1. INTRODUCTION
Securitization is gaining momentum in India and is developing and enhancing the financial markets. Boost in securitization is a sign of developed and advanced financial market of a country. In securitization, when the instrument gets listed on the stock exchange, it is governed by Securities and Exchange Board of India (“SEBI”). SEBI has recently released a consultation paper[1] proposing a review of the SEBI (Issue and Listing of Securitized Debt Instruments and Security Receipts) Regulations, 2008[2] (“SDI Regulations”), to address the evolving landscape of listed securitization in India and to capture changes pursuant to the developments in this dynamic finance market since the issue of SDI Regulations. This review aims to update existing regulations with the master direction issued by the Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021[3] (“RBI SSA Directions”) issued in 2021 for pass through certificates (“PTCs”), enhance transparency, safeguard investor interests and enhance the regulatory framework governing securitized debt instruments (“SDI”) in India.
Securitization is a process in which receivables / assets are pooled together and then re-packaged into instruments known as PTCs. PTCs when listed on the stock exchange are known as SDIs and are governed by the norms and framework as prescribed by SEBI including SDI Regulations. The cash flow from the underlying receivables / assets is passed on to the investors or holders of PTCs / SDIs. Securitization allows the originator to convert illiquid assets into liquid ones, providing an alternative source of funding. SDIs provides access to these originators to the capital markets. As per the market study, not only banks and financial institutions, but a lot of corporates and businesses (including start-ups) have opted SDIs as a mode of raising funds.
From a reading of the consultation paper, it appears that SEBI intends to make this product available to only institutional investors despite retail investors being an integral investor class for this product. Further, while setting out guidelines of listed securitisation and ensuring investor protection and transparency in the capital markets, SEBI has gone a step forward in regulating a product that is already regulated by RBI for securitisation by financial institutions. This may lead to inconsistencies in the two regulations and overlap as regards securitization transaction of financial institutions.
2. ANALYSIS
(a) Ticket Size
Another proposal by SEBI is the introduction of a minimum ticket size of INR 1,00,00,000/- (Indian Rupees One Crore Only) for investments in SDIs. This proposal will make the investments in SDIs less attractive for retail investors and will eventually reduce / halt the retail participation in SDIs. While the intention of SEBI may be to only make this product available to sophisticated institutional investors that understand this product, retail investors being a key class of investors in this product, this move could reduce the overall depth and diversity of market participants, potentially leading to lower demand and less liquidity in the market for SDIs.
The minimum ticket size may not be a vital factor for consideration for the institutional and sophisticated investors to invest in SDIs. Considering how SEBI has been active in making changes in the debt space to make a conducive environment for retail participation, the high-ticket size for SDIs wipes out the interest of the retail investors all together. In fact, in cases of public issue of debentures, the ticket size is as low as INR 1,000/- (Indian Rupees One Thousand Only). The consultation paper lacks in recognising the difference between public and private issue of SDIs and makes no distinction for a varied ticket size. Further, the alternative investment funds that accepts investment from sophisticated and institutional investors have a ticket size as high as INR 1,00,00,000/- (Indian Rupees One Crore Only).
(b) Track Record and Operational Experience Requirements
SEBI proposed that the obligors and originators must necessarily have a track record of operations of 3 financial years which resulted in the creation of the type of debt or receivables that the originator is seeking to securitize. It also requires originator and obligor to have a business relationship for at least 3 years.
This proposal lacks in identifying the difference between the business model of an RBI regulated entity (like banks and financial institutions) and non-RBI regulated entity (like a manufacturer, distributor, developer, etc.). Use of SDIs by both such entities differ in purpose and business and accordingly there cannot be uniform rules applicable for operations.
For a RBI regulated entity, where securitization is also governed by RBI SSA Directions, there is no such requirement of 3 years track record of operations or a lending relationship. These kinds of restrictions create practical challenges at the time of pool selection/building relationships and eventually leads to discouragement for opting capital markets route out of the fear of scrutiny, non-compliance and penalty by the regulators.
For non-RBI regulated entities, the meaning of debt or receivables is quite distinct. These entities undertake securitization of lease rental receivables, trade receivables, warehousing, etc. and not of loans and advances. The obligors in case of a non-RBI regulated entities are businesses and corporates unlike in an RBI regulated entity where an obligor is usually an individual / corporate taking loans and advances. In such circumstances, it can be difficult for obligors and originators to showcase performance history and business relations for 3 years. It can prove to be more complex for obligors and originators to develop a pool that can be securitized keeping in mind the costs, compliances and liabilities for issue of SDIs. Besides, the track record of operations and timeline of business relations cannot be a criteria to determine and anticipate the possibility of performance of the pool of assets.
