## Wednesday, June 15, 2022

### Reconsidering SEBI disgorgement

by Renuka Sane and S. Vivek.

SEBI disgorgement is a regulatory remedy to recover wrongful gains from entities that have violated securities laws. It is justified based on the equitable principle that no one should benefit from their own wrong. This seems like a non-controversial, even obvious, ground for regulatory action that has 'compelling intuitive appeal'. However, there are basic conceptual issues that are not clearly settled, not just India but in other jurisdictions as well. For example, the U.S. Supreme Court has considered three cases on disgorgement over the last few years - in one case, it held that disgorgement was beyond the powers of the Federal Trade Commission, overruling decades worth of practice, and in another, upheld Securities and Exchange Commission's power to seek disgorgement but with important conceptual restrictions.

These are trends that the Securities and Exchanges Board in India (SEBI) should be watching carefully. Lack of conceptual clarity about the remedy can put years of regulatory action at risk, if the basis of the remedy is questioned in a case before superior Courts. Further, a study of how SEBI orders are interpreting disgorgement powers and if they are consistent with the conceptual justifications is critical. SEBI disgorgement does not have any statutory limit - the order can direct recovery of all the wrongful gain, whatever they may be. This exercise of of vast discretion by SEBI Whole-Time Members (who are executive members of the regulator and typically do not have substantial judicial training), without transparent statutory or conceptual guidance, raises regulatory governance concerns.

In a new working paper, Reconsidering SEBI disgorgement, we study disgorgement from three perspectives:

1. The theory of disgorgement: Disgorgement is a distinct remedy that must be distinguished from other remedies such as compensation, restitution, and penalties. Disgorgement is different from compensation because compensation is focussed on the loss suffered by claimants whereas disgorgement is focussed on the gains made by the wrongdoer. While disgorgement and restitution are both gain-based remedies, there is a subtle yet important difference. Restitution is focused on reversing a wrongful gain of the defendant based, for example, on a wrong or incorrect transfer from the plaintiff. Here, the (wrongful) gain made by the defendant is equal to the loss suffered by the plaintiff - the property in question (money, for example), is returned to status quo. Disgorgement, on the other hand, strips the defendant of its gains, even if such gains are not made from the plaintiff, and even if the plaintiff does not suffer any loss. Accordingly, the loss suffered by the plaintiff need not correlate to the defendant's gain that is clawed back through disgorgement. The objective for disgorgement is to have a deterrence effect, and not to merely reverse an illegal transfer. Penalties are also generally imposed for the purpose of deterrence, among others. However, while disgorgement amounts must be equal to the gains made by the wrongdoer, penalties can be imposed merely on the basis of the violation and need not correlate exactly to the gains, if any, made by the wrongdoer.

2. The evolution of disgorgement at SEBI: SEBI had even in the early years tried exercising powers to claw back illegal gains (disgorgement), or compensate victims in insider trading cases, with mixed success at appellate fora. Subsequently, parliamentary and expert committees over the years have recommended providing SEBI with clear powers to trace the illegal gains made by wrongdoers and return such gains to their victims. Before such powers could be formalised through statute, disgorgement was used by SEBI Whole-Time Members (WTMs) as a quasi-judicial innovation in their orders,and received approval from the Securities Appellate Tribunal. Since, at that time, SEBI WTMs did not have the power to impose monetary penalties, SEBI disgorgement was justified as a 'remedial' power which only returns the wrongdoer to status quo, and hence can be distinguished from a punishment. Further, as there was no express statutory provision at the time for SEBI disgorgement, it was traced back to 'equitable' powers of SEBI WTMs.

In 2014, the Securities and Exchange Board of India Act, 1992 (SEBI Act), was amended to clarify that SEBI disgorgement was part of SEBI's remedial powers. The amendment also stated that the amounts so clawed back are not to be deposited with the Consolidated Fund of India as in the case of penalties; instead, they are retained by SEBI's Investor Protection and Education Fund, to be used in terms of SEBI's own regulations. Interestingly, despite tracing its origins to Parliamentary and expert committees which discussed disgorgement powers in the context of using the proceeds to compensate victims, the amendment did not require SEBI to even attempt to distribute the amounts to victims. Since then, SEBI's power to direct disgorgement without clear statutory limits has been entrenched. Gradually, SEBI also received judicial recognition for its power to impose interest on the disgorgement amount. These rates are calculated from the date of the violation, sometimes going back 10 years or more (as opposed interest on penalties which is typically calculated from the date of non-payment after the SEBI order). Further, the initiation of proceedings for disgorgement or penalties, remains with SEBI and it is unclear how it is exercised.

