Virtual Power Purchase Agreement’s (VPPA’s) are unique financial instruments that have the potential to substantially increase the demand for renewable energy, especially from the corporate sector. In India there is a lack of clarity regarding the jurisdictional and statutory regulation of VPPA. This essay is an attempt to address this issue by firstly laying down where exactly the conflict lies and secondly, by providing a solution to the conflict backed with coherent reasons.
1.1 What is VPAA and what are its benefits?
A Virtual Power Purchase Agreement (VPPA) is a financial contract in which the buyer agrees to purchase renewable energy attributes from the developer at a ‘pre-agreed price’, also known as the ‘strike price’. However, unlike a regular power purchase agreement (PPA), wherein the buyer physically receives the energy, in a VPPA the buyer is not receiving the energy. Rather, the electricity is being sold by the developer in the merchant market i.e. at the Indian Energy Exchange (IEX). If the market price of energy traded at IEX exceeds the pre-agreed price under the VPPA, the excess amount is paid by the developer to the buyer. If the market price is less that the pre-agreed price, the difference is paid by the buyer to the developer.
For instance, if the strike price is INR 5/kWh under the VPPA. There arise two scenarios:
(a) When the price of the electricity in the merchant market is INR 7/kWh.
The developer sells the power at INR 7/kWh, thereby earning a profit of INR 2/kWh. The offtaker purchases the power at INR 7/kWh, thereby incurring a loss of INR 2/kWh.
Therefore, the settlement for that particular day will be done by the developer paying the offtaker INR 2/kWh.
(b) When the price of the electricity in the merchant market is INR 3/kWh.
The developer sells the power at INR 3/kWh, thereby incurring a loss of INR 2/kWh. The offtaker purchases the power at INR 3/kWh, thereby earning a profit of INR 2/kWh.
Therefore, the settlement for that particular day will be done by the offtaker paying the developer INR 2/kWh.
Hence, at the end of the settlement period, both the developer and the offtaker have neither incurred loss or gained profit from the sale and purchase of the power and have successfully hedged their price risk.
A VPPA will be settled financially as a fixed-for-floating swap or contract-for-differences. Under the VPPA, there will be a pre-agreed settlement period, typically every month or quarter. During that time, the developer will sell energy on the wholesale market, at the floating market price. At a pre-determined interval, as may be agreed between the parties, the developer will calculate the difference between the floating market price and the fixed VPPA price. At the end of the settlement period, the differences are calculated. If the total is positive, the developer will pay the buyer the difference. If the total is negative, the buyer pays the developer the difference, thereby guaranteeing that the project always receives the agreed upon VPPA price.
The benefits for the buyer are twofold: firstly, in exchange for its purchase, the Buyer receives Renewable Energy certificates (REC’s). If you hold REC’s it is equivalent to owning a certain amount of green/renewable energy. Thus, these REC’s are purchased by the obligated entities to meet their renewable purchase obligations (RPO) . Secondly, since the price being paid is a ‘pre-agreed’ price, the transaction helps buyers hedge risk against the volatile energy prices. Continuing our example from above, since the market wholesale price is high, B’s electricity cost would also be high. However, the same can now be set off by the additional amount that B receives from the VPPA transaction. The reverse is also true. If the wholesale market price is low, B would be obligated to pay the difference to A. However, the lower energy cost in general will offset this additional burden.
1.2 Characterizing a VPPA
As we can note from above, a VPPA is a financial contract used to hedge risk by both the parties. However, it is important for us to determine under which category of financial instruments does the VPPA fit into. The characteristics of a VPPA are similar to that of a derivative contract. A derivative contract is a financial instrument wherein the value of the contract is dependent on an underlying asset. These underlying assets can be anything and includes commodities as well. The Securities Contract Regulation Act, 1956 (SCRA) has defined the term “commodity derivative” . Further, in a derivative contract parties take a position. One party believes that the price of the underlying asset will go up (long position) and the other party believes that the price of a commodity will go down (short position). A VPPA too has such characteristics. The settlement under a VPPA is also dependent on the price of energy in the merchant market and further, the buyer takes a long position i.e. price of energy will increase , whereas the developer takes a short position i.e. price of energy will decrease.
