Carbon considerations in procurement and finance


The importance of carbon-ready contracts

Very few areas of law are more changeable and subject to the political tides as climate change law. A range of federal and state regulatory schemes and policies relating to greenhouse emissions have been implemented in recent years, some economy-wide and some industry-specific, and some more permanent than others. There is also the prospect that, at some point, a national carbon price will be reintroduced in Australia either by way of a ‘tax’ or an emissions trading scheme.

All contracts that could be materially impacted by rises in costs or that could face additional risks arising from new emissions regulatory regime(s) should contain specific clauses that enable your organisation to take advantage of future carbon opportunities, as well as pass on or allocate risks and costs of compliance. Conversely, contracts that relate to activities that have the potential to generate tradeable units, such as Australian Carbon Credit Units, should contain provisions allocating rights to such units, and contain mechanical provisions to clarify each party’s responsibilities in relation to the schemes under which those units are created. It is important that contracts are drafted to respond to current and potential future schemes, particularly for long-term contracts.

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Key risks and opportunities

The introduction (and sometimes repeal) of these schemes has real and direct impacts on a wide range of services, procurement and operational contracts since they can:

  • increase costs – administrative costs of compliance, the cost of procuring carbon credits, costs associated with implementing emissions abatement technologies or processes;
  • increase risks – compliance and regulatory risk, reputational risks and litigation risk – particularly where contracts do not adequately address the impacts of these new regimes and give rise to disputes between parties;
  • create opportunities – to devise new income streams from the generation and sale of carbon credit units; and
  • impose obligations that require cooperation between the parties to fulfil – eg where the obligation holder may need to rely on its contractor to provide required information about activities and emissions.

In our experience, standard change-in-law provisions are ill-equipped to adequately address these new schemes. This is because they can rely on complex concepts to determine how to group and calculate emissions and define who is responsible for reporting and/or emissions abatement. In some circumstances those responsibilities can be shifted between parties (eg between a principal and their contractor/operator of a facility, or between different entities in a corporate group) and sometimes they cannot. In some circumstances these clauses are drafted in a way that cannot apply to these schemes at all as they exclude changes in law that are reasonably foreseeable.

Asking the right questions

  • What existing or proposed contracts are on foot in your organisation that are affected by current carbon policies and/or may be affected by the introduction of any new carbon price?
  • What new costs and risks would your organisation wish to pass on to the other contracting party (such as clients, customers, service providers, operators) and do your contracts currently provide for this?
  • Is it possible your organisation would wish to take advantage of opportunities arising under current offsetting schemes (such as the Climate Solutions Fund – see Page 21) or future expanded carbon emissions trading schemes, and do your contracts currently facilitate this?
  • Do your organisation’s contracts currently require reasonable cooperation between the parties to fulfil any new regulatory requirements?
  • Does your organisation have processes to ensure any contracts into which your organisation enters appropriately consider where bespoke carbon-ready language is adopted?
For more information, contact Jillian Button | Patricia Saw

Corporate PPAs: questions to ask, traps to avoid

As electricity prices rise and we move towards a carbon constrained future, companies are looking for ways to manage their exposure to changing electricity prices and to purchase electricity from renewable sources. Generators are also looking beyond retailers as potential offtakers to support the development of new renewables facilities. Consequently, power purchase agreements with corporate offtakers (Corporate PPAs) for electricity from renewable facilities have become increasingly popular in Australia.

Companies looking to enter into Corporate PPAs can come from any industry or a group of industries where the load is large enough to support a generator’s project, either in part or as a whole. Banks, local councils, water corporations, energy-intensive industry and universities have all ventured (or are looking to venture) into the world of Corporate PPAs.

The electricity industry is highly regulated, with set roles for generators, retailers and customers, which means there can be significant regulatory barriers for electricity users to contract directly with a generator. Generators and corporates have been innovative in tailoring the structure of their Corporate PPAs to suit the individual needs of a deal and to overcome these regulatory barriers.

Key risks and opportunities

Key drivers for entering into Corporate PPAs are:

  • Securing stable energy pricing: a well-negotiated Corporate PPA can secure lower and predictable energy pricing to shield the energy buyer from the volatile energy prices it faces under its electricity retail contracts.
  • Green credentials: large-scale generation certificates (LGCs) available from a renewable energy generator can be an important tool for demonstrating that the entity is achieving specific targets relating to renewable energy generation (eg emissions reduction targets or promotion of renewable energy in a particular jurisdiction).
  • Managing retail contract exposure: a company can also use the LGCs to manage its exposure under its retail contracts to retailers.

Key risks to be managed include:

  • Connection delay: as a result of an increase in the development of renewable facilities and network congestion in certain parts of the grid, some new generators are experiencing significant delays in achieving connection. If the renewable facility is not yet operational, it is important to undertake proper due diligence to understand the likelihood of your generator counterparty experiencing these types of connection delays, and to make sure risk of connection delay sits with the right party under the contract.
  • Change in law: the energy regulatory landscape is one that is subject of constant policy discussions and reform, so change in law risk is a matter that is often heavily negotiated in corporate PPA arrangements.
  • Dealing with multiple offtakes: generators will often contract with multiple offtakers in respect of the same renewable facility. You may need to consider whether this raises any issues regarding priority with other offtakers.
  • AFSL: the transactions contemplated under a corporate PPA often fall within the broad definition of a ‘derivative’ under the Corporations Act. You may need to consider whether an Australian Financial Services Licence is required for entry into a corporate PPA, or whether an appropriate exemption applies.

