Local Shares Summary Report AN IN-DEPTH EXAMINATION OF THE OPPORTUNITIES AND RISKS FOR LOCAL COMMUNITIES SEEKING TO INVEST IN NEPAL’S HYDROPOWER PROJECTS IN PARTNERSHIP WITH © International Finance Corporation 2018. All rights reserved. 2121 Pennsylvania Avenue, N.W. Washington, D.C. 20433 Internet: www.ifc.org The material in this work is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. IFC encourages dissemination of its work and will normally grant permission to reproduce portions of the work promptly, and when the reproduction is for educational and non-commercial purposes, without a fee, subject to such attributions and notices as we may reasonably require. IFC does not guarantee the accuracy, reliability or completeness of the content included in this work, or for the conclusions or judgments described herein, and accepts no responsibility or liability for any omissions or errors (including, without limitation, typographical errors and technical errors) in the content whatsoever or for reliance thereon. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. The findings, interpretations, and conclusions expressed in this study do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The contents of this work are intended for general informational purposes only and are not intended to constitute legal, securities, or investment advice, an opinion regarding the appropriateness of any investment, or a solicitation of any type. IFC or its affiliates may have an investment in, provide other advice or services to, or otherwise have a financial interest in, certain of the companies and parties. All other queries on rights and licenses, including subsidiary rights, should be addressed to IFC’s Corporate Relations Department, 2121 Pennsylvania Avenue, N.W., Washington, D.C. 20433. International Finance Corporation is an international organization established by Articles of Agreement among its member countries, and a member of the World Bank Group. All names, logos and trademarks are the property of IFC and you may not use any of such materials for any purpose without the express written consent of IFC. Additionally, “International Finance Corporation” and “IFC” are registered trademarks of IFC and are protected under international law. Cover photo credit: Sophia Khatun Tamot 2018 Acknowledgements T his study was carried out by a consortium of Policy Singh (Asian Development Bank), and Marcelo Andrade Entrepreneurs Inc., Pioneer Law Group and Kriti (Pronatura International). Capital Investments Ltd, with the International Centre for Integrated Mountain Development as a Tremendous support and guidance was provided by Justin knowledge partner. The primary authors were Nirjan Rai Pooley, Pablo Cardinale, Debra Sequeira, Lopa Shah, and Padmendra Shrestha. The contributing authors were Kamal Dorabawila, Sunrita Sarkar, Jamie Fergusson, Anup Raj Upreti, Deepesh Vaidya, Narayan Chaulagain, Elizabeth White, Edmond Mjekiqi, Wendy Jo Werner, Sandeep Karki, Bhawana Baniya, Srijana Bhattarai, Mohammad Rehan Rashid, Lakhdeep Babra, Hyun- Shreeya Rana, Suman Basnet, Jyotsna Tamang, Ankita Chan Cho, and Morgan Landy. We recognize the ongoing Shrestha, Binod Bhattarai, Shristi Sijapati, and Pratikshya support of IFC’s Environmental and Social Governance Dahal. Department and Infrastructure Department, as well as the feedback and collaboration of colleagues at The World The IFC team that commissioned and led the study was Bank Group. Kate Lazarus (Team Lead), Sophia Tamot (Technical Coordinator), and Upasana Pradhan Shrestha who We are thankful for the generous support from the provided constant encouragement, guidance, and feedback Australian and Japanese Governments and The Rockefeller throughout the study. They were also instrumental in Foundation. setting up the independent consultative panel of national and international experts who provided strategic guidance We are grateful to all the key informants and participants and key input at various phases of the study. at the stakeholder meetings representing various sectors including, but not limited to, the government, public utility, We are immensely thankful to our panel members: power producers, banks, merchant banks, and regulators. Sambriddhi Kharel (Gender Specialist), Kulman Ghising Their participation helped the team capture diverse (Nepal Electricity Authority), Niraj Giri (Securities Board perspectives on the issue of local shares. of Nepal), Maha Prasad Adhikari (Investment Board of Nepal), Sagar Gautam (Ministry of Energy, Water During the field visits, local communities in Rasuwa, Resources and Irrigation), Pravin Raman Parajuli (Nepal Solukhumbu, Dolakha, Lamjung, and Ilam enthusiastically Merchant Bankers’ Association), Bir Bahadur Ghale participated in focus group discussions and individual (Hydro Developer), Deepak Gyawali (Water Expert interviews. We thank all participants from the local & Civil Society), Khadga Bisht (Independent Power communities for sharing their insight and experiences. The Producers Association of Nepal), Dal Bahadur Adhikari hydropower projects visited were highly supportive towards (Ministry of Law, Justice & Parliamentary Affairs), the study. We are especially thankful to Sanima Mai, Mahesh Aryal (Ministry of Finance), Joon Hyung (Nepal Chilime, and Solu hydropower companies for allowing the Water & Energy Development Co.), Arbind Kumar team to visit the project generation sites, and Sanima Mai Mishra (National Planning Commission), Abhishek for helping to coordinate with the local communities. 3 Local Shares Summary Report EQUITY PARTICIPATION unanticipated capital gain windfalls. Chilime’s management in response, welcomed this new group Local shares in Nepal is an evolving concept of equity of potential equity investors and worked proactively participation where project affected communities have with the securities regulator, issue manager, and local a constitutional right1 to invest in a hydropower project communities including social volunteers and teachers to company. Currently, an important source of capital for mobilize local capital, without additional costs, dispel hydropower projects, this practice has helped build doubts where such beliefs persisted, and promote a project ownership and support among communities and transparent, inclusive approach, where possible. thereby mitigate project disruption risks. LEGAL FRAMEWORK Nepal has been leading the way in implementing this The requirement for “…up to 10 percent…” of local shares new form of local equity partnership in hydropower can be traced back to the period between 2008 and 2010 development. This study examines the Nepali local shares when the first legal basis for local shares was established phenomenon, its potential for benefits against existing through the Securities Registration and Issuance risks and opportunities, and identifies areas where there is Regulation (2008)2 that provided an up to 5 percent significant room for improvement. option for public companies engaged in hydropower to set aside local shares. This was subsequently amended to “… EARLY EMERGENCE up to 10 percent...” following immense political pressure The inception of the local shares practice, in its current fueled by a petition to the Supreme Court3 by local form commenced with the development of the 22.1MW communities affected by the Chilime hydropower project, Chilime hydropower project company, a subsidiary of the along with the setting of another precedent by the 456MW Nepal Electricity Authority, when it acquiesced to local Upper Tamakoshi Project that had recently negotiated a 10 demands for equity shareholding. percent equity stake with local communities. The timing of this development in 2010, is of particular A clear methodology is prescribed for hydropower significance, as the company had completed almost seven companies wishing to go public, which requires an allotment years of operation and was already profitable, when the of up to 10 percent of equity for local communities during issuance of local shares was announced. the first phase of the Initial Public Offering (IPO) followed by a minimum of 10 percent equity during the second phase The primary driver behind the eventual vocal of the IPO for the general public.4 The study also examined local demand was a keen desire of project affected alternate delivery mechanisms and concluded that the communities to join the exuberance of existing current system was the simplest and most viable. However, shareholders, which included NEA employees and for companies that wish to remain private, the study has members of the public, who had been enjoying identified a few alternate options.5 1 The Constitution of Nepal, 2015: Article 59(5) provides that while using the natural resources by the federal, provincial or local government, the local community shall be given priority to make investment in such percentage as specified by the law on the basis of nature and size of investment. 2 Rule 7(5) of this regulation reads: the body corporate, while making public issue of securities pursuant to these regulations, may reserve … up to 5 percent for the local residents depending on the nature of business like hydropower … out of the shares set aside for public issue. Additionally, SEBON added that the shares reserved as such shall not be eligible to be sold or transferred within a minimum period of three years from the date of allotment. 3 Local communities affected by Chilime hydropower project continued to stage protests at the project site even while the case was being adjudicated at court, de- manding their right to 8 percent equity, as per their agreement with the project. 4 The local shares category has a lock in period of 3 years while the general public shares can be traded immediately. 5 Refer to main report for more details. 1 CURRENT EXUBERANCE TREND OF HYDROPOWER INDEX9 Since 2010, there has been an outburst of interest from communities across Nepal to invest in local shares, as evidenced by the oversubscription of shares during the IPO of almost every hydropower company in Nepal. Nepal’s politicians, policymakers, government6 and the private sector have also been leveraging this overwhelming public enthusiasm to feed the political narrative that harnessing Nepal’s hydro through its own resources7 is the path to imminent prosperity. This unique mechanism of financing is 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. To date, 17 publicly-listed hydropower companies8 have Interviews with women and men revealed that income from issued local shares equivalent to 10 percent of its equity. shares had helped them cover hospital expenses, purchase The oversubscription has been by around 30 percent additional land and even finance their children’s education. on average. In the secondary market, the hydropower Of particular significance cited was the benefit from bonus sub-index mirrors the volatility of the NEPSE index. In shares issued over the years. For example, a family of the last three years, 13 hydropower companies have gone four who had purchased 160 units at IPO now had 384 public and raised around NRs. 1.9 billion ($19 million) units in ten years.10 This was seen as equivalent to saving through their IPO from the general public and another money, which otherwise would have been spent had they NRs. 1 billion ($10 million) from the local communities. not purchased shares. For women in particular, owning an On July 8, 2018, 456MW Upper Tamakoshi hydropower asset for the first time in their life built self-confidence, and company announced a local share offering for NRs. the additional income helped provide a sense of financial 1 billion ($9 million). With an increasing number of security. Additionally, visits to the bank or an urban area hydropower companies seeking SEBON’s approval for for work related to share application or trading was eagerly IPOs, all of these indicators are likely to considerably anticipated by some women as an outing opportunity. increase in the coming years. LIMITATIONS However, one major problem that exists in this apparent Attempts to gauge and learn from local communities’ ‘win-win partnership’ is the general lack of understanding experiences were restricted by limited case studies as among the majority of stakeholders on how local there were very few companies whose stocks were trading shares actually work. Much of the rhetoric around in the secondary market (instances where the local shares this phenomenon has been dominated by its optimistic had crossed the 3-year lock in period to qualify for potential to deliver almost guaranteed profits at the trading), hence, making it impossible to ascertain and individual level with little appreciation of the potential learn from how the stock of companies will perform in risks and challenges associated with such a market the secondary market. What is also clear is that despite instrument. 