ABSTRACT

Securitization has emerged globally as an important technique for bundling assets and

segregating risks into marketable securities. This paper discusses the present nascent state of the

securitization market in India, its potential and attempts to identify what needs to be done by

various stakeholders in this market for securitization to grow to its full potential in India.

The growth in the Indian securitization market has been largely fuelled by the

repackaging of retail assets and residential mortgages of banks and FIs. This market has been in

existence since the early 1990s, though has matured significantly only post-2000 with an

established narrow band of investor community and regular issuers. According to Industry

estimates, the structured issuance volumes have grown considerably in the last few years;

though still small compared to international volumes. Asset backed securitization (ABS) is the

largest product class driven by the growing retail loan portfolio of banks and other FIs,

investors’ familiarity with the underlying assets and the short maturity period of these loans.

The mortgage backed securities (MBS) market has been rather slow in taking off despite a

growing housing finance market due to the long maturity periods, lack of secondary market

liquidity and the risk rising from prepayment of the underlying loan.

Securitisation in India largely adopts a trust structure with the underlying assets being

transferred by way of sale to a trustee company. The SPV, formed as a trustee company, issues

securities that are either pass through certificates or pay through certificates (‘PTC'). The trustee

is the legal owner of the underlying assets in both the scenarios. The investors holding pass

through certificates are entitled to a beneficial interest in the underlying assets held by the

trustee. Investors holding pay through certificates are entitled to a beneficial interest only in the

cash flows attained from the underlying securities to the extent of the obligation agreed with the

holders of primary and secondary tranches of PTC. 

Special Purpose Vehicle (SPV) is an instrumental institution used for

specific purposes by firms. The SPV is useful for tax planning, risk management, project

financing and company restructuring. SPVs have benefits for economy and business, and involve

usually large size of projects that vary from about US$100 to US$500 million per

project. However, SPVs have also some bad records. Huge business, finance, and accounting

scandals involve the use of SPVs. The drawbacks of SPVs are due to lack of regulatory measures

relating the application of SPVs, so that SPVs are used for hiding identities, debts and hiding

non-productive assets. SPVs are used to deceive investors so that they cannot judge the value and

risks of the firms and investments correctly. The huge financial and accounting scandals such as

Enron involved the use of SPVs for not reporting or undervaluing debt and overvaluing net

worth. This report explains the natures of SPVs and discusses the advantages of forming

SPVs. This report also studies the use of SPVs by companies in India and abroad and the extent

to which SPV has helped in the successful turnaround or failure of the companies being studied.

The negative effects of SPVs may be reduced with enough regulation on consolidation of

financial reporting and disclosures. With these regulations, SPVs cannot be used to deceive

investors and also cannot be used for hiding identities, assets and liabilities.

CHAPTER – 1

Hypothesis

The use of Special purpose vehicle through Asset Reconstruction Company’s.

OBJECTIVES OF THE DISSERTATION

The major objectives of undertaking this dissertation topic are:

To determine the factors responsible for success in business scenario.

To discuss the role of SPV’s in Indian business scenario.

To study the Securitisation market in India and the relationship between SPV and

Securitisation.

To understand the issues related to and the benefits arising from the creation of

SPV.

The role Special Purpose Vehicle plays in Asset Reconstruction Company.

RESEARCH METHODOLOGY

Secondary Research:

Discussing the aims and objectives of the study with faculty members.

Collecting information from various articles on the internet.

Analysis and findings of the data collected.

Submission of the preliminary reports.

LIMITATIONS OF THE DISSERTATION

There are certain limitations to the research work done which are as follows:

The dissertation only considers and focuses on the Indian scenario.

The dissertation considers cases of only few companies as matter to study.

The Dissertation uses secondary source of data which are available; no primary survey or

data collection has been conducted.

The information available on the sale of assets in the case study is limited.

CHAPTER – 2

2.1 SPECIAL PURPOSE VEHICLE – Concept

Securitisation offers higher quality assets to investors by virtue of the fact that the

structures insulate investors from the bankruptcy risk of the Originator. In order to ensure that

the assets actually achieve the bankruptcy remoteness, it is essential to move them out of the

balance sheet of the Originator and park them with another independent entity. Typically an SPV

is employed to purchase the assets from the Originator and issue securities against these assets.

