Securitisation as a concept, has a history of over 50 years. In this write up, the author traces the events leading up to the evolution of securitisation in 1970 with the issuance of the first MBS program by Ginnie Mae.
-Richa Saraf (richa@vinodkothari.com)
The Government had been intending to facilitate ease of doing business and bring in uniformity in the rates of the stamp duty on securities across States and thereby build a pan-India securities market. In this regard, the Central Government, after due deliberations and consultations with the States, through requisite amendments in the Indian Stamp Act, 1899 and Rules made thereunder, has created the legal and institutional mechanism to enable States to collect stamp duty on securities market instruments at one place by one agency (through Stock Exchange or Clearing Corporation authorized by it or by the Depository) on one instrument.
While the relevant provisions of the Finance Act, 2019 amending the Indian Stamp Act, 1899 and the Indian Stamp (Collection of Stamp-Duty through Stock Exchanges, Clearing Corporations and Depositories) Rules, 2019 were notified simultaneously on 10th December, 2019 and these were to come into force from 9th January, 2020, due to lockdown, the effective date was later extended to 1st July, 2020 vide notification dated 30th March, 2020 .
In this article, the author tries to highlight two major areas in which there is need for clarity.
Article 246 of the Indian Constitution stipulates that Parliament has exclusive power to make laws with respect to any of the matters enumerated in List I in the Seventh Schedule (“Union List”), and the Legislature of any State has exclusive power to make laws for such State or any part thereof with respect to any of the matters enumerated in List II in the Seventh Schedule (“State List”).
Entry 91 of the Union List provides the Central Government with the power to prescribe the rate of stamp duty on issue and transfer of debentures, transfer of shares and bill of exchange. Further, as per Entry 63 of the State List, the State Government has power to prescribe rate of stamp duty in respect of documents other than those specified in the provisions of List I. Therefore, the power to levy stamp duty on issuance of shares vests with the respective State Governments.
The amended stamp duty rate prescribed by the Finance Act, 2019 stipulates that for issue of security other than debenture, a stamp duty of 0.005% shall be payable . As per Section 2(23A) of Indian Stamp Act, the term “securities” shall include securities as per Section 2(h) of Securities Contracts (Regulation) Act, 1956 , i.e. the following:
(i) Shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate;
(ii) Derivative;
(iii) Units or any other instrument issued by any collective investment scheme to the investors in such schemes;
(iv) Security receipt as defined under Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002;
(v) Units or any other such instrument issued to the investors under any mutual fund scheme;
(vi) Government securities;
(vii) Instruments as may be declared by the Central Government;
(viii) Rights or interest in securities.
In accordance with the provisions of the Constitution of India, the Central Government does not have the power to levy stamp duty on issue of shares. However, considering the aforesaid definition, it can be said that the Central Government has prescribed stamp duty rates for the “issue of security other than debenture”, including for “issue of shares”, which shall be chargeable with stamp duty of 0.005%.
This is susceptible to constitutional challenge and may be declared as ultra vires the Constitution.
Prior to the Finance Act, 2019, as per erstwhile Article 27 of the Indian Stamp Act, only debentures which qualified as “marketable securities” were liable to be stamped under Article 27 of the Indian Stamp Act. Now, pursuant to the Finance Act, 2019, Article 27 provides an ad-valorem rate of duty of 0.005% on issue of “debentures”, and the term has been defined as follows:
Section 2(10A) “debenture” includes-
(i) debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not;
(ii) bonds in the nature of debenture issued by any incorporated company or body corporate;
(iii) certificate of deposit, commercial usance bill, commercial paper and such other debt instrument of original or initial maturity upto one year as the Reserve Bank of India may specify from time to time;
(iv) securitised debt instruments; and
(v) any other debt instruments specified by the Securities and Exchange Board of India from time to time.
Accordingly, it can be inferred that irrespective of the fact that the debentures are marketable or not, stamp duty shall be payable on issuance as well as transfer of debentures.