6 For example, the Vidhyut Utpadan Company, established under the Company Act with joint ownership of the MoEWRI (20 percent), NEA (10 percent), Ministry of Finance (5 percent), Ministry of Law and Justice (5 percent), Employees Provident Fund (10 percent) and Nepal Telecom (10 percent), Citizen Investment Trust (5 percent), HIDCL (4 percent) and Rastriya Beema Sansthan (2 percent) is expected to issue 17 percent of its shares to the general public, 10 percent to locals affected by its hydropower projects and 2 percent to the extremely poor. 7 Such a view was expressed by MoEWRI through its official campaign slogan—Nepal ko pani, janatako lagani (translation: people’s investment in Nepal’s water resource), an effort spearheaded by the former Minister of Energy, Janardhan Sharma. Current Minister Barsha Man Pun has recently given fresh impetus to this campaign by renaming it—Nepal ko pani, janatako lagani, harek Nepali vidhyut ko share dhani (translation: Let the people invest in Nepal’s water and let every Nepali be an electricity shareholder) 8 The number is based on the publicly listed hydropower companies by the end of Fiscal Year 2016/17. 9 Indicator of price movements of listed companies in the Nepal share market 10 In the case of individuals who had purchased local shares of Chilime in 2010. 2 Clockwise from left: Women’s group in Rasuwa; mixed group of participants at Salme Bazar, Solukhumbu; women’s group at Lamabagar, Dolakha and; mixed group of participants at Dordi Village Municipality, Lamjung the drop by one-third of peak prices in 2014 to today, the potential implications on shareholders vis a vis enthusiasm for shares remain unabated. amount of allocation, process of allocation, timing, price, eligibility, delivery model, financing and holding However, there are other existing challenges associated with and divestment. The basis for the disaggregation through the hydropower local shares’ life cycle (e.g., what happens specific attributes are provided in the table below. to the share value at the end of the concession period); and the challenges associated with the differing nature of project ALLOCATION AMOUNT companies (e.g., what happens to companies that do not There have been varying practices in relation to want to be listed on the stock exchange and want to remain the amount of local shares issued or committed by private), for example. The resolution of these will be crucial hydropower companies to date. For example, 17 publicly- to ensuring more clarity on the viability of local shares and listed hydropower companies have issued local shares its potential impacts on the hydro sector, economic impacts equivalent to 10 percent of its equity, while three private on individual investments, socio-economic impacts on companies with foreign direct investments have committed individuals as well as the economy. to issue local shares in their project development agreements,11 and some private projects and those built under direct ownership of NEA have not issued any. RISKS, CHALLENGES AND OPPORTUNITIES The current law for allocating up to 10 percent is applicable only to hydropower companies that want The current local shares model has been assessed from to raise equity from the public. For other types of eight primary attributes to understand and appreciate investments, especially mega projects with or without FDI 11 Project Development Agreements of 900MW Upper Karnali, 900MW Arun 3 and 216MW Upper Trishuli 1 include commitments to grant economic interests to local people. 3 LOCAL SHARES: KEY EVALUATION PARAMETERS Themes Description Major Policy Question Amount of allocation Total shares set aside for local What is the appropriate amount of shares that communities should be allocated to communities? Process of allocation Process of distributing shares to Does the distribution process consider the special individuals aspects of issuing in rural locations and ensure fair access? Timing Time of issuance of local shares Should shares be issued before or after commercial operation? Price Price at which shares are made Should local shares be offered at par value or at a available to local people premium? Eligibility People eligible for local shares, Should the degree of affectedness be a criterion for including categorization of eligibility share issuance? Delivery model Institutional mechanism for Apart from the direct shareholding model for public offering shares to local people limited companies, what are alternative options for private limited companies? Financing Financing the purchase of local What instruments and options can be made shares available for financing local share purchases? Holding and divestment Retention and liquidation of local How do people retain or divest their local shares? shares that choose to remain private, the government is relying wish to inspect them. SEBON has recently introduced on project-specific project development agreements additional disclosure requirements as part of its efforts (PDAs) and other contractual documents to make this to enable informed investments amongst potential provision mandatory. For example, the jurisdiction shareholders. for projects that are 500 MW and above rests with the Investment Board of Nepal, which has successfully However, the allotment process for private projects, such treated the local shares issuance as a PDA negotiating as Upper Trishuli-1, Upper Karnali, or Arun-3 HPPs, has issue to be decided on a case by case basis. Given the yet to be decided. While it is the Company’s responsbility huge demand for local shares, there have even been to distribute local shares in the case of Upper Trishuli-1 instances where some companies are including these and Arun-3, it is the Government’s responsbility for aspirants in the promoter shares category. Upper Karnali, as here, the portion for local shares distribution will come out of NEA’s 27% equity. ALLOCATION PROCESS The process of allocation of all shares by companies A number of problems are associated with technology going public, whether in hydropower or any other which are currently being solved. Paper share certificates sector, is guided by the Securities Issuance and Allotment have now been replaced with electronic forms. Share Guideline 2017. SEBON has several other requirements applications are now managed online eliminating the need on how companies should, through their issue manager, for time-consuming journeys and lengthy queues and communicate with the public about their share offerings. instead enabling immediate refunds for un-allotted shares. For example, SEBON requires issue managers to make Additionally, the new current bottom-up allotment model, available the prospectus and other issuance-related guided by the principle of equitable distribution, ensures documents to potential applicants should the latter a minimum number of 10 shares to all aspiring retail 4 investors, so applicants no longer need to apply for more Of 17 listed hydropower companies that have offered shares than they want to.12 This is an important issue in local shares, six have done so prior to COD, while others allotment that needs to be communicated to the general as late as five years after COD. Companies issuing after public. Furthermore, NEPSE is working to operationalize COD were doing so to raise capital to either reduce online trading. These developments are expected to greatly the debt in their capital structure or inject equity into improve operational efficiency, promote transparency and subsequent projects. For projects that have negotiated cut the risk for manipulation and delay. Given these rapid PDAs with the government and have local shares changes and considering the transition may take some requirements, the agreement on timing for issuing local time, SEBON, issue managers, banks and hydropower shares is conducted during project negotiations.15 companies must intensify communications and public education efforts. While most local communities appear to assume a flexible approach on the timing of local shares issuance – from TIMING anywhere between mid construction to COD; developers The 2016 Securities Regulation stipulates the following looking to raise equity from the public prefer the offering conditions before a company can issue shares to the during the time of construction, when the capital raised public: can be used to finance the project. Additionally, earlier • Completed one year of operation, including holding an buy-in of communities also appeared to ensure lesser annual general meeting (AGM);13 demands on the project. Offering local shares after • Obtained the required licenses and permits to develop COD, as quite a few hydropower companies have done, the HPP; guarantees even lesser risks to local communities; the • Obtained land and other infrastructure are ready for raised fund has been used by companies to pay off loans construction; or invest in other projects. • Promoters have fully paid up their share of equity; • Completed financial closure; However, banks and financial institutions expressed • Signed the power purchase agreement (PPA) with their preference for local shares to be issued earlier on NEA. in the project cycle, given that increased equity during construction phase would lower their exposure in The requirement of these conditions compel companies the company and help attain some protection against wanting to issue shares to the public to have mitigated construction risks. its commercial risks. On local shares, although prevailing laws do not specifically say when they can be issued, there PRICE: PAR VALUE AND PREMIUM is an implied statement14 that it must be done before the The initial offering of shares by all companies seeking to general shares issuance. SEBON further restricts persons raise capital from the public must do so at par16 value. that have acquired local shares of a company to buy However, companies can issue shares at a premium shares of the same company during an IPO. provided a due diligence audit has been carried out.17 12 Under the current law, the allotment at IPO is done in the following manner: the process begins with all eligible applicants apportioned 10 units of shares each, thus ensuring a guaranteed minimum number of shares for everyone. Moving on to the second round, where only those who applied for more than 10 units of shares remain, each applicant, once again, are apportioned another 10 units of shares. This process of allotment is continued up until the applications outnumber the number of shares and allocation cannot be made in blocks of 10. Thereafter, the selection of recipients for allotment is done through a lottery, and the allotment process described above is followed until all shares are fully alloted. 13 It should be noted that the requirement for the completion of one year of operation is for the hydropower company and should not be confused with the HPP’s COD. 14 This is because of the provision in the 2017 Directives, which requires companies to issue all undersubscribed local shares during the offering to the general public. 15 The PDA of Upper Trishuli-1 has a provision requiring that local shares be issued within three years after financial closure. The PDA of Upper Karnali HPP requires local shares to be issued any time after COD. The PDA of Arun-3 HPP has more specific provisions: that 50% of the local shares be issued within one year of COD and the remaining be issued between years two and three after COD. 16 While the Companies Act sets the par value of the share of public companies at NRs. 50 ($0.5) or higher (but multiples of 10), the 2016 Securities Registration and Issue Regulation sets it at NRs. 100 ($1). 