• Annexure – I Presentations Given by Outside organisations to the In-House
• Annexure – II Accounting Treatment
• Annexure – III Disclosure of Information to investors
• Annexure - IV Proposed Prudential Guidelines for Asset Securitisation

(see para 1.4, 10.2.1, 10.2.2.7)

1. Smt. Rupa Devi Singh, Vice President & Group Head, Financial Engineering, SBI Caps gave a detailed presentation covering the Indian experience in contrast to the ground realities in some of the developed countries. The various hindrances faced by SBI Caps in their attempt to structuring securitisation deals were explained at length. She stated that officials from SBI Caps along with NHB had visited USA in 1994 to get a feel of the securitisation process and interact with various agencies engaged in securitisation. She explained the intricacies pertaining to treatment of receipts as equity by the Originator out of the sale proceeds. She stated that there were difficulties in creating a trust as the existing legal and other environment are not conducive for trusts to come into being. She also informed the Group that Ashok Leyland and Tata Finance were active in this field among NBFCs. She stressed the importance of securitisation as this instrument is destined to play a leading role in funding long term assets of say, 15 years maturity. She informed the Group that Institute of Chartered Accountants of India (ICAI) are yet to issue suitable guidelines for securitisation although SBI has already written to them. She explained the difference between Pass Through Certificate and Pay Through Certificate. She pointed out that while an umbrella legislation could be considered in the long run, minor amendments to some legislation and issuance of clarifications for the present, will facilitate the promotion of securitisation in the short run.

2. Shri R.V. Verma, General Manager, NHB informed the Group that NHB has acquired vast experience in mortgage securitisation in recent years and has reached an advanced stage of preparation for launching the securitisation product in a big way. Shri Verma spoke on securitisation of mortgage loans and operational and regulatory issues. He informed the Group the huge funds requirements (Rs.1,50,000 crores during current five year plan) and the constraint of the meeting these requirements through either budgetary allocation of Government or normal credit flow of the banking sector. He stated that housing finance institutions have reached a stage where they can go direct to the market without the intermediation of banking institutions. He explained how supply of funds to the mortgage market through securitisation could lower the interest rates on mortgage loans. Long term debt market can be facilitated through introduction of mortgage backed securities (MBS). He explained how the regulatory, promotional and financial roles of NHB are mutually synergic. While the regulatory role gives an opportunity to have on site supervision and off-site surveillance, the information can be gainfully utilised to promote research, analysis of past performance and the behaviour of various classes of mortgage loans. These can lower the yield on securitisation paper and increase the spreads. He suggested that a beginning could be made by securitising loans of individual housing finance companies followed by pooling of portfolio of different housing finance companies. He informed that Ninth Five Year Plan had indicated resources mobilisation to the extent of Rs.2,500 crores through securitisation. There is growing gap between the demand and supply of houses. The current environment of deregulation can be capitalised upon by introduction of an active secondary mortgage market. NHB had taken up the matter of securitisation with State Governments through Ministry of Urban Development. Simplified foreclosure laws are attracting the attention of the Government. This, coupled with mortgage insurance can improve the competitiveness of securitised instrument. Through securitisation, funds can be channeled into housing sector through MBS. He also impressed upon the need of implicit guarantee of the Government to the MBS issue of NHB. He indicated that ‘cherry picking’ would be required in the beginning. This may give incentive for quality portfolios, standardised documentation etc. He pointed out the need of adequate disclosures in the offer document regarding the items/ rights where recourse is available and items/ rights where recourse is not available. He also highlighted the pool selection criteria evolved by rating agencies in association with NHB which included unencumbered loans, lending to individual for residential houses only in the State of Maharashtra, Tamil Nadu, Gujarat and Karnataka with maximum loans to value (LTV) of 80 per cent. Joint loans with other lending institutions are to be excluded. The recourse to the Originator in the form of cash flow is limited to the cash pool set aside for these purposes by the Originator. He highlighted that pre-payment risk and default risk beyond credit enhancement in Pass Through Certificates will have to be borne by the investor. He also suggested that investment in MBS by banks should be (i) treated as priority sector lending, (ii) included in the allocation of the banks for housing finance and (iii) given 20% risk weight as in the case of investment of bonds of NHB.

