Comparison of the Draft Securitisation Framework with existing guidelines and committee recommendations

On 8th June, 2020, RBI issued the Draft Framework for Securitisation of Standard Assets for public comments. This draft Framework has brought about major changes in the regulatory framework governing securitisation. This framework on one hand, brings with itself a few new concepts to securitisation and alters the existing framework on the other. The capital requirements are aligned with that of Basel framework for securitisation, besides the minimum quantitative threshold. We have come up with a detailed analysis of capital requirements under the draft framework in another write up titled ‘Inherent inconsistencies in quantitative conditions for capital relief‘.
In continuation of our earlier brief write-up titled New regime for securitisation and sale of financial assets, here we bring a point by point comparative along with our comments on the changes. Further, we have covered the Draft Directions on securitisation in a Presentation on Draft Directions on Securitisation of Standard Assets. 

Particulars.Draft framework for securitisation of standard assets dated June 8, 2020Guidelines for securitisation of standard assets, 2006 and 2012Recommendations of Committee on the Development of Housing Finance Securitisation Market
General requirements for securitisation
Eligible assetsAll on-balance sheet standard exposures, except the following, will be eligible for securitisation by the originators:
a. Revolving credit facilities (e.g. Cash Credit accounts, Credit Card receivables etc.);
b. Loans with bullet repayments of both principal and interest; and
c. Securitisation exposures
d. Loans with tenor up to 24 months extended to individuals for agricultural activities defined under PSL directions where both interest and principal are due only on maturity and trade receivables with tenor up to 12 months discounted/purchased by lenders from their borrowers will be eligible for securitisation subject to the condition that the borrower/ drawee has fully repaid the entire amount of last two loans/receivables within 90 days of the due date.
In a single securitisation transaction, the underlying assets should represent the debt obligations of a homogeneous pool of obligors. Subject to this condition, all on-balance sheet standard assets except the following, will be eligible for securitisation by the originators:
i) Revolving credit facilities (e.g., Credit Card receivables)
ii) Assets purchased from other entities
iii) Securitisation exposures (e.g. Mortgage-backed / asset-backed securities)
iv) Loans with bullet repayment of both principal and interest
v) Trade receivables with tenor up to 12 months discounted/purchased by lenders from their borrowers will be eligible for securitisation. However, only those loans/receivables will be eligible for securitisation where a drawee of the bill has fully repaid the entire amount of last two loans/receivables within 180 days of the due date
Assigned assets should be eligible for securitisation by the assignee as long as the underlying mortgage pool satisfies all the other relevant regulatory conditions for securitisation.
Our Comment: The eligibility of securitisable assets remains similar, except for one. The draft Directions proposes to allow securitisation of receivables acquired from elsewhere, provided they are held for a period of 12 months. A minimum holding period of 12 months will prevent misuse of this provision. However, provisions of para 30 seem to be mismatching with this requirement. Further the draft Directions clarify that the bar on bullet loans is only in cases where both principal and interest are payable on maturity. That is to say, if the interest is regularly serviced, but the principal is paid as bullet repayment, the asset will remain eligible
Securitisation activities / exposures not coveredLenders in India, including overseas branches of banks in India, are not permitted to undertake the securitisation activities or assume securitisation exposures as mentioned below:
a. Resecuritisation exposures;
b. Synthetic securitisation; and
c. Securitisation with revolving credit facilities as underlying – These involve underlying exposures where the borrower is permitted to vary the drawn amount and repayments within an agreed limit under a line of credit (e.g. credit card receivables and cash credit facilities).
Lenders in India are not permitted to undertake the securitisation activities or assume securitisation exposures as mentioned below –
a. Re-securitisation of Assets
b. Synthetic Securitisations
c. Securitisation with Revolving Structures (with or without early amortisation features)
This is same as before.
Single asset securitisation“securitisation” means the set of transactions or scheme wherein credit risk associated with eligible exposures is tranched and where payments in the set of transactions or scheme depend upon the performance of the specified underlying exposures as opposed to being derived from an obligation of the originator, and the subordination of tranches determines the distribution of losses during the life of the set of transactions or scheme; Provided that the pool may contain one or more exposures eligible to be securitised;2006 definition included- single asset. However, the same was removed in 2012- In a single securitisation transaction, the underlying assets shall represent the debt obligations of a homogeneous pool of obligors
Our Comment: The concept of a single asset securitisation is completely new. Of course, for the purpose of STC label, it has to be a homogenous pool of assets; but for plain securitisation, the requirement for a pool or homogeniety goes away. The very idea of a single asset securitisation is actually counter-intuitive, because, in the same breath, the Directions also define securitisation as consisting of more than one tranche. The question of tranching a single asset does not arise. In fact, a single asset securitisation will be no different from loan sell-off, which was responsible for some of the malpractices noted by the RBI just before the 2006 Guidelines.
MHP requirements– Same as 2012 guidelines for assets other than residential mortgages.
– If the underlying exposures comprise of bank loans, lenders can securitise the loans only after a minimum holding period counted from the date of full disbursement of loans for an activity/purpose; acquisition of asset (i.e., car, residential house etc.) by the borrower or the date of completion of a project, as the case may be
– In case of loans purchased from other entities by a transferor – MHP of 12 months is required, which will be reckoned from the date on which the loan was taken to the books of the transferor.
– In the case of loans with bullet repayments of only either principal and interest – the MHP requirement will be reckoned based on the repayment frequency of principal or interest, as the case may be, that has a periodic repayment schedule.
– For residential mortgages, against which RMBS will be issued by the special purpose entity, the MHP applicable will be 6 months or period covering 6 instalments whichever is later.
– The MHP will be applicable to individual loans in the underlying pool of securitised loans. MHP will not be applicable to loans referred to in clause 7 (PSL loans).
MHP was applicable to various loans depending upon the tenor and repayment frequency. However, the same did not differentiate based on the nature of loans.For mortgage-backed securitisation, the minimum holding period should be reduced to six months/six-monthly instalments (permanently)
Our Comment: The change proposed for residential mortgages is a welcome change. under the existing framework, almost all the residential mortgages fall under the top bracket for MHP, that is, 12 months MHP becomes applicable on all cases. In case of residential mortgages, the full disbursement of the facility happens over a period of time. The minimum holding period along with the time spent until the full disbursment, together, makes the effective holding period significantly longer than the prescribed. Therefore, a reduction in the MHP was strongly advocated by the industry.

The word “acquisition of an asset” may cause confusion as it may have several meanings attached to it.