Such a structure provides a comfort to the investors that they are investing in a pool of assets

which Is held on their behalf only by the SPV and which is not subject to any subsequent

deterioration in the credit quality of the Originator. The SPV is usually a thinly capitalised

vehicle whose ownership and management are independent of the Originator. The main

objective of SPV is to distinguish the instrument from the Originator

A Special Purpose Vehicle (SPV) or more often called a Special Purpose Entity (SPE) is

a legal entity created by organizations to fulfill narrow, specific or temporary objectives.

SPV’s are typically used by companies to isolate the firm from financial risk. In such

case, a company will transfer assets to the SPV for management or use the SPV to finance large

project thereby achieving a narrow set of goals without putting the entire firm at risk.

Joy Jain of PricewaterhouseCoopers, an SPV is mainly formed to raise funds by collateralising

future receivables.

SPV are used by companies to fulfill several purposes as:

Risk Sharing: Corporate may use SPVs to legally isolate high risk project/asset

from the parent company and to allow other investors to take a share of the risk.

Securitization: SPVs are commonly used to securitize loans. For example, a bank

may wish to issue a mortgage-backed security whose payments come from a pool

of loans. However, to ensure that the holders of the mortgage-back securities have

the first priority right to receive payments on the loans, these loans need to be

legally separated from the other obligations of the bank. This is done by creating

an SPV, and then transferring the loans from the bank to the SPV.

Asset transfer: Many permits required to operate certain assets (such as power

plants) are either non-transferable or difficult to transfer. By having an SPE own

the asset and all the permits, the SPE can be sold as a self-contained package,

rather than attempting to assign over numerous permits.

For competitive reasons: For example, when Intel and Hewlett-Packard started

developing IA-64 (Itanium) processor architecture, they created a special purpose

entity which owned the intellectual technology behind the processor. This was

done to prevent competitors like AMD accessing the technology through pre-

existing licensing deals.

Financial engineering: SPEs are often used in financial engineering schemes

which have, as their main goal, the avoidance of tax or the manipulation of

financial statements. The Enron case is possibly the most famous example of a

company using SPEs to achieve the latter goal.

Regulatory reasons: A special purpose entity can sometimes be set up within an

orphan structure to circumvent regulatory restrictions, such as regulations relating

to nationality of ownership of specific assets.

Property investing: Some countries have different tax rates for capital gains and

gains from property sales. For tax reasons, letting each property be owned by a

separate company can be a good thing. These companies can then be sold and

bought instead of the actual properties, effectively converting property sale gains

into capital gains for tax purposes.

2.1.1 HOW IS AN SPV ESTABLISHED?

Like a company, an SPV must have promoter(s) or sponsor(s).

Usually, a sponsoring corporation hives off assets or activities from the rest of the

company into an SPV. This isolation of assets is important for providing comfort to investors.

The assets or activities are distanced from the parent company; hence the performance of

the new entity will not be affected by the ups and downs of the originating entity. The SPV will

be subject to fewer risks and thus provide greater comfort to the lenders.

What is important here is the distance between the sponsoring company and the SPV. In

the absence of adequate distance between the sponsor and the new entity, the later will not be an

SPV but only a subsidiary company. A good SPV should be able to stand on its feet, independent

of the sponsoring company. Unfortunately, this does not happen in practice. One of the reasons

for the collapse of the Enron SPV was that it became a vehicle for furthering the ends of the

parent company in violation of the prudential norms of corporate financing and accounting.

2.2 DIFFERENCE BETWEEN AN SPV AND A

COMPANY

Technically, an SPV is a company.

It has to follow the rules of formation of a company laid down in the Companies Act.

Like a company, the SPV is an artificial person.

It has all the attributes of a legal person.

It is independent of members subscribing to the shares of the SPV.

The SPV has an existence of its own in the eyes of law.

It can sue and be sued in its name.

The SPV has to adhere to all the regulations laid down in the Companies Act.

Members of an SPV are mostly the companies and individuals sponsoring the entity.

An SPV can also be a partnership firm.

This, however, is unusual and not popular.

