Development finance facilities: Prospects for APAC

1. Introduction

Sponsors and project developers across the renewables and energy transition space are currently facing a challenging macroeconomic environment. Despite trending downwards for well over a decade, development costs are now on the rise. This has been driven by multiple factors including increases in the cost of materials and supply chain vulnerabilities, to name a few. Jurisdictional factors also play a role with grid constraints and slow permitting processes rendering otherwise viable projects too expensive or slow to develop. Higher interest rates have added to developers' woes, disproportionately affecting the renewables sector - which has historically benefited from higher gearing than the oil and gas and metals and mining sectors. While some of this has been offset by buoyant power prices in certain markets, reliance on power price or “green” premiums does not appear to be a panacea. This article looks at pre-notice to proceed (NTP) development finance facilities and their increasing prevalence as a means to address these macroeconomic challenges as well as to accelerate the efficiency of capital deployment in support of the energy transition.

2. Pre-NTP, development finance facilities

Development-stage financing (or pre-NTP financing) broadly refers to the provision of capital to fund early-stage project development costs, including upfront grid connection deposits, long-lead item downpayments, lease option fees, permitting costs (including the cost of delays) and site control costs.

The appetite for development finance has grown rapidly across North America and Europe and we expect it won’t be long before similar trends are experienced in APAC, given the need for increased flexibility and diversity of funding in a continuously evolving global market.

There is no “one size fits all” precedent for a typical development-stage facility, as the terms of these facilities can vary greatly, owing to differences in the requirements of each sponsor, the risk appetites of each lender, and the unique characteristics of the underlying projects. While these financings can be raised on a standalone, single-project basis, it is more common for sponsors to take a “portfolio view”, often financing a pipeline of development-stage assets together or otherwise cross-collateralising a pool of assets spanning various technology types and stages of development.

Sponsors are carefully considering their portfolios, readily weighing up the upfront time, cost and resources required to raise project finance debt against the efficiencies and other benefits that portfolio or pooled asset financing models can offer. For these reasons we have focussed on portfolio or pooled asset financing structures in this article.

3. Structural features and considerations

Portfolio characteristics

How the portfolio is constituted, both now and in terms of future acquisition and divestment strategy, will play a central role for sponsors when considering what kind of development financing model to adopt. Crucially, this will also involve consideration of the portfolio’s asset class concentration and cross-jurisdictional reach. For portfolios containing purely development stage assets, depending on the lenders involved (and the strength of their relationship with the sponsor), financing options are largely limited to borrowing base structures unless a guarantee or similar credit enhancement is provided by an investment grade sponsor. Conversely, for sponsors with a blended portfolio of development stage, construction stage and operational stage assets, the financing structures and terms available can be significantly more flexible. It is therefore critical to understand from the outset what the financing is intended to achieve. For sponsors with significant existing portfolios, the intention may be to fund at a portfolio level and offer the operational assets and their cash flows as collateral for the development assets. For others, the intention may be to secure short-term funding for the acquisition of a pipeline of assets or as a bridge to either future full-scale project financing or divestment.

Security package, portfolio valuation and due diligence approaches

Security plays a pivotal role in protecting lenders’ interests. Under a traditional single-asset project finance model, the security package would typically include all asset security granted by the project SPV and some form of limited shareholder security over shareholder loans and the shares the shareholder holds in the project SPV. Whilst suitable in certain scenarios, all asset security packages are complicated and difficult to administer across portfolios with flexible characteristics and investment horizons. This is especially the case where the underlying portfolio contains assets across various jurisdictions where the cost implications and formalities associated with taking all asset security over each project can be cumbersome (e.g. stamp duty, notarization and legalisation of security documents). Such project-level financings will also contain restrictions on changes of control, divestment, project documents, offtake strategy and other indebtedness which may also cut across a sponsor’s investment strategy.

Sponsors capable of backing a facility with a guarantee or similar form of credit-enhancement from an investment grade sponsor can achieve a less restrictive covenant package and more limited asset-level controls and security, which can also have the effect of reducing the overall cost of capital. This is because credit assessments will place greater emphasis on the guarantee-providers’ credit worthiness rather than the value of the project asset themselves.

Alternatively, structures also exist where security is only taken over the funding vehicle itself, with no recourse to the sponsor and no asset level security. Under these financing models, cash flows and minimising cash leakage as well as the underlying value of the portfolio of assets becomes the key focus for lenders, who will be relying on this analysis to get comfortable that, notwithstanding the absence of all-asset security, value leakage from the pool of assets is limited and/or there is sufficient realisable value in the underlying assets contained within the portfolio to sustain the financing. This may require lenders to conduct more detailed due diligence into each individual asset in order to ascribe an overall capital value to the portfolio. Borrowing base style facilities will also include periodic revaluation mechanics to test the value of the portfolio during the life of the facility, including prepayment cash sweeps for any excess debt following any asset value deterioration (whether due to divestment or otherwise). Conversely, where a portfolio substantially comprises operational assets, Lenders may be comfortable relying solely on a cash flow assessment of the portfolio in order to demonstrate sufficient debt service coverage.

Other key facility features

These facilities are usually revolving in nature, capable of being drawn in multiple currencies and often also for the purposes of issuing letters of credit and other forms of collateral for the underlying projects. It is also not uncommon for development finance facilities to include pre-baked accordion mechanics to allow the borrower access to additional financing within the envelope of the existing financing package as the portfolio evolves.

Given these are effectively bridging or mini-perm style facilities, the tenor is typically between two and five years, with no fixed amortisation schedule, PIK interest mechanics and principal repayable on maturity.

4. Opportunities for APAC

While the uptake of these facilities remains strong across North America and Europe, so far these structures have not been prevalent across APAC for a number of reasons.

Firstly, the maturity of each market across APAC can vary greatly, which has so far limited the ability of these facilities to be deployed at scale cross-jurisdictionally. Regulatory regimes are often still evolving, inconsistent and prone to unexpected changes, particularly in emerging markets. Moreover, supply chains can be less mature, contractors less experienced and offtake solutions less flexible, making it more difficult to take a holistic view of the value and prospects of a cross-jurisdictional pool of assets. As a consequence, while we have seen many multi-currency, multi-jurisdictional facilities raised in mature markets such as Europe, the unique features of each market across APAC renders cross-jurisdictional facilities more difficult to establish. In addition, there can be local currency-related challenges, which can make it difficult for a single pool of financial institutions to make all potentially required currencies available under such a facility.

Secondly, in order to value a development pipeline, the assets themselves need to be tradeable and capable of being simply and effectively ascribed a reliable valuation. This can be particularly difficult in emerging markets where renewable energy penetration is less pronounced.

Notwithstanding these obstacles, we are optimistic that these challenges can be overcome and that development stage, pre-NTP financing has a vital role to play in support of the energy transition. In fact, we are starting to see interest in these facilities in Australia, given the extensive development pipeline for renewable energy generation and storage projects, and the fact that many of the sponsors are international, with other projects in Europe or North America to bundle into a portfolio with Australian assets. In Australia the development pathway can be prolonged due to planning and permitting processes and grid connection, meaning developers wish to recycle capital rather than having it tied up in a smaller number of projects. Helpfully, in Australia there is both an active secondary markets for development stage assets and a strong appetite for project financing or portfolio based financing, creating a variety of ‘take out’ options for any incoming financier of a development asset (or portfolio). We expect similar trends to also evolve and shape other markets across APAC, particularly in mature jurisdictions or in places where there are sizeable pipelines of projects, warranting this calibre of financing solution.

Contributions by Associate, Emily Allison