MRR requirements-Underlying loans with original maturity of 24 months or less- 5%
-Underlying loans with original maturity of more than 24 months as well
as loans with bullet repayments- 10%
– Residential mortgage backed securities -5%
-Underlying loans with original maturity of 24 months or less- 5%
-Underlying loans with original maturity of more than 24 months as well as loans with bullet repayments- 10%
For mortgage-backed securitisation, the MRR should be reduced to 5% or equity (non-investment grade) tranches, whichever is higher. Any first loss credit enhancement provided by the originator will be included in the MRR. If the equity tranche and credit enhancement together are less than 5%, then the difference must be held pari passu in other tranches.
Manner of maintenance of MRR-First loss tranche or other tranches pari passu and with similar terms as offered to the invetsors
-First loss exposure of not less than MRR of every securitised exposure in the securitisation transaction
– Investment in the securities issued by the SPV
-Credit enhancement
– Investment in equity tranche
Our Comment: Residential mortgages are one of the safest asset class in the retail segment. treating it at par with other riskier asset classes is not appropriate. this issue was discussed at length in the Harsh Vardhan Committee report and the recommendations made therein have been accepted.

Further, 5% can be combination of first loss and equity tranche.

Investments not eligible for the purpose of MRRInvestment in the Interest Only Strip representing the Excess Interest Spread/
Future Margin Income, whether or not subordinated, will not be counted towards
the MRR.
Investment in the Interest Only Strip representing the Excess Interest Spread/ Future Margin Income
This is similar to current requirements, however, subordination will not matter for counting MRR.
Originating standardsUnderwriting standards –
– Should not be less stringent than those applied to credit claims and receivables retained on the balance sheet of the originator.
– Where underwriting standards change, the originator should disclose the timing and purpose of such changes.
– In cases of securitisation of exposures purchased by originator from other lenders, the requirements applicable for underwriting standardsshall apply to the standards of due diligence process adopted by the originator which may include verification of consistency of loan origination process of the lender from whom the exposures were purchased by the originator
– The originators should apply the same sound and well-defined criteria for credit underwriting to exposures to be securitised as they apply to exposures to be held on their book.
– To this end, the same processes for approving and, where relevant, amending, renewing and monitoring of credits should be applied by the originators.
The Committee Report talked about establishing underwriting standards for mortgage loans by the market intermediary proposed to setup for the development of a mortgage securitisation market in India.
The standards relating to origination remains similar in case of self originated assets. However, a new section is added for exposures acquired from elsewhere. Standards, similar to origination standards, must have been adopted while carrying out due diligence of the exposures acquired.
Payment priorities and observability– Priorities of payments should be clearly defined at the time of securitisation;
– Appropriate legal comfort regarding their enforceability should be provided;
– Junior liabilities should not have payment preference over senior liabilities which are due and payable.
– All triggers affecting the cash flow waterfall, payment profile or priority of payments of the securitisation should be clearly and fully disclosed in offering documents and in investor reports, with information in the investor report that clearly identifies the breach status, the ability for the breach to be reversed and the consequences of the breach.
Securitisations featuring a replenishment period should include provisions for appropriate early amortisation events and/or triggers of termination of the replenishment period, including, notably:
a. deterioration in the credit quality of the underlying exposures;
b. a failure to acquire sufficient new underlying exposures of similar credit quality; and
c. the occurrence of an insolvency-related event with regard to the originator or the servicer.
No such provision. However, disclosure of payment waterfall was mandated.
Our Comment: The existing guidelines hardly speaks anything about payment priorities. However, in the proposed guidelines, this has been taken up at length. Not only does the guidelines require detailed disclosure regarding payment priorities, but also appropriate legal comfort regarding the same. This is in all likelihood, has been inserted in light of the legal proceedings relating to payment to investors to securitisation transactions executed by a leading housing finance company.

Also, for the first time, the regulators have recognised replenishing structures, which are also called revolving structures. The guidelines also require disclosures relating to early amortisation triggers for revolving structures

Limit on Total Retained Exposures– The total exposure of a lender to the securitisation exposures belonging to a particular securitisation structure or scheme should not exceed 20% of the total securitisation exposures created by such structure or scheme.
– Credit exposure on account of interest rate swaps/currency swaps entered into with the SPE will be excluded from this limit.
– The 20% limit on exposures will not be deemed to have been breached if it is exceeded due to amortisation of securitisation notes issued.
The total exposure of lenders to the loans securitised in the following forms should not exceed 20% of the total securitised instruments issued :
– Investments in equity / subordinate / senior tranches of securities issued by the SPV
including through underwriting commitments
– Credit enhancements including cash and other forms of collaterals including overcollateralisation, but excluding the credit enhancing interest only strip
– Liquidity support.The 20% limit on exposures will not be deemed to have been breached if it is exceeded due to amortisation of securitisation instruments issued.
This is same as before.
Listing of securities issued in a securitisation– If the value of the exposures underlying a residential mortgage backed securitisation is Rs.500 crore or above, the securities issued must be mandatorily listed.
– For securities issued in residential mortgage backed securitisations where the value of the exposures underlying is less than Rs.500 crore, and securities issued in other securitisation transactions, listing of the securities or notes is optional.
No provision for listing.PTCs issued in mortgage-backed securitisation should be mandatorily listed if the securitisation pool is larger than ₹500 crore.
This is completely a new requirement. The idea is to create a secondary market for the investors in mortgage backed securities. Also, currently mutual funds are allowed to invest only in listed securities, so this requirement will also take care of that issue.

Having said the above, currently, the listing of securitised debt instruments is governed by the SEBI (Issue and Listing of Securitised Debt Instruments) Regulations, 2008. Also, the SEBI (Listing Obligations and Disclosures) Requirements, 2015 has provisions relating to listing of SDIs. Both of these may require tweaking, especially the provisions dealing with corporate governance.

