Source: Reserve Bank of India · RBI/DOR/2021-22/85 · issued 24 Sep 2021 · ~1 min read
📜 Read the original circular — full text as issued by RBI
RBI/DOR/2021-22/85
DOR.STR.REC.53/21.04.177/2021-22
September 24, 2021
( Updated as on December 05, 2022 )
All Scheduled Commercial Banks (including Small Finance Banks but excluding Regional Rural Banks);
All All-India Term Financial Institutions (NABARD, NHB, EXIM Bank, and SIDBI);
All Non-Banking Financial Companies (NBFCs) including Housing Finance Companies (HFCs)
Master Direction – Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021
Please refer to the Draft Framework for Securitisation of Standard Assets that was released on June 8, 2020 for comments from various stakeholders.
2. Based on the examination of the comments received, the Reserve Bank has issued the Master Direction – Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021, which are enclosed . These directions have been issued in exercise of the powers conferred by the Sections 21 and 35A of the Banking Regulation Act, 1949; Chapter IIIB of the Reserve Bank of India Act, 1934; and Sections 30A, 32 and 33 of the National Housing Bank Act, 1987.
3. These directions come into immediate effect replacing the existing instructions on the matter of securitisation of standard assets. All lending institutions are advised to take necessary steps to ensure compliance with these directions.
Yours faithfully,
(Manoranjan Mishra)
Chief General Manager
DOR.STR.REC.54/21.04.177/2021-22
September 24, 2021
( Updated as on December 05, 2022 )
Master Direction – Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021
Introduction
Securitisation involves transactions where credit risk in assets are redistributed by repackaging them into tradeable securities with different risk profiles which may give investors of various classes access to exposures which they otherwise might be unable to access directly. While complicated and opaque securitisation structures could be undesirable from the point of view of financial stability, prudentially structured securitisation transactions can be an important facilitator in a well-functioning financial market in that it improves risk distribution and liquidity of lenders in originating fresh loan exposures.
Given the above, in exercise of the powers conferred by the Sections 21 and 35A of the Banking Regulation Act, 1949; Chapter IIIB of the Reserve Bank of India Act, 1934; and Sections 30A, 32 and 33 of the National Housing Bank Act, 1987, the Reserve Bank, being satisfied that it is necessary and expedient in the public interest so to do, hereby, issues the directions hereinafter specified.
Short title and commencement
1. These directions shall be called the Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021.
2. These directions shall come into force with immediate effect.
Chapter I: Scope and Definitions
A. Applicability and Purpose
3. The provisions of these directions shall apply to the following entities (collectively referred to as lenders in these directions) unless specifically mentioned otherwise:
Scheduled Commercial Banks (excluding Regional Rural Banks);
All India Term Financial Institutions (NABARD, NHB, EXIM Bank, and SIDBI);
Small Finance Banks (as permitted under Operating Guidelines for Small Finance Banks dated October 6, 2016 and as amended from time to time); and,
All Non-Banking Financial Companies (NBFCs) including Housing Finance Companies (HFCs).
4. These directions will be applicable to securitisation transactions undertaken subsequent to the issue of these directions.
B. Definitions
5. For the purpose of these directions, the following definitions apply:
(a) “bankruptcy remote" means the unlikelihood of an entity being subjected to voluntary or involuntary bankruptcy proceedings, including by the originator or the creditors to the originator;
(b) “clause” means a clause of these directions, unless otherwise specified;
(c) “clean-up call” means an option that permits the originator to call the underlying exposures or the securitisation exposures when the outstanding value of the underlying exposures falls below a pre-defined threshold, thereby extinguishing the remaining securitisation exposures of all parties;
(d) “credit enhancement” means a contractual arrangement in which an entity mitigates the credit risk associated with a securitisation exposure and, in substance, provides some degree of added protection to other parties to the transaction so as to mitigate the credit risk of their securitisation exposures;
(e) “early amortisation provision” means a mechanism that, once triggered, accelerates the reduction of the investor’s interest in underlying exposures of a securitisation structure and allows investors to be paid out prior to the originally stated maturity of the securitisation notes issued;
(f) “excess spread (or future margin income)” means the difference between the gross finance charge collections and other income received by the special purpose entity (SPE), and securitisation notes interest, servicing fees, charge-offs, and other senior SPE expenses.
