A clean house

A year ago, Masala bonds – rupee-denominated debt sold to offshore investors – were the new kids on the block. With the support of both prime minister Narendra Modi and the notoriously conservative Reserve Bank of India, the country’s central bank, they were being touted as a potential saviour of the economy; drivers of future growth.

Although issuance was by no means huge – it was never in danger of hitting the heights of the Panda bond market, for example – it was at least steady. And at the start of the year, boosted by a rebound in the value of the rupee against the US dollar, there was real movement in the market. By the end of April, India’s largest Indian power company NTPC, Housing Development Finance Corp, National Highways Authority of India and Mahindra Finance were all in the market.

Indeed, many eyes were on NTPC. In 2016, it had priced Rs20bn (US$312m) of five-year bonds at 7.48%. Upsized, the paper priced at the tight end of guidance, inside NTPC’s onshore curve and an eye-popping 20bp inside the Reuters Triple A five-year benchmark for Indian government bonds.

This year, it returned with another Rs20bn five-year trade, this time at 7.28%. Again, this was significantly inside its onshore paper and more than makes up for the structure’s 5% withholding tax which has to be carried by the issuer.

As Joywin Mathew, legal director at DLA Piper noted: “The advent of Masala bonds may herald a new phase in investor appetite to participate in one of the world’s fastest growing economies.”

But then the legislation changed, which slammed the brakes on the market. In the summer, the regulators changed the playing field completely.

“The deal pipeline in May was more positive in the market than I had seen for years since the advent of Masala bonds,” said Vicky Muenzer-Jones, debt capital markets partner at Norton Rose Fulbright in Singapore. “A few people had warned that something might happen, as the regulators had never apparently decided how to categorise Masala bonds,” she added, explaining that the markets were pretty much blindsided by the new regulations.

It was a two-pronged attack by the regulators. In June, the RBI added new rules into the mix. It bumped up the minimum tenor of Masala bonds from three years to five. It also put a cap on any coupon that could be offered – at 300bp over equivalent government bonds.

The move instantly shut out a significant number of names from any potential issuance and to all intents and purposes closed the market to anything other than the highest quality names.

“Based on the US dollar curve, the 300bp margin suggests that the RBI only wants names that are Double B and above,” explained one leading Indian DCM banker. “Issuers want a shorter tenor; the hedging options are deeper at the shorter end of the curve.”

Wall of silence

It is a mark of how unsettling these changes have been, as well as the Indian government’s sensitivity to criticism, that bankers have been universally unwilling to talk on the record about what has happened.

But there was more to come. The next blow to the market came at the end of July, when the Securities and Exchange Board of India, the Indian financial regulator, effectively closed both the market and the pipeline down.

All rupee-denominated debt, both Masala and domestic, is categorised by the regulators in the same way and there is a foreign ownership cap of Rs2.4trn to maintain currency stability. SEBI ruled that when foreign investment hit 95% of that limit, foreign investors would have to bid for remaining capacity, and more to the point, all foreign investment in rupee-denominated debt would have to stop until capacity fell below 92%.

“It appears that SEBI panicked,” said Norton Rose’s Muenzer-Jones. “There was a significant increase in foreign ownership of rupee-denominated bonds, but we are not talking about billions of bonds. The line in the sand appeared to be that you can’t have this amount of corporate debt outside India.”

But Indian regulation famously resembles an iceberg. The thinking behind the legislation is always as important as what is actually said, and that lies hidden under water. And what happens in practice is not always the same as the theory.

It helps to understand what it was that drove the changes to Masala bonds. In short, prime minister Modi wants a clean house, which is why he has brought in checks and balances. And to do that, he is clearly happy to sacrifice growth for cleanliness. Of greatest concern were private Masala deals, with unlisted private companies subscribed to by unknown entities.

“There was a worry that the Masala bond market was fuelling money that could not be traced. SEBI and the RBI both have an unofficial security advisory role from the ministries, which were getting reports about Masala deals,” explained the head of India investment banking and capital markets for one of the major international banks based in Mumbai. “The overarching objective from the RBI was to kill corruption and to make sure that there was no dirty money – and this objective goes beyond helping the capital markets.”

Use of proceeds

There were security concerns about Masala money potentially being used to fund ongoing conflict in Kashmir, as well as funding global terrorist organisations. The government was also unhappy about the structure being used by parent companies to lend to their subsidiaries.

The government’s broader aims appear to be working, certainly if you look at what type of issuance there has been.

Last year, for example, saw Rp98bn issuance, according to Standard Chartered, with Rp35bn issuance in the public market and Rp63bn in the private market. This year, until the end of August, although volumes are similar, the public/private ratio has been reversed. The markets have seen Rp95bn issuance, with a hefty Rp83bn in the public market.

Despite all of the legalistic brouhahah, the structure of Masala bonds themselves have not been brought into question. The majority of those that have been issued to date have performed well in the secondary market, with a cash price of around 102. At the start of September, the NTPC five-year was trading at 102.22–102.66, while HDFC’s three year was at 100.56–100.89.

Indeed, it is significant to note that there is a secondary market. Investment management company BlackRock and other emerging market funds are fairly active, with bids appearing on a regular basis. It is, of course, not comparable with the US dollar secondary market, but these are encouraging signs.

Nor is it true to say that issuance has been shut down altogether. When deals are Reg S or 144A, then they can generally go ahead. The regulator is clearly accommodative towards the more open and widely distributed public trades.

At the beginning of August, for example, Export-Import Bank of Korea sold Rs3.2bn of four year Green Masala bonds at 6.20%, in the 144A/Reg S format. And at the time of writing, there are a couple of issues in the market. The Indian Renewable Energy Development Agency is expected to issue a Green Masala by the end of the month, and several bankers talk of another private deal that is currently being touted.

If there is a genuine frustration, it is that the regulations have discouraged anyone other than the highest grade of issuer to come to market.

“What is disappointing is that investors have not migrated down the credit curve,” said one of the bankers. A couple more issuers are likely before the year-end, though they are all Triple A names.

And this is where the market is at the moment. Is there a host of new issuers scrabbling at the door? No. The Masala bond market is merely marking time. For the foreseeable future, it is going to be a case of vanilla, high-grade issuance from familiar issuers in sectors such as renewables and toll roads, as well as agencies.