Conditions to be satisfied by the special purpose entitySPE should meet the following criteria –
– Transactions to be on arms lenght basis.
– Transactions should not intentionally provide for absorbing any future losses of the SPE by the originator.
– The SPE and the trustee should not resemble in name or imply any connection or relationship with the originator of the assets in its title or name.
– The originator should not have any ownership, proprietary or beneficial interest in the SPE. The originator should not hold any share capital in the SPE.
– The originator may have not more than one representative, without veto power, on the board of the SPE provided the board has at least four members and independent directors are in majority.
– The originator shall not support the losses of the SPE except under the facilities explicitly permitted under these directions and shall also not be liable to meet the recurring expenses of the SPE.
– The SPE should make it clear to the investors in the securities issued by it that these securities are not insured and that they do not represent deposit liabilities of the originator, servicer or trustees.
SPV should meet the following criteria –
– Transactions to be on arms lenght basis..
– Transactions should not intentionally provide for absorbing any future losses of the SPE by the originator.
– The SPV and the trustee should not resemble in name or imply any connection or relationship with the originator of the assets in its title or name.
– SPV should be entirely independent. The originator should not have any ownership, proprietary or beneficial interest in the SPV. The originator should not hold any share capital in the SPV.
– The originator shall have only one representative, without veto power, on the board of the SPV provided the board has at least four members and independent directors are in majority.
– The SPV should inform the investors in the securities issued by it that these securities are not insured and that they do not represent deposit liabilities of the originator, servicer or trustees.
– The originator shall not support the losses of the SPV except under the facilities explicitly permitted under these guidelines and shall also not be liable to meet the recurring expenses of the SPV.
– Securities to be compulsorily rated by a SEBI registered CRA and such rating at any time shall not be more than 6 months old and shall be made publicly available.
Broadly similar, however, the requirement for obtaining credit rating is not specified in the Draft Directions. However, the rating requirement is implied.
Additional conditions to be satisfied in case the SPE is set up as a trustIf the SPE is set up as a trust, then:
i. The originator shall not exercise control, directly or indirectly, over the SPE and the trustees, if any, and shall not settle the trust deed, if any.
ii. The SPE should be bankruptcy remote and non-discretionary.
iii. The trust deed, if any, should lay down, in detail, the functions to be performed by the trustee, their rights and obligations as well as the rights and obligations of the investors in relation to the securitised assets. The trust deed should not provide for any discretion to the trustee as to the manner of disposal and management or application of the trust property. In order to protect their interests, investors should be empowered in the trust deed to change the trustee at any point of time.
iv. The trustee, if any, should only perform trusteeship functions in relation to the SPE and should not undertake any other business with the SPE
v. A copy of the trust deed, if any, and the accounts and statement of affairs of the SPE should be made available to the RBI, if required to do so.
– The originator shall not exercise control, directly or indirectly, over the SPV and the trustees, and shall not settle the trust deed.
– The SPV should be bankruptcy remote and non-discretionary.
– The trust deed should lay down, in detail, the functions to be performed by the trustee, their rights and obligations as well as the rights and obligations of the investors in relation to the securitised assets.
– The Trust Deed should not provide for any discretion to the trustee as to the manner of disposal and management or application of the trust property. In order to protect their interests, investors should be empowered in the trust deed to change the trustee at any point of time.
– The trustee should only perform trusteeship functions in relation to the SPV and should not undertake any other business with the SPV.
– A copy of the trust deed and the accounts and statement of affairs of the SPV should be made available to the RBI, if required to do so.
This is the same as before.
In case of assets purchased for securitisationIn cases where the originator has purchased loans from another lender for the purpose of securitisation, the conditions specified above shall apply to the lender from whom the originator has purchased the exposures, as well.

However, for the purpose of sub-clause (d) of clause 29, only one of either the originator or the lender from whom loans were purchased but the originator, shall have the representative on the board of the SPE.

No such provision.
It appears that this requirement is applicable only for platforms/vehicles that are created for the purpose of securitisation. For instance, NHB may be creating a vehicle for facilitating securitisation of residential mortgage loans. Similarly, SIDBI may also create a similar vehicle. These vehicles do not have to meet any MHP requirements when the buy assets for the purpose of securitisation. However, such vehicle will have to meet SPE conditions.
Representations and WarrantiesSame as the earlier guidelines.An originator that sells assets to SPE may make representations and warranties concerning those assets. Where the following conditions are met the originator will not be required to hold capital against such representations and warranties –
a. Provided only by way of a formal written agreement.
b. The originator undertakes appropriate due diligence before providing or accepting any representation or warranty.
c. The representation or warranty refers to an existing state of facts that is capable of being verified by the originator at the time the assets are sold.
d. The representation or warranty is not open-ended and, in particular, does not relate to the future creditworthiness of the assets, the performance of the SPE and/or the securities the SPE issues.
e. The exercise of a representation or warranty, requiring an originator to replace assets (or any parts of them) sold to a SPE, must be:
i. undertaken within 120 days of the transfer of assets to the SPE; and
ii. conducted on the same terms and conditions as the original sale.
f. An originator that is required to pay damages for breach of representation or warranty can do so provided the agreement to pay damages meets the
following conditions:
i. the onus of proof for breach of representation or warranty remains at all times with the party so alleging;
ii. the party alleging the breach serves a written Notice of Claim on the originator, specifying the basis for the claim; and
iii. damages are limited to losses directly incurred as a result of the breach.
g. An originator should notify RBI of all instance where it has agreed to replace assets sold to SPE or pay damages arising out of any representation or warranty.
This is the same as before.
Accounting provisions– Lenders shall sell assets to SPE only on cash basis and the sale consideration should be received not later than the transfer of the asset to the SPE.
– Any loss, profit or premium arising because of the sale, which is realised, should be accounted accordingly and reflected in the Profit & Loss account for the accounting period during which the sale is completed. However, profits / premium, if any, arising out of such sales, shall be deducted from CET 1 capital or net owned funds for meeting regulatory capital adequacy requirements till the maturity of such assets
– Banks should not recognise the unrealised gains in Profit and Loss account; instead they should hold the unrealised profit under an accounting head styled as “Unrealised Gain on Loan Transfer Transactions”.
– The balance in this account may be treated as a provision against potential losses incurred on the credit-enhancing interest-only strip. The profit may be recognised in Profit and Loss Account only when credit-enhancing interest-only strip is redeemed in cash. The gain on sale represented by credit-enhancing interest-only strip need not be deducted from CET 1 capital since it is not recognised upfront.
– The credit-enhancing interest-only strip may be amortising or non-amortising.
– In the case of amortising credit-enhancing interest-only strip, a bank would periodically receive in cash, only the amount which is left after absorbing losses, if any, supported by the credit-enhancing interest-only strip. On receipt, this amount may be credited to Profit and Loss account and the amount equivalent to the amortisation due may be written-off against the “Unrealised Gain on Loan Transfer Transactions” account bringing down the book value of the credit-enhancing interest-only strip in the bank’s books.
– In the case of a non-amortising credit-enhancing interest-only strip, as and when the bank receives intimation of charging-off of losses by the SPE against the creditenhancing interest-only strip, it may write-off equivalent amount against “Unrealised Gain on Loan Transfer Transactions” account and bring down the book value of the credit-enhancing interest-only strip in the bank’s books. The amount received in final redemption value of the credit-enhancing interest-only strip received in cash may be taken to Profit and Loss account.
– Banks can sell assets to SPV only on cash basis and the sale consideration should be received not later than the transfer of the asset to the SPV.
– Any loss arising on account of the sale should be accounted accordingly and reflected in the Profit & Loss account for the period during which the sale is effected and any profit/premium arising on account of sale should be amortised over the life of the securities issued or to be issued by the SPV.
– In case the securitised assets qualify for derecognition from the books of the originator, the entire expenses
incurred on the transaction, say, legal fees, etc., should be expensed at the time of the transaction and should not be deferred.
– The accounting treatment of the securitisation transactions in the books of originators, SPV and investors in securities will be as per the guidance note issued by the ICAI with reference to those aspects not specifically covered in these guidelines
– Should not recognise the unrealised gains in Profit and Loss account; instead they should hold the unrealised profit under an accounting head styled as “Unrealised Gain on Loan Transfer Transactions”.
– The balance in this account may be treated as a provision against potential losses incurred on the I/O Strip due to its serving as credit enhancement for the securitisation transaction
– In the case of amortising I/O strips, an NBFC would periodically receive in cash, only the amount which is left after absorbing losses, if any, supported by the I/O strip. On receipt, this amount may be credited to Profit and Loss account and the amount equivalent to the amortisation due may be written-off against the “Unrealised Gain on Loan Transfer Transactions” A/c bringing down the book value of the I/O strip in the NBFC’s books.
– In the case of a non-amortising I/O Strip, as and when the NBFC receives intimation of charging-off of losses by the SPV against the I/O strip, it may write-off equivalent amount against “Unrealised Gain on Loan Transfer Transactions” A/c and bring down the book value of the I/O strip in the NBFC’s books. The amount received in final redemption value of the I/O Strip received in cash may be taken to Profit and Loss account.
The accounting framework for securitisation transactions in Ind AS 109, which is in line with IFRS 9. Globally, securitisation transactions are accounted as per IFRS 9 and regulators across the globe have placed reliance on IFRS 9 for capital treatment.