(g) “exposure amount” of a securitisation exposure means the sum of the on-balance sheet amount of the exposure, or carrying value – which takes into account purchase discounts and writedowns/specific provisions the lender took on this securitisation exposure – and the off-balance sheet exposure amount, where applicable.
(h) "first loss facility" means the first level of financial support provided by the originator or a third party to improve the creditworthiness of the securitisation notes issued by the SPE such that the provider of the facility bears the part or all of the risks associated with the assets held by the SPE;
(i) “implicit support” means the protection arising when a lender provides support to a securitisation in excess of its predetermined contractual obligation;
(j) “interest-only strip (I/O)” means an on-balance sheet asset of the originator that represents a valuation of cash flows related to future margin income;
Provided that if the interest-only strip is subordinated, it shall serve the purpose of credit enhancement and shall be referred to as credit-enhancing interest-only strip.
(k) “mortgage backed securities” mean securitisation notes issued by the special purpose entity against underlying exposures that are all secured by commercial or residential real estate mortgages;
(l) "originator" refers to a lender that transfers from its balance sheet a single asset or a pool of assets to an SPE as a part of a securitisation transaction and would include other entities of the consolidated group to which the lender belongs;
Explanation: Originator may not be the same lender which had initially sanctioned one or more of the exposures underlying a securitisation transaction since loans purchased from lenders can also be sold to SPEs for the purpose of securitisation.
(m) “overcollateralisation” means any form of credit enhancement by virtue of which underlying exposures are posted in value which is higher than the value of the securitisation notes;
(n) “replenishment” means the process of using the cash flows from the securitised assets to acquire more assets in the manner disclosed upfront in the prospectus of the scheme, which will continue for a pre-announced replenishment period, following which the securitisation structure switches to an amortising one;
Provided that assets purchased during the replenishment period shall be purchased from the same originator(s) of the assets underlying the securitisation notes already issued under the scheme.
(o) “residential mortgage backed securities (RMBS)” mean securitisation notes issued by the special purpose entity against underlying exposures that are all secured by residential mortgages;
(p) “re-securitisation exposure” means a securitisation exposure where at least one of the underlying exposures is a securitisation exposure;
(q) “standard assets” for the purpose of these directions shall mean exposures which are not classified as non-performing asset;
(r) “second loss facility” means a second level of financial support providing a second (or subsequent) tier of protection to the securitisation notes issued by the special purpose entity against potential losses not covered by the first loss facility, and is invoked only after the first loss facility has been drawn down and repudiated or exhausted, or the first loss provider is under insolvency or bankruptcy or liquidation;
(s) “securitisation” means a structure where a pool of assets are transferred by an originator to a SPE and the cash flow from this pool of assets is used to service securitisation exposures of at least two different tranches reflecting different degrees of credit risk, where payments to the investors depend upon the performance of the specified underlying exposures, as opposed to being derived from an obligation of the originator;
Provided that the pool containing a single asset eligible to be securitised is also permitted.
Provided further that a securitisation structure may have tranches with different maturities.
(t) “securitisation exposures” include but are not restricted to exposures to securitisation notes issued by the special purpose entity including asset-backed securities and mortgage-backed securities, credit enhancements, underwriting commitments, liquidity facilities, interest rate or currency swaps, credit derivatives and tranched cover;
Explanation: Reserve accounts, such as cash collateral accounts, which is earmarked to absorb credit losses arising from the securitisation and is recorded as an asset by the originator must also be treated as securitisation exposures.
(u) “securitisation notes” mean securities issued by the special purpose entity as a part of securitisation;
(v) “senior tranche” means a tranche which is effectively backed or secured by a first claim on the entire amount of the assets in the underlying securitised pool;
Provided that where all tranches above the first-loss piece are rated, the most highly rated position would be treated as a senior tranche.
Provided that when there are several tranches that share the same rating, only the most senior tranche in the cash flow waterfall would be treated as senior (unless the only difference among them is the effective maturity).
Provided that when the different ratings of several senior tranches only result from a difference in maturity, all of these tranches should be treated as senior tranches.
(w) “special purpose entity (SPE)” means a company, trust or other entity organised for a specific purpose, the activities of which are limited to those appropriate to accomplish the purpose of the SPE, and the structure of which is intended to isolate the SPE from the credit risk of an originator;
Explanation: Any reference to SPE in these directions would also refer to the trust settled or declared by the SPE as a part of the process of securitisation.
