The last laugh?

If our last two stories gave examples of fund managers and institutions trying to make the best of existing regulation to attract new pockets of capital, our last story tells the tale of what investors are forced to do when regulators push them into a corner. Specifically, it tells the story of what happens when investors are confronted with the nuclear weapon in a regulator’s arsenal: retroactive changes.

As we reported in October, UK fund manager HgCapital’s Renewable Power Partners I and II funds were posting respective IRRs of -3.35 percent and -33.6 percent as of 31 March 2015, according to the California Teachers’ Retirement System. The news is of special significance for Fund II, which was one of Europe’s largest renewables vehicle when closed on €542 million in 2011.

Most of HgCapital’s renewables misfortune, it appears, is due to retroactive cuts to solar tariffs the Spanish government enacted in 2013 (see A tale of regulatory change). A third of Fund I and a quarter of Fund II are invested in Spain, sources familiar with the vehicles say. HgCapital declined to comment.

The story is not over, however. HgCapital, along with 14 other disgruntled investors, is engaged in an arbitration process to try and recoup the losses. And according to legal sources with knowledge of the case, the plaintiffs stand a good chance of winning.

The outcome matters a lot: should HgCapital succeed, it is understood the fund manager could receive between €140 million and €150 million in compensation per vehicle. Sources say that would increase both funds’ return multiples by up to 0.6x and bump their respective IRRs to the low-double digits, a solid windfall for a renewable infrastructure fund.

The timing of the decision is not yet known, so HgCapital is said to be cautious in managing expectations. It is also waiting for the outcome before embarking on any fresh fundraising efforts. Yet it is not standing still: with Fund II expected to be fully invested by the end of this year, the firm is said to be talking to key investors to continue deploying money on their behalf in ad hoc projects. It is also considering various structures, such as segregated accounts, to be able to hold on to the assets for the longer-term.

Of course, it would have been better for HgCapital and its peers to anticipate an adverse regulatory move in the first place. And to its credit, the firm is candid about the fact that it sees arbitration as a last resort.

But you can’t expect all regulators to behave rationally. As one fund manager we recently spoke to puts it: “Investors seem to have a short memory. There is indeed a rich pipeline of renewable deals in Spain, but the regulator is neither sophisticated, nor independent. Mostly, it’s a puppet.”

Investors finding themselves wrong-footed in the future will be happy that a last resort option exists – if investors emerge victorious that is.