrower, inter-bank participations, trading in bonds, sale of entire portfolio of assets consequent upon a decision to exit the line of business completely, sale of stressed assets and consortium and syndication arrangements continue to remain exempt from the applicability of Chapter III of the Draft Sale Framework (which only applies to transfer of standard assets).

Stressed Assets

Stressed assets have been defined as: ‘ assets that are classified as NPA or as special mention accounts, and generally includes accounts, which are in default, as well as where lenders have given concessions for economic or legal reasons relating to the borrower’s financial difficulty ’.

Currently, the Master Circular on Prudential Norms on Income Recognition, Asset Classification and Provisioning (pertaining to advances), 2015, detail the criteria for standard assets, special mention accounts and non-performing assets. The classification has also been replicated in the Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions 2019 ( Prudential Stressed Asset Directions ).

The Draft Sale Framework does not replace or limit the application of existing RBI directions (especially the Prudential Stressed Asset Directions). Any regulated entity (that is permitted to take on loan exposures by its statutory or regulatory framework), can purchase stressed assets directly.

Promoters and Similar Persons Not Eligible to Buy Stressed Assets

The transferor is required to ensure that the transferee is not disqualified in terms of Section 29A of the Insolvency and Bankruptcy Code, 2016, and is not otherwise a promoter, associate, subsidiary or related person of the underlying obligor. Therefore, if there is an existing option to put loans on a promoter / similar entity, then the same may not be possible if the loan is a stressed asset.

In case of standard assets, the Draft Sale Framework has stipulated a table for MHP based on tenure of the loan. However, stressed assets are required to be held in the books of the lender for a period of 12 months.

Asset Classification and Provisioning

A purchased stressed asset can be classified as a ‘standard asset’ by the purchasing entity, in cases where the purchasing entity has no existing exposure to the borrower. However, in case, the purchasing entity has an existing exposure to the borrower whose stressed loan account is acquired, the asset classification of the purchased exposure shall be the same as the existing asset classification of the borrower with the transferee.

Transfer of Stressed Assets to ARCs

The Draft Sale Framework also deals with sale of stressed assets to asset reconstruction companies ( ARC ).

While Section 7 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 ( SARFAESI ) always provided that ARCs could issue debt instruments in lieu of the consideration payable for the acquisition of assets, RBI has now specifically provided for the same in the Draft Sale Framework. If such deals are done, it must clearly be established that the sale is effective. However, the Draft Sale Framework also provides that these instruments will have to be considered as debt on the books of the ARC, therefore implying that the ARC has an obligation to repay the debt and such oblgation cannot be linked to realization of the underlying asset. While this enabling provision is useful, ARCs are unlikely to opt for this route given that there is an obligation to repay the debt, the present structure of PTC may be the preferred option.

It is relevant to note that FPI entities continue to have the right to invest in security receipts and will also have the right to invest in the bonds issued by the ARC.

It is specifically clarified that transfer of stressed assets to non-ARCs can only be on a cash-consideration basis.

Swiss Challenge Method

In an attempt to de-regulate price discovery, the mandatory Swiss Challenge Method has been done away with. Lenders are now expected to put in place board approved policies on adoption of an auction-based method for price discovery.

Right of First Refusal

Under the current Guidelines on Sale of Stressed Assets by Banks, issued by the RBI on September 1, 2016, a bank selling a stressed asset is required to offer the right of first refusal to an ARC, which has already acquired the highest and significant share (~25-30%) in the asset. Such ARC is required to be provided the right to match the highest bid. In line with these guidelines, the Draft Sale Framework also provides the right of first refusal to ARCs, which hold a significant stake in the asset. Additionally, the Draft Sale Framework also provides that in the event such ARC does not want to purchase the asset or if no ARC holds a significant portion, then such right of refusal will have to be extended to a ‘financial institution’, if such institution holds a significant stake in the asset.

The Draft Sale Framework is a significant move by the RBI and is expected to streamline loan transfers in the country. This framework reinforces the RBI’s focus on addressing the health of banks and bad debt in the country, whilst remaining committed to a balanced approach on sale of assets. If passed in its current form, it will be a positive move by the regulator in developing a robust market for secondary transfers.

*Authors would like to thank Vidhi Sarin , Associate for her inputs.

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Home / Knowledge Hub / Blog / RBI Guidelines on Securitisation – Everything You Need to Know

RBI Guidelines on Securitisation – Everything You Need to Know

Securitisation is the process of grouping financial instruments together to create asset-backed security and then selling it to an investor for securing immediate cash payment. RBI came up with draft securitisation guidelines, which include the salient features of securitisation. These include guidelines for the minimum retention requirement (MRR) of underlying loans, types of securitisation realted transactions and eligibility of assets for securitisation.

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Securitisation helps provide banks and other lenders the capital they need to offer loans to borrowers who are expanding or growing their business, buying cars or homes, etc. Financial institutions like banks and NBFCs package a loan with similar loans via securitisation, and investors then purchase these as bonds. These payments are prioritised by risk called tranches and consider the timing of the payments. It allows short-term investors seeking immediate cash flow to repay the loan in the next few months or one year and long-term investors to plan their loan repayment a few to many years out. 

In this guide, you will learn the meaning of securitisation and the significant changes proposed by RBI to its norms. 

What Is Securitisation?

Securitisation is the process of grouping financial instruments together to create asset-backed security. The resulting security is sold to investors as a distinct unit. The assets are sold to a bankruptcy remote special purpose vehicle in return for an immediate cash payment. 

