Road InvITs May No Longer Be Penalised For Borrowing To Maintain Highways

The Securities and Exchange Board of India (Sebi) has proposed allowing infrastructure investment trusts (InvITs) owning road assets to add back major maintenance expenses funded through borrowings while calculating net distributable cash flow (NDCF), a move that could increase the cash available for distribution to unitholders.

The proposal, applicable only to projects in the roads and bridges sector, follows representations from the Bharat InvITs Association, which argued that the existing framework results in lower distributable cash despite maintenance expenditure being financed through debt rather than operating cash flows.

In its consultation paper, Sebi said the proposal has been made “considering the request of industry association and in order to facilitate ease of doing business”. The regulator has invited public comments on the proposal till June 22.

Why Sebi is Reviewing the Framework

Sebi introduced a standardised framework for calculating NDCF in December 2023, later incorporating the same into the InvIT Master Circular. The framework expressly bars trusts and their special purpose vehicles (SPVs) from distributing cash flows generated through external borrowings.

Under the existing framework, NDCF calculations begin with cash flow from operating activities. Since major maintenance expenditure on road projects is treated as an operating expense under accounting standards, the expenditure reduces operating cash flow and consequently lowers the NDCF.

According to the industry body, this creates a challenge for road InvITs, as major maintenance expenditure, while necessary to preserve road quality and meet concession agreement obligations, cannot be capitalised since it does not generate additional economic benefits, such as higher toll revenue or longer concession periods.

The association also told Sebi that major maintenance expenditure is typically funded through debt across the road sector and a departure from this approach could increase acquisition costs and discourage asset monetisation through the InvIT route.

Sebi noted that although major maintenance is classified as an operating expense, the expenditure is substantial over the life of a project and is necessary to maintain the asset and comply with concession requirements.

Debt-Funded Maintenance Expenses to Be Added Back

To address the issue, Sebi has proposed allowing payments made towards major maintenance expenses for road projects to be added back while calculating NDCF, but only to the extent such expenses are funded through external borrowing.

The proposal would require amendments to the NDCF computation framework at both trust level and the SPV and/or holding company level by introducing a new line item permitting such add-backs.

Sebi has proposed defining major maintenance expenditure as non-routine maintenance carried out in accordance with obligations specified in concession agreements. The relaxation would be available only for projects falling under the roads and bridges infrastructure sub-sector.

Unitholder Approval Mandatory

Sebi has further proposed that InvITs obtain unitholder approval before availing of the benefit. Under the proposal, resolutions would require support from at least 60 per cent of votes cast. The approval can be obtained either on a one-time basis covering the entire project lifecycle or for specific maintenance programmes. However, any proposal requiring additional borrowings beyond the approved amount would need fresh approval from unitholders before the debt is raised.

InvITs May Need to Give More Details to Investors

Sebi has also proposed a detailed disclosure framework to accompany such approvals. InvITs would need to disclose project-wise details of maintenance-related borrowings, categories of expenditure that qualify as major maintenance, year-wise estimates of future maintenance spending, and the potential impact of such borrowings on future growth plans.

The consultation paper proposes a specific disclosure warning investors that maintenance-related borrowings would reduce the leverage headroom available for future expansion even though they may increase cash available for distribution in the near term.

InvITs would also need to explain the likely impact on future distributions and disclose alternative funding sources if debt is unavailable for maintenance expenditure in later years.

Auditor Certification and Ongoing Reporting

To ensure the benefit is used only for eligible expenses, Sebi has proposed that statutory auditors certify that the expenditure qualifies as major maintenance under concession agreements and that the payments have been funded through external borrowings. Only the amount certified by the auditor would be eligible to be added back for NDCF calculations. Sebi has also proposed additional reporting requirements, including separate disclosure of maintenance-related borrowings in debt maturity profiles, net borrowing ratios and NDCF statements.

What This Means for Investors

If implemented, the proposal could help road-focused InvITs maintain higher distributable cash flows when they undertake major maintenance work using borrowed funds. This may support cash distributions to unitholders during such periods.

However, the proposal also highlights a key trade-off. While using debt for maintenance expenses could boost cash available for distribution in the short term, it would increase the InvIT’s overall borrowings and leave less room to raise debt for future acquisitions or expansion projects.

To protect investor interests, Sebi has proposed safeguards, such as unitholder approval along with detailed disclosures and auditor certification. These measures are intended to ensure investors clearly understand both the potential benefits and the longer-term impact of maintenance-related borrowings before such expenses are added back to distributable cash flow calculations.