3. Shri Naresh Takkar and Shri Basu of ICRA gave the presentation on ‘Structuring and Assessment of Credit Risk of receivables – System requirements’. The presentation covered the assessment of credit quality risk, structural and legal regulatory issues and system requirements from Originator point of view. The rating measures ability and willingness of the structure to sustain all repayment obligations (cash flows) over the currency of the transaction. Shri Basu explained the difference between traditional MBS/ABS, Collateralised Debt Obligations (CDO) and future receivables. In India, recent innovations include housing finance receivables, electricity receivables, school fees, future collections by builders, ticketing receivables by Air India etc. Large issues are not rated and are placed privately under bilateral arrangements. Shri Basu informed that there are Standby Administrators and Standby Trustees in the USA, which can be inducted if investors feel so. Credit enhancement bridges shortfalls in cash flows from time to time. He also pointed out that SPV could be tax neutral in case of Pass Through Certificates and tax assessable in case of Pay Through Certificates. In the process of risk assessment, the rating agencies undertake actuarial exercises to ascertain the probability of default. In the Indian scenario, very little information is available on the demographic characteristics of the pool of assets except for the data on income level of Obligors. Different geographical locations can have influence on the actuarial assessment (better quality assets in western and northern zones while the assets in southern part of the country have erratic behaviour). The nature of asset (e.g. ordinary / luxury car, heavy duty / light duty vehicle) also influences the level of credit enhancement. Credit enhancement is linked to targeted credit rating, which need not be ‘AAA’ in all the cases. In the payment mechanism, the Obligors make payments to the Originators even after securitisation. The re-investment risk in pay through structure can be minimised through investment in safe Government of India securities instead of securities of State Government / municipal bonds. In the case of third party guarantees, the credit risk is to be evaluated. In case of the floating rate instrument, benchmark rate and frequency of monitoring are important structure issues. The clarity of the definition of the roles of Originator, SPV and Servicer are other important determinants. He also elaborated the SPV structure in the form of Corporate or a Trustee. In the case of a Trust, although it is easier to create the entity, the investors have the right to seek even the minutest details of the underlying Obligors. He also stated that the nature of issue Pass Through Certificate, bonds or debentures is a grey area. He also informed that there was a ceiling of 10 per cent credit enhancement in USA till recently. On the subject of other legal and regulatory issues, Shri Basu opined that the notification to the Obligor is not required under the Indian laws. He also stated that call option for Originator (repurchase obligation of the Originator) is not allowed.

4. A team of four officers from ICICI gave the presentation on ‘Securitisation: Steps to be taken to initiate the instrument in India’. The presentation included assignment process, the structure of SPV, nature of securitised instruments and other issues. It was explained how Order II, Rule 2 of Code of Civil Procedure 1908 prohibits part assignment. Section 5 of Transfer of Property Act, 1882 states that the property being transferred must exist in present and prevents transfer of future receivable. Further, the high stamp duty ranging from 4 to 10 per cent in many States also needs to be exempted/ minimised for securitisation transactions. Under the Income tax Act (Section 60) transfer of income without transfer of underlying assets keeps Originator liable to taxation. Section 63 of the Income Tax Act, involving transfer of beneficial interest without transfer of legal interest, makes transferors liable to taxation. Section 10 (23G), which gives benefit of investment in infrastructure bonds, should be made applicable to securitisation debts representing loans for infrastructure developments. Regarding SPV, it was stated that it should achieve –

• Bankruptcy remoteness
• Tax efficiency
• Capability to issue publicly traded paper

Out of the various forms of SPV as Company, Trustee and Mutual Funds (which is not subject to taxation), the Mutual Fund (MF) is most suitable immediate remedy. A point was raised whether MFs can issue securities with assured returns. This may have to be examined in detail at a later stage. It was also pointed out that Regulation 43 of SEBI (Mutual Fund) Regulations 1996, needs clear definition of securitised debt. Second proviso of Regulation 43 ibid excludes investment by MFs in MBSs. This needs to be deleted. It was opined that banks and MFs might be initial bulk investors in securities debt as they are well informed of the intricacies of financial innovations. It was suggested that working capital agreement between the financial institution and the borrower may exclude all receivables (which the financial institutions may acquire in due course of time) to be charged to the bank. The treatment of exposure to Originator or Obligator should be made clearer. Treatment of up front income (difference between the yield earned on loans securitised and coupon rate for securitised debt over the tenure of the loan) should also be clarified. It was suggested that (i) RBI should issue clarifications to banks for issuance of NOCs within the definite time frame (as was done for Factoring), (ii) RBI should clarify that on securitisation deals, exposure will be on Obligors and (iii) Concessional finance should continue to be made available in the event of export receivable securitisation.

