It has been more than two-and-half years when the budget made a noise about infrastructure debt funds (IDFs). The Cabinet on 4th October finalised the tripartite agreement that will possibly pave the way for infrastructure debt funds (IDFs), but their acceptability by the capital market will only need to be seen

Vinod Kothari

In the spate of so-called steps to restart the jammed tempo of Indian economy, infrastructure obviously must have taken the key place. And as for reviving infrastructure, infrastructure financing, the government has taken a few initiatives, but all this is still too little for reviving the sector which, going by the mood that we saw at our recent Infrastructure Finance Summit, is almost in tears. But for brave faces seemingly saying—we can cope up with this also—the participants at the Infrastructure Finance event were melancholy.
 

One of the things the Cabinet recently cleared is the tripartite agreement that will possibly pave the way for infrastructure debt funds (IDFs). Several proposals for IDFs, mostly in the mutual fund route and some in the NBFC mode, are currently lying before the Securities and Exchange Board of India (SEBI) or Reserve Bank of India (RBI). The IDF guidelines of the RBI came in September 2011, following an announcement in Budget 2010¹. The guidelines require that the IDFs sign a tripartite agreement between the lender, the concessionaire and the IDF. The format of the tripartite agreement was not firmed up for all these months. It was only on 4 October 2012 that the tripartite agreement was finalised. With this, possibly, SEBI and RBI will give go-aheads for the IDFs, for which several applications are currently pending.
 

Read here about infrastructure bonds being eligible for investment by charitable/religious trusts.
 

It is not that tonnes of money are waiting for the launch of IDFs. As regards international investors, practitioners confirm that currently there is no interest in the India story, and more so for the infrastructure sector, which has recently seen such episodes as cancellation of telecom licenses, revocation of coal block allotments, and so on. The overall image of India was already tarnished with the infamous proposals of the then finance minister on retrospective taxation; with that, the blows that the courts gave in response to corruption scandals were just too much to bear.
 

In addition, the schemes of IDFs suffer from several fundamental flaws. The two options—mutual funds and NBFCs—have so much of disparity that they seem to be two uncomparable instruments. An IDF-NBFC, as the RBI calls it, has capital as its essential corpus and raises funding by issuing bonds. The capital of the IDF-NBFC acts as a first-loss credit enhancement. Given the capital requirement of 15%, and risk weight of 50% for the infrastructure loans that an IDF-NBFC will acquire, this would mean a minimum 7.5% credit enhancement for the bondholders. Every IDF-NBFC may be visualised as a sort of pool of infrastructure loans. Hence, the bonds issued by an IDF-NBFC essentially represent securitisation of the pool of loans that that the IDF-NBFC holds. In case of a proper securitisation of infrastructure loan pools, the sizing of the enhancement will be derived looking at several factors such as the default rate, level of diversification, granularity of the pool, and so on. The regulatory minimum credit enhancement of 7.5% for a dynamic pool with no safeguards as to diversification is unlikely to be as appealing to investors as a securitised instrument would have been.
 

On the other extreme, the mutual fund option, or the tag of “mutual fund” for any collective investment scheme that invests in infrastructure loans, is wholly misconceived. It is notable that in the Alternative Investment Fund (AIF) regulations, there is an option to have an AIF for infrastructure funding. However, mutual funds are seen as instruments that invest in capital markets. There is no question of credit enhancement in case of the mutual fund option—hence, any one loan out of the pool of infrastructure loan going bad will expose the investors to NAV losses. Unlike a mutual fund that invests in capital market instruments, the one investing in infrastructure loans is unlikely to have either the granularity that a mutual fund needs, or the transparency in the fair valuation of its own assets—leaving investors to a substantial disadvantage. The investments that such a “mutual fund” will make will be infrastructure loans, which are big ticket, illiquid and long maturity assets. There is no transparency in pricing of such assets, and it would always be hard and subjective to declare the NAV of such a mutual fund. If such a mutual fund is an open-ended fund, the fund manager may find it hard to liquidate the units. If the fund is a closed-end fund, the fund goes through the entire rigmarole of listing. In any event, the mutual fund route is understood, world over, as the device to make capital market investments, and it would not be surprising if a mutual fund agent markets an infrastructure mutual fund to unsophisticated investors claiming it to be something like a mainstream mutual fund.
 

In essence, with the AIF route being available, the mutual fund option should not have been envisaged for infrastructure loans.
 

Despite this, the reason why most players have opted to go for the mutual fund route to IDFs is clearly because of the convenience and scope for wide discretion in case of the mutual fund option as compared to the NBFC route.
 

It has been more than two-and-half years when the budget made a noise about IDFs. The regulators have taken their own good time to clear the all-needed documentation. So, hopefully the finalisation of the tripartite agreement is the last of the regulatory steps, and now, IDFs are at least regulatorily ready to take off. Their acceptability by the capital market, of course, will only need to be seen.
 

In the meantime, the interim report of the High Level Committee on Financing of Infrastructure came out in August 2012². Note that the Committee was constituted almost two years ago—in November 2010—so, it is not sure whether it is the complexity and enormity of the problem, or the changes in the constitution of the Committee, that even an interim report has taken this long time. The interim report has made several sector-specific recommendations, besides making pointed recommendations regarding IIFCL. The recommendations for IIFCL relate to redirecting of its operations, so that the overlaps between IIFCL and banks/IFCs could be avoided.
 

The essence of the Committee making its interim report lay in the fact that there were measures which required immediate attention, and it is not safe to wait for the submission of the final report, which may come around March 2013. However, it does not seem whether the government has taken any action on any of the sector-specific recommendations of the Committee, most of which may be politically sensitive.

In short, India still seems to be going slow, and not steady, on the highway of infrastructure.
 

To read more articles by the same writer, click here.
 

(Vinod Kothari is a chartered accountant, trainer and author. He is an expert in such specialised areas of finance as securitisation, asset-based finance, credit derivatives, accounting for derivatives and financial instruments and microfinance. He can be contacted at [email protected]. Visit his financial services website at www.vinodkothari.com.)