Long before the recent global financial crisis, the role institutional investors could play in infrastructure was much discussed and analysed. Since the crisis and the regulatory changes that followed, the liquidity of debt markets has reduced. Gaining access to investment for renewable energy projects is therefore a challenge and a huge gap has been left by traditional lenders. Here, we explore some of the alternative options available and consider how companies are accessing this funding.
Unlocking access to the pool of private capital held by pension funds, insurance companies and other long-term investors has been seen by many as crucial to bridging the gap left by traditional lenders. Following the events of recent years, institutional investors have finally begun to realise this potential. Direct institutional investor participation in energy and infrastructure has steadily increased and is becoming more and more apparent in renewable energy.
However, this type of investment is not always an easy fit. Investors must accept a risk profile and make investment decisions which may be unfamiliar, and concern assets that are less liquid than other investments. Even so, for institutional investors, who on some accounts manage global assets worth an estimated US$88 trillion, renewable energy fits well with their need for long term investments, to diversify investments, increase returns and reduce exposure to carbon-based technologies.
At the same time, renewable technologies - as well as business models for renewable energy projects - are becoming more mature. As a consequence, many perceive the overall risk involved is falling and making these projects more attractive investments. For developers of renewable energy projects, this means greater availability of funding to help finance projects. This increased appetite amongst institutional investors for renewable assets can lower lifetime cost of capital than otherwise available, which is helping projects become financially viable and making it easier to get them built.
For borrowers seeking to access this long-term investment, the process can be disarmingly similar to accessing traditional finance; although there are typically some differences. One such difference to bank lending is that the financing is often inflation-linked, potentially making early repayments more expensive. There can also be more structural requirements for the debt than traditional bank lending, including where institutions require listing of the debt or conversions to public liability companies of borrowing vehicles. As intended to be long term financing, typical bond market principles may apply to attract "Spens" payments to early redemptions. Larger investors now have teams of experienced professionals at their disposal to equal their banking rivals, which is necessary to undertake the additional work required for making such direct investments. It is clear that, overall, borrowers have benefited from access to long-term financing at competitive rates.
The importance of institutional investors is also evidenced by the fact that the Loan Market Association introduced a standard documentation for private placement. Market participants felt that the lack of standardised documents provided one obstacle to participation in the market; an obstacle which has since been overcome. The success came as part of a drive to simplify private placements and make them more accessible, with the intention of many market participants of ultimately creating a pan-European private placement market.
The firm has advised Primrose Solar Limited and Ecotricity on renewable projects financed by institutional investors. In the last quarter of 2014, Primrose Solar - a partnership between Pioneer Point Partners with the global investment management firm York Capital Management - closed two financings relating to five solar parks with an overall capacity of approximately 80MW. The long-term financing for both Primrose projects was provided by M&G Investments.
The fact that a major institutional investor (as per 30 June 2014 M&G Investments managed more than £253 billion of assets) provided long-term financing for these projects is a positive sign. It also endorses the quality of the solar parks, and demonstrates the increasing appetite of institutional investors in the sector.
Similarly, in the past month, the renewable energy company Ecotricity assisted by corporate finance consultant, Mike Humphreys, refinanced a portfolio of its operational wind and solar assets for approximately £70 million with Aviva Investors. Access to this investment replaced traditional project financed debt with its banks over each project, creating access to lower cost funds for Ecotricity from its operational assets. For Aviva, a further long term investment in renewables, which required a complex due diligence exercise to understand the operation of these assets.
Accessing such long-term funding for operational assets makes sense for both parties, but involves significant due diligence and understanding of the business from both parties. The investment shows how institutional investors are open to opportunities to fund operational - and increasingly new - renewable energy projects.
So far, most institutional activity has been based in solar and onshore wind. This is in part because the projects offer sufficient scale for institutions to find them worthwhile, they are technologically proven enough to provide comfort for institutions, and they have access to the financial support schemes to ensure the financial viability of projects.
There has been much publicity about investment in new major projects such as the Swansea Bay tidal lagoon, which is of such a scale that it demands institutional involvement For smaller projects, however, accessing institutional investment can be difficult, as both the scale of the project and the developer is carefully assessed by institutions.
The shift towards institutional investors being active in this sector looks set to continue and to accelerate further. Developers of all sizes and technologies will be seeking to find new ways of unlocking this potential.
This article was first published in Utility Week on 17 April 2015.