Asking the right questions

Once your organisation decides to enter into a Corporate PPA, the key questions to ask are: will your organisation require:

  • The ability to terminate the Corporate PPA early? Generators, particularly those that require a power purchase agreement to underpin any project financing for their project, require longer-term agreements (traditionally around 10–15 years). While corporates may wish to include an early termination for convenience clause, generators may require an early termination amount or ask for the price under the Corporate PPA to reflect the additional risk that the generator takes on in return.
  • A fixed commencement of the Corporate PPA (such as to align with any new retail contract)? If so, what liquidated damages will you require, if any, in the event of delay?What existing or proposed contracts are on foot in your organisation that are affected by current carbon policies and/or may be affected by the introduction of any new carbon price?
  • A set load from the renewable energy generation? What will the minimum supply requirements be? A right to be able to use the renewable project’s name and information in your marketing material?
  • An Australian financial services licence (AFSL) or obtain the services of a third-party who holds an AFSL to act as an intermediary?

And finally:

  • Can your organisation provide credit support (eg a parent company guarantee or a suitable bank guarantee)? Would your organisation prefer to negotiate credit support triggers such as a change to a company’s net debt-to-net worth ratio or a decrease in the net asset level by a certain amount?
For more information, contact Kate Axup | Kanana Fujimori | Luisa Colosimo

Green finance

Australia’s ‘green finance’ market continues to grow steadily in response to global environmental challenges and to support sustainable development. Innovative financial products continue to be developed to direct capital towards green projects and to promote sustainability causes or ESG-related performance targets. These financial products include green bonds, green loans and sustainability-linked loans (or SLLs).

A ‘green bond’ is a debt security issued into domestic or offshore capital markets, with the money raised to be invested into green projects. Typically, green bonds are purchased by institutional investors with mandates to invest capital into the green economy. Green bonds are like other bonds issued into the relevant capital market, but with additional features that allow them to be marketed as a ‘green bond’. Those additional features are increasingly becoming standardised, albeit by the market rather than regulation. The International Capital Markets Association (ICMA) has developed a set of ‘Green Bond Principles’ which are voluntary guidelines outlining recommend transparency and disclosure principles for green bonds.

Alongside green bonds, a market for green loans is emerging. Similar to green bonds, the use of proceeds of a green loan is for green projects. A set of Green Loan Principles has been established, and those are similar in nature to the Green Bond Principles.

The four key principles under the Green Bond Principles are

1.

the net proceeds of the bond issuance are to be used for green projects

2.

the issuer is to provide clear communication of the process for project evaluation and selection

3.

the net proceeds of the bond issuance are to be managed and tracked for the specified green purpose, and

4.

the issuer is to have ongoing reporting obligations.

Sustainability-linked loans are emerging in Australia

Separately, a market for SLLs is developing in Australia and offshore. An SLL incentivises the borrower to meet agreed sustainability or ESG-related performance targets. Unlike a green bond or green loan, the money borrowed does not need to be used for green purposes. Rather, the borrower is given a reduced interest rate if it meets the agreed targets.

The target that may be agreed can vary, from performance objectives such as greenhouse gas emissions and sustainable sourcing, to matters relating to employment targets. An SLL takes the form of a bilateral or syndicated loan in a form typically seen in the loan market, but with features that address the sustainability requirements.

Similar to green bonds and green loans, the market has developed a set of principles for SLLs. These principles have been driven by the Loan Market Association, and include (1) the borrower to clearly communicate its sustainability objectives and how those objectives align with the sustainability performance targets (SPTs) identified in the SLL, (2) ambitious and meaningful SPTs should be identified and negotiated between the borrower and the lenders target setting, (3) where possible, a borrower under an SLL should maintain records in relation to SPTs and provide information to lenders and (4) the need for external review / audit is to be negotiated by the borrower and lenders.

A$15.6B
Australia’s cumulative green bond issuance has grown to A$15.6B, which makes it the tenth largest market globally.

Source: Climate Bonds Initiative

(figures correct to 30 June 2019)

Key risks and opportunities

The key opportunities for entry by Australian corporates into the green finance market include:

  • Diversified investor base: Green bonds may attract a broader investor base for the issuance than typically available to a corporate, as they are typically held by institutional investors with mandates to invest in green projects.
  • Access to additional capital: Similarly, as investors and banks continue to get pressure from their stakeholders to mitigate climate change impact within their own organisations, there is a significant and growing pool of capital looking to get exposure to green and sustainable investment.
  • Social responsibility and promoting sustainability: Green finance is one of the many ways Australian corporates can work towards positive environmental and climate change solutions and see tangible impacts within their businesses.
  • Pricing advantage: The incentive-based structure of SLLs allows borrowers to benefit from a reduced margin if their sustainability performance targets are met. Stronger demands for green bonds into the future could see green bonds trading at a premium in the secondary market.

On the flipside, the risks to consider when entering this market include:

  • Regulatory and political uncertainty: Conflicting political discourse around climate change and renewable energy in Australia hampers our attractiveness as a destination for foreign green investment, which may include green finance.
  • Costs: There may be additional costs involved in verification and regular reporting compared to standard bond issuances or loans.
  • ‘Green washing’: Corporates risk losing integrity and brand credibility if they are unable to perform and meet their sustainability targets or portray their products or policies as producing positive environmental outcomes when in fact they do not.

Asking the right questions

  • Does your organisation have a robust ESG mandate that can be supported by green finance?
  • Is there potential for new projects to be financed by the green finance market, or for established projects to be refinanced into the green finance market?
  • Would raising green finance help your organisation demonstrate its commitment to green or sustainability-linked targets?
  • What are the additional upfront and ongoing costs in putting in place a green bond, green loan or SLL, and are those costs acceptable by reference to the benefits?
  • Has your organisation developed a green finance framework that sets out how an issuance would comply with the industry standard, such as the Green Bond Principles and Green Loan Principles?
For more information, contact James Darcy | Mayuri Dharmakulasingam | Paul Cerche

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