RBI securitisation update: simpler rules, simpler transactions

On 8 June 2020, the Reserve Bank of India launched a consultation for revisions to its securitisation framework. The consultation follows a number of recommendations outlined in the report published by its “Committee on the Development of Housing Finance Securitisation Market” in September 2019.

Local regulation - international perspective

While the changes to the rules would directly affect Indian commercial banks and non-bank financial corporations (NBFCs), the updates may also have an effect on international investors who participate in the Indian securitisation market through the increasingly popular foreign portfolio investor scheme. This is because many of these international investors are regulated outside of India (for instance, in the European Union (EU) and Japan) and, when making investments in securitisation transactions, must ensure those transactions meet certain transparency and risk retention requirements mandated by their regulators.

The details

Risk retention: The proposal outlines a significant simplification of the Indian minimum risk retention (MRR) rules. The MRR must, broadly, be met through first-loss retention of one type or other and is set at 5% for short-term loans and residential mortgages and 10% for other loans. There is provision for “L”-shaped retention in some circumstances, however, its use is more restrictive under the proposed amendments than under the existing regime. With the exception of the instances where the “L“-shaped retention is used, complying with the Indian rules is expected to satisfy the requirements under the retention rules which EU and Japanese investors must comply with when investing. However, care will need to be taken where second loss credit facilities are (as is common in the Indian securitisation market) provided by third parties, particularly where those facilities support junior tranches in transactions. These facilities provided by third parties can interfere with the calculation off the “first loss” under the EU rules. However, on such transactions the originator usually also retains (under the Indian “L”-shaped method) a sufficiently thick vertical tranche to comply with the “vertical retention” method under the EU rules. If the “L”-shaped Indian retention becomes less prevalent then compliance in practice with the EU rules may become more nuanced and would need to be carefully assessed on a case-by-case basis.

Transparency: Reporting templates to be issued on a transaction-by-transaction basis are attached to the consultation paper and would be issued periodically in respect of each transaction. The templates provide for aggregated pool-wide data, rather than loan-by-loan reporting requirements seen in some jurisdiction. By having data from different transactions presented in a similar format, investors will find it easier to contrast the content and performance of the underlying assets between their investments.

Permitted representations and warranties: The maximum scope of representations and warranties around the assets in the pool follow those in the existing securitisation rules. The present update may be an opportune time for the RBI to provide a degree of additional flexibility and outline the instances in which repurchases and indemnities for breaches of asset representations can be permitted in a manner equivalent to that seen in most EU transactions, and expected by a lot of international investors.

Credit enhancement resets: Credit enhancement resets will continue to be permitted in a number of circumstances and their exact implementation in individual transactions will need to be carefully checked on a case-by-case basis by EU investors for compliance with the EU risk retention requirements, which limit the degree by which credit enhancement can be released during the ongoing life of a transaction where first-loss risk retention is being used.

The domestic angle

As contemplated by Basel III, the RBI plans to introduce a set of “simple, transparent and comparable” (STC) criteria, against which securitisations can be assessed. A transaction which meets these requirements would allow domestic banks to hold less regulatory capital against their exposures to that transaction – with a risk weight floor as little as 10% in respect of senior exposures. This is similar in nature to the “simple, transparent and standardised” (STS) rules which are in place in Europe.

The RBI has also outlined the approaches which can be taken when regulated banks calculate the risk weightings of their securitisation positions. Two approaches have been put forward – SEC-ERBA and SEC-SA – and the RBI has requested comments from the industry on whether they should be alternatives or whether one should be prescribed as the preferred approach. Interestingly, the RBI has opted against implementing SEC-IRBA as an option.

Finally, with respect to the degree of significant risk transfer required to permit capital relief in respect of a portfolio of assets, a quantitative benchmark has been put forward, broadly matching that in place in the EU, being 50% of the mezzanine tranche(s) or 80% of junior the junior tranche. This will help provide a degree of certainty to banks when they undertake securitisations for balance sheet management purposes.

Timing

The consultation has requested responses by 30 June 2020 and the final rules look set to come into force during the course of 2020. We will continue to follow up the status. If you would like to know more about the rules, please reach out to James Pedley, Michael Lorraine, Amer Siddiqui or Kathryn James.