The accounting treatment provided in the draft Directions differ with Ind AS 109 at places. As per Ind AS 109, any gain/ loss on sale of financial assets have to be booked at the time of de-recognition. However, the Directions state the only realised gains and losses must be booked. Any unrealised gains should be held as “Unrealised Gain on Loan Transfer” – this may be treated as provision against credit enhancing IO strip which must be recognised only when the same is actually realised.

Further, any profits/ premium on sale of financial assets, even though realised, must not be treated as a part of CET 1 until the maturity of the transaction.

Simple, transparent and comparable (STC) securitisations– Only traditional securitisations that additionally satisfy all the criteria laid out in Annex 1 of these directions fall within the scope of the STC framework.
– The above criteria are based on the prescriptions of the Basel Committee on Banking Supervision.
– Exposures to securitisations that are STC-compliant can be subject to the alternative capital treatment as determined by clauses 112 to 114 or clauses 127 to 128
– The originator must disclose to investors all necessary information at the transaction level to allow investors to determine whether the securitisation is STC compliant. Based on the information provided by the originator, the investor must make its own assessment of the securitisation‘s STC compliance status before applying the alternative capital treatment
– For retained positions where the originator has achieved significant credit risk transfer in terms of the requirements of the clauses 79 and 80, the determination of compliance with STC requirements shall be made only by the originator retaining the position.
– STC criteria need to be met at all times. Checking the compliance with some of the criteria might only be necessary at origination (or at the time of initiating the exposure, in case of guarantees or liquidity facilities) to an STC securitisation. Notwithstanding, investors and holders of the securitisation positions are expected to take into account developments that may invalidate the previous compliance assessment, for example deficiencies in the frequency and content of the investor reports, in the alignment of interest, or changes in the transaction documentation at variance with relevant STC criteria.
– In cases where the criteria refer to underlying, and the pool is dynamic, the compliance with the criteria will be subject to dynamic checks every time that assets are added to the pool.
– Investors should consider whether the originator, servicer and other parties with a fiduciary responsibility to the securitisation have an established performance history for substantially similar credit claims or receivables to those being securitised and for an appropriately long period of time.
The Committeee recommended that it would be prudent to implement Basel III guidelines for securitisation exposures along with the rest of the Basel III package as and when it is implemented in India, after understanding the implications of the revised risk weight prescriptions that continue to rely on external ratings, through an impact analysis.
This an adaptation of the STC requirements laid down under the Basel framework.

The idea of global regulators is to distinguish between what is simple, transparent and comparable, from the ones which are exotic, complex or structured. the former are more akin to bonds – and therefore, these have the twin advantages of structural robustness with credit enhancements and bankruptcy remoteness, as also the simplicity of corporate bonds. Hence, STC securitisations have been promoted by laying down lower risk weights.

If a transaction qualifies to be STC, the same would require attract a lower risk weight, which is also in line with the Basel Framework.

