The ILFS Situation: Despite The Mayhem, An Innovative Solution Can Save The Day

Whilst there is the general  temptation to pass off the ILFS imbroglio as a normal risk in managing a business, this is yet one more instance of a governance failure which plagues the Indian business landscape. As I had written in this publication in a cover story on Jun 18, 2018, the ILFS governance deficit falls in the category of an organization with good intentions but pathetic standards of board oversight in a company where its leader was yet one more demi-God who could do no wrong. The fact that he quietly resigned from the company on the usual “health grounds” and moved to London for treatment, and with no official statement coming from the company in his absence for the last many weeks, indicates the extent of the casualness with which the matter has been allowed to be handled despite the mayhem it has created in the markets.

But this article is not about governance but about possible solutions to extricate ourselves from this mess given ILFS’s systemic ramifications and it’s “too big to fail status” in the Indian financial markets. The prime reason for the current predicament of  ILFS has been its penchant for over leverage and a highly risky capital structure based on such leverage in its legal and operational entities which hold its significant long-term infrastructure assets. Secondly, many government-owned entities are responsible for much of its cash flow deficits which in turn led to large asset-liability mismatches for its borrowings in the money markets – the primary reason for the debt markets freezing up. Given the reputation of its management but subject to further verification by the authorities, there does not seem to be any problem with the quality of the assets or any shady transactions despite its complex structure of 169 subsidiaries and SPVs through which leakage is eminently possible. Hence, one of the obvious solutions at this stage would be to split up and parcel out the various assets in an optimum structure to willing buyers at a negotiated price.

In such a situation the Government can play the role of a matchmaker to split up its various assets and merge them – on an arms-length basis – with suitable entities in its fold. The first entity which comes to mind is the National Infrastructure Investment Fund (NIIF ) which has been an extremely slow starter. Amongst the many big ideas and innovative initiatives, the Modi Government took early on in its tenure was the intent to create a vehicle for India's foray into a quasi-sovereign fund. During the heady days of the global commodity-led boom of 2004-2008, India had toyed with the idea but, like many things with an indecisive government of the day, it petered out.

In that context, I was enthused with the announcement to create NIIF in the Budget of Feb 2015. Conceptually it was simple : a seed funding of Rs 20,000 cr from the Government would be used to attract foreign capital of a similar amount, use the Rs 40,000 cr corpus to leverage further and then fund stalled, brownfield and greenfield infrastructure projects to fulfill India's dream of building world-class infrastructure and, more importantly, pump prime the economy by kick-starting the investment cycle which has been elusive for the last many years. PM Modi's aspirational plans for Smart Cities, Make in India, railway up-gradation, ports, highways, etc., hinged to a significant extent on this. Amongst various institutional models for setting up sovereign wealth funds, India adopted for the 'Investment Company model' where the Government sets up an Investment company to hold the assets primarily with a development objective, a strategy of more concentrated investments and active ownership in investee companies. Temasek in Singapore is modelled on this philosophy and is highly successful.

It has been almost three and a half years since then and NIIF has yet to take off in any meaningful way though it has a full-fledged team in place headed by an ex IFC executive since Nov 2016 and an SBI banker for an year before that. NIIF has had some investments from Abu Dhabi Investment Authority but is yet to find suitable assets for the initial deployment. This is where the assets of ILFS would be an ideal fit – both in scale and quality - given that NIIF’s mandate is solely to invest in purely long-term infrastructure assets. Additionally, its major shareholder – apart from the Government – is the Abu Dhabi Investment Authority itself which is a significant shareholder ( 13 % )  in ILFS apart from LIC ( 25% ) and Orix Corp of Japan ( 24%). Apart from the opportunity to absorb a massive investment portfolio into NIIF in one shot, FM Jaitley has little time till the next elections to showcase his pet project as a reasonable success and, more importantly, get this white elephant off the ground in a meaningful way.

Today’s media coverage on Uday Kotak assuming chairmanship of ILFS at the behest of the Government, if true, would indeed be very positive as he has the skills and knack to stitch up such win-win deals. It also opens up the possibility of Kotak Bank itself absorbing many of the financial arms of ILFS on an arms length, fully transparent basis which, subject to regulatory nod, would help in reducing Uday’s stake in line with RBI norms without selling any of his present holdings. Of course, ILFS has many assets in its 169 subsidiaries that would fit in with the likes of L&T and others as well.

The entire game at ILFS was based on rolling over liquid, short-term debt to create long-term assets. This economics has failed this time around – but with innovative thinking, and eliminating the opacity associated with it thus far, the panic in the markets can be stemmed without the necessity of recourse to public funds for a bailout.  And our own version of a sovereign fund can finally get going. 

And the Government can showcase one of its pet projects before its term ends.

Despite the mess, a win-win for all.

Prabal Basu Roy

Guest Author A Sloan Fellow from the London Business School, Director and Advisor to Chairmen of corporate boards, the author has formerly been a Group CFO in various companies.