There are four types of derivative contract : forwards, futures, swaps and options. A VPPA can be further categorized as a forward or a swap derivative. A VPPA cannot be categorized as a futures derivative because, unlike forwards and swaps, futures are standardised financial instruments which are traded on the exchange. On the other hand, forwards and swaps are customizable and over-the counter (OTC) transactions and hence are not traded on an exchange. A VPPA can be a forward or a swap contract because: 1) it is not a standardized contract. Rather, it is customized contract drafted according to party’s needs and demands; and 2) a VPPA entered into by parties is not an instrument that is traded on an exchange. Lastly, like in a VPPA, the forward or swap derivative contract also has a pre-agreed price in place.
To summarize, a VPPA can be categorized as commodity derivative contract. Further, it can be sub-categorized as a forward or a swap derivative as VPAA are customized in nature and are OTC transactions.
1.3 Scope of this Blog
In part 2 of this blog, we will discuss about the tussle between the SEBI (Securities Exchange Board of India) and the CERC (Central Electricity Regulatory Commission) with regards to the regulatory authority over the electricity derivative market in India, the compromise reached and the inadequacy of the compromise to deal with instruments such as the VPPA’s. In part 3 of this blog, we will discuss about legislative framework that will apply to VPPA’S. Finally, in part 4 of this blog, we conclude by summarizing the issues raised and recommendations proposed.
2. The tussle for Jurisdiction and the inadequacy of the compromise
2.1 Who should have control over the power derivative market in India- SEBI or CERC?
The dispute for the jurisdictional control of electricity futures and forwards contract in India is between SEBI, the financial market regulator and the CERC, a body which exercises functions and powers as a regulator in the whole of India with regard to electricity. The issue came up before the Bombay high court in the matter Multi Commodity Exchange of India Limited & Another v/s Central Electricity Regulatory Commission & Others. In short, the primary argument of both the sides are as follows:
SEBI argued that it had jurisdiction over the forwards and futures contracts of all types and thus it should have the jurisdiction over the electricity forwards and futures contracts. Further, it was also argued that the Electricity Act, 2003 (Electricity Act) did not even ‘remotely’ refer to and/or deal with forward contracts and futures. It argued that only ‘ready delivery contracts’ were contemplated by the electricity and since futures and forwards contracts were purely ‘financial contracts’, and thus the same cannot be under the jurisdiction of the CERC. Rather, they should be under the jurisdictions of a ‘specialised’ body put it place to deal with regulation of such ‘purely financial contracts’.
CERC on the other hand argued that the Electricity Act was enacted to consolidate the laws relating to generation, transmission, distribution, “trading” and use of electricity and for that effect could introduce any measure to assist in the development of the energy sector. It was submitted that on a combined reading of Section 66 read with Section 178 (2) (y) of the Electricity Act enables CERC to make regulations for the development of the energy market, including trading. It was argued that trading covers all aspects, including trading of futures and forwards dealing with electricity.
The Bombay High Court, took consideration of all the arguments presented and came to a very ‘inconclusive’ decision. It ruled that neither SEBI nor CERC could have complete control over electricity futures and forwards market. The court held:
“The futures contract in electricity cannot be exclusively dealt with by the authority under the FCRA. Similarly, in view of the specific provisions under the FCRA, CERC also cannot deal with the futures contract on its own and have no power to deal with the same in the futures contract, unless appropriate enactment has been made by way of statutory provision regulating the futures contract, giving powers only to one authority out of the aforesaid two authorities”.