Securitisation follows a 2 stage process – 

• Stage 1 involves the sale of assets to a SPV (special purpose vehicle) in return for immediate cash payment, known as DA or Direct Assignment transaction. 
• Stage 2  involves repackaging and selling the security interests representing claims on incoming cash flows from the assets to third-party investors by issuing debt securities called Pass Through Certificates . 

Securitisation aims to pool illiquid financial assets, such as credit card debts, mortgages or accounts receivables, and create liquidity for the issuing firm. Securitisation helps create liquidity for financial institutions, and they can create new capital to be offered as loans to other consumers. 

If you want to meet your securitisation needs and simplify transactions, you have to get on board Yubi Pools , an End-to-End Digital Securitisation Platform. The extensive product capabilities of the platform help you manage the entire lifecycle of Direct Assignment and Pass Through Certificate transactions across Origination, Execution, and Fulfilment.

What are the Major Changes Proposed by RBI in Securitisation Norms?

In the hopes of developing a robust market, RBI proposed some significant changes in securitisation norms. The revision in guidelines attempts to sync the regulatory framework with the Basel guidelines on securitisation that came into effect on January 1, 2018. Some of the salient features of the draft securitisation guidelines are given below:

• Transactions that result in multiple tranches of securities that reflect different credit risks are the only transactions that will be treated as securitisation transactions. 
• Staying aligned with the Basel-III guidelines, Securitisation External Ratings Based Approach or SEC-ERBA and Securitisation Standardised Approach or SEC-SA are the two capital measurement approaches that have been proposed. 
• A particular case of securitisation called STC or Simple, Transparent, and Comparable securitisations has been prescribed in the draft guidelines. It comes with clearly defined preferential capital treatment and criteria. 
• To allow single asset securitisations, the definition of securitisation has been altered. As per the revised guidelines, securitisation of exposures purchased from other lenders will be allowed. 
• The draft proposes a differential treatment for RMBS or Residential Mortgage Backed Securities compared to other securitisations in respect of prescriptions regarding MRR (minimum retention requirements), MHP (minimum holding period) and reset of credit enhancements. 

The proposed guidelines apply to all banks, non-banking financial companies, and all-India financial institutions. Housing finance companies must also abide by the latest changes in securitisation norms. 

What Is the Master Direction Issued by RBI for Securitisation of Standard Assets and Loan Transfer? 

RBI issued a master direction on transferring loan exposures and securitising standard assets. The directions came after RBI considered public comments on the draft rules, which were issued on June 8, 2020. The objective is to transform the opaque and complex securitisation structures to promote financial stability. 

The master direction will apply to all scheduled commercial banks in India. But the small finance banks, regional rural banks, all-India term financial institutions, and NBFCs will be excluded. 

In the master direction , RBI specified the MRR or minimum retention requirement for different asset classes. 

• For underlying loans with an original maturity of twenty-four months or less, the MRR will be 5% of the book value of the loans being securitised. 
• Loans with bullet payments or original maturity of more than twenty-four months will have a 10% MRR of the book value of the loans being securitised. 
• The MRR for the originator will be 5% of the book value of the loans being securitised in the case of residential mortgage-backed securities, regardless of the original maturity. 

The direction added that the minimum ticket size for issuance of securitisation notes will be one crore. 

Additionally, the central bank issued Reserve Bank of India (Transfer of Loan Exposure) Directions, 2021, which requires NBFCs, banks and other leading financial institutions to have a detailed board-approved policy pertaining to such transactions. 

There are various reasons why lenders resort to loan transfers, and it can range from rebalancing their strategic sales or exposures to managing liquidity. Additional revenues for raising liquidity will be created if there’s a robust secondary market in loans. 

The master direction prescribes a minimum holding period for different loan categories, and the loan will become eligible for transfer after this period. 

According to the master direction, the lenders need to put in place a comprehensive Board-approved policy for acquiring and transferring loan exposures. The guidelines must lay down the qualitative and quantitative standards related to valuation, due diligence, requisite IT systems for storage, data capture and management, periodic Board level overnight, risk management, etc. Moreover, the master direction directs that loan transfers must immediately separate the transferor from the rewards and risks associated with loans to the extent that the economic interest has been transferred. 

According to the master direction of RBI, the assets eligible for securitisation are as follows:

• Lenders, including overseas branches of Indian banks, will not undertake the securitisation activities or assume securitisation exposures as re-securitisation exposures, synthetic securitisation and structures in which short-term instruments are issued against loan-term assets. 
• It has been cleared that securitisation of exposures held by overseas branches of Indian banks will not contravene any extant regulatory or legal framework provisions, including Foreign Exchange Management Act, 1999 and the regulations or rules thereunder. 
• The originators of the exposures must satisfy the Minimum Holding period requirement according to Clause 39 of the Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 . 

Rating Criteria – Securitisation Transactions

A typical securitisation transaction structure is shown below. 

The originator is the seller of the assets, and it can be a financial institution/bank/company that had originally lent to the underlying Borrower. The sale is made to a special purpose entity (SPE), and the SPE raises funds from investors by issuing PTCs, and the proceeds are paid to the originator. 

The different types of securitisation transactions are as follows:

• Residential mortgage-backed securities 
• Personal loans like Micro credit-backed securities 
• Asset-Backed Securities, such as tractor loans and CVs

The rating criteria may differ but a general overview is explained below. The image shows the factors taken into consideration during the process. 

For more information on securitisation or to fulfill your specific needs, head over to the Yubi Invest platform. It is a one-stop platform dedicated to taking care of your securitisation requirements without any fuss. 