17 The calculation of the premium price of a company needs to be an average of the three prescribed valuation methods (capitalized earnings of the last three years, discounted cash flow method, and any internationally accepted method) or four times the net worth per share, whichever is lower: Clause 25 of Securities Registra- tion and Issue Regulation, 2016. For private limited companies and unlisted companies, the Companies Act states that premium shares can be issued provided the company does not have negative net worth and the issuance has been authorized by the AGM. 5 All 17 of the listed hydropower companies have issued THE RISE OF THE PROMOTER- local shares at a par value of NRs. 100 (US$1). The LOCAL SHARES exception is Chilime, where it offered at par as well as premium. For private PDA-based projects that are The Securities Regulation (2016) defines promoter required to offer local shares, the pricing18 is not defined shares as shares that are issued other than by in their PDAs. way of IPO and requires at least 51 percent of the shareholders to be in this category. As promoters, There is overwhelming evidence that local communities SEBON has in place certain restrictions to ensure view local shares view as an investment for which the success of the company, including early buy-in they are willing to pay. Low-cost or free options were into the investment. Given the lack of a screening occasionally raised as special considerations to be process, there is a growing trend of communities provided to the severely affected, the economically investing in promoter shares of hydropower vulnerable, and the socially marginalized. companies, and this has become a mechanism for some companies to meet the local aspiration SEBON has been discussing the possibility of introducing to invest. What makes this problematic is the other methods of price discovery in the Nepali capital lack of awareness among many investing locals market. In the new pricing regime, the price of a share of the difference between promoter and local at IPO would no longer be fixed by the regulator but shares, the latter being issued as part of public discovered, e.g., the book building method, through a issuance with SEBON’s approval and subject to process of estimated orders from a select group of invited additional disclosure requirements intended to large institutional buyers. If this is to be implemented, then protect investors. While this in itself is not a major the current practice of offering shares at IPO at a par value problem, what makes this problematic is the lack of NRs. 100 may no longer be relevant. of awareness among many investing locals of the difference between promoter and local shares, ELIGIBILITY the latter being issued as part of public issuance The Constitution of Nepal provides local communities “the with SEBON’s approval and subject to additional priority to make investment” in any commercial use of their disclosure requirements intended to protect natural resources, but leaves some room for debate as to investors. what constitutes a local community.19 SEBON through its amended Securities Registration and Issuance Regulation in This is problematic in places where companies 201620 defines eligibility based on the project-affected area have issued promoter shares, because such shares as per the environmental impact assessment (EIA) report. will bear more risks as it takes longer time to get profits from investment and more restrictions in In reality, the practice has varied from project to project, the form of lock-in period for selling compared to where boundaries are often negotiated to mitigate local general shares. disputes and obtain political acceptance. Some projects such as Khani Khola in Lalitpur have only issued shares As of date, the Office of Company Registrar has to four affected village development committees while asked the companies issuing such shares to stop others have been extending the eligibility criteria to all the practice until further notice in order to carry residents of the district. The process thus far in defining our further investigations. the eligibility has focused more on reaching a political 18 For Upper Karnali PDA, it is specified that it is GON’s responsibility to grant local people economic interests in NEA’s portion of equity, without specifying the quantum. The PDA of Arun-3 HPP provides that 50 percent of the local shares shall be issued at face value within one year of COD, and the remaining shares will be issued between year 2 and 3 after COD at a market value, which will not exceed 2.5 times the initial face value. Both the PDAs for Upper Karnali HPP and Arun 3 HPP do not specify the price of its fair value shares. 19 Article 59 (5) of The Constitution of Nepal, 2015. 20 Clause 9 (4) of Securities Registration and Issue Regulation, 2016 6 settlement and less on finding a technical standardized Discussions so far have centered around the use of special solution that enables equity. At present, this seems to have purpose vehicles (SPV), where the local communities settled largely at the district level and with a hierarchy that will own and participate in the SPV, the legal entity differentiates between the project affected and the rest of designed to hold all of the local shares of the hydropower the district. company. As proof of eligibility, people use citizenship certificate The various institutional options24 available for as their primary official document. Other documents structuring the SPV are: i) companies; ii) cooperatives, iii) include marriage certificate (for those married into the private trusts; and iv) collective investment schemes (CIS). eligible area), birth certificates (for under-age children), The delivery models are structured with the following and migration certificate. A few companies have also parameters: used land titles, but this has promoted an alleged trend of people purchasing land only to be eligible for local • Only those eligible for local shares can participate in shares. There is a practice of a cut-off date for any type of the SPV; migration document: while SEBON specified the cut-off • Funds raised by the SPV will be used for the single date as the day prior to the issuance of shares,21 this has purpose of investing in the shares of hydropower com- varied from project to project.22 pany where the local population have been deemed eligible to invest as affected communities; ALTERNATIVE LOCAL SHARES DELIVERY MODEL • The activity of the SPV will be limited to holding the All public hydropower companies in Nepal to date have shares of the hydropower company and distributing been issuing shares directly to individuals. The need the dividend to the SPV participants. to consider alternative delivery models has emerged mainly with regard to the requirement of private hydro In attempts at assessing whether local communities would companies23 that are contractually obliged to issue local be open to the idea of a collective or communal shares shares but wish to do so without converting the company model, a concept widely practiced in other jurisdictions, to a public limited. In other words, fulfil the requirement there was overwhelming evidence of mass distrust of granting local communities a stake in the project existing towards any body deemed to represent and through share ownership but continue to hold the status uphold the interests of the community. SPV possibilities25 of a private company, thereby avoiding any onerous tax discussed included municipalities, cooperatives, trusts, implications and the pressure of dealing with thousands companies, etc. of shareholders. The principal rationale for such aversion was further In the absence of an existing framework to guide such pointed to weak local governance, the prevalent practice companies, the study has assessed potential delivery of elite capture, social discrimination, among others. options, whose viability is dependent on legal reforms, As a result, individuals felt they were better off making strengthened public understanding of the capital market their own investment decisions, by themselves. Further, and of the hydropower sector, and most importantly, this way, they would have the flexibility to divest when political support to help win public confidence. required and even questioned the rationale of whether 21 Securities Issuance and Allotment Guideline, Revised 2017 22 For example, in Upper Trishuli-1, the cut-off date is the date on which the main construction activities are commenced, whereas in Upper Tamakoshi, this is specified as the day of financial closure. 23 A 2015 study commissioned by the Investment Board of Nepal that negotiated project development agreements for 900MW Arun 3 and 900MW Upper Karnali “Options and Mechanisms for Offering Project Shares to the Local Stakeholders” proposes a publicly-held SPV model as the most suitable mechanism for the delivery of local shares as it meets the expectations of both the local people and developers but both projects are yet to proceed with a suitable mechanism. The PDA for the 216MW Upper Trishuli 1 states that local shares shall be given “in an efficient manner without affecting day-to-day operation of the company.” In the case of Bhotekoshi HPP, the company has left it to the local communities to propose a delivery structure for the offering. 24 Refer to main report for more details. 25 Respondents were asked if they would be open to the concept of owning local shares through these alternative mechanisms. Each of the options were not discussed in detail. 7 the communal ownership model would help build a The consultants of an IBN comissioned study on local better sense of project ownership amongst communities shares,28 had identified a product to be categorized under as opposed to the individual direct shareholding method, the deprived sector lending portfolio as a Debt Linked wherein each person felt they had a direct stake in the Product on Equity/Cash Flows pledge, structured on future project. cash flows estimation of the parent company, that could be made available through the financial institution where the There are instances internationally, e.g. in Norway, first claim to the dividend from the company shall be from where local government bodies have invested equity in the Financial Institution financing the locals for purchase hydropower companies. Any investment returns are then of shares. This is similar to the Chilime financing model, used for the benefit of the communities. Most recently, the only difference is Chilime already had cash flows and local municipalities in Nepal have been set aside shares strong reserves of dividend payments to repay loans. as institutional investors. For example, the Trishuli- 3B hydropower project, has set aside 5 percent equity Chilime is the only hydropower company to have for affected municipalities of Rasuwa and Nuwakot. provided institutional financing for local shares. The However, how this will be done, considering Nepal’s laws company entered into an arrangement with two “A” class currently bar government bodies from participating in commercial banks—Mega Bank Nepal Limited and Janata income generating activities, remains to be seen. Bank Nepal Limited—with the following agreements: the banks would provide loans of up to 80 percent of the total ACCESS TO FINANCING shares allocated to each individual;29 the share certificate Nepal Rastra Bank’s (NRB) Unified Directive (17/074), would serve as collateral; the repayment period would be under the deprived sector lending requirement,26 has a three years, which coincided with the end of the lock- provision for Banks and Financial Institutions to provide in period and during these three years the banks would collateral-free loans of up to NRs. 50,000 (US$ 500) per retain the share certificate; and full repayment would household for the purchase of local shares. This so far be guaranteed through the channeling of dividends per has remained on paper and have not been implemented share directly from the company to the individual bank by banks. Primary deterrents cited by banks include the account. All this was possible because the company had high transaction cost and time involved for each customer, been offering dividends to its shareholders within a year and lack of adequate human resources within banks to of its IPO. Each individual loan was relatively small; the assess hydropower investments and so provide loans maximum being NRs. 12,043 per person (US$120).30 sans collateral with confidence. Banks clearly perceived hydropower a high risk sector and preferred not to lend to In general, people were investing “small amounts”31 the sector had it not been for the NRB Directive.27 through savings, loans from friends and relatives, or by selling off small assets.32 Others had taken loans from Microfinance institutions, on the other hand, with a cooperatives and microfinance institutions at around better presence than banks in rural areas, were found to 14-18 percent interest while a few from informal money be providing loans at interest rates between 18 and 20 lenders, at annual interest rates of up to 60 percent. percent, much higher than that of commercial banks. 