Continuing from part 1 of her post on Securitization of IP, Nehaa Chaudhari writes about Securitization of IP :
(This is a continuation of an earlier post, wherein PART A introduced the concept of securitization and its invocation into the field of intellectual property rights while highlighting generic concerns with the same. This part deals with specific issues that need to be addressed, the rating conundrum and ends with a few concluding remarks, based on the discussion in both parts.)
Specific issues regarding the securitization of intellectual property would vary depending on the nature of the underlying asset backing the instrument. In the context of copyrights, for instance, the absence of the requirement of registration in India makes it extremely difficult to ascertain prior instances of the work in question, which might potentially be lawsuits for copyright infringement. These lawsuits, if carried out successfully, would effectively erase the underlying intellectual property right and erode to naught, the value of the security instrument riding on the copyright in question. The Indian Copyright Act, 1957 also gives rights of assignment to the copyright holder, instances of the rights devolving on legal heirs etc, all of which need to be accounted for while structuring a securitizing transaction based on gains from copyrights. Further, in cases of joint authorship, where each author has the right to receipt of returns from the work, and if each author is not a part of the securitization process, the impact of the process on each of them would have to be ascertained and clearly demarcated, in order to not infringe on the exercise of their rights by non participating authors.
In the context of patents, as stated earlier, the key concern would be the ability to extract maximum returns from the patent backed security instrument, since the patents might get rendered invaluable in future.
The drawbacks associated with trademarks might overlap with those related to branding as well, given that they are closely associated with the goodwill enjoyed by the organization that continues to hold those intangible assets. A decline in the value of the brand would also have a corresponding negative impact on the value of the trademarks associated with that brand.
Trade secrets, on the other hand, constitute a unique class of intellectual property instruments, and in the cases of non disclosure, would not be suitable for securitization. Even in cases of disclosure, the organizations might want to exercise a high degree of control on them, given their inherent importance and value, and not just one that is linked to their returns.
The Rating Conundrum
Rating, in the context of the securitization of intellectual property rights, needs to be understood on two levels. Firstly, the rating of the underlying intellectual property rights themselves; and secondly, the rating of the securities issued against the underlying intellectual property right.
Rating intellectual property rights
Rating intellectual property rights, like rating in any other context, may be understood as a tool to ascertain the importance of each intellectual property right that a company owns, and the relative value of one as against another.
Rating intellectual property rights becomes all the more important in a global context, as explained here. In such a context, aside from the sheer number of intellectual property rights, (particularly in the context of patents) that a large organization may own, factors such as geographical location, the nature of the invention, recording, art form etc, applicability and utility in different areas and industries etc. are important factors that dictate the underlying value of any intellectual property right. Further, the value of any intellectual property right, as opposed to being a constant, is going to vary over periods of time and across geographical and industrial makers, among others.
Therefore, in light of the multitude of factors affecting valuation, it becomes all the more important to have an external agency rate each intellectual property right, as an indicator of expected returns. The rating ought to be done at various stages, every few years, given that the returns from the underlying right will be variables. Unfortunately, not too many organizations have their intellectual property rights rated, thus furthering the subjectivity involved in the valuation of intellectual property rights, which would hinder the securitization process. Rating intellectual property rights and the disclosure of the objective criteria on the basis of which it has been done would in turn boost investor confidence towards securities issued against the backdrop of returns from rated intellectual property rights.
Rating securities issued against returns from intellectual property rights
Rating securities issued against returns from intellectual property rights would effectively be an estimation of the likelihood of the investor being able to get a return on his investment. Various factors such as the bankruptcy remoteness of the SPV from the originator, the financial stability of both, the originator as well as the SPV, the market conditions and the expected returns on the underlying asset etc. would be criteria that would be taken into account before the securities are rated.
Working on the premise that the ultimate aim is to minimize the subjectivity and the uncertainty involved in a transaction of the securitization of intellectual property, it is submitted that rating as discussed above might prove to be a workable solution to the problem presented by the valuation of intellectual property, and even to specific problems discussed earlier.
Over the course of these 2 posts, an effort has been made to highlight a few issues that need to be addressed in order to aid the development of the securitization of intellectual property.
As seen from the preceding discussion, the valuation of intellectual property emerges as one of the primary concerns that emerges, along with subjectivity and uncertainty which cuts across the board. To that end, a solution in the form of rating intellectual property rights and the security receipts issued against them has been suggested. While the author notes that this is employed in some scenarios, the point being made is to expand the role that it plays, especially given the diversity and complexity of intellectual property rights held by various organizations.
In order to combat subjectivity and uncertainty, it might be tempting to structure a securitization transaction around a single intellectual property asset, over a portfolio of intellectual property assets, but it is submitted that the benefits of the latter would outweigh the former. A portfolio of intellectual property assets would contain a diverse range of assets, and would thus also bring about a diversification of risk, thus rendering them more attractive to an ordinary investor. Simply put, it would involve not placing all of your bets on just one turn, and instead spreading the risk over a specified range. Therefore, even in the event that some of the assets in that pool were unable to perform, the investor would still be able to receive some return on investment as a result of the presence of other assets. The loss brought about by the failure of a category of assets might be offset by the gains in another category, which would not be the case if there were only a single uniform class of underlying assets backing the securities purchased by the investor.
Hence, as seen from the preceding discussion, given the volatility in valuation of returns from intellectual property, jurisdictional issues, and the concerns that are unique to each category of intellectual property, the demand and feasibility of security instruments tied to an underlying pool of intangible assets is by and more suited to investors with a greater appetite and a greater ability to absorb risks, generally, institutional investors, and renders such instruments unattractive to and unsuited for retail individual investors.
In order for the market to be widened and to have greater appeal, the concerns flagged out need to be addressed, which may also involve revisiting traditional concepts and ideas of intellectual property rights, their rationale and their returns.