5. The presentation by the ILFS on the subject of ‘Infrastructure Financing and Securitisation’ emphasised two major benefits of securitisation (i) cost of funding will be reduced (ii) larger number of investors can be approached for meeting the infrastructure needs. The presentation gave a background on infrastructure financing, securitisation in infrastructure financing and constraints in securitisation. The nature of funds utilised for infrastructure (ports, roads, power projects, water and sewage etc.) development was highlighted with the need to perceive risk involved at pre-commissioning and post- commissioning stages. It was pointed out that only a few institutions understand infrastructure risks.

6. The bank is involved in securitisation since 1990. Shri Jayakumar emphasised the need of reducing the transaction cost and the creation of quality assets to develop securitisation in a significant way. He suggested that (i) in the short run, some guidelines can be framed to facilitate securitisation, (ii) in the long run, nodal agencies like NHB may undertake the activity of market maker by shifting from the role of refinancing in a phased manner. He opined that UK model is appropriate for Indian conditions. The trading in securitisation needs to be operationalised as some of the securitised debt in the past, although listed on the National Stock Exchange, was not traded. He also emphasised that structure / role of different agencies should be considered on a different footing from the issue of tax exemption. Reserve Bank of India (Department of Banking Operations and Development) may make uniform guidelines for investment in direct mortgage backed securities and asset backed securities. Shri Jayakumar also stated that the latest consultative paper of Bank for International Settlement, which gives lower risk weights for highest rated debt, might encourage high graded instruments in the area of securitisation.

7. Shri N.C. Roy, M.D., DCR India highlighted the relevance of the rating process in securitisation deals. He averred that the ‘informed’ investors will alone be deploying their funds on securitised papers and hence pointed out the need for transparency and information sharing of a high degree. This was followed by a detailed presentation by Shri A. Bhoumik of DCR India. He referred to the need of a guarantee company, as was the case with mortgaged loans in U.S.A. He stated that the support of guarantee companies could be considered towards extending credit enhancements especially for the infrastructure sector. Different future flow risks like product risk, obligor risk, etc. were highlighted. Referring to their past experiences, he stated that there had been no instance of default in the case of 117 international issuance on securitisation transactions rated by DCR between 1991-98 despite melt-downs in some of the emerging economies. The Group was informed that securitisation had survived economic downturn in Mexico during the Tequila Crisis of Mexico during 1995. Securitisation had also survived corporate default in Venezuela, Pakistan and Indonesia. In the case of India, there is good scope for securitisation of future flows of oil and gas receivables, credit card vouchers receivables and tolls / rentals / service contracts / fees, etc. As a part of the rating methodology, he averred that DCR assesses the legal and payment structure, track record of the management, MIS irrespective of the originator or investors. He explained that due diligence process followed by them is exhaustive which includes assessment of origination / underwriting policies, random sampling, documentation, etc. Credit enhancement is determined by worst case scenario, review of concentration issues, etc. The rating rationale gives transaction details such as the originators, tenors, security, legal issues, pool characteristics, sensitivity analysis, cash flow statements (which influences the AAA or other ratings), etc. The periodic service reports include pool behaviour, delinquencies, etc. Drawing upon the experience of a live deal, he brought out the importance of backup services especially in the case of bankruptcy of the originator. The issues like filing of suits by receiving and paying agents and pass through nature of SPV were the other issues highlighted during the presentation.

