Financing Energy Transition: Domestic institutional capital can massively support India’s ambitions

By Shantanu Srivastava, Energy Analyst at the Institute for Energy Economics and Financial Analysis (IEEFA)

Indian life insurers and pension funds, the biggest domestic institutional investors (DIIs) by assets under management (AUM), have largely stayed on the fence regarding investment in the country’s renewable energy sector. This is mainly because restrictive investment guidelines and a lack of investment avenues, among other reasons, have constrained these entities.

A concerted effort from the various sector regulators can help channel their enormous pool of capital into domestic clean energy infrastructure and contribute towards India’s energy transition goals.

Institutional investors and renewable energy assets are a good fit

Globally, institutional investors such as pension funds, insurers and sovereign wealth funds are some of the largest investors in sustainable finance markets. This has helped channel tremendous capital into low-carbon technologies such as renewable energy generation.

Several of the biggest institutional investors have supported the booming market for environmental, social and governance (ESG) investing by pledging to align their investment practices with ESG. In fiscal year (FY) 2021, US$1.7 trillion worth of ESG loans and bonds were issued globally, an enormous feat by any measure.

Renewable energy assets are a perfect fit, especially for the investment preferences of long-dated institutional investors such as pension funds and life insurers. These investors have large investment ticket sizes, are risk averse and are highly susceptible to climate risks in their portfolios.

LIC and EPFO, the domestic institutional behemoths

Among Indian institutional investors, two stand out prominently. First is the Life Insurance Corporation of India (LIC), the country’s largest life insurer, managing ~70% of the entire AUM of the industry or close to US$510 billion (as of March 2022). The second is the Employee Provident Fund Organization (EPFO), the largest pension fund in the country, managing assets worth ~US$196 billion (as of March 2021).

The investments by these two entities form one of the largest chunks of domestic institutional capital. Thus, their investment practices significantly impact capital allocation towards different sectors of the economy.

Sector regulators, the Insurance Regulatory and Development Authority of India (IRDAI) and the Pension Fund Regulatory and Development Authority (PFRDA), provide the investment guidelines for LIC and EPFO, respectively. Historically, these guidelines have been overly restrictive. As a result, LIC and EPFO’s investments in renewable energy have been low.

Restricted clean energy investments by the two entities

On the equity side, LIC’s non-consideration of climate risks has meant lower investment into climate mitigation assets such as renewable energy. Meanwhile, EPFO can only make equity investments in four exchange-traded funds (ETFs) approved by the PFRDA, preventing any sectoral bets.

Another restriction is on investment in project-level equity. This prevents LIC and EPFO from investing in the country’s operational de-risked renewable energy assets.

Lastly, infrastructure investment trusts (InvITs), which are an appropriate vehicle for investment in renewable energy assets, have not seen much investment due to the lack of InvITs operating in the market.

On the debt side, LIC and EPFO have a mandate to invest 40~50% of assets in state- and central-level securities. Another major chunk of LIC and EPFO’s investment in debt goes to AAA-rated bonds, which has primarily meant public sector undertaking (PSU) bonds, given the shallow corporate bond market in the country. However, private players have set up the majority of renewable energy capacity in the country.

Besides investment restrictions, non-consideration of climate risk on portfolio and non-alignment with ESG investing principles has meant that low carbon and high ESG-rated renewable energy assets do not feature as attractive investment options for LIC and EPFO.

Interventions needed to scale up clean energy investments by LIC and EPFO

Several changes are necessary to scale up clean energy investments by domestic insurers and pension funds, including weeding out several structural issues that have plagued these institutions for a long time.

Within debt markets, there is a need to grow the corporate bond market to make it accessible for the wider private sector, especially the smaller and lower-rated issuers. Some immediate solutions include lowering issuance costs, reducing issuance time, providing de-risking mechanisms such as credit derivative instruments, and tapping into the retail segment of investors. Longer-term reforms required are an increase in the thresholds for investment in private corporate bonds and the decoupling of renewable energy from the wider power sector for increased investment thresholds.

On the equity side, the PFRDA needs to allow investment options beyond ETFs for the EPFO. Meanwhile, LIC needs to reconsider its investment strategy through a change in the investment policy statement, to diversify away from its fossil fuel-heavy portfolio. Another intervention both entities require is permission to invest in project-level equity. Lastly, increasing investment thresholds in InvITs will signal more players to enter the market and provide investment opportunities for LIC and EPFO.

Lastly, incorporating climate risk considerations and ESG investing principles in the investment decision-making process will also help shore up renewable energy investments.

Insurance and pension funds have played a pivotal role in Indian capital markets and have been a key source of capital for several state and central-level entities. It is time that regulators widen these entities’ investment ambit to accommodate higher investment into the private sector, with the renewable energy sector taking the lead.