Securitisation: Central government’s intervention and clarification need of the hour
A credit alert is CRISIL’s opinion on a sharp and specific development. It conveys that CRISIL will revert shortly on the impact of the development on the ratings of those affected.
The past three months have seen a spate of downgrades and defaults on securitised instruments backed by receivables originated by Dewan Housing Finance Corporation Ltd (DHFL; the originator). CRISIL, too, has recently downgraded its ratings on pass-through certificates (PTCs) issued under DHFL-originated transactions (refer to the links for CRISIL’s latest rating rationales on Nirmaan RMBS Trust - Series II – 2014 and Nirmaan RMBS Trust - Series V – 2014).
The rating actions were triggered primarily by legal challenges that call into question the basic tenets of securitisation. These developments will need to be monitored closely and have the potential to impact the growth of India’s developing securitisation market that has, in the recent months, been the life-line of non-banks. Any disruption in the securitisation market, in turn, has implications for the country’s financial sector and the wider economy.
The situation calls for urgent intervention by the authorities concerned to contain the risks. A major action that has become an imperative is as follows:
- A central government notification pertaining to Rule 10 (dealing with third-party assets) of Insolvency and Bankruptcy Rules (Insolvency and Liquidation Proceedings of Financial Service Providers and Application of Adjudicating Authority), 2019, clarifying that the securitised assets (including assets which are sold under direct assignment transactions) and the associated credit collateral are to be kept outside the bankruptcy proceedings and to be dealt with by the Administrator as set out under the executed documents of securitisation transactions and purely for the benefit of the PTC-holders
What will also support future growth of the securitisation market is a legislative framework for securitisation (including assets which are sold under direct assignment transactions) covering all key aspects of such structured transactions. This will go a long way in addressing challenges emanating from misinterpretation of legal orders.
Sanctity of ‘bankruptcy-remoteness’ is the bedrock of the securitisation market
The legal construct of securitisation transactions is intended to ensure that the securitised assets are legally sold to a special purpose vehicle (SPV) and a legal separation of the originator is effected from the assets. The ‘bankruptcy-remoteness’ of the assets, i.e. the legal separation by virtue of which the securitised assets do not form part of the liquidation estate of the originator/servicer in the event of bankruptcy, is a key de-risking feature of securitisation.
Accordingly, securitisation transactions are evaluated by market participants, based primarily on the credit quality of the securitised pool of receivables and the availability of credit enhancement in the structure, with limited or no linkage to the creditworthiness of the originator (which is typically the same as the servicer and the cash collateral provider). Bankruptcy-remote structures enable securitised instruments to enjoy ratings that are typically higher than the rating of the originators.
Investors, too, make the same differentiation. This is evidenced by their willingness to take up securitisation exposures even as they did not readily invest in vanilla debt issued by many non-banks (non-banking finance companies and housing finance companies) since September 2018. The zooming securitisation market volumes and the growing reliance of non-banks on securitisation as a fundraising avenue also bear testimony to this.