26 As per Nepal Rastra Bank’s directive, authorized class ‘A’, ‘B’, and ‘C’ banks in Nepal have to lend 5%, 4.5% and 4% respectively of its total loan to the deprived sector. For example, a commercial bank is required to (i) provide at least 5% of its total lending as “deprived sector lending” and, (ii) out of the said percentage, at least lend 2% in the specified sector or activities as “direct lending”. The specified activities include a loan up to NRs. 50,000 ($500) per family for subscription of the local shares reserved by the hydropower projects. 27 According to NRB directive all commercial banks are required to invest at least 20 percent of their total loan portfolio in the productive sector, 12% of which should be in agriculture and energy sectors. In addition, the latest monetary policy makes mandatory for all banks to invest at least 5% of its total loan in the hydropower sector by the end of fiscal year 2017/18. 28 In 2015 IBN commissioned a study to look at options and mechanisms for the share offering of the Upper Karnali and Arun 3 hydropower projects. 29 It was impossible to determine the interest rate at which this loan was offered. Informally, the estimate is around 13-14 percent. 30 Calculation of maximum loan given by the banks for local shares (80% of maximum (NRs.100X34 + NRs.323.7 X 36) = 80% of NRs.15053.2 = NRs. 12042.56 ($120)) 31 People colloquially referred to investments of NRs. 10,000-20,000 (approximately US$ 100-200) to as being a small amount. 32 Assets included livestock, jewelry, etc. 8 SHARES, HYDROPOWER COMPANIES, AND THE END OF A PROJECT’S CONCESSION PERIOD Other than hydropower projects directly single project, unless it includes other revenue owned by the NEA, all hydropower projects in streams, the company will no longer have Nepal are built under the Build, Own, Operate, an income source, which is likely to result in Transfer (BOOT) model. A key requirement in a decrease in the price and tradability of its this model is that hydropower companies, at shares. Shareholders then have the option of the end of the project concession period, have amending the company objectives and pursuing to transfer the project to the government. The other revenue streams, including a new O&M Electricity Act (1992) specifies this period as 25 contract for its project, or completely liquidate years for export oriented projects and 35 years the company. Whereas, this is not the case for domestic consumption. What impact this for hydropower companies with multiple transfer has on the hydropower company share projects in the pipeline who are likely to have is not a well understood either by the locals or an uninterrupted revenue stream, for example, the policymakers. The uncertainty on this issue Chilime Hydropower Company which owns the stems from the following: 22.1 MW Chilime, 102 MW Middle Bhotekoshi, 42.5 MW Sanjen and 111 MW Rasuwagadi. i) What happens during project handover: The Electricity Act (1992) has two provisions Given the lack of understanding at the applicable to companies based on type of community level, it is important to strengthen ownership. For those with a majority of foreign the requirements on hydropower companies investment, the project is to be transferred to disclose all relevant information to potential to the government, but gets preference to shareholders through their prospectus and renegotiate a new agreement for project other documents. See section on transforming operations, at a price set by a committee. communities into informed shareholders. However, for companies with a majority of Nepali investment, the company can renegotiate At the policy level, the bureaucracy is aware of with the government and conduct business the requirement on hydropower companies to under a new agreement. This indicates that handover the project to government, but largely while the ownership of the project technically uncertain about the aftermath. This is partly reverts to the government, a new agreement because they feel no urgency to act given that the is renegotiable with the same company, for the first project to get to this particular stage is the purpose of operation and maintenance (O&M). Khimiti HPP in 2040. It is critical that the MoEWRI bring further clarity to this issue by stipulating a ii) What happens to the hydropower time frame for companies that hold a majority of company after handover: The Electricity Act Nepali investment to notify the government of (1992) requires all hydropower companies to their intent to handover the project to government hand over assets of the project whose licensing or negotiate a new O&M contract. Should the period has ended, such as land, building, and company state the former, the government can equipment. The company can meanwhile choose to call for new O&M bids. Should it request continue to legally exist and maintain ownership for the latter, the government can negotiate a new of its other assets. Shareholders will also contract with the same company. The government continue to own company shares. However, would need to decide the most appropriate time what this means for the price of its company before the end of the concession period to do this; shares, depends on how the company is the earlier the resolution, the more clarity it would structured. For a hydropower company with a provide to shareholders. 9 HOLDING AND DIVESTMENT KEY TAKEAWAYS The Securities Registration and Issuance Regulation establishes the restriction of tradability of all In short, the following can be summarized as the key preferentially distributed shares until the completion of findings of this study: a designated lock-in period. Preferentially distributed • Equity is one of the major tools for community bene- shares are any special category of shares that have been fits; also benefits developers by ensuring locals have a earmarked for a select group of applicants. For example, stake in the project. the law allows companies to set aside up to 4 percent of • Equity participation is very much in demand, but there ap- its IPO shares for its employees. In the hydropower sector, pears to be irrational exuberance. Even though the hydro staff and local shares are two types of preferentially market share values have dropped by one-third since their distributed shares. Under current law, both these types of high, it has not impacted demand for shares by locals. shares have a lock-in period of three years, the restriction • Equity shares have high risks but investors are general- for which applies from the date of allotment of shares. ly uninformed. There is a critical need to stress the full The intent here is to prevent early divestiture, so as to portfolio of community benefits, improve information ensure a stronger ownership of the project and a better flow, and education. performance of the company. There is an exception, • SEBON is playing a major positive regulatory role. however, that allows the trading of share even during this • Information Technology is making it possible for small period, which is in the event of death of the shareholder investors to buy and sell as long as they have commu- or if the shareholder’s property has to be divided amongst nications access. family members. • Finance is necessary; government has set the frame- work but banks are yet to respond. While holding shares, as specified in the Companies Act, • The current direct shareholding delivery model is the shareholders can enjoy three categories of benefits.33 In the simplest and most feasible option for local shares. For event a shareholder is looking to divest shares of a listed companies wishing to remain private, earning the trust public company, the sale has to take place in the country’s of local communities in the alternative delivery mecha- only stock exchange platform, NEPSE.34 In general, people nisms to deliver benefits and promote local ownership seemed to treat local shares as an asset that is meant to be are the biggest challenges. held rather than traded. This retention could be attributed to several issues: i) the community members view shares as LOCAL SHARES MODEL VERSUS a valuable asset, similar to land, that is to be retained for TRADITIONAL PRACTICES OF EQUITY the long-term, and ii) they have a limited understanding INVESTMENT of the share market. With regard to dividend collection, the switch to automation means dividends will now be The study looked at a few national and international transacted automatically removing the need for people examples35 with equity participation of local communities to physically travel to Kathmandu to collect dividend and found some key distinctions between Nepal’s payments. current local shares model and other practices of equity investment. 33 Benefits include in the form of: i) cash dividends: A company can offer shareholders cash dividends based on its performance, the amount of which is decided by the company’s board of directors and executed upon the decision of the shareholders through the AGM; ii) bonus shares: A company also has the option to offer bonus shares to its shareholders primarily as a substitute of offering cash dividends, which is generally done to meet a capital requirement; and iii) rights shares: A company additionally has the option of raising the required capital through the issuance of rights shares, which differs from bonus shares in that shareholders are required to pump in additional funds to collect the rights shares, albeit at a par value of NRs. 100. 34 There is discussion about SEBON approving the request of another private stock exchange as well. 35 Case studies looked at included the Khumbu and Salleri-Chialsa Micro Hydel Projects in Nepal, Wuswatim Hydro Project and Colombia Basin Trust in Canada, and Glomma and Lagen Basin in Norway. 