Interlacing Regulations: SEBI - RBI Harmonization of Securitized Assets Framework

By Shriyansh Singhal and Vishesh Khanna

Introduction

Securitization is an important process in which assets are pooled together and then re-grouped into pass through instruments (tax liability is passed down to the final beneficiary) as marketable securities. The cash flow from the underlying receivables is passed on to the purchasers/ investors in form of pass-through instruments, increasing liquidity for originators and lucrative investment avenues for buyers. In India, securitization is inherently governed by The Securities Exchange Board of India (SEBI) as well as The Reserve Bank of India (RBI).

This article examines the recent consultation paper released by SEBI aiming to amend SEBI (Issue and Listing of Securitized Debt Instruments and Security Receipts) Regulations, 2008 (SDI Regulations) in order to align and modernize the regulatory frameworks. These SDI Regulations deals with the issuance, listing and trading of Securitized Debt Instruments (SDIs) and Security Receipts (SRs). RBI governs the same under the Master Direction – RBI (Securitization of Standard Assets) Directions 2021 – for standard assets: (RBI SSA Directions) and the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) – for Stressed financial Assets. The authors in this article have analysed the major amendments that have been brought through the amendments as well as the potential implications and criticisms of the same.

Commendations & Critiques

SEBI felt a need to update the SDI Regulations to keep pace with the evolving market dynamics and RBI’s comprehensive directions. To facilitate a rigorous revamp of the SDI framework, SEBI formed a working committee with members from eminent financial and legal practises and RBI representatives. This group advised on multiple crucial aspects of SDI issuance, risk retention, disclosure requirements and trustee roles, in addition to clarifying overlapping legislative terms. The major changes introduced by the amendment include:

A.    Nature and Form of SDIs

1.     Dematerialization: The SDI issuance, listing and transfer is required to be done exclusively in demat form. This proposes to increase transparency in transactions and record-keeping as well as simplifying the trade processes, leading to better investor protection. The fully electronic process will enable regulators to easily track changes in ownership and mitigate fraudulent transactions. Over time, SEBI is steadily ensuring that all capital market instruments are exclusively traded in dematerialized form, enhancing transparency and security in the market. It supports mandatory requirement of the government and the notification issue by the Ministry of Corporate Affairs on Companies (Prospectus and Allotment of Securities) Second Amendment Rules, 2023 which encourages dematerialization of securities.

2.     Ticket Size and Investor Threshold: For the purpose of standardization of the entry cost for SDI Investment, SEBI has proposed minimum ticket sizes depending on the nature of the originator. Likewise, entities regulated by RBI have a minimum ticket size of Rs. 1 crore, SDIs backed by listed securities need investors to commit at least the face value of the underlying security. The introduction of minimum ticket size of Rs. 1 crore for investments in SDIs might make the investment less appealing for the retail investors and with time it might reduce the participation of retail investor in SDIs. It makes the product available to restrictively to institutional investors which will significantly impact the distribution of the market holding patterns which can even lead to lower liquidity and demand in the market. With the ticket size of one crore, it will completely sweep away the interest of retail investors which play a major role in market. Comparing SDIs with other forms of investment like debentures, the ticket size for public issue is 1,000 INR which takes into account the interest of retail investor maintaining inclusivity. Further, the changes proposed in the consultation paper does not differentiate between public and private issue of SDIs and there is no distinction in their ticket price which leads to ambiguity.

B.    Structure of Securitization Transactions

1.     Minimum Risk Retention (MRR): MRR is a crucial safety measure which ensures that the originator retains a part of the risk in securitized assets, coinciding their interests with the investors. The amendments propose a 10% MRR, with a trim down to 5% for transactions with receivables maturing under 24 months. SEBI’s proposal to align MRR requirement with RBI’s SSA Directions is step towards uniformity but it misses various key features.  The regulator suggests that originators (the entities creating securitization transactions) should retain 10% of the risk in the pool of assets they securitize. If the receivables (the underlying payments) mature within 24 months, the required retention drops to 5%. This approach is broadly similar to what RBI has outlined in its SSA Directions. SEBI’s proposals mainly focus on RBI regulated entities and overlooks the challenges faced by the entities not regulated by RBI. Alternatively, SEBI should strive for uniformity between regulated and non-regulated entities, ensuring a balanced framework that aligns with market realities and accommodates the unique characteristics of each entity.

