Waste not, want not: Energy-from-Waste refinancings – the opportunities and challenges

This greater interest in refinancing projects in the Energy-from-Waste (EfW) market has been driven by a number of factors, each of which has provided ideal conditions for refinancings to take place:

• greater liquidity in the debt markets and, in particular, appetite from institutional investors for the sector;
• lack of opportunities in other traditional infrastructure sectors; e.g. social and economic infrastructure;
• the greater maturity of the EfW sector and a growing knowledge base and acceptance of mainstream EfW, creating trust in the ability of developers in the EfW market to generate stable long-term revenue streams; and
• historically low interest rates.

These factors have encouraged sponsors to look far more seriously at creating value through the refinancing of existing operational projects. Even among developers of waste gasification facilities - who previously developed their facilities on an all-equity basis - there is now a greater appetite for raising commercial debt in order to refinance expensive equity. As the more risky construction phase of gasification projects passes, and the technology becomes better understood, sponsors are looking to capitalise on the opportunity to release some of this equity funding by taking on debt capital, assisted by the certainty that these projects have now achieved ROC ¹ accreditation.

The following article outlines some of the key issues which need to be considered by EfW developers when looking to refinance these projects, based upon Ashurst's experience in acting for both developers and lenders in this increasingly mature market.

Refinancing Structures

Refinancings are typically considered to fall into three broad categories:

• Simple refinancings – where the pricing/covenant/commitments/tenor are renegotiated with the existing bank group, but without any material changes to the parties involved or the hedging arrangements;
• Structural change refinancing - replacement of a particular facility through an amendment and restatement of the original financing document. This still involves the same debt providers, but introduces a change to the structure of the finance facility to more appropriately match the shareholders' evolving needs; and
• Full refinancing - a full repayment and cancellation of the existing financing arrangements, to be replaced by new financing documents, potentially with a new group of lenders.

In determining the most appropriate structure to adopt and the extent of any refinancing to be contemplated, the analysis will typically involve the consideration of the factors referred to below.

Factors affecting possible debt arrangements

In restructuring and/or refinancing the debt facilities, the sponsors will need to take the following into account in determining the most appropriate structure:

• whether new intercreditor arrangements will be required, depending on the new structure and identity of lenders;
• whether any "amendment fees" or "waiver fees" will be payable to the funder group, particularly in the event of a simple refinancing, where there will still be transaction costs and waiver fees to take into account;
• the impact on the security arrangements, particularly where commitments have been extended or the tenor is being increased. Any increase in risk being taken by the funders may require greater security to be provided by one or more of the contractual parties;
• any necessary changes in the identities of the agent, security trustee and/or account banks: depending on the parties involved in the new debt facility, one or more of these roles may need to be changed, potentially requiring notice to be given to various project document counterparties, and replacement direct agreements may need to be produced;
• the covenant and/or events of default package, particularly in light of the opportunity presented to borrowers to amend the debt terms. In particular, if there are unduly onerous covenants or restrictions on the activities of the borrower, a refinancing presents an ideal opportunity to renegotiate these requirements;
• any new bank requirement, due to updates in industry standard provisions (e.g. Basel III, CRD IV, EMIR, FATCA, etc.). ² Borrowers will need to be aware of these updated funder requirements when undertaking any refinancing;
• depending on the development plans of the shareholders, the borrower may wish to obtain pre-approval from the new lenders for any future development/expansion opportunities being contemplated at the time of refinancing. Dealing openly with the funders with regard to these future plans will avoid the need for expensive and protracted negotiations at a later date with the new bank group; and
• the shareholders will also need to consider whether they wish to renegotiate any restrictions on distributions (e.g. by removing any cash sweep arrangements or similar covenants).

Impact on interest rate swaps

In all but the most simple refinancings, the hedging counterparties will often have consent rights and/or rights to terminate their swaps in the event of a refinancing.

The existing terms of the interest rate swaps may even dictate the nature of the refinancing which is possible or, in more extreme cases, may prevent a refinancing taking place at all.

Relevant considerations include:

• whether the interest rate swaps are in or out of the money for the borrower – in order to avoid crystallising any significant hedging termination liabilities, the borrower may wish to explore options to keep some or all of the existing swaps in place following a refinancing;
• if the interest rate swaps are to be kept in place, it is likely that there will need to be amendments to these swaps to take into account the terms of any new facilities; the hedging counterparties may also need to accede to the terms of the new intercreditor arrangements;
• if the interest rate swaps are to be terminated, the parties will need to consider how the termination will take place and how the break costs are to be calculated – this will be key in considering the viability of any refinancing, given the potential hedge breakage costs involved; and
• the sponsors will also need to consider the extent to which the ISDA documents ³ will need to change as a result of the European Market Infrastructure Regulation.

As a general rule, fewer issues will arise if the hedging counterparties remain lenders under the new financed facility, as they are more likely to assist with the overall refinancing process. However, this is not always possible.

Interaction with authorities/commercial parties

Unless the refinancing simply involves the renegotiation of funding terms with existing lenders, it is likely that any refinancing will require some form of interaction with existing contractual counterparties. For more significant refinancings, this will require consent to be obtained from all major project parties (other than, perhaps, the Building Contractor, assuming that the project has passed all pre- and post- take-over commissioning tests) who may be required to enter into new direct agreements.