Annex 1 – STC requirementsWe have covered and analysed the requirements of Basel III STC criteria in another write up, which has been laid down in Annex 1 of the Draft Framework on similar lines
Refer our separate write up on the same – http://vinodkothari.com/2020/01/basel-iii-requirements-for-simple-transparent-and-comparable-stc-securitisation/
Provision of facilities supporting securitisation structures: General Conditions– Lenders may provide supporting facilities such as credit enhancement facilities, liquidity facilities, underwriting facilities and servicing facilities. Since such facilities may also be provided by entities that are not lenders, entities providing such facilities are generally referred to in these directions as “facility providers”.
– The facilities, as above, provided by facility providers should satisfy the following conditions, in addition to the specific conditions applicable to each facility as prescribed in the remaining sections of this Chapter:
a. Provision of the facility should be structured in a manner to keep it distinct from other facilities and documented separately from any other facility provided by the facility provider. The nature, purpose, extent of the facility and all required standards of performance should be clearly specified in a written agreement to be executed at the time of originating the transaction and disclosed in the offer document.
b. The facility is provided on an ‘arm’s length basis’ on market terms and conditions, and subjected to the facility provider’s normal credit approval and review process.
c. Payment of any fee or other income for the facility is not subordinated or subject to deferral or waiver.
d. The facility is limited to a specified amount and duration.
e. The duration of the facility is limited to the earlier of the dates on which:
i. the underlying assets are completely amortised;
ii. all claims connected with the securities issued by the SPE are paid out; or
iii. the facility provider’s obligations are otherwise terminated.
f. There should not be any recourse to the facility provider beyond the fixed contractual obligations. In particular, the facility provider should not bear any recurring expenses of the securitisation.
g. The facility provider has obtained legal opinion that the terms of agreement protect it from any liability to the investors in the securitisation or to the SPE/ trustee, except in relation to its contractual obligations pursuant to the agreement governing provision of the facility.
h. The SPE and/or investors in the securities issued by the SPE have the clear right to select an alternative party to provide the facility.
– Provision of the facility should be structured in a manner to keep it distinct from other facilities and documented separately from any other facility provided by the bank. The nature, purpose, extent of the facility and all required standards of performance should be clearly specified in a written agreement to be executed at the time of originating the transaction and disclosed in the offer document.
– The facility is provided on an ‘arm’s length basis’ on market terms and conditions, and subjected to the facility provider’s normal credit approval and review process.
– Payment of any fee or other income for the facility is not subordinated or subject to deferral or waiver
– The facility is limited to a specified amount and duration.
– The duration of the facility is limited to the earlier of the dates on which:
i) the underlying assets are redeemed;
ii) all claims connected with the securities issued by the SPV are
paid out; or
iii) the bank’s obligations are otherwise terminated.
– There should not be any recourse to the facility provider beyond the fixed contractual obligations. In particular, the facility provider should not bear any recurring expenses of the securitisation.
– The facility provider has written opinions from its legal advisors that the terms of agreement protect it from any liability to the investors in the securitisation or to the SPV/ trustee, except in relation to its contractual obligations pursuant to the agreement governing provision of the facility.
– The SPV and/or investors in the securities issued by the SPV have the clear right to select an alternative party to provide the facility.
This is same as before
Credit enhancement facilities– Credit enhancement is the process of enhancing credit profile of a structured financial transaction through provision of additional security/financial support, for covering losses on securitised assets in adverse conditions.
– The enhancements can be broadly divided into two types viz. internal credit enhancement and external credit enhancement.
– A credit enhancement which, for the investors, creates exposure to entities other than the underlying borrowers is called the external credit enhancement. For instance, cash collaterals and first/second loss guarantees are external forms of credit enhancements. Investment in subordinated tranches, overcollateralisation, excess spreads, credit enhancing interest-only strips are internal forms of credit enhancements.
– Credit enhancement facilities include all arrangements provided to the SPE that could result in a facility provider absorbing losses of the SPE or its investors. Such facilities may be provided by both originators and third parties. The facility provider providing credit enhancement facilities should ensure that the following conditions are fulfilled failing which such will be required to hold capital against the full value of the securitised assets as if they were held on its balance sheet:
a. All conditions specified in clause 46.
b. Credit enhancement facility should be provided only at the initiation of the securitisation transaction.
c. The amount of credit enhancement extended at the initiation of the securitisation transaction should be available to the SPE during the entire life of the securities issued by the SPE.
d. Any utilization / draw down of the credit enhancement should be immediately written-off by debit to the profit and loss account.
e. A credit enhancement facility will be deemed to be a second loss facility only where:
i. it enjoys protection given by a first loss facility;
ii. it can be drawn on only after the first loss facility has been completely exhausted;
iii. it covers only losses beyond those covered by the first loss facility; and
iv. the provider of the first loss facility continues to meet its obligations.
If the second loss facility does not meet the above criteria, it will be treated as a first loss facility
– Credit enhancement facilities include all arrangements provided to the SPV that could result in a bank absorbing losses of the SPV or its investors.
– Such facilities may be provided by both originators and third parties. A bank should hold capital against the credit risk assumed when it provides credit enhancement, either explicitly or implicitly, to a special purpose vehicle or its investors.
– The entity providing credit enhancement facilities should ensure that the following conditions are fulfilled.
– Where any of the conditions is not satisfied, the bank providing credit enhancement facility will be required to hold capital against the full value of the securitised assets as if they were held on its balance sheet.
– Credit enhancement facility should be provided only at the initiation of the securitisation transaction.
– The amount of credit enhancement extended at the initiation of the securitisation transaction should be available to the SPV during the entire life of the securities issued by the SPV.
– The amount of credit enhancement shall be reduced only to the extent of draw downs to meet the contingencies arising out of losses accruing to the SPV or its investors. No portion of the credit enhancement shall be released to the provider during the life of the securities issued by the SPV.
– Any utilization / draw down of the credit enhancement should be immediately written-off by debit to the profit and loss account.
– When a first loss facility does not provide substantial cover a second loss facility might carry a disproportionate share of risk. In order to limit this possibility, a credit enhancement facility will be deemed to be a second loss facility only where:
i. it enjoys protection given by a substantial first loss facility;
ii. it can be drawn on only after the first loss facility has been completely exhausted;
iii. it covers only losses beyond those covered by the first loss facility; and
iv. the provider of the first loss facility continues to meet its obligations.
If the second loss facility does not meet the above criteria, it will be treated as a first loss facility
– The first-loss facility would be considered substantial where it covers some multiple of historic losses or worst case losses estimated by simulation or other techniques. The second loss facility provider shall assess adequacy of first loss facility on an arm’s length basis and shall review it periodically at least once in six months. The following factors may be reckoned while conducting the assessment as well as review:
i) the class and quality of assets held by the SPV;
ii) the history of default rates on the assets;
iii) the output of any statistical models used by banks to assess expected default rates on the assets;
iv) the types of activity in which the SPV is engaging in or is permitted to engage in;
v) the quality of the parties providing the first loss facility; and
vi) the opinions or rating letters provided by reputable rating agencies regarding the adequacy of first loss protection.
This is similar to current requirements
Reset of Credit EnhancementSame as earlier guidelines issued by RBI. However, additional resets criteria are provided for MBS, which is as under:

-At the time of first reset, at least 25% of the total principal amount assigned at the time of initiation of the transaction must have been amortised. The subsequent resets may be carried out at every 10% (of the original level) further amortisation of the pool principal.
-A minimum gap of six months should be maintained between successive resets.