These vast powers are conferred on the regulator on the basis that SEBI disgorgement is only 'remedial' and is returning the wrongdoer to status quo. The use of the term 'disgorgement' while at the same time emphasising the return to status quo creates some confusion between the related albeit distinct remedies of disgorgement and restitution. In this context, we study whether in practice what kind of remedy SEBI disgorgement actually is, regardless of its nomenclature. Further, as a legal matter, returning the wrongdoer status quo is critical as a point of distinction from SEBI penalties; if the wrongdoer is left worse-off, it could be argued that SEBI disgorgement is a penalty by another name.

3. The practice of disgorgement at SEBI : If SEBI's case for disgorgement is based on clawing back illegal gains and returning the wrong-doer to status-quo, do they actually do so? We use all the SEBI disgorgement orders between January 1, 2018, and July 15, 2021, and find that in 9% of the cases there is no finding that the noticee has made a benefit or avoided a loss, and yet noticees have been ordered to disgorge. In none of the cases is there a finding that the direction brings the noticee back to status-quo and does not leave them worse off - a critical element in the justification for SEBI disgorgement and its characterization as a remedial power. Further, it is interesting that SEBI disgorgement is usually used for insider trading, and fraudulent trading offences, for which the SEBI Act allows penalties to be issued up to three times the profits made. Why is disgorgement, and not penalties, being used in these cases?

Our results suggest that lawmakers and the SEBI Board must review how SEBI disgorgement is conceptualised and what goals it serves. It should scrutinise how disgorgement orders are being issued under the existing framework so that they are consistent with the justifications for remedial measures (such as, allowing deductions for legitimate expenses and a transparent and careful system to determine causation of the gains from the wrong). A holistic look at remedies available for securities law violations is required so that they serve all the goals required for stakeholders - deterrence, compensation, and restitution.

S. Vivek is a researcher with the Regulatory Governance Project at the National Law School of India University, Bengaluru. Renuka Sane is a researcher at NIPFP. Author names are in alphabetical order.

## Friday, June 10, 2022

### Threats to legal certainty in government contracting by electricity distribution companies

by Akshay Jaitly and Ajay Shah.

### A battle in Andhra Pradesh, 2018-2022

In September 2018, electricity distribution companies in Andhra Pradesh (Discoms) filed a petition before the Andhra Pradesh Electricity Regulatory Commission (APERC) to reduce the feed-in tariff for wind power projects (that had been determined under Section 62 of the Electricity Act, where the regulator sets the price). Another petition was filed requesting APERC to revise the tariff payable by Discoms under solar power PPAs (this time discovered under Section 63 of the Electricity Act, where there is a competitive bidding process). The argument made by Discoms was that the tariff discovered in other states pursuant to competitive bidding was lower than the tariffs statutorily determined in Andhra Pradesh. There are also newspaper reports about the state load dispatch centre (SLDC) curtailing output by renewables generators, ostensibly in the interests of grid safety.

These attempts at reneging on contracts, by the state, go against basic notions of sanctity of contracting and legal certainty. When X contracts with Y, both are bound by and obliged to fulfil the terms of the contract, regardless of future fluctuations of prices and technology. The Indian Contract Act, 1872, and a line of case law under it, gives no space for either X or Y, as private persons, to renege on a contract because better prices had come about somewhere else in the economy.

It is also settled law that when the state enters into a contract, it does so in a commercial capacity and not as the sovereign. If the Indian state purports to renege on contracts in this fashion, it deepens the problems of the state as an untrusted counterparty, and fewer private persons will be willing to do business with the state in the future. This would harm the prices at which the state is able to enter into contracts.

As an example, consider a Jan 2022 story by Kailash Babar in the Economic Times, about NHAI terminating a contract with IL&FS which had been established in 2013. NHAI did not just walk away: it paid IL&FS Rs.891 crore for the privilege of terminating the contract. Concessions typically have a formula for termination compensation in three scenarios – authority default, no fault and concessionaire default. These are expressed as percentages of debt due plus some equity return and some other terms.

### Attempts at reneging on PPAs elsewhere in India

This experience from Andhra Pradesh is actually not unique. Discoms and regulators in Karnataka, Uttar Pradesh, Jharkhand and Tamil Nadu have subsequently attempted unilateral termination or renegotiation of renewable energy tariffs under validly executed PPAs.

Punjab took this one step further in November last year, by introducing and unanimously passing legislation to get out of its PPA obligations. A few months ago, we wrote about the Punjab Renewable Energy Security, Reform, Termination and Re-Determination of Power Tariff Bill passed in the Punjab Legislative Assembly. This law seeks to renege on PPAs that the Punjab state Discom had voluntarily entered into, on the basis that these created too heavy a financial burden on the state. This attempt by the state, to have immunity from contract performance, is under legal challenge.

