Materials in this series will also provide an overview of international experience in electronic registration and trading of mortgage loans.
PREREQUISITES FOR INTRODUCING DEPOSITARY REGISTRATION OF MORTGAGE NOTES
The modern financial system is hard to imagine without information technology. Raising the question of introducing depositary registration of mortgage notes is, in essence, an absolutely logical option for utilizing the advantages of information technology to increase the volume of the secondary securities market and enhance their liquidity.
In Russia, immediately after the adoption of the Federal Law "On Mortgage-Backed Securities" in 2003, the issue of improving technologies for transferring rights to mortgage loans arose. The labor-intensive and non-technological process of making endorsements on thousands of mortgage notes, which either constitute the collateral for the issuance of mortgage-backed securities using the structure of mortgage agents or are the subject of purchase and sale transactions between different creditors, carries significant operational risks and prolongs the timeframe for such transactions. In February 2008, amendments were adopted to the Federal Law of the Russian Federation "On Mortgage" (hereinafter – the Mortgage Law), which introduced the institution of depositary registration of mortgage notes. And although more than three years have passed since the inclusion of provisions on depositary registration of mortgage notes in the text of the Mortgage Law, depositary registration of mortgage notes is still fragmented, and a significant part of mortgage market participants uses only warehouse storage of mortgage notes. The main reason why mortgage market participants do not resort to depositary services for the registration of mortgage notes is the insignificant share of mortgage-backed securities in the total volume of financing for the issuance of new mortgage loans, as well as the underdevelopment of operations involving the pledge of mortgage note pools to raise financing.
However, with the gradual increase in the volume of the mortgage market, the search for new sources of liabilities or opportunities for loan refinancing will push mortgage lenders to use depositary registration of mortgage notes due to its obvious advantages. This scenario is outlined in the Strategy for the Development of Mortgage Housing Lending in the Russian Federation until 2030, approved by Decree of the Government of the Russian Federation No. 1201-r dated July 19, 2010 (hereinafter – the Strategy). In particular, the Strategy envisages that the volume of the mortgage-backed securities market will grow from current figures, constituting approximately 20% of the volume of issued mortgage loans, to 55% by 2020 and to 66% by 2030. The Strategy also stipulates that the development of mortgage market infrastructure in general and the introduction of electronic (depositary) registration of rights to mortgage notes in particular should contribute to increasing the market's technological sophistication and the speed of capital turnover, which in turn will help reduce costs and improve the quality of services provided in the market.
There are several ways to certify rights to mortgage notes:
Paper-based method: Rights under the mortgage loan are provided for in the credit agreement and the mortgage agreement.
Securities-based method: Rights under the mortgage loan are certified by a security (mortgage note), possession of which and the presence of a corresponding mark (endorsement) on it are sufficient conditions for exercising the rights under the mortgage note.
Depositary method: Rights under the mortgage loan are certified by a mortgage note, and rights to the mortgage note and encumbrances thereon, in turn, are confirmed by entries in securities accounts (which the depositary maintains electronically).
Depositary registration of mortgage notes is the most technologically advanced and market-responsive method of certifying rights to mortgage notes for the mortgage-backed securities market.
In general, each subsequent method of certifying rights under a mortgage loan has greater advantages compared to the previous method. Thus, the securities-based method of certifying rights is distinguished from the paper-based method by the following features:
The mortgage note belongs to the person named in this security, whereas with the paper-based method, the fact of ownership of rights under the mortgage loan can be certified by an unlimited range of documents;
The mortgage note is recognized as the only necessary and sufficient document certifying the rights under the mortgage note, whereas with the paper-based method, the debtor has the right to raise against the creditor objections based on documents relating to the mortgage loan, including correspondence between the debtor and the creditor;
The possession of the mortgage note by the pledgee or the absence of a mark or other certification of partial performance of the mortgage-secured obligation on it свидетельствует, unless proven otherwise, that this obligation or its corresponding part has not been performed;
When rights to the mortgage note are transferred, registration of the new pledgee in the Unified State Register of Rights to Real Estate and Transactions Therewith (USRRE) is not required, whereas with the paper-based method, the assignment of rights under the mortgage loan is only valid after state registration in the USRRE;
The holder of the mortgage note possesses all the rights certified by it, regardless of the rights of the original pledgee and previous holders of the mortgage note; the debtor is not entitled to raise against the holder of the mortgage note objections arising from his legal relations with previous holders of the mortgage note, whereas with the paper-based method, the debtor is entitled to raise any objections against the creditor making claims under the mortgage loan;
The text of the mortgage note takes precedence over the text of the credit agreement and the mortgage agreement;
A bona fide purchaser of a mortgage note acquires ownership of the mortgage note, except in cases where it is proven and confirmed by a final court verdict that the mortgage note left the possession of its holder through criminal means.