10 DIFFERENCES IN THE PRACTICE OF LOCAL AND TRADITIONAL EQUITY INVESTMENT In local shares In other practices of equity investment in HPP Individuals from project-affected Equity is usually generated through a contribution Financing of the population finance and invest directly from third-party sources. equity their portion of the equity. Equity is directly owned by individuals. Equity is held indirectly by locals through a Holding of the communal platform in the form of trusts, community equity groups, or local municipalities, among others Benefits from investments are accrued Benefits are distributed at the community level, with Benefits of the and enjoyed at the individual level. These some exception, where the communal benefits are equity include dividend payments, issue of rights then further distributed to its associated individuals, and bonus shares, and capital gain. but mainly in the form of dividend payments. As individual shareholders, individuals As community shareholders, individuals are not Risks of the equity are directly exposed to equity risks. directly exposed to risks. Given these differences, the benefit in the offering of local of local shares, assessing each of the options in depth shares is in the preference given to local communities and presenting a more scientific method to cater to each to invest in what is assumed to be a profitable business individual project based on size and scale, length of undertaking, but for which there are no guarantees of construction period, cost, etc. is an area policy planners returns. and regulating agencies should be thinking about in detail in the near immediate future. OPTIONS AND RECOMMENDATIONS ALLOCATION AMOUNT Retain the current amount of allocation of local shares The study's findings clearly indicate that the current for public companies: Despite overwhelming appetite policy for local shares meets the constitutional objective among potential shareholders to invest in local shares, of enabling local communities an opportunity to invest SEBON’s 10 percent ceiling on local shares offering by and thus accords them priority in doing so, but it is risky. hydropower companies takes into consideration the inherent risks of investing in the capital market and thus Additionally, given that the majority of these investors seeks to limit the exposure of local communities, who are are either ill-informed or ill-equipped or both, further generally unsophisticated investors. Additionally, SEBON measures are necessary to mitigate risks and protect is of the opinion that while project-affected communities shareholders. The options and recommendations can be treated preferentially, this threshold for local have been structured with the aim of improving and shares also allows for the wider Nepali population, streamlining current processes, and suggests changes only including those living in regions with low potential for where reforms are deemed to be absolutely necessary. hydropower, to have the opportunity to invest in general shares (a minimum of 10 percent). The current policy Further, noting the various challenges presented by the regime reflects a settlement of these interests and there is differing economics of each project, this study does not no sufficient reason to change it. aim to present a set of prescriptive solutions or one size fits all recommendations. The study rather recognizes For mega projects, the Government of Nepal should the need that in time, some tweaking and tailoring may define local shares requirement in project bid documents: be necessary to align the recommendations to suit each SEBON’s up to 10 percent policy for local shares and at individual project and its local environment. As Nepal least 10 percent for the general public are applicable to gains more experience in hydro development, the capital hydro companies going public. In contrast, mega projects market in general and most importantly in the delivery that wish to issue local shares but remain private have 11 been negotiating and agreeing on a quantum instead system. Therefore, even though it may take more effort of a percentage during project negotiations, which is a at the outset, it is recommended that there be special feasible approach given the clarity and certainty it will arrangements made by SEBON and CDS to educate provide project developers, financers as well as local and help build the capacity of local communities to use communities. However, going forward, it is recommended the new share application process, and ensure that the that the Government spell out the quantum of the local necessary support systems are in place, especially in shares requirement in project bidding documents during remote and rural areas. the international competitive bidding process, a practice that has already been adopted during the award of the Ensure adequate focus on women and vulnerable Super Six36 hydro projects. Inclusion of this requirement populations to enable smooth transitionary measures: as a bid condition will eliminate the need for protracted SEBON and CDS must ensure sufficient efforts to negotations on this issue between the government and the train key women individuals of mother’s groups (aama winning bidder. samuha), women’s credit saving groups, community based user groups, etc. so that they can assist other women and ALLOCATION PROCESS poor, vulnerable and marginalized individuals in adopting Promote further automation in Nepal’s capital market: and familiarising themselves with the new systems. As a result of the increasing shift towards a computerized capital market in Nepal, the process of becoming a TIMING OF LOCAL SHARES ISSUANCE shareholder is gradually becoming less cumbersome for The timing of the local share offering is the most critical the public. For example, aspiring investors no longer component that needs to strike a fair balance of interests have to deal with the inconvenience of being physically between local shareholders as well as project developers. present at collection centers while applying for shares As such, the study presents options below: and instead can do so from anywhere as long as they have access to the online banking system. Furthermore, i) Two possible options for public companies, for whom as a result of the integration with the banking system, the the public shares issuance (up to 10 percent for local application process, especially the process of allotment, is shares and a minimum of 10 percent general shares) now more efficient and secure for all investors. It is highly would be applicable; and recommended that the relevant government agencies ii) An option for private companies that are required to continue with their plans to further streamline and issue local shares but wish to retain their company’s integrate the electronic and computerized systems into the private status. country’s capital market. If the current practice of the local shares offering prior Ensure that local communities have the necessary to general IPO is to be continued, then do so with capacity to participate and take advantage of the additional safeguards for poor vulnerable households: modern systems: While pushing for a more computerized The current securities regime, which establishes the process of allocation, it is important to keep in mind that timing of how early hydropower companies can issue there are regions in the country where information on the shares to the public, requires a company to have taken capital market and user platforms have not adequately care of the majority of the risks associated with project reached. In some of these cases, SEBON has allowed development prior to them going public. This is to ensure local shares to be processed through the previous paper- a certain level of protection to the public investors. The based mechanism. This flexibility may be temporary, but law then offers the companies the flexibility to decide on careful attention must be paid to ensure it does not add when to go for an IPO, which in reality, companies do further delays to integrate all shareholders into the new so when they need cash the most – for many companies 36 The Government in 2010 had awarded six projects called the Super six through a competitive bidding process, where the bid documents had clearly outlined the need for projects to provide 10 percent equity to local communities. The projects include Solu (23.5 MW), Lower Solu (82 MW), Khare Khola (24.1 MW), Maya Khola (14.9 MW), Singati Khola (16 MW) and Mewa Khola (50 MW). 12 this is when about 70 percent construction is complete to iv) The two offerings carried out in immediate sequence either fund further construction works while for others and through the same approval process yield in re- it is well after COD, whether it is to service their debts duced shares issuance costs for the companies and an or invest in another project. While there are companies improved efficiency in the overall shares issuance pro- that have offered local shares on or after COD, requiring cess.37 Furthermore, the current sequence of allotment all companies to offer local shares post COD can be can be maintained such that undersubscribed local problematic for those that are genuinely seeking to raise shares can be alloted to those in the general shares. equity from the public to develop their project. When viewed from this perspective, the current approach One key implication of this reversal of sequencing arises appears practical. However, from a benefit sharing or only if local shares are offered after the company shares risk reducing perspective, this policy can only be truly are floated to the general public and has been listed at effective if it is augmented by a comprehensive financial NEPSE. Listing of shares in NEPSE would enable the access and awareness program that will help reduce the process of price discovery through trading of stocks in financial risks and socio-economic vulnerabilities of the the secondary market. That price, it should be noted, may local communities. For further details, see section below have a value that is higher or lower than the offer price at on financing and informing stakeholders. IPO. Hence, there is a need for a policy decision that will require the offering of local shares be done at the offer Reverse the timing of the shares offer sequence but price at IPO or market value, whichever is lower. If the allow companies flexibility in the timing of offer: The offer price is lower than NRs. 100 ($1), this will require current regime requires local shares to be offered prior another legal reform for all shares at IPO to be offered to the general public offer, the timing of which, on at a par value of NRs. 100 ($1). The preferential pricing average takes place for most companies when about 70% for local shares may also raise intensified interest from construction is complete while for others, it is at or after communities in claiming their eligibility. To avoid this, the COD. By seeking to reverse the sequence, but allowing eligibility for local shares at least for the severely affected the companies some flexibility in timing of offer, what is has to be decided prior to the issuance of general shares; achieved are four principal objectives: the cut off date being the financial closure date. See section on eligibility for more details. However, if the two i) Companies can directly go to the general public to offerings are carried out in tandem, as proposed in point raise capital (at least 10 percent) after meeting the re- iv above, the issue of IPO price or market price whichever quirements established by SEBON; is lower would not arise. ii) Project affected communities still get a preferential op- portunity to invest but now have an added layer of For private companies, local shares should be offered protection. In the new setting, the general public, con- on or after COD: For the three private companies in sidered to be a more sophisticated subset of the public the process of fulfilling their requirement to offer local investors, can weigh in on the value of the company shares, namely, Upper Trishuli-1, Upper Karnali, and shares before their local counterparts. This allows lo- Arun-3, the government has set different timings for each cal communities the benefit of observing how well the project. Going forward, the government should establish first phase of IPO performs before making their invest- a standard requirement on timing for all private hydro ment decisions. For example, if a company offering is companies instead of having to negotiate the timing of heavily undersubscribed during general IPO, this could offering for each and every new project,. The fact that i) be a signal for local communities on the risks of invest- these companies are not really looking to rely on local ing in that company; communities to raise capital, and ii) that the primary iii) Companies are allowed a certain degree of discretion benefits from these companies to local shareholders are to decide when to approach the public in order to raise likely to be in the form of dividends, the government equity as long as SEBON requirements are fulfilled; should require all private hydro companies to offer their and 37 This has already been made public but not yet practiced and implemented by SEBON. 