A seminal skirmish took place a while ago, in Gujarat in 2013, where the Appellate Tribunal for Electricity had held with reference to the actions of a Discom in Gujarat, that a PPA could only be reopened for "giving thrust to renewable energy projects and not for curtailing the incentives". In other words, PPAs could not be reopened to reduce tariffs. In this case, Gujarat Urja Vikas Nigam Ltd (GUVNL) had filed a petition before the Gujarat Electricity Regulatory Commission (GERC) in 2013, asking for a revision in solar tariffs determined by the commission in its 2010 order on the grounds of reduced customs and excise duties, which would justify a downward revision of the tariffs. The GERC dismissed GUVNL’s petition and its decision was upheld by the Appellate Tribunal for Electricity (APTEL) on appeal. APTEL held that since GUVNL had not established that there is a legal right available to it to seek a redetermination of the tariff by reopening the PPA, the GERC would not be expected to revisit the generic tariff ‘to dis-incentivise the project developers and consequently discourage future investment in the sector’.

### How the Andhra Pradesh story played out

Despite this, solar and wind power developers challenged this in the High Court of Andhra Pradesh. A single judge bench of the High Court dismissed the Discoms' petitions in September 2019, with a direction to APERC to decide the issues raised by the developers.

But the High Court directed the Discoms to pay an interim tariff (lower than the tariffs under the PPAs) until APERC adjudicated the matter. The legal foundations through which the court chose to go against contract law are not clear. This created tremendous commercial difficulties in the industry. In some instances, there are reports that even this lower interim tariff was not being paid by the Discoms, causing further distress to power generators.

The typical renewables project is a tight arrangement of capital and PPA, with little room for contracting wobbles. Once the predictability of cash flows was disrupted, some of the generating assets were classified as 'non-performing'. The generators tried to go to court to force lenders to not do so.

This problem then showed up at a Division Bench at the Andhra Pradesh High Court. The case played out over three years. The Division Bench held that:

1. The tariff under concluded PPAs cannot be re-negotiated;
2. Financial difficulty of Discoms is not a ground to permit non-performance of the PPAs or to reduce the tariff set out under the PPAs;
3. A tariff determined through competitive bidding process under Section 63 of the Electricity Act cannot be re-determined; and
4. Since renewable energy plants operate on a ‘must-run basis’, any arbitrary curtailment of power by the state load despatch centre without notice and not based on grid security or safety reasons is illegal.

This was a salutory reaffirmation of the foundations of commercial law: Contracts must be honoured, statutory processes cannot be unilaterally set aside, power validly contracted under a PPA can only be curtailed for technical reasons. At the same time, in a well functioning market economy, these events from 2018 to 2022 -- and the associated commercial consequences for private persons -- should have never taken place. Every investor looks at this fracas and chooses a somewhat higher risk premium for doing business in India.

### Implications for the Indian legal system

It is important to analyse what shapes these attempts at state immunity from contract law. In what ways can laws be amended, or principles be evolved, so that such attempts are eliminated or at least minimised?

Perhaps the Andhra Pradesh Discoms will appeal to the Supreme Court of India in this matter; perhaps the challenge to the Punjab PPA law will find its way to the Supreme Court. It is then interesting to envision: What is the Supreme Court order that can usefully underline the foundations of the extant contract law, and thus reduce the incentives to embark on such manoeuvres?

While a Supreme Court order in this regard might act as a deterrent in the future, the problem lies in the culture of government institutions, who are conditioned to exhaust all available means of reducing costs, irrespective of the merits of their position and the chances of success, out of fear of vigilance authorities. A solution would be for the government to develop guidelines and instructions setting out the bases on which appeals should be pursued or not.

In developing such guidelines, some of the questions for the state to consider would be as follows: Suppose the probability of success of such attempts at renegotiating are 0. Is it still efficient for a state government to initiate it? As Karan Gulati and Shubho Roy emphasise in a forthcoming paper, could it be that the time value of money that is used in Indian court orders make it efficient for the state government to embark on litigation that it has no possibility of winning? We need to also analyse the Indian justice system from this point of view, and identify the reforms through which the incentive of a state government is reshaped.

### Implications for electricity policy

As we have argued before, the Indian electricity sector has suffered from difficulties for a long time, but the recent years represent an escalation of stress to a different level. This comes from the combination of low price renewables, volatility in fuel costs, the impact of ESG investors abroad upon electricity purchase by large Indian firms, and the accelerating exit of commercial and industrial buyers from discoms.

It is sometimes comforting to think that discoms in India have always had problems. But the problems seen today are worse. Faced with extreme stress, there is an appetite for extreme measures. When the policy process is weak, there is a greater likelihood of poorly designed policy measures being adopted, such as attempts at reneging on contracts. When even a few discoms engage in such behaviour, this reduces the investability of the Indian electricity sector in areas that have connections with the Indian state.