8. Shri D. Thyagarajan informed the Group that CRISIL had pioneered securitisation rating in India in 1991 and has rated about 50 securitisation transactions with volume aggregating to well over Rs. 4,500 crore. Various forms of credit enhancements used include cash collateral, over-collaterisation, spread account and guarantee. He pointed out that there has been no instance of downgrading of rating in securitisation transactions. There has also been fairly accurate prediction of pool performances. CRISIL engages legal experts during the process of finalisation of transactions. The feasibility of issuing asset backed securities in demat form to save on stamp duty and minimise documentation was also highlighted. The issues regarding interest tax (the treatment of interest gain to the Originator as one time revenue gain or a continuous flow of gains over the tenor of the asset) and tax deducted at source were also highlighted. He pointed out that there was no separate legislation on hire purchase or leasing transactions. He suggested that the rights of the lessors in documentation need to be clarified in Motor Vehicle Act. A view was expressed that it may be helpful if the ownership / endorsements in the books (Registration Books in the case of securitisation of motor vehicles) are in the name of SPV in the records of Transport Authorities. The need to create awareness about the securitised instrument among the investors especially pension funds, banks, etc.) was emphasised. The regulators may prescribe investments by various institutions based on the rating of the securitised instruments. There is a greater need for rating in case of securitised paper vis-à-vis a conventional debt paper in view of the complexity of the structure involved and the fact that only a pool of assets back the paper, without backing of any entity. Private placement may also need to be rated. He suggested that the offer documents may disclose (i) all risks, and (ii) the ratings assigned besides the rating rationale. Originator’s annual report may disclose the securitisation kept off the Balance Sheets, extent and form of credit enhancement provided by the Originators and the potential liability therefrom. There is a need for accounting guidelines to be issued for originators, investors and SPVs. Some of the rating issues, which prevent the delinking of Originators' risks, are

• Commingling of cash flows,
• Lack of third-party services,
• Borrowers not used to making payments to parties other than the original lender, and
• Efficacy of third party services not tested out.

Due to these problems, CRISIL is not in a position to sign rating based only on quality of assets. There is also lack of legal case history to know how courts would view securitisation transaction in the event of the bankruptcy of the Originator.

9. Shri S.P. Ghosh gave a presentation on 'Opportunities for the development and growth of Asset Securitisation'. Shri Ghosh was a member of the team of 13 experts, which visited U.S.A. during 1995 to learn lessons from their securitisation experience. He highlighted the benefits of securitisation in a capital scarce economy like India. Securitisation helps in allocation of risk to the best owner. Non-credit risks are also measured and covered. It ensures direct reward for better credit quality and facilitates standardisation of industrial practices. Securitisation in India has to focus on greater communication between the Originator on the one hand and the auditors, rating agencies, investors, due diligence agencies, etc on the other. There is a need for the regulators to promote securitisation. He made a reference to the introduction of tax incentives in U.S.A. during 1981 by way of (i) loss allocation over residual life of assets; (ii) loss set off against past filing. From 1977 to 1999, assets worth trillions of dollars have been sold without default, loans have become cheaper and the regulators including U.S. Treasury are showing quick response to market responses in U.S.A. Shri Ghosh dwelled upon the focus areas for RBI. These included building of wide consensus on benefits of securitisation and encouragement of market development. Drawing from his experience in German market, where he had spent 6 months, Shri Ghosh referred to the nascent stage of securitisation during 1989-90, which culminated into the current matured stage of securitisation in a gradual way. He referred to the need of building skills in the area through different training institutions of RBI, seminars etc. Another suggestion was to reduce the risk weights in the securitised instrument to a level of around 20 per cent. He emphasised the need of high disclosure standards, which should be made mandatory. Specific sectors like housing and infrastructure should be focussed especially in view of the increasing role of HUDCO in urban infrastructure. For this purpose enabling institutions may be set up. Shri Ghosh referred to the need of specific notification to the institutional investors - banks, FIs and NBFCs. Individuals / retail investors may be targeted at a later stage. On the issue of SPV, he averred that SPV should only be a conduit having credible board and trustee character. Alternate structure in the form of MF, Trust, or Company should be allowed but all SPVs should be registered with RBI. There should be a separate chapter on SPV in RBI Act stipulating minimum capital, prudential norms, etc. SPV may not be treated as NBFC as monies held in Trust by SPV for investors are not deemed to be public deposits. As a conduit, SPV should be considered neither a borrower (S 58A) nor a lender (S 372 A). Speaking on the regulatory changes, he suggested amendments to Section 27 A & B of Insurance Act, 1938 to include securitised papers through a Notification by GOI. The guidelines should specify the capability of the organisation to handle the complex transaction before venturing into securitisation. This should include financial control, monthly reporting, audit co-ordination, pool extraction, portfolio MIS, systems upgradation and treasury skills (structuring, pricing, placement, etc.) The presentation ended with recommendations for amendments to RBI Act to allow for SPVs, clarification on money held by SPVs, inclusion of asset-backed securities in priority sector lending depending upon underlying receivables etc. The disclosure document should include the information on assets’ historical performance, cash flow elements and appropriation, investment consideration and risk factors, legal and tax structure, seller's business etc. There should be sufficient due diligence by auditors. As investors, the exposure should be treated against the asset class and not against the issuer or the instrument. Certain nodal institutions (infrastructure, housing, etc.) should be reoriented. Shri Ghosh emphasised the need to rewrite the laws. He referred to the compendium on transfer of property prepared by him during early 1998, which encompasses nine laws (four central and five state laws). One of the members expressed the concern that the current securitisation transactions may not be complying with all the legal requirements. Finally, Shri Ghosh emphasised the need for reporting the securitised transaction in RBI Bulletin / Website.

