FINANCIAL MARKETS AND REGULATORY SYSTEMS

ASSET SECURITIZATION IN INDIA

(Assignment towards partial fulfilment of the assessment in the subject of Financial Markets
and Regulatory Systems)

SUBMITTED BY: Avantika Arun

Roll No. 1178
B.Sc., LL.B. (Business Law Hons.)
Semester VII
SUBMITTED TO: Ms. Varendyam Tiwari
Faculty of Law

NATIONAL LAW UNIVERSITY, JODHPUR

SUMMER SESSION
(JULY NOVEMBER 2017)
INTRODUCTION

Securitisation in India is a fairly recent concept, began in the early nineties. Initially it started
as a device for bilateral acquisitions of portfolios of finance companies. These were forms of
quasi-securitizations, with portfolios moving from the balance sheet of one originator to that
of another. Originally these transactions included provisions that provided recourse to the
originator as well as new loan sales through the direct assignment route, which was structured
using the true sale concept. Through most of the 90s, securitisation of auto loans was the
mainstay of the Indian markets. But since 2000, Residential Mortgage Backed Securities
(RMBS) have fuelled the growth of the market.
The need for securitization in India exists in three major areas
Mortgage Backed Securities (MBS);
The Infrastructure sector; and
Other Asset Backed Securities (ABS).
It has been observed that Financial Institutions and Banks have made considerable progress
in financing of projects in the housing and infrastructure sector. It is therefore necessary that
securitisation and other allied systems get developed so that Financial Institutions and Banks
can offload their initial exposure and make room for financing new projects. With the
introduction of financial sector reforms in the early nineties, Financial Institutions and Banks,
particularly the Non-Banking Financial Companies (NBFCs), have entered into the retail
business in a big way, generating large volumes of homogeneous classes of assets such as
auto loans, credit cards receivables, home loans. This has led to attempts being made by a
few players to get into the Asset Backed Securities market as well. However, still a number
of legal, regulatory, psychological and other issues need to be sorted out to facilitate the
growth of securitisation.
LEGAL STATUS GIVEN TO SECURITISATION

In 2002, India enacted the Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interests Act, 2002 (SARFAESI). Though masked as a securitisation
related law, this law does very little for securitisation transactions and has been viewed as a
law relating to enforcement of security interests, as a very narrow avatar of personal property
security laws of North America. In commercial practice, SARFAESI has been very irrelevant
for real life securitisations. Most securitisations in India adopt a trust structure with the
underlying assets being transferred by way of a sale to a trustee, who holds it in trust for the
investors. A trust is not a legal entity in law but a trustee is entitled to hold property that is
distinct from the property of the trustee or other trust properties held by him. Thus, there is
isolation, both from the property of the seller, as also from the property of the trustee. The
trust law has its foundations in UK trust law and is practically the same in India. Therefore,
the trust is the special purpose vehicle (SPV). Most transactions till date use discrete SPVs
master trusts that are still not seen. The trustee typically issues Pass Through Certificates. A
PTC is a certificate of proportional beneficial interest. Beneficial property and legal property
is distinct in law the issuance of the PTCs does not imply transfer of property by the SPV but
certification of beneficial interest. An overview of the SARFAESI Act, 2002:
SARFAESI Act, 2002 contains 41 sections in 6 Chapters and a Schedule. Chapter 1 contains
two sections dealing with the applicability of the Securitisation Act and definitions of various
terms. Chapter 2 contains 10 sections providing for regulation of securitisation and
reconstruction of financial assets of Banks and financial institutions, setting up of
securitisation and reconstruction companies and matters related thereto. Chapter 3 contains 9
sections providing for the enforcement of security interest and allied and incidental matters.
Chapter 4 contains 7 sections providing for the establishment of a Central Registry,
registration of securitisation, reconstruction and security interest transactions and matters
related thereto. Chapter 5 contains 4 sections providing for offences, penalties and
punishments. Chapter 6 contains 10 sections providing for routine legal issues.

Section 5 of the Securitisation and Reconstruction of Financial Assets and Enforcement of

Security Interest Act, 2002, mandates that only Banks and financial institutions can securitise
their financial assets. In the traditional lending process, a Bank makes a loan, maintaining it
as an asset on its balance sheet, collecting principal and interest, and monitoring whether
there is any deterioration in borrower's creditworthiness. This requires a Bank to hold assets
till maturity. The funds of the Bank are blocked in these loans and to meet its growing fund
requirement a Bank has to raise additional funds from the market. Securitisation is a way of
unlocking these blocked funds.

