Innovative Financing

New funding mechanisms to increase capital flows

The past two years have been among the most successful for the Indian renewable energy sector. The year 2015-16 saw a record capacity addition in both the wind and solar segments, with solar crossing a cumulative capacity of 10 GW in November 2016. In 2016-17, solar tariffs came down significantly and reached below Rs 3 per unit in the recently concluded Rewa solar park bidding. Wind tariffs also dropped to a record low of Rs 3.46 per unit in the 1,000 MW auction conducted by the Solar Energy Corporation of India. These developments have largely contributed to increasing investor confidence in the renewable energy sector. This has further resulted in a greater infusion of funds into the sector, along with new financial tools to provide capital on better terms.

In order to achieve the ambitious target of 100 GW by 2022, an estimated investment of $100 billion will be required. While this is a sizeable amount, India’s renewable energy capacity expansion plans have already attracted significant domestic and international interest. In step with the current pace of development, there is a need to accelerate investments in the sector. This can be achieved by developing innovative financial mechanisms and alternative instruments to lower the cost of capital, and by eliciting low-cost, long-term commitments from global institutions. A number of financing mechanisms are currently being explored to meet the growing demand and achieve the capacity expansion plans.

Credit guarantee schemes

Financing a project typically involves a sponsor that acquires equity in the project company and a financial institution or a debt provider that lends money to it. This model can be improvised on if a third entity, a credit guarantee agency, is incorporated. Under the credit guarantee scheme, the agency assumes the post-construction payment risk, and insulates the lender from any payment delays or defaults that the project may be faced with.

As most of the discoms are in poor financial health, the offtaker risk for projects is very high. Therefore, in case of delays or defaults in payments, the credit guarantee provider reimburses the lenders. This mechanism reduces the perceived credit risk for financial institutions, thereby enabling them to extend loans or invest in bonds at competitive prices. In addition, this mechanism is highly beneficial for non-recourse project bonds to obtain a satisfactory credit rating and improve the overall marketability of a project. It has the added advantage of tapping a bigger pool of investors such as pension funds and insurance funds, which can help in reducing the overall interest rate for projects. For example, India Infrastructure Finance Company Limited’s partial credit enhancement scheme, with a backstop guarantee by the Asian Development Bank, has helped in improving the credit rating of bonds, enabling more banks to subscribe to them.

Green bonds

Green bonds have emerged as a key source of mobilising debt for climate-focused investment solutions and have helped reduce the overall cost of funds. These bonds open up investment avenues for institutions such as the Green Climate Fund, the Green Investment Bank and the Indian Renewable Energy Development Agency that are mandated to promote and invest in clean energy only. The majority of big industry players are of the opinion that green bonds are likely to become the principal source of financing in the next six to eight years. In light of the significant potential of green bonds in the country, the Securities and Exchange Board of India (SEBI) had released a concept paper for the issuance of green bonds in December 2015. India has now become one of the largest green bond markets in the world. Going forward, SEBI can work cohesively with market participants to encourage the adoption of green standards.

Equity participation by suppliers/EPC contractors

All projects involve a module or turbine supplier and an engineering, procurement and construction (EPC) contractor, or both, to ensure the quality of the project. However, despite satisfactory commissioning and a general 25-year power purchase agreement, the projects entail technology- and construction-related risks. In order to overcome these bottlenecks, an innovative mechanism can be put in place, wherein the supplier and the EPC contractor have equity participation in the project. This mechanism will ensure that instead of upfront payments, the technology provider gets returns only after satisfactory project operations, thereby ensuring high project quality. Further, this mechanism provides benefits like timely project execution, high operations and maintenance quality, and lower equity mobilisation by project sponsors. It also promotes lender participation as the technology and construction risks are assumed by the participating entities.

Yieldcos

Yieldcos essentially entail issuing bonds for pooled operational assets of a company. For example, if a company has operational assets in multiple states, it can pool all the assets and issue bonds to which financial institutions can subscribe. Through this mechanism, the risk is reduced as the bond is at the portfolio level rather than the project level. This leads to investors subscribing or refinancing the pool of operational assets at a cost that is comparatively lower than on a stand-alone basis. Utilising the asset portfolio enables the yieldcos to obtain low-cost capital, while also mitigating geographical and single-asset risks.

Securitisation

This financial mechanism involves the pooling of operational asset cash flows and transforming them into securities. The security issuer sells the rights to these underlying assets and undertakes off-balance sheet financing. Based on the risk appetite of different investors, various securities can be bundled together, thereby broadening the capital base. It is an ideal investment structure for the solar segment due to the inherent tax credit complications, illiquid nature of primary investments, etc.

Community-funded projects

This mechanism can be utilised for projects that involve community financing or participation through equity, and lays emphasis on local-level engagement and leadership. It is generally used for microgrid/off-grid-based solutions, wherein the entire community benefits from the project. With unclear returns on investment and high perceived risks for such micro projects, it is generally difficult to raise funds from secured lenders. Therefore, utilising the community-pooled financing mechanism can ensure the development of such projects.

Crowd funding platform

This is a new mode of alternative financing for small and personal projects, which can be subscribed to by a large number of people. The mode of financing can be customised as per the project requirement. However, this mechanism has not been implemented on a large scale yet.

Solar park financing vehicles

Solar parks have attracted huge interest from global investors and have been a success story in India. They come with inherent advantages such as access to various amenities and transmission and evacuation infrastructure, and require fewer approvals, thus minimising the project risk and making them attractive to developers and lenders. Aggressive bidding for solar park tenders has led to a major reduction in tariffs. Following the successful implementation of the first phase (20 GW) of solar parks, the government is planning the second phase of solar parks, aggregating 20 GW of capacity.

To further improvise the current model, a solar park financing vehicle (SPFV) can be set up under a public-private partnership model. The SPFV would obtain the requisite statutory or non-statutory clearances, carry out site-related investigations and sign long-term lease contracts with developers who would set up projects on a plug-and-play basis. Given that solar parks have certain inherent advantages, this model provides lenders with key benefits such as eliminating project development risks and reducing costs based on economies of scale and sharing of transmission infrastructure.

In light of the recent developments, most lenders in the renewable energy space have transitioned from a conservative to a highly optimistic outlook for the sector. So far, their experience has been positive. While the sector has become increasingly lucrative for lenders, the associated risks and challenges are also part of the deal. These include offtaker risk on account of the poor financial health of the discoms, unavailability or delayed access to transmission and evacuation infrastructure, and non-compliance with renewable purchase obligations by various states. These factors have a negative impact on project execution as well as overall financing in the sector.

It is important to note that lending to various sectors is influenced not only by the inherent risk or attractiveness of a particular sector, but also the lender’s risk assessment ability and comfort with the sector. With the growing experience in the renewable energy sector, lenders are now becoming comfortable in appropriately factoring in the associated risks and challenges. At present, most of them offer debt financing at a rate of 10.2 per cent to 12 per cent. However, with the increasing interest in this space and the utilisation of innovative financing mechanisms, the cost of capital is expected to come down.

In the past few years, investments in the Indian renewable energy sector have increased significantly. Globally, India is being looked at as a key country in terms of renewable energy expansion. However, the sector needs to accelerate its pace of growth to meet the government’s ambitious targets. According to Bloomberg New Energy Finance, in order to achieve the utility-scale renewable energy target, about $100 billion of asset finance will be required during 2016-22, including $30 billion in equity capital. In addition to financing, it is critical to increase capital flows and reduce financing costs in order to meet this target. Hence, going forward, more innovative financing mechanisms are likely to be developed to address these two critical aspects.

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