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RBI increases responsibilities of loan transfer parties

T he Reserve Bank of India (RBI) issued the Transfer of Loan Exposures Directions, 2021 (directions) in September 2021, which prescribe a comprehensive and robust framework to facilitate the sale, transfer and acquisition of loan assets, both standard and stressed, in the secondary market by lenders. These directions are applicable to all forms of loan transfers, including novation, assignment and loan participation.

Based on the recommendation of the Task Force on the Development of Secondary Market for Corporate Loans, the Committee on Development of Housing Finance Securitisation Market in India and the public responses received, it was decided to separate the regulatory guidelines for direct assignment transactions from the securitisation guidelines, and to revisit the guidelines for the sale of both standard and stressed exposures, which currently are contained in a number of circulars.

The directions make existing guidelines consistent with the changed resolution paradigm in the form of the Insolvency and Bankruptcy Code, 2016 (IBC) and the Prudential Framework for Resolution of Stressed Assets issued by way of the circular of 7 June 2019 (prudential framework). The directions are specific to the asset classification of the loan exposure being transferred; the nature of the entity, and the mode of transfer.

Other important provisions of the directions include situations where, in loan participation transactions, the legal ownership remains entirely with the transferor even after the beneficial interest has been transferred to the transferee. In such cases, the roles and responsibilities of the transferor and transferee shall be clearly delineated contractually. Loan transfers should result in the transfer of economic interest with no change in the loan contract. If there are any modifications, such as take-out financing, they shall be evaluated against the definition of restructuring contained in the prudential framework.

A loan transfer should result in the immediate removal of the transferor from the risks and rewards associated with loans to the extent that the economic interest has been transferred. In the case of any retained economic interest, the loan transfer agreement should clearly specify the distribution of the principal and interest income. The transferee should have the unfettered right to transfer or otherwise dispose of the loans free of any restraining conditions, including any consent requirement when it comes to resolution or recovery, to the extent of the economic interest transferred to them.

Lenders, regardless of whether they are transferors or otherwise, should not offer credit enhancements or liquidity facilities in any form in the case of loan transfers. A transferor cannot re-acquire a loan exposure, either fully or partially, that has been transferred by the entity previously, except under the prudential framework or the IBC.

In domestic transactions, the transferee should ensure that the transferor has strictly adhered to the minimum holding period requirements (MHP), which are three months for loans up to two years, and six months for loans of longer periods. For project loans, the period is calculated from the date of commencement of commercial operations of the project being financed. MHP is not applicable to the transfer of syndicated loans.

A transferor may transfer a single loan or a portfolio of loans that are not in default to permitted transferees through assignment or novation, or a loan participation contract. The transfer shall be for cash, received no later than at the time of transfer, transparently on an arm’s length basis. Where transfers result in a change of lender of record under a loan agreement, the transferor and transferee should ensure that the existing loan agreement provides for consent by the borrower to such transactions.

The transfer of stressed loans must be through assignment or novation only, not through loan participation. Lenders shall transfer stressed loans, including by way of bilateral sales or e-auction platforms, only to permitted transferees and asset reconstruction companies. The transferor must not assume any operational, legal or any other type of risks relating to the transferred loans, including additional funding or commitments to the borrower or transferee that relate to the loan transferred.

Aditya Vikram Dua is an associate partner and Parvathi Menon is an associate at SNG & Partners .

SNG & Partners One Bazaar Lane, Bengali Market New Delhi – 110001 India

www.sngpartners.in

Contact details Tel: +91 11 4358 2000 Email: [email protected]

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RBI’S Framework For Transfer Of Loan Assets.

RBI Image: Wikipedia

As an anticipated measure for the banking and financial sector, the Reserve Bank of India (RBI) has, towards the close of past week, issued the comprehensive framework for the sale or transfer of loan assets. Taking immediate effect from the date of its issuance, the framework titled ‘ Master Directions - Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 ’ issued vide circular DOR.STR.REC.52/21.04.048/2021-22 dated September 24, 2021 (the ‘ Master Directions ’) is being seen as a pivotal move by the Regulator towards introducing an efficient secondary market for loans and ensuring proper credit-risk pricing, besides improving transparency in the identification of embryonic stress in the banking system as well as resolution of stressed loan exposures.

The Master Directions owes its genesis to the ‘ Draft Framework for Sale of Loan Exposures ’ which was released by RBI in course of the first COVID-19 induced lockdown in the Country. The draft had taken into consideration the recommendations of the ‘ Task Force on Development of Secondary Market for Corporate Loans ’ constituted by RBI under the chairmanship of Mr. T.N. Manoharan in May, 2019 and comments from the stakeholders were invited. One of the key components of the Task Force’s recommendation was to separate the regulatory guidelines for direct assignment transactions from the securitization guidelines and treat it as a sale of loan exposure. The RBI had, accordingly, reviewed the recommendations and thought it prudent to comprehensively revisit the guidelines for sale of loan exposures, both standard as well as stressed, which were earlier spread across various circulars. The erstwhile guidelines or circulars on sale of loan exposures were particular to the asset classification of the loan exposure being transferred and / or the nature of the entity to which such loan exposure is transferred as well as the mode of transfer of the loan exposures. The need for a review also stemmed from the necessity to dovetail the guidelines on sale of loan exposures with the Insolvency and Bankruptcy Code, 2016 (‘ IBC ’) and the Prudential Framework for Resolution of Stressed Assets dated June 7, 2019 (“ Prudential Framework ”), which has witnessed substantial traction and developments towards building a robust resolution paradigm in India in the recent past.

