Securities and Exchange Board of India has come out with a consultation paper proposing a framework for restricted return infrastructure investment trusts (InvITs) that purports to provide fixed returns to investors while capping the upside and protecting the downside.
What is restricted return InvITs?
Under the proposed framework, the sponsor of the InvIT can offer an investor a certain fixed return or dividend expectation. If the return or dividend expectation is not generated by the InvIT then the sponsor steps to make good that shortfall with its own funds. According to the consultation paper, for any deficit in return compared to the floor, the sponsor or any sponsor group entity or pre-disclosed counterparties are required to bring funds to ensure minimum return to the unitholders.
So, the downside is protected. But if the dividend expectations are exceeded then the excess will go to the sponsor. In Sebi’s words the surplus return generated by the asset is typically distributed to the sponsor or any sponsor group entity or pre-disclosed counterparties. Therefore, the upside is capped.
Why has Sebi come out with this new class of InvITs ?
Under Sebi regulations InvITs have to pay out all gains and benefits from the assets should go to the unitholders without any restrictions. However during inspections of the capital structure of the registered InvITs, the regulator found that special purpose vehicles of certain InvITs had entered into agreements with sponsors, for providing additional benefits such as sharing of excess return, or revenue of the SPVs beyond a certain threshold.
In essence, the return to unitholders was managed and restricted to certain threshold as guided by the different agreements executed by the SPVs. Such arrangements were factored in the investment decision. The regulator said that such structured transactions – where returns to unitholders are potentially structured to provide a floor or cap or a collar in respect of returns - allow unitholders to receive assured returns, albeit with a cap on the upside and protection on the downside return generated by the assets owned by the InvIT.
What are the challenges in the current regime that this new product could address?
Under current regulations the InvIT can issue junior units to the sponsor, but with the new framework they can also issue senior units, because there is prospect of an upside, since returns to unitholders beyond a certain limit will go to the sponsor. The sponsor can pump in the excess return back into the InvIT, which can then use that in case of a shortfall in distribution or the sponsor can directly compensate the unit holder.
Who are the target investors of the restricted InvITs?
In the consultation paper, Sebi has specified that such products will be for sophisticated investors. The InvIT will be privately placed with minimum asset value of ₹50,000 crore and the minimum investment lot will be ₹500 crore. There is considerable interest in InvITs from sovereign funds and global funds and they have the potential to invest in well-defined, structured products that allow for bespoke arrangements. The sponsor and investor can enter into customized, flexible arrangements according to their requirements.