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As the secondaries market continues to grow and increase in complexity, we have noticed an uptick in interest among our clients in selling (and buying) loan participations. Participation arrangements can be a powerful tool for institutions on either side of the transaction – sellers can free up capital on their balance sheet, pare back funding obligations and reduce exposure to certain borrowers or industries, and buyers can get the economic benefit of a loan without having to manage a direct relationship with the borrower or comply with (typically more stringent) restrictions and consent requirements for direct assignments. Plus, while the transaction is undoubtedly complex, both parties can leverage the Loan Syndications and Trading Association’s form documentation to keep attention focused on those provisions most important to their institution and the specific transaction. Done right, a bespoke participation arrangement lets everyone leave the field a winner (trophies optional).

Below we discuss broadly the participation structure and its benefits, typical principal documentation and some key considerations and commonly-negotiated provisions.

Participation Structure and Its Benefits

For the uninitiated, a participation is best understood in contrast with an assignment. Both are mechanisms by which a lender of record under a loan agreement ( i.e. , the entity that is actually party to the contract as a lender) can transfer all or part of its interest in a funded or unfunded loan to a third party. However, unlike with an assignment (where the assignee steps fully into the shoes of the assignor as lender of record, and assumes direct contractual privity with the borrower and legal and beneficial ownership of the loan), the seller of a participation interest retains title to the loan and direct contractual privity with the borrower ( i.e. , the participant does not become a lender of record under the loan agreement) along with certain rights and obligations, and the buyer of a participation interest assumes the economic benefits and risks. The contractual relationship for a participation is just between the seller and buyer – the borrower is not typically involved, and indeed is often not even aware of the transaction.

Among the benefits to sellers of loan participations, perhaps the most obvious is the cash received from the buyer upon settlement. Loan participations in the non-distressed secondaries space are often purchased for prices at or near par ( i.e. , 100% of the principal amount of the debt participated), and that cash lands immediately on the seller’s balance sheet. For unfunded loans, because the participation agreement obligates the participant to fund (or reimburse, depending on timing) future draws through the seller, a seller also benefits by shifting much of the responsibility to fund future draws to the participant (noting, of course, that this introduces new credit risk with respect to the buyer). In addition, regulated lenders are not typically required to hold capital against participated loans. Sellers can also realize value by retaining some of the economics of the loan they’re selling a participation interest in. We see many participations where sellers retain some or all upfront fees paid by the borrower in respect of the loan, and a number where the buyer takes a haircut on the interest payments that are passed through to them, with the seller retaining the difference (noting that, if a seller is not passing along all or substantially all of the rights and obligations under the loan, the parties should carefully consider with counsel whether the sale would still be considered a true participation under New York law – if it wouldn’t, buyer may be at risk of being considered a mere contractual counterparty of seller subject to seller’s credit risk). Taken together, sellers can use participation arrangements to put cash on their balance sheets, reduce exposure to certain borrowers or industries and decrease regulatory capital obligations in compliance with internal or external requirements.

On the buyer’s side of the transaction, buyers benefit from being able to realize some or all of the economic benefits of a loan without incurring origination expenses, the bulk of ongoing administration expenses or the legal expense associated with preparing the underlying loan documentation (subject, of course, to indemnities, etc., that can flow through to a participant,  e.g. , agent expenses). From a credit perspective, depending on buyer’s internal comfort level, a buyer can draft to varying degrees behind the seller’s credit analysis and diligence of the borrower. In addition, since participants are typically not disclosed to a borrower, a buyer can generally keep its status as participant confidential.

Buyers and sellers alike benefit from not needing to seek consents and pay assignment or other fees that might be required in the case of a direct assignment.

Typical Principal Documentation

Sellers and their counsel typically hold the pen when documenting participation arrangements. While drafting parties can and do use their own forms, it often makes sense to leverage the Loan Syndication and Trading Association’s (LSTA) standard form participation agreement for par/near-par ( i.e. , non-distressed) trades as a starting point – even for bespoke, heavily-negotiated participations. The LSTA’s form participation agreement was developed to facilitate efficient documentation of transactions in the high-volume secondary market (where participations are often used as a backup settlement option for debt trades that can’t settle by assignment), and accordingly generally tracks market-standard terms and mechanics for participation arrangements. The LSTA form splits the participation agreement into two documents: (i) a longer set of standard terms and conditions (often referred to as STCs, and available  here  for LSTA members), which contains a baseline set of market-standard provisions, and (ii) a relatively short form agreement setting forth the transaction-specific terms of the participation (often referred to as the TSTs, and available  here  for LSTA members), which incorporates the STCs by reference and lets parties toggle on or off (often via checkbox), or otherwise supplement or modify, the various provisions of the STCs. The LSTA’s bifurcated documentation pulls all the transaction-specific information, business terms and frequently negotiated provisions into a more manageable document.

Of course, there are a number of points in the LSTA forms that counsel will typically want to smooth out when using them outside of the more commoditized secondary loan trading market ( e.g. , the need for trade confirmations and funding memoranda, delayed compensation, etc.). Nevertheless, starting with LSTA forms helps both buyer and seller cut down on legal expense, and focuses attention on the terms and provisions that are of particular importance to the parties and the specific deal. These efficiencies can also facilitate innovation.

Key Considerations and Commonly-Negotiated Provisions

Elevation . Buyer’s rights to request “elevation” of its participation ( i.e. , to seek to become a direct lender under the loan agreement) is often the subject of negotiation. Under the STCs, a buyer can always elevate if seller goes into bankruptcy. Otherwise, it’s up to the parties – in some transactions buyers are free to elevate at any time. In others, elevations triggers are heavily tailored, and can include conditions tied to seller’s credit rating, the amount of seller’s loans or commitments under the facility, disputes over collateral value (particularly for participations in NAV loans) or the occurrence of certain events (or failures by seller to take certain actions) under the loan documents.

Voting . The voting provisions in the participation agreement govern whether, when and to what extent, the buyer can direct seller’s votes as a lender under the loan documents. Participation provisions in loan agreements will sometimes limit a seller’s ability to grant voting control to a participant beyond the typical suite of “sacred” provisions ( e.g. , facility size, interest rates, payment dates, term, etc.). Otherwise, the parties can and do tailor the allocation of control to their liking – from no buyer voting rights at all to full buyer voting rights and everything in between. Buyers will often push for control over at least the “sacred” provisions in the loan documents. Sometimes buyers request decision-making power over waivers of certain events of default, facility subordination or other provisions important to the buyer’s credit analysis or institutional concerns. If the underlying loan agreement does include limitations on the seller’s ability to grant voting control, parties will typically clarify in the participation agreement that any voting rights allocated to buyer are allocated only to the extent it would not violate the loan agreement.

Sub-participations . One standard provision of the STCs we frequently see negotiated is the requirement that seller consent to a requested sub-participation by buyer “not be unreasonably withheld or delayed.” Often, sellers will request that that language be deleted. Buyers, in turn, will request some exceptions ( e.g. , permitting sub-participations to affiliates, if seller’s hold on the facility drops below some specified amount, etc.).

Loan agreement diligence .  Buyers and sellers should take care to consider the terms of the underlying loan documentation when documenting participation arrangements. Loan agreements in the secondaries market do not always include the detailed assignment and participation provisions lenders might expect in a loan agreement drafted with an eye towards syndication – indeed, it’s not infrequent that we see loan agreements that are silent on the subject. Sometimes there will be credit agreement provisions that necessitate representations from buyer or seller ( e.g. , a representation that buyer is not an affiliate of the borrower, not on a disqualified institution list or not otherwise an ineligible buyer) or explicitly require that seller maintain a participant register for tax purposes. While uncommon, credit agreements occasionally include borrower or other consent requirements for lender participations (and often the consequence for failing to obtain that consent is that the transaction is void). Additional complexities are introduced when participating in a bilateral loan – in the event a buyer wants to elevate its participation interest, significant revisions to the loan documents may be required to accommodate a multi-lender structure. Often specifically tailored provisions are required in the participation agreement to address a given loan agreement.

The above is just a sampling of bespoke provisions.

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Securitization- the lifeline of nbfcs.

Gaurja Newatia

Created on 19 Sep 2019

Wraps up in 6 Min

Read by 14k people

Updated on 10 Sep 2022

Non- Banking Finance Companies ( NBFC’s ) play a significant role in driving growth and development by providing financial services to Micro, Small and Medium Enterprises (MSME’s) most suited to their business model. They aim at promoting inclusive growth in the economy by extending credit in rural sectors and financially weaker sections of the society.

While NBFC’s can generate funding from a variety of avenues- mutual funds, insurance companies, bonds, commercial papers, etc., it is lending by banks through securitization which helps NBFC’s to remain in business.

Let us now learn what exactly is securitization and how it is a significant growth vehicle for NBFC's.

What is Securitization?

Securitization is a process where a pool of securities is bundled together and are given credit rating by an independent credit agency and then are sold to investors at a fixed coupon rate. Securitization, as the name suggests, involves the transformation of loans, which are a kind of illiquid assets into liquid assets. The underlying assets are generally secured loans such as home loans, automobile loans and unsecured loans like personal loans, etc.

It is a process by way of which an originator (bank) pools together its assets and then sells it to a Special Purpose Vehicle (SPV) – an entity specially created for the process of securitization which further sells it to investors.

To get a better understanding, consider the following example:

Suppose, a small bank ABC with an existing loan portfolio of 100 crores wants to raise a loan of 50 crores by monetizing its current assets.

The ABC bank will pool together 50 crores worth of loan which might contain thousands of loans and sells them to the SPV for cash.

The SPV then obtains credit ratings from an independent credit rating organization based on the future cash flow generated and the quality of the pooled amount.

Assuming the actual returns from the total loan book is 10%, and over the three years, due to the risk factor involved, the pooled amount is sold at 8.5%

The margin of 1.5% is used as maintenance charges by SPV and obligator(bank) who is responsible for collecting cash flows from the borrowers and transferring them to the investors.

Certificates are created worth 50 crores and are opened for investment. Once the issue is fully subscribed, the cash flows will be collected from the borrower and will be disbursed among the investors for three years.

The difference between what is charged from the borrowers (10.5%) and what is paid to the investors (8.5%) will be the servicing fee.

Parties in a Securitization Process:

Types of Securitised Products in India

Pass-Through Certificates (PTC's)

Pass-Through Certificates are similar to bonds, the difference being that they are issued against underlying securities. The payment to investors constitutes interest payments and principal payments received by the obligator on a pro-rata basis after deducting the servicing fee. However, in a Pay-Through Certificate, the principal and the interest amount is not transferred to the investor. Instead, the investors are issued new securities by SPV in return to this.

Direct Assignment

Direct Assignment involves buying a loan book at a fixed interest rate. Suppose a bank is interested in increasing his exposure to agricultural loan, to fulfill this, he will directly buy the pool of agrarian loan from an NBFC. Here, the terms are negotiable and can be customized in favor of both parties.