The company, as distinguished from an SPV, may be called a general purpose vehicle.

A company may do many things which are mentioned in the memorandum of association

(MoA) or permitted by the Companies Act.

An SPV may also do the same, but its scope of operation is limited and focused.

If it is not so, the SPV had better be called a company.

The MoA is quite narrow in the case of an SPV.

This is primarily to provide comfort to lenders who are concerned about their investment.

2.3 ADVANTAGES OF SETTING UP AN SPV

The biggest advantage is that it helps in separating the risk and freeing up the capital.

As a result, the SPV and the sponsoring company are protected against risks like

insolvency, which may arise during the course of operation. The SPV also allows securitisation

of assets without disturbing the managerial relationship. Under the arrangement, any predictable

income stream generated by secure assets can be securitised.

According to some estimates, the worldwide securitisation market has increased from

$1.2 billion of transactions in 1985, to $544 billion in 2003. Basically, a company can leverage

future earnings to raise funds.

The funds requirements for the infrastructure sector are huge. There are different

organisations, like the Infrastructure Development Finance Company (IDFC), Power Finance

Corporation (PFC), and Indian Rail Finance Corporation (IRFC) etc., which are engaged in

raising funds for development of infrastructure sector projects for the sectors they are involved

in. The proposed SPV, which is likely to be a government company, will add to the availability

of long-term funds for infrastructure sector projects.

2.4 SPV’s IN THE INDIAN CONTEXT

2.4.1 RBI’s DEFINITION OF SPECIAL PURPOSE VEHICLE

In India, Originator have the same flexibility in choosing an appropriate legal

structure for the SPV based on its individual requirements whether in form of a company,

trust (with or without a company as a trustee), MF, a statutory corporation, a society,

firm, etc., in short all possible forms of a business entity that is capable of being formed.

Consequently, the provisions of the parent law for incorporation of such entity, i.e., the

Companies Act, Trust Act, the Partnership Act, etc. will apply to the formation of such

SPVs.

While different forms of SPVs have evolved in various markets, Indian mortgage

sector has taken cues from the US market. The securitisation SPV assumes a character

different from a mere conduit in US. NHB has now taken upon itself the role similar to

that being performed by Fannie Mae and Freddie Mac in the US. NHB is presently

engaged in bringing to the market its pilot issue of MBS backed by mortgage pool of four

Housing Finance Companies. The pilot issue has been under discussion for two years

now and currently the structure and the modalities are being finalized by NHB. Based

upon the experience of the issue, NHB is likely to take a longer view of what role it needs

to play to give a fillip to the secondary mortgage market in India. Other players in the

housing market like commercial banks, HUDCO, State housing boards etc. may also

desire to participate in the secondary mortgages market as Originator or SPV or ancillary

service providers. For this segment of the market, as well as the segment relating to

issuance of ABSs, certain other kinds of SPVs would develop over a period of time.

2.5KEY FEATURES DESIRED IN AN IDEAL SPV

Based upon the international practices as discussed in the paragraph above, the WG

came to the conclusion that an SPV should, therefore, satisfy the following key

characteristics:

(a) An SPV must be capable of acquiring, holding and disposing of assets.

(b) It would be an entity, which would undertake only the activity of asset securitisation

and no other activity.

(c) An SPV must be bankruptcy remote i.e. the bankruptcy of Originator should not

affect the interests of holders of instruments issued by SPV.

(d) An SPV must be bankruptcy proof. i.e. It should not be capable of being taken into

bankruptcy in the event of any inability to service the securitised paper issued by it.

(e) An SPV must have an identity totally distinct from that of its promoters/

sponsors/constituents/ shareholders. Its creditors cannot obtain satisfaction from them.

(f) The investors must have undivided interest in the underlying asset (as distinguished

from an interest in the SPV which is a mere conduit).

(g) A SPV must be tax neutral i.e. there should be no additional tax liability or double

taxation on the transaction on account of the SPV acting as a conduit.

(h) A SPV must have the capability of housing multiple securitisations. However, SPV

must take precaution to avoid co-mingling of assets of multiple securitisations. In case of

transactions involving various kinds of assets, they should restrict the rights of investors

to the specific pool.