Another important change to be noted is that earlier w.r.t. mortgage debentures there was a specific exemption that provided that if the mortgage-deed was stamped and registered appropriately (which mortgage would be subject to relevant State stamp legislations), the debentures were exempt from stamp duty. However, pursuant to the Finance Act, 2019, the said exemption has been omitted, which brings us to another major question with respect to payment of stamp duty on issue of secured debentures- whether the security documents viz. deed of hypothecation or mortgage deed will be required to be additionally stamped or not.
In terms of the Finance Act, 2019, Section 4(3) has been inserted in the Indian Stamp Act, which stipulates that in case of any issue, sale or transfer of securities (which again includes debentures), where the duty has been paid on the principal instrument chargeable under Section 9A i.e. instrument chargeable with duty for transactions in stock exchanges and depositories, no stamp duty shall be required to be charged on any other instrument relating to such transaction.
Further, as per Section 9A(3), the State Government cannot charge or collect stamp duty on any note or memorandum or any other document, electronic or otherwise, associated with transactions mentioned in Section 9A(1). This implies that in case secured debentures are being issued in dematerialised form, or are traded over the stock exchange, then the security documents are not required to be separately stamped. In this regard, it is also relevant to cite the case of the Chief Controlling Revenue vs. the Madras Refineries Ltd. AIR 1975 Mad 362 wherein the issue of exemption on payment of stamp duty on incidental documents in case the principal document has already been stamped was discussed at length.
However, there is lack of clarity in case of transactions that do not involve stock exchanges and depositories, such as physical issuances. The question remains whether there will be double incidence of stamp duty- i.e. (i) on issue of debentures; as well as (ii) on mortgage deed or other relevant security documents. While this does not seem to be the intent of the Legislature, a clarification, in this regard, is definitely required.
Our write- up on the Amendments in the Stamp Act can be accessed from the link below:
https://vinodkothari.com/2019/03/single-point-collection-of-stamp-duty/
Our FAQs on the Amendments in the Stamp Act can be accessed from the link below:
https://vinodkothari.com/2019/12/faqs-on-recent-amendments-in-indian-stamp-act-1899/
-Kanakprabha Jethani (kanak@vinodkothari.com)
The draft framework for ‘Sale of Loan Exposures’[1] (‘Draft’) issued by the Reserve Bank of India (RBI) recently provides a detailed framework for sale of all kinds of loan exposures viz. standard, stressed and NPLs. The RBI invited comments and suggestions from the stakeholders on the Draft and has raised a few specific questions for discussion in the Draft.
Presently, there are two separate guidelines, one for sale of standard assets (Direct Assignment guidelines) and one for sale of stressed assets and NPLs (Master Circular on Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances[2])
While we have already prepared a comparative[3] and a detailed analysis[4] for sale of standard loans, we hereby provide an analysis of guidelines relating to sale of stressed assets and NPLs.
The existing framework for sale of loan exposures is posed in bits and pieces. The framework may broadly be understood in the following manner:
| For sale of standard loans (this includes assets falling between 0-90 DPD) | Guidelines on Transactions Involving Transfer of Assets through Direct Assignment (DA) of Cash Flows and the Underlying Securities- Provided in the Master Directions for NBFCs[5] |
| For Sale of stressed loans (this includes NPAs, SMA-2 and standard assets under consortium, 75% of which has been classified as NPA by other lenders and 75% of lenders by value agree to the sale to ARCs) | · Para 6 of Master Circular – Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances
· Notification issued by the RBI on Prudential Framework for Resolution of Stressed Assets[6] · Notification issued by the RBI on Guidelines on Sale of Stressed Assets by Banks[7] |
| For Sale of NPLs (this includes assets falling in the 90+DPD bucket) | · Para 7 of Master Circular – Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances
· Notification issued by the RBI on Guidelines on Sale of Stressed Assets by Banks |
The Draft proposes a consolidated framework to govern sale of loan exposures and is a combination of certain existing guidelines and some newly introduced ones. Let us delve into key changes introduced in the Draft one by one.
While the existing guidelines were specifically applicable to NBFCs, banks and other financial institutions, the applicability of the Draft is extended to SFBs and All India Financial Institutions (AIFIs) such as NABARD, NHB, SIDBI, EXIM Bank etc.
The existing guidelines were applicable to sale of loans by a financial entity to another. However, this did not prohibit sale of loans to non-financial entities. The only difference was that the rights under SARFAESI and other laws were impacted.