These proposals will lead to market participants rather opt for other financing options like direct assignment, securitization by issue of unlisted instruments, Trade Receivables Discounting System, traditional methods of fund raising etc.
(c) Minimum Risk Retention (“MRR”)
SEBI proposes to align the MRR requirement with that as provided in the RBI SSA Directions. However, it fails to provide the exemptions introduced over a period of time after acknowledging the development in the market, leading to inconsistencies between the regulations. It proposes that the originators must maintain MRR of 10%, however where receivables have a scheduled maturity of 24 months, the originator must maintain an MRR of 5%.
While SEBI attempts to align the MRR requirements with the RBI SSA Directions, in our view it must also consider in providing the exemptions for residential mortgage-backed securities as identified and evolved in the RBI SSA Directions of 2021 after a lot of deliberation and analysis from the market performance.
Further, while aligning the MRR requirements by SEBI for RBI regulated entities, SEBI seems to have disregarded securitisation transactions by non-RBI regulated entities that get listed. SEBI must consider acknowledging the securitization by non-regulated entities and addressing the issues of maintaining MRR in different forms by such entities. For example, in a securitization of asset lease rental, the asset is owned by the originator at all times. In some cases, the asset may also be secured by the originator Thus, prescribing MRR over and above the asset ownership or asset collateralisation can be quite onerous for these originators. As long as the economic interest is retained by the originator in any form, the MRR must be recognised with a distinctive understanding and not in the manner it is viewed for RBI regulated entities.
SEBI, as the capital markets regulator, may instead focus on setting out norms for adequate disclosures, accountability and transparency and appointment of intermediaries to conduct due diligence to protect the investors in listed securitisation.
(d) Minimum Holding Period (“MHP”)
SEBI proposes to align the MHP requirement with that as provided in the RBI SSA Directions. This can be aligned for an RBI regulated entity for uniformity between the PTCs and SDIs, however SEBI must exempt non-RBI regulated entities from complying with the MHP requirement as the fund raising by non-RBI regulated entities outside the debt capital market is more relaxed and with lesser compliance burden. Having MHP requirements for such entities will incentivise non-RBI regulated originators for opting other methods of fund raising and discourage use of SDIs. The assets of these originators are not as freely transferable and liquid like in the originators belonging to the finance market, and accordingly, the ‘skin in the game’ can be showcased by the MRR itself and MHP requirements can prove to be quite redundant for the non-RBI regulated entities.
(e) Modification in the definitions of Debt / Receivables
The proposal calls for a definition of “debt” and “receivables,” terms that are critical in the context of SDIs. SEBI has suggested to specifically and exclusively include listed debt securities and trade / rental / leasing receivables in the definition. The definition seems to be quite restrictive, and SEBI must consider providing a green flag for allowing securitization of any such mechanism that has a predictable cashflow. This will enable unique structures to be formed in the market and more creative innovations to be explored that will lead to development of new asset classes for investors. Further, in order to protect investors, SEBI may instead set out higher thresholds for disclosures and due diligence or consider introducing a minimum rating requirement for certain type of trades or a requirement of mandatory appointment of SEBI registered intermediaries or mandatory thresholds for anchor investor participation etc. instead of removing certain sectors and type of receivables from the purview of listed securitisation.
(f) Limitation on exposure of Obligor
SEBI proposes that no single obligor i.e., the party responsible for repaying the debt shall contribute more than 25% (twenty-five percent) to the overall asset pool, however this provision is not in line with the RBI SSA Directions which expressly permits single asset securitization.
In fact, securitization is a key liquidity option available for non-RBI regulated entities in the business of huge equipment, land leasing etc., or even RBI regulated entities desirous of doing single bond securitisation and prohibiting the same from the listed markets can be a hit for deepening the listed debt market in India. This can also be a loss of opportunity for these entities to seek more liquidity by restricting the wide gamut and ambit of the listed markets of India. Additionally, the essence of securitisation lies in redistribution of risks. In cases of huge and concentrated asset pools, securitisation will serve as a tool to redistribute risk. Depriving the market of single asset securitisation or highly concentrated asset securitisation will lack in serving the purpose of redistribution of risk.
Further the proposal that requires the pool to be homogenous is not favourable for the new participants and non-RBI regulated entities, as it will make their entry very restrictive in the market. Even the RBI SSA Directions permits the securitization of heterogenous assets and prohibiting the same hereunder shall not be a positive move for this evolving and developing market.
