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This Glossary has largely been derived from the UK “Green Investment Bank Commission report” and “The Sterling Bond Markets and Low Carbon or Green Bonds”, a report to E3G by Climate Bonds Advisory Panel member Alex Veys.
Accrued interest : The proportional amount of interest accrued since the last coupon payment date
Amortisation : paying off an interest bearing liability by gradual reduction through a series of instalments comprising both principal and interest components, as opposed to paying it off by a simple lump-sum payment.
Bid : The price at which broker will offer to buy a bond
Bid/offer spread : The difference between the bid and offer price
Asset backed or securitised bonds : similar to ordinary bonds but have specific assets whose revenues pay the interest and principal. An ordinary bond’s payments are generally guaranteed by the company that issues them. In asset backed or securitised bonds a set of revenue generating assets are put into a special purpose company and these assets pay the bond holder their interest and principal.
Bonds : can variously be described as IOUs, loans or debts. They are similar to bank loans, but generally last longer (from one year to over 30 years). When institutions, companies, governments and other entities want to raise long term finance but do not want to dilute their shareholdings (or can’t issue share capital), they turn to the bond markets. The biggest investors are generally insurance companies and pension funds. They buy bonds to generate return, offset their liabilities, generate income or diversify their portfolios.
Bond Index : A market cap weighted index of bonds
Broker : An intermediary putting buyers in touch with sellers
Call option : The right but not obligation to redeem a bond
Callable : A bond that has a call option
Cash sweep mechanism : A mechanism which dedicates all revenue at a certain level of seniority in the financing structure to the repayment of an outstanding loan or credit line before the next more junior layer receives any cash.
Choice : The bid/offer spread is zero
Clean Price : The price without any accrued interest, the one most often quoted.
Club Deals : instead of syndication, banks are clubbing together on equal terms to provide the debt facility through a club deal. This is where each bank commits to the level of funding they can provide to a particular deal and enough banks pool together to meet the total cost of the project to acquire or build. Each bank is involved in the negotiations of the terms and pricing.
CO2 equivalent (CO2e) : a measure of the warming effect (“radiative forcing”) of mixtures of greenhouse gases, expressed as a standard concentration of CO2. Thus in 1998 CO2 concentration was 365 ppm of dry air, but the effects of methane, nitrous oxide and other GHGs in the air at that time were in warming terms equivalent to another 47 ppm of CO2; the result is a CO2e of 412 ppm. Throughout this site, CO2 means CO2e unless otherwise stated.
Construction risk : this will cover the risks involved with the build, the interfacing of different contracts, the degree of protection from liquidated damages for project delays, other damages and build timing.
Controlling creditor : An institution which takes responsibility for monitoring the project implementation and negotiates with the project company or sponsor on behalf of all bondholders in case of need.
Conventional bond : one that has a fixed maturity date and a fixed coupon. It has few, if any, bells and whistles (like complex formulae for interest payment linked to equity prices, or maturity dates that can be changed). Simply put, it is a bond that will pay a set interest rate over a predetermined time and return the original or par value of the investment at this maturity date. These very plain bonds are often called “vanilla” bonds
Corporate Finance : debt provided by banks to companies that have a proven track record, using “on-balance sheet” assets as collateral. Most mature companies have access to corporate finance, but have limited total debt loads and therefore must rationalise each additional loan with other capital needs.
Corporate Lending : banks provide finance to companies to support everyday operations. An assessment is made of the company’s financial strength and stability, and debt is priced accordingly. These bank facilities place few restrictions on how the company can use the funds, provided certain general conditions are met.
Cost of Capital : the weighted average of a firm’s costs of debt and equity, in turn linked to risk involved in the underlying project or company. From an investment perspective, to be worthwhile, the expected return that an investor receives for putting money at risk must be greater than the cost of capital.
Cost of Debt : The effective rate that a company pays on its current debt. A company will use various bonds, loans and other forms of debt, so this measure is useful for giving an idea as to the overall rate being paid by the company to use debt financing. The measure can also give investors an idea of the riskiness of the company compared to others, because riskier companies generally have a higher cost of debt. Cost of Debt can be measured in either before- or after-tax returns; however, because interest expense is deductible, the after-tax cost is seen most often. The effective rate is made up of a risk margin determined by the lender, on top of a reference rate; in the UK the reference rate is usually LIBOR, the London Interbank Offered Rate, based on the interest rates at which banks borrow from each other in the UK; in Europe its the EURIBOR; in the US the US Federal Funds Rate. The rate is typically expressed as LIBOR + ‘x’ basis points, or ‘bps’, where the additional ‘x’ basis points (‘x’ hundredths of 1%) is what the bank charges for the risk of the loan.
Covenant : A legally binding agreement in a bonds prospectus
Coupon − the interest payment on a bond. This interest can be paid annually, semi-annually or even every three months, depending on the way the bond is structured. The size of the coupon gives an indication of the credit risk of the bond. The higher the coupon, the more risky the issuer, as an investor will require a higher interest rate to compensate them for the greater likelihood of the issuer defaulting.