Earlier guidelines on reset of credit enhancement – https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=8149&Mode=0For mortgage-backed securitisation, first reset in credit enhancement should be allowed at 25 per cent of repayment of the underlying pool and subsequent reset at every 10 per cent further repayment.
The recommendations made by the Committee on the reset of mortgage loan securitisation have been accepted here. Howeger, given the fact that the Directions make it clear that the size of enhancement has to remain fixed relative to the unamortised principal, the need for any reset may not arise at all. In any case, there is no concept of reset in the global securitisation scenario.
Liquidity facilitySame as earlier guidelines.– In case the facility fails to meet any of these conditions, it will be regarded as serving the economic purpose of credit enhancement and the liquidity facility provided by a third party shall be treated as a first loss facility and the liquidity facility provided by the originator shall be treated as a second loss facility.
– All conditions specified in paragraphs 11.1 to 11.8 above (general conditions)
– The securitised assets are covered by a substantial first loss credit enhancement.
– The documentation for the facility must clearly define the circumstances under which the facility may or may not be drawn on.
– The facility should be capable of being drawn only where there is a sufficient level of non-defaulted assets to cover drawings, or the full amount of assets that may turn non-performing are covered by a substantial credit enhancement.
– The facility shall not be drawn for the purpose of
a) providing credit enhancement;
b) covering losses of the SPV;
c) serving as a permanent revolving funding; and
d) covering any losses incurred in the underlying pool of exposures prior to a draw down.
– The liquidity facility should not be available for (a) meeting recurring expenses of securitisation; (b) funding acquisition of additional assets by the SPV; (c) funding the final scheduled repayment of investors and
(d) funding breach of warranties.
– Funding should be provided to SPV and not directly to the investors.
– When the liquidity facility has been drawn the facility provider shall have a priority of claim over the future cash flows from the underlying assets, which will be senior to the claims of the seniormost investor.
– When the originator is providing the liquidity facility, an independent third party, other than the originator’s group entities, should co-provide at least 25% of the liquidity facility that shall be drawn and repaid on a pro-rata basis. The originator must not be liable to meet any shortfall in liquidity support provided by the independent party. During the initial phase, a bank may provide the full amount of a liquidity facility on the basis that it will find an independent party to participate in the facility as provided above. The originator will have three months to locate such independent third party.
Treatment of liquidity facilitySince the liquidity facility is meant to smoothen temporary cash flow mismatches, the facility will remain drawn only for short periods. If the drawings under the facility are outstanding for more than 90 days it should be classified as NPA and fully provided for.– The commitment to provide liquidity facility, to the extent not drawn would be an off- balance sheet item and attract 100% credit conversion factor as well as 100 % risk weight. The extent to which the commitment becomes a funded facility, it would attract 100 % risk weight.
– Since the liquidity facility is meant to smoothen temporary cash flow mismatches, the facility will remain drawn only for short periods. If the drawings under the facility are outstanding for more than 90 days it
should be classified as NPA and fully provided for.
This is similar to existing requirements.
Underwriting facilities– An originator or a third-party service provider may act as an underwriter for the issue of securities by SPE and treat the facility as an underwriting facility for capital adequacy purposes subject to the following conditions:
a. All conditions specified in clause 46 are satisfied.
b. The underwriting is exercisable only when the SPE cannot issue securities into the market at a price equal to or above the benchmark predetermined in the underwriting agreement.
c. The facility provider has the ability to withhold payment and to terminate the facility, if necessary, upon the occurrence of specified events (e.g. material adverse changes or defaults on assets above a specified level); and
– In case any of the above conditions are not satisfied, the facility will be considered as a credit enhancement and treated as a first loss facility when provided by a third party and a second loss facility when provided by an originator.
– An originator may underwrite only investment grade senior securities issued by the SPE. The holdings of securities devolved through underwriting should be sold to unrelated third parties within three-month period following the acquisition.
– If a third party facility provider underwrites the securities issued by the SPE, the holdings of securities devolved through underwriting should be sold to third parties unrelated to the originator within three-month period following the acquisition.
– An originator or a third-party service provider may act as an underwriter for the issue of securities by SPV and treat the facility as an underwriting facility for capital adequacy purposes subject to the following conditions. In case any of the conditions is not satisfied, the facility will be considered as a credit enhancement and treated as a first loss facility when provided by a third party and a second loss facility when provided by an originator.
– All conditions specified in paragraphs 11.1 to 11.8 above.
– The underwriting is exercisable only when the SPV cannot issue securities into the market at a price equal to or above the benchmark predetermined in the underwriting agreement.
– The bank has the ability to withhold payment and to terminate the facility, if necessary, upon the occurrence of specified events(e.g. material adverse changes or defaults on assets above a specified level); and
– There is a market for the type of securities underwritten.
– An originator may underwrite only investment grade senior securities issued by the SPV. The holdings of securities devolved through underwriting should be sold to third parties within three-month period following the acquisition. During the stipulated time limit, the total outstanding amount of devolved securities will be subjected to a risk weight of 100 per cent. In case of failure to off-load within the stipulated time limit, any holding in excess of 10 per cent of the original amount of issue, including secondary market purchases, shall
be deducted 50% from Tier 1 capital and 50% from Tier 2 capital.
– A third party service provider may underwrite the securities issued by the SPV. The holdings of securities devolved through underwriting should be sold to third parties within three-month period following the acquisition. During the stipulated time limit, the total outstanding amount of devolved securities will be subjected to a risk weight of 100 per cent. In case of failure to off-load within the stipulated time limit, the total outstanding amount of devolved securities which are at least investment grade will attract a 100% risk weight and those which are below investment grade will be deducted from capital at 50% from Tier 1 and 50% from Tier 2.
This in principle is similar to the existing requirements. In any case, there in practice of underwriting of securitisation issuances.
Servicing facilities– A servicing facility provider administers or services the securitised assets. Hence, it should not have any obligation to support any losses incurred by the SPE and should be able to demonstrate this to the investors in the securitisation exposures. A facility provider performing the role of a service provider for a proprietary or a third-party securitisation transaction should ensure that the following conditions are fulfilled:
a. All conditions specified in clause 46.
b. The service provider should be under no obligation to remit funds to the SPE or investors until it has received funds generated from the underlying assets except where it is also the provider of an eligible liquidity facility.
c. The service provider shall hold in trust, on behalf of the investors, the cash flows arising from the underlying and should avoid co-mingling of these cash flows with their own cash flows.
– Where any of the above conditions are not met, the service provider may be deemed as providing liquidity facility to the SPE or investors and treated accordingly for capital adequacy purpose.
– A servicing bank administers or services the securitised assets. Hence, it should not have any reputational obligation to support any losses incurred by the SPV and should be able to demonstrate this to the investors. A bank performing the role of a service provider for a proprietary or a third-party securitisation transaction should ensure that the following conditions are fulfilled. Where the following conditions are not met, the service provider may be deemed as providing liquidity facility to the SPV or investors and treated accordingly for capital adequacy purpose.
– All conditions specified in paragraphs 11.1 to 11.8 above.
– The service provider should be under no obligation to remit funds to the SPV or investors until it has received funds generated from the underlying assets except where it is the provider of an eligible liquidity facility.
– The service provider shall hold in trust, on behalf of the investors, the cash flows arising from the underlying and should avoid co-mingling of these cash flows with their own cash flows.
Loan servicing process should be standardised and be adapted by all mortgage lenders. A Master Servicing agreement describing the standardised servicing process should be developed and adhered to by all lenders.

Further, the Committee stated that allied to the mortgage criteria, the GSE should also indicate servicing standards or milestones/ processes recommended for the servicing of conforming loans.