(x) “subordinate tranche” means any tranche that is junior to the senior tranche(s);
(y) “synthetic securitisation” means a structure where credit risk of an underlying pool of exposures is transferred, in whole or in part, through the use of credit derivatives or credit guarantees that serve to hedge the credit risk of the portfolio which remains on the balance sheet of the lender;
Explanation: The above definition does not include the use of instruments permitted to lenders for hedging under the current regulatory instructions.
(z) “tranche” means a contractually established segment of the credit risk associated with an exposure or a pool of exposures, where a position in the segment entails a risk of credit loss greater than or less than a position of the same amount in another segment, without taking account of credit protection provided by third parties directly to the holders of positions in the segment or in other segments;
Explanation: Securitisation notes issued by the SPE and credit enhancement facilities available shall be treated as tranches.
(aa) “tranche maturity” means the tranche’s effective maturity in years, and is measured as prescribed in Section E of Chapter VI of these directions;
(bb) “tranche thickness” means the measure calculated as detachment point (D) minus attachment point (A), where D and A are calculated in accordance with Section D of Chapter VI of these directions;
Chapter II: General requirements for securitisation
A. Assets eligible for securitisation
6. Lenders, including overseas branches of Indian banks, shall not undertake the securitisation activities or assume securitisation exposures as mentioned below:
a. Re-securitisation exposures;
b. Structures in which short term instruments such as commercial paper, which are periodically rolled over, are issued against long term assets held by a SPE
c. Synthetic securitisation; and
d. 1 Securitisation with the following assets as underlying:
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);
Restructured loans and advances which are in the specified period;
Exposures to other lending institutions;
Refinance exposures of AIFIs;
Loans with bullet payments of both principal and interest as underlying; and
Loans with residual maturity of less than 365 days; Provided that loans with tenor up to 24 months extended to individuals for agricultural activities (as described in Chapter III of the Reserve Bank of India (Priority Sector Lending – Targets and Classification) Directions, 2020 ) 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. However, only those loans/receivables will be eligible for securitisation where a borrower (in case of agricultural loans) /a drawee of the bill (in case of trade receivables) has fully repaid the entire amount of last two loans/receivables (one loan, in case of agricultural loans with maturity extending beyond one year) within 90 days of the due date. In case such assets are securitised, the investors in the securitisation notes issued against them should be able to verify the compliance of the underlying asset with the above requirement.
7. It is clarified that securitisation of exposures held by overseas branches of Indian banks shall not contravene any provision/s of extant legal/regulatory framework, including Foreign Exchange Management Act, 1999 and the rules or regulations thereunder.
8. Subject to the above, all other on-balance sheet exposures of originators, which are in the nature of loans and advances and are classified as Standard, are eligible as underlying assets in a securitisation transaction.
9. The originators of such exposures shall have satisfied the Minimum Holding period requirement as per Clause 39 of the Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 including the proviso to the above Clause. 2
3 Provided that for commercial or residential real estate mortgages, MHP shall be counted from the date of full disbursement of the loan, or registration of security interest with Central Registry of Securitisation Asset Reconstruction and Security Interest of India (CERSAI), whichever is later.
10. 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 the proviso to Clause 6.
11. The transactions undertaken in terms of these directions must not contravene the rights of underlying obligors. To ensure compliance with this stipulation, enabling clauses must be included in the contract between originator and servicing agent and all necessary consent from obligors (including from third parties), where necessary as per the respective contracts, should have been obtained.
B. Minimum Retention Requirement (MRR)
12. The MRR is primarily designed to ensure that the originators have a continuing stake in the performance of securitised assets so as to ensure that they carry out proper due diligence of loans to be securitised. The originators should adhere to the MRR as detailed below while securitising loans leading to issuance of securitisation notes other than residential mortgage backed securities:
For underlying loans with original maturity of 24 months or less, the MRR shall be 5% of the book value of the loans being securitised.
For underlying loans with original maturity of more than 24 months as well as loans with bullet repayments, as mentioned in proviso to Clause 6, the MRR shall be 10% of the book value of the loans being securitised.
13. In the case of residential mortgage backed securities, the MRR for the originator shall be 5% of the book value of the loans being securitised, irrespective of the original maturity.
