Steering the power and utilities sector through fraud and corruption risks

India has witnessed tremendous growth in the power and utilities sector in recent years, with the Government launching various reforms and schemes to increase electrification reach and spread across the country. As per Central Electric Authority, India is one of the world’s largest producers and consumers of power, with over 1 trillion units generated and an installed capacity of about 319,606 MW. Lately, there has also been a shift from using conventional energy to cleaner and greener sources of energy. Public-private partnerships, emphasis on research and development, and availability of resources in remote parts of the country are some of the trends that are expected to drive this sector in the future.

Perceived as a relatively risky sector to conduct business in, the power and utilities sector today faces many challenges. These include governance concerns, demands of the stakeholders involved, pricing pressure, market violability and fluctuating performances. These challenges have further increased the propensity of bribery and corruption risks. According to our recent EMEIA Fraud Survey 2017, “Human instinct or machine logic – which do you trust most in the fight against fraud and corruption?” 53% of the respondents in the power and utilities sector (globally) stated a slower economic growth than expected in their country as being a challenge in the growth or success of their business.

Some of the fraud risks that organizations in the sector face and the measures to mitigate them are as follows.

  1. Bribery and corruption: Conducting business in the power and utilities sector entails numerous approvals to build and operate establishments. This could make the sector vulnerable to bribery and corruption risks. According to EY’s EMEIA Fraud Survey 2017, 49% of the respondents in the sector (globally) stated that bribery and corruption practices are widespread in business. Expansion in emerging markets such as Africa, Asia and South America, which may be relatively high on the corruption index, could further amplify these threats. Risks range from bidding for tenders to implementing the programs and collecting dues. The practice of using third-party agents for facilitation or bribery payments seems to be a major roadblock, spurring unethical practices. However, the cost of non-compliance has significantly increased in the recent past. Amendments to the Companies Act, Prevention of Corruption Act and many other recent Indian and global reforms have resulted in an increasing number of investigations and prosecutions. Recent trend also shows individuals bearing the liability of such non-compliance, which may include key decision makers as well as the management. In addition, many power and utilities projects implemented in developing nations are funded by international development funds. Any breach or non-compliance could result in stringent action by the regulators, including blacklisting the organization, which might affect the overall growth and expansion of the business.
  2.  Fraud losses: High capital expenditure (capex) and operating expenses (opex) and widespread distribution channels, which involve multi-jurisdiction transactions, could make the sector prone to fraud losses as well. Some of the areas where organizations could lose revenue are capex and opex procurements where the quantities and value of purchases may be inflated to favor vendors, power theft and leakages in distribution channels, collection losses and bad debts. In extreme cases, fraud losses could even start from the implementation of the project and continue throughout its lifecycle. Gaps in compliance frameworks and governance mechanisms are some key reasons for such losses.
  3.  Financial reporting frauds: Many organizations in the sector, especially in renewable energy, are in the start-up stage and require funding from banks, non-banking financial institutions (NBFCs) or private equities or through listing in stock exchanges. The pressure to show and maintain profitable growth and margins, especially on early to mid-stage start-ups, could increase the risk of financial misreporting or window dressing, including deferment of costs, mis-classification of opex by capitalizing it or revenue recognition that is not in line with the accounting standards or principles. These frauds are typically perpetrated by employees in senior or decision-making positions and are camouflaged to avoid detection.

Turbocharging compliance

Organizations need to set up a robust compliance and governance mechanism to sustain in this volatile environment. While it may not be possible to completely eliminate these risks, taking measures to proactively mitigate and isolate the organization from them is seeing an uptick.

The right tone at the top is the key element in any compliance program, and many organizations are aligning to this philosophy. It is important to imbibe the regulatory and statutory requirements not just in form but also in spirit. Having a robust whistle-blower mechanism, which is also mandated under the Companies Act, is one such step in combating fraud risks. Increasing the use of social media and improving public awareness to drive anti-fraud campaigns can help identity issues at an early stage. Enforcement is key, with 81% of respondents to EY’s EMEIA Fraud Survey 2017 stating that prosecuting individuals would help deter fraud, bribery and corruption. Conducting due diligences on new markets, suppliers and vendors is also a crucial element in identifying potential issues at the inception stage.

The power the utilities sector is poised to grow with newer technologies and markets. Organizations are evolving their compliance procedures and ramping up by adopting technology-driven solutions such as data analytics and automated dashboards. These solutions can deal with large volumes of transactions and provide timely and concise information to mitigate losses. Thus, organizations that strive to be compliant and believe in sound corporate governance would derive immense benefits from them.

Follow @EY_India and track #EYForensic for regular updates

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