We should see each of these eruptions as illustrations of the underlying stress, and reorient ourselves towards the required fundamental electricity reform.

## Friday, June 03, 2022

### How "Orderly" is the Evolution of the Indian Yield Curve?

"Financial market stability and the orderly evolution of the yield curve are public goods and both market participants and the RBI have a shared responsibility in this regard."

Shaktikanta Das, Governor, RBI, October 2020

"Right from October 2020, we have given explicit guidance to the bond market. We expect an orderly evolution of the yield curve, it cannot be otherwise,"

Shaktikanta Das, Governor, RBI, February 2021

As the Covid pandemic has ebbed, central banks across the world are withdrawing the extra-ordinary easy monetary policy that was followed by them since the onset of the pandemic. Reserve Bank in India (RBI) is no exception. A week ago, it took the extra ordinary step of convening an ad-hoc meeting of the monetary policy committee (MOC) to hike the policy interest rates by 40 basis points and also increase the cash reserve ratio (CRR) for banks to take out liquidity from the banking system.

As this “normalisation” of the monetary policy unfolds, its impact on the financial stability has become a matter of concern. The statements of the RBI Governor quoted above, reflect the concern RBI has on financial stability and the evolution of the yield curve. While financial stability is a broad, all encompassing term, evolution of the yield curve is a much more specific idea that can potentially be objectively assessed. In this article I try to assess the orderliness of the evolution of the yield curve over the last four years.

Yield curve describes the basis interest structure in the economy. As the central bank takes policy actions bonds markets reprice the yields and the shape of the yield curve changes. As a fundamental input to pricing of a wide array of assets, predictable and orderly evolution of the yield curve is indeed desirable. High volatility and unpredictability in the evolution of the yield curve, especially when the policy actions taken to normalise monetary policy and regain the GDP growth trajectory post the pandemic, could result in mispricing of financial assets. RBIs concerns and expectation of such orderly evolution are understandable.

In this article, I try to assess the orderliness of evolution of the yield curve. I use data on the yield curve for the 4-year period of 1 April 2018 to 10 May 2022 to empirically assess how the yield curve has changed during this period. To be clear, this article does not evaluate the merits of the RBI’s intent or efforts at managing the yield curve; it only attempts to empirically assess how the yield curve has behaved over this period.

### Assessing the evolution of the yield curve:

While it is easy to understand why policy makers would want the yield to evolve in an “orderly” manner in response to policy actions, it is not very easy to define what exactly an orderly evolution means. Trading in government securities takes place every day where all types of financial institutions participate. Even the RBI, through its treasury operations and open market operations participates in the government bond market. The collective actions of all these players determine the prices of government bonds and hence the yield on them.

We could hypothesise orderly evolution to mean that the daily changes in the yields across the curve are smooth and stable. There are two parameters we can look at the describe such smooth and orderly evolution – the volatility of daily yield change and the correlation of changes in yields across varying maturities. If the volatility of daily change in yields remains low and the correlation of yield changes across maturities is high, then it would mean that the yield curve is moving with the policy rates, in a non-disruptive and predictable manner. Such a yield curve can be considered as evolving orderly. On the other hand, increased volatility of daily change and reduced correlation would signal increase in the “disorder” in the evolution of the yield curve.

### Data and analysis:

The data for this analysis is the daily yields data on the 3 month treasury bills (T Bills), 1 year, 3, year, 5 year, and 10 year maturity government securities (GoI securities) from 01 April 2018 to 10 May 2022, a total of 993 trading days of data obtained from Bloomberg. Of these maturities the 10-year securities are the most liquid and provide data for every trading day. For the other securities there are days where there would be no trading and hence no data would be available. We consider the previous days yield to continue for such non trading days which means that the change in yields for such days is considered to be zero.

For the purpose of my analysis, I divide the data into 4 time periods as follows:

The first period is from 1 April 2018 to 11 February 2019 which can be called the "pre low interest rate" period. RBI started cutting policy rates from February 19 up until May of 2020. Hence this is the period of stable policy rates. This period has data for 215 trading days.

The second period is from 19 February 2019 to 31 October 2020 is the "downward policy rates and pandemic period" when policy rates were reduced regularly to hit the lowest rate of 4% of repo by May 2020. I extend the period to Oct 31,2020 as RBI clearly started focusing on orderly evolution from October onwards. This period gives us data on 411 trading days.