The consolidation by RBI of a self-contained, comprehensive, and independent set of regulatory guidelines on transfer/sale of loan exposures is being seen as a laudable step in the direction of putting together a ‘ robust secondary market in loans which can be an important mechanism for management of credit exposures by lending institutions and also create additional avenues for raising liquidity ’. This write-up attempts to briefly summarize some key components of the Master Directions.

The Master Directions whilst superseding a host of existing circulars/directions (or a portion thereof) in relation of transfer of loan exposures (Chapter VI), has put forth a unified and singular framework for the sale of loan exposures by banks and other financial institutions. The exhaustive breadth of the framework is quite evident from the Chapters under the Master Directions which not only provide for ‘ General Conditions applicable to all Loan transfers ’ (Chapter II), but also cater specifically to transfer of loan exposures of standard assets (Chapter III) as well as stressed loan exposures (Chapter IV), including their respective and intrinsic modalities. The framework concludes with the imperative of ‘ Disclosures and Reporting ’ (Chapter V) and stipulates the mechanism for the stakeholders in that regard.

Applicability

On expected lines, nearly all constituents of the Financial sector regulated by RBI are mandated to ensure compliance to the Master Directions, both as a transferor as well as transferee of the loan exposures – Scheduled Commercial Banks, all NBFCs (including HFCs), Regional Rural Banks, Co-operative Banks, All India Financial Institutions and Small Finance Banks. In addition, the Master Directions also permits asset reconstruction companies (ARCs) [1] and companies [2] (save a financial service provider [3] ) to be ‘transferees’ of the loan exposures only if the same is pursuant to the resolution plan under the Prudential Framework and if they are permitted to take on loan exposures in terms of a statutory provision or under the regulations issued by a financial sector regulator.

It would be pertinent to take note that though all lenders permitted to acquire loans are required to ensure compliance to the extant Master Directions; yet, the acquisition of loans pursuant to securitization are required to be independently dealt under the provisions of RBI’s ‘ Master Directions – RBI (Securitization of Standard Assets) Directions, 2021 ’ dated September 24, 2021 (the ‘Securitization Guidelines’). The coverage of the Master Directions includes transfer of loan exposures through novation, assignment, or risk participation. In cases of loan transfers other than loan participation, legal ownership of the loan shall be mandatorily transferred to the Transferee to the extent of economic interest transferred under the loan exposures.

For the Transferees which are financial sector entities (not falling under clause 3 of the Master Directions) and the ARCs, the prudential norms (asset classification, provisioning norms etc.) of their respective sectoral regulators (SEBI, IRDA, PFRDA etc.) shall be applicable post-acquisition of loan exposure under the Master Directions.

Basic Ingredients

Before venturing into the other nuances, it is an imperative that one accounts for the understanding of some key ‘constructs’ which cut across the Master Directions:

* Transfer : Quite apparently, the expression denotes the process of transfer of the economic interest in a loan exposure by the transferor and acquisition of the same by the transferee. The subject matter of transfer being the ‘ economic interest ’ of the transferor in the loan exposure, it is important that the risks and rewards associated with loans are clearly demarcated and separated in favour of the transferee; especially when some portion of the economic interest in the loan exposure is retained by the transferor.

It is significant to take note that the transfer of the said economic interest can be with or without the transfer of underlying contract. Essentially, even loan participation transaction have also been recognized under the Master Directions (for transfer of standard loans) wherein the transferor transfers all or part of its economic interest in a loan exposure to transferee without the actual transfer of the loan contract, and the transferee(s) fund the transferor to the extent of the economic interest transferred which may be equal to the principal, interest, fees and other payments, if any, under the transfer agreement.

* Transferor : Often referred as ‘assignor’ (in assignment transactions) or ‘grantor’ (for risk participation), transferor under the Master Directions would include Clause 3 entities which transfer their economic interest in the loan exposures.

* Transferees : These refer to entities in whose favour the economic interest in the loans are transferred and would include Clause 3 entities as well as the ARCs/companies to the extent permitted under the Master Directions. It is clarified that the transferee should neither be a person disqualified under the IBC [4] nor, in cases of loan exposures where frauds have been identified, belong to an existing promoter group [5] of the borrower or its subsidiary / associate / related party [6] etc. (domestic as well as overseas).

v Minimum Holding Period (MHP) : As the expression suggests, the MHP refers to a threshold period for which the transferor should hold the loan exposures, along with its risks and rewards, before the economic interest in respect thereto is transferred. The intent of having a MHP is to ensure that the loan has been seasoned in the books of the originator (or the transferor) for a certain specified time period. The MHP for loans with tenor up-to 2 years and more than 2 years, as per the Master Directions, have been capped at 3 months and 6 months, respectively.

The holding period for the Transferor, in case of secured exposures, is to be computed from the date of registration of the underlying security interests; unless, of course, the loan is unsecured in which case the MHP runs from the date of first repayment under such unsecured exposure. However, in case of project loans, the foregoing months of MHP is required to be calculated from the date of commencement of commercial operations of the project being financed. Besides, the loans acquired by the Transferor itself are required to have a MHP of at-least 6 months from the date of acquisition of the loan on the books of the Transferor, irrespective of the tenor of the loan exposures.

It would be of significance to note that the MHP criteria prescribed under the Master Directions do not apply for loans transferred by an arranging bank under a syndication arrangement.

