Infrastructure Debt Funds: Government’s call for Infrastructure Development
Infrastructure Debt Funds (“IDFs”) were mooted in the budget speech of 2011- 2012 as notified special vehicles to attract foreign funds for financing infrastructure development projects.1 Accordingly, in order to augment and accelerate capital funding in the form of long term debts for government infrastructure projects and provide a framework for setting up and operating IDFs, the Securities and Exchange Board of India (“SEBI”), notified an amendment to the SEBI (Mutual Funds) Regulations, 1996 (“MF Regulations”) on August 30, 2011 to include a new chapter VI-B.2 The Reserve Bank of India (“RBI”) also notified broad parameters allowing banks and non-banking financial companies (“NBFCs”) to set up IDFs on September 23, 2011 (“RBI Guidelines”).3 Therefore, the IDFs has the option to either operate under the trust route as mutual funds (“IDFs-MF”) regulated by SEBI or corporate route as NBFCs (“IDFs-NBFC”) regulated by RBI.
On one hand SEBI has notified a detailed structure for operation of IDFs-MF. On the other, RBI Guidelines only lay down broad parameters allowing banks and NBFCs to be sponsors4 of SEBI regulated IDFs-MF, specifically highlighting that detailed guidelines for operation of IDFs-NBFC would be issued separately. This bulletin analysis the structure of IDFs notified under the MF Regulations and RBI Guidelines highlighting the impact on infrastructure funding in India.
1.0 IDFs under MF Regulations
1.1. Eligibility for launching an IDF Scheme
As per the MF Regulations, an existing mutual fund may launch an IDF Scheme if it has an adequate number of key personnel having “adequate experience” in the infrastructure sector. However, no parameters have been defined to measure adequacy of experience in the infrastructure sector. The MF Regulations further provide that an “applicant” who wishes to launch “only” IDF Schemes may be allowed to do so if the “sponsor” or the parent company of the “sponsor”5 has been (a) carrying on activities or business in infrastructure financing for a period of at least five years, and (b) fulfills a further eligibility criteria mentioned under regulation 7 of the MF Regulations.6
1.2 Structure of IDF Scheme
An IDF Scheme can be either floated as a close-ended scheme with a minimum five year maturity period or as an open-ended scheme with a lock-in period of five years with “interval periods” of less than a month. Units issued to investors under any of these schemes are required to be listed on a recognized stock exchange. The IDF Scheme must have a commitment of minimum INR 250 million from a minimum of five “strategic investors.”7 Each “strategic investor” is required to contribute a minimum of INR 10 million with no one holding more than 50% of the net assets of the IDF Scheme. Each unit issued must be of a minimum INR 1 million and can be partly paid at the time of issuance. The partly paid units can only be listed after being fully paid on subsequent capital calls.
Although mutual funds are supposed to mobilize participation from the general public, in light of the minimum investment size prescribed for each investor, it seems that IDFs would primarily cater to High Net-worth Individuals (“HNIs”). The structure notified under the MF Regulations looks similar to a private equity investment model with peculiarities like minimum investment limit and issuance of partly paid units to investors. For better monitoring SEBI has recently come out with draft SEBI (Alternative Investment Funds) Regulations, 2011, proposing to making it mandatory for all private pools of capital including debt funds and infrastructure equity funds to register with it. Keeping up with this trend, SEBI has tried to create a dedicated regime for debt funding of infrastructure sector through the inclusion of IDFs under the tighter mutual funds regulatory framework.
1.3 Permissible Investments
The MF Regulations mandate for investment of at least 90% of the net assets of the IDF Scheme in debt securities or securitized debt instruments of infrastructure companies. They can also invest in projects or special purpose vehicles that are specifically created for the purpose of facilitating or promoting investment in the infrastructure sector. SEBI has also allowed IDFs-MF to refinance bank loans for existing and revenue generating infrastructure projects. Till date, banks have been the main source of funding for these projects, but were unable to provide long-term funding given their asset-liability mismatch. Through refinancing of bank loans an equivalent volume of funds would be released for fresh lending to infrastructure projects. As a result, there would be a two-fold flow of funds for infrastructure development, one through the IDFs and other through banks.
The remaining 10% of net assets of IDFs are permitted to be invested in equity shares, convertibles including mezzanine financing instruments of both stock listed and unlisted companies engaged in infrastructure or related infrastructure development projects. Further, there is a cap of 30% of the net assets for investment in debt securities or assets of any single infrastructure company or project or bank loan given in respect of completed and revenue generating infrastructure projects. However, this limit can extend to 50% upon
approval by board of trustees and the asset management company of the scheme. IDFs can invest up to a maximum of 25% of their net asset in listed securities of the “sponsor” or his associate/group company. Such investments are subject to a prior approval from trustees and a complete disclosure to investors in this regard.
1.4 Taxation of IDFs and valuation of their assets
Section 10(23D) of Income Tax Act, 1961 (“IT Act”) provides for income tax exemption to SEBI registered mutual funds. Within the provisions of MF Regulations, IDFs are required to be set up as mutual funds and compulsorily register with SEBI. Thus, all incomes accruing to the IDF-MFs will be exempted from income tax. Furthermore, Section 10(35) of the IT Act also extends a similar exemption from income tax to all incomes received in respect of units of a SEBI registered mutual fund. Thus, investors of an IDF Scheme will also be able to claim income tax exemption for returns received in respect of units held by them.
MF Regulations mandate for a valuation “in good faith” by the asset management company of all the assets held by the IDF. This has to be done in conformity with the valuation principles approved by the trustees. The same is to be calculated and declared at least once in 90 days. Such frequent valuation seems to be onerous and will add to the administrative cost and expenses of the IDF.
