The article is written by Stuti Jain, from Vivekananda institute of professional studies pursuing B.B.A.LLB (Hons) Course. This article explains the process of securitization of Intellectual property, its merits-demerits, and whether it would be a right step to implement such a phenomenon in India.

Introduction 

Intellectual property (IP) as an asset is playing a very crucial role in the world economy today. A company does rely on its tangible assets, however, the amount of return a company gets from its intangible asset is applaudable. The IP includes three dimensions, trademark, Copyrights and patent. Most of the hi-tech products, innovations, and symbols are protected by these IP. Since it is an intangible asset, no one, even the highest of the qualified people can estimate the exact value that this intangible asset could produce. Since now it is considered as an asset, just like a traditional asset, not, even IP assets could be mortgaged. 

Let us understand the concept of “securitization” now. According to the Reserve Bank of IndiaI, “Securitisation is the process of pooling and repackaging of homogenous illiquid financial assets into marketable securities that can be sold to investors.” Securitization is a process by which the holder of an asset (originator) sells the asset to a special purpose vehicle/entity (SPV), which is specifically made for this purpose. The SPV further creates the marketable securities which are backed by these assets and sells the asset-backed-securities (ABS) to the investors in the capital market.

The proceeds from the purchase of these ABS from the investors are used to repay the originator by SPV. Hence, through this process, an illiquid asset of originator gets converted into a marketable security. Securitization’s main purpose is to increase liquidity in the economy against illiquid assets. Through securitization, the securities which are backed by assets are created. Traditionally, only tangible assets like buildings or properties, or automobiles were the assets used to back these securities. However, in the new era, these IPs are also used to back the securities. The owners of these IP assets use this asset as a mode of funding. Also, when these IP have prospects of future receivables, like future royalty payments, these IP could be securitized.

Parties to securitisation on IP

Originator

The originator in the process of the Asset securitization is called the bank usually. However, in the case of the IP, the originator is the company who owns the assets and it needs to be securitized. The originator is basically the company, whose intellectual property is being “securitized” i.e, financed to the investors indirectly. The originator transfers his IP assets to the SPV in exchange for the money.

Originator needs to establish its own SPV in order to transfer the IP assets to such SPV in return of the money. However, it might be possible that multiple originators assign their Ip assets to one SPV. It will reduce the cost of starting up the SPVs for the multiple originators. 

Special Purpose Vehicle(SPV)

An SPV is created by the originator to transfer those IP, in return of the funds that SPV provides to the originator. These funds are raised by the SPV from the investors in return of the IP asset security backed instrument. The SPV is an entity that is created by the originator to transfer the assets (herein the IP), which has a separate legal entity from that of the Originator or the parent company. And since the IP is now transferred to the SPV, it is the job of SPV to further transfer these IPs to the investors.

These SPV are also called “bankruptcy-remote entities.” This is because even if the originator goes bankrupt, there will be no effect on the IP transferred by the originator to the SPV since it has a separate legal entity from that of the originator. Investors are people willing to buy the assets (in this case IP). The role of investors is further explained in detail. The investors can rely on SPV to invest their money and buy those IPs, as it is free from the risks and influence of the originator. 

The SPV can also make a trust, and transfer the IP asset to that trust. 

Investors

Investors are the common people who are willing to invest their money. Investors pay the SPV or their underwriters or trustees the amount specified in various forms of negotiable instruments in return of the IP asset-backed security. The money raised by the SPV from the investor, against the IP asset-backed security is used to repay the originator. 

Servicer

There must be someone who should take care of the assets while it is going through all these processes of the securitization right? The servicers, generally the originator, are the people, mostly managerial related people, who perform the day-to-day exercises for the IP. Usually, these day to day exercises include the payment and the collection of the amounts, taxes related. For IP, the servicer provides the reports related to the annual or monthly expenditure, sales etc related to the IP. Servicer provides these reports to the investors and trustees (explained below) to ensure transparency with the investors. 

The servicers provide reports on the payments etc to the trustee, and the trustee ensures that the dues from the investors are complete. In short, the servicer is the manager of the IP asset until the whole process of securitization takes place. 

Trustee

The trustees act as a link between the investor and the SPV/Trust. The duty that trustees perform, is to make sure that he protects the investors who buy the security from the SPV. There is a trust agreement between the SPV and the trustees, in which details of the duties of trustees are written. The trustees make sure that the assets that are transferred are free from any claims (usually like it is not further licenced etc). Also, trustees hold the receivables, receiving payments and making payments to the investors. Hence the main motive of the trustee is to secure the investment of the investors.