Why would banks be buyers?

• As per the Reserve Bank of India, banks need to lend to the “priority sector” (Table 1), which includes the following categories:
• Agriculture
• Micro, Small and Medium Enterprises (MSME)
• Export Credit
• Social Infrastructure
• Renewable Energy

                              Table 1: Priority Sector Lending Requirements

Banks do not necessarily want to be the originators of the loan while on the other hand, NBFC’s would like to sell their loans for the purpose of generating more cash and extending more credit. To fulfill the requirements of the RBI, banks go for buying NBFC's loans.

• Commercial Banks can lend only at Marginal Cost of Funds based Lending Rate (MCLR) plus some spread where the MCLR is fixed (can be changed only at monthly reset dates) for each and every customer, and only the spread is variable. However, NBFC's can charge various rates from customer i.e., Prime Lending Rates (PLR) plus spread. Here, both PLR and Spread are variable. Thus, banks here can take advantage of higher interest rate margins earned by NBFC's.  
• When the RBI goes for slashing of lending rates, while banks have to pass on the interest rate benefits, NBFC’s can choose not to pass on the interest rate benefits to the borrowers. Thus, even though there is a cut in lending rates, the securitized pool sold to the banks will yield the same amount of returns.  
• There are some sectors, for example, Real Estate, where banks cannot lend directly due to restrictions imposed by the RBI. In such cases, banks can expand their portfolio and take exposure in such sectors through NBFC's.  
• Thus, through securitization, banks take advantage of Interest Rate Arbitrage and by earning some additional money through investing in NBFC’s.

How does the risk get shared?

Securitization is an easy way out for NBFC's, to transfer their pool of illiquid assets to banks in order to convert them into tradeable securities. However, to ensure that NBFC's do bear some risk even after the Securitization Process, the concept of Minimum Retention Ratio (MRR) was brought forward. This means if a part of the loan pool goes into default, the first blow will be borne by the originator(NBFC's)

The RBI guideline dated November 29, 2018, states that loans which have an original maturity of 5years or above which receive six monthly installments or two quarterly installments, the MRR requirements would be 20% of the book value of the loans being securitised/20% of the cash flows from the assets assigned.

Why are banks shying away from securitization? What exactly are the risks associated with lending to NBFC’s?

There are two risks associated with lending to NBFC’s

Consider a situation where ABC bank lends to XYZ, which is an NBFC. XYZ further gives it to a company, say PQR. If PQR defaults on payment, then XYZ would not receive payment who also would not be able to pay ABC. This is the solvency risk or the default risk or credit risk.

Let us now understand how NBFC’s face Liquidity Risk.

NBFC’s issue commercial papers or non-convertible debentures for short term (3 months-1 years) to raise money from various mutual funds, banks, etc. The raised money is then used to extend loans to borrowers for the long term (5 years). This means that NBFC's will return lenders their money within three months but will receive money from the borrower after five years. 

Why do NBFC's resort to this practice?

Only because short-term loans are cheaper, and long-term loans are expensive, NBFC's take advantage of the situation and earn an interest rate margin.

Let us now understand how exactly this technique works well for NBFC's.

To make this system work well, NBFC's go for rollover. Say, for example, an NBFC owes payment to its lenders for commercial papers after three months. To ensure complete repayment without default, the NBFC will issue new commercial papers to another set of lenders. The raised money will then be used to repay the earlier lenders. This is the Rollover Strategy. This goes on and on to ensure liquidity.

However, what if NBFC fails to find this set of new lenders?

To repay its previous lenders, it will approach its borrower asking for repayment. But, the borrower won't be able to repay the NBFC since all of its money would be invested in his project. This situation gives rise to what is popularly known as the Liquidity Crisis.

The Liquidity Crisis in one NBFC creates a general perception that all NBFC’s are going to default on their payments, creating a kind of systematic risk i.e., when one party suffers, all the parties suffer. The IL&FS liquidity crisis is one suitable example in this context.

The recent liquidity crisis is going to impact the sentiments of particularly Mutual Funds since any default in interest, or principal payments would ultimately have to be borne by the investors. Thus, the only way to lift NBFC’s out of the crisis is securitization. Hence, it would not be wrong to call Securitization- The lifeline of the NBFC sector.

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Securitization and Direct Assignment Transactions in the Indian Economy

[ Vineet Ojha is Manager – IFRS & Valuation Services at Vinod Kothari Consultants Pvt Ltd]

The current financial year has witnessed a sharp surge and a life time high in the volume of securitization and direct assignment transactions in the Indian economy. Consequent to the funding problems that non-banking finance companies (NBFC) and housing finance companies (HFCs) have been facing over the last few months, direct assignments of retail portfolios have picked up considerable pace, with volumes touching an all-time high of Rs. 1.44 lakh crore during the nine-month period (April-December) of financial year 2019 (FY 19). Of this, around Rs. 73,000 crore was raised by NBFCs and HFCs through sell-down of their retail and small and medium enterprises (SME) loan portfolio to various investors (primarily banks). Investor appetite, particularly from public sector banks and private banks, is high at present, considering investors are not exposed to entity-level credit risk, and are seen taking exposure to the underlying pool of retail and SME borrowers. Yields have gone up significantly with the changing market dynamics. The momentum in the securitization market is likely to remain strong in the current fiscal as it is emerging as an important tool for retail-focused NBFCs for raising funds at reasonable costs while simultaneously providing a hedge against asset-liability mismatches. A visual trend of the market over the years can be seen below:

Source: India Securitization Market: Booklet by VKCPL

Why the sudden surge?

Looking at the figure above, we can see a sharp surge in the direct assignment volumes in FY19. A majority of the issuances comes from the third quarter with around Rs. 73,000 crores. Although the major driver is the Infrastructure Leasing and Financial Services Limited (IL&FS) imbroglio, it is not the only reason for this development.

IL&FS crisis

Following the IL&FS crisis, the Reserve Bank of India (RBI) has time and again prompted banks to assist NBFCs to recover from the cash crunch. However, wary of the credit quality of the NBFCs and HFCs, the banks have shown more interest in the underlying loan portfolios than on the originator itself. Through direct assignment and securitization, these institutions get upfront cash payments against selling their loan assets. This helps these institutions during the cash crunch. Funds raised by NBFCs and HFCs through this route helped the financiers meet sizeable repayment obligations of the sector in an otherwise difficult market.

RBI relaxes MHP norms for long tenure loans

Another reason that explains this sudden surge in the volume of direct assignment or securitization volumes is the relaxation of the minimum holding period (MHP) criteria for long-tenure loans by the RBI. This increased the quantum of assets eligible for securitization in the system. The motivation was the same is to encourage NBFCs and HFCs to securitize their assets to meet their liquidity requirements. More details about this can be found here.

Effects of Securitization

Primarily, priority sector lending (PSL) requirements were the primary drivers for securitization. The number of financial institutions participating in securitization were quite low. Now, for liquidity concerns, NBFCs and HFCs were forced to rely on securitization to meet their liquidity needs. This not only made them explore a new mode of funding, but also solved other problems like asset liability mismatches. In the nine months of FY19 and FY18, the share of non-PSL transactions has increased to 35 per cent compared to 24 per cent in FY17 and less than 20 per cent in the periods prior to that.

However, it is not a rosy picture all over. Due to the implementation of IFRS, upon de-recognition of a loan portfolio from the financial statements of the company, the seller shall have to recognize a gain on sale on the transaction. These gains disturb the stability of the profit trend in these financial institutions which would result in volatile earnings in their statements. The NBFCs have been trying to figure out solutions which would allow them to spread the gain on transfer over the life of the assets instead of booking it upfront.

The securitization market remained buoyant in the third quarter driven by the prevailing liquidity crisis following defaults by IL&FS and its subsidiaries. This surge is good for the Indian securitization market as India’s contribution to global securitization market, at about USD 12 billion, is barely recognized, for two reasons – firstly, India’s market has so far been largely irrelevant for the global investors, and secondly, bulk of the market has still been driven by PSL requirements. PSL-based securitizations obviously take place at rates which do not make independent economic sense. Now due to the surge in non-PSL based securitization, the rates at which the portfolios are sold are attractive to investors. This could attract global investors to the market.

Now that financial institutions have gained exposure to the securitization markets, they find that the transactions are attractive for sellers as well as investors. Our interaction with leading NBFCs reveals that there are immediate liquidity concerns. Banks are not willing to take on-balance sheet exposure on NBFCs; rather they are willing to take exposure on pools. Capital relief and portfolio liquidity are additional motivations for the originators (and other potential investors) to enter into securitization transactions.

– Vineet Ojha

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Assignment Of Loan

Jump to section, what is an assignment of loan.

Under an assignment of loan, a lender (the assignor) assigns its rights relating to a loan agreement to a new lender (the assignee). Only the assignor's rights under the loan agreement are assigned. The assignor will still have to perform any obligations it has under the facility agreement.

The debtor, the recipient of the loan, must be notified when a debt is assigned. When there is an assignment of a loan, a Notice of Assignment (NOA) is sent out to the debtor informing them that a new party is now responsible for collecting any outstanding amount.

Assignment Of Loan Sample

Reference : Security Exchange Commission - Edgar Database, EX-10.14 5 dex1014.htm ASSIGNMENT OF LOAN DOCUMENTS , Viewed October 21, 2021, View Source on SEC .

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I am a business, transactions, and estate attorney working out of central Texas.

Sarah brings together her accounting and legal background to help solve client problems. Sarah couples her broad, general commercial legal background with our client’s international and business problems to arrive at elegant solutions that work for their business.

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India Corporate Law

Rbi’s move to revamp loan transfers in india.

On June 08, 2020, the Reserve Bank of India ( RBI ) released two draft frameworks — one for securitisation of standard assets ( Draft Securitisation Framework ) and the other on sale of loan exposures ( Draft Sale Framework ). In our previous article (available here ), we had dealt with key revisions introduced by the RBI under the Draft Securitisation Framework. This article contains a brief summary of the Draft Sale Framework.

The Draft Sale Framework is addressed to the same constituents as the Draft Securitisation Framework and is expected to operate as an umbrella framework, which will govern all loan transfers (standard and stressed assets).

The Draft Sale Framework is broadly divided into three parts viz., (i) general conditions applicable to all loan transfers; (ii) provisions dealing with sale and purchase of standard assets; and (iii) provisions dealing with sale and transfer of stressed assets (including purchase by ARCs).

The core principles of transfer appear like the previous guidelines on direct assignment. However, the scope of transfer has now been expanded to include various kinds of economic transfers of loan assets, including participation arrangements and transactions in which the loan exposure remains on the books of the transferor even after the said transactions.