This issue will be more acute if the project was originally established as a PPP project: typically the consent of the procuring authority to the refinancing will also need to be obtained and, in many cases, a large share of the refinancing gain may need to be negotiated and shared with the relevant authority. In tandem, one of the more significant issues to be addressed upfront with any procuring authority is the extent to which any compensation on termination payable under the PPP agreement will be increased to cover all new debt being assumed by the borrower. Unless the authority is prepared to increase its exposure and repay the new debt following any termination, the borrower's ability to assume increased debt levels may be severely restricted if the payment of compensation on termination is a key part of the credit story: for example, if the asset has to be handed back to the authority on termination of the PPP agreement.

Other key considerations in relation to the PPP agreement are as follows:

• funders will typically want confirmation from the procuring authority and other key contractual parties that there are no outstanding liabilities existing at the time of refinancing and that there are no breaches which are capable of triggering termination. Formal acknowledgements will typically be required from these counterparties, which may require settlement of existing and outstanding claims;
• if there are any "simmering" disputes or other matters which could or should be clarified or addressed at the time of refinancing, these should be dealt with by the developers before involving new funders: new funders will typically wish to start with a "clean slate" and therefore will not want to lend into a project which has existing unresolved issues; and
• in return for granting their consent, procuring authorities and/or key contractual counterparties may require concessions from the borrower. Such concessions may, in the more simple cases, simply involve payment of a "consent fee" or "waiver fee". In more complex cases, counterparties may, in return for granting their consent, require a relaxation of covenants, the release of existing security, a renegotiation of liability caps or even a share of the refinancing gains being made.

Before approaching new debt providers, sponsors should consider what third party consents will be required and what concessions such third parties may seek to extract in return for giving their consents. Refinancing is also an ideal opportunity for shareholders to extract concessions from third parties and to "tidy up" a previously complex structure put in place at the time of the original financial close.

Shareholder debt/equity

The shareholders will also need to consider whether to refinance or to amend the terms of any shareholder-provided subordinated debt or equity. In particular, if this subordinated debt or equity is to be restructured or refinanced, the shareholders will need to consider the tax and accounting implications of distributing the refinancing proceeds to the shareholders. 

Clarity on tax and accounting issues should be obtained from financial advisers before engaging with debt providers.

Accounting considerations

At the time of the refinancing, shareholders will need to seek expert advice as to whether the refinancing constitutes an extinguishment of the debt or a modification to the debt, for financial reporting purposes. There may also be considerations to address in terms of the accounting treatment of any related interest rate swap termination or amendment payments. 

On several recent refinancings, the accounting analysis has become a critical workstream and has been the cause of significant delay to the overall refinancing process. Developers should be aware that not all financial advisers are aligned in their analysis of the relevant accounting considerations.

Process

Once the overall terms of the refinancing have been agreed by all parties, advisers will also need to consider carefully the process involved in effecting the refinancing. Given the need to raise new debt before the existing security package has been released, the parties will need to consider the use of escrow mechanics and how the grant of new security will be coordinated with the release of the old security package.

While this may appear to be a simple mechanical process, the mechanisms associated with a full refinancing can give rise to significant legal and commercial issues, particularly where unexpected events occur between the date that the new debt is raised and the date that the old lenders are fully repaid and have released their security.

The process of terminating the interest rate swaps will also need to be considered, including any associated notice periods to enable termination of these swaps to occur.

Conclusion

Carefully managed, and with the right financial and legal advisory team, a refinancing of an Energy-from-Waste project can give rise to significant financial and commercial benefits for the shareholders/developers.

Projects that were originally financed in a difficult market and on the basis of onerous commercial and financial terms can be restructured in a way which results in a cleaner and less restrictive structure, enabling the original developers and shareholders to create a platform for greater growth and expansion of existing facilities.

The opportunity to refinance the debt can also act as a catalyst for other improvements in the project documentation and may assist in the development of a more mutually beneficial relationship with the authority which shares in the refinancing benefits.

1. Renewables Obligation Certificates issued under the UK's Renewables Obligation scheme, and designed to encourage the generation of electricity from eligible renewable sources.
2. Basel III is an internationally agreed set of measures developed by the Basel Committee on Banking Supervision in response to the financial crisis of 2007-09, whose aim is to strengthen the regulation, supervision and risk management of banks. It builds on the measures set out in the Basel I and Basel II documents. CRD IV (the Capital Requirements Directive IV ) is an EU legislative package which sets out prudential rules for banks, building societies and investment firms. EMIR is the European Market Infrastructure Regulation on derivatives, central counterparties and trade repositories, which imposes requirements to improve transparency and reduce risks associated with the derivatives market. FATCA is the Foreign Account Tax Compliance Act, a 2010 United States federal law requiring foreign financial institutions and certain other non-financial foreign entities to report on the foreign assets held by their US account holders.
   
3. Industry standard documents for swaps and derivatives trades, produced by the International Swaps and Derivatives Association (ISDA).