10. Shri Kanti Shah and Ms. Geetika Hatangadi gave a presentation on 'Securitisation in the Australian Market'. Government sponsored mortgage programme was initiated in Australia during mid 1980s. Reserve Bank of Australia released prudential guidelines for securitisation during 1995. Banks and their subsidiaries have the largest pool of assets, which can be securitised. Australia has well defined foreclosure laws. Any mortgage loan with more than 80 per cent of loan to value (LTV) is backed by insurance. The securitised instrument ranges from tenure of 30 days (commercial paper) to MBS bond with a legal life of 30 years. There is a clear separation between the originator and SPV; an originator cannot own or control the SPV. The credit enhancement facility is limited in amount and time frame. Regarding the SPV structure, there is a complete tax exemption in case of trusts. In the case of corporate, the tax exemption is given in case the inflow and outflows are matching. During 1998, the share of offshore issues increased significantly compared with the domestic issues.

(see para 4.5, 8.1.3 & 9.8 & 10.2.4))

1. There are broadly two approaches to accounting treatment for securitisation, namely,

1. `Indivisible unit approach', according to which the Originator accounts for the securitised assets which are considered to be transferred as indivisible units that are either entirely sold or entirely retained.
2. `Financial components approach' which recognizes that securitised assets can be divided into a variety of components. For example, a loan portfolio, which is securitised may give rise to a servicing asset and an interest-only strip receivable etc., apart from the loan asset which is transferred. Thus, as per this approach, a component of the securitised asset may be sold, while the other components are retained by the Originator and, therefore, treated as separate assets.

2. It appears that the Financial Reporting Standard (FRS) 5 on `Reporting the Substance of Transactions' (issued in April 1994 in U.K.) broadly follows the first approach, i.e., the financial assets are considered to be transferred as indivisible units. On the other hand, the Statement on Financial Accounting Standard (SFAS) 125, on `Financial Instruments: Transfers', issued by the Financial Accounting Standards Board (FASB) in USA follows the financial components approach. The International Accounting Standard (IAS) 39 on `Financial Instruments: Recognition and Measurement' is broadly in accordance with the SFAS 125, i.e., it also follows the financial components approach.

3. The financial components approach requires that all assets obtained and liabilities incurred in consideration of the securitised assets should be recorded at fair values (where it is not practicable to estimate the fair value, the same is required to be taken at zero).

4. In India, at present, the generally accepted accounting principles, including the Accounting Standards issued by the Institute of Chartered Accountants of India, are primarily based on historical cost convention. In other words, the fair values are generally not recognized as the basis for valuation of assets and liabilities. One of the factors which hinders adoption of fair value as the basis of valuation is the non-availability of fair values of various assets because of lack of relevant markets.

5. In India, the securitisation of assets is still in infancy. Thus, the innovations of various financial components of securitised assets in the financial markets may not be impending. Accordingly, the financial components approach may not be relevant at present.

6. At present, in India, the basic issue with regard to accounting for securitisation is: Whether the securitised assets should be considered as an off-balance sheet item or not, rather than the esoteric issue of fair value basis for valuation of assets.

7. In view of the above, it appears that the approach adopted by FRS 5 in UK, i.e., indivisible asset approach, would be more relevant in the Indian situation. In any case, since the Research Committee of the Institute of Chartered Accountants of India (ICAI) is bringing out a Guidance Note on the subject, the approach to be followed in this regard would have to be decided by the Committee and thereafter approved by the Council of the Institute.