14. The MRR shall be retained by the originator as follows:
a. Upto 5 per cent of the book value of loans being securitised:
First loss facility, if available;
If first loss facility is not available, or where retention of the entire first loss facility amounts to less than 5 per cent, balance through retention of equity tranche;
Where retention of the entire first loss facility, if available, and equity tranche amounts to less than 5 per cent, balance pari passu in remaining tranches sold to investors.
b. Greater than 5 per cent of the book value of loans being securitised:
First loss facility, or equity tranche or any other tranche sold to investors, in any combination thereof. Explanation: It is clarified that first loss facility for this purpose shall not include overcollateralization available, if any.
15. Investment in the Interest Only Strip representing the Excess Interest Spread/ Future Margin Income, whether or not subordinated, will not be counted towards the MRR.
16. MRR should not be reduced either through hedging of credit risk or selling or encumbering the retained interest. MRR has to be maintained by the originating lender itself and not by any of its group entities. The form of MRR should not change during the life of securitisation. The MRR as a percentage of unamortised principal should be maintained on an ongoing basis except for reduction of retained exposure due to repayment or through the absorption of losses. Specifically, in cases of securitisations featuring replenishment period, MRR should be maintained not only at the initiation of the securitisation but also at the end of the replenishment period.
17. For complying with the MRR under these guidelines lenders should ensure that proper documentation in accordance with law is made.
C. Origination Standards
18. Underwriting standards for exposures securitised should not be less stringent than those applied to exposures retained on the balance sheet of the originator. Where underwriting standards change between the loan origination and till all the claims associated with securitised note are paid-off, the originator should disclose to the entities having securitisation exposures the timing and purpose of such changes.
19. In cases of securitisation of exposures purchased by originator from other lenders, the requirements applicable for underwriting standards shall apply to the standards of due diligence process adopted by the originator which may include verification of sufficiency and consistency of loan origination process of the lender from whom the exposures were purchased by the originator.
D. Payment priorities and observability
20. To prevent investors being subjected to unexpected repayment profiles during the life of a securitisation, the priorities of payments for all liabilities in all circumstances should be clearly defined at the time of securitisation and appropriate legal comfort regarding their enforceability should be provided.
21. To help provide investors with full transparency over any changes to the cash flow waterfall, payment profile or priority of payments that might affect a securitisation, all triggers affecting the cash flow waterfall, payment profile or priority of payments of the securitisation should be clearly and fully disclosed in offer documents and in investor reports, with information in the investor report that clearly identifies the breach status in respect of expected cash flows to the note holders, the ability for the breach to be reversed and the consequences of the breach.
22. To ensure rights and interest of the securitisation note holders are protected, definitions, policies and remedies pertaining to the contours and caveats around the performance of the underlying loans must be suitably communicated. Further, the rights and control of the securitisation note holders must be documented to account for all circumstances, including insolvency of all entities involved in securitisation, such as the originator SPE, etc. Full disclosure and supporting documentation regarding legal and financial risk factors must be made available to prospective and existing investors within a reasonable period of time, on an ongoing or on demand basis.
23. Securitisations featuring a replenishment period should include provisions for appropriate early amortisation events and/or triggers of termination of the replenishment period, including, notably:
deterioration in the credit quality of the underlying exposures;
a failure to acquire sufficient new underlying exposures of similar credit quality; and
the occurrence of an insolvency-related event with regard to the originator(s).
24. In the event actions of associated institutional stakeholders (originator, SPE, servicing agent, credit enhancement provider and others) that are not prohibited in this framework, result in material alteration of the risk profile of the securitisation notes at any point, the originator shall ensure that same is adequately informed and disclosed to investors, credit rating agencies and other service providers within a maximum time frame of 14 calendar days.
E. Limit on Total Retained Exposures by Originators
25. The total exposure of an originator 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. However, the exposure of originators to credit enhancing interest only strip shall be excluded from this limit.
26. Credit exposure on account of interest rate swaps/currency swaps entered into with the SPE will be excluded from this limit.
27. The 20% limit on total retained exposures will not be deemed to have been breached if it is exceeded due to amortisation of securitisation notes issued.
F. Issuance and Listing
28. The minimum ticket size for issuance of securitisation notes shall be Rs.1 crore.
4 Explanation: Ticket size, for the purpose of these directions, refers to the size of investment by a single investor.
29. Listing of securitisation notes, especially in respect of certain product class, such as RMBS, and/or generally above a certain threshold is recommended, though not mandatory. In any case, any offer of securitisation notes to fifty or more persons in an issuance would be required to be listed in terms of Securities and Exchange Board of India (Issue and Listing of Securitised Debt Instruments and Security Receipts) Regulations, 2008.