Rating agency 

Since a general citizen, with not much expertise on all these processes, can not evaluate which investment is prudent for him, the rating agency comes to their defence. 

Securitization of IP involves the securing of the future profits that the IP can provide to the firm. Hence, due to the uncertainty of future events, there are a lot of risks attached to the IP. The Rating agencies analyse the possible future cash flows from the IP backed instruments given by SPV to the investors. It basically gives the rating to the debtor’s (the ability to pay back the loan), which is normally known as “structuring the transaction”. Through this process the agencies, investors, originators get to know, how much risk are they putting their money into. For eg., if the rating agency assigns a higher risk to a particular IP, the returns or losses expected from that IP will also be higher. On the other hand, the lower risk-rated, i.e., safer assets will provide lesser returns usually. This rating indicates the possibility of the cash flow that might come from the securitized IP. Hence, the rating agencies play a very important role in this process, as it is the main evaluator of the cost at which the IP should be transferred. Rating agencies have to keep in mind the future change in trend, the demand for the goods or service that the IP is for, the overall economic structure etc. 

Credit enhancer

The investor money is further protected by the credit enhancers. As we know, the value of the Security is determined by the asset which has backed it, herein the IP asset. The credit enhancement can reduce the losses that the investor might face due to the unstable or fluctuating IP. Credit enhancers should be at least creditworthy enough that it covers the loss due to the fluctuation of the IP. If an asset is credit enhanced, it has a good effect on the rating that is provided by the rating agency. If the assets are credit enhanced, the asset would get a better rating (i.e., more possibility of repayment) and hence investors will be more willing to buy that security since first it is a good rating, secondly, it is credit enhanced. 

Insurance companies

Insurance companies protect investors. It provides insurance to investors in case the securities issued by the SPV default. 

Underwriter

The underwriters mainly represent the SPV. It analyzes the demand for the particular IP amongst the investors. They do function like marketing, selling the IP assets to the investors. They do the traditional task of the sales manager of a company. They might also provide discounts, or liquidity support to the investors in order to attract the investors. 

Process 

1. The originator, as mentioned above, is the one which possesses the IP asset. If he is of the view that the IP that he has right now, can predictably generate cash flows for him in future, he initiates the process of securitisation. The originator then sets up the SPV.
2. Originator sells his IP asset to the SPV which is the independent identity. 
3. The SPV creates securities that are backed by these IP assets. These securities are often accompanied by the interest. In case there is a trust that is created by SPV, the asset is further transferred to the trust, and the trustees are appointed to look after that asset in the trust along with the other roles mentioned above. These securities are ultimately sold to the investors.
4. Then the role of the credit rating agency comes into the picture. The rating agency gives the rating to that IP asset security. In order to attract the investors, and to make them feel safe about their money, these agencies give the rating to these securities, as to how safe they are in terms of paying the returns back. 
5. The servicer, insurance company, credit enhancer play their respective roles thereafter. 
6. These IP backed securities are then transferred to underwriters, who perform the task of a salesperson and attract the investors to buy the IP backed securities by advertisements etc.
7. The investors in the capital market or the person appointed by them, if they are interested to buy the securities, can contact SPV directly or through the underwriters or trustees. The investors get IP backed securities (that are marketable) in lieu of the money that they provide to these SPV/ trustees.
8. The money provided by these investors is the money through which SPV pays back to the originator, for the transfer of the IP assets. In short, SPV raises funds from the investor to pay to the originator who issued them the IP asset. 

Merits and demerits 

Merits

For originator

1. An additional mode of financing: The traditional financing, by giving tangible assets as collateral to raise funds is definitely a good option for a firm. But just relying on those limited tangible assets would restrict them. The firms by securitisation of IP could widen its scope.
2. Cheaper source of raising funds: the interest rates on the security that investors demand on the security backed by the SPV depends on the quality and the credit rating of the IP asset. The interest is still much lower in case of IP securitization, as compared to the traditional tangible asset securitization. It helps the originator to raise the funds cheaper than the tangible assets.’
3. Future receivables converted to present receivable: IP securitization essentially also replaces the rights to future receivables (royalties) with presently available cash. Hence this instant money could be used by the firms who are in desperate need of the funds, for the R&D, expansions etc. 
4. Reliable for investors: Since credit rating agencies rate the securities, mutual trust and transparency is created amongst the investors who might not be well educated about the phenomenon of securitization. This helps the SPV and the originator to raise funds easily, as more investors would invest the money by depending upon the ratings of the security. 
5. Provides liquidity: The obvious aim of the securitization is providing liquidity in the economy. Hence, the illiquid asset of the originator gets converted into capital market securities. 

