Equity Lock-in Period Should be Removed to Boost Foreign Direct Investments in Solar

Removing the one-year lock-in period for controlling shareholding could help increase investment flow into the solar market in India, which sorely needs it. A ‘controlling shareholding’ is the ownership (directly or indirectly) of over 51% of a company’s voting shares or the right to appoint most directors to the company board.

Earlier, this time frame was three years. Many solar developers had shared with Mercom that the timeline to maintain the controlling shareholding for three years was too long and unreasonable, restricting short-term equity investment in the sector.

So, the Ministry of New and Renewable Energy (MNRE) amended guidelines directing that the shareholding in the special purpose vehicle or company executing the power purchase agreement (PPA) should not fall below 51% for one year from the commercial operation date (COD) of the project. Similarly, for a consortium, the members’ combined shareholding should not fall below 51% in the one year from the COD.

According to this rule, developers who want to exit by selling their projects in the secondary market cannot do so for 2.5-3 years from the date of signing the PPA.


The rationality behind the requirement of lock-in period

When the national solar mission was announced in 2010, solar photovoltaic technology was new and very expensive and had to be bundled with thermal power from NTPC, for which the subsidiary, NTPC Vidyut Vyapar Nigam Ltd (NVVN), was brought in. The initial projects had feed-in-tariffs as high as ₹17.90/kWh to promote renewable energy. Even when the reverse bidding started, the tariffs discovered were as high as ₹10.95/kWh to ₹12.75/kWh. To ensure the ownership of solar projects bundled with thermal power did not change until their performance was established and the quality of projects was good, the government advocated the lock-in period for controlling shareholding.

But now, the scenario has changed, and there are over 35.5 GW of large-scale solar projects currently in operation. Also, solar is the most competitive source of power and doesn’t need to be bundled with thermal. Developers are aggressively bidding in e-reverse auctions taking ownership of the risks involved. Investors are aware that low-quality projects would have no buyers in the market; hence the fear that a short lock-in period would lead to low-quality assets is unsubstantiated.

Over the years, the government has relaxed several regulations, including the networth, bank guarantee requirement, and bidders’ qualifications, among others. But the lock-in period clause remains unchanged for over ten years now. The time has come for this rule also to be revised based on the changing market conditions.

Manoj Gupta, Vice President of Solar and West Energy Business, Fortum India, said, “The lock-in period concept was good initially while the market size was small, and the developers put in all the capital. However, the market size is moving towards 10-15 GW projects annually. And to grow in this range, we need to have substantial capital from international funds. In the past, we have seen many projects were not delivered or constructed on time due to capital shortage and shareholding restrictions.

Gupta also added that developers are also facing issues like delays in signing PPAs and the availability of short-term equity for projects due to the lock-in period. This is allegedly causing further delay in securing the land to bring the lenders to the table.

Echoing similar thoughts, a senior executive of the French renewable energy developer said there is no logic or need for any lock-in restrictions for developers because it does not serve any purpose. During the project development, developers need the flexibility to get the best financing, undertake restructuring for legal framework compliance, tax optimization, etc. In addition, developers also do not get the benefits of real-time evolving financing scenarios in Indian as well as global renewable energy markets.

“It’s become difficult for any developer to bring investors on board for projects due to lock-in period. As investors can only hold 49% of equity despite investing huge capital, which makes them uncomfortable to invest even in investment-worthy projects in India,” said Animesh Damani, Managing Partner, Artha Energy Resources.

However, Vinay Kumar P, Founder and Chief Executive Officer (CEO) of Varp Power believes that the apparent reason for lock-in is to ensure that developers do not build projects only to flip them after commissioning. In the industry, it is a general hypothesis that allowing and promoting a build-and-flip approach harms asset build quality with consequent impacts on solar/wind projects’ useful life and yields during operation.

“The concern about developers building and flipping projects is baseless. We are assuming that investors lack the ability to do proper due diligence and will readily invest millions on low-quality assets. On the contrary, most large-scale solar project investors are sophisticated and understand what they are getting into. Solar is a mature asset class with over a hundred GW of solar projects being built globally every year. Almost 40 GW of solar projects were bought and sold worldwide in just the first six months of this year,” said Raj Prabhu, CEO of Mercom Capital Group.

Disadvantages of lock-in period

Most foreign investors planning to acquire quality projects would like to invest in the early stages to have a say in the construction of the projects and ensure the adoption of the latest technologies. Without controlling stake in the projects, the investors are skeptical about early-stage investments.