8. Under both the above approaches to accounting for securitisation, the central issue is when can the securitised assets be removed from the balance sheet of the Originator. This issue is to be decided by answering the following two questions:

1. Whether the Originator has access to the benefits of the securitised assets and exposure to the risks inherent in those benefits; in other words, whether all significant risks and benefits in the securitised assets have been transferred by the Originator, and
2. Whether the Originator has a liability to repay the proceeds of the notes issue.

As per SFAS 125, the basis for removal from the balance sheet of the Originator is whether he has surrendered control over the securitised assets.

9. An issue arises as to which criteria should be adopted to decide whether significant risks and benefits have been transferred (or control has been surrendered) on the securitised assets. The conditions laid down in SFAS 125 are more detailed and appear to be more stringent. IAS 39 while providing for surrender of control, only gives illustrations of situations under which control can be considered to be lost. FRS 5 provides indicative criteria (Annexure `A') for deciding whether all significant risks and benefits in the securitised assets have been transferred. In resolving the issue of the criteria to be adopted, it is felt that in India, FRS 5 may be appropriate due to following reasons:

1. The criteria of transfer of risks and benefits would be more readily understood as the present generally accepted accounting principles are based on `transfer of risks and rewards of ownership' (e.g., in AS 9 on `Revenue Recognition') while resolving the issue of `substance over form'.
2. SFAS criteria for surrender of control are too detailed, complicated and, therefore, may be too cumbersome to apply.

The Research Committee of the ICAI may, however, consider prescribing specific criteria for deciding when significant risks and benefits in the securitised are transferred.

10. As per FRS 5 where the originator has transferred all significant benefits and risks relating to the securitised assets and has no obligation to repay the proceeds of the note issue, derecognition, i.e., removal of the securitised assets from the balance sheet of the originator is appropriate. On the other hand, where the originator has retained significant benefits and risks relating to the securitised assets from the balance sheet, it is not appropriate to derecognise the securitised assets from the balance sheet, but an asset equal in amount to the amount of securitised assets is shown on the balance sheet of the Originator, i.e., it is not treated as an off-balance sheet item.

11. In practice, the Originator retains some benefits such as interest-only strip receivable or offer to perform some service related to the securitised asset, e.g., servicing of loans in return of some fee, providing liquidity to issuer in return of a fee etc., or there is a limited recourse obligation. As per SFAS 125, while it is possible that the originator surrenders control over the basic securitised asset, say, a loan, and, therefore, it qualifies to be recognized as a sale (derecognition), he may retain certain rights such as interest-only strip receivable and a service asset, which are recognized as assets valued on the basis of fair values. FRS 5 in the Application Note on Securitised Assets does not appear to prescribe such recognition of assets. In other words, as per FRS 5, it appears that the retention of rights and obligations of the aforesaid nature have to be considered in deciding whether significant risks and benefits in the securitised asset have been transferred and, then, on that basis, the `entire asset' is derecognized or continued to be recognized (`indivisible asset' approach). However, FRS 5 recognizes that there could be situations whereby even though significant risks and benefits relevant to the securitised assets have been retained by the originator but there is absolutely no doubt that its downside exposure to loss is limited. In such a situation, the Standard requires that a linked presentation should be used, i.e., the proceeds of the note issue to the extent they are not returnable should be shown deducted on the face of the balance sheet within a single asset caption. The Standard also requires various disclosures to be given in case of linked presentation.

12. The following are some examples of the accounting treatments of asset securitisation in different situations:

The remaining 10 of the finance would be included within liabilities.

The following will be the journal entries in respect of the above:

Securitisation of over-collateralised asset: Accounting at the time of selling the asset as well as at the time it flows back or in the event it does not flow back

13. In this situation, the assets transferred are in excess of the amount of consideration received by the Originator. The objective of transferring this excess is to provide security to the Issuer as the excess can be used by the Issuer in the event the securitised assets are not fully realised by the Issuer to the extent of the consideration paid to the Originator.

