Tuesday, 16 October 2018

IFR India Offshore Financing Roundtable 2016: Part 2

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IFR: On a technical question around execution, especially around issues that have fallen on debut, the questions that it raised in my mind is underwriters in India don’t have many tools to deal with that situation and in some respects are hostage to fortune.

Globally underwriters have things like over-allotment options and there are all sorts of mechanisms and mechanics at play to deal with stabilisation. Would you like to have more stabilisation tools at your disposal as an underwriter executing transactions in India?

Sumit Jalan, Credit Suisse: That’s a good question. Practically-speaking, the framework of the Indian market is a different to the Western world; as are the economics for intermediaries. IPO pricing is very consensus-driven and there’s a concerted effort in the context of getting the pricing right. There’s feedback from investors, feedback from intermediaries, and the principals make their call.

Outside of communication via this feedback process and the advice underwriters give, we in India have not seen things like greenshoe options, which exist in certain markets, take off at all. Is there a desire? Yes; it certainly helps. If there is inventory, it does help intermediaries but it’s a broader debate. Underlying economics also need to work and that’s where the fabric of the market in India is very different from the Western world.

IFR: I wanted to talk about State sell-downs a bit later but I wanted to move now to the debt side and to Jayen. We’ve seen a surge of interest in the Indian debt markets given new ECB regulations and the Masala bond phenomenon has come onto the scene. Is this hype or is this actually going to result in real activity?

Jayen Shah, IDFC Bank: It is resulting in real activity. If you cast your minds back to July 2013 to October 2013, dollar/rupee went into a steep fall and was followed by a raft of measures by the Reserve Bank to arrest the fall, stabilise it and rebuild the country’s reserves.

The local debt financing markets reopened slowly and steadily. Looking back at the statistics, what kind of investors started taking longer-dated currency bets or interest-rate bets? One community that stood out were foreign institutional investors and foreign portfolio investors through their debt funds.

This was in early 2014, even before the current government took office, on the back of the rising credibility of RBI governor Raghuram Rajan across the international investor community. And by that I mean real-money managers, hedge funds, sovereign wealth funds and pension funds. We saw a steady increase in registrations at SEBI for their India-related onshore access to bond markets and a subsequent increase in inflows.

The government securities and onshore corporate bond markets started seeing a fairly reasonable inflow month-on-month, quarter-on-quarter, from the international investor community, which definitely pointed out to an opinion building that the international investor community saw long-term dollar/rupee stability as well as interest rates coming down.

Fast-forward and we see that the government securities window available to foreign investors – which was recently announced is rising to US$30bn equivalent via staggered increases – has remained almost full for the last few quarters. Whatever was made available as a limit for international investors to participate in Indian Government bonds has been filled it up. Foreign investors continue to hold that position.

That suggests their opinion on dollar/rupee being a better performer relative to other currencies or a local interest-rate curve steadily coming down. That opinion remains a positive. It leads to the next level of expansion as Indian regulators have received feedback that there are still pockets of investors or large liquidity pools that are not yet enabled to come through the FII/FPI framework.

In that context, the Masala bond fills the gap. From the borrower’s perspective, it’s no different than issuing an INR bond or a debenture except the process required is a little more rigorous and more tasks need to be completed before the borrower can issue to international investors under the Masala Bond framework.

The guidelines finally came through in September 2015. If you recollect, the IFC had been permitted by the government and RBI, to open up the surrogate INR bond market such that issuance was in dollars but was benchmarked to the prevailing dollar/INR rate. At every debt-servicing date (for interest and principle) investors are paid at the spot rate.

The Triple A rated IFC, which has successfully executed its mandate, has raised US$1.5bn or and more under that framework. It has taken all of the steps towards creating a Masala Bond market by raising money under its own banner. The performance of the bonds has been stable in the secondary market. They have access to onshore bond markets through FII/FPI regulations but to address a wide community of investor requirements, the Masala Bond is another bridge.

There is a lot of excitement, both onshore and offshore, to see how the first or second issues open the market. Like everywhere else, the opening of the market is typically done by a good quality Triple A rated onshore borrowers that could be a quasi-sovereign or government-related institution or PSU or PFI. Some of them have done roadshows and non-deal roadshows, and that has been encouraging.

Local domestic markets have also performed so at every point in time a company CFO can measure where their next US$100m, US$200m, US$500m is going to cost and what maturity buckets they can raise funding for. Masala Bonds need to dovetail with the ECB issuing guidelines as to the end-use of proceeds so in that sense it has to match up with the guidelines prescribed by the RBI’s ECB rules. But in essence the CFO will decide as to what and which markets will be efficient.