13 local shares on or after COD. This way, one of the most introducing and enforcing a common framework that critical risks to project development, i.e. construction risk, ensures consistency among all of the projects. SEBON’s is eliminated, enabling the project to start to generate recent effort at regulation to align project area with electricity, earn revenue, service its debts and eventually the project-affected area as identified in the EIA is a distribute dividend payments to shareholders from its commendable start. But this needs to be strengthened profits. by ensuring that all EIAs follow a standard set of definitions for project affected people based on a degree PRICING OF LOCAL SHARES of affectedness and the project’s socio-economic area of Expect the current pricing mechanism to change due to influence, which includes direct impact areas and indirect newer policies being discussed: SEBON currently requires impact areas along with administrative boundaries.39 For that the offer price of shares at IPO of all companies the purpose of local shares, a common cut off date should (regardless of the sector) be set at par value. There is an also be identified for all projects by SEBON, which is exception to this rule, effective only if the company is ideally the date of the financial closure.40 able to fulfill a number of criteria for it to be eligible for SEBON’s approval to offer shares at a premium. One of Differentiate treatment for categories within those these criteria38 requires the company to demonstrate a eligible for local shares: Categories based on affectedness three-year history of capitalized earnings, which is not will help identify communities that should receive first possible for most hydropower companies, especially those priority for local shares and separate them from the rest limited to a single HPP. Such companies will have to of the people residing within the administrative boundary, wait at least three years after COD, by when it will have which is the district. Each category should receive different generated some revenue. Hence, the share price of such treatment with regards to preferential access, allotment companies at IPO and during the local share offer are and/or pricing. Some standard criteria on preferential likely to be at par if the existing practice of issuing shares allocation for all projects is difficult to prescribe given the is continued. However, in the event that SEBON allows the differing degree of affectedness for each project and the companies to declare an IPO with premium value based on population density in the severely affected areas compared other price discovery methods, where capitalized earnings to the rest of the district. However, regardless of whether are not necessary, then an increasing number of companies the current timing of local shares is switched with the may be eligible to call for an IPO with a premium value general IPO, or not, first preference in terms of allotment, embedded in the offer price. In such cases, the government financing and price should be given to the directly affected. should clarify whether to require the company to offer the shares to locals at a subsidized rate or to allow the Standardize proof of eligibility requirements; eliminate company the right to seek premium value from the local the use of land titles for eligibility: Current identification communities. requirements in the form of either a citizenship, marriage, birth, or migratory certificate should continue with a ELIGIBILITY CRITERIA standardized cut-off date, for example, the financial Introduce a set of common standard definitions across closure date. Practice of using land titles, should be all EIAs for eligibility and cut-off date: The variation eliminated as this has allegedly boosted opportunistic in practice in how projects have been defining eligibility land rush to the affected areas, also flagged by many for local shares has resulted in some level of confusion communities as a major issue. The study further among stakeholders. However, this can be overcome by recommends that SEBON monitor the effectiveness of the 38 Section 36 of Securities Issuance and Allotment Directive, Revised 2017 39 Direct impact areas include areas that may be disturbed by the project’s construction and installation activities, whereas indirect impact areas include areas which are not directly affected by project activities but which could potentially experience beneficial/adverse impacts from the project or may raise community expectations/ concerns of such impacts. Administrative boundaries include villages, towns or districts. Refer to Hydro EIA Manual, 2018, Ministry of Forests and Environment. 40 In practice, using the date of the EIA as the cut off date may be impractical given the length of time between finalizing the EIA assessment and EIA approval. 14 current policy requirement to grant special consideration not their worth. Also, as a public company, the SPV will to women, poor and vulnerable households that have have to abide by the set of requirements established difficulty in establishing proof of eligibility. by SEBON prior to collecting funds from the local communities, including, among other things, conducting ALTERNATIVE DELIVERY MODELS FOR PRIVATE due diligence of and developing a prospectus for the COMPANIES SPV. These are extensive processes in place to protect the Collective Investment Scheme (CIS) is a possibility public investors with better disclosure of information but requires significant reform: In redesigning CIS as a from companies. These requirements may be appropriate possible delivery model for local shares, the new regulation for public companies that have a level of complexity, but needs to bear in mind that the Special Purpose Vehicle in the case of the single-purpose SPV, this could mean (SPV) being created will be limited to collecting funds avoidable paperwork and associated costs. Changing from the eligible population of a project-affected area; some of these requirements could help in reducing the investing all its funds thus collected to the local shares of high administrative cost associated with incorporating a particular hydropower company; holding the allotted and operating public companies. However, as a special shares for the lifetime of the project, and distributing case where the SPV is being created to meet the interest dividends to its participants in regular intervals. Designed of the hydropower companies that do not want to go as a company with limited mandate and minimal asset, public, there is a strong argument to be made for the the SPV can also be required to have a lesser set of hydropower company to pay and help set up the SPV. administrative requirements (e.g., limited roles of sponsor, fund manager, supervisor and depository resulting in Both the public option, listed or non-listed, have the reduced cost of operation) and protective measures in potential to offer a price efficient exit to local investors place (e.g., limited requirement in the capacity of the after they are listed in the NEPSE and the OTC market, sponsor or the fund manager because of the lack of a need respectively. However, the local communities have an for active investment decisions), especially in relation to the incentive to prefer to have their SPV listed in the secondary current mutual fund regulation. These changes would have market so as to enable them to benefit from a better and a direct impact on the associated cost of incorporating and transparent price formation. For all these benefits listed operating the SPV. While this model does provide limited here, the public-listed company model is currently the best representation of local communities in the governance option for companies looking for alternative delivery models of the SPV, the relatively low cost of incorporation and for local shares. However, the success of the delivery model operation and the opportunity for a market-based price depends on the willingness of the local communities to efficient exit for unitholders41 helps in making it a viable agree, accept, and abide by in the process of establishing and model for the delivery of local shares. operating the SPV. The suggested changes here could help increase the possibility of this happening. The publically-listed company model is currently the best option, but requires some changes: While the ACCESS TO FINANCING private company model is restricted by the maximum Ensure effective implementation of the deprived sector number of shareholders, structuring the SPV as a public lending requirement: Given that most hydropower projects company, whether listed or non-listed, does away with to date have been relatively small, there has been, except in the limitation on local participation. However, the Chilime, no provisioning of institutional financing for local process of establishing a public company is relatively shares. However, such financing options may be required more burdensome than that of establishing other with an increasing size and number of projects in each delivery models. These include requirements on initial district and communities become eligible for a proportional capital and regulatory fees, which by themselves are not increase in allotment of shares. The provisioning of prohibitive in nature but needs some work around. Plus, alternative financing mechanisms for community members local communities may consider them to be a nuisance is recommended so that they will not have to seek loans at 41 Albeit with value relatively less than of the shares of the company that owns the project 15 exorbitant rates from informal money lenders. As part of make periodic payments as part of the company corporate this, the government needs to develop operational guidelines social responsibility. The details would need to be captured and stricter enforcement to implement its deprived sector in the project’s individual benefit sharing agreement, where lending requirements, for example, with deferred payment women, poor, vulnerable households would be provided options under escrow arrangement of future cash flows. preferential treatment. Reducing the cost of borrowing is another factor that needs to be considered, which is possible if the NRB guidelines Investment Instrument: The current instrument in use to also offer a refinancing facility of loans at lower rates, which invest in local shares is equity. However, there are other would not only enable local access to low cost loans but possible instruments that can be considered to lessen allow faster repayments with adequate cash flows. some of the negative aspects associated with equity. Two options42 have been looked at that could further reduce risk Offer alternative financing without exacerbating the – i) convertible preferred shares; and ii) convertible debt. vulnerabilities of the marginalised poor: Given the risks They are not recommended at this time but could be made associated with HPP and the inability of most community available when risk of equity becomes more evident. members to hedge, the challenge is in building their capacity to cope with inherent risks involved with equity HOLDING AND DIVESTMENT participation along with the presence of some interceptive There is no sufficient reason to suggest change in the risk mitigation measures. To ensure the appropriate lock-in period: The three-year lock-in period for local inclusion of the economically disadvantaged, there needs shares limits the liquidity of one of the most prized assets to be a consideration of two primary elements: how they of the local people. The intent of this policy, as expressed source their fund and what financing instruments best by SEBON, is to prevent a potential elite capture of local serve their interests. shares immediately after it is listed and eligible for trade. This policy also ensures that local communities remain Source of fund: One option is that the government associated with the project through their shareholding for establish a dedicated fund to provide loans to the target at least three years. Several stakeholders, including in the population, which can be offered under relatively favorable communities, had raised the need to update this policy lending terms, including the possibility of using shares as to give local communities more control and liquidity of collateral. However, it is important to define the criteria for their assets. However, in reviewing the positions expressed eligibility for this fund. For example, the current definition by the various constituencies, the relatively small size under the NRB circular, which defines the "poor section" of individual shareholding (100-200 units), and the as population with low income, women, ethnic community, preferential treatment in terms of pricing and timing this differently-abled, and marginalized communities, could population is recommended to receive, there is no strong be taken as a basis for defining eligibility. This could rationale to suggest the need for a change in the current further extend to households designated as those living regulation. below the poverty line. As of 2017, the government had distributed ID cards (gareeb parichaya patra) to almost Reinforce automation in the process of holding and 400,000 households as part of efforts to reinforce targeted divesting shares: Automating the practice of holding programs and subsidies aimed at poverty alleviation. and divestment will help in transforming a more efficient holding and divestment. For example, the dividends Another option, likely to more feasible for mega projects, that most local investors have thus far been deprived is for project companies to arrange for financing since of will now be directly deposited in their banking this is generally a relatively small target population of account. Despite the challenges of uptake for some vulnerable people. The financing could include a mix of rural investors, this transition to a computerized capital grant with a small portion of loan with arrangements in market ecosystem is highly encouraging and needs to be place to channel dividend payments to service the loans or efficiently expedited. 