(i) The SPV agreement may not release its employees or trustees from their responsibility

for acts of negligence and a willful misconduct.

Instrument issued by an SPV should have the following characteristics:

(a) Be capable of being offered to the public or private placement.

(b) Permit free or restricted transferability.

(c) Permit issuance of pass through or pay through Securities.

(d) Represent the amounts invested and the undivided interest or share in the assets (and

should not constitute debt of SPV or the Originator).

(e) Be capable of being classified as senior / subordinate by differentiation in ranking of

security or in receiving payments.

(f) May be issued in bearer form or registered in the holder’s name, may or may not be

endorsable and may be issued in definitive form or book entry form.

Bankruptcy-remoteness and insolvency laws

Standard and Poor's has developed the following the 'Special Purpose Entity' criteria

which a SPV should satisfy to be deemed as bankruptcy-remote.:

o Restrictions on objects and powers: The purpose of this restriction is to reduce the

SPV's internal risk of insolvency due to claims created by activities unrelated to

the securitised assets and issuance of rated securities.

o Debt limitations: An SPV should be restricted from issuing other debt except in

circumstances those are consistent with the rated issuance.

o Independent director: Interlocking directorates between the Directors of the SPV

and that of its parent present a potential conflict of interest. If the parent becomes

insolvent in a situation where the SPV is performing adequately, there may be an

incentive for the parent entity to voluntarily file the SPV into bankruptcy and

consolidate its assets with those of the parent. If the SPV has at least one director

who is independent from the parent and this director's vote is required in any

board action seeking bankruptcy protection for the SPV, the SPV is unlikely to

voluntarily file an insolvency petition.

o No merger or reorganization: This requirement ensures that, while the rated

securities are outstanding, the bankruptcy-remoteness of the SPV will not be

undermined by nay merger or consolidation with a non-SPV or any

reorganization, dissolution, liquidation, or asset sale.

o Separateness: Separateness covenants are designed to ensure that the SPV holds

itself out to the world as an independent entity, on the theory that if an entity does

not act as if it had an independent existence, a court may use principles of

piercing the corporate veil, alter ego, or substantive consolidation to bring the

SPV and its assets into the parent's bankruptcy proceedings.

o Security interests over assets: A debt security interest opinion is generally

required that the issuing SPV can grant a security interest over its assets to the

holders of the rated securities. This element helps in reaching the analytic

conclusion that an issuer is in fact an SPV by reducing the incentives of the parent

to involuntarily file the entity. By reducing the practical benefit of insolvency

filing, the likelihood of voluntary insolvency is decreased.

Each of these characteristics is important to the overall concept of bankruptcy remoteness

and regardless of the specific organizational structure of the SPV, these elements should,

generally, be treated in the relevant organisational documents. Such an SPV is regarded

as being sufficiently protected against both voluntary and involuntary insolvency risks.

CHAPTER-3

3.1 SECURITISATION – Concept

Securitisation is the process of pooling and repackaging of homogenous illiquid financial

assets into marketable securities that can be sold to investors. Through it illiquid assets are

converted into trade able security with a secondary market. It is measure of replenishing the

funds by recourse to the secondary market. Thus, the securitisation is a process by which the

originators of assets like loans which are illiquid are able to transfer such assets to a special

purpose vehicle (‘SPV') which, in turn, issues tradable liquid securities to investors. In a typical

securitisation transaction, the company seeking to raise funds transfers certain of its assets to an

SPV that is organised in such a way that minimises the likelihood of bankruptcy.

Figure 1 below presents the structure of a Collateralized Loan Obligation (CLO), a

typical securitization transaction.

In the above CLO transaction, the originator packages a pool of loans and assigns his

interest therein, including the underlying security, to a bankruptcy remote & tax neutral entity

which, in turn, issues securities to investors. The idea of such an exercise is to completely

transfer the interest in pool of loans to the investors (a “true sale”) and achieve a rating higher

than that of the Originator.

With the help of securitization transaction, an originator can transfer the credit and other

risks associated with the pool of assets securitized. Securitization can provide much needed

liquidity to an Originator’s balance sheet; help the originator churn its portfolio and make room

for fresh asset creation; obtain better pricing than through a debt-financing route; and help the

originator in proactively managing its asset portfolio. Securitization allows investors to improve

their yields while keeping intact or even improving the quality of investment.