The Triple A onshore borrowing curve stands at a very small margin over the onshore government yield curve; around 20bp-40bp over above the G-Sec curve. To put that price point into perspective and measure it up to foreign investor demand when it comes to Masala issuance, another element that comes into play is the cross-currency swap curve.

Over the last few quarters the cross-currency swap curve hasn’t really moved in line with the momentum in the G-Sec market or onshore credit curves. Effectively, the spread that is left for a foreign investor is fairly slim. If today a Triple A Indian corporate is able to issue a rupee bond in significant size (up to US$400m equivalent at 8%), the cross-currency curve at around of 6.5%-7% leaves about 100bp-120bp as a credit spread.

Now, this is tighter than a BBB minus typical bond will yield to a foreign investor. So this is still a dimension that needs to be solved for. But other than that pricing dimension, which is a good from a CFO’s perspective, this is a good thing to solve for rather than being dependent on the international markets.

To sum up, excitement is there, both onshore and offshore. It opens up a bigger flow of money to come to India. Keeping aside the pricing dimension on a day-to-day basis, it opens up a much wider pool of investors so the opportunity for international investors to come to India or Indian issuers to raise money is helping the globalisation of Indian financial markets.

Fast-forward to post-issue with regards to secondary market performance, we’ll get a measure as to how the domestic markets are performing, how international markets are performing for the same issuer. And that will always help the CFO in his longer financing plan.

One key thing that all of us just spoke about is when the capex or investment cycle picks up in India. When that happens, the bridges that have been created and are bringing money into the country will help in a big way in bringing in much-needed debt capital to finance long-term asset building in the country.

IFR: Marco: what’s in the Masala bond theme for you? As of end-November, there are eight or nine issuers in the hard pipeline, plus there’s a soft pipeline of similar size of even bigger. This is potentially rich pickings for international stock exchanges.

Marco Estermann, SIX Swiss Exchange: That’s exactly the question, Keith. We have seen Indian issuers coming to the Swiss franc market profiting from interest rates of close to zero able to raise Swiss franc debt with coupons of 2.75% to 3.25%, which even including the cross-currency swap rates back into US dollars or rupees has still been attractive to Indian issuers.

In the past, we have seen Indian issuers tapping the US dollar or Singapore dollar markets. Masala bonds open up a new opportunity for overseas investors. And as an exchange, we are waiting for feedback from some of these Masala bonds being roadshowed in Europe.

Investors will look at these bonds, pricing in the hedge costs or the cross-currency swap rates and we will see whether this is still interesting for a broader universe of Indian issuers to get into these markets. If we do see interest from investors to take on the risk and hedge costs themselves, it could be very interesting for Indian issuers to tap into this broader investor base and to tap into new asset pools that are outside the domestic markets.

We are certainly there as an exchange to take on that demand and help issuers tap Swiss investors, raising rupees also in the Swiss market.

IFR: Bharat, we’ve talked about the pricing aspects and the wait-and-see attitude. I’m curious to understand your perspective on the preparedness of Indian issuers to tap this market, bearing in mind that we have a lot of Triple A parastatals in the pipeline.

Do you think that Masala bonds could be an interesting route for mid-market Indian corporates, bearing in mind there’s no cap on all-in costs to the borrower and Indian banks maintain relatively high lending costs. Might we see a marginal bid from US high-yield investors? Could that be an avenue for issuers for whom the domestic bond market is closed?

Bharat Reddy, JP Morgan: The diversification of the investor base would open up a new source of funds, potentially at lower cost. However, the proof of the pudding is in the eating. Some very large public sector entities have publicly announced their intention to tap the Masala Bond market.

What remains to be seen is what pricing they are able to achieve, especially the first few; this is still to be tested. Once that pricing is achieved, the determinants of the growth of this market will be a little clearer as will the extent to which smaller companies will tap this market and where they would be priced.

If this market develops, it could reduce dollar issuance to a large extent. Hence corporates that borrowed in dollars and swapped into Indian rupees will now go only for rupee issuance. But we need to see how the pricing happens and take it from there.

Mangesh Kulkarni, Axis Capital: In the case of Masala Bonds, apart from the Triple A issues that are in the pipeline, I agree there is a significant niche that could open up. Promoters are looking at that mezz piece and borrowing from high-yield investors in dollar-equivalent rates of 13%-plus area, which with hedging leads to an all-in cost of about 20%.

For most of these guys, they depend upon on their own treasury to manage or hedge. Rupee offerings at these levels, even in the absence of dollar earnings, would make immense sense for them in terms of the overall risk cost perspective.

Investors in these mezz pieces can use the Singapore NDF route to hedge. That can help reduce the cost. So although this is not what Masala bonds are supposed to achieve, that actually would help bridge a significant gap for financings, including some of the infra projects which are getting stuck.

