Infrastructure investment trusts (InvITs) are making inroads into Indian financial markets as an instrument for power sector infrastructure owners to monetise assets and for investors to gain exposure to the sector.
Growing investor interest is illustrated by the recent issuance by Powergrid, announced by KKR-backed Virescent to set up a renewable energy-focused InvIT, and the attractive returns generated by Indigrid, India’s first power sector InvIT. Regulators also are warming to such instruments as a means to help mobilise much-needed investment in the renewable energy generation sector.
With an installed renewable capacity of 103GW, or 26% of total capacity, India is steadily moving towards its 2030 RE target, but the goal of 500GW of non-fossil fuel capacity by 2030 is a tall order. Cheap long-term finance is among critical prerequisites, given the capital-intensive nature of RE technologies where the majority of costs are front-loaded. Innovative instruments such as green bonds and InvITs are increasingly used by industry players to tap into a diversified pool of capital to fulfil this expanding capital need.
Globally, institutional capital from pension funds, insurers, sovereign wealth funds and foundations and endowments have provided progressively more capital for the RE sector. Institutional investments in renewable projects directly and through renewable-focused funds total about US$12billion annually, as per a 2020 IRENA report. Institutional investors have the capability and the appetite to provide the huge, long-term capital infusions needed to support dramatically more renewable projects. Their need for asset diversification and higher yields, and the mounting demand for better environmental stewardship, drive them towards renewable infrastructure.
India has a vast and growing pool of institutional capital, led by the insurance sector. Life insurers have combined assets under management (AUM) of Rs39 trillion, as of March 2020, as per the Insurance Regulatory and Development Authority of India (IRDAI). Historically these assets have been invested in central and state government securities and investment grade debt securities of the country’s largest corporates. In 2020 more than 60% or Rs23.7 trillion of investments were made in central, state and other approved securities.
Pension funds from the National Pension Scheme (NPS) and Employee Provident Fund Organization (EPFO) which respectively had a last reported AUM of Rs6.6 trillion (October 2021) and Rs16.6 trillion (March 2019), are potential sources of domestic institutional capital to be deployed at scale into the RE sector.
Domestic insurers and pension funds previously did not invest in the RE sector due to various factors, such as lack of appropriate instruments, inhibiting regulations, limited understanding of the sector dynamics and aversion to risk.
The risk associated with direct investments in project or company level debt and equity of RE companies might not yet qualify as investment grade for domestic institutional investors. However, investments via the InvIT route provide a viable option. InvITs are pooled investment vehicles, enabling direct investment from individual and institutional investors in primarily operational infrastructure projects.
Key features of InvITs that reduce the risk are: investing in a pool of assets; mandatory distribution of 90% of net distributable cash flows to unit investors; a leverage cap of 70% on the net asset value; and a cap on exposure to assets under construction.
Global pension funds and sovereign wealth funds have invested significantly in InvITs of other infrastructure assets. In a renewable energy InvIT, investors gain long term higher yields backed by stable and predictable cashflows and project developers secure cost-effective, patient capital.
Earlier this year, the insurance industry regulator allowed domestic insurers to invest in debt securities and subscribe to units of listed InvITs. In a similar move, the Reserve Bank of India (RBI) in November 2021 amended foreign exchange regulations allowing foreign portfolio investors to invest in InvIT debt securities.
EPFO, which manages the country’s biggest pension corpus, has approved investing up to 5% of the annual deposits in alternative investment funds (AIFs) including InvITs. This is in addition to the already established rules by Pension Fund Regulatory and Development Authority (PFRDA) which allows private sector (tier 1) NPS subscribers to invest in units issued by InvITs. In August 2021, to increase retail investor participation in these securities, capital market regulator SEBI reduced the trading lot size of listed InvITs.
IRDAI’s approval came as a welcome move. Insurers enthusiastically subscribed to power sector instruments, an InvIT launched by state-owned Power Grid Corporation of India ltd (PGCIL) and a Non-Convertible Debenture (NCD) issuance by IndiGrid. Power Grid raised Rs34.8 billion from anchor investors including insurers and 10% of the total book of IndiGrid’s issue came from insurers.
Virtually all assets in current power sector InvITs are from the transmission side but the stage is set for further RE assets to be included in the mix. InvITs backed by transmission assets are isolated from the volatility in electricity prices and have offered a pre-tax return of 8-9.3% in the past. RE InvITs’ return expectations would be slightly higher.
Such returns are quite rare in domestic debt markets. In an era of multi-decade low interest rates in OECD countries, an anticipated yield of 8-9% by InvITs makes a very strong investment case for international investors, even after accounting for country risk and currency hedging cost.
For projects with sovereign grade counterparties, successful operating history, a strong sponsor profile and investment grade ratings, such an instrument gives access to a vast pool of domestic and international institutional capital.
Yield investors such as pension funds and insurers will appreciate the sector’s long-term price and volume prospects, thanks to power purchase agreements from the central government underpinning RE auctions in India.
By fetching premium valuations for operational assets, InvITs can help unlock and recycle the capital tied up in more than 100GW of operational RE projects in India. This monetisation enables project developers to invest in new, larger RE assets. InvITs also provide a cost-effective route for RE sponsors/project developers to pay off high-cost debt in existing projects.
InvITs are similar to yieldcos of the developed world, though with better regulatory oversight as well as attractive tax benefits. Yieldcos were designed in the early 2010s as a new financial vehicle to own and operate fully built and operational power generating projects. A 2020 OECD report found that ~US$150 billion of institutional capital in green infrastructure (not exclusively renewable energy) globally was held through yieldcos, highlighting the important role of these securitised products.
Past experience with these instruments has not been good. In 2016, U.S. solar developer SunEdison, the sponsor for two listed yieldcos, went bankrupt when the yieldco “bubble” burst. Within a year, several similar companies had their market capitalisations tank. A major reason for the debacle was the massive amount of debt capital directed to increasing dividends.
This is a critical point regarding such structures. They constantly need external growth capital, both debt and equity, as most of the internal cash accruals are distributed to unitholders. For RE utilities with fixed long-term contracted cash flows, the underlying business model is low-risk.
However, risk increases when a growth equation is added, that is, when future dividend pay-outs are conditional on winning new auctions and delivering on under-construction projects. As the risk increases, so does the pressure on management to deliver on growth promises.
India’s InvIT norms are more stringent than those for yieldcos. To avoid the risk of a yieldcos-style bubble, investor expectations regarding risk-return dynamics need to be moderated.
Shantanu Srivastava is an IEEFA Energy Finance Analyst
This article first appeared in the Hindu Business Line