The third period is from 01 November 2020 to 31 December 2021 which starts with the date of RBI publicly announced its focus on orderly evolution of the yield curve and ends with roughly the end of the pandemic and the reopening of the economy. While the end date is admittedly somewhat arbitrary it coincides with global trend towards rising rates that started in January 2022. This period gives us data on 282 trading days.

The fourth and the shorted period is from 01 January 2022 to 10 May 2022 is the last period where Indian interest rates started inching up (along with interest rates across the world). It includes a few days of data post the surprise, out of turn policy rate hike in May 2022. This period has data on 85 trading days.

For each of these four periods, I compute the following:

• Daily change in the yields of each of the four maturity GoI securities.
• Average daily yield change and the standard deviation of the change in the daily yield which I use as the measure of volatility of the daily change.
• Correlation between yield changes of these 4 GoI securities.

### Results:

Figure 1 below presents a chart of the daily yield change in these 4 securities over this entire period of little over 4 years and 993 trading days.

Figure 1: Daily Change in Yields on GoI Securities in Basis Points

Source: Bloomberg, author’s analysis

Overall, the chart shows that the volatility of the daily change seems to go up with the onset of Covid in March 2020 with larger and more frequent spikes. This is especially true for the lower maturity; the 3 year and the 1 year maturity securities.

In order to understand the trends in the pattern of the daily change in yield, I plot the 30-day moving average of the daily change in yield as presented in Figure 2 below.

Figure 2: 30 Day Moving Average of Daily Change in Yields on GoI Securities in Basis Points

Source: Bloomberg, author’s analysis

Figure 2 clearly shows a pattern in the changes in the yield curve. The first period has much smaller change daily change in the curve and the changes across maturities are fairly highly correlated. The second period shows much more volatility in the daily change and a significant reduction in the correlation between yield change across maturity. This volatility comes down in the third period and the correlation improves, probably as an outcome of RBIs repeated exhortations and possibly actions in the bond market. The last period shows further reduction in volatility but the correlation is still lower than in the first period indicating that RBIs notices to the bond market and actions have had some success.

In order to more concretely understand the volatility and correlations across these periods, next two charts present the mean daily change in yields and the volatility of the daily change measured as the standard deviation of the daily change in yield.

Figure 3: Mean Daily Change in Yields on GoI Securities

Source: Bloomberg, author’s analysis

This chart clearly describes the interest rate trends in these four periods. The first period had, by and large, stable yield curve with very small changes in yields. The second period shows a secular decline in interest rates across all maturities in response to policy rate changes. The third period shows a reversal of trends and modest rise of interest rates ie the upward movement of the yield curve which becomes much more pronounced and sharper in the fourth period.

Figure 4: Volatility of Daily Change in Yields on GoI Securities

Source: Bloomberg, author’s analysis

This chart shows that the volatility of yield changes has indeed gone up noticeably in the third period when the overall rates showed an increase. The volatility increased especially for the shorter maturity papers – 1 year and 3-year maturity. This probably is the basis of the RBIs focus on ‘orderly’ evolution and hints to the bond market of its discomfort with high volatility. The fourth period shows that the elevated volatility has persisted which means that the bond market has responded only modestly to the RBI’s exhortations. Another important feature to note is that the volatility of the 10 year and the 5 year maturity securities has been contained in the third and the fourth period while that of the shorter maturity securities has continued to remain high. This possibly could also be due to RBI’s targeted interventionsh in the bond market to contain the rise and volatility of yields on long term securities.

Finally, I look at the correlations of yield changes across these maturities. Table below presents the correlation matrix of the four periods.

Table: Correlation Matrix for Yield Change in GoI Securities of Varying Maturities

Source: Bloomberg, author’s analysis

The correlation matrix shows high correlations between yield changes in the first period that start going down in the second period and decline precipitously in the third period. While they improve in the fourth period, they are still below the high levels of the first period. Clearly, the yield curve moved more haphazardly in the third period with high volatility and low correlation between yield changes across maturities. The fourth period shows improvement in correlations probably due to RBIs constant notices to the bond market (and its possible interventions in the market), they do not reach the levels of the first halcyon period.

### Conclusion:

This data shows that RBI concern on orderly evolution of yield curve is well placed. The data clearly shows that in period 2, as the policy rates came down, the yield curve volatility shot up. It may well be that the RBI’s focus during this time was on keeping the long-term interest rates low to facilitate economic recovery during the pandemic. The bond market, on the other hand, was concerned about the economic impact of the pandemic and resulting tussle between the RBI and bond market participants actions resulted in increased volatility and break down of correlations in yield movements across maturity. RBI became aware of this volatility towards the third quarter of fiscal 2022 and realised that low rates will not be enough for economic recovery and the excess volatility must be curbed. As it started expressing its desire of an orderly evolution (accompanied possibly by market interventions) there was a modest decline in volatility and improvement in correlations. However, the markets are still not anywhere close to the halcyon pre-pandemic period.