Three types of transfers that have been recognised under the Draft Sale Framework viz., (i) assignment; (ii) novation; and (iii) loan participation (which includes both risk participation and funded participation). Whilst loans can be transferred via any of the aforesaid transfer methods, (a) revolver loans and loans with bullet payments of principal and interest can only be transferred through novation and loan participation; and (b) stressed assets can only be transferred through assignment and novation. Transfer by way of novation is exempt from the applicability of the guidelines, except for a diktat that approval of all parties, including the borrower, is required for novation.

RBI has indicated that all these transfers are required to result in immediate legal separation of the transferor from the assets, which are transferred and put beyond the reach of the transferor as well as the creditors of the transferor. RBI has also suggested that these should be bankruptcy remote and a legal opinion should be obtained in this regard.

In line with the position in the 2012 guidelines, transferors are not permitted to offer any credit enhancement or liquidity facility for loan transfers. Diligence requirements continue to be strict and the purchasing lender is required to apply the same standard of care while assessing the asset, as if it were originating the asset directly and cannot outsource its due diligence.

The RBI has also permitted transfer of a single loan asset or part of a single asset to a financial entity through novation or loan participation. Only financial entities carrying on business in India will be eligible to participate. Loans acquired from other entities can also be assigned.

Participation Agreements

The Draft Sale Framework also seeks to permit and regulate participation arrangements. Participation arrangements though popular in certain other jurisdictions were not common here, except inter alia , in accordance with the guidelines issued by the RBI on December 31, 1998. The1998 guidelines permitted two types of participations, inter-bank participations with risk sharing and inter-bank participations without risk sharing. While the assignment agreements that were entered into earlier were akin to participation agreements in spirit, the permissibility of participation is an interesting development and a regulatory headway made in the growth of the loan market. The Draft Sale Framework seeks to allow both risk participation and funded participation in loans. Participation agreements in respect of stressed assets has not been specifically permitted.

The Draft Sale Framework specifically recognizes transfer of external commercial borrowings by ‘eligible lenders’ (as defined under the Master Direction on External Commercial Borrowings, Trade Credits and Structured Obligations), subject to any loss or hair cut being to the account of the transferor.

It is expected that the RBI will provide further clarity on whether all lenders (i.e. overseas branches, onshore branches, etc.) can purchase such assets and whether the exposure must continue to remain in foreign currency, both for standard and stressed assets

The RBI has not stipulated the requirement for a transferor to maintain minimum risk retention for loan transfers. This will enable the transferee to deal with the loan independently. However, transferors will have to comply with the ‘minimum holding period’ requirement.

Transfer of loan accounts at the instance of the borrower, inter-bank participations, trading in bonds, sale of entire portfolio of assets consequent upon a decision to exit the line of business completely, sale of stressed assets and consortium and syndication arrangements continue to remain exempt from the applicability of Chapter III of the Draft Sale Framework (which only applies to transfer of standard assets).

Stressed Assets

Stressed assets have been defined as: ‘ assets that are classified as NPA or as special mention accounts, and generally includes accounts, which are in default, as well as where lenders have given concessions for economic or legal reasons relating to the borrower’s financial difficulty ’.

Currently, the Master Circular on Prudential Norms on Income Recognition, Asset Classification and Provisioning (pertaining to advances), 2015, detail the criteria for standard assets, special mention accounts and non-performing assets. The classification has also been replicated in the Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions 2019 ( Prudential Stressed Asset Directions ).

The Draft Sale Framework does not replace or limit the application of existing RBI directions (especially the Prudential Stressed Asset Directions). Any regulated entity (that is permitted to take on loan exposures by its statutory or regulatory framework), can purchase stressed assets directly.

Promoters and Similar Persons Not Eligible to Buy Stressed Assets

The transferor is required to ensure that the transferee is not disqualified in terms of Section 29A of the Insolvency and Bankruptcy Code, 2016, and is not otherwise a promoter, associate, subsidiary or related person of the underlying obligor. Therefore, if there is an existing option to put loans on a promoter / similar entity, then the same may not be possible if the loan is a stressed asset.

In case of standard assets, the Draft Sale Framework has stipulated a table for MHP based on tenure of the loan. However, stressed assets are required to be held in the books of the lender for a period of 12 months.

Asset Classification and Provisioning

A purchased stressed asset can be classified as a ‘standard asset’ by the purchasing entity, in cases where the purchasing entity has no existing exposure to the borrower. However, in case, the purchasing entity has an existing exposure to the borrower whose stressed loan account is acquired, the asset classification of the purchased exposure shall be the same as the existing asset classification of the borrower with the transferee.

Transfer of Stressed Assets to ARCs

The Draft Sale Framework also deals with sale of stressed assets to asset reconstruction companies ( ARC ).

While Section 7 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 ( SARFAESI ) always provided that ARCs could issue debt instruments in lieu of the consideration payable for the acquisition of assets, RBI has now specifically provided for the same in the Draft Sale Framework. If such deals are done, it must clearly be established that the sale is effective. However, the Draft Sale Framework also provides that these instruments will have to be considered as debt on the books of the ARC, therefore implying that the ARC has an obligation to repay the debt and such oblgation cannot be linked to realization of the underlying asset. While this enabling provision is useful, ARCs are unlikely to opt for this route given that there is an obligation to repay the debt, the present structure of PTC may be the preferred option.

It is relevant to note that FPI entities continue to have the right to invest in security receipts and will also have the right to invest in the bonds issued by the ARC.

It is specifically clarified that transfer of stressed assets to non-ARCs can only be on a cash-consideration basis.

Swiss Challenge Method

In an attempt to de-regulate price discovery, the mandatory Swiss Challenge Method has been done away with. Lenders are now expected to put in place board approved policies on adoption of an auction-based method for price discovery.

Right of First Refusal

Under the current Guidelines on Sale of Stressed Assets by Banks, issued by the RBI on September 1, 2016, a bank selling a stressed asset is required to offer the right of first refusal to an ARC, which has already acquired the highest and significant share (~25-30%) in the asset. Such ARC is required to be provided the right to match the highest bid. In line with these guidelines, the Draft Sale Framework also provides the right of first refusal to ARCs, which hold a significant stake in the asset. Additionally, the Draft Sale Framework also provides that in the event such ARC does not want to purchase the asset or if no ARC holds a significant portion, then such right of refusal will have to be extended to a ‘financial institution’, if such institution holds a significant stake in the asset.

The Draft Sale Framework is a significant move by the RBI and is expected to streamline loan transfers in the country. This framework reinforces the RBI’s focus on addressing the health of banks and bad debt in the country, whilst remaining committed to a balanced approach on sale of assets. If passed in its current form, it will be a positive move by the regulator in developing a robust market for secondary transfers.

*Authors would like to thank Vidhi Sarin , Associate for her inputs.

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Assignment: Definition in Finance, How It Works, and Examples

Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master's in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

Yarilet Perez is an experienced multimedia journalist and fact-checker with a Master of Science in Journalism. She has worked in multiple cities covering breaking news, politics, education, and more. Her expertise is in personal finance and investing, and real estate.

What Is an Assignment?

Assignment most often refers to one of two definitions in the financial world:

• The transfer of an individual's rights or property to another person or business. This concept exists in a variety of business transactions and is often spelled out contractually.
• In trading, assignment occurs when an option contract is exercised. The owner of the contract exercises the contract and assigns the option writer to an obligation to complete the requirements of the contract.

Key Takeaways

• Assignment is a transfer of rights or property from one party to another.
• Options assignments occur when option buyers exercise their rights to a position in a security.
• Other examples of assignments can be found in wages, mortgages, and leases.

Uses For Assignments

Assignment refers to the transfer of some or all property rights and obligations associated with an asset, property, contract, or other asset of value. to another entity through a written agreement.

Assignment rights happen every day in many different situations. A payee, like a utility or a merchant, assigns the right to collect payment from a written check to a bank. A merchant can assign the funds from a line of credit to a manufacturing third party that makes a product that the merchant will eventually sell. A trademark owner can transfer, sell, or give another person interest in the trademark or logo. A homeowner who sells their house assigns the deed to the new buyer.

To be effective, an assignment must involve parties with legal capacity, consideration, consent, and legality of the object.

A wage assignment is a forced payment of an obligation by automatic withholding from an employee’s pay. Courts issue wage assignments for people late with child or spousal support, taxes, loans, or other obligations. Money is automatically subtracted from a worker's paycheck without consent if they have a history of nonpayment. For example, a person delinquent on $100 monthly loan payments has a wage assignment deducting the money from their paycheck and sent to the lender. Wage assignments are helpful in paying back long-term debts.

Another instance can be found in a mortgage assignment. This is where a mortgage deed gives a lender interest in a mortgaged property in return for payments received. Lenders often sell mortgages to third parties, such as other lenders. A mortgage assignment document clarifies the assignment of contract and instructs the borrower in making future mortgage payments, and potentially modifies the mortgage terms.

A final example involves a lease assignment. This benefits a relocating tenant wanting to end a lease early or a landlord looking for rent payments to pay creditors. Once the new tenant signs the lease, taking over responsibility for rent payments and other obligations, the previous tenant is released from those responsibilities. In a separate lease assignment, a landlord agrees to pay a creditor through an assignment of rent due under rental property leases. The agreement is used to pay a mortgage lender if the landlord defaults on the loan or files for bankruptcy . Any rental income would then be paid directly to the lender.

Options Assignment

Options can be assigned when a buyer decides to exercise their right to buy (or sell) stock at a particular strike price . The corresponding seller of the option is not determined when a buyer opens an option trade, but only at the time that an option holder decides to exercise their right to buy stock. So an option seller with open positions is matched with the exercising buyer via automated lottery. The randomly selected seller is then assigned to fulfill the buyer's rights. This is known as an option assignment.

Once assigned, the writer (seller) of the option will have the obligation to sell (if a call option ) or buy (if a put option ) the designated number of shares of stock at the agreed-upon price (the strike price). For instance, if the writer sold calls they would be obligated to sell the stock, and the process is often referred to as having the stock called away . For puts, the buyer of the option sells stock (puts stock shares) to the writer in the form of a short-sold position.

Suppose a trader owns 100 call options on company ABC's stock with a strike price of $10 per share. The stock is now trading at $30 and ABC is due to pay a dividend shortly. As a result, the trader exercises the options early and receives 10,000 shares of ABC paid at $10. At the same time, the other side of the long call (the short call) is assigned the contract and must deliver the shares to the long.

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One-time gains: nbfcs seek change in accounting policy.

So far, non-bank lenders take a one-time gain on all loan sales to banks in direct assignment transactions. Prior to the implementation of Ind-AS accounting system, these gains were amortised over the life of the loan.

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Compare the Best Home Equity Loan Lenders

• Best Home Equity Loan Lenders FAQs

Home Equity Loan Lender Reviews

How to choose a home equity loan lender.

• Why You Should Trust Us

Best Home Equity Loan Lenders of April 2024

Affiliate links for the products on this page are from partners that compensate us (see our advertiser disclosure with our list of partners for more details). However, our opinions are our own. See how we rate mortgages to write unbiased product reviews.