A typical securitisation transaction consists of the following steps:

1. Creation of a special purpose vehicle to hold the financial assets underlying the

securities;

2. Sale of the financial assets by the originator or holder of the assets to the special

purpose vehicle, which will hold the assets and realize the assets;

3. Issuance of securities by the SPV, to investors, against the financial assets held by it.

This process leads to the financial asset being taken off the balance sheet of the

originator, thereby relieving pressures of capital adequacy, and provides immediate

liquidity to the originator.

The legal framework for securitisation in India with the enactment of the “The

Securitisation and Reconstruction of Financial Assets and Enforcement of Security

Interest Ordinance, 2002” (The SARFAESI Act). Its purpose is to promote the setting up

of asset reconstruction/securitisation companies to take over the Non Performing Assets

(NPA) accumulated with the banks and public financial institutions. The Act provides

special powers to lenders and securitisation/ asset reconstruction companies, to enable

them to take over of assets of borrowers without first resorting to courts.

3.2 PARTIES INVOLVED IN SECURITISATION

PROCESS

There are primarily three parties to a securitisation deal. They are as follows:

Originator: It is the entity on whose books the assets to be securitised exist. It sells the

assets on its books and receives the funds generated from such sale. In a true sale, the

originator transfers both the legal and the beneficial interest in the assets to the SPV.

Special purpose vehicle (‘SPV'): The issuer also known as the SPV is the entity that

would typically buy the assets (to be securitised) from the originator. It plays a very

crucial role in as much as it holds the assets in its books and makes the upfront payment

for them to the originator and thereby removes the assets from the balance sheet of the

originator.

Investors: The investors may be in the form of individuals or institutional investors like

FIs, mutual funds, provident funds, pension funds, insurance companies, etc. They buy a

participating interest in the total pool of receivables and receive their payment in the form

of interest and principal as per agreed pattern.

A securitisation transaction generally involves some or all of the following parties:

The initial owner of the asset (the originator or sponsor) who has a loan agreement with

the borrowers (obligors).

The issuer of debt instruments who also is the SPV. The structure keeps the SPV away

from bankruptcy of the originator, technically called ‘bankruptcy remote'.

The investment bankers who assist in structuring the transaction and who underwrite or

place the securities for a fee.

The rating agencies that assess credit quality of certain types of instruments and assign a

credit rating.

The credit enhancer, possibly a bank, surety company, or insurer, who provides credit

support through a letter of credit, guarantee, or other assurance.

The servicer, usually the originator, who collects payments due on the underlying assets

and, after retaining a servicing fee, pays them over to the security holders.

The trustee, who deals with issuer, credit enhancer and servicer on behalf of the security

holders.

The legal counsel, who participates in the structuring of the transaction.

The swap counterparty that provides interest rate/currency swap, if needed.

3.3 SECURITISATION MARKET IN INDIA

Issuance volume in the Indian securitisation market fell by 29% in FY2011 over the

previous fiscal to Rs. 30,825 crore. While securitisation of retail loans (both Asset-Backed

Securitisation or ABS, and Residential Mortgage-Backed Securitisation or RMBS, cumulatively)

was slightly lower by about 6%, the drop in overall volume was mainly owing to Single

corporate loan securitisations [also known as Single Loan Collateralised Loan Obligations

(CLOs) or Loan Sell-Offs (LSOs)] falling out of favour. LSOs-the largest product class in

FY2009, dwindled down to a trickle in FY2011, the reduction being mainly a fall-out of draft

regulatory guidelines.

As expected by ICRA, pursuant to the draft guidelines of the Reserve Bank of India

(RBI) issued in first quarter of FY2011, regarding the minimum holding period (MHP) and

minimum retention requirement (MRR), LSO transactions were adversely affected, and almost

stopped in the second half of the previous fiscal. Regulatory factors like “priority sector lending”

(PSL) targets for banks—and the resultant acquisition of such loan pools from non-banking

finance companies (NBFCs)—continued to be the key motivator for ABS and RMBS

transactions. Microfinance loan securitisation saw a surge in the second half of FY2011 as MFIs

found it difficult to obtain alternate source of funding and investors (mainly banks) took

exposure in these transactions mainly driven by the motive of fulfilling their PSL targets.