G. Conditions to be satisfied by the special purpose entity
30. The SPE should meet the following criteria to enable the originator to apply the guidelines on capital adequacy and other aspects as prescribed in these directions with regard to the securitisation exposures assumed by it:
a. Any transaction between the originator and the SPE should be strictly on arm’s length basis.
b. 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.
c. The originator should not have any ownership, proprietary or beneficial interest in the SPE except those specifically permitted under these directions. The originator should not hold any share capital in the SPE.
d. The originator should not have 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.
e. If the SPE is set up as a trust, then:
The originator shall not exercise control, directly or indirectly, over the SPE and the trustees, and shall not settle the trust deed, if any.
The originator shall not have any ownership, proprietary or beneficial interest in the trustees.
The SPE should be bankruptcy remote and non-discretionary.
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.
The trustee should only perform trusteeship functions in relation to the SPE and should not undertake any other business with the SPE.
A copy of the trust deed, if any, and the accounts and statement of affairs of the SPE should be made available by the originator and/or other lenders, to the RBI, if required to do so.
f. 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.
g. The SPE should make it clear to the investors in the securitisation notes issued by it that these securitisation notes are not insured and that they do not represent deposit liabilities of the originator, servicer or trustees.
31. In cases where the originator has purchased loans from another lender, the provisions of Clause 30 shall apply to the lender from whom the originator has purchased the exposures, as well.
Provided that for the purpose of sub-clause (d) of Clause 30, only one of either the originator or the lender from whom loans were purchased by the originator, may have the representative on the board of the SPE.
H. Representations and Warranties
32. An originator that sells assets to SPE may make representations and warranties concerning those assets. The originator will be required to hold capital against such representations and warranties if any of the following conditions are not satisfied:
a. Any representation or warranty is 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 securitisation notes 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:
undertaken within 120 days of the transfer of assets to the SPE; and
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:
the onus of proof for breach of representation or warranty remains at all times with the party so alleging;
the party alleging the breach serves a written Notice of Claim, specifying the basis for the claim; and
damages are limited to losses directly incurred as a result of the breach.
g. An originator should notify RBI (Department of Supervision) of all instances where it has agreed to replace assets sold to SPE or pay damages arising out of any representation or warranty.
I. Accounting provisions
33. Originators 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. Further, there should not be gap of more than 30 days between transfer of the assets and the issuance of securitisation notes.
34. NBFCs which are required to comply with Indian Accounting Standards (IndAS) shall continue to be guided by the Standards and the ICAI Advisories with respect to accounting for securitisation exposures and transactions.
35. In case of other lenders, any loss, profit or premium realised at the time of the sale should be accounted accordingly and reflected in the Profit & Loss account for the accounting period during which the sale is completed.
36. For such lenders specified at Clause 35, the following treatment shall be applicable in the case of unrealised gains arising out of sale of underlying assets to the SPE such as that associated with expected future margin income (represented by interest-only strips or otherwise):
The unrealised gains should not be recognised in Profit and Loss account; instead the lenders shall hold the unrealised profit under an accounting head styled as “Unrealised Gain on Loan Transfer Transactions”.
The profit may be recognised in Profit and Loss Account only when such unrealised gains associated with expected future margin income is redeemed in cash. However, if the unrealised gains associated with expected future margin income is credit enhancing (for example, in the form of credit enhancing interest-only strip), the balance in this account may be treated as a provision against potential losses incurred.
In the case of amortising credit-enhancing interest-only strip, a lender 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 lender’s books.
In the case of a non-amortising credit-enhancing interest-only strip, as and when the lender receives intimation of charging-off of losses by the SPE against the credit-enhancing 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 lender’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.
Chapter III: Simple, transparent and comparable (STC) securitisations
37. Only 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 108 to 110.
38. 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.
39. For securitisation exposures retained by the originator, where significant credit risk transfer in terms of the requirements of the Clauses 81 and 82 have been achieved by the originator, the determination of compliance with STC requirements shall be made by the originator.
40. 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) of 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.
41. 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. The criteria for the addition of assets shall be clearly described in relevant transaction documents.
42. Investors should consider whether the originator, servicer and other parties with a fiduciary responsibility to the securitisation note holders have an established performance history for substantially similar credit claims or receivables to those being securitised and for an appropriately long period of time.
