Renewable energy projects are strategic for investors. As a source of profitability and sustainability, they contribute to the diversification of their portfolio to green investments. Strategic and financial investors have expressed a significant appetite for clean energy investment, says David Faravelon, senior manager at De Gaulle Fleurance.
Halfway between debt and equity, bonds convertible into shares (convertible bonds) are increasingly favored by French and international investors to secure their investments by adapting to the specific features of the renewable projects.
Between the beginning of January and the end of March 2023, funds raised via these financial instruments exceeded 4 billion euros in Europe (vs. 960 million last year over the 1st quarter) .
Among the range of legal instruments available to investors, convertible bonds give their holders the option to convert them into one or more other securities of the issuing company , customarily shares, at a predetermined conversion price set at a discount to the current share price, during a specified conversion period.
This hybrid nature provides investors with advantages over a similar investment in traditional bonds or the ordinary shares of the issuing company. Convertible bonds are securities whose complexity may vary according to their interest rate (fixed, variable or indexed), their conversion and redemption terms, covenants and events of default as well as their conversion ratio.
Since convertible bonds are flexible and may be issued in tailored multi-tranche structure, they are popular instruments amongst green companies as they are well suited to financing ongoing development and construction costs for a renewable project or portfolio of projects, which require significant financing spread over time.
To determine and size each tranche, investors and sponsors will have to conduct a thorough analysis of the timing and amount of funds needs and determine whether the financing will be sufficient to either execute the projects or bridge the sponsors towards a next round of investment.
There are number of benefits for issuers and investors in convertible bonds. Convertible bonds offer an attractive risk/return profile for investors, who, as creditors, benefit from an income through the coupon payments and a protected return of principal on their final maturity date as well as even rank with the company's unsecured debt and rank ahead of an investment in the ordinary shares of the company in the event of project failure.
Investors also have upside participation in the performance of the projects by enjoying leverage through conversion of convertible bonds into shares in the event of milestones or liquidity events.
For issuers, convertible bonds defer capital dilution and offer attractive financial resources with front payments. The conversion option enables them to reduce the remuneration of the convertible bonds given that in consideration of the equity call option, investors request lower remuneration than traditional bonds as well as a non-conversion premium only payable where the convertible bonds reach maturity and are not converted, which is not the most common case.
Due to the complex nature of the documentation, investors and issuers will need to pay particular attention to the negotiation of the main terms of transaction documentation, in particular the terms and conditions as well as subscription agreement, i.e.: the maturity of the convertible bonds, their tranches, their redemption conditions, in particular voluntary or mandatory early redemption, negative pledges and events of default that could lead to accelerated redemption or conversion of the bonds, and the conversion conditions based on milestones or specific liquidity events, as well as the conversion ratio to be used where applicable.
In France, in addition to market practice, necessary specific requirements must be observed. Documentation is usually governed by French law. Shareholders' authorization for the issuance of convertible bonds is required. In addition, French equity-linked instruments such as convertible bonds include a legally required set of adjustment provisions with limited additional provision options. Confirmation of tax treatment is also a key element in France.
Investors should also pay particular attention to the use of funds resulting from the subscription to the convertible bonds, and to the selection process for eligible renewable projects, by precisely defining the categories and eligibility criteria for such projects. Control over the management and allocation of funds, as well as monitoring of the development of projects financed by convertible bonds, will be ensured through specific reporting to be submitted by the sponsors, setting out specific quantitative and qualitative indicators. This heightened vigilance regarding the way in which proceeds are allocated and projects carried out will enable early detection of any events of default.
This vigilance should be even more accentuated with regards to the EU regulation 2020/8521 on taxonomy (the "EU Taxonomy Regulation"), whose purpose is to establish a European Union-wide classification system to identify economic activities that are considered sustainable. Even though all the investors do not fall under the scope of the disclosure obligations included in the EU Taxonomy Regulation as of today, pressure of their LPs to disclose this information on a voluntary basis is increasingly growing.
On 5 October 2023, the European Parliament formally adopted the regulation laying down the EU green bond standard ("EuGB Regulation") for bonds that pursue environmentally sustainable objectives as defined by the EU Taxonomy Regulation. The EuGB Regulation will make it easier for investors and companies to identify environmentally sustainable investments while ensuring that such investments are trustworthy.
By David Faravelon, senior manager at De Gaulle Fleurance.
