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Regulating ESG Rating Providers in India

– SEBI approves regulations for ERPs through amendments to CRA Regulations

– Payal Agarwal, Deputy Manager (payal@vinodkothari.com)

As ESG and climate change concerns assume global priority, there is a growing interest among businesses to claim their offerings, products or structures to be green.  This  growing interest of a variety of stakeholders has led to the emergence of ESG Rating Providers (“ERPs”) for ranking an entity’s ESG profile, providing “green” or other coloured labels, or giving other affirmations as sustainability or sustainable-linkage. Unlike credit ratings, ESG ratings are currently not within the direct domain of securities regulators; however, to the extent ESG ratings relate to securities offerings or financial products, the securities regulators claim to have jurisdiction., he International Organization of Securities Commissions (“IOSCO”) has been working towards evolving recommendatory standards. IOSCO published its final report on Environmental, Social and Governance (ESG) Ratings and Data Products Providers (“IOSCO Consultation Report”) in November, 2021.

Following the same, SEBI released a consultation paper on Environmental, Social and Governance (ESG) Rating Providers for Securities Markets (“ERPs Consultation Paper”) on 24th January, 2022, and on the basis of the public consultation as well as global regulatory developments, had proposed a draft regulatory framework for ERPs (“Draft ERP Framework”) on 22nd February, 2023. Recently, on 29th March, 2023, SEBI has approved to bring a regulatory framework for ERPs in India, by inserting a new chapter to the existing SEBI (Credit Rating Agencies) Regulations, 1999 (“CRA Regulations”).

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Government credit enhancement for NBFC pools: A Guide to Rating agencies

Vinod Kothari Consultants P Ltd (finserv@vinodkothari.com)

 

The partial credit enhancement (PCE) Scheme of the Government[1], for purchase by public sector banks (PSBs) of NBFC/HFC pools, has been discussed in our earlier write-ups, which can be viewed here and here.

This document briefly puts the potential approach of the rating agencies for rating of the pools for the purpose of qualifying for the Scheme.

Brief nature of the transaction:

  • The transaction may be summarised as transfer of a pool to a PSB, wherein the NBFC retains a subordinated piece, such that the senior piece held by the PSB gets a AA rating. Thus, within the common pool of assets, there is a senior/junior structure, with the NBFC retaining the junior tranche.
  • The transaction is a structured finance transaction, by way of credit-enhanced, bilateral assignment. It is quite similar to a securitisation transaction, minus the presence of SPVs or issuance of any “securities”.
  • The NBFC will continue to be servicer, and will continue to charge servicing fees as agreed.
  • The objective to reach a AA rating of the pool/portion of the pool that is sold to the PSB.
  • Hence, the principles for sizing of credit enhancement, counterparty (servicer) risk, etc. should be the same as in case of securitisation.
  • The coupon rate for the senior tranche may be mutually negotiated. Given the fact that after 2 years, the GoI guarantee will be removed, the parties may agree for a stepped-up rate if the pool continues after 2 years. Obviously, the extent of subordinated share held by the NBFC will have to be increased substantially, to provide increased comfort to the PSB. Excess spread, that is, the excess of actual interest earned over the servicing fees and the coupon may be released to the seller.
  • The payout of the principal/interest to the two tranches (senior and junior), and utilisation of the excess spread, etc. may be worked out so as to meet the rating objective, provide for stepped-up level of enhancement, and yet maintain the economic viability of the transaction.
  • Bankruptcy remoteness is easier in the present case, as pool is sold from the NBFC to the PSB, by way of a non-recourse transfer. Of course, there should be no retention of buyback option, etc., or other factors that vitiate a true sale.
  • Technically, there is no need for a trustee. However, whether the parties need to keep a third party for ensuring surveillance over the transaction, in form of a monitoring agency, may be decided between the parties.

Brief characteristics of the Pool

  • For any meaningful statistical analysis, the pool should be a homogenous pool.
  • Surely, the pool is a static pool.
  • The pool has attained seasoning, as the loans must have been originated by 31st March, 2019.
  • In our view, pools having short maturities (say personal loans, short-term loans, etc.) will not be suitable for the transaction, since the guarantee and the guarantee fee are on annually declining basis.

Data requirement

The data required for the analysis will be same as data required for securitisation of a static pool.

Documentation

  • Between the NBFC and the PSB, there will be standard assignment documentation.
  • Between the Bank and the GoI:
    • Declaration that requirements of Chapter 11 of the GFR have been satisfied.
    • Guarantee documentation as per format given by GOI

[1] http://pib.gov.in/newsite/PrintRelease.aspx?relid=192618

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