IFR India Offshore Financing Roundtable 2016: Part 1

IFR: Welcome to IFR’s latest India Offshore Financing Roundtable. In our discussion, we’ll review ECM activity to-date, including IPOs, and contrast 2015 deal flow with expectations set a year ago. The financing landscape in India is changing so we’ll also touch on the changing External Commercial Borrowing regime. I wanted in particular to gauge the panel’s thoughts about the development of the Masala Bond market.

But let’s start with ECM. At the end of 2014, expectations for the following year were very high. A year later, while we’ve seen some notable IPOs, it’s fair to say that reactions to the deals that have emerged have been mixed. Some issues have popped on debut while others have fallen quite heavily in aftermarket trading. In terms of investor take-up, some have been subscribed by foreign buyers; others by domestic investors. Sumit: can you review ECM activity in India in 2015, with a focus on IPOs?

Sumit Jalan, Credit Suisse: The most critical aspect of equity capital markets activity has been that recent issuance has been linked to the real economy and to how fast the real economy is growing. Beyond that it’s been more a question of momentum. There are investors who are interested in a particular sector or in a particular stock and they’re happy to buy those stocks or those particular sectors.

Because of the current government’s mandate, which is unprecedented, what we’ve seen over the last one and a half years is a lot of expectations from all sides of the investing world, both offshore and onshore, so I would say relatively quicker money flew into the country, hence the interest.

But the real economy takes time to move and that’s where the dichotomy between the financial economy and the real economy started expanding that much more. The primary capital requirement of Indian corporates has not been high because growth had to pick up first. When we’ve seen ECM activity, it’s either been related to balance sheet repair or it’s been secondary exits from private equity rather than money going into companies and towards building the nation.

So that’s one part. My personal view remains that interest in India, irrespective of moods and sentiments, remains high. India is one of the few countries, globally-speaking, which still has potential and have been delivering secular growth. You can shave off some percentage points or basis points here or there but the story is largely intact and investor interest remains.

Now to your question on the IPO side particularly, some of the listings may not have performed as well in the context of after-market performance. That is driven more by the valuations achieved and how the stock stories were sold and not necessarily whether investor interest seen in certain stocks at the time of IPO and which led to good levels of subscription waned three days after the IPO.

What tends to happen is the first real number investors get to see after the listing is the announcement of the quarterly results, and there are adjustments around that in terms of growth expectations. We do occasionally see that immediately after listing we see some churn by initial investors. It’s been a mixed bag so far in the Indian context. There have been a few stellar performances post-listing and there have been enough under-performances too. I wouldn’t read too much of a pattern just yet in IPOs on the level of interest in the context of their performance.

Investor interest remains robust but investors have become a bit more discerning in the context of what kind of paper has been hitting the market so there has been some differentiation between the chaff and the grain. Not every issue will experience the same level of excitement, but in general, interest within the ECM broader category, as well as IPOs, remains high.

IFR: Bharat, my point was exactly that; that it’s hard to discern a pattern in terms of performance of ECM transactions. One of the things that certainly strikes me is that we have a situation where not all of investor constituencies have been playing at the same time; it’s either foreigners or it’s local high net worth or retail. What should we read into that?

Bharat Reddy, JP Morgan: I agree with what Sumit said, that international investor interest, especially on the institutional side, is high vis-a-vis Indian companies and Indian stocks. In a global scenario where you have low interest rates, emerging market equities are clearly the way to go. And if we look at the classical BRICS complex, India seems to be a shining star.

For retail investors it’s a slightly different story. It does come down, as Sumit pointed out, to a question of valuation and specifically in IPOs, whether a promoter is willing to leave money on the table or whether the banks that are advising them are equally inclined to price something conservatively or aggressively.

Retail investors in India have traditionally been, for want of a better phrase, a little spoiled. Before SEBI, there used to be an institution called, The Controller of Capital Issues. Essentially, the government used to set the price and on listing, you used to get an almost guaranteed upward appreciation of a very significant percentage.

Those days are far behind us now and what we are seeing more and more is that retail investors have been burned on occasion and are hesitant to come back into the market directly. You’ll find them being much more prudent in terms of deploying their money and prefer to use intermediaries rather than invest directly in the stock market.

