The existing cap on leverage, of 49%, in InvITs is impeding new issuances significantly and their development
At the heart of the ILFS debacle remains the inability of Indian developers to monetise the completed infrastructure asset portfolio in a timely and efficient manner. It is very interesting to note that ILFS/ITNL filled a prospectus with SEBI for launching their own InvIT platform in 2017. Had they raised equity capital via InvITs in 2017, the present situation perhaps would not have arisen.
The risk of investing in infrastructure projects reduces materially post the commissioning and stabilisation period. If infrastructure developers can sell their operating projects at fair value to Indians as well as FIIs via InvITs, they could reduce leverage and generate cash to invest in new under-development projects. It is a true win-win-win for investors-developers-India as it provides opportunities for investors to have a good long-term stable investment, developers to deleverage and release locked-in capital to grow, and India to have incremental investment in under-development infrastructure projects.
The bulk of infrastructure financing in India, over the last few decades, has come from banks . However, asset-liability mismatches and rising bad loans have limited the ability of lenders to fund the country’s humongous infrastructure funding requirement. While an active corporate bond market is imperative, its conspicuous absence leaves debt-laden infra-developers with few options to refinance projects and recycle their locked-in capital. Infra debt funds and Take Out financing have not lived up to their potential.
An InvIT is a trust registered with SEBI and listed on the Indian stock exchanges. It acquires the initial infrastructure asset portfolio of a sponsor/developer and issues units in lieu. InvITs not only offer developers a robust platform to divest their operating assets, but also offer investors the ability to invest in stable operating infrastructure assets.
What’s working well?
*Globally well accepted asset class: The operating framework behind InvITs and REITs builds on the experience of similar instruments like business trusts, yield cos, MLP, infrastructure funds in the US, the UK, Singapore, Hong Kong and Australia.. Over US $ 1 trillion of investments have been made in such platforms owning long-term assets like roads, power generation, power transmission, warehouses, ports, gas pipelines, real estate, etc.
Attractive long-term investment opportunity: With the InvITs listed today offering upwards of 12-13% yields, it provides a compelling value proposition on a risk adjusted basis. Some of the key features highlighted below adds to the attractiveness for investors, institutions and individuals alike.
* Revenue-generating assets: SEBI requires InvITs to invest at least 80% of their assets in completed and revenue-generating projects, and not more than 10% of their assets in under-construction projects. This ensures that InvITs are not exposed to some of the key risks inherent in the infrastructure sector like financial closure, regulatory approvals, time and cost overruns, etc.
* Minimum 90% income to be distributed: SEBI requires InvITs to distribute a minimum of 90% of their cash earnings to investors at least semi-annually. This can provide clear visibility to investors on cash flows and they, in turn, earn frequent distributions.
*Robust corporate governance framework by SEBI: InvITs are managed by an independent trustee and investment managers. They operate the assets on behalf of the unit-holders. The board of the investment manager comprises at least 50% independent directors. There are several other governance measures like half yearly valuation report by independent valuers, mandatory rating requirement, stringent disclosure norms as well as restricted voting by the sponsors in related party transactions.
*Long-term investors are investing in it: There are several Indian insurance companies, mutual funds, pension funds and corporate treasuries that have subscribed to these investments besides marquee foreign institutional investors in the three issuances till now.
What could provide impetus to InvITs?
CRISIL Infrastructure Advisory estimates that India needs to spend ~Rs 50 lakh crore on infrastructure over the next five years to meet its growth targets. The government needs to facilitate the setting up of many more InvITs to ensure incremental investment in infrastructure sector in India and avoid NPAs because of delayed churning of assets. This will also help reduce the dependence on bank financing while also providing the financial community with a credible investment opportunity.
The existing cap on leverage, of 49%, in InvITs is impeding new issuances significantly and their development. SEBI can consider a leverage limit of up to 70% . A prerequisite for this higher leverage can be a base rating—like “AA+” by two or more rating agencies—and majority approval from unit-holders. This will ensure stability of the platform without increasing the risk to unit holders. InvITs suit the investment objectives of insurance companies and pension funds. The investment cap of 5% for insurance companies while investing in a single InvIT is restricting participation. IRDA should increase the limit to 10%, in line with the limit prescribed by SEBI for mutual funds and its own cap for insurance companies while investing in listed equities.
Clarity from IRDAI on allowing insurance companies to invest in debt securities issued by InvITs in line with traditional companies will help issuers significantly. Similarly, PFRDA asks for a minimum rating of AA for the sponsor of an InvIT to allow participation by pension funds. Considering the fact that the InvIT is independent of its sponsor, the rating threshold should apply only to the InvIT.
Regulators, especially SEBI, have played a monumental role in making InvITs and REITs a reality in India. They must act now to ensure the market for InvITs develop in India,. It would be a shame if cases of corporate default continue when there is such a robust capital market instrument available to avert these systemic crises. It seems now or never for InvITs.
The author is Former finance secretary