India’s energy transition goals need an ESG push. But there’s little clarity on what it is

Survey data shows that 32 per cent of European investors say that ESG is essential to their investment approach.

21 December, 2022
The Print

The FY24 budget is likely to focus on building a market for carbon. This is welcome, as India is committed to achieving net-zero emissions by 2070. The transition requires investments—estimated to be almost $28 billion yearly—to move from coal and fossil fuels to renewables.

The Environment-Social-Governance (ESG) investing landscape will help India make this transition. ESG are a set of standards used by socially conscious investors to decide which companies to invest in. But we must overcome two challenges to harness these funds. First, we need to reduce the opacity on what qualifies as ESG to achieve credibility in the eyes of investors. The second and bigger challenge is to improve the overall policy environment that will make our energy sector an attractive investment destination.

Attracting ESG investors

Driven both by regulatory mandates and demands from investors, global funds are seeking investment opportunities that incorporate ESG considerations and not just financial returns. Survey data shows that 32 per cent of European investors say that ESG is essential to their investment approach. ESG funds are expected to become almost one-third of the total assets under management by 2025. A small domestic mutual fund industry is also looking for ESG investments. The Indian energy sector has an opportunity to harness global and domestic funds for its energy transition goals.

Investors, however, worry about ‘greenwashing’, that is, the difficulty of credibly gleaning information about the truth of a firm’s ESG qualities before investing. The environmental disclosures are more clear-cut than ‘social’ or ‘governance’ disclosures. And yet, research finds a weak correlation between ESG scores and emissions growth across large emitters.

In response to the rise of the ESG movement, the Securities and Exchange Board of India (SEBI) made the Business Responsibility and Sustainability Report (BRSR) mandatory for the top 1,000 listed companies in India from FY23. Mandatory disclosure regimes, however, can quickly become over-prescriptive and cease to provide meaningful information, as we have seen in the case of rating agencies. Mandatory disclosures can also add to information overload, reducing the ability of smaller investors to discover the true substance of what is on offer.

Large institutional investors driven by an ESG mandate are incentivised to obtain the necessary information themselves. The parameters that the regulator finds useful may not be the parameters that matter the most to them. Similar concerns have been raised about the SEBI disclosures, especially that Indian firms might find it challenging to implement them, given the reliance on coal. The costs of a mandatory disclosure regime may, therefore, not provide commensurate benefits.

Developing credible third-party agencies that certify ESG standards will take time, and different agencies may take different routes for certification. This idea should not be immediately discarded in favour of entry barriers on who can provide ratings and imposing uniformity on how ratings are done. The evolution of differential standards by multiple players is more likely to be sustainable in reducing the information asymmetry between investors and companies in the long run.

Improving policy environment

Let’s assume that the industry was able to find a solution vis-à-vis the credibility of ESG scores. (rephrased for clarity, please see if this is okay) Investment in the energy sector would continue to be poor. This is because investments in energy imply dealing with the electricity sector, which is beset with problems.

The biggest among these is that of contract enforcement. Electricity regulators in several Indian states have reneged on power purchase agreements signed with solar producers. In the case of Uttar Pradesh, the electricity regulator proposed a reduced tariff from what was agreed upon in the original power purchase agreement (PPA). In Tamil Nadu, the state electricity board got into a tussle over payment to various solar power producers. While both regulators lost at the Appellate Tribunal for Electricity (APTEL), the signal to the private sector has been that of an unpredictable and risky investing environment. Lack of clarity on clearances by the government before projects can start add to the risk of investing in India.

>Another concern is the poor financial health of the state electricity boards. Private power producers have to sell to state electricity boards, which may default on payments due to their poor balance sheets. As of April 2022, distribution companies (discoms) owed Rs 1,23,244 crore to power-generating firms, of which almost Rs 21,000 crore was to renewable energy providers. As a consequence, private players are going to exercise caution before entering into risky contracts.

Our energy transition requires a fundamental reform of the power sector. While ESG disclosures are important, the real challenge is to improve the ‘investibility’ of the sector that will bring in the pools of private capital.

Low IBC recoveries are a worry. But solutions lie in cutting court delays, not blaming CoC

Revisiting commercial decisions taken by the Committee of Creditors (CoC) increases uncertainty in the IBC process.