14. In the above situation, all risks and rewards are not transferred to the Issuer. If the amount received as a consideration is non-refundable, i.e., it is absolutely certain that this amount will not be returned to the Issuer, it may be appropriate to disclose the transaction as a linked presentation as suggested in FRS 5. Thus, non-refundable amount received may be shown as a deduction from the gross amount of the receivables and the net amount of receivables will be shown in the outer column. A disclosure should, however, be made in respect of the net amount of the receivables that a charge exists in favour of the Issuer. In case the Issuer uses these receivables, then these should be removed from the balance sheet and the loss to that extent be recognized in the profit and loss account of the period concerned. Where the Issuer reaches a situation under which he does not have to exercise recourse to the excess, the receivable would continue to be disclosed as a normal receivable. In the books of the Issuer, the securitised receivables received should be shown to the extent of consideration received, i.e., the receivables received as a over-collateral should not be disclosed on the face of the balance sheet, but may be shown as a note to the accounts explaining the nature thereof.

15. On a perusal of FRS 5 and SFAS 125, it appears from the accounting point of view, that the securitisation can be in respect of existing assets. For instance, para 52 of SFAS 125, related to `Revolving Period Securitisations (i.e., securitisation of certain types of receivables, say, credit card receivables, existing as well as to be received over a future specified period) states as below:

In view of the above, it appears that any money received for future cash flows by the Originator should be treated as a borrowing until its treatment as a securitised asset could be decided upon. The aforesaid treatment is justified in view of the fact that an asset or a liability should not be recognized which may arise in future. In accounting, only the past transactions or events can give rise to assets, liabilities, income and expenses.

Disclosures

16. The disclosure requirements would depend upon the method of accounting finally decided by the Research Committee of ICAI. However, in general, the following disclosures may be made:

1. the accounting policies followed,
2. the characteristics of securitisations, i.e.,

17. As discussed earlier, in India, perhaps the FRS approach may be more appropriate. A summary of three types of accounting treatments, namely, derecognition, linked presentation and separate presentation as per FRS 5 are given in Appendix ‘A’.

18. Issuer (SPV) may maintain balance sheet of its own. Considerations similar to those related to accounting for securitisation in the books of the originator also apply in relation to accounting in the books of the Issuer. In the books of issuer, mirror entry to the entry passed by the originator should be passed. For e.g. on the facts given in para 12(i), the following entry would be passed :

Debtors A/c. Dr.

To Cash / Bank A/c.

Issuer (SPV) may maintain balance-sheet of its own.

19. Another issue, which may be of relevance, is how the noteholders would value their investments in the loan notes, keeping in view the fact that there may be certain peculiar features in respect thereof. For example, the notes may be redeemed by the issuer in installments based on the receipts from the securitised loans, the amounts and the timings of which may or may not be reasonably certain. It is, therefore, argued that such notes may be valued on the basis of the net present value of the expected net cash inflows over the period of the investments. In this context, it may be noted that at present also some securities exist which provide for periodical piecemeal redemption. It is submitted that such securities are presently valued as per the requirements of Accounting Standard (AS) 13, `Accounting for Investments', issued by the Institute of Chartered Accountants of India. The said standard does not exempt securities of the nature of loan notes issued under a scheme of securitisation. Thus, it appears that the loan notes should also be valued at cost, if investment therein is considered of long term nature and at the lower of cost and fair value if they are in the nature of current investments, as per the requirements of AS 13. However, provision for diminution should be made to recognize a decline other than temporary in the value of the long term investments.

20. The broad issues raised in the above paragraphs are still to be resolved by the Research Committee and the Council of the ICAI. In view of this, the views expressed herein regarding preference for accounting treatments as per FRS 5 may undergo change.

(see para 8.1.5, 10.2.5 &, 10.3.2)

Securitisation is a new and emerging concept in India. However, it has the potential to become one of the largest sources of debt finance in the country. One of the key elements in the development of this market would be investor acceptability. While in the initial stages, the market is expected to be limited to institutional investors, eventually it has to attract the participation of retail investors. Considering the novelty of the concept, it is imperative that investors are able to identify and comprehend the various risks associated with investing in securitised debt and make an informed investment decision. Investor acceptability would be driven by the extent to which such risks are disclosed and explained. In this context, the need for adequate disclosures and information dissemination mechanism cannot be overemphasised.

The present paper seeks to outline some of the key information requirements that are required to be disclosed in the Offer Document as a best practice model. While recognising that the nature of information would vary depending on the types of asset classes that would be securitised, an attempt has been made to introduce an element of uniformity in the disclosure requirements across asset classes.

