A. What is Pooled Fund ?
Pooled funds are funds in a portfolio from many individual investors that are aggregated for the purposes of investment. Mutual funds, hedge funds, exchange traded funds, pension funds, and unit investment trusts are all examples of professionally managed pooled funds. Investors in pooled funds benefit from economies of scale, which allow for lower trading costs per dollar of investment, and diversification. Mutual funds are among the best-known of pooled funds.
Besides saving on transaction costs and diversifying portfolio, investors can take advantage of opportunities typically available to only large investors. However, the disadvantages include losing control over the investment decisions.
B. What is Pooled Financing?
Pooled financing facilities first appeared in the United States in 1970 for the purpose of lowering the cost of debt for municipalities. Since that time, they have been offering a unique and advantageous mechanism for small communities to finance municipal projects.
These institutions, established as government entities, pool a number of local projects for financing and thereby offering larger debt issues, with better credit ratings. Because pooled issues can be structured to achieve high credit ratings in the primary market, debt servicing costs will be reduced. Savings are also realized through a reduction in transaction costs associated with the economies of scale in the underwriting process. Such pooled financing entities usually operate without state guarantees.
However, there is some commitment of state government funds in the form of grants to enhance the pooled financing.
Source: USAID Pooled Financing Workshop, May 2005
This structure is often called a “reserve account” model, where government grants (typically equal to 1/3rd of the pooled facility financing) are placed in a reserve account and held as collateral for investors in the event any local project fails to make a required debt service payment.
C. Parties to the Pooled Debt financing
The various parties involved in a Pooled Debt financing typically include:
- Fund / SPV (state level entity, FI)
- Investors (both institutional and individuals)
- Project implementing agency (primarily ULBs)
- Guarantors / Credit Enhancement providers (state government, FIs, multilateral agencies)
- Asset Management Company (AMC) / Fund Manager
- Trustee
- Rating Agency
D. Benefits
- Improve Market Access
ULBs are able to tap capital markets though they otherwise lack the financial scale, expertise and credit history to go to the markets on their own. Pooled financing institutions serve as a creditworthy link between local projects and sources of capital. These institutions could also provide finance and project development expertise to ULBs through technical assistance services. They can also assist in functions that private sector lenders / investors do not want to undertake viz. project preparation and development.
2. Lower Transaction Costs
By pooling a number of smaller projects for financing, the transaction costs of borrowing for the ULBs can be substantially reduced, since the transaction costs of one financing can be spread over multiple projects. Also, to pool projects for financing, individual loan agreements need to be standardized (with specific terms, conditions and collateral requirements), which also reduces transaction costs.
3. Lower Borrowing Costs
Borrowing costs can be reduced substantially through various credit enhancement mechanisms. This could be provided by government, FIs or multi-lateral agencies. As a result of these forms of credit enhancement, the credit ratings are generally higher than those of most ULBs governments included in the financing.
E. Types of credit support / enhancement
Pooled debt financing typically involves one or more of the following credit support / enhancement mechanisms:
- Reserve Account
- Over Collateralization
- Intercepts of (grant) transfer
- Multilateral agency credit enhancement / guarantee
F. Documents
The typical set of transaction documents include the following:
- offer memorandum
- trust agreement or indenture for the pooled financing
- loan agreements between the facility and local borrowers in the pool
- authorizing resolutions of the local borrowers
- legal enforceability opinions by local counsel
G. Examples of Pooled Financing in India
Pooled financing mechanisms have been introduced in the past to support urban local bodies (ULBs) that are too small to raise debt on their own and help them to achieve a lower cost of funds than they could achieve alone. Governments have often channeled grant funds for project development and subsidies to specific activities through such entities. Pooled financing instruments have provided a mechanism to develop, collect and channel resources from innovative financing instruments in India. Some of the notable examples are mentioned in brief:
- Pooled Finance Development Fund Scheme (PFDF) was launched in 2006 by Ministry of Urban Development (MoUD), Government of India. The objectives of the scheme include facilitating urban local bodies (ULBs) to access the capital and financial markets for investment in essential municipal infrastructure; development of bankable urban infrastructure projects (viz. school facilities, hospitals, pharmacies, hypermarkets, roads, bridges) and facilitate development of India’s municipal bond.Under this scheme, states were required to set up a State Level Pooled Finance Entity (SPFE) which would provide the institutional framework for pooled finance. SPFE will finalise the bond pool or pool of projects, based on various parameters including ULBs that accept all conditionality stipulated by the credit rating agencies, appropriate size of bond issue (i.e. neither too small nor too large) and include mix of projects / ULBs to include some financially stronger projects /ULBs and others that might not be so strongThe pooled fund thus raised by the SPFE would be lent to specific projects undertaken by one or more ULBs. Investors in the pooled fund benefit from credit enhancements such as escrow account, debt reserve and third-party guarantees.
It is noteworthy that the state governments and ULBs were also required to undertake the reform process outlined in the Jawaharlal Nehru National Urban Renewal Mission (JNNURM) and the Urban Infrastructure Development Scheme for Small and Medium Towns (UIDSSMT).
