Improved flexibility in the energy transition export credit market
In July this year, following an EU-led initiative, the Organisation for Economic Co-operation and Development’s Arrangement on Officially Supported Export Credits (commonly known as the OECD “Consensus” or sometimes, the Arrangement) was significantly updated and modernised, ultimately enabling export credit agencies (“ECAs”) to better support the financing of energy transition projects.
Since the establishment of the first ECA in 1919, governments have used ECAs to help domestic companies secure supply contracts in the international market and to provide financial support (whether loans, guarantees, insurance or interest rate support) by or on behalf of the government for export of goods and/or services (“Official Support”). Prior to the intervention by the OECD, the sole determinant of the level of Official Support provided by an ECA was the government itself. Consequently, certain exporters, buttressed by superior financial terms, were able to dominate the market. To counter this, the OECD introduced regulations to create a level playing field for Official Support and to encourage competition based on price and quality rather than the most favourable officially supported financial terms.
As a result, ECAs from all OECD member countries are regulated by the Consensus. The Consensus limits the financing terms and conditions that ECAs can offer in relation to Official Support with a repayment term of two years or more, including by setting maximum repayment terms and minimum interest rates and exposure fees. The Consensus does not have the force of law in itself, although the level of compliance by participant ECAs is extremely high and in some jurisdictions, like the EU, it has been incorporated in to law.
The update to the Consensus is intended to allow ECAs to offer greater support for green projects in an increasingly competitive landscape, while avoiding market distortions. The main changes are focused, as anticipated, on:
- expanding the scope of “green projects” that benefit from more favourable terms;
- extending repayment terms and introducing greater repayment flexibility; and
- simplifying the Consensus.
Of particular interest to energy transition developers, investors and financiers are the updates to the terms the Consensus allows ECAs to offer on climate-friendly projects. Special rules applicable to project financing transactions have been removed meaning that shorter repayment term restrictions and lengthy eligibility criteria by virtue of the limited-recourse nature of a financing no longer apply. This shift means that ECA-backed project financings for energy transition projects will now be looking to the more favourable terms of the specific Climate Change Sector Understanding (“CCSU”) which now covers a broader scope of green or climate-friendly projects eligible for more flexible financing terms.
The revised CCSU envisages three types of climate-friendly projects:
- climate change mitigation, covering environmentally sustainable energy production including production, transport and storage of clean hydrogen and ammonia, carbon capture, use and storage, battery production, transmission and distribution infrastructure, zero and low emissions transport and manufacturing, extraction, recycling, refining and processing of clean energy minerals and production of low carbon fuels;
- climate change adaption, covering projects that reduce the location-specific context of vulnerability to climate change; and
- water, including infrastructure for the supply of drinking water, wastewater collection and treatment and the modernisation of such facilities.
The revised financial terms available to climate-friendly projects include:
- an increase in the maximum repayment term to up to 22 years, depending on the type of project. All climate change adaption and water projects now have a maximum term of 22 years, (up from 15 years and 18 years, respectively). The maximum repayment term for climate change mitigation projects varies; most can benefit from a 22 year term but combined heat and power projects and energy from waste have a maximum of 15 years, for example, and fossil fuel power with carbon capture, 18 years. Even for projects not meeting the eligibility criteria under the CCSU (or the Sector Understanding on Export Credits for Nuclear Power Plants (NPPSU)), there is a general increase in maximum repayment term restrictions for most projects (other than fossil fuel power stations without carbon capture), where the maximum repayment term has increased to 15 years (up from 8.5-12 years);
- greater flexibility regarding the schedule of repayments over the life of the financial package including;
- principal repayments at least annually rather than every six months;
- the option for interest payments to be every 12 months (rather than 6 months) where principal repayments are made annually;
- the removal of the requirement for 2% of the principal sum of credit to have been paid within 18 months from the starting point of credit;
- where it is not possible to match available funds to the debt service profile anticipated under the baseline CCSU provisions, more flexibility has been added to allow ECAs to agree alternative debt repayment profiles, provided that:
- no single repayment of principal or series of principal repayments within six months can exceed 35% (or 30% for fossil fuel plants operating CCS or projects otherwise subject to a 15 year repayment term);
- the first repayment is made no later than 36 months (or 24 months) after the starting point of credit; and
- the maximum weighted average life of the repayment period is greater than 70% (or 65%) of the repayment term of the transaction or six years;
- removal of the specific limitations on local cost support for CCSU projects meaning that climate-friendly projects are now subject to the standard Consensus local costs provisions, which have been broadened to allow support not exceeding 40% of the export contract value for high income countries and 50% for all other countries; and
- a lowering of the minimum credit risk premium rates through a “term adjustment factor" for higher-risk transactions with longer repayment terms.
Whilst the Consensus reforms did not include an express requirement for ECAs to limit or reduce their support for fossil fuel projects, the focus on flexibility for climate-friendly projects is expected to enable, as intended, more green projects to benefit from ECA finance. The changes could have a substantial, positive impact on the debt service profile climate-friendly projects will have to cover, allowing them greater flexibility to cover early capital expenditure and ultimately increase debt sizing. ECAs have welcomed the long-awaited overhaul of the Consensus provisions, citing the additional transparency and scope to be more reactive to climate-friendly projects as positive for the export finance market. In recognition of changes in technology that may require future changes to the provision of export credit, the participants to the Consensus identified areas which they commit to future examination, including net zero energy buildings, fuel cell projects and clean fuels.
We continue to monitor developments in the export finance market and across all aspects of energy transition. If you have any questions, please do get in touch to speak to our experts.