* Permitted Transferees : These include (i) Scheduled Commercial Banks, (ii) NBFCs (including HFCs), (iii) All India Financial Institutions and (iv) Small Finance Banks. The significance of carving out the foregoing financial sector entities from Clause 3 of the Master Directions lies in the fact that the transferor is permitted to transfer its loans (which are not in default) to permitted transferees only through novation, assignment, or loan participation. For the stressed exposures, the transfer is mandated only to such permitted transferees and ARCs and singularly through assignment or novation of such loan exposures.

Underlying Elements

The finer nuances of the Master Directions would certainly surface once the provisions have been widely given effect to by the stakeholders; however, as it stands, the framework undoubtedly promises to streamline the procedures and requirements for the stakeholders considering transfer of their loan exposures – standard as well as stressed. Some fundamental provisions of the Master Directions have been summarized as below:

* Overarching Transfer conditions : Quite categorically, the Master Directions stresses on the necessity of delineation of Transferor’s ‘risks and rewards’ associated with the loan exposures to the extent of the transfer. In fact, it is stated that not only should the transferee have the unrestrained and unconditional entitlement to transfer or dispose of the loans to the extent of economic interest acquired by it, but also in the event of any economic interest in the loan exposure is retained by the transferor, the loan transfer agreement should demarcate the distribution of the principal and interest income from the transferred loan between the transferor and the transferee. The Master Directions also caution against any modification of terms of the underlying financing agreement and require that any change, in course of such transfer, should withstand the test of not being categorized as ‘Restructuring’ under the Prudential Framework. It would be significant to take note that the transfer of loan exposures under the Master Directions not only should be without recourse to the Transferor, but also the transferor or transferee should not be constrained to obtain consent from the transferee/ transferor, as the case may be, in the event of resolution or recovery in respect of the beneficial economic interest retained by or transferred to the respective entity. In addition to the foregoing, the Master Directions also prescribe for the enumerated conditions applicable to all transfers of loan exposures:

(i) The Transferor shall have no obligation to re-acquire or fund the re-payment of the loans or any part of it or substitute loans held by the Transferee or provide additional loans at any time;

(ii) If the security interest is held by the Transferor in trust with the Transferee as the beneficiaries, the Transferee shall ensure that a mutually agreed and binding mechanism for timely invocation of such security interest is put in place;

(iii) Any rescheduling, restructuring or re-negotiation of the terms of the underlying agreement attempted by Permitted Transferee, after the transfer of assets to the transferee, shall be as per the Prudential Framework;

(iv) The Clause 3 entities, regardless of whether they are transferors or otherwise, should not offer credit enhancements or liquidity facilities in any form in the case of loan transfers.

In case the transfer of loan exposures which are not compliant with the requirements mentioned in the Master Directions, the onus is on the Transferee to maintain capital charge equal to the actual exposure acquired and the Transferor is required to treat the transferred loan in its entirety, as if it was not transferred at all in the first place, and the consideration received by it shall be recognized as an advance.

* Board-approved Policy : The Transferors are mandated to put in place a comprehensive Board-approved policy for transfer and acquisition of loan exposures under the Master Directions. These guidelines must, inter alia , lay down the minimum quantitative and qualitative standards relating to due diligence, valuation, requisite IT systems for capture, storage and management of data, risk management, periodic Board level oversight, etc. Further, the policy must also ensure the independence of functioning and reporting responsibilities of the units and personnel involved in the transfer/acquisition of loans from that of personnel involved in originating the loans.

* Transfer of Standard Assets : The transfer of loan exposures classified as ‘standard’ can be undertaken through the mechanisms of assignment or novation or a loan participation. The transfer of such loan exposures should be only on a cash basis to be received at the time of transfer of loans; besides, the requirement of the transfer consideration being arrived at in a transparent manner on an arm's length basis. The Master Directions require the Transferees to monitor, on an ongoing basis and in a timely manner, the performance information on the loans acquired, including through conducting periodic stress tests and sensitivity analyses, and take appropriate action required, if any. Further, the Transferor’s retention of economic interest, if any, in the loans transferred should be supported by legally valid documentation supported by a legal opinion.

The requirements of Chapter III of the Master Directions are, however, not applicable to certain identified loan transfers, as below:

(i) transfer of loan accounts of borrowers by a lender to other lenders, at the request/instance of borrower;

(ii) inter-bank participations as per the RBI’s circulars;

(iii) sale of entire portfolio of loans consequent upon a decision to exit the line of business completely;

(iv) sale of stressed loans; and

(v) any other arrangement/transactions, specifically exempted by the RBI.

* Minimum Risk Retention : The Master Directions are explicit in their requirement of the requisite due diligence in respect of the loans exposures and mention that the said exercise cannot be outsourced or delegated by the Transferee. In order to ensure a systemic departure from the conventional practice of placing solitary reliance on the due diligence of the originator (or the Transferor), the Master Directions mandate the Transferee to undertake the due diligence of the loan exposures through its own staff, at the level of each loan, and as per the same policies as would have been done had the Transferee been the originator of the loan. In case the due diligence of entire portfolio is undertaken by the Transferee, the requirement of a minimum retention requirement (MRR) of the Transferor can be dispensed with.

However, in case of loans proposed to be acquired as a portfolio, if a transferee is unable to perform due diligence at the individual loan level for the entire portfolio, the Transferor shall retain at least 10% of economic interest in the transferred loans as MRR. In such a case as well, the Transferee is required to undertake due diligence at the individual loan level for not less than one-third (1/3 rd ) of the portfolio by value and number of loans in the portfolio. As per the Master Directions, in case of multiple Transferees, the MRR would still be on the entire amount of transferred loan, even if any one of the transferee is unable to perform the due diligence at an individual level.