For the investor: 

1. Rating agencies can ease up research: The rating of these IP assets helps the investor in many ways. Since the IP asset is rated by the rating agencies, it becomes easier for the investors to analyse the expected profit margins out of that investment.
2. Diversification of risk: Since the securities aren’t just backed by just a single IP asset, rather it is backed by a number of IP assets and other assets. It helps the investor to diversify the risk. For example, in case one of the many IPs are facing losses, then the other IP, which might yield profit, can balance out the loss that the first IP has made. Hence the investment is not stuck at just one place, rather the risk of the losses or profit is divided into various securities. 
3. Separate legal entity: Investors’ money is safe when they invest their money into these IP backed securities, as even if the originator goes insolvent, it doesn’t affect the securities since the IP asset is transferred to the SPV, which is a separate legal entity.

Demerits: 

1. In case the SPV does not have the support of the insurance agencies or the credit enhancement agency in the process of the securitization, the investors are at a great pitfall. It is because in case the IP asset faces huge loss (if potential cash flows are not in a manner it should have been) then the investors face the overall loss. For eg., if the originator is a singer, who is of the view that his music album is going to give him a potential income in the future, then he will lend his royalty rights to the SPV. These SPV would sell this royalty backed security to the investors. There is no insurance company or the credit enhancement company backing these securities. Now, in case the music album is a flop, it is the investors who would face the loss as a whole and not the originator, nor the SPV. 
2. Unlike the tangible assets like land or the automobiles, the predictable cash flows from the IP is highly unstable. The IP of a company depends on the tastes and the preferences and the future fashion of the customers. Hence a minute change in the current fad and the fashion would either break or make the profits for that particular IP. Hence, investing in the IP can prove to be an extremely risky transaction. 
3. The law of the IP is not very specific. For example, what is considered as novel and innovative is totally up to the discretion of the patent officers or the courts. Hence, the validity of a Patent or any other kind of IP can be denied in case of a future dispute regarding that particular IP which is being securitized, leading to the losses of the investors. 
4. There is no specific method or calculator through which one can derive the exact value of the IP. The value differs from one person’s perception of others. For example: if an individual is of the view that the patented asset is profitable, the rating prescribed to such asset would be set higher, whereas if other is of the view, that the patented asset might not be profitable would give a lower rating to the same IP.
5. The cost of the whole process of securitization is lengthy, complex and of-course costly since it involves the valuation of IP, the formation of SPV, the premiums paid to insurance companies, the fees charged by the agencies involved etc. In developing countries like India, where there is a lack of IP experts, it can be risky. 
6. The IP has a lot of rights associated with it. For example, in case of the copyright of a film, the right to broadcast, the neighbouring rights, or performers right, the right of the author, all are different and are generally distributed amongst the different holders.
7. The time period for which the work is protected under IP in particular. Hence, the term of maturity of the securities backed by the IP should be less than the term for which that IP is protected. For example, the term for which work is protected under copyright is 60 years counted from the year following the death of the author. Hence the date of maturity must be before that 60 years after the author’s death.

Enron and Adelphia scandal 

This scandal is a big example as to how the securitization and the formation of the SPV, could prove to be quite manipulative. In this case, Enron was a biggie in the wall street with the business of energy. The first step to its scandal started with the company switching from the Historic method of accounting to the Mark to market (fair value) accounting method. In Historic, the balance sheet shows the original value of the cost at which it was bought, whereas, in fair value accounting, the balance sheet shows the current market value of the asset. Through this process of accounting, the company started to show a strong balance sheet by falsely showing the higher cost of its assets. Additionally, Enron resorted to borrowing funds by creating the SPV. SPV is generally created when a company has to get into an extremely risky project, it transfers its assets to the SPV so that even if there are huge losses, there is no impact on the parent company.

Enron used it to give results to his malice intentions. When Enron sold the assets to the SPV, the SPV further took a loan from the banks and other financial institutes. Enron’s reputation was quite good in the market, hence they used to give personal guarantees to these banks who lent money to the SPV. As soon as the SPV got the loan, it used to transfer such loans back to the SPV in the form of revenues from the sale of the assets. By this, Enron didn’t show any ‘liabilities’ at its balance sheet, rather there were just revenues that surrounded the balance sheets. Enron formulated nearly 3000 special purpose entities, to perform this task. Enron’s shares in the year 2001 touched the sky-high at $90. When such manipulation finally became public, the stock smacked down to $0.26. It’s considered as one of the greatest manipulations in the US stock markets. 