(g) Limitation on number of investors
SEBI proposed limiting the number of persons to whom invitation or offer can be made for issuance of SDIs on a private placement basis to 200 persons for both primary and secondary market. This proposal is restrictive in nature and is also not in line with RBI SSA Directions, which specifically restricts the number of investors in primary market and not in secondary market. In fact, no other regulatory authority has prescribed limitation on the secondary market. While the proposal seems to be an attempt to align with the requirements of the Companies Act, 2013 (“Act”) which prescribes that an offer for private placement must be made to not more than 200 people in a financial year, it is pertinent to note that this is only in case of primary market offering. The Act further stipulates that in case offer is made to more number of people than the prescribed limit within a given period of time, then the same shall be deemed to be a public issue. However, the proposal is further restricting the transactions in the secondary market as well. The very essence of the instrument being listed gets defeated if such cap of maximum number of investors is imposed in the secondary market. Additionally, this can provide difficulties in giving exit to investors, especially if the ticket size shall be as high as INR 1,00,00,000/- (Indian Rupees One Crore Only).
(h) Dematerialization
One of the cornerstone proposals is the mandate to issue SDIs in dematerialized form only. This recommendation comes in response to the growing need for greater transparency, ease of trading, and reduction in the operational risks associated with physical securities.
The move is also expected to help in better monitoring and tracking of SDI ownership. As the entire process becomes electronic, it would be easier for regulators to track ownership changes and prevent fraudulent activities. Steadily, SEBI is ensuring that all listed capital market instruments are issued and traded in dematerialised form only. This proposal directly supports the mandatory dematerialisation requirement of the government and the notification issued by the ministry of corporate affairs[4] that is encouraging dematerialisation of securities.
(i) Appointment of Trustee
SEBI has proposed to appoint only a SEBI registered debenture trustee to act as the trustee for the securitization transaction. Proposals are made for aligning the provisions for removal and obligations of a trustee with that of the SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021.
Removal of scope of appointing non-SEBI registered trustees shall make the process of securitization more secured and investor friendly. It will ensure that the trustees are at all times under the scrutiny and audit of the regulator.
3.KEY TAKEAWAYS
SEBI’s proposals to the framework for SDIs aims to standardize and regulate the process, but it introduces several challenges that could potentially stifle market growth and innovation. While the intent of these proposals is to streamline the securitization process and ensure greater transparency, the lack of differentiation between RBI-regulated and non-RBI-regulated entities poses significant concerns, particularly in terms of the eligibility criteria and operational requirements for originators and obligors. While the consultation paper has identified the gaps and grey areas in the SDI market faced by the market participants, some of the proposals fail to resolve the issues and make SDI a more attractive product.
The business model of RBI regulated, and non-RBI regulated entities differ in nature and therefore, certain provisions cannot be applied to RBI regulated, and non-RBI regulated entities in the similar manner, which eventually makes this proposal less effective / unfavourable in nature. The need to regulate an already regulated product by RBI in a manner that at some places is non consistent may lead to chaos and overlap between regulations.
These changes are expected to attract institutional investors however, it will eventually reduce / halt the retail participation in SDIs and will make the instrument less attractive. SEBI’s proposals aim to bring uniformity and structure to the securitization process, they do not seem to adequately address the unique challenges faced by non-RBI regulated entities and could inadvertently reduce the attractiveness and effectiveness of SDIs as a financing tool. A more nuanced approach, recognizing the differences between regulated and non-regulated entities, and offering flexibility in areas like track record requirements, MRR and MHP, is crucial for fostering a robust and inclusive securitization market in India.
Authors: Apurva Kanvinde,Smit Parekh and Harshit Khandelwal
Footnotes
[1] SEBI Consultation Paper dated November 1, 2024 https://www.sebi.gov.in/reports-and-statistics/reports/
nov-2024/consultation-paper-on-review-of-sebi-issue-and-listing-of-securitised-debt-instruments-and-security-receipts-regulations-2008_88172.html
[2] SEBI (Issue and Listing of Securitised Debt Instruments and Security Receipts) Regulations, 2008 – https://www.sebi.gov.in/legal/regulations/aug-2023/sebi-issue-and-listing-of-securitised-debt-instruments-and-security-receipts-regulations-2008-last-amended-on-august-18-2023-_76336.html
[3] SSA Directions https://www.rbi.org.in/scripts/bs_viewmasdirections.aspx?id=12165
[4] MCA Notification dated 27th October 2023 – https://www.mca.gov.in/bin/dms/getdocument?mds=Zv
NqoKdfvPrRcqeoGzGdDg%253D%253D&type=open