* Transfer of Stressed Assets : Chapter IV of the Master Directions deals specifically with the transfer of stressed loan exposures to ARCs and other Permitted Transferees. It is specifically stated that the mechanism for transfer of such stressed accounts can be consummated only through assignment or novation. Besides the requirement of a Board-approved policy for transfer as well as acquisition of stressed loan exposures and the parameters thereof, the Master Directions mandate such transfers to ARCs and other Permitted Transferees only. Importantly, the Transferor is necessarily required to undertake an auction through a ‘ Swiss Challenge method ’ both in cases where (i) the aggregate loan exposure to be transferred is Rs. 100 crore or more after bilateral negotiations; and even under (ii) a transfer pursuant to the Resolution Plan approved in terms of the Prudential Framework (irrespective of the monetary threshold).

The transfer of such stressed loan exposures, as per the Master Directions, should be bereft of any operational, legal or any other type of risks relating to the transferred loans including additional funding or commitments to the borrower / transferee. In fact, it is specifically required for the transferor to ensure that no transfer of a stressed loan is made at a contingent price whereby in the event of shortfall in the realization of the agreed price, the Transferor would have to bear a part of the shortfall.

In addition, the Transferor is required transfer the stressed loans to transferee(s) other than ARCs only on cash basis and the entire transfer consideration should be received not later than at the time of transfer of loans. The stressed exposure can be taken out of the books of the Transferor only on receipt of the entire transfer consideration.

Quite significantly, the Master Directions prescribed that if the Transferee of such stressed loan exposure (except ARCs) have no existing exposure to the borrower whose stressed loan account is acquired, the acquired stressed loan shall be classified as “Standard” by the transferee. However, in case the Transferee has an existing exposure to such borrower, the asset classification of the acquired exposure shall be the same as the existing asset classification of the borrower with the Transferee, irrespective of whether such acquisition is pursuant to the transferee being a successful resolution applicant under the IBC.

Further, the Master Directions require the Transferee to hold the acquired stressed loans in their books for a period of at least 6 months before transferring to other lenders; however, such holding period is not applicable in case the transfer of stressed loan exposure is to an ARC or is pursuant to a resolution plan approved in terms of the Prudential Framework.

As regards the mandate of undertaking the ‘Swiss Challenge method’ is concerned, the Master Directions require the lenders put in place a Board-approved policy which should, interalia , specify the minimum mark-up over the base-bid required for the challenger bid to be considered by the lender(s), which in any case, shall not be less than 5% and shall not be more than 15%. However, for transfer of stressed exposure under the Prudential Framework, the minimum mark-up over the base-bid required for the challenger bid is to be decided with the approval of signatories to the ICA representing 75% by value of total outstanding credit facilities and 60% of signatories by number.

Additionally, the Master Directions provide for sharing of surplus between the ARC and the Transferor, in case of specific stressed loans; though, the clarity in respect of such specific stressed loans is not mentioned. The repurchase of stressed loan exposures is also stipulated from the ARCs in cases where the resolution plan has been successfully implemented

* Accounting : In the event the transfer of loan exposures results in loss or profit, which is realized, the same should be accounted for and, accordingly, reflected in the P&L account of the Transferor for the accounting period during which the Transfer is consummated. However, the unrealized profits (if any) arising out of such Transfers, shall be deducted from the Common Equity Tier 1 (CET 1) capital or net owned funds of the Transferor for meeting regulatory capital adequacy requirements till the maturity of such transferred exposures. The Master Directions prescribe maintenance of borrower-specific accounts both by the Transferor as well as the Transferee of the retained and transferred loan exposures, respectively. It has been further clarified that the extant requirements of RBI for ‘income recognition, asset classification, and provisioning’ shall, accordingly, be ensured by the transferor and the transferee with respect to their respective shares of holding in the underlying loan exposures.

Though it would be quite nascent to present an analysis of the Master Directions even before it has been actually implemented, yet there are indeed some crucial aspects which underline the significance of the Master Directions issued by RBI which can be summarized as follows:

*Identification and Resolution of Stressed Exposures : Though quite a premature assessment, yet it is felt that the framework under Master Directions could facilitate the development of a robust distressed asset ecosystem and speed-up the resolution of various stressed exposures, which could be driven by the ensuing characteristics of the Master Directions:

(i) Early Identification and Resolution of Stressed Exposures : The framework has expanded the definition of stressed exposures (‘stressed loans’) to include both non-performing assets (NPAs) and special mention accounts (SMAs). Also, the deregulation of the price discovery process will enable faster and more efficient pricing of exposures – especially when coupled with a wider range of eligible investors.

(ii) Enhanced Viability of Stressed Asset Takeover Structures : More importantly, the Master Directions allow investors in stressed assets to classify the exposure as standard, although subject to any other exposure to the same entity on the investor’s books not being sub-standard on the date of the acquisition of the asset. This could significantly lower capital charge and provisioning requirements for the acquirer/investor of the stressed assets. Given that most stressed assets are restructured as well – often including a complete management overhaul, the rationalization of the capital charge and provisions could make such assets more attractive to prospective acquirers.

