A decade after the Global Financial Crisis – Indian Securitisation market poised for a leap forward, by Vinod Kothari & Abhirup Ghosh

With the taxation issues resolved in the Budget 2016, and foreign portfolio investors allowed to invest in asset backed securities, Indian securitisation market is poised for a big leap forward. The indicative data available for the financial year 2016-17 mark a sharp 60% increase in the volume of pass-through securities (PTCs), signaling the much sharper growth to come.

The tax problem referred to above was the tax on distribution of income by the special purpose vehicle (SPV). The Budget 2013 had introduced a tax on distribution of income by SPVs, which actually amounted to a tax on gross income of the securitisation investors, at rates ranging from 25% to 30% percent. This obviously diverted the market almost entirely to the so-called direct assignment (DA) mode, which does not suffer the said distribution tax.

Some unique features of the Indian market:

Before getting into the shape and the growth tangent of the Indian market, it is important to understand a few unique features of the Indian market, distinguishing it from the rest of the world.

Priority sector lending requirement as securitisation driver

Priority sector lending (PSL) is the regulatory mandate to banks in India, whereby banks are required to dedicate a certain percentage of their gross banking advances. Since several banks don’t have the branch network or origination and/or distribution capabilities to handle such loans, they fail to achieve this target by themselves. Regulations permit a bank, failing to achieve the target, to either buy such portfolios from other banks/NBFCs, or to buy pass-through certificates backed by qualifying receivables.

The PSL requirement has been the mainstay of Indian securitisation market for several years. The originations are mostly done by NBFCs, and are lapped by the banks. For several NBFCs, this is just a part of their business model, and accounts for the lower cost of refinancing of the NBFCs’ portfolios.  In fact, most of the transactions pertain to the PSL category.

Direct assignments versus Pass through certificates

The prevalence of a bilateral assignment, almost similar to whole loan sales that take place in several jurisdictions, being taken as a part of securitisation marketplace, is a unique feature of the Indian market.

Market impacted by regulation

As stated earlier, the securitisation distribution tax was a major deterrent for the investors to invest in securitized debt instruments, that why, the focus shifted on direct assignments. But considering the fact that the securitisation structures have now gained tax transparency, there is a high probability that the direct assignments will start dying down.

Non-banking finance companies as originators and banks as investors

It has been noted earlier that the securitisation market was, all these years, driven by priority sector lending requirements. It is typically the banks who look out for investing in priority sector loans portfolio originated by non-banking financial companies, so as to meet the regulatory requirements.

Tax transparency of securitisation transactions

The Union Budget, 2016 has allowed complete pass through of income tax to securitisation trusts and replaced the distribution tax with tax deducted at source. The change in the tax provisions were much awaited by the industry and hopefully will bring back the PTCs transactions allowing the markets to grow beyond direct assignments.

Section 115TCA was introduced to the Income Tax Act, 1961 vide the Finance Budget 2016. As per the said section any income earned by an investor of an securitisation trust, out of the investments made by the securitisation trust, shall be charged to tax in the hands of the investors in the same manner in which it would have been taxed, had the investments of the securitisation trust been made directly by the investor.

Therefore, allowing tax transparency to the securitisation transactions.

However, the Finance Budget 2016 also introduced section 194LBC whereby income payable by securitisation trusts to resident investors shall be subject to tax deductible at source at the rate of 25% for individuals or HUFs and 30% for any other person.

Impressive Growth in the period of financial dislocation

Soon after the removal of the SDT the market, which was otherwise dominated by directed assignment, witnessed a rush in terms of PTC issuances. The gross volume of the PTC issued during the year ending on 31^st March, 2016 stood at Rs. 25,000 crores and the volume of PTCs issued in the very next was roughly around Rs. 40,000 crores reporting a growth of  60%.

The figure below shows the securitisation volumes during the past few years.

Figure 1: Volume of securitisation in India [FY 12 – FY 17]

The market has posed a respectable growth despite the fact that the country witnessed one of the biggest crisis in the recent times, i.e., demonetisation of high value currency notes.