IFR: Marco, let me come to you. When you go to meetings, how do you gauge the level of interest among Indian companies in looking at international listings or getting shares sold to international investors? Has that changed over the course of the past year?

Marco Estermann, SIX Swiss Exchange: We have been coming here for the last two and a half years. When we first started coming here, it was much harder because the Indian economy had stalled; nobody really wanted to invest and companies were not running at full capacity. When Prime Minister Modi took power, there was a lot of enthusiasm and optimism; and people wanted to move forward. They were looking to expand and raise their levels of capacity utilisation.

As Sumit mentioned, there has been some realism coming back into the economy. People are a bit more cautious. Prime Minister Modi has not necessarily achieved everything he has laid out and delivered everything people were hoping for so expectations have become a bit more realistic when they were exaggerated when he took office last year. That said, there is a lot of optimism within the corporate sector even though I believe on the real economy side the pick-up still needs to happen.

Companies have not yet reached [optimal] capacity utilisation levels, so capex has not started to play into the story so the requirement for capital is not what we expected to happen a year and a half ago. Nevertheless, the interest in SIX Swiss Exchange and a potential overseas listing is here. Companies are very much interested in diversifying their investor base, looking at different markets to raise capital.

With PM Modi’s visit to the UK, Masala Bonds have come into perspective, and I think Indian corporates have also become more international on a general level. They’re expanding their businesses globally and therefore, they’re also looking to tap into international investor classes and to raise capital overseas.

IFR: Tarun, we’ve touched on valuations, we’ve talked about the cyclical factors at play in the economy. When do we get to the point where we start to move into this capex cycle? When is that going to be and how long will it take to unfold in terms of synching it with the capital-raising cycle?

Tarun Gupta, T&A Consulting: When we were sitting here last year, everybody expected the capex cycle to revive in the third quarter of 2015. But having spoken to several companies and banks, there’s a fair degree of expectation that the cycle will revive towards the second quarter of 2016. You’re already seeing some signs: diesel consumption is moving up and the Eastern part of the country is showing higher rates of consumption.

Some positive indicators are coming in and the new Pay Commission will revive demand for cars and consumer goods. And then hopefully the clearing of the logjam of projects in the national highways will again create demand for steel, cement etc. Those factors are positive.

But I have a fundamental view on the overall capital-raising cycle. As an economy we’ve grown from US$1trn economy to a US$2trn economy. If we are to achieve our vision of being a US$10trn economy by 2030, we need to tap into different pools of capital. It’s not a question of only foreign portfolio investors; it’s not a question of only one pool in particular; it’s about investor diversification as well as geographical diversification.

IFR: Manan, let’s say we get the cycle; we get the capital requirement and the capital demand from the investor side be they here or internationally. One of the key talking points has been the accompanying cycle of deregulation, making it easier for corporates to raise capital, freeing them from the shackles that have been in play.

Last year’s Sahoo Report around Depositary Receipts hasn’t led to an explosion of activity. How long does it take for new regulations or new regimes to bed themselves in to the extent that they actually facilitate broader capital markets access?

Manan Lahoty, Luthra & Luthra: Let’s just take a step back. The DR construct is actually a super-structure with five very different fundamental laws and regulators who come into play. There’s companies law, there is securities law, there’s exchange control law, which is, of course, something that the RBI is looking at. There is the money laundering aspect to it and there is the taxation aspect; so five very important and sensitive areas of law coming together to make this happen.

The DR scheme that came in last year is very different from the one we used to have. There are obviously going to be some grey areas as to how to interpret a particular provision, who’s going to regulate and who’s going to come out with regulation. There is still that lack of clarity in the minds of the regulator as to who’s responsible for what.

The [DR] regulation itself is just four pages long; it’s crisp and well drafted. Apart from the headline regulations having being issued, RBI has taken steps to clarify some of the important aspects. From SEBI’s perspective, it think it has less to do with DRs from Indian companies; they’re not Indian securities although SEBI regulates some of the intermediaries involved.