42 Refer to main report for more details. 16 Moving towards online trading: A critical element in documents disseminated out together as a package with the limited ability of local communities to divest at their regards to the prospectus. will is the high transaction cost involved till date. To i) First, despite the difficulty in accessibility of the in- address this, the appropriate policy response would be formation but for the purpose of full disclosure, sev- to introduce online trading, which will also eliminate the eral copies of the entire prospectus should be made need for brokers. Until this is achieved, requiring current available in a printed form to the local communities brokers to offer services at the district level and allowing through the offices of their respective sub-national banks to provide brokerage facilities as an additional government bodies. service is recommended. ii) Second, a non-technical summary of the most relevant information of the prospectus, similar to the summary profile from the paper-based application form, should be TRANSFORMING COMMUNITIES INTO printed and made available, especially at urban centers INFORMED SHAREHOLDERS and also at the offices of the local bodies. These can also be handed out during training sessions (described later) Given the lack of clarity among local people on what to target individuals who can serve as information hubs may happen to their share value at the end of the project within the social network of the local communities. company’s license period, it is important to strengthen iii) And third, a more accessible document targeting the rural the requirements on hydropower companies to disclose communities should be developed with only the informa- all relevant information to their potential shareholders tion most relevant for them. These include the conditions through their prospectus and other documents. and restrictions in the process of application, investment risks by highlighting a few case studies such as the exam- ple of National Hydropower Company (see box below INFORMATION HIGHLIGHTS IN PROSPECTUS AND on Issue of Corporate Governance: a case study) and a PROJECT WEBSITE brief summary on the kinds of shares and rights associ- The prospectus as well as the project website should ated with each: local shares, promoter shares, employee clearly state in a visibly highlighted box: the length shares, general public shares, etc. of concession period, the expiry date of the project’s concession period or PPA, and for projects that are within ENHANCING EDUCATION AND UPTAKE five years of achieving the end of their license period: At the other end of the communication spectrum are the the projected status of the hydropower company in the recipients of the information, i.e., the local communities, post- concession period and the potential impact on and their ability to absorb whatever information is offered shareholders. to them. Given their limited capacity, SEBON should, on its own and in collaboration with hydropower companies, TAILORED PROSPECTUS PACKAGE invest in making them better informed of their investment Because a prospectus is a legal document, it is drafted decisions. These can be done through various literacy in very technical manner and is extremely detailed. As a programs, which should include subjects on financial result, it reads as if the information is not written with literacy focused on the capital market, plus courses on the intent to communicate with any target audience, hydropower and the process of HPP development. but in response to SEBON’s disclosure requirements. When it comes to communicating such company This can be done earlier in the project cycle so people related information the level of detailing that is found become more aware of the context of hydropower in a prospectus can be confusing, not only to the rural development in their area. Local communities would also communities but even to the relatively more literate benefit indirectly if these literacy programs are offered to urban population. Furthermore, any effort to make the other stakeholders in the community, such as the local prospectus more accessible must take into consideration media as well as the elected representatives and the staff of that there are varying levels of ability to absorb the the sub-national government offices. information. Thus, SEBON should have three distinct 17 Other important stakeholders include the traditional ISSUE OF CORPORATE community-based networks, such as aama samuhas, GOVERNANCE: A CASE STUDY local clubs, women’s cooperatives, schools, and business associations, that can serve as trusted intermediaries to National Hydropower Company Limited disseminate information to the target groups. As mapped (NHPC), which has been operating the 7.5 earlier, these are agencies with high influence in the MW Indrawati III Hydro Power Project since community and can provide the necessary guidance to 1999, issued 1,400,000 units of public shares those who are not able to make their own decisions. These in 2004. However, it has not yet been able to activities can be undertaken by SEBON or a SEBON- distribute profit to its valued shareholders; approved/accredited training agency, and can be financed conduct an annual general meeting in time; in part or whole by the hydropower companies. Increased has a negative earning per share of NRs. efforts must also be made to encourage the business media 2.81($0.02); and a net worth per share of below and independent brokers to monitor, analyze and produce NRs. 100 ($1). This reflects a serious issue of well researched information online through blogs and corporate governance in the company. The websites. These can play an important role in assuring that problem started when its subsidiary company, investors have improved stock market knowledge. Sunkoshi Hydropower Company, failed to complete the construction of the 4.5 MW Along with the efforts at building capacity, any strategy Lower Indrawati Hydropower Project. This to make communities more informed about local shares was because of management issues including should include the use of multiple mediums and an construction delays and high cost overruns, understanding of the preferred time and channels/stations, especially after raising 1:1 rights shares worth programs, including the usage of door to door campaigns NRs. 694 million in 2008. In 2014, the then targeted at housewives. Long-form communication Ministry of Energy, based on instructions from materials can include newspapers or other printed the Commission for Investigation of Abuse materials such as brochures, pamphlets, and factsheets. of Authority, cancelled its generation license. Furthermore, with the gradual penetration of social media, This resulted in a huge loan default by the especially Facebook, into the rural communities, these can company that completely ruined its balance be an ideal two-way communication platform for relevant sheet, resulting in no dividends being paid to actors, including SEBON and companies to engage with the shareholders. Further, the promoter shares local communities. had already been converted into tradable ordinary shares. In 2011, the company’s share MAKING PROJECT WEBSITE A MANDATORY price dropped from a high of NRs. 600 ($6) to PLATFORM TO PROMOTE TRANSPARENCY AND NRs. 37 ($0.3). This brought to the forefront ACCOUNTABILITY several issues of corporate governance: i) The setting up of a project website with periodic project capacity of hydropower developers to utilize updates should be made mandatory. Logistical challenges the money raised from public, ii) accountability are often a big barrier for local communities to access the of promoters who put the public investment project public information center. At a time when Nepal’s into risks, iii) lack of education among public current internet penetration rate has reached 63%, with investors to understand and respond to the over 95% using 2G or 3G mobile data, an effective and cost corporate malpractice, and iv) urgent need of efficient way to reach the local communities is through the the hydro sector regulator who can monitor internet. A website in Nepali that provides information in issues of corporate governance to protect the a simple, reader-friendly language can be relied upon as an investment of general citizens. authentic source as opposed to news or updates on social media, which may at times even be false. 18 STRENGTHENING COMMUNICATION AND PUBLIC LEARNING LESSONS FROM CHILIME CONSULTATION The aspiration to invest in shares of hydropower Effective communication is a product of consistent and companies, at both the local and national levels, has sustained effort to communicate. For companies, given the been propelled by the narrative established by Chilime’s long gestation period of project development, they should bullish run in the share market. But what we can learn formalize an engagement plan and also standardize all most from Chilime, is that despite its uniqueness - of communication with local communities. This should be having a favorable PPA rate and entering the capital done as early as possible, even during the initial surveys, market at a favorable time - what it has established and sustained throughout the life of the project. Public is given a momentum to the concept that with careful consultations are an integral part of community engagement, execution, value can be created and shared. Some of and it is crucial that the hydropower company engage Chilime’s circumstances that can be replicated and which in continuous dialogue with the communities about contributed towards its success, can be summarized by potential environmental and social impacts, including the following factors. These include: community development activities, and community needs i) The ability to build on time44 and on budget and; so that companies understand the expectations of local ii) The ability to facilitate greater public participation in communities and vice versa. In addition to engaging with equity. existing stakeholder groups, the hydropower company should require the project affected populations to elect However, the caveat is that, meeting the above conditions their own project level committee with at least two women alone, although likely to be contributable factors, will not representatives that can work to represent genuine local necessarily guarantee a profitable project that can keep interests. This committee will work with the company to shareholders happy. develop community development plans, benefit sharing agreements, and agree on compensation, land acquisition, THE RISE (AND FALL) OF MASS SPECULATION resettlement and rehabilitation. Two projects43 that have done The local shares phenomenon is happening at a time this have been successful in their local level negotiations with when Nepal has tapped only a fraction of its hydropower the communities that included acquisition of private land and potential, which means that there is currently a very resettlement planning. With specific regard to local shares, limited supply of hydropower company shares in the hydropower companies should prepare a set of messages that capital market. With thousands of additional MW in the are factual and accessible and communicate it consistently pipeline and a corresponding increase in the supply of during all its interactions with local communities and ensure shares, there will be a natural downward pressure on the adequate outreach to those unable to partake in public average price, which may have a significant impact on how meetings – these can include people with diminished mobility, local communities view local shares as an asset and their those occupied with household chores, adolescents or young willingness to invest in it. adults attending school, among others. A MARKET YET TO MATURE The local shares regime has been in place for a very short KEY OBSERVATIONS AND CONCLUSION period of time. During this period, about two dozen hydropower companies have offered or are in the process This section highlights the main issues of local shares that of offering local shares. In all these, local communities have been identified in the study. While these serve as the have participated exuberantly, placing immense faith in the key takeaway points of the report, the underlying intention performance of companies and the overall share market, is also to reiterate and emphasize the context within which albeit with limited comprehension of both. But neither the local shares have evolved so that the development of investors nor the market have had to face major adversity relevant policies in the coming days is grounded in its reality. to date that has tested their tenacity to invest long term. 43 Upper Karnali HPP and Arun 3 HPP. 44 Chilime was constructed just two years behind schedule. In comparison, other projects have faced significant delays by several years at least. 