2. Tamil Nadu Water and Sanitation Pooled Fund (TNWSPF) a pooled entity created to specifically help small ULBs in Tamil Nadu to finance their water and sanitation services by raising capital market resources on a pooled basis. It raised Rs. 30.41 crore by way of bond issue during 2002 to fund water and sanitation projects of 13 ULBs.
The proceeds were lent to the 13 ULBs as sub-loans to finance their infrastructure projects. Majority of the funds went to refinance outstanding loans at lower interest rates for previously completed water and sanitation projects.
ULBs paid back their TNWSPF debt obligations from project and municipal revenues, including water tariffs and from interest earned on the money deposited from connection fees. These were deposited into an escrow account.
The bond was AA rated primarily due to the various credit enhancement structure put in place including debt service reserve fund (DSRF) of about 1.5 times the annual principal and interest payments; local debt service reserve fund created by each ULB; interception of State revenue transfer payments and finally, partial credit guarantee provided by USAID, to help re-supply 50% of the principal amount of a default paid for by DSRF.
3. Karnataka Water and Sanitation Pooled Fund (KWSPF), was created as a trust to tap the market borrowings. The Fund issued Rs. 100 crores of tax-free pooled bonds in 2005 with a 15 year tenor with 3 year moratorium. The Bond carried a coupon rate of 5.95% and was rated LAA (SO) by ICRA, indicating high credit quality.
The funds were used to part finance the Greater Bangalore Water and Sewerage Project (GBWASP) proposed to be implemented across (erstwhile) seven City Municipal Corporations (CMCs) and one Town Municipal Corporation (TMC) adjoining the Bangalore Municipal limits; CMCs and TMC have since been merged with the Bangalore Mahanagar Palike in 2006-07. The overall cost of the project was approximately Rs. 340 crores.
Loans were issued out of the pooled bond proceeds to the ULBs. The ULBs were required to fund 1 / 10th of their annual repayment instalment by depositing equivalent funds in a designated bank account; which were pooled together to fund an escrow account. The bond holders were serviced from the funds lying in this escrow account.
Government of Karnataka would provide funds to cover the deficit, if any. In case of any deficit even after this top up, funds from Bond Service Fund (BSF), which had a corpus of Rs. 25.5 crore, would be utilized. The BSF, whose size was determined by the rating agency in order to achieve the target rating, was funded upfront and hence acted as a source of credit enhancement.
Also acting as credit enhancement was a guarantee from USAID (a departmental undertaking of the US government) to the extent of 50% of the bond principal.
4. Pooled Municipal Debt Obligation (PMDO) facility was setup in October 2006 by IL&FS, a 16 member consortium that consists of 13 public sector banks and 3 Financial Institutions with pre-determined pro rata share in each term loan sanctioned, with a corpus of Rs. 2,750 crores. The facility was administered by a Credit Committee, comprising of 11 members.
IL&FS Urban Infrastructure Managers Ltd. (IUIML), was the AMC with wide-ranging scope, including origination of deals / projects; conducting detailed technical, financial and legal appraisal of projects; co-ordinating with lenders and borrowers for documentation, release of funds and timely repayment; monitoring the project implementation performance; hold discussions with lenders for revival of plans in case of default by borrowers etc.
The facility was engaged primarily in providing finance to private sector, ULBs and SPVs promoted under PPP arrangements, to implement urban infrastructure projects for water supply and sewerage, solid waste management, roads and urban transport, environmental projects, healthcare, education etc.
Though urban infrastructure sector is one of the key drivers of the Indian economy, attracting commercial debt to fund urban infrastructure has always been a challenge. The sector received funding primarily from HUDCO and multilateral institutions (World Bank, Asian Development Bank, Japan International Co-operation Agency, KfW etc.), which was generally routed through GoI and the respective state governments.
The underlying strategy was to improve credit worthiness and bankability of urban infrastructure projects, and use efficient transaction structures built on robust risk management processes, which have been successfully replicated in other infrastructure sectors.
5. Green Climate Fund by SIDBI
SIDBI has recently received approval of funding of US$ 215.6 m (approved a US $ 200 million loan and US $ 15.6 million grant for capacity building) from the Green Climate Fund, an entity set up by the United Nations Framework Convention on Climate Change (UNFCCC).
This will help SIDBI to create a corpus of US $ 1 billion with SIDBI bringing in the balance US $ 800 million, partly from its balance sheet and partly raised from the market. This fund would be used for ‘financing mitigation and adaptation projects’ (FMAP) of Medium and Small Enterprises (MSMEs), such as renewable energy, energy efficiency, energy storage and e-mobility.
The FMAP facility would provide about 10,000 concessional loans to MSMEs, to promote low-emission, climate-resilient technologies. The program is expected to result in a reduction in greenhouse gas emissions to the tune of 35.3 million tonnes. Adaptation activities would lead to substantial water savings and building resilience in vulnerable communities, thereby benefiting more than 10.8 million beneficiaries.
-By Ravi Unni (Project Lending, Carbon Finance & Asset Management)