The Draft guidelines specifically state that the sale of sale of loans may be made by the entities mentioned above as sellers to any regulated entity, which is allowed by its statutory or regulatory framework to buy such loans.
Hence, any sale of loans, to entities whose regulatory/statutory framework does not allow such purchase, cannot be done. Further, sale of loan to entities whose regulatory/statutory framework allows such purchase, irrespective of whether such entity is a financial entity or not, shall be governed by the provisions of the Draft.
The Draft directions contain separate provisions for sale of standard assets, sale of stressed assets to ARCs and sale of NPAs. Under the existing framework, an asset was said to be standard, till it is classified as NPA i.e. after 90 DPD. The Draft defines stressed assets to include NPAs as well as SMA accounts. Thus, any 0+ DPD account becomes a stressed asset. Due to this, the provisions relating to sale of standard assets, which are broadly in line with the guidelines on DA, shall not apply on assets falling between 1 to 90 DPD.
Since the classification of the asset is strictly based on the number of days past due, it may raise various practical difficulties. For example, if the due date for repayment of a loan installment is January 1, 2020 and there is a grace period of 10 days. The loan is classified as SMA-0 on February 1, 2020 (irrespective of the fact that it is not even 30 days past the grace period) and now, the sale of such loan shall be as per the guidelines for sale of stressed assets.
Under the existing guidelines, the sale to ARCs was allowed on a ‘with’ or ‘without’ recourse basis and sale of NPAs to parties other than ARCs was allowed on a non-recourse basis only. The Draft clearly states that any sale of loans shall be on a ‘without recourse’ basis only. While there will be no impact on sale of standard assets and sale NPAs to parties other than ARCs, the transactions of sale of stressed assets to ARCs shall certainly be affected.
The Draft contains specific provisions with respect to the loans that were granted by the originator for on-lending. Para 51 of the Draft states that “Lenders may also purchase stressed assets from other lenders even if such assets had been created out of funds lent by the transferee to the transferor subject to all the conditions specified in these directions.”
Let us take an example to understand this:
A is an NBFC, which has given out a loan amounting to Rs. 100 @ 5% p.a. to B, which is another NBFC. Now B, gives out loans of Rs. 20 each @ 7% p.a. to 5 individuals.
Now, A can purchase these 5 loans from B, when they become stressed i.e. 0+ DPD. Here, it is clearly visible that the risk undertaken by B has no risk at all. The funds for lending have been provided by A. B keeps the assets in its books only till they are standard. As soon as assets turn SMA-0, B will remove them from its books sell them off to A. Additionally, till the time assets were standard, B earned a spread of 2%.
The Draft defines transfer as- “transfer” means a transfer of economic interest in loan exposures in the manner prescribed in these directions, and includes loan participations and transactions in which the loan exposure remains on the books of the transferor even after the said transaction.
Para 9 contradicts the definition, requiring a legal separation of the asset from the books of the transferor. Tis issue has been discussed at length in our write-up titled “Originated to transfer- new RBI regime on loan sales permits risk transfers.[8]”
The Draft further specifies that the sale/transfer of loans may be done by way of assignment or novation. Presently, most of such transactions are effected through assignment only. The loan agreement usually contains a clause whereby the borrowers gives consent to the lender to sell the loan to a third party. In case such a clause is not there in the loan agreement, the sale of loan would require consent of all the parties to the agreement, including the borrower. In this case, the transfer of loans will have to be effected through novation of the agreement.
The Draft simply clarifies that transfer may be done through either of the modes. We do not see any practical implication as such.
The asset classification criteria has been divided into 2 categories:
If the existing exposure is not standard in the books, the asset classification of the acquired asset shall also be as per the existing exposure. This seems to be derived from the asset classification practices followed earlier to determine stress in the assets i.e. if the borrower is defaulting in one of the exposures, it is likely to delay/default in repayment of other exposures as well.
However, this shall increase the provisioning requirements for the transferee and thus, may be a demotivating factor for sale of stressed assets.
The Draft extends MHP requirements to ARCs as well. The business of ARCs includes frequent selling and buying of loans and portfolios. Putting a holding requirement of 12 months may slow down the business.