A senior executive of a Mumbai-based investment company said, “If MNRE removes the lock-in period, investors tend to acquire the entire project in a single shot. The current situation doubles the efforts of investors to acquire the whole project. In addition, investors do not like to be in a position where they are not in control despite investing a substantial share of capital in the project. At the moment, investors are not in a controlling position, as they can have only 49% equity shareholding, compelling them to create a new structure to secure shadow control, especially in the project development stage.”

“All these issues can be avoided and simplified if there are opportunities to acquire the overall project at one go or by allowing investors to hold at least 51% or more controlling shareholding. The Ministry should at least allow majority controlling shareholding to investors who can give them the confidence to invest heavily in the sector.”

According to Mercom’s Q1 2021 India Solar Market Update, the large-scale solar project pipeline stands at 53.6 GW, with 24.1 GW tendered and pending auctions at the end of Q1 2021. Developers find it difficult to bring in the volume of investment that the sector needs. The participation of international investors is integral, which makes a case for relaxing the current equity lock-in norm.

Benefits of relaxing the rules

Solar is now a mature technology finding its way into the portfolio of investors, pension funds, development banks, and utilities alike. Indian developers bring in over a decade of experience constructing these projects and no longer need to be monitored with the lock-in period as earlier.

“A project goes through several stages; the pre-construction period is when the risk is at its highest. Investors who come in at this stage expect healthy returns for the risks they are taking, along with control of the technology, component selection, and build quality,” commented Prabhu.

According to a UK-based investor, the government is now concerned about the networth of the developers rather than the technical qualifications as the case was earlier. To bring in networth, the regulations need to be flexible. There are many benefits in relaxing the controlling shareholding rules – the developers must linearly grow with their internal investments, due to which the growth is curtailed. Instead, they could capitalize the asset as soon as it is built or the PPA is signed so they can work on a more robust portfolio. The added advantage of having access to a larger pool of capital is that the bids will be competitive, which is the government’s main goal – to discover lower tariffs.

The investor further added that if the financial strength of international investors should be merged with the project execution capabilities of Indian developers, investors need to have major shareholding at an early stage. Also, the government is aiming at foreign direct investments or low cost of investment, and for that, we need enabling regulations and not restrictive ones. Removing the equity lock-in regulations can unlock huge benefits but retaining these regulations has none whatsoever.

Developers also believe that reducing or removing the lock-in period can enhance foreign investment in the Indian solar market. They believe that despite many barriers, investors are investing heavily in the market, which could be increased further by removing barriers like the lock-in period.

Speaking to Mercom on investing in the solar market, Rahul Varshney, Country Head, India, at Statkraft, said uncertainty around local laws, bidding procedures – including the foresight on timelines or possible procedural delays – offtake risks, or adoption of tariffs by utilities are the main issues to acquire projects in the early stages. That said, removal of lock-in period is expected to facilitate greater participation by investors in good quality operational solar assets, which is a positive development for the industry.

Gupta said, “There should not be any lock-in period after issuance of letter of intent (LoI) or PPA signing. It will help in boosting investment in the solar sector. Investors would be involved in project development activity from day one.”

A senior executive of the French renewable energy developer also echoed similar thoughts and said removing this one-year lock-in period would increase the foreign investment. The executive feels that this would allow foreign investors to aggressively invest in new projects as India requires to develop over 200 GW of solar capacity to achieve its 350 GW solar capacity target by 2030.

“Billions in foreign capital with an ESG investment priority is out there to be deployed with the expectation of higher returns than what is available in developed countries. To tap into this pool, restrictions need to be removed; PSA and PPA signing should be made automatic and guaranteed. This will ramp up foreign investments exponentially,” noted Prabhu.

“The investment will not increase overnight, but see a big uptake in the solar sector if MNRE removes the lock-in period,” said Damani.

“It would certainly have a positive impact. The fact that investors could have control from the beginning would be a big attraction for investors, as those waiting to acquire a project could do so in a single shot,” said a senior executive of a Mumbai-based investment company.

Varshney said foreign investors prefer to circumvent initial developmental hurdles by deploying capital by acquiring quality operational projects whose costs are crystallized. Shortening or removing the lock-in period would be an enabler for such deals, although this may not be the sole driver to magnify merger and acquisition activities.

“The time is right for the government to remove the equity lock-in period and open up the solar sector for much-needed foreign investments,” added Prabhu.