Harsh Vardhan is an independent management consultant and researcher based in Mumbai. The author thanks Surbhi Bhatia for research assistance, and Josh Felman and anonymous referees for very useful comments

## Saturday, May 14, 2022

### Consumer Grievance Redress in Indian Financial Markets

by Vimal Balasubramaniam, Renuka Sane and Srishti Sharma.

Consumer financial protection, the world over, has become a core function for regulators in financial markets. One aspect of consumer protection regulation is handling customer complaints. Analysing consumer complaints is important to not only evaluate the functioning of the consumer complaints mechanism, but also because it provides useful feedback for policy. All financial regulators in India mention consumer protection in their regulations, and have some mechanisms for consumer grievance redress and enforcement. However, systematic evidence on the grievances consumers face, and how the complaints mechanism responds to the complaints is missing. There is no work thus far that also maps actual incidence of grievances to those observed by the regulatory system --an important metric for policy and institutional design for grievance redress.

In a new working paper, Consumer Grievance Redress in Indian Financial Markets, we offer the first systematic evidence through a representative survey in the National Capital Region (NCR) region in India, on the extent of grievances in retail financial markets and how much the formal complaint mechanism actually misses. We also offer evidence on the type of grievances, and the reasons people don't complain. Our results suggest the following:

1. Official estimates of complaints under-report total grievances by 60-80 times. That is for every complaint on banking and payments that makes it to the regulatory system, there are 60 grievances that do not get reported. For every official complaint on insurance there are 88 complaints that do not get recorded.

2. Grievances in banking and payment mostly pertain to "transaction issues" such as delays in payments, and technology malfunction. Grievances in insurance, however, often pertain to "non transaction issues" such as mis-selling and fraud.

3. When presented with hypothetical scenarios most respondents say they would lodge a complaint. However, in reality, very few of them do. This suggests that there are a number of frictions in the process - ranging from limited information about the process, to limited faith that a resolution is even possible.

4. Those in vulnerable groups (with low education and low assets) are less likely to voice their complaints, and more likely to not have enough information about the redress procedure.

We hope these results provide inputs to the design of grievance redress mechanisms in financial markets in India. In order to sustain participation in, and enable the efficient use of financial markets by households, a two-fold approach is required. First, there is a need for generating meaningful data on consumer experiences with financial products, and grievance redress frameworks while they interact with retail financial products and sales practices. This will enable an understanding of how the current system works, and whether it can be scaled from a banked population of 300 million it currently serves to over a billion Indians it will be expected to serve. Second, there is a need for a contextualised learning of what the principles and design of a grievance redress system that needs to cater to more than a billion Indians ought to look like. Our research is a step in this direction.

Renuka Sane and Srishti Sharma are researchers at NIPFP. Vimal Balasubramaniam is a researcher at Queen Mary University, London.

## Call for Papers: Field Workshop on Household Finance

25th June, 2022

XKDR FORUM and DVARA RESEARCH FOUNDATION invite submissions for a one day workshop which is being planned for June 25, 2022. The workshop will feature three research papers and one panel discussion. The workshop aims to cover presentations and discussions across the following set of research topics:

• Household portfolio choice
• Personal insolvency
• Financial inclusion
• Impact of payments and fintech
• Consumer protection in retail finance
• Regulation of retail financial markets

Preliminary versions of the paper may be considered provided that the research question is clearly outlined along with preliminary results.

Please send in your submissions before May 25, 2022. Selection decisions will be announced by June 6th, 2022. For further queries and submissions, write to outreach@xkdr.org

## Tuesday, April 19, 2022

### Implications of free transmission of renewable energy

by Akshay Jaitly and Ajay Shah.

### Inter-state electricity transmission

Transporting electricity across long distances requires investments in the transmission system where high voltages are used to minimise losses. An emphasis on renewable electricity generation requires significant new transmission capacity to transport electricity from the natural locations for generation (e.g. Himalayan hydel, or SPV in Rajasthan) to the centres of consumption in the peninsula. In an announcement in December 2021, 23 inter-state transmission system (ISTS) projects have been initiated by the government, at a cost of Rs.159 billion.

As with other elements of the electricity system, investments in transmission would ideally be done through the price system, where the price for transmission is discovered on a market. Once the price system is in motion, present or anticipated high prices would create incentives for investment in transmission. The structure of the Indian electricity market does not permit this: as this announcement of 23 projects shows, we effectively have a centrally planned system where officials control the resource allocation, and only bring in private firms as vendors playing a defined role in a centrally planned system. Transmission investments and prices are largely government controlled, and not discovered through the price system, which always involves misallocation of resources.