On the other hand, this may ensure that ARCs put better recovery efforts, before selling the loans to other entities.
The existing guidelines did not lay the responsibility of reporting to CIC on any of the parties. Thus, the same was determines by the agreement between the parties. Usually, in case of sale to ARCs, the reporting is done by the ARCs and in case of sale to banks/FIs, the reporting is done by the originator only (since originator usually acts as a servicer).
The Draft specifically lays the responsibility of reporting on the transferee. Reasonably, the servicer of the loans has entire information of the servicing of the loan, repayment patterns etc. and thus, is the most suitable party to do the reporting. Let us examine a few cases with regard to reporting:
| Transferee | Servicer | Reporting Obligation on | Remarks |
| ARC | ARC | ARC | Since the ARC is servicing the loan, it shall be able to properly report the details to CICs |
| Bank/FI | Originator | Bank/FI | The Bank/FI will have to obtain the servicing details from the originator and then report the same to CICs |
| Bank/FI | Bank/FI | Bank/FI | Since the bank/FI is servicing the loan, it shall be able to properly report the details to CICs |
Hence, the reporting obligation may be placed on the servicer or may be kept open for the parties to decide.
The existing guidelines relating to sale of NPAs required the transferor to work out the NPV of the estimated cash flows associated with the realisable value of the assets net of the cost of realisation. At least 10% of the estimated cash flows should be realized in the first year and at least 5% in each half year thereafter, subject to full recovery within three years.
The above requirement is not there in the Draft, the reason for which is unknown.
The Draft provides that in case of sale to ARCs, if the ARC is not able to redeem the SRs/PTCs by the end of resolution period (obviously due to inadequate servicing of the loans) the liability against the same should be written off as loss.
The Draft allows all the regulated entities, other than the transferor, to take over the assets from ARCs, once they turn standard on successful implementation of resolution plan. Earlier only ARCs were allowed to buy assets from other ARCs. This is a welcome move as it will enable other financial entities to buy assets from ARCs.
The Draft has come with some interesting proposals and the RBI is yet to receive comments on the same from the industry. The representations from the industry and the response of the RBI on the same will formulate the new regime for securitisation.
Our other write-ups may be referred here:
https://vinodkothari.com/2020/06/presentation-on-draft-directions-on-sale-of-loans/
https://vinodkothari.com/2020/06/new-regime-for-securitisation-and-sale-of-financial-assets/
[1] https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=957
[2] https://www.rbi.org.in/Scripts/BS_ViewMasCirculardetails.aspx?id=9908#7
[3] https://vinodkothari.com/2020/06/originated-to-transfer-new-rbi-regime-on-loan-sales-permits-risk-transfers/
[4] https://vinodkothari.com/2020/06/comparison-on-draft-framework-for-sale-of-loans-with-existing-guidelines-and-task-force-recommendations/
[5]https://rbidocs.rbi.org.in/rdocs/notification/PDFs/45MD01092016B52D6E12D49F411DB63F67F2344A4E09.PDF
[6] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11580&Mode=0
[7] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=10588&Mode=0
[8] https://vinodkothari.com/2020/06/originated-to-transfer-new-rbi-regime-on-loan-sales-permits-risk-transfers/
Watch our Youtube video explaining the entire Udyam Registration process here: https://youtu.be/dqm64_oTbnQ
Read our other resources on related topics here –
-Megha Mittal
“Opportunity amidst tragedy” would likely be the most suitable phrase to summarise the journey of cryptos during the Global Pandemic- with disruption taking a toll on people and economies, and physical proximities massively restrictred, cryptos have outshone traditional assets, by virtue of its inherent features- easy liquidity, access and digitalisation.
Further, as countries around the globe attempt to stimulate their economies by opening floodgates of liquid funds, the ‘digital natives’ have and are expected to increasingly venture into adventure-some investments- think, cryptos. And while such adventurous investing may be short-lived, the results may infact have a long-lasting impact- it is this expected impact that has sets the ‘bull’ stage for cryptos in times to come.
In this brief note, we cover the recent highlights and developments in the crypto-industry, also discussing developments in the relatively new concepts of stablecoins, crypto-lending.
