The Australian Federal Government recently released the findings of the Expert Review on the design of the $10 billion Clean Energy Finance Corporation (CEFC). The Expert Review Panel was appointed by the Government on 12 October 2011, with Ms Jillian Broadbent AO as its Chair and Mr Ian Moore and Mr David Paradice as members. The Panel consulted broadly in preparing its report and responded positively to many submissions made by industry participants, including Baker & McKenzie. The report can be found here.
Guiding principles and operating framework
The central objective enunciated by the Panel is for the CEFC "to apply capital through a commercial filter to facilitate increased flows of finance into the clean energy sector thus preparing and positioning the Australian economy and industry for a cleaner energy future".
The CEFC will be based on three principles that will determine where and how it invests.
The first principle is that the CEFC will focus on investments in renewable energy, low-emissions and energy efficiency technologies (and associated manufacturing businesses) in Australia. Fifty percent or more will be allocated to renewable energy investments and up to fifty percent to low emissions and energy efficiency.
The second guiding principle is that the Board will apply a 'commercial filter' to investment decisions. A 'commercial filter' to investment has been defined as requiring investments to:
• be at the later stages of development – i.e projects ready for commercialisation and deployment (with the CEFC having the potential to invest in some market demonstration projects);
• to have a positive expected rate of return; and
• to have the capacity to repay capital.
However, this filter will not be as stringent as the private sector equivalent as the Government's public policy objectives for the CEFC and the value of positive externalities will also be taken into account. The overall aim for the CEFC is to invest responsibly and manage risks so as to be financially self sufficient and to increase the funds available to the CEFC.
The Panel has proposed the Australian Government borrowing rate as an appropriate benchmark for its overall target rate of return for the investment portfolio over time. That rate currently sits at 3.87% for ten year bonds.
The third principle is that existing financial barriers should be addressed through structuring investments with that objective in mind and evaluating whether the positive public policy externalities justify doing so. This principle relates to the CEFC's objective of using its funding to leverage and catalyse greater private capital investment with the aim of overcoming lack of funding in the sector.
The CEFC will have flexibility as to how it invests, with the majority of its investments to be loan based in the early phase. It will seek to diversify across geographies, technologies, projects, counterparties and investment partners. Investments may be direct or indirect with the concessional financing element likely to be reflected in lower pricing, longer tenors or acceptance of higher risks.
The framework is summarised at the end of this alert.
In addition to the above principles, a number of other key recommendations were included in the report, with some of the most significant listed below:
• the CEFC should only invest in commercial activities principally located in Australia (but this would not exclude foreign participation in projects operating in Australia);
• the flexible definition of 'renewable energy' contained in section 4 of the Australian Renewable Energy Agency (ARENA) Act 2011 should be adopted by the CEFC, which means the CEFC will adopt a broad approach to assessing investment opportunities in the renewable energy stream;
• the eligibility threshold for low-emissions technology should be set at 50 per cent of the average emissions intensity of electricity generation in Australia;
• there is the potential for overlap in the functions of the CEFC and those of existing Government renewable energy and energy efficiency funding bodies (including Australian Renewable Energy Agency and Low Carbon Australia Limited). The Panel has identified the CEFC's place in the innovation chain and recommended that it seek to work cooperatively with these other bodies who tend to operate at different points of the chain. It has also recommended that the Government and the CEFC assess how the CEFC and Low Carbon Australia could integrate their operations and programs;
• manufacturing businesses should be eligible for investment where they produce later stage inputs for renewable energy, low-emissions technology and energy efficiency projects;
• any investment by the CEFC should not impact on a project's eligibility for Large Scale Generation Certificates under the Renewable Energy Target;
• the CEFC should generally seek to co-finance investments;
• carbon capture and storage and nuclear power should be excluded;
• the CEFC should be exempt from the Government's Commonwealth Procurement Guidelines; and
• robust government structures should be put in place for the CEFC, including through the publication of annual reports and details of its investment approach and decisions.
The Panel has proposed that the CEFC be established as a corporation operated by an independent Board comprising seven members with expertise in the clean energy financing industry who will in turn appoint a CEO. The $10 billion in funds to be invested by the CEFC are to be divided into two streams with 50% set aside for renewable energy and enabling technologies and 50% for low-emissions and energy efficiency technologies. Investments may be direct or indirect.
The CEFC will have a broad investment mandate and flexibility in the investments it can make. The Panel has recommended that the CEFC adopt a financing methodology of assessing investment proposals on a case-by-case basis, applying the 'commercial filter' (discussed above), and utilizing a range of tailored financing instruments. This flexible funding structure would also include channelling a proportion of its funds through intermediaries and pooled funds, especially when investing in energy efficiency projects, and permit the facilitation of community based projects.
While decisions about individual investments would be made independently by the Board, the Government will still set the investment mandate of the CEFC, having regard to the recommendations of the Panel, and be able to provide directions in relation to this broad mandate. The independence of decision making would be protected by the corporate status of the CEFC, with Board members having set terms and remuneration being determined by the Remuneration Tribunal.
The report will now be considered by the Government, which will respond with proposed enabling legislation and an initial investment mandate.
The Government has announced that legislation establishing the CEFC will be introduced in the coming Budget sittings of Parliament (in May) to allow it to begin its set-up and implementation activities and then commence investment operations from 1 July 2013.
The report expressly states that the CEFC will invest on the premise that existing Government policies, such as the Carbon Pricing Mechanism, continue to operate. There has been a clear attempt to mitigate any sovereign risk associated with a change in government through the recommendation to appropriate the full $10 billion in funding in this year's Budget.
Key messages for investors
• With $10 billion in funding for investment, the CEFC has strong potential to play an important role in funding a challenging industry, as it has a lower targeted rate of return than other financial lenders, is able to factor in positive public policy externalities and has a certain source of funding.
• The Government can be expected to take steps to insulate the operation of the CEFC from any potential change in government.
• The CEFC can be expected to commence investment operations by from 1 July 2013.
• Fifty percent or more of the CEFC's investments is likely to be in a wide range of renewable energy projects, including hybrid and enabling technologies.
• Up to fifty percent of the CEFC's investments is likely to in low emissions technologies and energy efficiency projects.
• The CEFC can be expected to apply a 'commercial filter' to its investment decisions which will enable it to seek to achieve its public policy objectives with a commercial approach.
• Investors should contact us or monitor the Clean Energy Finance Corporation website www.cefcexpertreview.gov.au/content/Content.aspx?doc=thecefc.htm for updates.
Source: Clean Energy Finance Corporation Expert Review – Report to Government March 2012 page 12