In the remainder of this article, we discuss the outlook on ISTS and its implications for renewable energy. To summarise ISTS, it is an electricity grid that runs across the entire country. It connects to end-points who are either generators or users. There is a process, and there are rules and capacity constraints, which determine whether a given person gets on to ISTS. Once a person is physically on ISTS, they are directly buying and selling from others on ISTS; these transactions are immune to the policies of the local discom. There is one constraint: the buyer and seller on ISTS cannot be within the same state.

### Special prices for transmission of renewables

The CERC (Sharing of Inter-State Transmission Charges and Losses) Regulations, 2010 had some remarkable clauses: 7(u) and 7(v) established that for a period of three years, solar generation would be charged zero rates for transmission charges or losses. This suggested a world where a solar generator could sell to any buyer in India with no friction from transportation. These zero charges have been expanded and carried forward to cover all renewable energy commissioned till 30 June 2025. For renewable energy projects commissioned prior to 30 June 2025, for a period of 25 years, there will be no charge for transmission. For projects commissioned from 30 June 2025 onwards, the charges come back in gradually, to a level of 100% of the normal charge for projects commissioned after 1 July 2028. This creates a special deal for any renewables project that gets to the finish date by 30 June 2025.

Open access through discoms: In the present legal system, discoms are supposed to give out ‘open access’, where a buyer and seller of electricity are able to privately negotiate transactions, and have guaranteed access to the transportation services of the discom for the transport or electricity within or outside the state. In practice, this de jure situation does not map out into the de facto: many discoms refuse to provide or otherwise impede these services, as they would like to continue overcharging their best customers.

Open access through ISTS: Transmission across the state border through the ISTS seems to offer an increasingly viable way out of this barrier. It appears that when a renewables generator connected to the ISTS network sells to a third party outside the state who is also connected to the ISTS network through a PPA, neither of the two discoms can impede the transaction. This has been possible for a while, but the expansion of ISTS mentioned above will make such transactions more accessible to a wider range of sellers and buyers.

We could thus have generator $A$ in Dahanu (at the north end of Maharashtra) who is unable to sell to a buyer $B$ in Palghar (40 kilometres away), but she would be able to sell to a buyer $C$ who is across the state border in Vapi (at the south end of Gujarat, 70 kilometres away), assuming that connectivity to ISTS exists.

### Implications

There are two kinds of ‘free’ in the title of this article. One refers to transportation of electricity without paying for it. Another refers to economic freedom: rational transactions under open access which are impeded and disincentivised within and across states (between a renewables generator and a buyer) and those using ISTS that are seemingly encouraged across the state border. What are the implications of these two kinds of free coming together?

There is no free lunch. When transportation is subsidised for renewables, someone has to pay for this. This can either be an explicit on-budget subsidy, or it can be a within-sector subsidy. In the Indian case, when government-owned transmission utilities undercharge transmission for renewables, this comes with higher prices for fossil fuel generators. Such tax-and-subsidy policies normally require sophisticated public finance analysis, which is not visible, thereby elevating the risk of unanticipated effects.

The ability of renewables generators to frictionlessly transport electricity across state borders is likely to significantly impact upon the distorted pricing being run by discoms. The paying customers (C&I) in any state have a strong incentive to cut the discom out of the transaction and directly buy from any generator. In addition, some C&I customers have ESG equity investors, and need to demonstrate they are using renewable energy. Both imperatives create incentives for C&I customers in each state to find a renewables generator somewhere in India (but not in their own state, where ISTS transactions are absent), and buy directly, thus avoiding the exaggerated prices charged by the discom and freeing themselves from their often unreliable service.

We will have situations where a Gujarat renewables generator will sell to a Maharashtra C&I customer, while at the same time a Maharashtra renewables generator will sell to a Gujarat C&I customer. At an engineering level, transmission between two states would only take place in one direction, and the two streams would get netted out. This would yield the efficient outcome where in each state, buyers and sellers achieve higher economic freedom, and are less controlled by the discom.

Zero or low pricing for transmission of renewables has been around for a while, but earlier there were capacity constraints in inter-state transmission which was holding back this process. The substantial expansion of the ISTS described above would help translate the threat of exit by an increasing number of C&I users into a reality. The rise of ESG investment is also relatively recent. We would hence hazard a guess that these transactions will become more important by 2023 and 2024.

In a recent paper, we argued that the Indian electricity sector in 2021 or 2022 is different from what was seen in the preceding 30 years. While electricity went along a muddled path of non-reform for decades, while private participation only came into the edges of a fundamentally centrally planned system, the stress on the incumbent system is mounting. We are coming to the point where the good old ways are untenable. Inexpensive ISTS, which enables C&I customers to buy cheap renewables from across the state border, adds to this scenario. Other recent developments are also pushing discom finances over the edge [example].