Credit line : An amount of credit extended by a lender, which the borrower may use on a revolving basis.
Credit ratings : a rating of the likelihood of credit default (credit-worthiness) of an investment, used by most investors to assess the comparative risk of investment opportunities. Most ratings are provided an “independent” agency, usually one of the three major rating agencies, Moody’s, Standard and Poor’s (S&P) and Fitch. The three agencies all have similar rating categories. Some of the largest institutional investors (see below) don’t use the ratings agencies but instead rely on their own internal risk assessment teams.
Credit risk : The risk that a bond will default on its payments
Debt : securities such as bonds, notes, mortgages and other forms of paper that indicate the intent to repay an amount owed. A cash payment of interest and/or principal is made at a later date. This is in contrast to an equity investment where there is an exchange of shares of common stock, or ownership of the company.
Debt Service Coverage : Amount of cash available to meet annual interest and principal repayments.
Debt to Equity : this ratio simply indicates the amount of debt from banks and the amount of equity from the various sources in a given project. Owners will generally want to introduce debt into a renewable energy project to reduce the overall cost of funds and enhance their returns, given that debt is cheaper than equity as it takes a lower risk position.
Dirty price : The clean price plus accrued interest
Duration : The present value weighted average time to a bond’s cash flows
EIB : The European Investment Bank
Environmental risk : environmental and social risks associated with the project, often subject to legal requirement for an impact assessment.
Equity : an investment in exchange for ownership of a company entitled to the earnings of a company after all other investors (e.g. debt-holders) have been paid.
Export Credits, Insurance, and other Risk Management Instruments : used to transfer specific risks away from the project sponsors and lenders to insurers and other parties better able to underwrite or manage the risk exposure.
Face value : The original size of a bond at issuance.cf Principal
Feed-in Tariff (FIT) : a common mechanism for encouraging investment in renewable generation. A feed-in tariff is essentially a premium rate paid for clean generation, e.g. from solar panels or small wind turbines, and guaranteed for a long time period.
First call date : The first date at which a bond can be called
First call price : The price at which the bond can be called
Fungible : When a good or a commodity‘s individual units are capable of mutual substitution. Examples of highly fungible commodities are crude oil, wheat, orange juice, precious metals, and currencies. It refers only to the equivalence of each unit of a commodity with other units of the same commodity. Fungibility has nothing to do with the ability to exchange one commodity for another different commodity.
GEMM : Gilt Edged Market Maker
Gilt : a bond issued by a Government
IBRD : The International Bank for Reconstruction and Development, part of the World Bank Group
Index bonds : those whose coupon and/or principal are not fixed but can change with reference to some sort of index. The best example of this is index linked gilts (“linkers”). Here, the coupon and principal rise (and fall) in line with inflation offering protection against inflation. Conventional bonds, although they may offer a higher initial interest rate, can see their real value whittled away in a high inflation environment. For this reason, pension funds and insurance companies with very long-term inflation linked liabilities like linkers. However, it is worth making a note that linkers suffer from significantly wider bid/offer spreads than conventional gilts, due to their lower liquidity.
Infrastructure Funds : traditionally interested in lower risk infrastructure such as roads, rail, grid, waste facilities etc, which have a longer term investment horizon and so expect lower returns over this period.
Institutional Investors : includes insurance companies and pension funds, which tend to invest large amounts of money over a long time horizon with lower risk appetite.
Internal Rate of Return (IRR) : is used for each potential project as a key tool in reaching investment decisions. It is used to measure and compare the profitability of investments. Funds will generally have an expectation of what IRR they need to achieve, known as a hurdle rate. The IRR can be said to be the earnings from an investment, in the form of an annual rate of interest.
Inter‐dealer brokers (IDBs) : Brokers who only deal with other brokers
Investment Grade : Defined by the credit rating agencies usually above BBB-/Baa3/BBB- respectively. A ‘good’ investment grade rating is A/A2/A.
Issuer − the issuer of the bond (i.e. borrower of the money) defines the credit risk of the bond. That is, the likelihood that the investor will be repaid their initial loan. For example, governments are generally considered to have a low credit risk, although this generally varies between rich countries and developing countries.
Junior (to) : Ranks behind in a wind up situation
Lead manager/co‐lead manager : The broker of cobroker who brings new bonds to market
Liquidity : Market liquidity is an asset‘s ability to be sold without causing a significant movement in the price and with minimum loss of value. Money, or cash in hand, is the most liquid asset, and can be used immediately to perform economic actions like buying, selling, or paying debt, meeting immediate wants and needs.
Make a market : To give a two way price in a bonds
Market makers : Brokers who make markets
Market risk : these assessments are typically provided by market specialists who report on topics including future electricity prices, future green subsidy prices, future carbon prices, and the prospect of new competitors.