43. RBI would verify the preferential regulatory capital treatment assignments made by the lenders, including the originator, as part of the supervisory review. If it is discovered that a transaction does not satisfy the STC criteria for regulatory capital purposes, RBI would take appropriate supervisory action including inter alia additional capital under the Pillar 2 framework, and/or by denying preferential regulatory capital treatment for that specific transaction and potentially others as well.
Chapter IV: Provision of facilities supporting securitisation structures
A. General conditions
44. Lenders may provide supporting facilities such as credit enhancement facilities, liquidity facilities, underwriting facilities and servicing facilities. Apart from lenders, 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”. Such facility provider(s) must be regulated by at least one financial sector regulator.
45. 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:
all claims connected with the securitisation notes issued by the SPE are paid out; or
the facility provider's obligations in relation to such facility 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 securitisation notes issued by the SPE have the clear right to select an alternative party to provide the facility subject to compliance of instructions in this direction.
B. Credit enhancement facilities
46. 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, over-collateralisation, excess spreads, credit enhancing interest-only strips are internal forms of credit enhancements.
47. Credit enhancement facilities include all arrangements that could result in a facility provider absorbing losses of the investors in a securitisation transaction. 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 credit enhancement provider will be required to hold capital equal to the full value of the securitised assets:
All conditions specified in Clause 44-45.
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 SPE during the entire life of the securitisation notes in respect of which such credit enhancement is provided, subject to any resets of such credit enhancement specifically permitted under these directions.
Any utilization / draw down of the credit enhancement should be immediately written-off by debit to the profit and loss account by facility provider.
C. Reset of credit enhancements
48. Resets can be applied to external forms of credit enhancements, which is in first or second loss position. The original amount of external credit enhancements provided at the time of initiation of securitisation transaction can be reset by the credit enhancement provider subject to the conditions enumerated below.
a. At the time of reset, all the outstanding tranches of securitisation notes should be re-rated (other than equity tranches). The first reset of credit enhancement will not be permitted if the rating of any of the tranches has deteriorated vis-a-vis the original rating of these securitisation positions. Subsequent resets would not be permitted if the rating of any of the tranches has deteriorated vis-à-vis the rating at the time of previous reset.
b. If reset is permissible in terms of (a) above, the amount of credit enhancement required for retaining the original or current outstanding rating, whichever is higher should be determined by the concerned rating agency for the first reset. Similarly, for subsequent resets, the amount of credit enhancement required for retaining the higher of the rating at the time of previous reset and current outstanding rating should be determined by the concerned rating agency.
Provided that only the rating agency, subject to its continued rating operations, which had rated the securitisation transaction initially shall re-rate it for the purpose of reset of credit enhancement. Enabling clauses and commercial terms must be made part of the initial contract to ensure the implementation of this regulatory advisory failing which credit enhancement reset cannot be executed.
c. The reset of credit enhancement would be subject to the consent of the investors in the securitisation notes. The consent may either be explicitly obtained during every reset or the transactions documents may contain general clauses providing implicit consent of the investors for rest of credit enhancement.
d. The reset of credit enhancement should be provided for in the contractual terms of the transaction and the initial rating of the transaction should take into account the likelihood of resets. Such contractual clause should include clearly defined portfolio-level delinquency triggers, which, if met, should result in the credit enhancement resets not available or possible.
e. In case such a contractual clause was not available originally, reset of credit enhancement may be carried out subject to the consent of all investors of outstanding securitisation notes.
f. In structures where external credit enhancements exist providing first loss credit enhancement (FLCE) and second loss credit enhancement (SLCE), the reset may be carried out simultaneously between FLCE and SLCE in a proportion such that the reset maintains at least the outstanding rating [as envisaged in (b) above] of SLCE.
g. Reset of equity tranche is not allowed as it would tantamount to a reset of an internal credit enhancement.
49. For all securitisations other than residential mortgage backed-securitisations, at the time of first reset, at least 50% of the total principal amount assigned at the time of initiation of the securitisation transaction must have been amortised. The subsequent resets may be carried out after the pool principal has amortised in steps of 10%, i.e., up to at least 60%, 70% and 80% of the original level. However, a minimum gap of six months should be maintained between successive resets.
50. For residential mortgage-backed securitisations, at the time of first reset, at least 25% of the total principal amount assigned at the time of initiation of the securitisation 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.