ADVANTAGES OF DEPOSITARY REGISTRATION OF MORTGAGE NOTES
Depositary registration of mortgage notes is aimed at reflecting transactions with mortgage notes in securities accounts using special technical means that allow for the transfer of a large number of mortgage notes to a new owner (e.g., to a mortgage agent upon issuance of mortgage-backed securities) with minimal costs, a high degree of security, and in the shortest possible time.
Depositary registration of mortgage notes ensures the prompt recording of the transfer of rights to the mortgage note (see table), increased security of the transfer of rights to the mortgage note, and thereby (upon issuance of mortgage-backed securities) reduced costs and enhanced control over the composition of the mortgage cover.
1. Prompt Recording of the Transfer of Rights to the Mortgage Note
According to Art. 48 of the Mortgage Law, when transferring rights to a mortgage note, the transferring party makes a note on the mortgage note about the new owner. In the case of transferring a large number of loans combined into pools (sometimes such pools combine thousands of mortgage notes), the transfer of rights to mortgage notes by manually making notes on each mortgage note requires a significant amount of time and labor resources.
With depositary registration of mortgage notes, the transfer of rights to mortgage notes can be carried out simultaneously for the entire pool of mortgage notes entered into the depositary registration system. All operations for the transfer of the mortgage note are carried out in the form of entries in the securities account, and no notes about the new owner of the mortgage note are made on the mortgage note itself.
2. Increased Security of the Transfer of Rights to the Mortgage Note
When transferring rights to mortgage notes in a non-automated way, especially if such a transfer involves a large number of mortgage notes, there is a high risk of technical errors that can cause damage, including to participants in the mortgage lending market and investors in mortgage-backed securities.
Furthermore, since the transfer of mortgage notes is carried out through their physical transfer, the risk of loss or damage to mortgage notes increases during their transportation from the owner of the mortgage note to its acquirer.
Depositary registration of mortgage notes allows minimizing these risks. After the mortgage note is transferred for depositary registration (immobilized), all operations with such a mortgage note are carried out in the form of entries in the securities account at the depositary. Depositary registration does not involve the physical transfer or transportation of the mortgage note to the new owner of the mortgage note and significantly reduces risks associated with the human factor.
3. Cost Reduction
Compared to making written endorsements on each mortgage note, the depositary method of registering rights to mortgage notes is a less costly method of registering rights to a security.
Cost reduction in depositary registration of mortgage notes is also associated with the absence of transportation costs necessary for the physical transfer of mortgage notes to the new owner, as well as with the reduction of technical risks associated with the transfer of rights to mortgage notes, which are ultimately factored by banks issuing mortgage loans certified by mortgage notes into the cost of the mortgage loan.
4. Enhanced Control over the Composition of the Mortgage Cover
Custody and ensuring control over the making of endorsements on mortgage notes constituting the mortgage cover are carried out by the specialized depositary of the mortgage cover. But in practice, custody is often carried out in a regional subdivision, and the owner is provided access to the mortgage notes (for example, for presentation in court proceedings or registration of changes with the registering authority).
If such physical access to the mortgage note exists, there is a risk that disposition endorsements could be made on it, which the specialized depositary cannot prevent (risk of fraudulent actions). This means that the entries in the register of the mortgage cover may not correspond to the actual circumstances.
Depositary registration of mortgage notes eliminates the risk of such fraudulent actions with mortgage notes and provides an opportunity to guarantee the correspondence of the mortgage cover register to the actual state of affairs, since with depositary registration, all operations with mortgage notes are reflected only in the securities account.