The capital management company NordVest GmbH is currently working together with FinanceConnect – a joint venture of Energieforen Leipzig GmbH, Versicherungsforen Leipzig GmbH and Pine Valley Capital GmbH – on the conception of the NV Infrastructure Fund I to support the energy transition. The aim is to provide equity capital in particular to municipal utilities and municipal companies in the long term in order to finance central infrastructure projects in the areas of electricity and heat networks, storage solutions, gas transformation as well as water infrastructure and generation.
The focus of the project is on ensuring municipal services of general interest while at the same time ensuring the financing capacity of companies and "turnaround projects" vis-à-vis banks and institutional investors.
From our experience of many discussions with institutional investors and municipal utilities, some central challenges can be derived.
From the point of view of the utility companies, these include:
- Ensuring that all municipal utilities and utility companies have equal access to money from the Energy Transition Fund
- The establishment of project and special purpose vehicles should not be slowed down by the municipal supervisory authority and companies should be enabled to do so
- In regulated business areas, returns on equity must be so attractive that institutional investors are happy to invest in Germany with comparable infrastructures and risk profiles, and utilities are able to recoup the equity costs via the regulatory requirements.
From the point of view of the investors, it is clear:
- Investments, whether in the form of equity or debt, require clear demarcations and an assessment or appropriate remuneration of risks.
- Institutional investors want the funds used to be as "pure" as possible in accordance with the regulatory requirements that apply to them (depending on the investor group: Investment Ordinance, Insurance Supervision Act, Solvency, etc.). Investors want to invest specifically in energy transition projects – but not in other municipal fields of activity such as swimming pool operations. The solution lies in the project company structure: "If municipal utilities are willing to manage their investments in clearly defined project companies, from the bank's point of view, the credit check is not based on the municipal utility, but on the cash flows of the respective project. In addition, other investors can be involved in the projects who only want to have influence on the project, but not on the activities of the municipal utility."
- Basically, investors compare any investment with standard investments, such as buying a federal bond, which offers a high rating, a fixed coupon and daily saleability. Every investment must be comparable to this.
- Higher risks of fluctuations in earnings or repayment risks, longer capital commitment or non-tradability, as well as higher internal expenditure to understand the financial product and monitor performance later must be taken into account by appropriate hedging structures and higher earnings expectations. These earnings requirements also play a role in the regulatory minimum yield requirements (actuarial interest rate) and equity deposit requirements applicable to institutional investors.
- The long-term financial viability of municipal companies can be ensured, among other things, by managing assets and infrastructure services in special project companies in order to relieve the balance sheets and expand financing leeway
The regulatory authorities for the energy and financial sectors should set correspondingly positive framework conditions. #BNetzA #BAFIN #BMWE
Here we see the following fields of action:
Industry needs a decentralized and flexible fund architecture with high responsiveness
We therefore propose that the planned Energy Transition Fund be designed as an umbrella structure with clearly defined criteria for subordinate sub-funds, which in turn may have subsidies or guarantees to mobilise additional private funds. These subsidies, guarantees or first-loss pieces make it easier for privately initiated funds to enter and mobilise private funds (insurance companies/pension funds) or make them possible in the first place. Subordinate funds should be made available from existing funds and organizations to ensure rapid action.
Equal access to capital from EMF is essential
The German energy industry is characterized by a decentralized and multi-layered structure, and this applies in particular to the member companies of the VKU. Reality shows that many investments by the municipal utilities are implemented within a manageable time and with relatively small amounts. A centralised allocation structure would slow down this dynamic. These characteristics must be reflected in the structure for allocating funds through the Energy Transition Fund. This means that such a fund, or intermediaries attached to it, must be able to lend equity capital to projects in the six-figure range. This can only be done through a decentralised structure in which intermediaries, such as NV FinanceConnect infrastructure funds, are provided with capital or risk assumptions, which they can invest more efficiently in the private sector."
A central organisation of the EMF will lead to a concentration of capital among large and very large players in the industry. We are convinced that equal access for all municipal actors – regardless of size and region – to subsidies and guarantees from the Energy Transition Fund is central to the success of the energy, heat, mobility and water transition. It is precisely these companies that cover the wide range of project-specific and locally or regionally required expertise and implement the necessary transformation projects comprehensively and practically on site.
Attention to multi-layered investor requirements
The best possible transparency about the success of the invested capital can be provided by special purpose vehicles, which are to be established by municipal utilities as subsidiaries for the construction and operation of projects. The main advantages are clearly definable risks for the municipal utilities and investors, the granting of loans based on cash flows and thus also a lower use of expensive subordinated capital. To this end, it is necessary that municipal companies can set up such companies quickly and uniformly throughout Germany without bureaucracy and do not have to overcome any additional hurdles of municipal supervision compared to private companies. Blueprints can also be created for company leaders, which facilitates legal and organizational implementation and reduces internal hurdles.
Securing earnings for (partially) regulated business areas
The returns that the regulated companies can pay as users of the investment funds to be made available, as investment income in the sense of interest, are largely predetermined by regulation. While borrowing costs are largely based on the conditions available on the market for the respective company, the return on equity is based on national calculation logics. For the allocation of investor money, it would be necessary to increase equity yields in a European comparison alone. If this is to be seen as difficult in the current discussion, it would be a veritable option to link the return to the transformation pact towards a carbon-free economy and to provide a yield premium for projects in taxonomy classes 8 and 9.
Alternatives to Securing Earnings for Regulated Companies
The returns that the regulated companies can pay as users of the investment funds to be made available, as investment income in the sense of interest, are largely predetermined by regulation. An increase in the earnings of the utilities in order to serve higher capital costs seems difficult to impossible. In order to facilitate the pooling of fixed available cash flows by the municipal companies to the risk-oriented return of the financial investors and, if necessary, to make it possible at all, we need instruments that can be added to significantly lower capital costs, especially with regard to subordinated capital.
One option is to use equity from the special fund, which acts as a first-loss piece in the capital of the private-sector funds. The contribution of this first-loss piece significantly reduces the risk premium of private sector investors. Alternatively, a first-loss guarantee from the federal government could also be made available without capital commitment. There are already successful examples of this within KfW in microfinance funds (KfW as well as the EFSE or Green for Growth Fund).
In addition to direct grants for investment measures, low-interest and/or indemnified loans (similar to KfW promotional loans) are available. These support the returns to the financial investors through leverage. In addition, support with regard to the risk profile is a good idea. The lower the risk of return fluctuation or default of the investments is assessed, the more willing investors are to accept a lower return on investment. Conceivable here are sureties or guarantees as well as co-investments, which absorb shares of any risks first.
The outlined design of the Energy Transition Fund offers a unique opportunity to secure the investment capacity of municipal companies in the long term and to mobilise institutional capital for services of general interest. A flexible, decentralised fund framework – combined with targeted risk hedging mechanisms – creates the basis for a sustainable financing architecture for the transformation.