2.     Clean-up Call Option: SEBI has stipulated a clean-up call option which allows originators to exit from securitization transactions when the asset pool has reached a minimal threshold. With a maximum cap of 10% of the initial pool value, this option offers flexibility as well as ensures the call option is not being used as a disregard credit enhancement. Accordingly, originator must demonstrate a minimum operating experience of three years. It requires only established entities participate in the market. These kinds of restriction can create challenges during the time of asset pool selection which can eventually lead to discouragement among the originator due to fear of non-compliance and scrutiny by the regulators.

C.    Trustees’ Role and Responsibilities  

Composition and Oversight: Trustees play a pivotal role in managing and protecting SDI investors’ interests but will now be restricted to SEBI-registered Debenture Trustees. Additionally, the consultation paper proposes to cap the number of investors to maximum of 200. If the issuer wants to issue more than 200 investors, the issuance of security must be classified as a public offer. This proposal is in line with the requirement of the Companies Act, 2013 which mandates that the private offer must not be more than 200 investors in a financial year. This mandate only applies to primary market and not secondary markets (RBI SSA directions specifically restrict the number of investors in primary market and not in secondary market).

However, the proposal imposes restrictions on transactions in the secondary market as well, which could have adverse consequences. Limiting secondary market activity may lead to issues such as market manipulation and the potential for unfair gains or losses. This ensures that only entities with sufficient regulatory oversight and experience are entrusted upon with this responsibility. Updated guidelines reinstate trustee duties to enhance accountability and transparency and also align trustee regulations with ones applicable to mutual fund and debenture trustees under other SEBI regulations.

D.    Enhanced Periodic Disclosure Requirements

SEBI mandates that issuers of SDIs to provide bi-annual updates on the performance and rating variations to the exchanges keeping in view the importance of prompt and clear disclosure. This enables investors to make deliberate decisions based on precise and recent information.

E.    Authoritative Changes and Explanations

1.     Updating Redundant Legislative Innuendo: Various provisions the SDI Regulations still refer to which are now-defunct laws, e.g. the Monopolies and Restrictive Trade Practices (‘MRTP’) Act, 1969 and the Companies Act of 1956. These amendments are going to replace these references with the Competition Act, 2002, and the Companies Act, 2013; consequently, modernizing the legal basis of securitization and excluding the outdated terminology.

2.     Defining Debt and Receivables: This consultation paper by SEBI presents a clear definition of eligible assets, which allows only listed debt securities, trade receivables, rental income, and equipment leasing receivables as underlying assets for SDIs. Heterogeneous/single-asset pools are not contained in order to ensure that securitization only includes properly stipulated, homogenous asset classes.

Conclusion

The proposals for streamlining regulation in SDI market aims to address number of existing irregularities that might hinder market growth and expansion which includes introduction of minimum ticket size of Rs. 1 crore that might exclude retail investors from market. The consultation paper aims to highlight the gaps and irregularities that are often faced by the investors in SDI market. Some of the proposals fail to resolve the problem and potentially diminishing the attractiveness of SDI investments for certain stakeholders.

Notable amendments include mandatory dematerialization and appointment of trustee which promises greater transparency and more structured securitization process. Liquidity provisions are another welcome addition mitigate the risk of default and will ensure timely receipt of payment by the investors, contributing to market stability. Moreover, the inclusion of clear definition of assets aims to reduce the ambiguities present in the market.

This mix of advancement and challenges underscores the needs for continued engagement of stakeholders to refine the framework. A balanced approach will ensure the securitization process becomes more attractive, secure and beneficial for both issuer and investors.

Disclaimer

The views expressed in this article are solely those of the author(s). This article is intended for educational/information purposes only. The source of this article is publicly available information and under no circumstances should the contents of the article be construed to be professional advice by the authors.