Going forward, ICRA expects the issuance volumes to remain modest, in the backdrop of

uncertainty regarding the final regulatory prescriptions and subdued investor demand.

Nevertheless, regulatory factors such as PSL targets (for banks) would continue to drive trading

in certain loan assets. Similarly, the final shape of the guidelines on MHP and MRR proposed by

the RBI for securitisation and the applicability of the same for bilateral transactions are expected

to influence issuance volumes. SEBI’s recent action of issuing the model Listing Agreement for

Securitised Debt Instruments is another step towards bringing in transparency and improving

secondary market liquidity for these instruments.

3.3.1 MARKET ACTIVITY

ABS continues to form a major part of transactions in FY2011

Securitisation market in India slowed down by a further 29% in value terms during

FY2011. The number of transactions in FY2011 was almost 20% lower than that in the previous

fiscal. Though there was a small decline in retail loan securitisation (both ABS and RMBS), it

was the drastic reduction in the LSO issuance that contributed to the sharp slowdown in the

overall securitisation market.

Figure 1: Trend in Securitisation - by number Figure 2: Trend in Securitisation - by value, in Rs. crore

Source: ICRA’s estimates Source: ICRA’s estimates

Table 1: Trend in SF Issuances - by value, in Rs. crore

FY2008 FY2009 FY2010 FY2011

Amount Share Amount Share Amount Share Amount Share

ABS 31,323 49% 13,581 25% 21,497 50% 20,920 68%

RMBS 588 1% 3,291 6% 6,254 14% 5,029 16%

Total Retail 31,911 50% 16,872 31% 27,751 64% 25,948 84%

Securitisation

LSO5 31,819 50% 35,608 66% 14,581 34% 4,341 14%

Others6 -- -- 1,160 2% 787 2% 536 2%

Overall total 63,730 100% 53,640 100% 43,118 100% 30,825 100%

Growth 73% (16%) (20%) (29%)

Source: ICRA’s estimates

As can be seen from table 1, notwithstanding the decline in both the ABS and RMBS product,

the overall share of retail loan securitisation increased during FY2011. The average deal size

was lower in FY2011, mainly due to the greater share of the microfinance loan pools.

3.3.2 EXAMPLES OF SECURITISATION IN THE INDIAN CONTEXT

First securitisation deal in India between Citibank and GIC Mutual Fund in 1991 for Rs

160 mn.

L&T raised Rs 4,090 mn through the securitisation of future lease rentals to raise capital

for its power plant in 1999.

India’s first securitisation of personal loan by Citibank in 1999 for Rs 2,841 mn.

India’s first mortgage backed securities issue (MBS) of Rs 597 mn by NHB and HDFC in

2001.

Securitisation of aircraft receivables by Jet Airways for Rs 16,000 mn in 2001 through

offshore SPV.

India’s first sales tax deferrals securitisation by Govt. of Maharashtra in 2001 for Rs

1,500 mn.

India’s first deal in the power sector by Karnataka Electricity Board for receivables worth

Rs 1,940 mn and placed them with HUDCO.

India’s first Collateralised Debt Obligation (CDO) deal by ICICI bank in 2002

India’s first floating rate securitisation issuance by Citigroup of Rs 2,810 mn in 2003.

The fixed rate auto loan receivables of Citibank and Citicorp Finance India included in

the securitisation

India’s first securitisation of sovereign lease receivables by Indian Railway Finance

Corporation (IRFC) of Rs 1,960 mn in 2005. The receivables consist of lease amounts

payable by the ministry of railways to IRFC

India’s largest securitisation deal by ICICI bank of Rs 19,299 mn in 2007. The

underlying asset pool was auto loan receivables.