*Impetus to Long-Term Funding structures : The Indian credit markets have for long been bereft of avenues for mobilizing capital through long-term debt instruments. As a result, liability structures for corporate borrowers in sectors such as power generation and roads front load cash outflows during the project life. This, at least in part, reflects the non-availability of long-dated liabilities for the financial sector. Therefore, an ecosystem which allows lenders to off-load long-dated exposures after a certain time period with reasonable foresightedness could enable borrowers to raise long-term debt instruments from the financial system in a cost-efficient manner.

*Independent Credit Evaluations Could Prove Critical : The Master Directions mentions that transferees may have the loan pools rated before acquisition so as to have a third-party view of their credit quality in addition to their own due diligence; though, the latter is a mandatory requirement and cannot substitute for the due diligence that the transferee(s) are required to perform. Also, in case of transfer of stressed assets, it becomes critical to ensure that the valuation of the exposure and associated risk capital allocation are based on an assessment of the asset to meet its contractual debt obligations. Even restructured accounts have subsequently come under stress in some cases due to fundamental weaknesses in the business profile, heightened management risk/weak governance structures and unsustainable debt levels even after restructuring. Though not prescribed as a mandatory requirement under the Master Directions, yet a third-party evaluation by a credit rating agency could provide an added layer of assessment and valuations for such exposures along with subsequent capital charge and provisioning norms could be linked to the outcome of such evaluation.

Aditya Bhardwaj, Associate Partner, Link Legal.

[1] Registered with the Reserve Bank of India under Section 3 of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002

[2] Sub-section (20) of Section 2 of the Companies Act, 2013

[3] Sub-section (17) of Section 3 of the Insolvency and Bankruptcy Code, 2016

[4] Section 29A of the Insolvency and Bankruptcy Code, 2016

[5] As defined under SEBI (ICDR) Regulations, 2018

[6] As defined under the Insolvency and Bankruptcy Code, 2016

Disclaimer: The contents of this article are for general information and discussion only and is not intended for any solicitation of work. This article should not be relied upon as a legal advice or opinion.

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RBI's final guidelines on securitisation, direct assignment

Icra research has come out with its report on rbi final guidelines on securitisation and direct assignment transactions- significant decline in volumes expected..

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The sale of season: Holding period requirements for assignments and securitisation

– Team Finserv | [email protected]

Any sale or assignment or transfer, including securitisation, of loans is subject to a minimum seasoning with the originator. Under the extant regulatory provisions, such requirement is referred to as ‘Minimum Holding Period’ (MHP), which means the minimum period for which the originator should have held the loan exposures before the same is transferred to the transferee or Special Purpose Entity (SPE), as the case may be. This serves several purposes: that the loan was not originated for sale, the originator has had some equity in the loans, and that there is a benefit of hindsight of performance.

MHP requirements have always been a part of the regulations in India. However, on December 5, 2022, the Reserve Bank of India (RBI) made certain amendments to the Master Direction – Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 [1] (‘TLE Directions’) as well as the Master Direction – Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021 [2] (‘SSA Directions’). Among the other changes, there was a change in the MHP provisions; this change may have a significant impact on future transactions. 

This write-up intends to clarify the position with respect to the computation of MHP for different types of loans under TLE Directions as well as SSA Directions.

Relevance of CERSAI registration for MHP requirement

The MHP requirements are prescribed under para 39 of the TLE Directions and the same is also applicable for securitisation transactions.

Para 39 of the TLE Directions prescribes the following MHP requirement:

• 3 months in case of loans with tenor of up to 2 years;
• 6 months in case of loans with tenor of more than 2 years.

However, the key question is the starting point of the MHP.

The TLE Directions, as amended, provide for MHP to start from the date of registration of the underlying security interest with Central Registry of Securitisation Asset Reconstruction and Security Interest of India (CERSAI). Further, the proviso to para 39 states that in case of loans where security does not exist or security cannot be registered with CERSAI , the MHP shall be calculated from the date of first repayment of the loan. [Bold was added pursuant to the amendment dated December 5, 2022, and italicised part is for emphasis] .

The requirement for CERSAI registration has been there in the SARFAESI Act over the years; and the RBI has, vide various circulars, been also adding force to the CERSAI registration requirement. However, the present amendment of the TLE and SSA Directions makes CERSAI registration almost compulsive. Except in case of those secured loans where CERSAI registration cannot be done, CERSAI registration becomes the starting point for MHP for most secured loans. As entities will not want to defer a potential opportunity for either an assignment or securitisation of the loans, originators will rush to have CERSAI registrations done upon origination [3] .

The amendment bestows an overwhelming significance to CERSAI registration. Security interest in India may be registered under various forums [4] . However, no other security interest registration shall be considered for counting the MHP. The only exception in para 39 is where security interest cannot be registered with CERSAI, or where there is no security interest, or in case of project loans.

Hence, an important question comes up: what security interest is required to be registered under CERSAI.

MHP for securitisation of loans

But before we delve into such discussion, it is important to take note of the changes in the MHP requirements under the SSA Directions.

The computation of MHP under SSA Directions is provided as follows:

Usually, in case of real estate projects or construction finance, the disbursement is linked to the stages of construction. Now, in case of securitisation of such loans that are not fully disbursed, there could be concerns about the potential lender’s obligation to complete the disbursement, after the loans have been securitised. Though TLE Directions clearly recognise a partial transfer of loans, the same shall not be permitted under the SSA Directions.

Further in cases of loans where the property is under development, for the purpose of computing MHP, the date when full disbursement is completed would in any case be much after the first registration with CERSAI and hence, the same may be considered.