07 December, 2022
The Print

There are concerns that lenders have had to take large haircuts on firms that go through the Corporate Insolvency Resolution Process or CIRP under the Insolvency and Bankruptcy Code or IBC. The unease over low recoveries resulted in the National Company Law Appellate Tribunal, or NCLAT, ordering restarting of a concluded resolution process of Videocon Industries in January this year.

Revisiting commercial decisions taken by the Committee of Creditors (CoC) increases uncertainty in the IBC process. While anxiety about low recoveries from the IBC may be valid, we should revisit how large the haircuts are and investigate the factors that drive this outcome. Improvements in recoveries are more likely to result from systematic fixtures to overall policy environment as opposed to revisiting individual cases.

Importance of commercial wisdom

The NCLAT ruling on Videocon mentioned earlier ordered the re-opening of a resolution plan that was accepted by a CoC majority even though only 4.15 per cent of the admitted claims were recovered. It is understandable that the court is concerned over low recoveries. However, this decision seems to go against a Supreme Court ruling, which said that “the adjudicating authority or the appellate authority cannot sit in an appeal over the commercial wisdom of CoC.”

The decision also seems contrary to the IBC, which intended to reduce the scope of such judicial discretion. Ultimately, the question of what the alternative to the 4.15 per cent recovery was, is best understood by members of the CoC themselves. There may be merit in trusting the commercial wisdom of stakeholders, even if, in particular instances, it goes against our notions of fairness.

Overstating haircuts

We may be overstating the impact of haircuts lenders see in the IBC. When a firm gets into trouble and anticipates that it will not be able to repay its loans, it typically seeks to restructure its debt obligations with the lender. A lender makes a decision based on a judgement about the firm’s business, and the impact it can have on its provisioning. By the time a firm comes to the IBC, one can assume that the restructuring process has not worked. While we don’t have adequate data for whether restructuring became more effective because of the potential threat of the IBC, conversations with industry players suggest that it did.

Another metric of voluntary settlements is withdrawals under Section 12A of the Bankruptcy Code. Seven hundred and forty of the 5,889 firms that have come to IBC have been withdrawn under 12A, while 552 have led to a resolution plan. Clearly, some voluntary mechanism is working for debtors and creditors, and presumably, the lender is getting a better deal from this settlement than the recovery numbers reflect.

According to the Insolvency and Bankruptcy Board of India (IBBI), about 35 per cent of CIRPs that resulted in a resolution plan were earlier with the Board for Industrial and Financial Reconstruction (BIFR) and/or defunct. It is not surprising that creditors cannot recover much from these firms. Potential buyers may not want to invest in a firm that has little to no value as a going concern. The liquidation value of these firms would be even lower. The fact that there were bidders who could see some value in these firms should actually be celebrated.

On average, creditors have been able to realise 31 per cent of their claims in CIRPs, which led to a resolution plan. This number does not account for lenders’ recoveries, made either because of improved restructuring even before the firm enters IBC, or because of withdrawals under Section 12A. This is a reasonable outcome for a system that has had to bear the brunt of a legacy of Non-Performing Assets (NPAs).

Causes of low recoveries

There are several causes for low recoveries. Delays in courts have a direct bearing on the recoveries that banks are able to make from the IBC. The more time a firm spends in the process, the more value it loses. The average time taken for the closure of an IRP is 561 days. The policy focus should be on how these delays can be reduced. A few days ago, the Supreme Court said that merely increasing judges would not improve pendency. There is merit in this argument, as what is also required is process improvement at the tribunals.

The market for distressed firms in India is a buyers’ market, and it is possible that these firms are driving a hard bargain. The small size of the market is because of two reasons. First, the distressed debt market is in its early stages and will take time to evolve. Second, there has been an effective elimination of promoters from the bidding process because of Section 29A of the IBC. If we want better recoveries, perhaps we should look for ways to expand the pool of potential buyers and increase competition for these distressed assets. It could be that several bankrupt firms should not have been given loans in the first place. However, this cannot be solved through reform of the IBC. A long-term improvement will only happen through systemic reform of all factors contributing to the problem.