The provisions relating to servicing are more or less same, except that the draft Directions specifically mention that if any of the conditions mentioned therein is not met, then the servicer will be deemed to be a liquidity support provider.
Requirements to be met by lenders who are investors in securitisation exposures
Due Diligence Requirements– Lenders must have a comprehensive understanding of the risk characteristics of its individual securitisation exposures as well as the risk characteristics of the pools underlying its securitisation exposures, at all times. Lenders also have to demonstrate that for making such an assessment they have implemented formal policies and procedures as appropriate.
– Lenders should be able to access performance information on the underlying pools on an ongoing basis. Such information may include, as appropriate, but not limited to the following: the average credit quality through average credit scores or similar aggregates of creditworthiness, extent of diversification of the pool of loans, volatility of the market values of the collaterals supporting the loans, cyclicality of the economic activities in which the underlying borrowers are engaged, exposure type, prepayment rates, property types, occupancy, etc.
– Lenders should have a thorough understanding of all structural features of a securitisation transaction that would materially impact the performance of their exposures to the transaction. Such information may include, as appropriate, but not limited to the following: seniority of the tranche, thickness of the subordinate tranches, its sensitivity to prepayment risk and credit enhancement resets, structure of repayment waterfalls, waterfall related triggers, the position of the tranche in sequential repayment of tranches, liquidity enhancements, availability of credit enhancements in the case of liquidity facilities, deal-specific definition of default, etc.
– Apart from the above, lenders should take note of, analyse and record the following while taking the decision regarding a securitisation exposure:
a. the reputation of the originators in terms of observance of credit appraisal and credit monitoring standards, due diligence standards in case the securitised assets had been purchased, adherence to minimum retention and minimum holding standards in earlier securitisations, and fairness in selecting exposures for securitisation;
b. loss experience in earlier securitisations of the originators in the relevant exposure classes underlying the securitisation position, incidence of any frauds committed by the underlying borrowers, truthfulness of the representations and warranties made by the originator;
c. the statements and disclosures made by the originators, or their agents or advisors, about their due diligence on the securitised exposures and, where applicable, on the quality of the collateral supporting the securitised exposures; and
d. where applicable, the methodologies and concepts on which the valuation of collateral supporting the securitised exposures is based and the policies adopted by the originator to ensure the independence of the valuer.
Lenders can invest in or assume exposure to a securitisation position only if the originator (other NBFCs / FIs / banks) has explicitly disclosed to the credit institution that it has adhered to MHP and MRR stipulated in these guidelines and will adhere to MRR guidelines on an ongoing basis.
– Before investing, and as appropriate thereafter, NBFCs should be able to demonstrate for each of their individual securitisation positions, that they have a comprehensive and thorough understanding of risk profile of their proposed / existing investments in securitised positions. NBFCs will also have to demonstrate that for making such an assessment they have implemented formal policies and procedures appropriate for analysing and recording the following :
a) information disclosed by the originators regarding the MRR in the securitisation, on at least half yearly basis;
b) the risk characteristics of the individual securitisation position including all the structural features of the securitisation that can materially impact the performance of the investing NBFC’s securitisation position (i.e., the seniority of the tranche, thickness of the subordinate tranches, its sensitivity to prepayment risk and credit enhancement resets, structure of repayment waterfalls, waterfall related triggers, the position of the tranche in sequential repayment of tranches( time-tranching ), liquidity enhancements, availability of credit enhancements in the case of liquidity facilities, deal-specific definition of default, etc.);
c) the risk characteristics of the exposures underlying the securitisation position (i.e., the credit quality, extent of diversification and homogeneity of the pool of loans, sensitivity of the repayment behavior of individual borrowers to factors other than their sources of income, volatility of the market values of the collaterals supporting the loans, cyclicality of the economic activities in which the underlying borrowers are engaged, etc.);
d) the reputation of the originators in terms of observance of credit appraisal and credit monitoring standards, adherence to MRR and MHP standards in earlier securitisations, and fairness in selecting exposures for securitisation;
e) loss experience in earlier securitisations of the originators in the relevant exposure classes underlying the securitisation position, incidence of any frauds committed by the underlying borrowers, truthfulness of the representations and warranties made by the originator;
f) the statements and disclosures made by the originators, or their agents or advisors, about their due diligence on the securitised exposures and, where applicable, on the quality of the collateral supporting the securitised exposures; and
g) where applicable, the methodologies and concepts on which the valuation of collateral supporting the securitised exposures is based and the policies adopted by the originator to ensure the independence of the valuer.
– When the securitised instruments are subsequently purchased in the secondary market by an NBFC, it should, at that point in time, ensure that the originator has explicitly disclosed that it will retain a position that meets the MRR.
Stress TestingLenders should regularly perform their own stress tests appropriate to their securitisation positions. For this purpose, various factors which may be considered include, but are not limited to, rise in default rates in the underlying portfolios in a situation of economic downturn, rise in pre-payment rates due to fall in rate of interest or rise in income levels of the borrowers leading to early redemption of exposures, fall in rating of the credit enhancers resulting in fall in market value of securities and drying of liquidity of the securities resulting in higher prudent valuation adjustments. Based on the results of stress tests, additional capital shall be held to support any higher risk, if required.Lenders should regularly perform their own stress tests appropriate to their securitisation positions. For this purpose, various factors which may be considered include, but are not limited to, rise in default rates in the underlying portfolios in a situation of economic downturn, rise in pre-payment rates due to fall in rate of interest or rise in income levels of the borrowers leading to early redemption of exposures, fall in rating of the credit enhancers resulting in fall in market value of securities (Asset Backed Securities / Mortgage Backed Securities) and drying of liquidity of the securities resulting in higher prudent valuation adjustments.
Same as before.
Credit Monitoring– The counterparty for the investor in the securities would not be the SPE but the underlying assets in respect of which the cash flows are expected from the obligors. The securitisation exposures of lenders will be subject to the requirements of Paragraphs 8.3 to 8.10 of the circular dated June 3, 2019 on “Large Exposures Framework”.
– Monitor performance information on securitisation exposures and take appropriate action, if any required, on an ongoing basis.Action may include modification to exposure ceilings to certain type of asset class underlying securitisation transaction, modification to ceilings applicable to originators etc.
– For this purpose, lenders should establish formal procedures appropriate to their banking book and trading book and commensurate with the risk profile of their exposures in securitised positions as stipulated in clauses 63 to 65. Where relevant, this shall include the exposure type, the percentage of loans more than 30, 60 and 90 days past due, default rates, prepayment rates, loans in foreclosure, collateral type and occupancy and frequency distribution of credit scores or other measures of credit worthiness across underlying exposures, industry and geographical diversification, frequency distribution of loan to value ratios with bandwidths that facilitate adequate sensitivity analysis. Lenders may inter alia make use of the disclosures made by the originators in the form given in Annex 2 to monitor the securitisation exposures.
– Lenders 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. Action may include modification to exposure ceilings to certain type of asset class underlying securitisation transaction, modification to ceilings applicable to originators etc.
– For this purpose, lenders should establish formal procedures commensurate with the risk profile of their exposures in securitised positions as stipulated in para 2.1.2. Where relevant, this shall include the exposure type, the percentage of loans more than 30, 60, 90, 120 and 180 days past due, default rates, prepayment rates, loans in foreclosure, collateral type and occupancy and frequency distribution of credit scores or other measures of credit worthiness across underlying exposures, industry and geographical diversification, frequency distribution of loan to value ratios with bandwidths that facilitate adequate sensitivity analysis. NBFCs may inter alia make use of the disclosures made by the originators in the form given in Appendix 1 to monitor the securitisation exposures.
The Directions propose a see-through approach for monitoring of the credit of the securitisation exposures. Though the Present Guidelines also talks about credit monitoring, however, not as elaborately as proposed in the Directions.

