Sharing hydro locally12 April 2019
A study by the International Finance Corporation (IFC) says that Nepal’s most vulnerable investors will benefit from improved safeguards on local shares in hydropower projects.
Nepal built its first hydropower project in 1911 and over the next eight decades the country’s hydropower development was government-led with international bilateral and multilateral assistance. However, as the political landscape of the country changed during the 1990s, local communities were able to increasingly voice their discontent about the social and environmental impacts of such project development. In an effort to negotiate and obtain acceptance in order for projects to proceed, hydropower companies, especially independent power producers, began communicating directly with project-affected communities. From this, the concept of project developers directly sharing the benefits of a hydropower project with the local community, and allowing them to invest in hydropower schemes through the purchase of local shares, was introduced.
Nepal has been leading the way in implementing this new form of local equity partnership in hydropower development. Currently, an important source of capital for hydropower projects, this practice has helped build project ownership and support among communities, as well as mitigate project disruption risks.
Since 2010, there has been great interest across Nepal for local investment in shares. During the Initial Public Offering (IPO) of almost every hydropower company in Nepal there has been an oversubscription of shares. To date, 17 publicly-listed hydropower companies have issued local shares equivalent to 10% of its equity, with oversubscription around an average of 30%. While over the past three years, 13 hydropower companies have gone public and raised around US$19M through their IPO from the general public, and another US$10M from the local communities.
Nepalese politicians, policymakers and the private sector are reported to be using such public enthusiasm to demonstrate how this unique financing mechanism can lead to imminent prosperity. While this is described as being further reinforced by hydro developers who have seen a partnership with the people pay off with dividends in the form of garnering project support, managing local expectations, and in raising project equity.
The Government of Nepal requires hydropower developers to offer up to 10% of their shares to communities affected by the project. With a goal to develop 10,000MW in the next ten years, as much as US$439M in equity could be raised from project-affected communities alone.
However, there is a general lack of understanding among the majority of stakeholders on how local shares actually work. Although local people have revealed that income from shares had helped them cover hospital expenses, purchase additional land and even finance their children’s education, there is little appreciation of the potential risks and challenges associated with such a market instrument.
In September 2018 the IFC, a member of the World Bank Group, released the first in-depth analysis of Nepal’s innovative benefit sharing policy. The objectives of the study, which was supported by the Australian and Japanese governments, was to develop a knowledge product that documents the practices of local shares in Nepal and evaluates local shares in relation to international benefit sharing practices in infrastructure development. The ultimate aim is to improve the overall approach to local shares through the assessment of risks, challenges and opportunities including measures to mitigate risks, improve participation of socially and economically vulnerable groups, and overcome the challenges in policy formulation and implementation.
Local Shares: An In-depth Examination of the Opportunities and Risks for Local Communities Seeking to Invest in Nepal’s Hydropower Projects found that the investment model offers great potential to create local ownership and increase public support for hydropower projects. However, it also found a widespread lack of understanding of how the market mechanism works, and a lack of effective safeguards to reduce risk to investors. This is especially true for women and others who are socially, economically and culturally disadvantaged.
Many poor rural households borrow at high interest rates or sell primary assets to invest in local shares. The study found they often have unrealistic expectations of returns, and are unclear on the risk of loss. That could explain why, despite a fall in value since their peak in 2014, demand for local shares continues to grow.
“If the intent of any benefit sharing mechanism in infrastructure development is to improve the lives of the project-affected communities, especially the vulnerable and traditionally marginalised, then the ability of local shares to ensure this particular outcome is fairly limited,” the report states. This is because the impact of local shares depends not only on the performance of the market, but also on each shareholder’s ability to make timely investment decisions. There is also a limit on the extent to which it can be made socially inclusive. In the case of local shares, the more affluent population in the communities, with their greater financial capacity and a stronger social safety net, can have a larger appetite for risk and hence the potential to reap higher rewards than their non-affluent counterparts.”
“The comprehensive consolidation of this report is very timely and will hopefully enable informed discussions at the policy level to improve and strengthen the local shares mechanism as a viable model of equity participation involving local people,” said Kulman Ghising, Managing Director of Nepal Electricity Authority.
Among other things, the report recommends that policies on local shares must find a fair balance between ensuring adequate protection for the local communities and ensuring that these policies do not drastically upend the accepted practices of hydropower development. “Such balance is important,” the report states, “because Nepal is already struggling to provide an enabling environment for investment, and will have to work harder to avoid placing unnecessary and excessive burden on the private sector.”
Equal consideration must also be given to the fact that investments, particularly investments made in a speculative market, are always going to have inherent risks that no policy regime can fully eradicate. The best way to minimise risks for local communities, according to the report, is to increase their understanding of how the capital market works and the fundamentals of the hydropower company they are about to invest in. For this, financial information needs to be simplified to be more easily understood by non-experts, and the state needs to invest in financial literacy programmes and impose stringent disclosure requirements to ensure that the general public gets accurate and timely information.
Other recommendations include:
- Defining the local share requirements in project bid documents.
- Creating low-risk mechanisms for vulnerable households to finance their share purchases.
- Computerising the share allocation process.
- Improving transparency and accountability by making it mandatory for all projects to put their information online.
In conclusion the report states that: “it is important to keep in mind that local shares evolved to fulfill a specific purpose and, as of now, it has served the purpose well: for local communities, it offers opportunity for capital gains that they aspire for; for hydropower companies, it offers the possibility of reducing project disruption through increased local ownership of their project. This equilibrium will likely continue to exist as long as both the local communities and the hydropower companies perceive local shares as a win-win situation for both.”
However, looking to the future, the IFC warns it will be difficult to predict the direction and impact of local shares on local communities, given the uncertainty in the Nepali capital market for hydropower company shares and likelihood of oversupply of hydro shares in the secondary market. The report advises that in pursuing policies on local shares the multiple facets of this phenomenon should be considered carefully.
“Nepal’s local shares model is unique. It recognises the importance of communities in private sector hydropower investment,” says Wendy Werner, IFC Country Manager for Bangladesh, Bhutan and Nepal. “IFC aims to ensure the private sector contributes to sustainable power development and that this investment opportunity is within reach of every citizen, balancing the potential returns with the project risks.”
This article was compiled from the full report called Local Shares: An In-Depth Examination Of The Opportunities And Risks For Local Communities Seeking To Invest In Nepal’s Hydropower Projects. By IFC in partnership with Australian Aid. 2018. See www.ifc.org for more details.