Is it the right step towards a better framework for India

In India, the law that governs the securitization of assets is The Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (also known as the SARFAESI Act). Basically, the scope of this SARFAESI act extends to the Non- Performing Assets, which are usually tangible assets. There is no law in India, that governs the securitization of the IP. Not just India, even the economic giant USA does not have any specific law that governs IP securitization. Though this concept has come from this country, still there is no specific law. Moreover, in case of the IP securitization, there is a need for the valuation of the IP, for which also there is no specific provision in SARFAESI act. 

In India, there is not much importance that is given to the IP as a whole. Like only the high-tech companies till now know the actual importance of the IP as an asset. Even in our accountancy system, there is not ample elaboration given to this field of IPR. There is just one term called ”goodwill or royalties” that the Indian accounting system uses into the balance sheets. The valuation of the IP needs expertise knowledge, and India has started realising the importance of IPR in the past few years only. 

Bureaucracy in India is something one cannot put a blind eye on. This whole process is extremely complicated, makes the investors vulnerable to the risk of getting trapped into the jaws of the various agencies who have an active role in this process. The investor would depend completely upon the evaluation of IP assets by the rating agencies. Hence, even a small amount of corruption in such agencies could lead to quite a handsome amount of losses to the investors. Moreover, Insurance agencies usually cover the losses partially and not in full. Due to the absence of any specified supervisory body, there would be no particular entity that could be blamed for such a loss. And the matter would be as usual listed in the pending cases of the courts. 

For now, especially after the COVID-19, India is in a phase of the great recession. The securitization of IP, yes, has a lot of advantages, but the negative aspects of this process cannot be undermined. In a country like India, where there are not many experts who can handle and administer this whole process systematically, could lead to further deterioration of the whole Indian economy.

The interest of the small investors will be at stake in case the securitization of IP starts in India. Indian economy is full of ups and downs, fluctuation in taste and preferences. This led to the huge fluctuation of the IP backed assets, as mentioned above. This would prove to be a huge loss for the investors per se. Naturally, no investment is risk-free, but it would be better if it is not prone to fluctuation and has less complexity.

The concept that the IP asset once transferred to the SPV, wouldn’t have an effect over the asset, even if the originator goes insolvent is not appropriate. For example, Vijay Mallya, the owner of the kingfisher airlines, placed his brand as collateral to SBI. Now, suppose the bank would have securitized the brand name into the ABS. Wouldn’t the insolvency of the Vijay Mallya effect that “brand name”? The Brand name or the other IP related to the originator would obviously depreciate if the parent company or the originator would go into the insolvency. 

In the national IPR policy, drafted by the Department of Industrial Policy & Promotion, it is proposed that facilitating securitization of IP rights and their use as collateral by the creation of enabling legislative, administrative and market framework; would provide support for the financial aspects of IPR. However, it hasn’t yet been approved by the cabinet. If approved, then, the IP could be used as collateral to raise funds. Indian big investors and companies are looking forward to the introduction of this concept, however, since small and medium companies tend to follow their traditional easy way of raising funds, this concept is a far off the mark. 

Conclusion

The USA has definitely benefited from the process of securitization. However,in case India chose to adopt this as an acceptable practice, it is highly crucial that our legislative department must formulate a special law that governs this process separately. Or the other alternative is definitely the amendment of the SARFAESI act, with the inclusion of the IP as an asset for the securitization process. Without a definite law which would govern this process, it would be highly dangerous to use it as a practice to raise funds. After the major frauds by Vijay Mallaya and Nirav Modi, a lot of pitfalls were highlighted in our legal system governing the banking and the financial laws. Also, this process must have a supervisory agency who could make the person liable in case of default, just like in SARFAESI, the supervisory agency is RBI. Moreover, the bureaucracy in India is something one cannot put a blind eye on. Sooner or later, this process would be prone to manipulation, since it is much easier to manipulate an intangible asset as compared to the tangible asset. 

Hence to conclude, for now, India is not actually ready to indulge in this process, until there is any specific law. Also, due to the current recession in the economy due to COVID-19, introducing such a risky phenomenon would add risk to the market collapse.

References 

• http://www.buildingipvalue.com/05_intro/023_026.htm

• http://nopr.niscair.res.in/

• https://ipo.org/wp-content/uploads/2013/04/Securitisation_of_IP_in_the_US.pdf

• http://law.stanford.edu/wp-content/uploads/2015/03/AlekseevInnokenty2002.pdf
• https://www.investopedia.com/

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