A home equity loan is a type of second mortgage that lets you take equity out of your home to use for things like home renovations, debt consolidation, or other major expenses.

The Best Home Equity Loan Lenders

• U.S. Bank Home Equity Loan : Best overall
• Navy Federal Credit Union Home Equity Loan : Best overall, runner-up
• Discover Home Equity Loan : Best for no fees
• Flagstar Home Equity Loan : Best for large loan amounts
• Connexus Home Equity Loan : Best for small loan amounts

Keep reading for details on our picks for the top home equity loan companies.

7.15% or 7.20%

• Check mark icon A check mark. It indicates a confirmation of your intended interaction. 80% Max CLTV
• con icon Two crossed lines that form an 'X'. Not available in Delaware, South Carolina, or Texas
• Rates shown for loans in the amount of $50,000-$99,999 up to 60% LTV, and for customers with automatic payments from a U.S. Bank personal checking or savings account with a FICO score of 730 or higher. Rates may vary by region and are subject to change.

starting at 6.640%

• Check mark icon A check mark. It indicates a confirmation of your intended interaction. 100% Max CLTV
• Check mark icon A check mark. It indicates a confirmation of your intended interaction. Available in 50 states and Washington, DC
• con icon Two crossed lines that form an 'X'. Must be a member of the military, a veteran, a family member of someone who has served, or a Department of Defense civilian
• Personal guidance from first call to closing
• No application or origination fee
• Navy Federal servicing for the life of your loan

7.24% - 13.99%

• Check mark icon A check mark. It indicates a confirmation of your intended interaction. No closing costs
• Check mark icon A check mark. It indicates a confirmation of your intended interaction. Accepts scores down to 660
• con icon Two crossed lines that form an 'X'. Not available in Iowa or Maryland
• Low, Fixed APRs
• Fixed Repayment Terms
• $0 Origination Fees

Undisclosed

• Check mark icon A check mark. It indicates a confirmation of your intended interaction. 90% Max CLTV
• con icon Two crossed lines that form an 'X'. Not available in Texas
• Tailored to meet your needs. If you require extra funds to help pay for big projects or unforeseen circumstances, Flagstar offers a variety of home equity options to help you reach your goals.

7.74% to 7.96%

• Check mark icon A check mark. It indicates a confirmation of your intended interaction. Higher max CLTV
• Check mark icon A check mark. It indicates a confirmation of your intended interaction. Allows smaller loan amounts
• con icon Two crossed lines that form an 'X'. Not available in Maryland, Texas, Hawaii, or Alaska
• con icon Two crossed lines that form an 'X'. Doesn't disclose lender closing fees
• Use the funds from your Home Equity Loan for home renovations or repairs, college tuition, consolidating debt, vacations, and more – you decide!
• Your interest rate and monthly payment amount will not change over the course of your Home Equity Loan, making budgeting a breeze.
• Within 24 hours of applying, a personal lender will reach out to get the process started and will be available to chat whenever you have questions. To speak with a personal lender with Home Equity Loan expertise today, book an appointment.
• Most Home Equity Loans can be processed entirely online in just minutes and do not require a home appraisal.

Best Home Equity Loan Lenders Frequently Asked Questions

It depends. Be sure to compare rates and fees on multiple options to see which type of home equity loan is the most affordable for you. Consider that on a HELOC, you'll only pay interest on what you owe, while home equity loans have the benefit of a fixed interest rate. Cash-out refinances typically have the lowest rates, but you could end up paying more in fees.

If you use your home equity loan funds to "buy, build or substantially improve your home," the interest is tax deductible, according to the IRS . But if you use it for personal expenses, you won't be able to deduct it.

We've gathered our top picks for the best home equity loan lenders here, and our current top pick is U.S. Bank . But the best one for you depends on your needs and current financial situation. It's generally a good idea to shop around with a few lenders to see which offers you the best deal in terms of rates and fees.

Mortgage lenders often look for scores of at least 680 for a home equity loan, though some may have requirements that are higher or lower than this.

Consumer rates have been up across the board in recent years, and that includes home equity loan rates. To make sure you're getting the best rate available, be sure to shop around and compare offers.

When you're researching potential banks to get a home equity loan from, be sure to consider the total costs of a potential loan. This includes both fees and the interest rate you'd pay. Consider other features and benefits a lender offers as well, and whether the lender has good customer reviews.

Best Overall

U.S. Bank is a strong lender overall for home equity loans, with no closing costs, a wide range of loan amounts, and a discount for existing customers.

This lender offers home equity loan amounts from $15,000 to $750,000, which is a wider range than what many other lenders offer. You can get a loan with a term up to 30 years.

If you have a U.S. Bank checking or savings account , you could get a 0.5% rate discount if you set up automatic payments.

What to look out for:  U.S. Bank home equity loans aren't available in Delaware, South Carolina, or Texas

Best Overall, Runner-up

Navy Federal Credit Union

Navy Federal Credit Union is a great home equity loan lender for those who qualify for a Navy Federal membership. It offers competitive mortgage rates , a good selection of term lengths, and no fees.

This lender is a strong option for VA loan borrowers, who might not have a ton of equity built up if they put 0% down on their home when they purchased it. It also has good online customer reviews.

What to look out for:  Navy Federal is our "best overall" runner-up because, while it's a very strong lender overall, you have to be a member of Navy Federal Credit Union to get a loan with this lender. To qualify, you need to be a member of the military, a veteran, a family member of someone who has served, or a Department of Defense civilian. 

The BBB gives Navy Federal an  NR (No Rating)  because it's currently responding to complaints that were previously closed.

Best for No Fees

Discover is an affordable home equity loan lender that doesn't charge any closing costs, and it will also pay any third-party costs you incur.

This lender accepts borrowers with scores of at least 660, which is a bit lower than what many other lenders require. Typically, lenders look for scores of at least 680, though some require scores above 700.

Discover offers home equity loans with 10-, 15-, 20-, and 30-year terms and loan amounts from $35,000 to $300,000.

What to look out for: If you pay off your loan within three years, you'll have to reimburse Discover for some of the closing costs, up to $500. This fee doesn't apply if you live in Connecticut, Minnesota, North Carolina, New York, Oklahoma, or Texas.

Best for Large Loan Amounts

Flagstar Bank

Flagstar Bank is a good option for borrowers who need larger loan amounts, since you can get a home equity loan for up to $1 million.

If you qualify, you can get a home equity loan from Flagstar for any amount between $10,000 and $1 million. It also charges no lender fees, though you still may need to pay some third-party fees at closing.

If you have a bank account with Flagstar, you could potentially get a 0.25% rate discount if you set up automatic loan payments from your account. 

What to look out for:  Flagstar home equity loans aren't available in Texas.

Best for Small Loan Amounts

Connexus Credit Union

Connexus Credit Union offers smaller loan amounts, shorter terms, and a higher max CLTV, making it an affordable choice for borrowers looking to fund smaller projects or keep their interest costs down.

With Connexus Credit Union, borrowers can get a home equity loan with a term of just five years with loan amounts as low as $5,000. If you want to limit your overall interest costs, a shorter term is often a good choice because you'll spend less time paying back the loan. 

What to look out for:  Connexus doesn't disclose whether it charges its own closing fees, but says borrower closing costs can range from $175 to $2,000. Connexus home equity loans aren't available in Maryland, Texas, Hawaii, or Alaska.

As you search for the right home equity loan lender for you, consider the loan amounts a lender offers as well as the amount of equity it will let you take out of your home. You want to make sure the lenders you're considering can meet your needs.

Reach out to at least two or three different lenders to get quotes so you can compare costs. Be sure to consider both the rates you're offered as well as any fees the lender charges.

Other Home Equity Loan Lenders We Considered

• Northpointe Home Equity Loan : Northpointe is one of our best mortgage lenders , but it doesn't provide information on the requirements or features that come with its home equity options.
• Rocket Mortgage Home Equity Loan : Rocket Mortgage is our favorite lender for refinancing , but it doesn't disclose rates or other information for its home equity loans.
• TD Bank Home Equity Loan : This lender's home equity loan offerings aren't available in most states.
• New American Funding HELOC : Regions is a solid home equity loan lender, but it's only available in certain states.

Why You Should Trust Us: How Did We Choose the Best Home Equity Loan Lenders?

We looked at the top mortgage lenders in the US that offer home equity loans to find our favorites. We then evaluated them based on four main criteria:

• Affordability. We evaluated home equity loan affordability based on mortgage rates, fees, and max CLTV. When looking at rates, we looked at both the lender's current advertised APR and, where available, its minimum and maximum APR. For fees, we looked at whether the lender charges any application or closing fees. Home equity loans typically come with some third-party closing costs, but some lenders will also charge their own fees, as well. All of our top picks say they don't charge lender closing costs, with the exception of Connexus, which doesn't disclose whether it charges any additional fees.
• Customer satisfaction. We looked at online customer reviews to gauge how satisfied customers are with each lender.
• Trustworthiness. Most of our top picks have an A+ rating from the BBB. We also considered any recent public scandals from the last three years.
• Availability.  Some lenders only offer home equity loans in certain states, so we looked at where each lender offers home equity loans. All of our picks lend in most states, and typically only have one or two states where they don't lend.

See our full ratings methodology for mortgage lenders »

• Main content

India: RBI'S Framework For Transfer Of Loan Assets

As an anticipated measure for the banking and financial sector, the Reserve Bank of India (RBI) has, towards the close of past week, issued the comprehensive framework for the sale or transfer of loan assets. Taking immediate effect from the date of its issuance, the framework titled ' Master Directions - Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 ' issued vide circular DOR.STR.REC.52/21.04.048/2021-22 dated September 24, 2021 (the ' Master Directions ') is being seen as a pivotal move by the Regulator towards introducing an efficient secondary market for loans and ensuring proper credit-risk pricing, besides improving transparency in the identification of embryonic stress in the banking system as well as resolution of stressed loan exposures.

The Master Directions owes its genesis to the ' Draft Framework for Sale of Loan Exposures ' which was released by RBI in course of the first COVID-19 induced lockdown in the Country. The draft had taken into consideration the recommendations of the ' Task Force on Development of Secondary Market for Corporate Loans ' constituted by RBI under the chairmanship of Mr. T.N. Manoharan in May, 2019 and comments from the stakeholders were invited. One of the key components of the Task Force's recommendation was to separate the regulatory guidelines for direct assignment transactions from the securitisation guidelines and treat it as a sale of loan exposure. The RBI had, accordingly, reviewed the recommendations and thought it prudent to comprehensively revisit the guidelines for sale of loan exposures, both standard as well as stressed, which were earlier spread across various circulars. The erstwhile guidelines or circulars on sale of loan exposures were particular to the asset classification of the loan exposure being transferred and / or the nature of the entity to which such loan exposure is transferred as well as the mode of transfer of the loan exposures. The need for a review also stemmed from the necessity to dovetail the guidelines on sale of loan exposures with the Insolvency and Bankruptcy Code, 2016 (' IBC ') and the Prudential Framework for Resolution of Stressed Assets dated June 7, 2019 (" Prudential Framework "), which has witnessed substantial traction and developments towards building a robust resolution paradigm in India in the recent past.

