Innovations that can double NIP’s share of bond financing
The government expects corporate bonds to contribute only 6-8% of PNI investments – in line with the historical trend – and mainly through public sector issuance.
But that will not be enough. If bond funds are to be channeled directly to individual infrastructure projects, the gap between investors’ low risk appetite and project risk levels must be bridged. For this, innovation and regulatory authorization are essential.
Innovations such as asset pooling, a well-capitalized credit guarantee improvement company, and widespread adoption of the INFRA EL rating scale can help raise an additional Rs 7 to 10 lakh crore. infrastructure bond issues until fiscal year 2025.
It can potentially double the share of bond financing in the PIN.
Pooled assets provide scale, diversification and flexibility to structure cash flows. This can attract foreign capital, improve investor confidence in the bond market, and therefore facilitate the monetization of operational infrastructure assets.
Take-out financing facilitated by pooling assets can help banks and non-banks free up outstanding credit tranches for new loans.
The pooling vehicles that can support bond issues are:
Infrastructure Investment Trusts (InvIT): Combined Assets Under Management (AUM) of InvITs and Real Estate Investment Trusts (REITs) reached ~ Rs 2 lakh crore, marking a huge compound annual growth rate of 42% since the launch of the first InvIT in fiscal 2018.
This was made possible by tax benefits, mandatory distribution of excess cash flows and restriction of investments in assets under construction. InvITs must also have a credit rating of AA and above. It is interesting for investors in the bond market.
CRISIL’s calculation shows that InvITs can enable the monetization of Rs 6.5 lakh crore of medium-term infrastructure assets, which can be partly financed by bond issues of Rs 3-4 lakh crore for roads, energy transmission, gas pipelines, telecommunications infrastructure, and renewable energies.
Co-debtor structures: These are several ad hoc vehicles (SPVs) of a sponsor acting as guarantor of the collective debt of all SPVs. Sponsors can set up pools of selected SPVs to meet the risk appetites of different investors. These structures are used to finance operational assets in sectors such as renewables and roads, including toll-operate-transfer packages.
Securitization and covered bonds: Loans to operational infrastructure assets can be securitized by lenders, in the same way retail loans are packaged and sold. The presence of cash collateral to absorb losses inspires confidence in investors, who can also take comfort in well-established legal and administrative practices governing securitization. Lenders can also explore covered bonds backed by a loan pool where investors can benefit from dual recourse – to the issuer and the loan cover pool – if the credit quality of the issuer deteriorates.
There are also other innovations that can boost bond issuance:
A well-capitalized credit guarantee improvement company: This can facilitate issuance by raising stand-alone credit ratings of operational infrastructure assets to levels desired by investors. The capital invested in such a company would have a significant multiplier effect.
INFRA EL rating scale: This scale provides additional credit information on expected losses (EL) over the life of an infrastructure debt, thus complementing traditional credit scoring. It allows investors to use EL, as well as the PD rating, and choose investments based on their risk appetite.
But these innovations must be complemented by four measures to stimulate demand:
First, attract retail investors through tax rationalization, such as capital gains tax parity between stocks and debt products, the promotion of exchange-traded funds and other index funds.
Second, develop a market infrastructure such as credit default swaps by allowing participants to underwrite CDS, and quickly set up the proposed institution to provide secondary market liquidity to bonds.
Three, and perhaps the most critical, would be measures to attract foreign capital, such as easing withholding taxes and including Indian bonds in global indices to channel capital from global index funds. Foreign investors are key to securing a strong market appetite for corporate bonds, especially given the potential crowding out of domestic funds by the government’s massive borrowing program.
Four, and materially important, are improved reporting on environmental, social and governance (ESG) factors. ESG profiling of companies is an essential element in attracting foreign capital. Globally, the ESG-mandated AUM totaled $ 40 trillion in December 2020 and is expected to reach $ 100 trillion by fiscal year 2030.
This growing basin presents a huge opportunity. The Indian corporate bond market can seize this opportunity by building an ecosystem that encourages ESG adoption and assessment.
(Gurpreet Chhatwal is Managing Director of CRISIL Ratings. The opinions are his)