When the government decided to initiate power sector reforms in 1991, little did it know that it is opening a Pandora's box. Much of the confusion is its own doing.
The government and the interested Independent Power Projects (IPPs) faced many hurdles and differences on the direction of reforms. But it has been a learning experience for both. One of the biggest concerns for both was the fragile financial health of the government controlled State Electricity Boards (SEBs).
The SEBs were caught in a vicious circle. Large-scale subsidisation of tariffs had dented their profit making abilities. As a result, these boards were not able to upgrade their billing networks and to make investments for reducing their high transmission and distribution losses. This inability to upgrade their infrastructure led to large-scale pilferage of electricity, adding to their woes.
Normal SEB Collections
As a result none of the IPPs felt secure about the ability of the electricity boards to pay up their dues when the time came. To overcome this problem the respective state governments offered to be guarantors for the SEBs. The power corporations were not satisfied and asked the central government to be the counter-guarantors. The central government refused to do so for all IPPs and decided to give counter guarantees to only select Mega Power Projects (MPPs) i.e. power projects over 1000 MW capacity.
To end this stalemate, both the parties hit upon a concept known as 'Escrow'. Escrow is basically a vehicle for risk mitigation. There are two types of escrows - Pure escrow and trigger mechanism escrow.
Pure Escrow implies that both the SEB and the IPP pre-decide an amount to be deposited and maintained in the escrow account. This amount is immovable and acts as a cushion against any default by the purchaser (in this case the SEB). However, pure escrow is not very popular in India.
Trigger mechanism escrow basically means the opening up of a special account (escrow) in which all the receivables of the concerned SEB will be deposited. The concerned SEB is free to utilise and transfer all the funds in this account to its own account. But a minimum 1.1% or 1.25% of the estimated monthly receivables have to be maintained in the escrow account.
If for some reason the SEB is not able to meet its financial commitment to the supplier (IPP or the financial institution, which has undertaken to securitise the IPP), the supplier then executes a letter of credit (LOC) to the SEB. When an LOC issued by the supplier fails, then only the supplier gives a notice to the bank to freeze the escrow account. Therefore, the first charge on receivables in case of any default will lie with the concerned IPP or the financial institution, which has securitised the IPP.
Trigger scenario incase of SEB default
Once the supplier or the financial institution recovers its dues using the escrow account, the freeze on the account is lifted and the SEB can resume transferring all the receivables in the account to its own operating account.
For this reason trigger mechanism escrow is also known as default escrow.