The pandemic has not only altered the country’s economic trajectory, it has also brought to the fore the need to focus on social infrastructure. For long, nature has been warning us to shift towards sustainable growth models. Government policy and direction are central to achieving this, be it through infrastructure build-outs, fiscal stimulus or retooling of the economy to address health, inequality and climate change challenges.
Two areas stand out, ripe with possibilities for India and India Inc. alike. One is the under-developed, yet expanding, corporate bond market. The second is something that’s been getting serious attention the world over: environmental, social and governance (ESG)-driven investing.
Deepening of the corporate bond market
The fulcrum of the government’s India development (and now building-back) strategy is the National Infrastructure Pipeline (NIP), which envisages Rs 111 lakh crore investments between fiscals 2020 and 2025. The focus on sustainable growth will add to that tally. Raising this much money, however, is an onerous ask, particularly given the overwhelming fiscal burden today. Therefore, developing the corporate bond market and finding alternative fund-raising avenues will be critical. In line with the historical trend, the government expects corporate bonds to contribute only 6-8 per cent of NIP investments, primarily through public sector issuances. That won’t suffice.
The corporate bond market in India has grown by more than four times in the last decade to around Rs 32.5 lakh crore (bonds outstanding in fiscal 2020). Still, it is less than 20 per cent of GDP, which is very low compared with international standards. Besides, the market is grappling with the structural challenges of width and depth of issuances. Access to bond market funding is limited to high-rated entities, predominantly in the financial sector. Over 65-70 per cent of bond issuances are by financial sector entities, and over 85-90 per cent are AA and above. If bond funds have to be directly channeled towards individual infrastructure projects, the gap between the low risk appetite of investors and risk levels of projects needs to be bridged.
Innovation and Regulatory help Innovations such as asset pooling, a well-capitalised Credit Guarantee Enhancement Corporation and widespread adoption of the EL (expected loss) rating scale can help mobilise an additional Rs 7-10 lakh crore via infrastructure bonds by fiscal 2025.
Pooled assets enable scale, diversification and flexibility to structure cash flows. This can help attract foreign capital, improve the confidence of bond market investors and consequently facilitate monetisation of operational infrastructure assets. Such takeout financing can help banks and non-banks free up chunks of outstanding credit for fresh lending.
Three pooling vehicles that can support bond issuances are:
Infrastructure investment trusts (InvITs): The assets under management (AUM) of InvITs and real estate investment trusts have reached nearly Rs 2 lakh crore as of fiscal 2021, a 42 per cent compounded annual growth rate since the first InvIT was launched in fiscal 2018. CRISIL’s estimates show InvITs can enable monetisation of Rs 6.5 lakh crore worth of infrastructure assets over the medium term, which can be part-funded by bond issuances of Rs 3-4 lakh crore for roads, power transmission, gas pipelines, telecom infrastructure and renewables.
Co-obligor structures: These comprise multiple special purpose vehicles (SPVs) of a sponsor acting as a guarantor for the collective debt of all SPVs. Sponsors can form pools of select SPVs tailor-made to fit the risk appetites of different investors. Such structures are already being used to fund operational assets in sectors such as renewables and roads, including toll-operate-transfer bundles.
Securitisation and covered bonds: Lenders can securitise loans to operational infrastructure assets, just the way retail loans are packaged and sold. The presence of cash collateral to absorb losses will instil confidence in investors, who can also derive comfort from the well-established legal and administrative practices governing securitisation. Lenders can also explore covered bonds backed by a pool of loans where investors can enjoy dual recourse – to the issuer and the cover pool of loans – if the issuer’s credit quality weakens.
Other Booster Shots
A well-capitalised Credit Guarantee Enhancement Corporation can facilitate bond issuances by lifting standalone credit ratings of operational infrastructure assets to levels desired by investors. Capital invested in such a corporation would have a significant multiplier effect.
A recent, and salutary, augury is the launch of the Expected Loss, or EL, rating scale by the Securities and Exchange Board of India. This provides additional information on the EL over the lifetime of an infrastructure debt issuance, complementing the traditional credit rating. Investors can use EL, along with the probability of default rating, and pick investments aligned with their risk appetite. CRISIL Ratings estimates that innovations can double the supply of corporate bonds in the domestic market to Rs 65-70 lakh crore (outstanding) by March 2025. That would increase the size of the corporate bond market to 21-23 per cent of GDP by fiscal 2025.
Yet, the demand for corporate bonds is expected to fall short by close to Rs 5 lakh crore, according to CRISIL’s calculations. Hence, the supply-side innovations need to be complemented by four measures to stoke demand:
One, attracting retail investors through tax rationalisation, such as capital gains tax parity between equity and debt products and promotion of exchange-traded and other index-linked funds.
Two, developing market infrastructure such as credit default swaps, and quickly setting 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 of withholding tax, and inclusion of Indian bonds in global indices to channel capital from global index funds. Foreign investors are essential to ensure high market appetite for corporate bonds, especially given the potential crowding out of domestic funds by the government’s gigantic borrowing programme.
Four, and materially important, is enhanced reporting on ESG factors.
The ESG factor
ESG has moved from being a just another investor-centric data point to an integral factor in strategic decision-making. This makes ESG profiling of companies a crucial facilitator to draw foreign capital. Between 2018 and 2020, more than $100 billion flowed into ESG funds globally, clocking a 15 per cent CAGR. ESG-mandated AUM totaled $40 trillion as of December 2020, and is expected to touch $100 trillion by fiscal 2030.
In India, too, ESG funds are expected to grow by at least 15 per cent annually, to over $60 billion in 2025. In lockstep with overseas investors, domestic institutional investors and lenders have also started taking into account a multitude of ESG factors, including environmental impact, climate change, resource conservation and impact on marginal communities. That growing pool presents a humongous opportunity for India’s corporate bond, equity and loan markets to tap, by developing an ecosystem that encourages ESG adoption and assessment. In this, the government and regulators are expected to provide the biggest impetus.
The signs are encouraging. While the Indian government has been setting up structures to meet India’s Paris Agreement targets and Sustainable Development Goals, the Reserve Bank of India has joined the Network of Central Banks and Supervisors for Greening the Financial System and the Securities and Exchange Board of India has launched Business Responsibility and Sustainability Reporting for enhanced disclosures. Then there are the stewardship codes developed by SEBI, PFRDA and Irdai, as well as India’s active role in global ESG fora.
These positive developments notwithstanding, newer challenges are bound to emerge as more and more investors, bond holders and lenders implement ESG strategies. We anticipate issues around lack of expertise, less-evolved analytical tools and disclosures on environmental and social factors compared with more structured corporate governance ones, and changing of strategies from exclusion to active ownership and integration.
CRISIL’s recent survey of nearly 100 respondents, comprising corporates, investors and intermediaries, establishes beyond doubt that ESG is perceived as significant, even critical, for raising capital. The importance of ESG further goes up in relation to patient capital. However, data consistency remains a key stumbling block for investors.
Investors who responded to the survey reported inability to read the signals and cut through the noise. That’s partly because the information is not material to the company and partly because it is not in a state that is readily ingestible. Moreover, the respondents felt that the evaluation of companies through multiple frameworks largely devoid of local nuances has not been of much help. They want to see Indian companies assessed against a hybrid global-local ESG framework with a localised understanding.
Over the next few years, raising the ESG quotient will require building up expertise and integrating it into decision making. It will also necessitate standardistion of disclosures and access to credible independent scores and benchmarks. The government thus has its task cut out on the two prongs – corporate bonds and ESG. The sooner we align these to our common ends, the better it will be for us.
(The author is Managing Director & CEO at Crisil Ltd)