3.4 NEED FOR SECURITISATION IN INDIA

The generic benefits of securitization for Originators and investors have been discussed

above. In the Indian context, securitization is the only ray of hope for funding resource starved

infrastructure sectors like Power. For power utilities burdened with delinquent receivables from

state electricity boards (SEBs), securitization seems to be the only hope of meeting resource

requirements. As on December 31, 1998, overall SEB dues only to the central agencies were

over Rs. 184 Billion. (According to reports, the power sector in India needs a funding of about

USD 17 billion over the next 10 years.)

Securitization can help Indian borrowers with international assets in piercing the

sovereign rating and placing an investment grade structure. An example, albeit failed, is that of

Air India’s aborted attempt to securitize its North American ticket receivables. Such structured

transactions can help premier corporate to obtain a superior pricing than a borrowing based on

their non-investment grade corporate rating.

A market for Mortgage backed Securities (MBS) in India can help large Indian housing

finance companies (HFCs) in churning their portfolios and focus on what they know best – fresh

asset origination. Indian HFCs have traditionally relied on bond finance and loans from the

National Housing Bank (NHB). MBS can provide a vital source of funds for the HFCs.

After the merger of India’s largest financial institution ICICI with ICICI Bank, ICICI,

faced with SLR and other requirements, is actively seeking to launch a CLO to reduce its overall

asset exposure. It appears to be only a matter of time before other Public Financial Institutions

merge with other banks. Such mergers would result in the need for more CDOs in the

foreseeable future.

3.5 CURRENT SECURITISATION ACITIVITY IN INDIA

To analyze the potential of securitization India, we split the securitization market into the

following four broad areas:

3.5.1 ASSET BACKED SECURITIES (ABS)

Asset backed Securities are the most general class of securitization transactions. The

asset in question could vary from Auto Loan/Lease/Hire Purchase, Credit Card, Consumer Loan,

student loan, healthcare receivables and ticket receivables to even future asset receivables. The

split of outstanding ABS in the US is given in Figure 2.

In the Indian context, there has been moderate amount of activity on the Auto Loan securitization

front. Companies like TELCO, Ashok Leyland Finance, Kotak Mahindra and Magma Leasing

have been securitizing their portfolio of auto loans to buyers like ICICI and Citibank over the

past years, with several of the recent transactions rated by rating agencies like CRISIL and

ICRA.

In April 1997, Global Tele-Systems Ltd. raised approximately USD 32 million by securitizing

the future receivables of its consumer telecom business to an SPV named Integrated Call

Management Centre. Tata Finance was the sole investor in the pass-through certificates issued by

the SPV.

One of the first publicized structured finance transactions in India was the Rs. 4.09 billion

non convertible debenture program by India Infrastructure Developers Ltd (IIDL), an SPV set up

for building and operating a 90 MW captive co-generation power plant for IPCL (March, 1999).

IIDL raised finances on the BOLT (Build Operate Lease Transfer) model on the strength of its

future cash flows from IPCL and limited support from L&T. The transaction was rated AA- (SO)

by CRISIL.

While the activity in the ABS market is picking up in India, the number of investors for

securitized paper is very limited. In the absence of a Securitization Act, there are taxation and

legal uncertainties with the securitization vehicle. In India, transfer of secured assets as required

for securitization, can attract a stamp duty as high as 10% in some states precluding transaction

possibilities. With favorable legislation and taxation regime, the ABS market in India can hope

to see a lot of activity in future.

3.5.2MORTGAGE BACKED SECURITIES (MBS)

As we discussed above, MBS constitutes about 76% of the securitized debt market in the US. In

contrast, the MBS market in India is nascent - National Housing Bank (NHB), in partnership

with HDFC and LIC Housing Finance, issued India’s first MBS issuance in August 2000. The

deal size was Rs. 10.35 billion comprising 11,106 individual housing loans HDFC and LIC

Housing finance Ltd.

The potential of MBS in India, however, is huge. With NHB actively looking towards the

development of a Secondary Mortgage Market (SMM) in the country, the MBS market in India

could soon overtake the other securitization transactions in the country. An MBS market can

help small HFCs with good origination capabilities and limited balance sheet strength in staying

profitable and concentrate on the housing loan origination. The most important roadblocks for

MBS in India are lack of mortgage foreclosure norms and the high incidence of stamp duty for

assignment of mortgage necessary for securitization.