51. The excess credit enhancement can be released subject to the following conditions:
a. The release of credit enhancement would be subject to a reserve floor as a percentage of the initial credit enhancement provided at the time of transaction, i.e., at any time, the level of credit enhancement available, following any reset shall not drop below the prescribed reserve floor. Thus, even if the required level of credit enhancement to maintain the ratings, as assessed by the credit rating agency during a reset, is lower than the reserve floor, the excess amount available for reset shall be computed as the difference between the available credit enhancement and the reserve floor.
b. The stipulation of the floor may be based on the transaction structure, depending on asset class, the track record of the originator and other pool specific factors such as concentration of long term contracts in a pool, and in no case should be less than:
30% of the initial credit enhancement for securitisations other than residential mortgage backed-securitisations; and
20% of the initial credit enhancement for residential mortgage backed-securitisations.
c. A maximum of 60% of the credit enhancement in excess of that required to retain the credit rating of all the tranches as referred to in sub-clause (b) of Clause 48 assigned to them can be considered for release, at any point of time subject to fulfilling the reserve floor indicated at (a) above.
d. The reset should not lead to exposures retained by originators along with credit enhancements offered by them falling below the level of MRR prescribed in Section B of Chapter II of these directions.
52. In order to facilitate a common understanding amongst stakeholders and to allow the market to understand the linkage between good pool performance and CE reset, credit rating agencies will disseminate information pertaining to CE reset via press release and would confirm that ratings will not be adversely affected by such reset.
D. Liquidity facilities
53. A liquidity facility is provided to help smoothen the timing differences faced by the SPE between the receipt of cash flows from the underlying assets and the payments to be made to investors. A liquidity facility should meet all of the following conditions to guard against the possibility of the facility functioning as a form of credit enhancement and/ or credit support:
a. All conditions specified in Clauses 44-45.
b. The documentation for the facility must clearly define the circumstances under which the facility may or may not be drawn on.
c. 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.
d. The facility shall not be drawn for the purpose of:
providing credit enhancement;
covering losses of the SPE;
serving as a permanent revolving funding, i.e., liquidity support should be an exception rather than the norm; and
covering any losses incurred in the underlying pool of exposures prior to a draw down.
e. The liquidity facility should not be available for the following purposes:
meeting recurring expenses of securitisation;
funding acquisition of additional assets by the SPE;
funding the final scheduled repayment of investors; and
funding breaches of warranties.
f. Facility should be provided to SPE and not directly to the investors.
g. 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, and thus will be senior to the senior tranche.
h. The originator must not be liable to meet any shortfall in liquidity support provided by any independent third party.
54. If any of the conditions are not satisfied, a liquidity facility will be regarded as serving the economic purpose of credit enhancement. In such cases, the liquidity facility provided by a third party shall be treated as a credit enhancement.
55. Since the liquidity facility is meant to smoothen temporary cash flow mismatches, the facility will remain drawn only for short periods, preferably not used for two consecutive repayments to investors. If the drawings under the facility are outstanding for more than 90 days it should be classified as NPA and fully provided for.
E. Underwriting facilities
56. An originator or a third-party service provider may act as an underwriter for the issue of securitisation notes by SPE and treat the facility as an underwriting facility for capital adequacy purposes subject to the following conditions:
All conditions specified in Clauses 44-45 are satisfied.
The underwriting is exercisable only when the SPE cannot issue securitisation notes into the market at a price equal to or above the benchmark predetermined in the underwriting agreement.
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
57. In case any of the above conditions are not satisfied, the facility will be considered as a credit enhancement.
58. An originator may underwrite only investment grade senior notes issued by the SPE. The holdings of securitisation notes devolved to the originator through underwriting would not attract provisions of Clause 25 provided they are sold to unrelated third parties within three-month period following the acquisition. For the period between acquisition and upto three months, the originator will maintain capital equal to as if the exposures were held on the books of the originator.
F. Servicing Facilities
59. 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, except to the extent contractually provided in the servicing facility agreement indemnifying the SPE from defaults, breaches, negligence or fraud by the servicing facility provider, 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:
All conditions specified in Clauses 44-45.
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.
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.
The service provider should remit all the cashflows arising from the underlying loans forming part of the securitised pools to the SPE as per the agreed mechanism, irrespective of any retained interest in the securitisation transaction in other capacities.
60. 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.
Chapter V: Requirements to be met by lenders who are investors in securitisation exposures
A. Due Diligence Requirements
61. Lenders can invest in securitised notes only if the originator has explicitly disclosed to the purchasing lenders that it has adhered to the MRR and MHP requirements and will adhere to MRR on an ongoing basis, as applicable and advised in this direction.