2.2 The inadequacy of the compromise
In July 2020, it was reported that a compromise was reached between the SEBI and CERC on the dispute regarding the jurisdiction of electricity futures and forwards. As per the compromise, SEBI is to oversee all ‘financially traded electricity forwards; while CERC would regulate ‘physically settled forward’ where electricity is delivered on a future date at a contracted price.
The inadequacy of the compromise is related to the fact that a VPPA doesn’t fit into any one of these categories and has come characteristics from each of these. For ex – VPPA can be termed as a pure financial instrument as it is primarily used for hedging the price risk and the buyer doesn’t receive the electricity in physical form. On the other hand, the fact that the buyer receives REC’s and that purchase of green energy is credited under his/her name prevents it from being categorised as a purely financial contract. Therefore, the compromise between SEBI and CERC does not in fact clear the fog for regulatory authority over VPPA’s in India.
In our opinion, the jurisdiction of VPPA’s should rest with the CERC. The reasons being: Firstly, the primary purpose behind having the oversight of the SEBI is to regulate those instruments that can be traded on an exchange by anyone who intends to make a ‘profit’ via such trading. The need for the jurisdiction of SEBI for ‘futures’ is because futures are standardised and are trade-able and both these things need to be done under the monitoring of the SEBI. However, the VPPA are customisable based on the needs of the parties and are not traded as futures and hence the vigilance of the SEBI, as a market regulator is not required. Secondly, OTC derivatives are not governed by SEBI. This can be evidenced from the fact that Section 18A of the SCRA doesn’t envisage the regulation of OTC derivatives, such as forwards and Swaps. This is further testament to the fact that, VPPA’s are not under the jurisdiction of SEBI. Lastly, VPPA’s have more characteristics of a ‘physically deliverable contract’ than of a purely ‘financial contract’, thereby shifting the scales in favour of CERC. Purely financial contracts such as ‘futures’ operate in realm of price discovery and profit-making. In such endeavours, the product is never delivered. However, in VPPA, although there is no ‘physical’ delivery of electricity, delivery is being done in the form of REC’s. Thus, there is some tangible connection between the product and the financial instrument.
3. Which statute will govern VPPA’S?
As we have clarified above, OTC are not governed by the SCRA. Rather OTC derivatives are under the regulatory framework of the Reserve Bank of India (RBI). Section 45V of the RBI Act, 1934 (RBI Act) ( inserted by the Reserve Bank of India (Amendment) Act, 2006) reads as follows:
“Notwithstanding anything contained in the Securities Contracts (Regulation) Act, 1956 (42 of 1956) or any other law for the time being in force, transactions in such derivatives, as may be specified by the Bank from time to time, shall be valid, if at least one of the parties to the transaction is the Bank, a scheduled bank, or such other agency falling under the regulatory purview of the Bank under the Act, the Banking Regulation Act, 1949 (10 of 1949), the Foreign Exchange Management Act, 1999 (42 of 1999), or any other Act or instrument having the force of law, as may be specified by the Bank from time to time.”
Hence, as per the RBI Act, an OTC derivative can only be valid if at least one of the parties is RBI, a scheduled bank or any other agency under the purview of the RBI. However, parties who contract a VPPA are not such entities being regulated by the bank and hence such contracts will not be regulated under the RBI Act.
However, the draft CERC (Power Market) Regulations, 2020 (Regulations) have attempted to allow for electricity OTC forward contracts between buyers and sellers. This can be gauged from Regulation 43of the draft Regulations which lay down that both electricity generating companies and open access consumers can be participants of the OTC platform. But, with regards to VPPA’s there are some roadblocks in the way. On reading Regulation 7, which lays down that the settlement of contracts transacted in the OTC market shall be done only by physical delivery of electricity. Thus, there is a clear embargo under the draft Regulations for the VPPA to fall under the jurisdiction of CERC. The only foreseeable solution is that the CERC may include REC’s under the ambit of “physical delivery of electricity” or an amendment to the effect that Regulation 7 covers “physical delivery of goods” rather than just electricity. If it can’t be categorised that way, then VPPA’s cannot be entered into an OTC market.