The consolidation by RBI of a self-contained, comprehensive, and independent set of regulatory guidelines on transfer/sale of loan exposures is being seen as a laudable step in the direction of putting together a ' robust secondary market in loans which can be an important mechanism for management of credit exposures by lending institutions and also create additional avenues for raising liquidity '. This write-up attempts to briefly summarize some key components of the Master Directions.

The Master Directions whilst superseding a host of existing circulars/directions (or a portion thereof) in relation of transfer of loan exposures (Chapter VI), has put forth a unified and singular framework for the sale of loan exposures by banks and other financial institutions. The exhaustive breadth of the framework is quite evident from the Chapters under the Master Directions which not only provide for ' General Conditions applicable to all Loan transfers ' (Chapter II), but also cater specifically to transfer of loan exposures of standard assets (Chapter III) as well as stressed loan exposures (Chapter IV), including their respective and intrinsic modalities. The framework concludes with the imperative of ' Disclosures and Reporting ' (Chapter V) and stipulates the mechanism for the stakeholders in that regard.

Applicability

On expected lines, nearly all constituents of the Financial sector regulated by RBI are mandated to ensure compliance to the Master Directions, both as a transferor as well as transferee of the loan exposures – Scheduled Commercial Banks, all NBFCs (including HFCs), Regional Rural Banks, Co-operative Banks, All India Financial Institutions and Small Finance Banks. In addition, the Master Directions also permits asset reconstruction companies (ARCs) 1 and companies 2 (save a financial service provider 3 ) to be 'transferees' of the loan exposures only if the same is pursuant to the resolution plan under the Prudential Framework and if they are permitted to take on loan exposures in terms of a statutory provision or under the regulations issued by a financial sector regulator.

It would be pertinent to take note that though all lenders permitted to acquire loans are required to ensure compliance to the extant Master Directions; yet, the acquisition of loans pursuant to securitisation are required to be independently dealt under the provisions of RBI's ' Master Directions – RBI (Securitisation of Standard Assets) Directions, 2021 ' dated September 24, 2021 (the 'Securitisation Guidelines'). The coverage of the Master Directions includes transfer of loan exposures through novation, assignment, or risk participation. In cases of loan transfers other than loan participation, legal ownership of the loan shall be mandatorily transferred to the Transferee to the extent of economic interest transferred under the loan exposures.

For the Transferees which are financial sector entities (not falling under clause 3 of the Master Directions) and the ARCs, the prudential norms (asset classification, provisioning norms etc) of their respective sectoral regulators (SEBI, IRDA, PFRDA etc) shall be applicable post-acquisition of loan exposure under the Master Directions.

Basic Ingredients

Before venturing into the other nuances, it is an imperative that one accounts for the understanding of some key 'constructs' which cut across the Master Directions:

• Transfer : Quite apparently, the expression denotes the process of transfer of the economic interest in a loan exposure by the transferor and acquisition of the same by the transferee. The subject matter of transfer being the ' economic interest ' of the transferor in the loan exposure, it is important that the risks and rewards associated with loans are clearly demarcated and separated in favour of the transferee; especially when some portion of the economic interest in the loan exposure is retained by the transferor.

It is significant to take note that the transfer of the said economic interest can be with or without the transfer of underlying contract. Essentially, even loan participation transaction have also been recognised under the Master Directions (for transfer of standard loans) wherein the transferor transfers all or part of its economic interest in a loan exposure to transferee without the actual transfer of the loan contract, and the transferee(s) fund the transferor to the extent of the economic interest transferred which may be equal to the principal, interest, fees and other payments, if any, under the transfer agreement.

• Transferor : Often referred as 'assignor' (in assignment transactions) or 'grantor' (for risk participation), transferor under the Master Directions would include Clause 3 entities which transfer their economic interest in the loan exposures.
• Transferees : These refer to entities in whose favour the economic interest in the loans are transferred and would include Clause 3 entities as well as the ARCs/companies to the extent permitted under the Master Directions. It is clarified that the transferee should neither be a person disqualified under the IBC 4 nor, in cases of loan exposures where frauds have been identified, belong to an existing promoter group 5 of the borrower or its subsidiary / associate / related party 6 (domestic as well as overseas).
• Minimum Holding Period (MHP) : As the expression suggests, the MHP refers to a threshold period for which the transferor should hold the loan exposures, along with its risks and rewards, before the economic interest in respect thereto is transferred. The intent of having a MHP is to ensure that the loan has been seasoned in the books of the originator (or the transferor) for a certain specified time period. The MHP for loans with tenor upto 2 years and more than 2 years, as per the Master Directions, have been capped at 3 months and 6 months, respectively.

The holding period for the Transferor, in case of secured exposures, is to be computed from the date of registration of the underlying security interests; unless, of course, the loan is unsecured in which case the MHP runs from the date of first repayment under such unsecured exposure. However, in case of project loans, the foregoing months of MHP is required to be calculated from the date of commencement of commercial operations of the project being financed. Besides, the loans acquired by the Transferor itself are required to have a MHP of atleast 6 months from the date of acquisition of the loan on the books of the Transferor, irrespective of the tenor of the loan exposures.

It would be of significance to note that the MHP criteria prescribed under the Master Directions do not apply for loans transferred by an arranging bank under a syndication arrangement.

• Permitted Transferees : These include (i) Scheduled Commercial Banks, (ii) NBFCs (including HFCs), (iii) All India Financial Institutions and (iv) Small Finance Banks. The significance of carving out the foregoing financial sector entities from Clause 3 of the Master Directions lies in the fact that the transferor is permitted to transfer its loans (which are not in default) to permitted transferees only through novation, assignment, or loan participation. For the stressed exposures, the transfer is mandated only to such permitted transferees and ARCs and singularly through assignment or novation of such loan exposures.

Underlying Elements

The finer nuances of the Master Directions would certainly surface once the provisions have been widely given effect to by the stakeholders; however, as it stands, the framework undoubtedly promises to streamline the procedures and requirements for the stakeholders considering transfer of their loan exposures – standard as well as stressed. Some fundamental provisions of the Master Directions have been summarized as below:

• Overarching Transfer conditions : Quite categorically, the Master Directions stresses on the necessity of delineation of Transferor's 'risks and rewards' associated with the loan exposures to the extent of the transfer. In fact, it is stated that not only should the transferee have the unrestrained and unconditional entitlement to transfer or dispose of the loans to the extent of economic interest acquired by it, but also in the event of any economic interest in the loan exposure is retained by the transferor, the loan transfer agreement should demarcate the distribution of the principal and interest income from the transferred loan between the transferor and the transferee. The Master Directions also caution against any modification of terms of the underlying financing agreement and require that any change, in course of such transfer, should withstand the test of not being categorised as 'Restructuring' under the Prudential Framework. It would be significant to take note that the transfer of loan exposures under the Master Directions not only should be without recourse to the Transferor, but also the transferor or transferee should not be constrained to obtain consent from the transferee/ transferor, as the case may be, in the event of resolution or recovery in respect of the beneficial economic interest retained by or transferred to the respective entity. In addition to the foregoing, the Master Directions also prescribe for the enumerated conditions applicable to all transfers of loan exposures:
• The Transferor shall have no obligation to re-acquire or fund the re-payment of the loans or any part of it or substitute loans held by the Transferee or provide additional loans at any time;
• If the security interest is held by the Transferor in trust with the Transferee as the beneficiaries, the Transferee shall ensure that a mutually agreed and binding mechanism for timely invocation of such security interest is put in place;
• Any rescheduling, restructuring or re-negotiation of the terms of the underlying agreement attempted by Permitted Transferee, after the transfer of assets to the transferee, shall be as per the Prudential Framework;
• The Clause 3 entities, regardless of whether they are transferors or otherwise, should not offer credit enhancements or liquidity facilities in any form in the case of loan transfers.

In case the transfer of loan exposures which are not compliant with the requirements mentioned in the Master Directions, the onus is on the Transferee to maintain capital charge equal to the actual exposure acquired and the Transferor is required to treat the transferred loan in its entirety, as if it was not transferred at all in the first place, and the consideration received by it shall be recognised as an advance.

• Board-approved Policy : The Transferors are mandated to put in place a comprehensive Board-approved policy for transfer and acquisition of loan exposures under the Master Directions. These guidelines must, inter alia , lay down the minimum quantitative and qualitative standards relating to due diligence, valuation, requisite IT systems for capture, storage and management of data, risk management, periodic Board level oversight, etc. Further, the policy must also ensure the independence of functioning and reporting responsibilities of the units and personnel involved in the transfer/acquisition of loans from that of personnel involved in originating the loans.
• Transfer of Standard Assets : The transfer of loan exposures classified as 'standard' can be undertaken through the mechanisms of assignment or novation or a loan participation. The transfer of such loan exposures should be only on a cash basis to be received at the time of transfer of loans; besides, the requirement of the transfer consideration being arrived at in a transparent manner on an arm's length basis. The Master Directions require the Transferees to monitor, on an ongoing basis and in a timely manner, the performance information on the loans acquired, including through conducting periodic stress tests and sensitivity analyses, and take appropriate action required, if any. Further, the Transferor's retention of economic interest, if any, in the loans transferred should be supported by legally valid documentation supported by a legal opinion.

The requirements of Chapter III of the Master Directions are, however, not applicable to certain identified loan transfers, as below:

• transfer of loan accounts of borrowers by a lender to other lenders, at the request/instance of borrower;
• inter-bank participations as per the RBI's circulars;
• sale of entire portfolio of loans consequent upon a decision to exit the line of business completely;
• sale of stressed loans; and
• any other arrangement/transactions, specifically exempted by the RBI.
• Minimum Risk Retention : The Master Directions are explicit in their requirement of the requisite due diligence in respect of the loans exposures and mention that the said exercise cannot be outsourced or delegated by the Transferee. In order to ensure a systemic departure from the conventional practice of placing solitary reliance on the due diligence of the originator (or the Transferor), the Master Directions mandate the Transferee to undertake the due diligence of the loan exposures through its own staff, at the level of each loan, and as per the same policies as would have been done had the Transferee been the originator of the loan. In case the due diligence of entire portfolio is undertaken by the Transferee, the requirement of a minimum retention requirement (MRR) of the Transferor can be dispensed with.

However, in case of loans proposed to be acquired as a portfolio, if a transferee is unable to perform due diligence at the individual loan level for the entire portfolio, the Transferor shall retain at least 10% of economic interest in the transferred loans as MRR. In such a case as well, the Transferee is required to undertake due diligence at the individual loan level for not less than one-third (1/3 rd ) of the portfolio by value and number of loans in the portfolio. As per the Master Directions, in case of multiple Transferees, the MRR would still be on the entire amount of transferred loan, even if any one of the transferee is unable to perform the due diligence at an individual level.