Typically there is always an expectation that a year hence equity valuations will be significantly higher so to bridge that, for promoters willing to pay that higher cost, I think that opportunity or that window would get addressed by this.

IFR: Manan, from a framework perspective, are you comfortable with what the government actually issued so far in terms of rules of the game?

Manan Lahoty, Luthra & Luthra: If you think about the Masala Bond regulations and the development process, it’s one of the most significant developments in the capital markets space in India in recent times. Go back as many years as you like; the RBI has always discouraged Indian companies from borrowing outside India. Over the years RBI has looked at how much capital is being raised, the size of FX reserves and whether the rupee is appreciating or depreciating. On that basis, RBI would allow borrowings from foreign lenders, particularly for short tenures.

So RBI has always been mindful about allowing any Indian company in any sector to go the ECB route. Where we are now with the Masala Bond rules is a significant departure. RBI always looked at a number of key things at the policy level.

Who can borrow? What is the cost of borrowing? What is the use of proceeds? What security are you providing? Is it hedged; all those sorts of things. With the Masala Bond rules, the RBI has essentially stepped back a little, in part because of the success of the IFC issuance but also because of the Sahoo Committee Report, which essentially told RBI that all it needed to worry about essentially is the risk of market failure and that is linked to whether an issuer that takes out a foreign loan is hedging the currency risk or not.

The RBI realises that with a Masala bond, borrowers need not worry about hedging, as the currency risk is passed on to investors. So RBI has issued a significantly simple and liberalised regulations. For example, an Indian company can now borrow using Masala bonds and price it at any level, so no cap of Libor plus 350bp, Libor plus 500bp as with foreign currency ECB. And borrowers can, broadly speaking, use the proceeds for any purpose (excluding a short list of few proscribed items).

These are significant departures from what we are used to seeing insofar as Indian borrowing from offshore. It’s a significant change from a regulatory and policy perspective.

Tarun Gupta, T&A Consulting: If you look globally, we’ve had similar cases in other emerging economies that have been successes and failures. In the case of Dim Sum bonds denominated in RMB, it was a success whereas in the case of the international Philippine peso bonds, it was not so successful.

In the Indian context, there’s a big government push behind this initiative at the moment and as my co-panellists have mentioned, it’s the public sector quasi-sovereign names that are driving it initially.

The question is: might they be open to paying premium pricing to tap into the international investor bid? There’s such a big thrust at the moment to take this route. Whether that translates into the mid-market names remains to be seen and will need to be tested but it’s a fantastic instrument. There’s potentially bigger demand out there. And as Mangesh mentioned, some of these infra projects are big, capital-hungry projects. Whether this will translate into the infra space I’m not sure.

IFR: If Masala Bonds do pick up, what changes might that have on the domestic market? Could the domestic market be left behind in that we might see issuers actually issuing outside of India in favour of instead of issuing in India?

Jayen Shah, IDFC Bank: There will always be parts of the market open for large domestic investors. But assuming over a period of time Masala Bonds do pick up and there is a liquid market, domestic investors could be left with two options in the onshore market: go down the credit curve or go long, as in beyond the 10-year, 12-year, 15-year points on the curve.

But I would guess domestic investors would lobby the regulators to allow them to invest in Masala Bonds as well, but that’s Blue Sky thinking. Giving corporates and institutions free access to onshore/offshore markets without having to go to RBI for approvals is a potential precursor of full capital account liberalisation in an indirect format.

In summary, offshore markets will help determine certain credit spread parameters and this will definitely help borrowers. Local investors will have to adjust to this new paradigm but that’s still some years away.

Mangesh Kulkarni, Axis Capital: At the end of the day, it’s the issuer who will benefit. The classic Indian credit market was dominated by banks. If you look at what has happened in the last three to five years, a portion of the loan market has been replaced by the bond market. We have a mutual fund industry that holds about INR7trn to INR8trn (US$100bn-$120bn) in the form of bonds. If this option was not available, demand for bank credit would have been higher and it would have been priced slightly higher. So in the process what has happened in the overall cost structure, the issuer is benefiting.

Masala Bond are opening a new avenue. But domestic banks are smart and will adjust their spreads. In the end, it’s the end-customer, the issuer who is benefiting and which in turn will help the economy to grow.

IFR: When you say the domestic banks will adjust their spreads, you mean they’ll become cheaper?

Mangesh Kulkarni, Axis Capital: They will have to be. There are competitive pressures. If you look at domestic bonds, typically, because of the availability of mutual funds as an option, spreads have come down. As Jayen mentioned, top Indian borrowers are borrowing at 20bp-30bp over the sovereign. There is a demand for that; issuers are getting better and cheaper pricing.


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