As the focus continues to be on additional steps to provide further impetus to the Indian economy, the microstructure of the financial markets assumes significance. From a financial market perspective, the focus must now be on “structures, security design, and market access”. Mainly, further accelerating capital flow must be the prime objective.
“Structures” refers to financial vehicles that provide and improve capital access to businesses. Real Estate Investment Trusts (REITs) and Asset Reconstruction Companies (ARCs) are very significant moves. Now is the time to expand the theme of aggregation vehicles across the spectrum to a wide variety of assets such as natural gas pipelines, transmission assets, large-scale container businesses etc. REITs and ARCs at a fundamental level, allow the operator and creator of assets to access capital providers. When successful, both sides benefit immensely: operators through access to low cost and ample funding while the investors get access to assets through which to earn returns. India should now look at structures like REITs across capital expenditure heavy sectors. There is virtual unanimity on the scale of investment that India requires. Hence, structures that can facilitate the flow of capital by clear demarcation between the roles of the various stakeholders is much needed.
However, for structures to succeed in the long-run, the government must be cognizant of “security design” needs. “Security-design” refers to the financial instruments that allow capital to be invested in investment opportunities. The one key lesson from the credit issues that have plagued the credit sector in India is that standard financial securities such as bonds, loans and equities haven’t been able to create the transparency required for effective implementation of projects and corporate governance standards.
Indian regulators, investors and project developers need to seriously think about creating standardised new securities that can align the incentives of the various parties involved, especially with a view towards immense clarity regarding the cash flow profiles at both corporate and project levels. For India to generate the next phase of growth, “transparency of cash flows” will be a vital component, if not the most important one.
Therefore, when designing the standardised structures under reference or vehicles of investments, significant attention is needed towards creating the “securities” that will allow ownership of the “structures”. The non-alignment of the incentives of the equity and debt holders, especially with a view on the cash flow profiles has been one of the most significant factors of an exacerbated credit issue within the Indian credit spectrum.
Additionally, beyond structures and security design, market access needs to be improved for Indian investments. Improving market access involves broadly two components: Greater global participation in Indian markets and market makers to warehouse risk and provide liquidity. Both parts go hand in hand towards creating markets with great depth and liquidity, thereby providing the much-needed price discovery.
The recent talk about including Indian bonds in global benchmark indices is what will precisely lead to greater market access. Inclusion of Indian sovereign debt in global benchmark indices will imply considerably more capital in Indian bonds, thereby generating liquidity and hence allowing greater participation by both investors and market makers. Higher liquidity in sovereign debt curve across the term structure entails a deep and liquid benchmark curve of which to price corporate credit.
As mentioned above, the liquidity provision will require more participation of market makers in India to warehouse risk and provide liquidity. More significant liquidity provision isn’t limited to just bond trading desks but includes any asset that might utilise structures mentioned above. Such market-making businesses will provide market liquidity and, most importantly, price transparency. But, for such market-making enterprises to be successful, stable policy regimes will be a must.
A quick look at the sectors much affected by credit constraints such as real estate, or thermal power indicates that the problems emanate from two core issues, namely, of corporate governance and most critically over-investment due to a lack of price discovery. A market that can signal low returns within a short time or indicate over-investment in certain areas will assist follow-on investors, both in the equity and credit space, make much more informed decisions.
Effective “structures, security design and market access” will allow the ecosystem in India to signal any impending issues. Essentially, reducing the time lag between sectors getting overheated or unattractive and investors gauging the same is dependent in no small extent on frameworks that allow expedited information delivery. As we move forward, robust structures that generate information with alacrity are the need of the hour.
(The views expressed in this article are personal and that of the author. The author heads Development Tracks, an infrastructure advisory firm. You can contact him at [email protected] or @Taponeel on Twitter)