MEASURES FOR NON -PERFORMING ASSET MANAGEMENT

Nationalization of Banks
 Sick Industrial Companies Act, 1985/ Board for Industrial & Financial Reconstruction, 1985.

Recoveries of Debts due to Banks and Financial Institutions Act, 1993

Corporate Debt Restructuring System

SARFAESI Act, 2002

The SARFAESI Act has been largely perceived as facilitating asset recovery and
reconstruction. Since Independence, the Government has adopted several ad-hoc measures to
tackle sickness among financial institutions, foremost through nationalisation of Banks and
relief measures. Over the course of time, the Government has put in place various
mechanisms for cleaning the Banking system from the menace of NPAs and revival of a
healthy financial and banking sector. Some of the notable measures in this regard include:

Sick Industrial Companies (Special Provisions) Act, 1985 or SICA: To examine

and recommend remedy for high industrial sickness in the eighties, the Tiwari
committee was set up by the Government. It was to suggest a comprehensive
legislation to deal with the problem of industrial sickness. The committee suggested
the need for special legislation for speedy revival of sick units or winding up of
unviable ones and setting up of quasi-judicial body namely; Board for Industrial and
Financial Reconstruction (BIFR) and The Appellate Authority for Industrial and
Financial Reconstruction (AAIRFR) and their benches. Thus in 1985, the SICA came
into existence and BIFR started functioning from 1987. The objective of SICA was to
proactively determine or identify the sick/potentially sick companies and enforcement
of preventive, remedial or other measures with respect to these companies. Measures
adopted included legal, financial restructuring as well as management overhaul.
Recoveries of Debts due to Banks and Financial Institutions (RDDBFI) Act,
1993: The procedure for recovery of debts to the Banks and financial institutions
resulted in significant portions of funds getting locked. The need for a speedy
recovery mechanism through which dues to the Banks and financial institutions could
 be realised was felt. Different committees set up to look into this, suggested formation
of Special Tribunals for recovery of overdue debts of the Banks and financial
institutions by following a summary procedure. For the effective and speedy recovery
of bad loans, the RDDBFI Act was passed suggesting a special Debt Recovery
Tribunal to be set up for the recovery of NPA. However, this act also could not speed
up the recovery of bad loans, and the stringent requirements rendered the attachment
and foreclosure of the assets given as security for the loan as ineffective.
Corporate Debt Restructuring (CDR) System: Companies sometimes are found to
be in financial troubles for factors beyond their control and also due to certain internal
reasons. For the revival of such businesses, as well as, for the security of the funds
lent by the Banks and FIs, timely support through restructuring in genuine cases was
required. With this view, a CDR system was established with the objective to ensure
timely and transparent restructuring of corporate debts of viable entities facing
problems, which are outside the purview of BIFR, DRT and other legal proceedings.
In particular, the system aimed at preserving viable corporate/businesses that are
impacted by certain internal and external factors, thus minimising the losses to the
creditors and other stakeholders. The system has addressed the problems due to the
rise of NPAs. Although CDR has been effective, it largely takes care of the interest of
Bankers and ignores (to some extent) the interests of borrowers stakeholders. The
secured lenders like Banks and FIs, through CDR merely, address the financial
structure of the company by deferring the loan repayment and aligning interest rate
payments to suit companys cash flows. The Banks do not go for a one time large
write-off of loans in initial stages.
SARFAESI ACT 2002: By the late 1990s, rising level of Bank NPAs raised concerns
and Committees like the Narasimham Committee II and Andhyarujina Committee
which were constituted for examining Banking sector reforms considered the need for
changes in the legal system to address the issue of NPAs. These committees
suggested a new legislation for securitisation, and empowering Banks and FIs to take
possession of the securities and sell them without the intervention of the court and
without allowing borrowers to take shelter under provisions of SICA/BIFR. Acting on
these suggestions, the SARFAESI Act was passed in 2002 to legalise securitisation
and reconstruction of financial assets and enforcement of security interest. The act
 envisaged the formation of asset reconstruction companies (ARCs)/ Securitisation
Companies (SCs).