3.5.3 COLLATERALISED DEBT OBLIGATION (CDO)

In this era of bank consolidations, CDOs can help banks to proactively manage their portfolio.

CDOs can also help banks in restructuring their stressed assets. ICICI made an aborted attempt to

do a CBO issuance in August 2000. The CDO market in India is, however, likely to grow slowly

owing to its complexities. The taxation and accounting treatment for CDOs needs to be clarified.

3.5.4 ASSET BACKED COMMERCIAL PAPER (ABCP)

Asset Backed Commercial Paper (ABCP) is usually issued by Special Purpose Entities (ABCP

Conduits) set up and administered by banks to raise cheaper finances for their clients. ABCP

conduits are usually ongoing concerns with new CP issuances taking out the previous ones.

Apart from legal requirements, an active ABCP market requires a large number of investors who

understand the instrument and have appetite. India’s securitization market may not be mature

currently for instruments like ABCPs.

3.6 ISSUES FACED BY INDIAN SECURITISATION

MARKET

Presently, there are several issues which plague the market for asset securitisation. The end result

is that the securitisation has still not realised its full potential and there is urgent need to address

the issues facing the Indian securitisation market in order to develop the market. The following

issues are in the perspective of securitisation transactions of standard assets which are not

governed by the SARFAESI Act. It governs the instruments known as ‘security receipts' that can

only be issued by asset reconstruction companies in respect of distressed assets.

Stamp Duty on the assignment: One of the major hurdles facing the development of

the securitisation market is the stamp duty structure. In India, stamp duty is payable on

any instrument which seeks to transfer rights or receivables. 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 states that still

have a high stamp duty. Few states have reduced their stamp duty rates, though quite a

few still maintain very high rates ranging from 5-12 per cent. To the investor, if the

securitised instrument is issued as evidencing indebtedness, it would be in the form of a

debenture or bond subject to stamp duty, and if the instrument is structured as a Pass

Through Certificate (PTC) that merely evidences title to the receivables, then such an

instrument would not attract stamp duty. Some states do not distinguish between

conveyances of real estate and that of receivables, and levy the same rate of stamp duty.

SEBI has suggested to the government on the need for rationalisation of stamp duty with

a view to developing the corporate debt and securitisation markets in the country, which

may going forward be made uniform across states as also recommended by the Patil

Committee.

Foreclosure Laws: Lack of effective foreclosure laws also prohibits the growth of

securitisation in India. The existing foreclosure laws are not lender friendly and increase

the risks of MBS by making it difficult to transfer property in cases of default.

Taxation related issues: There is ambiguity in the tax treatment of mortgage-based

securities, SPV trusts, and NPL trusts. Presently, the investors or the buyers (PTC and

SR holders) pay tax on the earnings from the SPV trust. As a result the trustee makes

income payouts to the investors without any payment of tax. The Income Tax law

envisages the taxation of an unincorporated SPV either at the trust SPV level or the

investor level in order to avoid double taxation. Therefore, any tax pass through regime

merely represents a stance that the investors in the trust will bear the tax liability instead

of the Trust being held liable to tax the investors on their respective earnings.

Issues under the SARFAESI Act: A security receipt (SR) gives its holder a right of title

or interest in the financial assets included in securitisation. This definition holds good for

securitisation structures where the securities issued are referred to as pass through

certificates. However, the rationale fails in the case of pay through certificates with

different classes of primary and secondary rights to the cash flow. Also, the SARFAESI

Act has been structured such that SRs can be issued and held only to Qualified

Institutional Buyers (QIBs). There is a need to expand the investor base by including

NBFCs, non-NBFCs, private equity funds, etc.

Legal Issues: Investments in PTCs are typically held-to-maturity. As there is no trading

activity in these instruments, the yield on PTCs and the demand for longer tenures

especially from mutual funds is dampened. Till recently, Pass through Certificates (PTC)

were not explicitly covered under the Securities Contracts (Regulation) Act, definition of

securities. This was however amended with the Securities Contracts (Regulation)

Amendment Act, 2007 passed with a view to providing a legal framework for enabling

listing and trading of securitized debt instruments. This will bring about listing of PTCs

which in turn will support market growth.