(i) Terms of the Offer

The offer document should seek to provide information describing the terms of the offer. Typically the summary terms of the offer should include :

1. Description of the instruments ( pass through, pay through, Class A, Class B etc.)
2. Maturity/Redemption
3. Interest rate, probable yields
4. Interest and principal payment dates
5. Optional redemptions, if any
6. Description of underlying Security
7. Terms of payment
8. Minimum Application
9. Interest rate on application money
10. Offer programme - Opening and Closing dates
11. Listing details / Transferability
12. Rating of the securities and explanation of the rating. The text of the rating rationale could be provided as an Annexure.

• Quality of the receivables and strength of the cash flows
• Payment structure
• Adequacy of the credit enhancements
• Originator profile
• Risks and concerns for investors and the mitigating factors

• Any other relevant information

3. Description of the Issuer (SPV)

This should include constitution, activities, ownership, capital structure and other details of the Issuer

(iii) Objects of the Offer and end use of funds

(iv) Transaction Structure

The structural summary should provide brief information regarding the key structural features of the transaction. This would include :

1. Transfer of receivables and flow of funds (ideally represented by a schematic diagram)
2. Priority of distributions and allocation of funds

- Class A Securities Interest

• First allocation of principal
• Class B interest
• 2^nd allocation of principal
• Reinstatement of reserve account, if any

1. Early Amortisation events, trigger clauses etc.
2. Events of default and change in priority of distributions on occurrence of such events

1. Prepayment risks – Prepayment on receivables will cause prepayments on the securities resulting in reinvestment risk to the investor
2. Potential loss on securities due to limited assets of the SPV
3. Bankruptcy of originator could result in losses or delays in payments on the securities ( i.e. in the event the court in the bankruptcy proceedings concludes that the sale is not a 'true sale' )
4. Prepayments, potential losses and change in order of priority of principal payments following an event of default.
5. Risks arising out of geographic concentration of receivables, if any
6. Any other risk specific to the transaction and asset class.

(vi) Disclaimers

That ,

(vii) Information related to other risks

The extent of information requirement would depend on the nature of risk associated with a particular transaction. Broadly stated, these risks are asset risk, third party risk, legal risk, and cash flow risk. Of course, in addition to these risks, investors bear the market risk that the value of their investment will change. The disclosures in the offer document should not only aim to inform the investors about these risks but also provide sufficient information on the various parameters governing these risks so that they are able to assess and measure these risks.

Given this objective, the broad disclosure requirements against each of the risk categories could be as under:

A. Asset risk

The assets backing a securitisation are its fundamental credit strength. Therefore, the risk associated with the performance of the asset(s) and the obligors behind them needs to be analysed and disclosed in detail.

b) Distribution of pool by original Loan to Value ratio *

1. Delinquency experience

		1997	1998	1999
E.g.	Average number of contracts outstanding
	Average monthly number of contracts
	delinquent
	Average monthly delinquencies as a %
	of average contracts outstanding

2. Credit Loss and Repossession Experience

• Number of contracts outstanding

III. If the asset is in the nature of a debt from a single obligor (e.g. lease rental from a corporate / loan from a single corporate), then detailed information about the obligor performance needs to be suitably disclosed. Such information could comprise the following :

1. Description of the obligor’s activities
2. Past 3 years of financial performance
3. Existing ratings of outstanding securities
4. Declaration on outstanding disputes/ litigation
5. Past defaults etc.

If the asset is in the nature of a pool of debt from multiple obligors, such information could be provided for those obligors whose debt constitute more than 25 % of total debt in the pool.

IV. Information about Originator : To arrive at a judgement on the likely performance of an asset in future, investors would also need to have adequate information about the originator and the credit origination procedure. This is particularly relevant for future flow receivables where the performance risk remains linked to the originator. Information about the originator could comprise the following :

1. Business profile of the Originator
2. Industry structure and the competitive scenario
3. Capital Structure
4. Management
5. Credit extension norms and process. This would include a statement on the loan sanctioning criteria, appraisal norms, approval mechanisms, credit supervision & collection mechanism etc.
6. Asset quality and capital adequacy
7. Loan default / Credit loss – historical experience
8. Claims against the Originator, disputes, contingent liabilities etc.