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India’s First Debt ETF To Have AAA-Rated State-Run Firms

Only state-owned firms that have a rating of ‘AAA’ may raise debt through India’s first debt exchange traded fund, according to a senior government official.

Companies like Oil and Natural Gas Corp., Housing and Urban Development Corporation, Power Grid Corporation of India Ltd., Konkan Railway Corporation Ltd., among others, may be part of the debt ETF which is expected to launch in the next fiscal, the official said.

The ETF may help about thirteen AAA-rated Central Public Sector Enterprises to raise total debt of Rs 10,000 crore, the official said. The structure or the criteria of the ETF will be finalised in a month’s time, and banks will not be part of the first issue of the debt ETF, the official cited earlier said.

Debt ETFs are exchange traded funds which pool debt raised by a set of companies. Investors subscribe to units of the ETF, which trade on an exchange. Finance Minister Arun Jaitley, in Union Budget for 2018-19, announced creation of a bond ETF for public-sector companies.

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Edelweiss Asset Management Ltd. has been selected as the asset management company for the ETF.

There is a borrowing need that CPSEs have, there is need to deepen the bond, and put out good products for the retail investors to migrate them from fixed deposits to mutual funds and debt products that are limited now, said Radhika Gupta, chief executive officer of Edelweiss Asset Management Ltd. “The debt ETF bridges that gap,” Gupta told BloombergQuint.

Limited Benefits?

The debt ETF, while an innovative structure, may not do much to help the borrowing firms or the government, at least in its current form.

To a large extent, bonds of public sector companies are priced based on their government ownership rather that the individual company’s credit profile. As such the difference in borrowing costs is limited.

For instance, NTPC issued bonds maturing in 2029 at a coupon of 8.30 percent in January. A similar 10-year bond by Power Grid Corporation of India was issued at a coupon of 8.36 percent.

As such, a pooling of AAA-rated companies would not lead to any material reduction in funding costs for these firms. At a later stage, if the ETF pools companies across different rating categories, lower rated firms may benefit by a reduction in borrowing costs. In contrast, better rated firms may be at a cost disadvantage if they choose to raise funds via this route.

Also, unlike the PSU equity ETFs, there is little benefit for the government in launching debt ETFs since there are no divestment proceeds that accrue out of this.

For investors, while the debt ETF will allow for diversification, limited liquidity in the underlying bonds may be a deterrent.

The debt ETF will allow in-built diversification for investors and as it’s a new product there can be lot of liquidity on the exchange if there’s sufficient investor interest, said Neeraj Gambhir, an independent financial market analyst.

The challenge is that ETF as a product will succeed if the cash market is liquid, and ETF is a low-cost way of buying diversification, Gambhir told BloombergQuint. He said valuing the ETF will also be a challenge as it will have multiple underlying bonds, and if bond market itself isn’t liquid, there could be issues regarding valuation.

Tailoring The Product

To be sure, the government may continue to tweak the product to increase its acceptance.

The government seeks to tailor the ETF such that it attracts retail participation, the official quoted above said. He added there are discussions to not only have a specified holding period for retail investors, but also a window of redemption in case an investor wants to exit his investment during an emergency.

Also, if a company does not want to raise debt when a subsequent tranche of the ETF is issued, it would be replaced with an another firm in appropriate proportions to ensure the benefit of diversification holds.

The government could also eventually decide to pool lower rated firms with higher rated firms.

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