The Directions states the investors should consider the underlying exposures as a the counter-party instead of the SPE. In fact, the securitisation exposures of the lenders should be subject to the RBI’s Large Exposures Framework issued on 3rd June, 2019. It seems the see-through approach must be adopted even while applying the provisions of the Large Exposure Framework.

Capital requirement for securitisation exposuresGeneral conditions –
Lenders must maintain capital against all securitisation exposure amounts, including those arising from the provision of credit risk mitigants to a securitisation transaction, investments in asset-backed or mortgage-backed securities, retention of a subordinated tranche, and extension of a liquidity facility or credit enhancement. For the purpose of capital computation, repurchased securitisation exposures must be treated as retained securitisation exposures. (General conditions are covered in clause 70-78)Derecognition of transferred assets for the purpose of capital adequacy –
An originator has to maintain capital against the exposures transferred to a special purpose entity, which then forms the underlying for securities issued by the SPE, i.e., the exposures transferred to a special purpose entity must be included in the calculation of risk-weighted assets of the originator, unless certain conditions are satisifed.Approaches for computation of risk weighted assets –
Banks – Banks may apply either Securitisation External Ratings Based approach (SECERBA) or Securitisation Standardised Approach (SEC-SA) for calculation of risk weighted assets for credit risk of securitisation exposures.NBFCs/HFCs – NBFCs (including HFCs) shall apply only SEC-ERBA for calculation of risk weighted assets for credit risk of securitisation exposures.Securitisation exposures to which none of the above approaches can be applied must be assigned a 1250% risk weight by lenders.
If an originator failed to meet the requirement laid down in the directions, it was requried to maintain capital for the securitised assets as if these were not securitised. This capital would be in addition to the capital which the lender is required to maintain on its other existing exposures to the securitisation transaction.

In the existing framework, the credit enhancement provided by the originator was reduced from capital funds. The deduction was made 50% from Tier 1 and 50% from Tier 2 capital.

Owing to the implementation of Ind-AS many securitisation transactions came on the books as they did not qualify for de-recognition under Ind-AS.

However, on 13th March, 2020, RBI issued guidance on implementation of Ind-AS which inter alia, laid down that securitised assets not qualifying for de-recognition under Ind AS due to credit enhancement given by the originating NBFC on such assets shall be risk weighted at zero percent. However, the NBFC shall reduce 50 per cent of the amount of credit enhancement given from Tier I capital and the balance from Tier II capital.

This is quite different from the existing framework. What is coming out clearly that going forward, in order to avail capital relief, the transaction should have a mezzanine tranche.

Also, the rule with respect to capital relief in case of absence of a mezzanine tranche lacks clarity. It says: the originator should not be holding more than 20% of the “exposure value” of the first loss positions. If the intent of this is to limit the originator’s position only to 20% of the first loss tranche, this is absolutely impractical. However, if the intent is to relate the “exposure value” to the total of the asset pool, then, what is being implied is that the first loss tranche shall not be more than 20% of the total pool, which is mostly easy to satisfy.

There is another rule which defines what the thickness of the first loss tranche should be. This requirement states that the minimum first loss tranche should be the product of (a) exposure (b) weighted maturity in years and (c) the average slippage ratio over the last one year.

The slippage ratio is a term often used by banks in India to mean the ratio of standard assets slipping to substandard category. So, if, say 2% of the performing loans in the past 1 year have slipped into NPA category, and the weighted average life of the loans in the pool is, say, 2.5 years (say, based on average maturity of loans to be 5 years), the minimum first loss tranche should be [2% * 2.5%] = 5% of the pool value.

Also, this part of the Directions shall become applicable on the existing transactions as well. Given the structures prevalent in the market, most of the transactions will fail to qualify for capital relief.

The definition of mezzanine tranche includes all tranches to which are, though subordinated to “senior tranches”, but to which a risk weight of less than 1250% is applied. The risk weight of less than 1250% is applicalbe to all tranches rated B- or above, as per the table given in para 108 (ERBA approach). Therefore, the so-called mezzanine tranche is, effectively, much lower rated than the curernt practice in the market where a mezzanine tranche, even if it exists, is mostly investment-grade rated. The net result of this may be that the market-driven first loss class may be fruther split by the structurer into an unrated class, and classes rated above CCC, so that the latter classes qualify as mezzanine classes. If there are such mezzanine classes, risk – weighted contribution by the originator to such mezzanine classes should not be more than 50%. Typically, there may be several mezzanine classes – say ranging from A rated class all the way to B- class – hence, the originator may hold some of them completely, and sell some of them entirely, achieving not more than 50% exposure on risk-weighted basis.

The definition of mezzanine tranche includes all tranches to which are, though subordinated to “senior tranches”, but to which a risk weight of less than 1250% is applied. The risk weight of less than 1250% is applicalbe to all tranches rated B- or above, as per the table given in para 108 (ERBA approach). Therefore, the so-called mezzanine tranche is, effectively, much lower rated than the current practice in the market where a mezzanine tranche, even if it exists, is mostly investment-grade rated. The net result of this may be that the market-driven first loss class may be further split by the structurer into an unrated class, and classes rated above CCC, so that the latter classes qualify as mezzanine classes. If there are such mezzanine classes, risk – weighted contribution by the originator to such mezzanine classes should not be more than 50%. Typically, there may be several mezzanine classes – say ranging from A rated class all the way to B- class – hence, the originator may hold some of them completely, and sell some of them entirely, achieving not more than 50% exposure on risk-weighted basis.

Read our separate write up on the above topic – http://vinodkothari.com/2020/06/inherent-inconsistencies-in-quantitative-conditions-for-capital-relief/

Disclosure Requirements for originators– Weighted average holding period of the assets securitised and the level of their MRR in the securitisation
– Disclosure to be made at initiation and then to be confirmed half-yearly
– In notes to annual accounts, disclose:
(a) Outstanding amount of securitised assets as per books of the SPEs
(b) Total amount of exposures retained by the originator as on the date of balance sheet to comply with the MRR
– Weighted average holding period of the assets securitised and the level of their MRR in the securitisation
– Disclosure to be made at initiation and then to be confirmed half-yearly
– In notes to annual accounts, disclose:
(a) Outstanding amount of securitised assets as per books of the SPEs
(b) Total amount of exposures retained by the originator as on the date of balance sheet to comply with the MRR
This is same as before.

Our earlier write-ups maybe referred here:

http://vinodkothari.com/wp-content/uploads/Risk_weight_cut_down_STC_securitisation.pdf

 

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