Listing of security receipts

SEBI notified the Securities and Exchange Board of India (Issue and Listing of Securitised Debt Instruments) Regulations, 2008 way back in May 2008, however, not even a single issuance has been listed as of yet.

As per the aforesaid regulations, in order to get an issuance listed, a special purpose vehicle will have to be constituted as per the provisions of the aforesaid regulations and such shall be managed by trustees who are registered with the SEBI.

The various requirements for public offer and listing of securitized debt instruments are as follows:

1. Assignment of debt or receivables:
   • Will have to be done in accordance with Regulation 10, which states the transfer should be by way of a true sale.
   • The assignment must be done of identifiable stream of cashflows that are free from encumbrances and set-off and the originator must have valid enforceable interest on the assets prior to securitisation.
   • The assignment of the debt or receivables must happen at arm’s length for commercial consideration
   • Originator must have obtained all necessary regulatory and contractual consents for such assignment and adheres to all representations and warranties with regard to receivables.
2. Scheme of SPVs:
   • Fund raising by SPVs will have to be done only through offer of securitized debt instruments by launching one or more schemes
   • There may be an option for clean-up call
   • The winding up of the scheme shall happen in any of the following manner: a) on full redemption of the securitised debt instruments, b) attaining legal maturity as stated in the terms of issuance and c) vote of investors by special resolution for the winding up of the scheme
3. Credit enhancements and liquidity facilities, if any, will have to mentioned in the offer documents
4. The maximum security receipts that an originator can retain is 20% of total issue size
5. The instruments will have to be rated mandatorily and the ratings shall have to be mentioned in the offer documents.

Innovative structures during the year

With every passing year, the securitisation market in India is getting more and more matured and new structures are getting tried and tested. In the past years we have seen innovations like mortgage guaranteed securitisation structures, multiple originator securitisation structures and CBO/CLO transactions being tried in the market.

This year has been no different and there have been few innovative structures that have been tried. The same have been discussed briefly below:

Trade receivables securitisation[1]:

This year witnessed the first instance of the trade receivables securitisation in India. Barclays Bank PLC had discounted Rs. 1,125.53 crore worth of letters of credit issued by LC Banks. The tenure of the LCs stood were over 365 days from the LC discounting date. The transaction was carried out through three Trusts wherein receivables against 45 LCs issued by 5 domestic banks were transferred. The transaction was rated by ICRA Ratings and a credit rating of ICRA A1+ [SO] was assigned to the PTCs issued under the transaction.

SME Debt Pool Program[2]:

This is a one of its kind transaction where IntelleGrow arranged for a transaction wherein debt of the 7 SMEs in the country were pooled together to do a single bond securitisation issuance. The first issuance amounted to INR 320 million (USD 5.3 million).

Looking forward

The benefits reaped by the market participants from the revised taxation framework is very clear from the shift in the volume of transactions, this only indicates that the securitisation will no more be driven only the PSL requirements in India and the market participants will start looking at the economics of securitisation as well. It is almost certain that there will be shift in focus from direct assignments towards PTC issuances.

Though the change in the foreign exchange regulations, permitting FPIs to invest in securitised debt instruments, has not yet been able to create much of an impact, but there is a strong likelihood that it will take off in the upcoming financial year(s).

We have indicated the reason due which the mutual funds are currently staying away from the market, but it is felt owing to the removal of tax concerns, the presence of mutual funds in the Indian securitisation market will increase.

The market has already witnessed the first trade receivable securitisation transaction during the last year and looking at the rapid growth in the scope for trade credits in India, it seems this will be the asset class to look out for in the next financial year.

Also, there has been sharp growth in the P2P lending space, so there is a possibility of witnessing few transactions being tried in this space as well.

The ongoing efforts by various stakeholders in the market only indicate that the securitisation in India is here to stay.

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[1] http://www.icra.in/Files/Reports/Rationale/Barclays%20Bank%20%20-R-28022017.pdf

[2]http://www.indianweb2.com/2016/09/29/intellegrow-launches-indias-first-sme-debt-pool-program-collaboration-symbiotics-geneva/