• Transfer of Stressed Assets : Chapter IV of the Master Directions deals specifically with the transfer of stressed loan exposures to ARCs and other Permitted Transferees. It is specifically stated that the mechanism for transfer of such stressed accounts can be consummated only through assignment or novation. Besides the requirement of a Board-approved policy for transfer as well as acquisition of stressed loan exposures and the parameters thereof, the Master Directions mandate such transfers to ARCs and other Permitted Transferees only. Importantly, the Transferor is necessarily required to undertake an auction through a ' Swiss Challenge method ' both in cases where (i) the aggregate loan exposure to be transferred is Rs. 100 crore or more after bilateral negotiations; and even under (ii) a transfer pursuant to the Resolution Plan approved in terms of the Prudential Framework (irrespective of the monetary threshold).

The transfer of such stressed loan exposures, as per the Master Directions, should be bereft of any operational, legal or any other type of risks relating to the transferred loans including additional funding or commitments to the borrower / transferee. In fact, it is specifically required for the transferor to ensure that no transfer of a stressed loan is made at a contingent price whereby in the event of shortfall in the realization of the agreed price, the Transferor would have to bear a part of the shortfall.

In addition, the Transferor is required transfer the stressed loans to transferee(s) other than ARCs only on cash basis and the entire transfer consideration should be received not later than at the time of transfer of loans. The stressed exposure can be taken out of the books of the Transferor only on receipt of the entire transfer consideration.

Quite significantly, the Master Directions prescribed that if the Transferee of such stressed loan exposure (except ARCs) have no existing exposure to the borrower whose stressed loan account is acquired, the acquired stressed loan shall be classified as "Standard" by the transferee. However, in case the Transferee has an existing exposure to such borrower, the asset classification of the acquired exposure shall be the same as the existing asset classification of the borrower with the Transferee, irrespective of whether such acquisition is pursuant to the transferee being a successful resolution applicant under the IBC.

Further, the Master Directions require the Transferee to hold the acquired stressed loans in their books for a period of at least 6 months before transferring to other lenders; however, such holding period is not applicable in case the transfer of stressed loan exposure is to an ARC or is pursuant to a resolution plan approved in terms of the Prudential Framework.

As regards the mandate of undertaking the 'Swiss Challenge method' is concerned, the Master Directions require the lenders put in place a Board-approved policy which should, interalia , specify the minimum mark-up over the base-bid required for the challenger bid to be considered by the lender(s), which in any case, shall not be less than 5% and shall not be more than 15%. However, for transfer of stressed exposure under the Prudential Framework, the minimum mark-up over the base-bid required for the challenger bid is to be decided with the approval of signatories to the ICA representing 75% by value of total outstanding credit facilities and 60% of signatories by number.

Additionally, the Master Directions provide for sharing of surplus between the ARC and the Transferor, in case of specific stressed loans; though, the clarity in respect of such specific stressed loans is not mentioned. The repurchase of stressed loan exposures is also stipulated from the ARCs in cases where the resolution plan has been successfully implemented

• Accounting : In the event the transfer of loan exposures results in loss or profit, which is realised, the same should be accounted for and, accordingly, reflected in the P&L account of the Transferor for the accounting period during which the Transfer is consummated. However, the unrealised profits (if any) arising out of such Transfers, shall be deducted from the Common Equity Tier 1 (CET 1) capital or net owned funds of the Transferor for meeting regulatory capital adequacy requirements till the maturity of such transferred exposures. The Master Directions prescribe maintenance of borrower-specific accounts both by the Transferor as well as the Transferee of the retained and transferred loan exposures, respectively. It has been further clarified that the extant requirements of RBI for 'income recognition, asset classification, and provisioning' shall, accordingly, be ensured by the transferor and the transferee with respect to their respective shares of holding in the underlying loan exposures.

Though it would be quite nascent to present an analysis of the Master Directions even before it has been actually implemented, yet there are indeed some crucial aspects which underline the significance of the Master Directions issued by RBI which can be summarized as follows:

• Identification and Resolution of Stressed Exposures : Though quite a premature assessment, yet it is felt that the framework under Master Directions could facilitate the development of a robust distressed asset ecosystem and speed-up the resolution of various stressed exposures, which could be driven by the ensuing characteristics of the Master Directions:
• Early Identification and Resolution of Stressed Exposures : The framework has expanded the definition of stressed exposures ('stressed loans') to include both non-performing assets (NPAs) and special mention accounts (SMAs). Also, the deregulation of the price discovery process will enable faster and more efficient pricing of exposures – especially when coupled with a wider range of eligible investors.
• Enhanced Viability of Stressed Asset Takeover Structures :More importantly, the Master Directions allow investors in stressed assets to classify the exposure as standard, although subject to any other exposure to the same entity on the investor's books not being sub-standard on the date of the acquisition of the asset. This could significantly lower capital charge and provisioning requirements for the acquirer/investor of the stressed assets. Given that most stressed assets are restructured as well – often including a complete management overhaul, the rationalisation of the capital charge and provisions could make such assets more attractive to prospective acquirers.
• Impetus to Long-Term Funding structures : The Indian credit markets have for long been bereft of avenues for mobilising capital through long-term debt instruments. As a result, liability structures for corporate borrowers in sectors such as power generation and roads front load cash outflows during the project life. This, at least in part, reflects the non-availability of long-dated liabilities for the financial sector. Therefore, an ecosystem which allows lenders to off-load long-dated exposures after a certain time period with reasonable foresightedness could enable borrowers to raise long-term debt instruments from the financial system in a cost-efficient manner.
• Independent Credit Evaluations Could Prove Critical : The Master Directions mentions that transferees may have the loan pools rated before acquisition so as to have a third-party view of their credit quality in addition to their own due diligence; though, the latter is a mandatory requirement and cannot substitute for the due diligence that the transferee(s) are required to perform. Also, in case of transfer of stressed assets, it becomes critical to ensure that the valuation of the exposure and associated risk capital allocation are based on an assessment of the asset to meet its contractual debt obligations. Even restructured accounts have subsequently come under stress in some cases due to fundamental weaknesses in the business profile, heightened management risk/weak governance structures and unsustainable debt levels even after restructuring. Though not prescribed as a mandatory requirement under the Master Directions, yet a third-party evaluation by a credit rating agency could provide an added layer of assessment and valuations for such exposures along with subsequent capital charge and provisioning norms could be linked to the outcome of such evaluation.

1. Registered with the Reserve Bank of India under Section 3 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002

2. Sub-section (20) of Section 2 of the Companies Act, 2013

3. Sub-section (17) of Section 3 of the Insolvency and Bankruptcy Code, 2016

4. Section 29A of the Insolvency and Bankruptcy Code, 2016

5. As defined under SEBI (ICDR) Regulations, 2018

6. As defined under the Insolvency and Bankruptcy Code, 2016

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Accounting for Direct Assignment under Indian Accounting Standards (Ind AS)

By Team IFRS & Valuation Services ( [email protected] ) ([email protected])

Introduction

Direct assignment (DA) is a very popular way of achieving liquidity needs of an entity. With the motives of achieving off- balance sheet treatment accompanied by low cost of raising funds, financial sector entities enter into securitisation and direct assignment transactions involving sale of their loan portfolios. DA in the context of Indian securitisation practices involves sale of loan portfolios without the involvement of a special purpose vehicle, unlike securitisation, where setting up of an SPV is an imperative.

The term DA is unique to India, that is, only in Indian context we use the term DA for assignment of loan or lease portfolios to another entity like bank. Whereas, on a global level, a similar arrangements are known by various other names like loan sale, whole-loan sales or loan portfolio sale.

In India, the regulatory framework governing Das and securitisation transactions are laid down by the Reserve Bank of India (RBI). The guidelines for governing securitisation structures, often referred to as pass-through certificates route (PTCs) were issued for the first time in 2006, where the focus of the Guidelines was restricted to securitisation transactions only and direct assignments were nowhere in the picture. The RBI Guidelines were revised in 2012 to include provisions relating to direct assignment transactions.

Until the introduction of Indian Accounting Standards (Ind AS), there was no specific guidance regarding the accounting of direct assignment transactions, therefore, a large part of the accounting was done is accordance with the RBI Guidelines. The introduction of Ind ASes have opened up several new challenges for the financial entities.

Following issues are relevant:

• Whether DA would lead to de-recogntion?
• Whether there will be a gain on sale upon such de-recognition?
• Whether DA should be be treated as a partial transfer of asset or transfer of the whole asset?
• Continuing valuation of retained interest?

In this article, we intend to discuss those issues and suggest potential solutions for those as well.

Prior to addressing the above issues, the following is a comparison between DA and securitisation for a better understanding:

De recognition in case of Direct Assignment

Ind AS 109, provides a clear guidance as to the de recognition principles to be followed. Para 3.2.2 says that:

“3.2.2 Before evaluating whether, and to what extent, derecognition is appropriate under paragraphs 3.2.3–3.2.9, an entity determines whether those paragraphs should be applied to a part of a financial asset (or a part of a group of similar financial assets) or a financial asset (or a group of similar financial assets) in its entirety, as follows.

 (a) Paragraphs 3.2.3–3.2.9 are applied to a part of a financial asset (or a part of a group of similar financial assets) if, and only if, the part being considered for derecognition meets one of the following three conditions.

(i) The part comprises only specifically identified cash flows from a financial asset (or a group of similar financial assets). For example, when an entity enters into an interest rate strip whereby the counterparty obtains the right to the interest cash flows, but not the principal cash flows from a debt instrument, paragraphs 3.2.3–3.2.9 are applied to the interest cash flows.

 (ii) The part comprises only a fully proportionate (pro rata) share of the cash flows from a financial asset (or a group of similar financial assets). For example, when an entity enters into an arrangement whereby the counterparty obtains the rights to a 90 per cent share of all cash flows of a debt instrument, paragraphs 3.2.3–3.2.9 are applied to 90 per cent of those cash flows. If there is more than one counterparty, each counterparty is not required to have a proportionate share of the cash flows provided that the transferring entity has a fully proportionate share.

 (iii) The part comprises only a fully proportionate (pro rata) share of specifically identified cash flows from a financial asset (or a group of similar financial assets). For example, when an entity enters into an arrangement whereby the counterparty obtains the rights to a 90 per cent share of interest cash flows from a financial asset, paragraphs 3.2.3–3.2.9 are applied to 90 per cent of those interest cash flows. If there is more than one counterparty, each counterparty is not required to have a proportionate share of the specifically identified cash flows provided that the transferring entity has a fully proportionate share.