62. For the overseas branches of Indian lenders, they should not invest or assume exposure to securitisation positions in other jurisdictions which have not laid down any MRR. Regarding MHP, the overseas branches of Indian lenders operating in jurisdictions which do not have regulations related to MHP, may comply with regulations prescribed in those jurisdictions.
63. Further, only if the originator has explicitly disclosed that it has complied with the applicable provisions of the Reserve Bank of India (Know Your Customer (KYC)) Directions, 2016 (as amended from time to time), lenders may invest in such securitised notes.
64. 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.
65. 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.
66. 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.
67. Apart from the above, lenders should take note of, analyse and record the following while taking the decision regarding a securitisation exposure:
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;
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;
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
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.
B. Stress testing
68. 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 securitisation notes and drying of liquidity of the securitisation notes 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.
C. Credit monitoring and valuation
69. Lenders shall have Board approved policies detailing valuation of the securitisation notes in which they have invested. The policies should inter alia describe the models used for valuation, the assumptions underpinning the models, the policy regarding back-testing and stress testing the valuation model and its parameters etc. The Board approved valuation policies and the use of such policies in assigning valuation to the investment positions in securitisation notes by lenders will be a part of supervisory review.
70. The counterparty for the investor in the securitisation notes 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 DBR.No.BP.BC.43/21.01.003/2018-19 dated June 3, 2019 on “Large Exposures Framework” (as amended from time to time).
71. 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, modification to ceilings applicable to originators etc.
72. 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 65 to 67. 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.
Chapter VI: Capital requirements for securitisation exposures
A. General Conditions
73. 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, whenever securitisation exposures are a subject of repurchase agreements and repurchased by a lender, the exposure must be treated as retained exposure and not a fresh exposure. Lenders must deduct from Common Equity Tier 1 or net owned funds any increase in equity capital resulting from a securitisation transaction, either realised at the time of sale of underlying assets to the SPE, or unrealised gains on sale of underlying assets such as that associated with expected future margin income, where recognised upfront, till the maturity of such assets.
74. For the purpose of calculating exposure amount, a lender shall measure the exposure amount of its off-balance exposure as follows:
for credit risk mitigants sold or purchased by banks (including small finance banks), the treatment set out in Paragraph 7 of the “ Master Circular – Basel III Capital Regulations” dated July 1, 2015 (as amended from time to time) will apply;
for credit protections, including off-balance sheet exposures, sold or purchased by NBFCs, the treatments set out in the relevant Master Directions (as amended from time to time) will apply;
for facilities that are not eligible credit risk mitigants, use a credit conversion factor (CCF) of 100%; and
for derivatives contracts other than credit risk derivatives contracts, such as interest rate or currency swaps sold or purchased by the lenders, to the extent not covered by sub-clauses (a) to (c) above, the measurement approach set out in the circular dated November 10, 2016 on “Guidelines for computing exposure for counterparty credit risk arising from derivative transactions” will apply.
75. For the purposes of calculating capital requirements, a lender’s exposure A overlaps another exposure B if in all circumstances the lender will preclude any loss for the lender on exposure B by fulfilling its obligations with respect to exposure A. For example, if a lender provides full credit support to some securitisation notes and holds a portion of these securitisation notes, its full credit support obligation precludes any loss from its exposure to the securitisation notes. If a lender can verify that fulfilling its obligations with respect to exposure A will preclude a loss from its exposure to B under any circumstance, the lender does not need to calculate risk-weighted assets for its exposure B.
76. To arrive at an overlap, a lender may, for the purposes of calculating capital requirements, split or expand its exposures, i.e., splitting exposures into portions that overlap with another exposure held by the lender and other portions that do not overlap; and expanding exposures by assuming for capital purposes that obligations with respect to one of the overlapping exposures are larger than those established contractually. For example, a liquidity facility may not be contractually required to cover defaulted assets in certain circumstances. For capital purposes, such a situation would not be regarded as an overlap to the securitisation notes issued by that securitisation. However, the lender may calculate risk-weighted assets for the liquidity facility as if it were expanded (either in order to cover defaulted assets or in terms of trigger events) to
Reproduced for reference with acknowledgment — Source: Reserve Bank of India · RBI/DOR/2021-22/85 · issued 24 Sep 2021. The plain-English explanation above is BankPulse’s own independent summary.