We expect that increased ISTS access will increase economic freedom, and help private investors think more in terms of market opportunities rather than regulatory constraints. But this present moment of the policy configuration will also not be seen as stable, for a 25-year horizon, by private investors. What the state giveth, it can equally take away. All in all, we expect that discom finances will weaken, the ROE in renewables will go up, but the impact upon investment will be somewhat muted owing to fears about the next string of policy actions.

## Wednesday, March 30, 2022

### Energy transition investment in India and in the world

by Akshay Jaitly and Ajay Shah.

At a time when the 20th century has returned, in terms of geopolitical conflicts, we should not take our eyes off the climate change problem. CO2 is a global pollutant, and it will be harder than ever to get the world economy to safety, so we will need to make more of an effort.

### Measuring energy transition investment in 2021

BloombergNEF builds an important annual statistical picture in the Energy Transition Investment Trends' report. The 2022 report measures global investments into the carbon transition. They break this down into two groups: the direct energy transition investments, and the investments in R&D for improved technology.

The headline numbers for 2021 are that there was \$755 billion of energy transition investment and \$165 billion in technology development, adding up to \$920 billion. Under energy transition investment', the sub-components that are tracked by BloombergNEF are (a) Renewable energy; (b) Energy storage; (c) Electrified transport; (d) Electrified heat; (e) Nuclear; (f) Hydrogen; (g) CCS and (h) Sustainable materials. For the Indian economy, it is largely a story of learning, purchasing and implementing the technology developed elsewhere in the world. As an example, many people all over the world invested in, and took the steps on the journey to, cheap solar photovoltaics. We in India are the beneficiaries by being able to buy solar panels or the machines that make solar panels, without needing to invest risk capital in developing the technology. We also can do M&A, like Reliance Industries’ buyout of solar cell and panel manufacturer REC Solar Holdings for \$771 million in late 2021. Hence, for the remainder of this article we focus on the \$755 billion of energy transition investments (worldwide) in 2021. ### The big facts Of the \$755 billion, there are two large components -- \$366 billion into renewable energy and \$273 billion into electrified transport. But there are also many other things going on (energy storage, electrified heat, nuclear, hydrogen, CCS, sustainable materials), adding up to the remaining \$116 billion. Investment into the energy transition has grown well. A decade ago, this was at \$264 billion, thus giving an average compound growth of 11% per year in USD.

The report estimates that to get to net zero, these numbers need to triple to 2025 and then double to 2030. Overall, a six-fold rise is required from 2021 to 2030.

Energy transition investment in 2021 in China was at \$266 billion (out of the total of \$755 billion), and in India it was \$14 billion. The Chinese GDP is about five times larger than India, but their investment in the energy transition last year was 19 times larger than India's. If we apply the Indian share in world GDP of 3%, the value of Indian energy transition investments should be at \$23 billion. If we relate this to the Indian share in world CO2 emissions of 7%, this should be at \$53 billion. By these two normative yardsticks, then, energy transition investment in India needs to be 1.6 or 3.8 times bigger than it is. ### What impedes the energy transition in India? If we multiply the present value of \$14 billion a year by 6 x 1.6 or 6 x 3.8, we get to the estimated required investment in India for 2030 of \$134 billion or \$319 billion. Such values cannot be obtained from the fiscally stressed Indian exchequer. They can only be obtained from the private sector. But the private sector is still skeptical about energy investment in India (as is evidenced by the relatively low value of \$14 billion in 2021). The present policy frameworks for the sectors that receive energy transition investments have been in place for decades. Intensification of these frameworks, or better implementation of the present policy paradigm, is unlikely to shift the needle sufficiently. For instance, persisting along this path will mean that electricity in India will continue to be unreliable, expensive and carbon-intensive. When we look at the landscape of \$755 billion of investment in 2021, it is not, China apart, taking place in a world of central planning; it is in a world in which the government sets up the foundations through which the price system operates, and then the precise decisions about technology and business model are made locally by private persons. This is the key transformation that is required in India. The decision to put up a solar plant or build an electrolyser should be made by an individual looking at the prospective profit, not a government official who puts out a tender. The decision to put up a storage facility should be made by a private person who sees opportunities in a large gap between the highest price of the day and the lowest price of the day.

As we argue in a recent paper, the problems of the Indian climate transition are now beyond the calibrated control of officials. The government controlled system is experiencing substantial stress, owing to the contradictions inherent in it. A centrally planned system is ill equipped to think about technical and business model problems in each square kilometre of India. Government control will tend to push simplistic solutions that will drive up the cost imposed upon society for the energy transition.