SHORTCOMINGS FACED BY INDIAN SECURITISED MARKETS:

I. Stamp Duty:
One of the biggest hurdles facing the development of the securitisation market is the stamp
duty structure. Stamp duty is payable on any instrument which seeks to transfer rights or
receivables, whether by way of assignment or novation (new clause added to the contract) or
by any other mode. Therefore, the process of transfer of the receivables from the originator to
the SPV involves an outlay on account of stamp duty, which can make securitisation
commercially unviable in several states. If the securitised instrument is issued as evidencing
indebtedness, it would be in the form of a debenture or bond subject to stamp duty. On the
other hand, if the instrument is structured as a Pass Through Certificate that merely evidences
title to the receivables, then such an instrument would not attract stamp duty, as it is not an
instrument provided for specifically in the charging provisions.
Among the regulatory costs, the stamp duty on transfers of the securitized instrument is again
a major hurdle. Some states do not distinguish between conveyances of real estate And that
of receivables, and levy the same rate of stamp duty on the two. Stamp duty being a
concurrent subject i.e. it is under the concurrent list in Schedule 7 of the Indian Constitution,
specifically calls for a consensual legal position between the Centre and the States.
II. Foreclosure Laws:
Lack of effective foreclosure laws also prohibits the growth of securitization in India. The
Existing foreclosure laws are not lender friendly and increase the risks of Mortgage Backed
Securities by making it difficult to transfer property in cases of default. Transfer of property
laws lacks on this aspect.
III. Taxation related issues:
Tax treatment of Mortgage Backed Securities, SPV Trusts and NPL Trusts is unclear.
Currently, the investors (PTC and SR holders) pay tax on the income distributed by the SPV
Trusts and on that basis the trustees make income pay outs to the PTC holders without any
payment or withholding of tax. The view is based on legal opinions regarding assessment of
investors instead of trustee in their representative capacity. It needs to be emphasized that the
Income Tax Law has always envisaged taxation of an Unincorporated SPV such as a Trust at
only one level, either at the Trust SPV level, or the Investor/Beneficiary Level to avoid
double taxation. Hence, any explicit tax pass thro regime if provided in the Income Tax Act
does not represent conferment of any real tax concession or tax sacrifice, but merely
represents a position that the Investors in the trust would be liable to tax instead of the Trust
being held liable to tax on the income earned. Amendments need to be made to provide an
explicit tax pass thought treatment to securitization SPVs and Non Performing Assets
Securitization SPVs on par with the tax pass through treatment applied under the tax law to
Venture Capital Funds registered with SEBI. To make it certain that investors as holders of
Mutual Fund (MF) schemes are liable to pay tax on the income from MF and ensure that
there is no tax dispute about the MBS SPV Trust or NPA Securitization Trust being treated as
an AOP(Association of Persons), SEBI should consider the possibility of modifying the
Mutual Fund Regulations to permit wholesale investors (investors who invests not less than
Rs. 5 million in scheme) to invest and hold units of a closed-ended passively managed mutual
fund scheme. The sole objective of this scheme is to invest its funds into PTCs and SRs of the
designated Mortgage Backed Security.
IV. SPV Trust and NPA Securitization Trust:
Recognizing the wholesale investor and Qualified Institutional Buyers (QIB) in securitization
trusts, there should be no withholding of tax requirements on interest paid by the borrowers
(whose credit exposures are securitized) to the securitization trust. Similarly, there should be
no requirement of withholding tax on distributions made by the securitization Trust to its
PTC and SR holders. However, the securitization trust may be required to file an annual
return with the Income-tax Department, Ministry of Finance, in which all relevant particulars
of the income distributions and identity of the PTC and SR holders may be included. This
will safeguard against any possibility of revenue leakage.
V. Legal Issues:
Listing of PTCs on stock exchange: Currently, the Securities Contract Regulation Act
definition of securities does not specifically cover PTCs. While there is indeed a legal view
that the current definition of securities in the SCRA includes any instrument derived from, or
any interest in securities, the nature of the instrument and the background of the issuer of the
instrument, not being homogenous in respect of the rights and obligations attached, across
instruments issued by various SPVs, has resulted in a degree of discomfort among exchanges
listing these instruments. To remove any ambiguity in this regard, the Central Government
should consider notifying PTCs and other securities issued by securitization SPV Trust as
securities under the SCRA.