Project Bonds And Energy Transition: A Proven Financing Solution

• Published date: 28 February 2023
• Subject Matter: Finance and Banking, Financial Services
• Law Firm: Norton Rose Fulbright
• Author: Vishal Mawkin, Peter Young and Miguel Torres Caro

This article was first published in Butterworths Journal of International Banking and Financial Law (JIBFL) in October 2022 and was written by Vishal Mawkin, Peter Young and Miguel Torres Caro.

Content

• Introduction
• Legal considerations
• Commerical/structural considerations
• Transaction management considerations
• Conclusion

Introduction

The stricter monitoring/disclosure and liquidity requirements faced by banks in the wake of the global financial crisis mean that projects can often no longer be funded by traditional bank debt alone. The debt capital markets have stepped up to the challenge and project bonds are on the rise, particularly amidst the green finance boom. Whilst the specific challenges that project bonds pose when used in a project financing arrangement are complex, they are by no means insurmountable and with the help of experienced professionals, project bond financings can be structured in a way that offers a viable alternative solution.

Concrete steps to establish, develop and encourage energy transition have been embraced by governments and the wider public sector, financial institutions and investors. Global investment in energy transition totalled US$755bn in 2021, an increase of 27% when compared to 2020, and renewable energy achieved a record US$366bn of investment in 2021. These already impressive numbers will continue to grow as the world moves towards the goal of achieving net-zero emissions by 2050, as pledged in the Paris Agreement.

Traditional project finance loan arrangements are already being stretched thinly to cover the increasing capital deployment demand for the development of renewable energy projects against this backdrop, as banks' funding sourcing and loan diversification needs - exacerbated by the implementation of Basel III regulations - make it difficult for traditional loan financing to keep pace with energy transition projects.

In response, many banks have already started to increase their use of so-called "mini-perm" structures. These short- term debt financing solutions incentivise refinancing following project completion, either by exposing the project company to a risk of default should a refinancing not be possible prior to maturity (a "hard"mini-perm) or through "soft" means, such as periodically increasing the margin on the loan (a "soft" mini-perm). The use of both hard and soft mini-perm structures increases the need for additional capital, since long-term projects not only need to secure initial funding, but also refinancing as part of their long-term funding strategy.

Thankfully, the capital markets have a solution to offer. Project bonds - an attractive and now well-established alternative or complimentary financing method to traditional bank loans - could be the answer. This is even more so in the renewables space as a result of the recent boom in the use of green bonds. But, what is a project bond? What are the requirements for a bond to be labelled as "green", and what are the main issues to be considered by potential issuers and sponsors intending to raise debt through the international capital markets?

What is a project bond?

A project bond is not a distinct "type" of bond (as the name may suggest) at all, but rather an umbrella term that covers a wide array of bond products that are categorised by their repayment source being limited to the cash flows of a particular project. Project bonds are generally issued by a special purpose vehicle (ProjectCo or the Issuer) to finance or refinance either the whole or part of a project.

Historically, project bonds have most commonly been used to refinance an existing project after its construction phase has been completed, as investors have not traditionally been prepared to assume the construction risk of a project.

However, in recent years, the use of project bonds to fund the construction phase of greenfield projects has become more commonplace where ProjectCo can show that it meets specified rating requirements and/or the project bonds include appropriate credit enhancement features.

The green bonds boom

"Green bond" is a label used for bonds which proceeds are earmarked for the financing of green initiatives. Demand for green bonds has been on the rise ever since the World Bank issued the first green bond in 2008. While in 2012 the green bond market amounted to only US$2.6bn, in 2021 green bond issuances reached US$517.4bn and they are expected to reach approximately US$2.5trn by 2025.

Work among regulators is ongoing, but there is currently no established definition as to what...