(b) In all other cases, paragraphs 3.2.3–3.2.9 are applied to the financial asset in its entirety (or to the group of similar financial assets in their entirety). For example, when an entity transfers (i) the rights to the first or the last 90 per cent of cash collections from a financial asset (or a group of financial assets), or (ii) the rights to 90 per cent of the cash flows from a group of receivables, but provides a guarantee to compensate the buyer for any credit losses up to 8 per cent of the principal amount of the receivables, paragraphs 3.2.3–3.2.9 are applied to the financial asset (or a group of similar financial assets) in its entirety.”

If the de recognition criteria is not met in entirety, then all the conditions mentioned in para 3.2.2(a) has to be satisfied, which talks about fully proportionate share of total cash flows from the financial asset and fully proportionate share of specifically identified cash flows of the financial asset. If these conditions are met, then partial de recognition is possible. The part that is still recognized, is not connected with de recognition and further accounting related to de recognition. However, for actually de recognizing the asset, the de recognition criteria in para 3.2.3 and para 3.2.6 has to be looked at.

Para 3.2.3 goes as follows:

“3.2.3 An entity shall derecognise a financial asset when, and only when:

(a) the contractual rights to the cash flows from the financial asset expire, or

 (b) it transfers the financial asset as set out in paragraphs 3.2.4 and 3.2.5 and the transfer qualifies for derecognition in accordance with paragraph 3.2.6.”

Thus, if the contractual rights to the cashflows expire, then the asset can be de-recognized. If the condition is not met, then it has to be seen that whether the asset is transferred as per para 3.2.5 and the transfer meets the de recognition conditions set out para 3.2.6.

Para 3.2.6 states that:

“3.2.6 When an entity transfers a financial asset (see paragraph 3.2.4), it shall evaluate the extent to which it retains the risks and rewards of ownership of the financial asset. In this case:

(a) if the entity transfers substantially all the risks and rewards of ownership of the financial asset, the entity shall derecognise the financial asset and recognise separately as assets or liabilities any rights and obligations created or retained in the transfer.

 (b) if the entity retains substantially all the risks and rewards of ownership of the financial asset, the entity shall continue to recognise the financial asset.

 (c) if the entity neither transfers nor retains substantially all the risks and rewards of ownership of the financial asset, the entity shall determine whether it has retained control of the financial asset. In this case:

(i) if the entity has not retained control, it shall derecognise the financial asset and recognise separately as assets or liabilities any rights and obligations created or retained in the transfer.

 (ii) if the entity has retained control, it shall continue to recognise the financial asset to the extent of its continuing involvement in the financial asset (see paragraph 3.2.16).”

Para 3.2.6 brings out that, if all the risks and rewards of ownership of financial asset is transferred, then the asset shall be de recognized. If the risks and rewards incidental to ownership of financial asset is not transferred, then obviously the asset cannot be de recognized. However, if there is a partial transfer of risks and rewards of ownership, then the surrender of control has to be evaluated. If there is surrender of control, then the asset can be de recognized. If not, there shall be partial de-recognition, that is, the asset shall be recognized in the books of the seller only to the extent of continuing involvement.

Computation of Gain on Sale

It is a general notion that a sale results in a gain or loss, be it arbitrary or anticipated, the same is required to be accounted for. In case of a direct assignment, there is a sale of the loan portfolios, however, the same completely depends upon whether the assigned loan portfolio is getting derecognised from the books of the assignor or not. If it is not derecognised from the books of the assignor, then the question of recognising a gain or loss on sale does not arise. However, if the sale qualifies for de-recognition, then the seller must book gain or loss on sale in the year of sale.

Upon reading of Ind AS 109 and study of example stated in application guidance in para B3.2.17, the way of computing the same can be derived as follows:

Gain on sale = Sale consideration – Carrying value of asset*Fair value of transferred portion/(Fair value of transferred portion + Fair value of retained portion)

This can be explained with the help of the following example:

The gain or loss on sale does not depend on the sale consideration completely. There may be cases where the carrying value of the transaction and sale consideration are same, i.e. at par transactions. As per Ind AS 109, the computation of gain on sale remains same in cases of at-par or premium structured transactions, however, even at-par transactions could lead to a gain or loss on sale..

The reason for same is that the computation of gain on sale takes into account the retained interest by the Assignor comprising of the difference between the interest on the loan portfolio and the applicable rate at which the direct assignment is entered into with the assignee, also known as the right of excess interest spread (EIS) sweep.

The above settles for the computation of the gain/loss, however, the bigger change seen in the present regime is on the part of recognition of such a gain in the books of the Assignor.

In the present scenario, Ind AS 109 prescribes that the gain on sale or de recognition be recorded upfront in the profit and loss statement.

For reference, para 3.2.12 states that:

“ 3.2.12 On derecognition of a financial asset in its entirety, the difference between:

(a) the carrying amount (measured at the date of derecognition) and

(b) the consideration received (including any new asset obtained less any new liability assumed) shall be recognised in profit or loss.”

Further in case of de recognition of a part of financial asset, para 3.2.13 states that:

“3.2.13 If the transferred asset is part of a larger financial asset (eg when an entity transfers interest cash flows that are part of a debt instrument, see paragraph 3.2.2(a)) and the part transferred qualifies for derecognition in its entirety, the previous carrying amount of the larger financial asset shall be allocated between the part that continues to be recognised and the part that is derecognised, on the basis of the relative fair values of those parts on the date of the transfer. For this purpose, a retained servicing asset shall be treated as a part that continues to be recognised. The difference between:

(a) the carrying amount (measured at the date of derecognition) allocated to the part derecognised and

(b) the consideration received for the part derecognised (including any new asset obtained less any new liability assumed) shall be recognised in profit or loss.”

Hence, it is clear that the gain on de recognition should be recorded in the profit and loss statement.

From a practical standpoint, the above recognition is seen as a demotivation for entering into a direct assignment transaction, since the same would result in a volatility or irregularity in the profit or loss statement of the NBFCs.

This approach is in stark contrast to what has been prescribed in the RBI Guidelines on Securitisation, which requires gain on sale to be amortised over the life of the transaction. As per the RBI Guidelines provide the following:

As per para 20.1 of RBI Guidelines on Securitisation of Standard Assets issued in 2006:

“In terms of these guidelines banks can sell assets to SPV only on cash basis and the sale consideration should be received not later than the transfer of the asset to the SPV. Hence, any loss arising on account of the sale should be accounted accordingly and reflected in the Profit & Loss account for the period during which the sale is effected and any profit/premium arising on account of sale should be amortised over the life of the securities issued or to be issued by the SPV. ”

Also, as per para 1.4.1. of RBI Guidelines on Securitisation of Standard Assets issued in 2012:

“The amount of profit in cash on direct sale of loans may be held under an accounting head styled as “Cash Profit on Loan Transfer Transactions Pending Recognition” maintained on individual transaction basis and amortised over the life of the transaction .”

As the accounting treatment offered by Ind AS defaces the profit and loss statement by distorting the income recognition pattern of the NBFCs, NBFCs are not in favour of recording this gain upfront. The concern is aggravated due to the liquidity crunch currently faced by the NBFCs caused by recent downfall of IL&FS. The default on payment obligations of loans and deposits amounting to approximately Rs. 90,000 crore, by India’s leading infrastructure finance company, shook the confidence of the lenders and triggered a panic sentiment amongst the market lenders including NBFCs. As a result of the panic, banks are unwilling to lend to the NBFCs and their cost of funds are going up. However, the banks are showing interest in acquiring their loan portfolios instead. Therefore, the NBFCs are somewhat being forced to accept this distortion in their profit or loss statement.

Another question that arises is- whether de-recognition in books of assignor affects recognition in the books of the assignee.

As per para 3.1.1 of Ind AS 109, an entity shall recognise a financial asset or a financial liability in its balance sheet when, and only when, the entity becomes party to the contractual provisions of the instrument. Therefore, the transferee should recognise the financial asset or financial liability in its balance sheet only when he becomes a party to the contractual provisions of the instrument.

Para B3.2.15 of the same standard, provides that if a transfer of a financial asset does not qualify for de-recognition, the transferee does not recognise the transferred asset as its asset. In such a case the transferee is required to derecognise the cash or other consideration paid and recognises a receivable from the transferor. The transferee may measure the receivable at amortised cost (if it meets the criteria in paragraph 4.1.2) if the transferor has both a right and an obligation to reacquire control of the entire transferred asset for a fixed amount (such as under a repurchase agreement).

Therefore, de-recognition from the books of the seller is clearly a determinant for recognition in the books of the buyer.

Impact on GST on the gain on sale

In the last couple of years, if there is anything that has bothered the financial entities in India, other than IndAS, then it has to be GST. Therefore, it becomes pertinent to take a look at whether GST will become applicable in any manner whatsoever.

Under GST regime, assignment of loans are treated as dealing in securities and are therefore exempted from GST. Link to our detailed writeup in this regard has been provided in the footnote [1] .

Reporting of Retained Interests

A partial de-recognition is where the transferor transfers only a part of the asset and retains a part of it.

Currently, as per the RBI Guidelines, NBFCs are required to comply with the minimum retention requirement of 10%, that is, they should have a continuing interest of 10% on the loans that it intends to transfer. Therefore, if an NBFC is intending to sell of a portfolio of Rs. 100 crores, it has to retain at least 10% of the said portfolio and can sell of only Rs. 90 crores representing the remaining part.

Therefore, this becomes a classic case of partial de-recognition.

The value of retained interest should be accounted for as per the original accounting criteria as and when it was originated. For instance, if the pool recognised under FVOCI method, the retained interst must continue to be valued at FVOCI.

The manner of recognition or valuation of the retained interest will not change when a part of the pool is sold off.

Before the introduction of Indian Accounting Standards, RBI guidelines were followed for de recognizing the asset and recording the gain on sale after de recognition. There was no accounting guidance for financial instruments and their de recognition. In the absence of it, RBI guidelines were followed which talked about true sale. In case, the conditions of true sale were satisfied, then the asset was de recognized and the gain was regularised over the period by amortising the gain on de recognition.

While a well-documented piece of legislation is welcomed, however, every new thing has some shortcomings. In this case, the irregularities in the profit and loss and the complexities surrounding the de-recognition test comes as shortcomings. However, it is expected, with the passage of time, these shortcomings will also be settled.

[1] http://vinodkothari.com/2018/06/gst-on-assignment-of-receivables-wrong-path-to-the-right-destination/

Can the Originator recognise a lower upfront income by giving impact of historical pre-terminations while discounting the future cash flows? This will reduce the impact of irregular upfront income to some extent.

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10 Charts to Explain 22 Years of China-Africa Trade, Overseas Development Finance and Foreign Direct Investment

By Oyintarelado Moses

From 2000-2022, China’s engagement with African countries through trade, overseas development finance and foreign direct investment (FDI) has bolstered ties and increased policy relations, particularly in the areas of development. Past trends in economic engagement have led to both benefits and risks to African governments, spanning economic growth and environmental impacts on biodiversity. Nonetheless, China’s presence throughout the region has produced lessons that could inform the next phase of African countries’ development trajectories.

