The Green Investment Bank (GIB) Commission, in a report published last week, considers that the UK is not on track to deliver the target level of investment in major renewables projects (such as offshore wind) and that the GIB can play a key role in unlocking both private capital and debt finance for such projects to be delivered. 

In addition to addressing the key issue of capital constraints in the debt and equity markets, the GIB Comission states that measures are needed to maintain R&D support and to ensure that offshore wind licence holders can develop their round-2 and 3 sites at the required rate. 

Co-investment, with the GIB providing additional equity or debt, remains an option.  However, given the scale of the planned renewables projects, the GIB Commission's report suggests a greater volume of private sector investment can be unlocked by providing risk reduction products on commercial terms.  It calculates that a GIB with a capital base of £100-£400 million could unlock an additional £3 billion of finance, which could be enough to bridge the estimated finance gap in offshore wind in 2013.   

The GIB Commission favours tailoring financing products on a project-by-project basis, with "contractor default" letters of credit, "extreme events" insurance and contingent loan facilities all identified as potential options that could help to reduce risks to investors.  The GIB Commission believes that these products should increase overall returns to equity, making them attractive to equity and debt providers.

The GIB may also have a role to play in dealing with concerns around availability of debt finance in the event of market failure.  A key benefit of state-backed development banks, similar to KfW in Germany and Caisse de Depots in France, is the ability to reduce the cost of capital whilst maintaining private sector disciplines in relation to project management.  However, the GIB Commission notes that a variety of alternative mechanisms have been used by the Government in the past to give project support, such as government-sourced income streams (e.g. BBC Broadcasting House; Skynet5 military satellites).  The possibility has been raised of this type of public-sector contract assisting wind farms in raising capital, which would appear to suggest some sort of government off-take contract. 

The GIB Commission is calling for urgent action to ensure that the GIB is established and active within six months.  Whilst this may be a shorter timetable than that envisaged by the Chancellor of the Exchequer, (who has stated that detailed proposals will be published after the Spending Review in October 2010) it is clear that the GIB is a high priority for the Government. 

Investors in offshore wind and other major renewables projects will expect to see much greater detail around the proposals over the coming months, including in particular on how the GIB will be funded.  It is generally recognised that the finance required for such projects and related infrastructure is significantly beyond the amounts GIB will be able to unlock, and that successful implementation will require a supportive commercial, regulatory, industry and economic framework for such projects.  However, the GIB will have a role to play on some projects, and investors should therefore look to position themselves to make the most of the opportunities arising from GIB's involvement in the sector. 

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Full Article

Introduction

The UK is facing a massive need for investment in order to meet its climate change and renewable energy targets, estimated at £550 billion between now and 2020. The Green Investment Bank (GIB) Commission, an independent advisory group set up by George Osborne in November 2009, has consulted with experts from government, financial institutions, businesses and NGOs to identify barriers to investment.

The GIB Commission argues for the creation of a GIB to encourage investment by mitigating and better managing risk, rather than simply increasing rewards to investors. It recommends that GIB support of the delivery of the emission reduction targets should be based on a public-private investment model and involve the least cost to taxpayers and energy consumers.

Structure and funding

The report foresees the private sector playing an important role in the GIB. The GIB Commission recommends that the GIB should be commercially independent and not accountable to Parliament or ministers for individual lending and investment decisions. This is with the aim of placing GIB liabilities off the Government balance sheet (although the Chancellor of the Exchequer seems to be opposed in principle to this treatment). The GIB Commission also suggests that the GIB's board of directors should be drawn primarily from the private sector.

The GIB Commission proposes that operationally the GIB should be organised into two divisions (the UK Fund for Green Growth and the Banking Division) and draw its funding from a variety of sources, from existing grant funding to green bond issues, as outlined below:

  • UK Fund for Green Growth

This division would provide public sector funding and support for low-carbon innovation and commercialisation. Its remit would include administering Government grants, subsidies and low-interest loans, providing early stage venture capital and providing a unified point of advice. It would take its funding from the budgets of the Carbon Trust, Energy Technologies Institute and Technology Strategy Board, as well as six other identified Government agencies.

  • Banking Division

This division would act as catalyst to private sector investment. Its role would include: (i) identifying market failures that currently limit such investment; and (ii) investing at commercial rates (with profits reinvested). It would also enable access to capital markets by aggregating opportunities for a "green bond" issuance e.g. for offshore wind and energy efficiency. In addition to green bonds, other potential sources of funding would be private sector and state-owned bank capitalisation, revenue from the UK's EU ETS auction and proceeds from the sale of Government-owned assets.

