Small Hydro Power Project Nepal - Supporting Financial Institutions

This is part of a condensed report on the Small Hydropower Promotion Projct (SHPP). For an overview on the whole report please refer to following page: SHPP Report.

Supporting Financial institutions

A large aspect of SHPP’s sector development focussed on SHP financing. Improving the stability of political, regulatory and financial environments builds the basis for the provision of SHP investment opportunities and capital inflows. Even though this is a big task to be carried by the renewable energies or SHP sectors alone, there have been many activities in the past years to mitigate factors that are deterring private equity and debt providers from involvement in SHP in Nepal. We will highlight a few experiences from banks, insurers and investors. What they have in common is that they seek financing opportunities that deliver a good balance of security (predictability of the environment, risk, insurance), liquidity (exit options) and yield (returns), based on their own motivations and profiles. 

Banks Counselling

Given investment volumes in the range of a few million USD, an important part of technical support to the sector included upgrading the capacity of the financial institutions to understand small hydropower generation and to understand whether a project was going to be feasible or profitable. The sector needed a party to carry out appraisals on received proposals. In former times the Nepal Industrial Development Corporation (NIDC) used to provide a similar service for tourism and agriculture/forestry projects, but this service was terminated in 1990 after a failed attempt to merge NIDC with the Ministry of Industry. Now financial institutions needed to rely on external experts or develop in-house expertise like the Clean Energy Bank (see box). SHPP conducted many events to bring this expertise to financial institutions, using training sessions with Swiss and local technical and financial experts.

“No risk – No Gain”

The idea that no worthwhile profit will be gained without a substantial amount of input is a well known concept when it comes to investment. Still, smart investors are aware of the risks they are taking and should know which opportunities exist to mitigate such risks. The table below groups the main risks that investments in renewable energies are exposed to.

For further information about risk management click here.

Risk	Description/examples	Mitigation
Hydrological and Environmental Risks	Landslides, floods; ESIA/permits;	Proper analysis; Building a school and temple.
	Socio cultural/community conflict.
Professional Risks	Cost/time overrun during construction	Turn key or CPE contracts? active monitoring, penalties to contractors in case of delay, insurance Guarantee from contractor, EM supplier and designer.
	Design failure or inability to reach designed output/performance during operation.
Political Risks	Risk of confiscation, expropriation and nationalization;	Improvement of political framework conditions – stability; Very limited influence by investors.
	Changed regulation on tax holidays;
	Political unrest; Strikes
Market Risk	Reliability of buyer	Good PPA, guaranteed for at least payback period; Different rates in dry / wet season.

Public and private investors and equity financing

The main advantage of working with these financiers is that they can bring in a lot of ‘non-financial resources’ like modern and efficient project management skills. This often leads to significant efficiency and productivity increases. Additionally, this kind of capital and the corresponding ‘non-financial resources’ have a leveraging effect of attracting debt financing at more interesting terms.
In the case of Nepal, these financiers have certainly had a good influence on single SHP projects and the growing volume of private SHP plants in operation. There is, however, a strong indication that organising this kind of capital through equity investment companies could result in better accessibility to capital for SHP financing. 

For further information about Project Financing click here.

Mechanisms and Mechanics of Perfecting Security under Project Finance

The following factors must be considered in the loaning of money on project finance basis for a hydropower project in order to perfect security.

Revenue: watertight arrangement for commercial operation during debt service period:

• PPA:
• Assign it to the lender(s) with the Nepal Electricity Authority’s (NEA) consent.
• Ensure that the revenue stream received from NEA is directed to a bank account specified by the lender. NEA will have to be approached for their concurrence.
• Designate such a bank account as an ‘escrow account’ in which the lender shall have the first lien.
• Allow the developer to withdraw money from such an account without any hindrance only to the extent necessary to operate the project plant and to maintain the plant in top condition pursuant to ‘prudent operating practices’.
• Money to be automatically transferred to the lenders for their debt service (both principal and interest thereon) on specified dates.
• Allow the developer to withdraw money from the account for the distribution of dividend to its shareholders, to the extent permissible based on fund balance in the escrow account after leaving an amount necessary to meet one (or the unit agreed between the borrower and lender) debt service obligation in immediate future.

Expenditure: watertight arrangement during construction period

• Assign all contracts or agreements, inter alia, related to construction, supply, transportation, erection or installation, consultancies (design, engineering, supervision, etc.) to the lenders so that they are able to continue to complete implementation and operation of the project in the case of borrower default by being able to step into the shoes of the borrower or have someone do so on the lender’s behalf. (Should even include employment contracts of key personnel that are indispensable for the implementation of the project!)
• Ensure that the borrower company’s equity-holders inject their equity, at least, on pari passu basis, if not more, during the implementation of the project.
• Ensure that both debt and equity for the project are injected into a dedicated bank account on which the lender has the first lien and outflows from this account are closely monitored by the lender.
• Ensure that proper contractual arrangements are made such that (a) cost and (b) time constraints are not exceeded. (Time overrun tends to be more expensive than cost overrun due to additional interest during construction, loss of revenue and even penalty to NEA for delayed delivery of electricity.).
• Ensure that there are no gaps and cracks between various contracts or agreements, which could increase the total project cost.
• Ensure that the borrower company has or is able to access the necessary contingency fund to complete the project even if the project cost goes up due to unforeseen reasons.
• Payments for construction closely supervised by lenders.

Safety-net: success or failure dependent on robust and sturdy safety-net of insurance

• Risk assessment should be made to prepare a risk profile, which will dictate the insurance program.
• Ensure that all necessary insurance policies are put in place in order to cover all exposures to all possible risks (e.g., CAR, EAR, TAR, ALOP, increase in cost due to devaluation, contractors’ equipment, third party liability, comprehensive workmen’s compensation, professional liability and so on and so forth). The words of the proposed insurance policies are to be finalized in consultation with the lender.
• Ensure that the lender is mentioned in such insurance policies as the co-insured in order to provide for the eventualities emanating from default by the borrower.
• Ensure that the project’s cost estimate has adequately budgeted for the payment of insurance premium.
• Documentation to perfect security
• Execute loan agreement between the lender and the borrower to sign off on the arrangements agreed and put in place as listed above.
• Have such agreement ‘registered’ wherein all tangible and intangible (various contracts, agreements, license, etc.) assets are mortgaged against the loan, enabling the lender to foreclose without having to resort to court of law.