New Guidelines Restrict Short-term Equity Investment in Solar Projects

The industry consensus seems to be that investors do not like the mandatory three-year lock-in period for solar projects


In an amendment to the competitive bidding guidelines for procuring power from grid-connected solar photovoltaic (PV) projects, issued by the Ministry of New and Renewable Energy (MNRE) in July 2019, it was noted that the project developers need to maintain a controlling shareholding of 51% in the special purpose vehicle (SPV) or project company executing the power purchase agreement (PPA). Up until 2019, this period of maintaining controlling the shareholding in the SPV or project company used to be for one year after the COD. This has now been amended for a period of three years after the commercial operation date (COD) of the project.

For the uninitiated, the term “Control” in the tender documents means the ownership (directly or indirectly) of more than 51% of the voting shares of a company, or the right to appoint the majority of directors to the board.

The amendment to three years essentially means that investors looking for an exit by selling their projects in the secondary market will have to wait for a period of 4-5 years from the point of award.

Many developers have expressed to Mercom that the new timeline to maintain the controlling shareholding is too lengthy and unreasonable.

A finance executive from a large renewable energy project developer said, “The extension of the timeline to maintain controlling shareholding for a period of three years after COD does not make much sense. I believe that this has been done to protect the industry from the so called “fly by night” operators who are looking at short-term gains. But such players find multiple other routes to sell their stakes in projects before the given timelines. The other problem is, why extend controlling shareholding in solar projects to a period of three years and not five?. From the government’s point of view, even five years should not be long enough. These projects are going to be operational for 25 years.”

Now, is the change in the lock-in period of majority shareholding discouraging investors from participating in tenders? To this, the executive responded, “No, this is not the only reason why investors would not want to participate in tenders. In that aspect, concerns still remain due to tariff caps and state-specific idiosyncrasies.”

The consensus among developers is that maintaining high standards for certification and standards should be more than enough to ensure the quality of equipment. Another executive from a private equity backed solar development company expressed the need for a change in the clause, stating that “The rationale given for the three-year criteria is that it would result in solar developers using better quality modules as poor quality modules will show degradation within three years. There are various ways to ensure quality of modules like photovoltaic (PV) module qualification and safety standards, which are already being factored in tenders. Also, looking at the project sizes, all independent power producers are serious companies who won’t be using poor quality modules as it would impact their generation and valuation where again, there are penalties in the PPA as a deterrent. In our opinion, the regulator needs to revise the lock-in period to maintain controlling shareholding to one year after the scheduled commissioning date.”

It has been an uphill task for developers to raise equity as well as debt in a market already reeling under liquidity crunch. Equity finance is generally limited to states with good policy and business environment. The Andhra Pradesh fiasco has increased the risk of raising equity finance in general, and developers are trying to tap all sources of equity to move their projects towards financial closure. To ensure timely financial closures they need to look at both short-term and long-term equity investments. Ultimately the developers who have won the bids to develop projects also need to ensure they meet deadlines failing, which they end up facing penalties or worse still face a cut in the tariffs. Private equity investors generally exit projects after initial years of project operation to invest in new projects. MNRE increasing the period of maintaining controlling shareholding in the SPV or project company from one to three years might close doors for such short-term investors, which the developers cannot afford in a market starved for finances.

A few developers have also written to the Ministry of New and Renewable Energy (MNRE), asking them to amend bidding guidelines to incorporate a shorter period to allow investors to exit the majority shareholding. However, it seems the government has not moved from its stance.

In October 2019, the MNRE, to expedite and streamline the process of developing solar projects, issued amendments to its guidelines for the competitive bidding process. The changes tackled a variety of issues such as payment security mechanism, curtailment of power, land acquisition, timely tariff adoption among, and many others. However, it did not address the shareholding clause.

Contrary to the beliefs of most solar developers, a few experts believe that this is a move that will help the utility-scale solar market mature. Explaining the government’s move, an executive from a lending institution told Mercom, “The government wants to encourage long term serious investors to participate in solar project development. This is good for the market, as the move will ensure that the developers are not cutting corners by deploying solar equipment of inferior quality. This is crucial for garnering the trust of non-banking finance companies (NBFCs) and banks that are lending to utility-scale solar projects in India, which are supposed to operate for a very long period. Therefore, in my view, the government’s actions seem reasonable.”

It is good to see that the Indian government is putting a lot of emphasis on maintaining the quality of solar projects that are being developed in the country. In January 2019, the MNRE issued the first notification on the approved list of manufacturers and models (ALMM) that would be utilized in government-owned projects and those set up for the sale of electricity to the government.

Before that, the government launched the Bureau of Indian Standards (BIS) initiative for the solar sector, which in and of itself seems to have led to increasing costs and restricting new technologies. Therefore, the industry is now finding it difficult to grapple with the sheer number of reforms.

According to sources in the industry, developers are also finding it difficult to raise debt as well as equity finance. In May 2019, Mercom reported that India’s NBFC crisis was exacerbating the financing challenges for utility-scale solar projects. The government only has a little more than two years to achieve the coveted target of 100 GW of solar capacity. But, the continuously changing regulations and policy seem to be hampering the operations of developers and equipment suppliers who are looking for stability for a boost in sentiment.

With this amendment, regulators are assuming that whoever purchases a project after a year is not sophisticated enough to know what they are doing, will not do any due diligence, and they need to be protected. I do not think there are many unsophisticated investors that are blindly buying large-scale solar projects,” said Raj Prabhu, CEO of Mercom Capital Group.

There are different kinds of investors in project development – those that are motivated by high risk high reward projects, get in early and take on all the initial approval risks to get the project to a development phase. Another set of investors who have a slightly lower risk profile will get in and develop a project and  eventually sell to investors that have the lowest risk profile, like pension funds, who do not want development risk but are willing to take a lower return for a safe 20+ years of steady returns.

“When the government starts regulating the timeframe for shareholders, they are essentially disrupting investment into the sector. Unless developers and investors can generate some capital from their projects, they are not going to be able to invest in new projects, which is how the cycle typically works in many markets around the world,” added Prabhu.

In its aim to ensure the quality of projects, the government, in its over cautious nature is failing to see the practical difficulties of developers and needs to address the issue before projects start to derail instead of taking off.

Image credit: Azure Power