GIB products

The report proposes that the Green Investment Bank would offer the following products:

(a) Early stage grant funding;

(b) Pari-passu equity co-investment;

(c) Loan facilitation and structured finance based on "off-take" agreements;

(d) Debt provision through partnerships with the private sector;

(e) Intermediate/mezzanine funding; and

(f) Risk management – long-term carbon underwrite/floor price for carbon

Support for the delivery of offshore wind

The need to increase investment in offshore wind in order to meet the UK's renewable energy targets is highlighted in the GIB Commission's report. One of the reasons identified is the lack of capital, due to investors' perception of the level of risk involved, which is then compounded by the lack of historical performance data to prove otherwise. As well as overcoming this problem, measures will need to be taken to maintain ongoing public R&D support, improve efficiency and investor confidence in the value of the market mechanism, and develop incentives (or penalties) to ensure that offshore wind licence holders develop their round-two and –three sites at the required rate.

The GIB could have a significant role to play in unlocking the private capital required. This could take the form of co-investing, by providing additional equity or debt. However, given the scale of the planned renewables projects, the GIB Commission's report suggests that a greater volume of private sector investment could be unlocked by providing risk reduction products on commercial terms. Taking the important role played by multilaterals and export credit agencies over the last few years in providing liquidity and credit support to projects as its inspiration, the GIB Commission calculates that a GIB with a capital base of £100-£400 million could unlock an additional £3 billion of finance, which could be enough to bridge the estimated finance gap in offshore wind in 2013.

Deciding which products to use would have to be done on a project-by-project basis, but some of the options below could help to reduce the risks to investors to an acceptable range:

  • Contractor default letters of credit

These would give confidence that any claim against contractors (due to, for example, delay) would be honoured with immediate release of funds, even if a dispute was ongoing or the contractor was insolvent.

  • Extreme events insurance

This would insure against events not typically covered by contractors' liability policies (and therefore not covered by the contractor default L/C) such as poor weather preventing construction for more than 30 days during the summer season.

  • Contingent loan facilities

A standby loan facility would be made available for draw-down in the event of a cost overrun, usually matched with an equity draw-down facility (to maintain leverage).

Charges for these products would be made on commercial terms and offered through an open market process, to mitigate state aid concerns. The GIB Commission believes that these products should increase overall returns to equity, making them attractive to equity and debt providers.

The report also explains that many of those it has spoken to during the course of its investigations believe the greatest assistance the GIB could provide would be in relation to the provision of debt finance. A key benefit of creating a state-backed development bank, similar to those that exist in Germany (KfW), France (Caisse de Depots) and other European countries, would be the ability to reduce the cost of capital whilst maintaining private sector disciplines in relation to project management. Whilst such a bank does not exist in the UK, the report identifies that in the past the UK has used a variety of different alternative mechanisms to give project support, such as government-sourced income streams (e.g. BBC Broadcasting House; Skynet5 military satellites). The possibility has been raised of this type of public-sector contract assisting wind farms in raising capital, which would appear to suggest some sort of government off-take contract.

Other examples include:

  • Explicit guarantees (of the debt, not the entity, so as not to contravene EU state aid rules) with payment of a guarantee fee (e.g. Network Rail).
  • Underpinning of senior debt, where the Treasury uses its borrowing advantage to reduce the cost of capital for the non-risky part of the capital structure only (e.g. FSTA air tanker refuellers; Woolwich DLR extension). The attachment point (percentage at risk) is key.
  • Implicit but not explicit Government support (e.g. Transport for London). The GIB Commission views this less favourably due to the ambiguity caused.
  • Regulatory duty to allow entity to finance itself (e.g. regulated utilities/organisations such as BAA, National Grid). The regulator in effect underpins the investment grade rating for senior debt within regulatory ring-fenced assets.

Conclusion

Investors in offshore wind and other major renewables projects will expect to see much greater detail around the proposals over the coming months, including in particular on how the GIB will be funded. It is generally recognised that the finance required for such projects and related infrastructure is significantly beyond the amounts GIB will be able to unlock, and that successful implementation will require a supportive commercial, regulatory, industry and economic framework for such projects. However, the GIB will have a role to play on some projects, and investors should therefore look to position themselves to make the most of the opportunities arising from the GIB's involvement in the sector.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 07/07/2010.