African countries are currently emerging from several years of economic challenges brought about by the COVID-19 pandemic, Russia’s war in Ukraine and the climate crisis. These events have led to contractions in economic growth, global supply chain disruptions and the rise in the prices of energy products and food sources such as wheat. US dollar effective exchange rate increases have led to an expansion in dollar-denominated debt, thereby worsening the costs of servicing debts. A growing portion of government revenue is servicing debt repayment rather than addressing pressing development goals.

Despite such challenges, the global energy transition present opportunities to reach aspects of Africa’s low-carbon development goals, particularly pertaining to energy access and transition. Access to enough capital or beneficial economic exchange is a hurdle toward reaching this goal. Given China’s past years of economic interactions with African countries, China is one of many country partners poised to contribute solutions to this challenge.

The 10 charts below illustrate key findings from a new report published by the Boston University Global Development Policy Center and the African Economic Research Consortium. The charts highlight that Chinese economic engagement pertaining to energy and transition materials entails support for electrification and extraction. In the future, Chinese trade, finance and FDI should prioritize contributing to electrification infrastructure, while balancing extraction activities to align their economic engagement more closely with Africa’s energy access and transition goals.

Chart 1: Share of Primary Energy Consumption in Africa by Source, 2000-2022

As African countries shape their development goals around the United Nations 2030 Sustainable Development Goals (SDGs) and the African Union Agenda 2063, priorities of energy access and transition remain paramount. In 2021, 43 percent of Africa’s population did not have access to electricity, and of the population with access, 90 percent of energy consumption relied on fossil fuels (coal, oil and gas), as seen in Chart 1. Capitalizing on Africa’s renewable energy potential could contribute significantly to addressing these challenges, as Africa’s wind and solar potential are among the highest in the world. One of the essential factors needed for unlocking this renewable energy potential is access to channels of economic engagement with external partners.

Chart 2: Africa-China Trade Balance, 2000-2022

Africa-China trade engagement is significant but has largely moved from relatively balanced trade to trade deficits for African countries, as seen in Chart 2. From 2000-2022, Africa-China import and export values of goods increased from $11.67 billion to $257.67 billion. Throughout those years, African countries’ top trading country partners have gradually shifted from predominantly the United Kingdom and the United States to China. Trade deficits for the African continent have accompanied deepened ties through three major periods of the global financial crisis (2008-2009), a decline in commodity prices (2014-2015) and a global pandemic (2020-2021). In 2022, a high import value of goods from China and relatively lower value of exports to China continued a trade deficit that landed at 2.6 percent of GDP in 2022.

Chart 3: Africa’s Exports and Imports to China by Sector

Chart 3 shows that African countries primarily exchange natural resources for manufactured goods in their trade relationship with China. In 2022, approximately two-thirds of Africa-China exports were concentrated in just four commodities: petroleum crude oil (41 percent), refined copper (15 percent), iron ore and concentrates (5 percent) and aluminum ores and concentrates (5 percent) by trade value. Largely due to the primary commodity exports, exports from Angola, South Africa, Sudan, the Democratic Republic of Congo and the Republic of Congo alone amounted to 69 percent of all total exports to China. Top imports from China were telecommunications equipment (6 percent), fabrics (3 percent), footwear (3 percent) and refined oil (3 percent).

The types of top commodities extracted and exported reveal insights into some of China’s past priorities in the region. Crude oil exports to China address domestic oil demand in China’s growing economy, while copper, iron and aluminum are inputs into the supply chains of green technologies such as electric vehicle batteries, solar panels and wind energy generation equipment. Imports of these renewable energy equipment that use Africa’s commodities are not a core aspect of the trade relationship, suggesting there is potential for China to boost the export of these technologies to African counties for the benefits of energy access and transition.

Chart 4: Chinese Loans to Africa by Sector in Billions USD, 2000-2022

China’s overseas lending and development finance has contributed to infrastructure development throughout the region. Overall lending from 2000-2022 has amounted to an estimated $170.08 billion, of which $134.01 billion came from China’s development finance institutions, the China Development Bank (CDB) and the Export-Import Bank of China (CHEXIM). Development finance was primarily distributed to the energy, transport, information and communication technology (ICT), financial services and industry, trade and services sectors, as seen in Chart 4. Although this financing is significant in volume and impact, China’s lending has declined since its peak in 2016 and existing debt burdens and high global interest rates limit the ability to borrow more from China.

Chart 5: Chinese Loans to Africa: Energy Lending and Total Lending, 2000-2022

As seen in Chart 5, China’s overseas development finance in the energy sector is fossil fuel heavy, but targets both electrification and extraction purposes. At least 51 percent of the $52.38 billion in CHEXIM and CDB energy finance has been distributed to fossil fuel projects with oil, coal and gas energy sources. While lending for oil extraction largely dominates, shifts away from coal projects have been observed since China’s 2021 pledge to not finance new coal-fired power plants overseas. Finance to hydropower projects also constitutes a substantial amount of energy development finance at 31 percent, of which much is for the purpose of electrification.

In contrast, financing to renewable energy projects is at meager amounts, with only $975.11 million (2 percent) of DFI financing, only from CHEXIM, going to wind and solar projects likely due to knowledge gaps and technology risk perceptions regarding renewable energy technologies amongst DFIs. Surprisingly, there is also no evidence of development finance to sovereign governments for the purpose of transition material projects. Nevertheless, China’s energy loans have served the purpose of both electrification and extraction, where 54 percent of finance has supported power generation and transmission and distribution projects and 35 percent has supported extraction projects.

Chart 6: Top Five Creditors to African Economies, 2000-20 22

Since 2000, Africa’s total public debt (internal and external) has expanded rapidly, most recently due to increased budgets expenditure during the pandemic. As seen in Chart 6, Of Africa’s total external debt, China’s share has grown from 1 percent in 2000 to 13 percent in 2022 given vast infrastructure lending to African countries. Africa’s debt stock to China is driven by debt owed from Angola ($20.98 billion), Ethiopia ($6.82 billion), Kenya ($6.69 billion), Zambia ($5.73 billion), Egypt ($5.21 billion), Nigeria ($4.29 billion), Cote d’voire ($3.85 billion), Cameroon ($3.78 billion), South Africa ($3.43 billion) and the Republic of Congo ($3.42 billion).

China has prioritized debt restructuring, and forgiveness of interest-free loans rather than debt forgiveness to address demands for debt relief. However, debt from China alone does not explain high debt-to-gross domestic product (GDP) ratios. Bondholders hold a substantial amount of Africa’s debt, as well as the World Bank, the African Development Bank and France. Together these bilateral and institution creditors held 65 percent of Africa’s external debt in 2022. Current debt burdens and high interest rates on new loans constrain efforts to take on new loans, leaving space for expansion of both highly concessional loans and FDI.

Chart 7: Trend in China’s Greenfield and Mergers and Acquisitions (M&A) FDI to Africa, 2000-2022

For African governments, FDI is perceived as a viable option of capital to achieve development goals without worsening debt levels. From 2000-2022, Chinese companies announced $112.34 billion in greenfield FDI and completed $24.60 billion worth of mergers and acquisitions (M&A) deals, as seen in Chart 7. Overall, two-thirds of both streams of FDI went to resource-rich countries such as Algeria, the Democratic Republic of Congo, Egypt, Ghana, Guinea, Morocco, Nigeria, Niger, Zambia and Zimbabwe. Both streams of FDI were supplied in cycles given the nature of equity investment which centers on holding an asset and selling for profit. After dips in FDI during 2020-2021, greenfield announcements and M&A deal completions appear to be on the rise again.

Chart 8: Greenfield vs. M&A FDI Sector Distribution

Chart 8 shows that Chinese FDI to energy and non-energy mining sectors, driven mostly by Chinese state-owned enterprises, dominates the distribution of equity. Chinese companies have distributed 30 percent of greenfield FDI to ventures in the industry and trade/services sector, primarily for manufacturing projects. A substantive amount of greenfield FDI was also supplied to the energy (27 percent) and non-energy mining and processing (25 percent) sectors, which are the sectors where Chinese companies have focused their M&A deals. Much of the FDI energy announcements and deals are driven by Chinese SOEs motivated to expand market presence and explore and extract primary commodities to prepare them for exports to China. In fact, the majority of both greenfield and M&A FDI financed fossil fuel projects, although 8 percent of greenfield FDI, $3.31 billion, was funneled to power-generating renewable energy projects. Relative to the $975.11 million in Chinese overseas development finance for renewable energy, this capital for wind and solar projects is substantive, and is generally disseminated through a diverse set of private, state-owned enterprises (SOEs) and mixed ownership Chinese companies. While this modest amount of green financing has flowed to electrification projects, most of overall Chinese energy FDI was directed to extraction projects.

Chart 9: Chinese FDI for Non-energy Mining and Processing in Africa by Metal or Mineral in Billions USD, 2000-2022

From 2000-2022, equity to non-energy mining and processing projects has grown, of which 99 percent catered to the purpose of exploration, extraction and processing of minerals and metals, as seen in Chart 9. FDI for minerals and metals projects has amounted to $28.62 billion in Chinese greenfield announcements and $12.10 billion in completed M&A deals. FDI to copper, aluminum and iron were most prominent, which mirrors the transition materials with the highest export value to China. About one-third of non-energy mining investment supported copper projects primarily in the Democratic Republic of Congo, Zambia and Uganda. Together with cobalt and lithium, which were among the top materials financed, these materials are important commodities for the electric vehicle battery supply chain, as well as other renewable energy technologies. Both aluminum and iron also play essential roles in solar photovoltaic (PV) panels and wind infrastructure, respectively.

The statistics underscore the primarily upstream role African countries play in the supply chains of renewable energy technologies. Chinese companies are supplying FDI that supports extraction of primary commodities, but African countries are not yet fully benefitting from those technologies with these inputs either through value addition opportunities or importing renewable energy equipment.

Chart 10: China’s Two-tracked Economic Engagement for Energy and Transition Materials

Overall, Chinese economic engagement in the energy and transition materials sectors follows two tracks: electrification and extraction, as illustrated in Chart 10. Chinese DFIs and investors are financing power plants, transmission and distribution lines and solar and wind farms that boost energy access in the region. On the other hand, Chinese investors and some DFI finance is serving the purpose of exploring, extracting and then exporting primary energy commodities, minerals and metals back to China. The first track aligns closely with African countries’ development goals related to energy access, and the second track often generates export revenues that feed into African countries’ economies.

However, ongoing trends toward increasing FDI financing, which has largely hinged on extraction projects, does not bode well for aligning Chinese economic engagement with low-carbon development goals in the region. Future engagement needs to strike a balance between these two tracks, where highly concessional loan finance, FDI and trade can focus on capitalizing on the vast renewable energy resources that African countries have in order to achieve their energy access and transition goals.