Although, the clarity must come from the CERC itself with regards to whether or not VPPA’s are considered as ‘physical delivery of electricity’, we feel that VPPA’S are contracts that can be and should be allowed on the OTC market. The reasons behind this are twofold: Firstly, in the explanatory memorandum of the draft regulations it has been stated that one of reasons for introducing the OTC platform is to cater to the “growing requirement for purchase of renewable power to meet renewable purchase obligation by the obligated entities”. VPPA’s are one of the primary instruments which will help fulfil this requirement. Since, in a VPPA there is no obligation to deliver only to the buyer, it allows entities with distributed loads or with lack of access of renewable energy to purchase renewable energy attributes and meet their renewable purchase obligations. Secondly, although there is no ‘physical delivery’ of the electricity to the purchaser, the electricity is being delivered into a grid and all the REC’s “associated” with that electricity are in the name of the buyer. Thereby, the buyer is getting due credit for his ‘purchase’. This is different from a purely ‘financial contract’ wherein the purchaser will have no link with the electricity as soon as he/she trades the same with some other person.
Our primary aim with this blog post was to explore and resolve certain conflicts that may potentially arise with regards to VPPA’s in India. With regards to the jurisdiction of VPAA, we have suggested that the jurisdiction should rest with the CERC and not the SEBI. The primary reasons being that OTC contracts don’t fall under the purview of the SEBI and this is augmented by the fact that, VPPA’s are not purely financial contracts, that operate in the realm of price discovery and profit making. With regards to the statutory authority regulating VPPA’, there seems to be a need for the regulatory authorities to clarify a lot of aspects. However, in our opinion, the draft bill in its current form allows for VPPA’s on the OTC market. Such a reading is in line with the purposes of introducing a OTC platform and is also aligned to the semi-financial and semi-delivery nature of VPPA’s.
About the Authors
Mr. Anuj Singh Chauhan is an alumni of the Hidayatullah National Law University, Raipur (HNLU). He currently is a Legal Associate at Adani Green Energy.
V. Shanthan Reddy is a 3rd year law student at the National Academy of Legal Studies and Research (NALSAR), Hyderabad. He is also an Associate Editor at the Indian Journal of Projects, Infrastructure, and Energy Law (IJPIEL).
Managing Editor: Naman Anand
Editors-in-Chief: Akanksha Goel & Samarth Luthra
Senior Editor: Aakaansha Arya
Associate Editor: V. Shanthan Reddy
Junior Editor: Dipali Singh
Preferred Method of Citation
Anuj Singh Chauhan and V. Shanthan Reddy, “Virtual Power Purchase Agreements in India– Resolving Potential Jurisdictional and Statutory Conflicts” (IJPIEL, 15 February 2021)
 Section 2(i) of the Central Electricity Regulatory Commission (Terms and Conditions for recognition and issuance of Renewable Energy Certificate for Renewable Energy Generation) Regulations, 2010 defines ‘obligated entity’ means the entity mandated under clause (e) of subsection (1) of section 86 of the Act to fulfill the renewable purchase obligation.
 Section 2(m) of the Central Electricity Regulatory Commission (Terms and Conditions for recognition and issuance of Renewable Energy Certificate for Renewable Energy Generation) Regulations, 2010 defines ‘renewable purchase obligation’ means the requirement specified by the State Commissions under clause (e) of sub-section (1) of section 86 of the Act, for the obligated entity to purchase electricity from renewable energy sources.
 Section 2(bc) of the Securities Contract Regulation Act, 1956 defines “commodity derivative” means a contract-
(i) for the delivery of such goods, as may be notified by the Central Government in the Official Gazette, and which is not a ready delivery contract; or
(ii) for differences, which derives its value from prices or indices of prices of such underlying goods or activities, services, rights, interests and events, as may be notified by the Central Government, in consultation with the Board, but does not include securities as referred to in sub-clauses (A) and (B) of clause (ac)