1.5 Disclosures in offer document and transaction by employees
On the lines of SEBI‟s mandate to protect the interest of investors, MF Regulations prescribe that the offer document of an IDF Scheme shall contain adequate disclosures to equip investors for making an informed investment decision. These regulations also make it mandatory for the employees/directors of the asset management company or the trustee company to make a disclosure of any transactions done with the investee companies within one month of completion of the transaction to the compliance officer.8 The post transaction one month long time period for disclosure is in line with a similar provision in case of real estate mutual fund scheme.9 The compliance officer is thereafter required to give a reasoned report to the trustees of the IDFs-MF on probable conflict of interest issues. Though the MF Regulations provide for a post-transaction disclosure, in our opinion, it is essential to make it mandatory for the interested director/employee to report to the compliance officer before the transaction is consummated, so that all conflict of interest issues can be discussed and addressed before hand.
2.0 RBI Guidelines on IDFs
Any investments by banks and NBFCs in IDF Schemes will require a prior approval from the RBI. The RBI Guidelines prescribe various thresholds for investment in trust based IDFs by banks and NBFCs. Banks acting as sponsors to IDFs-MF will be subject to
existing prudential limits on investments in financial services companies and their capital market exposure while NBFCs will need to have at least $60 million as net-owned funds. Moreover, NBFCs are also required to be in existence for five years to invest in IDFs-MF, meaning thereby that start-up NBFCs would not be able to invest in trust based IDFs. Though detailed guidelines for IDFs-NBFC are still awaited, some of the key features enumerating from Finance Ministry‟s Press Release and RBI Guidelines are:
- IDFs setting up as NBFC must have net-owned-funds of at least $60 million and issue rupee or dollar denominated bonds of minimum 5 year maturity to investors;
- They should be assigned a minimum credit rating „A‟ or equivalent of CRISIL, FITCH, etc.;
- They are only allowed to invest in Public Private Partnership (“PPP”) projects and post-commercial operation date (“COD”) infrastructure projects. Such projects should have been in satisfactory commercial operation for at least one year before any investment is made in them. They should also be party to a tripartite agreement with the concessionaire and the project authority for ensuring a compulsory buyout with termination payment. Normally, PPP projects have high risk associated with them. Once construction is complete it would substantially come down, improving the credit rating and ensuring long term debts from investors;
- Income of IDFs-NBFC will be exempted from income tax and withholding tax on interest payments on the borrowings has been reduced from 20% to 5%;10
- Potential investors would mainly include off-shore and domestic institutional investors, off-shore HNIs and NRIs. Insurance and Pension Funds are one of the key investors as they have long term resources, but would require regulatory approval before investing in IDFs. As per the current norms of Insurance Regulatory and Development Authority (“IRDA”), it is mandatory for insurance companies to direct 15% of their investment towards infrastructure.11 Moreover investment limits of Foreign institutional investors (“FIIs”) for corporate bonds issued by infrastructure companies has been recently increased to $25 billion12 and investment limits in IDFs needs to be correspondingly changed to augment overseas fund flow.
India‟s Planning Commission has projected an investment of approximately INR 45 trillion for infrastructure development during the 12th Five Year Plan (2012-17). The proposed IDF regime would certainly be instrumental in mobilizing capital to meet this aspiring budget and deficits in the infrastructure sector. The government along with the regulators also aspires to accelerate the evolution of secondary market for both debts and bonds with the creation of institution of IDF. This garners much more prominence in the wake of the current upward interest rate regime in the country and considering that banks are also approaching their exposure limits. From the perspective of an investor, making investment in IDFs is a lucrative option as it would assure long term benefits and would guard to an extent against market sensitivities.
SEBI seems to have taken a short cut by establishing the institution of IDF within the current framework of mutual funds, and not establishing a separate and dedicated regime. However, it would ensure investors of tax benefits along with professional management and good governance of their capital. At the same time, it is imperative that RBI also comes out with detailed guidelines at the earliest, providing with definite contours for establishment of IDFs under the corporate route.
1 As per Para 144, Part B, Speech of Finance Minister, Budget 2011-2012
2 Vide SEBI (Mutual Funds) (Amendment) Regulations, 2011 dated August 30, 2011
3 RBI Press Release: 2011-2012/461 dated September 23, 2011
4 “Sponsor” means any person who alone or in combination with other body corporate establishes a mutual fund.
5 Parent company of the sponsor means a company which holds at least 75% of paid up equity share capital of the sponsor
6 “Sponsor” must (a) be carrying on business in financial services for a period of at least 5 years, (b) have positive net worth in all the immediately five years, (c) have profits in three out of the immediately preceding three years after providing for depreciation, interest and tax, (d) contribute 40% to the net worth of the asset
management company, etc. An applicant is further required to appoint trustees, an asset management company and custodian to the mutual funds before a certificate of registration can be granted
7 Either an infrastructure finance company registered with the RBI as a NBFC or a scheduled commercial bank or an international multinational financial institution
8 Compliance Officer of a mutual fund is responsible to monitor and report compliance to all acts, rules, regulations etc. issued by SEBI or central government. He is also responsible to redress investors‟ grievances
9 See regulation 49(k) of MF Regulations
10 Supra n. 1 read with section 195 of IT Act
11 See regulation 3 of IRDA (Investment) Regulations, 2000
12See Finance Ministry, Press Release, September 12, 2011 available on http://www.finmin.nic.in/press_room/2011/FII_corporate_dept.pdf