19 Conversely, at the tail end, only a couple of companies have NEPAL’S ELECTRICITY completed their lock-in periods and most local investors SECTOR REGULATOR have not had the opportunity to realize profit from their investments. However, the Nepali share market has Many experts identified the need of a regulator experienced a long bearish run—a significant portion of to ensure a healthy and competitive practice which happened during the course of this study period— in the electricity sector. SEBON’s approval resulting in a drastic decrease in the price of hydropower process for public shares is about compliance company shares. Because this new price point offers lesser with disclosure and not about the actual risks return, this could change how communities perceive the of the company. In the banking sector, the potential to ensure capital gains and their demand for local sector specific risks of BFIs are regulated by shares. Additionally, given the long gestation period, the Nepal Rastra Bank, the central bank of Nepal associated opportunity cost, and the delayed returns from to ensure the soundness of the company. investment, local communities may no longer be attracted Similarly, Insurance Board is the regulator for to shares, especially if the current market hype ends. As the insurance companies. There is currently a the market for hydropower company shares thus matures, lack of regulator in the electricity sector. The community members may find other better short-term Electricity Regulatory Commission, established investments. after the enactment of Electricity Regulatory Commission Act (2017) on September 4, STRENGTHENING TRADITIONAL FORMS OF 2017 has a mandate to, among other things, BENEFIT SHARING determine the power purchase rate for NEA, The impact of local shares is dependent not only on the fix electricity tariffs after holding public performance of the market, but also the ability of each hearings, and develop grid and distribution individual to be cognizant of and, more importantly, have the codes. While SEBON continues its role as capacity to make timely investment decisions. Furthermore, a market regulator, the newly established in defining local shares as an opportunity to invest, there is a Electricity Regulatory Commission can lead in limitation on how socially inclusive this instrument of benefit coordination with other regulatory agencies sharing can be designed: investments naturally offer higher in securing the health and performance of the degree of rewards (albeit non-guaranteed) to those willing overall electricity sector. to take on larger risks. 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 investment in Nepal, wherein government bodies46 are larger appetite for risk and, therefore, the potential to reap a being considered as investment partners in hydropower higher reward than their non-affluent counterparts. development. As practiced internationally, this set up would allow for any financial benefits accrued to be used Nepal has in place a number of traditional benefit for the development purpose at the community level. sharing mechanisms45 that have the potential of There must be increased effort by the government in becoming better instruments to positively impact the strengthening these mechanisms in order to ensure that lives of local communities. There are also recent efforts the lives of the affected communities whose resources are at institutionalizing the traditional form of equity being exploited also benefit in the process. 45 These include, among others, i) a royalty sharing mechanism that apportions back half of the revenue collected by the central government to the subnational govern- ments through the development budget; ii) local livelihood support initiatives undertaken by HPCs that offer various types of livelihood trainings and employment opportunities to project-affected community members, iii) a community development and local infrastructure initiatives, wherein HPCs contribute to smaller commu- nity-based infrastructure like rural electrification, drinking water supply, irrigation facilities, etc. 46 For example, Upper Trishuli 3 B has set aside 5 percent share ownership to the municipalities of Rasuwa and Nuwakot. 20 ISSUE OF REBALANCING INCOME IN RURAL AREAS Review of legal documents and available market data: The study demonstrates that offering equity presents too This included a comprehensive examination of relevant many challenges in administration and risk, and logistical policies and legislations, including the Constitution of challenges in identifying target groups and so other local Nepal, Electricity Act and Regulations, Securities Act and benefit mechanisms can be much more effective, such Regulations, Companies Act and Regulations, among as skill training, jobs and local business development. others. Other key documents examined were project- But the study does show particular benefits from share specific, including power development agreements (PDA), ownership for women,47 a group that is easy to identify, environmental impact assessments (EIA), and company and so they can be a target group for redistribution prospectuses. To examine the market performance of income opportunities through equity. Efforts by of hydropower companies, data was obtained from hydropower companies, SEBON and the government government sources and from financial statements of listed to focus on this group have immense potential to yield companies. tangible outcomes in terms of improved access to wealth, financial literacy, and the ripple effect on family health Field visits: The team interviewed communities and education, among others. from fourteen project sites in four districts - Rasuwa, Solukhumbu, Dolakha, and Lamjung. Three specific Finally, it is important to keep in mind that local shares criteria were used to select the projects to ensure the widest evolved to fulfill a specific purpose and, for the moment, possible sampling: i) characteristics of offering local shares, it serves it well: for local communities, it offers a chance ii) installed capacity range, and iii) type of investment at netting the capital gains they seek; for companies, it in the project, projects with foreign direct investment, offers the possibility of reduced project disruption due to projects belonging to Nepal Electricity Authority and/or its increased local ownership. This equilibrium is likely to subsidiary companies, and independent power producers. remain, for as long as both the local communities and the companies continue to perceive local shares as a win-win Focus group discussions and semi-structured interviews: The for both. However, given the uncertainty in the Nepali team carried out a total of 22 focus group discussions (FGD) capital market for hydropower shares and the likely event and 110 semi-structured interviews (SSI) with community of oversupply of such shares in the secondary market, it is members within the immediate project vicinity and at the difficult to predict the future direction and the impact that district level. Best efforts were made to ensure maximum local shares will have on local communities. It is therefore inclusivity in the FGDs, in terms of both gender and ethnicity. critically important to consider carefully all of the various Four separate women-only FGDs were conducted by a female facets of this phenomenon in pursuing further policies to member of the study team. For respondents that did not own guide it. shares, an attempt was made to identify the underlying reasons, if any. STUDY METHODOLOGY Key informant interviews: The team conducted 50 key informant interviews (KII) to explore the discourses Primary sources: As an exploratory research into the around the emergence, adoption, and transformation practices of local shares in Nepal, this study relied extensively of the practice of local shares in Nepal. Respondents on primary sources to obtain the necessary information. were professionals, government officials, NEA and IPPs, 47 A significant number of women now own shares, as the current share allotment is based on individual applications, with a capped amount for each applicant. Thus, most households apply for all eligible family members to maximize their chances of obtaining more shares. As a result, women are now getting an equal opportunity to take part in the process. Interviews conducted with women demonstrated perceived benefits in terms of enhanced self-esteem, improved financial awareness, access to an additional income source, among others. 21 and experts on project financing and capital markets. practices and challenges in the delivery of local shares. The team also interviewed representatives from various The fourth workshop focused on the status of the shares political parties and members of the parliament who have of hydropower companies at the end of the projects’ influenced their respective party’s position on hydropower concession period. development. Consultative Panel: IFC formed a consultative panel Accounts from the field: The team conducted rapid comprising national and international experts to provide assessments of local communities in Rasuwa and Ilam, feedback and suggestions on the study. The study team with a special focus on marginalized peoples that have presented the report to the consultative panel at different invested in local shares of Chilime Hydropower Company phases of the study: i) on the design of the study after the and the Sanima Mai Hydropower Company. The inception phase; ii) on findings after the field visits, and iii) assessment of 97 respondents was intended to capture any final presentation with recommendations towards the end of economic changes and social empowerment as a result the study period. owning local shares. Secondary sources: The team reviewed various reports Expert Consultations: The team organized four on benefit sharing, national and international practices of consultations with sector experts to deliberate on equity investments in infrastructure, local shares options, policy implications of its preliminary findings. The first among others. Other sources included relevant newspaper workshop focused on alternative delivery models of local articles, company documents, websites, brochures, annual shares. The second workshop discussed eligibility criteria reports and web portals related to information on the for local shares. The third workshop deliberated on the hydro companies and the Nepali capital market. 22 IN COOPERATION WITH KNOWLEDGE PARTNER International Finance Corporation The World Bank Group Nepal Office P.O. Box 798 Yak and Yeti Hotel Complex Durbar Marg, Kathmandu, Nepal Tel.: 977-1-4236000 Fax: 977-1-4225112 www.ifc.org/hydroadvisory