In a nutshell, the MHP computation under TLE Directions and SSA Directions would be as follows:

Registration of Security Interest with CERSAI

The primary requirement of registration of security interest with CERSAI by financial sector entities comes from section 23 of the SARFAESI Act:

Further, section 26D provides for the repercussions of not registering the security interest with the CERSAI, which goes as follows:

Interesting to note that only “secured creditors” are required to ensure registration of security interest with the CERSAI.

The term “secured creditor” has been defined to mean the following entities:

• any bank or financial institution or any consortium or group of banks or financial institutions holding any right, title or interest upon any tangible asset or intangible asset as specified in clause (l); [HFCs having assets of Rs. 100 crores and above are notified as financial institutions pursuant to MoF notification dated June 17, 2021 . Further, NBFCs with asset of Rs. 100 crores and above are entitled for enforcement of security interest in secured debts of Rs. 50 lakhs and above, as financial institutions pursuant to MoF notification dated February 24, 2020 ]
• debenture trustee appointed by any bank or financial institution; or
• an asset reconstruction company whether acting as such or managing a trust set up by such asset reconstruction company for the securitisation or reconstruction, as the case may be; or
• debenture trustee registered with SEBI appointed by any company for secured debt securities; or
• any other trustee holding securities on behalf of a bank or financial institution , in whose favour security interest is created by any borrower for due repayment of any financial assistance.

Also, it must be noted that section 23 states that the registration of security interests should be done in accordance with the manner prescribed. In this regard, SARFAESI (Central registry) Rules, 2011 (‘CERSAI Rules’) [r.w. amendments dated May 15, 2013 and January 22, 2016 ] provide for the manner in which different forms of security interests can be registered with the CERSAI and the applicable fee. The relevant extracts of the rule 4 and rule 7 from the CERSAI Rules, have been provided below:

• Particulars of creation, modification or satisfaction of security interest in immovable property by mortgage by deposit of title deeds or other than by deposit of title deeds.
• Particulars of creation, modification or satisfaction of security interest in hypothecation of plant and machinery, stocks, debt including book debt or receivables, whether existing or future.
• Particulars of creation, modification or satisfaction of security interest in intangible assets, being knowhow, patent, copyright, trade mark, licence, franchise or any other business or commercial right of similar nature.
• Particulars of creation, modification or satisfaction of security interest in any under construction residential or commercial building or a part thereof by an agreement or instrument other than by mortgage.
• Particulars of securitisation or reconstruction of financial assets or satisfaction thereof.

The aforesaid provisions clearly specify the registration of mortgages, assignment of receivables, hypothecation on plant and machinery, stocks and intangible assets. However, the hypothecation of motor vehicles, which is an important asset class in the Indian asset-backed finance industry, is not specifically captured thereunder. Also, there is no residuary clause in the table, under which hypothecation on motor vehicles could be registered with the CERSAI.

Further, based on the inputs received from the CERSAI helpdesk and upon perusal of the CERSAI website, it can be inferred that the security interest created in the form of hypothecation over vehicles are not registered on CERSAI portal; instead, the same is registered on the Vahan registration portal. 

Connecting the above discussion with the new requirements under the TLE Directions, while it is adequately clear that for security interests on assets like immovable properties, plant and machinery, stocks and intangible assets, CERSAI registration is mandatory, and such registration shall become a prerequisite for TLE and also the starting point for the MHP computation. But for security interests on motor vehicles, it is safe to conclude that the absence of machinery provisions in the CERSAI Rules makes the provisions of the SARFAESI Act inoperative.

Therefore, it is safe to conclude that CERSAI registration cannot be deemed a mandatory requirement for the transfer or assignment of loans secured by way of hypothecation on vehicles or security interest on such other assets that cannot be registered on CERSAI portal. The MHP would accordingly be calculated from the first repayment of the loan.

Further, in addition to the above, the SARFAESI Act (section 31) also specifically excludes the following security interests, which will also not require CERSAI registration:

• a lien on any goods, money or security given by or under the Indian Contract Act, 1872 or the Sale of Goods Act, 1930 or any other law for the time being in force;
• a pledge of movables within the meaning of section 172 of the Indian Contract Act, 1872;
• creation of any security in any aircraft as defined in section 2(1) of the Aircraft Act, 1934;
• creation of security interest in any vessel as defined in section 3(55) of the Merchant Shipping Act, 1958;
• any rights of unpaid seller under section 47 of the Sale of Goods Act, 1930 (3 of 1930);
• any properties not liable to attachment (excluding the properties specifically charged with the debt recoverable under this Act) or sale under the first proviso to section 60(1) of the Code of Civil Procedure, 1908;
• any security interest for securing repayment of any financial asset not exceeding Rs. 1 lakh ;
• any security interest created in agricultural land ;
• any case in which the amount due is less than 20% of the principal amount and interest thereon.

The second piece of the law that talks about registration of security interest with the CERSAI is para 108 of the NBFC-NDSI Master Directions / para 94 of NBFC-NSI Master Directions , which requires registration of all mortgages with CERSAI. This requirement is applicable to all NBFCs, irrespective of their size.

Computation of MHP for different types of loans

Based on the above discussion, the table below summarises the date from which computation of MHP should start, for different types of loans:

[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12166&Mode=0

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12165&Mode=0

[3] There is no mandatory timeline for registration of security interest under CERSAI Rules. That is to say, the originator may register security interest even after time lag after origination. However, in that case, MHP will start running not from the date of the origination, but from the date of CERSAI registration.

[4] Our article on Fragmented framework for perfection of security interest can be read here – https://vinodkothari.com/2021/03/fragmented-framework-for-perfection-of-security-interest/

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