Interview: Nakul Zaveri on impact investing and climate finance

IUKDPF Research Associate Dr. Jai Bhatia speaks with Nakul Zaveri (Managing Partner – Relativity Alternative Investment Strategy). Nakul has over 20 years of experience in the climate change and finance sector, and is currently running a private equity fund focused around sustainable and responsible investing. The fund invests in businesses that address challenges arising from mega trends, such as climate change.

JB: What are the most attractive opportunities and the biggest challenges for private equity in the area of development? How do you understand development finance?

NZ: Let me first take a step back. When we talk about private investing or private equity, we are essentially looking at investing predominantly In the unlisted segment – it has a very wide band from early stage venture investing to growth investing to late stage investing. I also want to point out that the investment strategy is socially based on maximising risk adjusted returns. What does that mean? It just means that you are not gunning for the highest returning asset, but looking to be compensated for the risks. So, the challenges for private equity in the areas of development are not very different from investing in areas of non-development – the boundaries between them is blurred, addressing the challenges arising from climate change, poverty has now come to the forefront and therefore development finance is slowly but surely becoming mainstream.

“…development finance is slowly but surely becoming mainstream.”

When I look at development finance, I always tend to look at it as in two buckets grants for areas in which there is very little economic return and then a whole host of other areas where a capital can actually generate economic returns, and in some case is best in class returns such as investments in infrastructure and investment in small and medium enterprises. The new trend that is coming out is that there is a whole area of sustainable social investments. There is an ecosystem developing around impact or social investments. There have been massive amounts of capital mobilization from the institutions such as the World Bank, the Asian Development Bank or some other BFIs in multilateral institutions. However, there is a strong belief in the market that a combination of private capital grants, subsidies and patient capital can take on impact investing and generate risk adjusted returns. 

JB: Could you explain the difference between finance first capital and patient capital investment ideologies around green finance in India?

NZ: Green finance is a very broad term – it covers everything from renewable investing to investing in waste and water. Green finance has essentially evolved after the fact that climate change has had a material impact on businesses, societies, what we consume and how we live. A vast number of studies show that climate change is accelerating the good and bad – therefore addressing issues of climate change requires a multi-pronged approach starting from policy to finance, which is at the heart of green finance. In India, there is a lot of discussion around clean technology. Clean technology has now evolved and has become more mainstream. For example, in the late 2000s, India had between 20 to 30 megawatts of solar power but now the scale has changed to 30 to 40 gigawatts of solar power.

“addressing issues of climate change requires a multi-pronged approach, starting from policy to finance, which is at the heart of green finance.”

Transition finance is leading the way – we are talking about brown becoming green in other words, there is lot of financing that is expected to support decarbonisation in existing industries like mining, heavy industries, coal, steel, chemicals, and iron where there is expected to be a reduction on the amount of CO² emissions. Many mainstream companies have committed to becoming zero carbon. So, there is a road map that people are looking to and that is part of green finance – people are thinking about recycling materials in a much more commercial sense and in the last one to two years, increasing number of companies have appointed chief sustainability officers. Lastly, the ecosystem and tools, both in terms of technology and enforceability to monitor and provide data to meet climate goals has become more mainstream.

JB: Given the big trends globally in green finance, where would you say are the opportunities for India to lead?

Let’s look at the challenges and identify the opportunities – there is massive amount of urbanization taking place right across the world and cities are getting congested. So, there are opportunities are around buildings, urban infrastructure and safety and security. Another challenge is that there is a massive amount of data being generated which requires storage in data centres and data centres by definition consume a lot of energy. The opportunity lies in making data-oriented practices more efficient and in big data analytics and automation.

Regions like Europe are making regulations for companies to disclose climate risks and that has a domino effect on how investors react to that sort of data. Opportunities lie in understanding the material effect of such trends on risks and returns and spotting the solutions around them. There is also a significant push around electric mobility or transport or solutions. The electric vehicles technology is going to dawn a very, very different generation of opportunities – we already seeing that in emerging markets.

The last 3 months with the Coronavirus situation some of these things have got significantly accelerated and opportunities for India to lead around these areas are going to be more material and significant going forward.

Click here to read Mudaliar and Patel on the transition to electric mobility in India.

JB: Could you explain how green bonds or impact bonds from the global South work in practice? Are they considered to be riskier because they are from the Global South and what are the characteristics of these bonds that make it attractive to the borrower as well as the lender?

There are two ways to think about it – let’s take the numbers, India’s green bond issuance stood at approximately US$ 7.5 to 8 billion between 2012 and 2018 and it was essentially the second largest issuer of green bonds in the emerging market segment. But China issued in the same period US$108 billion of green bonds. India requires a massive amount of funding – approximately US$ 2.5 trillion to meet the climate change actions that we committed to at COP in Paris.

The big challenge is the maturity mismatches between long-term green investments and short-term interest of investors. Large investment projects did not exist 15 or 16 years ago on the renewable energy side, which is changing now. Regulations and policies need to evolve and the big elephant in the room is currency risk which makes Indian investments a little less appetising for some of the global investors needs to be addressed. There area number of harmonised frameworks coming out from a reporting or auditing perspective. Banks have taken significant amount of obligations on themselves to meet and finance sustainable oriented projects. So that is going to see lot of capital being pushed into that area. Asset managers and asset owners are also pushing sustainable finance and in a couple of years large countries in the emerging market will become very, very sizable players around green bonds.

JB: What are some of the tools or instruments that Indian companies used to finance development projects such as solar energy projects in Africa? What is the goal that private equity plays there and are there opportunities for development partners such as the UK to participate in this sort of investing?

NZ: There are various tools and instruments that are available. Outside of China, India has done significant work around sustainable investing, many investment experts consider India closer to a developed market rather than a frontier market. 

Indian companies are moving to different geographies like Africa and South East Asia where India takes modular solutions which have worked in India. For example, large companies in renewal energy, telecoms and food and beverage have clearly make inroads in Africa. Generally, equity as an instrument is being used most commonly but there is also the India’s export import bank which has helped mobilise capital for trade with Africa, specifically around wastes projects, water projects and wind and solar projects. There is also significant amount of push from the government for companies of Indian origin to increase their presence outside of India and share technologies. For example, the line of credit provided by the government to finances joint ventures especially in South Africa, Kenya Mauritius, Ghana, Nigeria.

India has done significant work around sustainable investing, many investment experts consider India closer to a developed market rather than a frontier market.

Another instrument is private equity, which is capital that can move very fast, and undertake very deep diligences. It can obtain and address the solutions required to invest for areas which may not be extremely ripe for very large and listed and public market interventions. Private equity can move first with a little help of the world’s largest DFIs and MFIs into these areas previously geographies that were considered riskier. Indian private equity managers and Indian fund managers are taking a regional approach: they take their expertise and capital given that they can be nimble footed while investing. Private equity provides a way to address opportunities in development finance.

JB: There is a popular perception that many poor countries are over-indebted because they are getting all these very large loans from countries like China – do you think that affects how attracted private equity is to these particular countries?

Private equity looks for risk adjusted returns from its investment from both the North and the South. So, when it comes to different geographies which have a debt problem the risk over there becomes a little larger, but if the opportunity exists and the risk adjusted return makes sense, then in a  material sense there is no reason why private equity capital can’t be mobilised there and more often than not the government and its policymakers want to create an ecosystem for equity capital to try and balance the debt capital. Countries eventually need businesses to spur a long-term sustainable growth, and that is increasingly done by private capital these days.

Dr Jai Bhatia is a research associate at the India-Development Partnership Forum. Her research examines various aspects of Indian development finance.