Undesirable shake-up

Yet another Infrastructure Leasing and Financial Services Ltd (IL&FS) related episode has rocked the mutual fund industry and investors. Investments, perceptibly considered ring-fenced from the stress of the ultimate parent company — the IL&FS group — have been thrown open to uncharted legal and structural risks, that now carry far reaching implications not only for Indian debt markets but also for long-term infrastructure financing. Special purpose vehicles (SPVs) of IL&FS that up until now appeared to be sheltered from the credit risks of the sponsor or the ultimate parent company, have been exposed to unfamiliar default risks. CRISIL downgraded the bonds issued by one of IL&FS’ SPVs, Jharkhand Road Projects Implementation Company (JRPICL) to junk status, as it defaulted on its payment due on January 21, despite adequate funds in its escrow account. ICRA downgraded six mutual funds having exposure to JRPICL and other IL&FS’ SPVs that could also follow suit and default.

At the heart of the problem lies the SPV management’s decision to withhold payment of regular dues, citing the NCLAT’s stay order issued on October 15, 2018, that was aimed at ensuring a smooth formation of a resolution plan following the crisis at IL&FS group. The six-page order among other things imposes a stay on “other financial facilities or obligations availed by ‘IL&FS’ and its 348 group companies in respect of the principal or interest”. Do SPVs of IL&FS fall under the ambit of the 348 group companies stated in the order? This is open to interpretation, but the management for now appears to have conveniently extended the NCLAT’s moratorium to regular debt payments too, despite having adequate funds. According to CRISIL, the defaulted JRPICL has enough funds to comfortably service its dues; as on December 31, 2018, the company had surplus funds of ₹345 crore which is around 4.5 times the quarterly debt obligation of ₹76 crore.

This raises several concerns. One, annuities of SPVs flow into trustee-controlled escrow accounts, which, along with a waterfall mechanism, protect the SPV’s cash flows from stress at the sponsor level. The actions of IL&FS’ SPV raises concerns on the sanctity of the hitherto ring-fenced SPVs and the payment waterfall structure. This could have overarching implications on similar structures such as securitised debt that could spawn unwarranted credit risks for lenders. Two, long-term financing of the infrastructure sector could suffer a huge setback, as monetising good operational assets would become extremely challenging, if other similar structures failed to adhere to conventions. Precedence of profitable and cash-rich SPVs defaulting can send lenders running for cover and lead to larger systemic risk for India debt markets. Above all, for mutual fund investors having exposure to such SPVs and other similar structures, weeding out risks would be impossible, as unveiling the ultimate parent company behind the intricate web of such complex structures would be no mean task. The NCLAT’s ruling will be critical here.

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