What perhaps has to happen is for all the entities responsible for these five important aspects of law to come together in one room and understand who has to do what for it to actually take birth. The DR scheme hasn’t been born yet although there’s a lot of interest.

Moving to ECM activity in the last 12 months, you see a couple of trends. The regulators have come out with some new products. You can now do InvITs; you can do REITs; you can list an Indian company overseas without first listing in India; headline news around Masala Bonds, of course, has just come in and there is more and more in the pipeline.

A lot of options are being explored and there’s a lot to be done but it will take time. How long it’s difficult to guess. The pattern I wanted to comment on is, if you look at Indian IPOs over the past 10-15 years, you’ve seen peaks in activity. The IPOs back in 2009 and 2010 were largely on the back of just two sectors: infrastructure and real estate.

To Sumit’s point, if you look at the last 12 months activity has come from a range of diversified sectors which have come in. You’ve got Indigo, you’ve got Coffee Day, you’ve got two banks trying to do IPOs, you’ve got a match-making company [matrimony.com] trying to do an IPO, a diagnostics company. It’s exciting to see that pattern in the sense that we’re not just riding the wave of two or three sectors.

IFR: Bharat, is the government is realistic about making DRs happen? Are corporates looking at that route?

Bharat Reddy, JP Morgan: Well, as we all know, the Finance Minister in his last budget did mention that the Sahoo Committee recommendations had been accepted by the Department of Economic Affairs, and the new DR Scheme 2014 was to be implemented. However, there are some specific issues regarding custodians, domestic depositaries and overseas depository banks which need to be addressed by SEBI and the MoF in an appropriate way.

The onus of responsibility in the guidelines for reporting is on the local custodian. The local custodian sits under the bailiwick of the local Indian regulator while the overseas depository bank does not. So the problem is that although the custodian works as an agent of the depository bank, they’re not in a position to certify what the depository bank is doing. So I think there needs to be some broad rationalisation in terms of reporting requirements, which the regulator needs to address.

Also, things like foreign ownership gaps in particular companies: if the onus of responsibility is upon the local custodian/domestic depositary to govern that, it might be a bit of a challenge so some other methodology perhaps needs to be found.

On taxation, the DR Scheme 2014 actually talks about any underlying security. It need not be an equity share; it could be a debt instrument, a mutual fund or anything else. But current income tax guidelines say that it has be a security which is listed on a domestic exchange. So then that leaves the taxation benefit: in other words, DR to DR trading goes out of the window for unlisted companies or companies which are not listed on a stock exchange domestically. And certainly not the other instruments, like mutual fund units or debt.

So I think a number of government agencies – SEBI, RBI, Ministry of Finance and not least the Department of Revenue – need to co-ordinate their activities to make the scheme operable.

IFR: Mangesh, when you take all of these factors into account, we’ve discussed four or five different themes, do you share the level of optimism of your colleagues on the panel?

Mangesh Kulkarni, Axis Capital: Yes. There’s a lot of optimism about the country and while I share the view that stock exchanges or capital markets look to the future and at growth, I don’t necessarily share the view that [issuers] have run ahead of themselves. There are expectations that companies will perform and that there will be growth and issuers have priced accordingly. The result is probably markets moving ahead when in actual practice we’ve not seen reforms happening at the ground level.

Having said that, one particular change that has happened in the last 18 months is quite a few companies whose balance sheets were impaired now looking at selling some of their non-core operating assets and putting put money back into core businesses. Once they start correcting their balance sheets, they will probably be able to raise more money. I think this is how the infra-cycle will move: you have seen a lot of infra companies selling non-core assets that they’ve diversified into. Everything is slowly falling into place and I agree that possibly over the next six, seven months we could see the real economy also moving.

IFR: So taking all of this to some sort of conclusion on the ECM side, Sumit, are you building a shadow pipeline that is bigger than this year or the same size as this year’s?

Sumit Jalan, Credit Suisse: The general sense is that the economy is looking like it’s moving into realistic acceleration mode. We are hearing that much more in conversations that have started happening on the ECM side with respect to primary fund-raising and not just around secondary exits. I’m hoping to see a lot more activity for the coming year than what we have seen so far.