The Expected Loss (EL) scale, an innovative credit framework for operational infrastructure projects, was launched by CRISIL Ratings in 2017 in consultation with the Ministry of Finance and other stakeholders.
It was launched in response to the pitch made by the then finance minister, late Arun Jaitley, in his February 2016 budget speech when he urged the new rating scale should factor in the in-built structural safeguards of the infrastructure projects.
Operational infrastructure projects such as roads, transmission assets, renewables assets and airports have, by nature, several in-built structural safeguards. These are in the form of legal contracts mostly with government entities, thereby providing strong cash flow visibility. These contracts also ensure entry barrier and give monopolistic position to the assets. Some of the infrastructure projects such as roads also have a termination clause that is the equivalent of a collateral in a manufacturing plant.
Ratings assigned under the EL framework are an opinion on the expected loss to be incurred over the life of a debt instrument and account not only for the probability of default, but also post-default recoveries.
Thus, the EL ratings complement conventional credit ratings (based on the probability of default approach) by incorporating the specificities of operational infrastructure projects that contribute towards post-default recovery.
EL ratings focus on recovery of dues to investors and lenders over the life cycle of an infrastructure project by factoring in the possibility of refinance/restructuring and the presence of embedded safeguards (such as termination payment), thus enabling them in the effective pricing of the credit risk.
In January 2021, the Insurance Regulatory and Development Authority recognised the EL scale, followed by the Pension Fund Regulatory and Development Authority in July 2021. The Securities and Exchange Board of India recognised and standardised the scale in July 2021.
Recently, there has been some debate around whether the EL ratings of credit rating agencies (CRAs) and the Expected Credit Loss (ECL)-based provisioning required under the accounting norms are one and the same.
While the two may sound similar and have a mathematical construct that looks same (both are calculated as PD x LGD x EAD), CRISIL Ratings would like to highlight that EL is not the same as ECL.
This article attempts to answer the following questions:
How different is EL from ECL?
Is EL of 1% the same as ECL of 1%?
Utility of EL for the pricing of debt instrument
Is adoption of Ind-AS accounting a pre-requisite for adopting EL ratings?