Maturity − The date at which a bond is repaid. There are a number of subtleties around the maturity date, but most bonds have a single fixed date. The further in the future the maturity date (the “longer” the bond), the more risky the debt as there is more time for the issuer to get into trouble. Indeed, some bonds (including the famous war loan from the UK Government) are “undated”, which means that the issuer never has to repay the debt. Undated, or perpetual, bonds often have features that allow the issuer to pay back the debt under certain circumstances: these are called “call options” and give the issuer the right, but not the obligation, to pay the lender.
Mezzanine finance : as its name implies, this type of lending sits between the top level of senior bank debt and the equity ownership of a project or company. Mezzanine loans take more risk than senior debt because regular repayments of the mezzanine loan are made after those for senior debt, however, the risk is less than equity ownership in the company. Mezzanine loans are usually of shorter duration and more expensive for borrowers, but pays a greater return to the lender (mezzanine debt may be provided by a bank or other financial institution). A renewable energy project may seek mezzanine finance if the amount of bank debt it can access is insufficient: the mezzanine loan may be a cheaper way of replacing some of the additional equity that would be needed in that situation, and therefore can improve the cost of overall finance and thus the rate of return for owners.
Monoline : a bond insurer that specifically insures the principal and coupons of bond issuers. The insurers take a fee and allow the insured bond to be rated at levels of up to AAA, whereas the stand-alone bond may be rated at A or below.
Offer : The price that a broker will sell a bond
Operation and Management risk : once a project has been commissioned the plant will need to be properly maintained and staffed to ensure optimal performance. An assessment will be made of staffing and costs, as well as contracts required during the operational period and provisions required for decommissioning.
Par : 100
Pari-passu : refers to two or more loans, bonds, classes of shares having equal rights of payment or level of seniority.
Perpetual : No final maturity date
Policy and Regulatory risk : as the policy or incentive mechanism may be a key part of making renewable energy project economics attractive, changes to these factors pose a risk: a long-term, stable policy regime with a sound legal basis is essential for serious investment to occur. Regulatory risk is also considered for the permits, authorisations and licences required to plan, construct, operate and decommission renewable energy projects. A sound track record of stable and consistent regulation, well managed price or other reviews, and clarity over the development of regulations or policy to implement new renewable energy legislation, are important.
Private Finance Initiative (PFI) : is a way of creating “public private partnerships” (PPPs) by funding public infrastructure projects with private capital. Developed initially by the Australian and United Kingdom Governments, PFI projects aim to deliver infrastructure on behalf of the public sector, together with the provision of associated services such as maintenance.
Probability of default : The likelihood that a scheduled payment under a loan will not be made. Used in the calculation of regulatory capital.
Project Finance or Limited Recourse Finance : debt is borrowed for a specific project, the amount of debt made available will be linked to the revenue the project will generate over a period of time, as this is the means to pay back the debt. This amount is then adjusted to reflect inherent risks, e.g. the production and sale of power. In the case of a problem with loan repayment, rather like a typical mortgage, the banks will establish first “charge” or claim over the assets of a business, as described above. The first tranche of debt to get repaid from the project is usually called “senior debt”.
Provisioning : Earmarking funds for probable future losses on loans due to defaults.
Public-Private Partnership (PPP) : a government service or private business venture which is funded and operated through a partnership of government and one or more private sector companies. PPP involves a contract between a public sector authority and a private party, in which the private party provides a public service or project and assumes substantial financial, technical and operational risk in the project.
Refinancing : this is where a project or a business has already borrowed money but decides, or needs, to replace existing debt arrangements with new ones, similar to refinancing a mortgage. Reasons for refinancing include: more attractive terms becoming available in the market (perhaps as lenders become more familiar with the technology, meaning more money can be borrowed against the asset); or the duration of the loan facility, e.g. loans are often structured to become more expensive over time because of the increasing risk of changes to regulation or market conditions. One of the results of the financial crisis was that banks became extremely reluctant to lend for more than six or seven years, which “forced” projects that required longer-term loans to refinance in the future, and take the risk of the terms available at that time.
Regulated Asset Base (RAB) : with privatisation of the utilities, a new mechanism (the RAB) was created to provide credible commitments to investors. The RAB is backed up by an independent regulator with a duty to ensure that the utilities’ functions can be financed. In effect, the RAB receives investments once completed and the capital costs are then remunerated through the RAB and the duty-to-finance functions of the regulator.
Risk Capital : equity investment that comes from venture capitalists, private equity funds or strategic investors (e.g. equipment manufacturers). Besides the developers’ own equity and private finance, risk capital is generally the only financing option for new businesses.
Risk-sharing : The risk of a loan is shared with other parties, which have an interest in promoting lending to the sector or beneficiary in question. The other party may or may not be better able to evaluate the risk.
Senior debt : The highest level in a company’s debt structure with most certainty of repayment.
Special Purpose Vehicle (SPV) : a discrete renewable energy business created around a project, in a legal form, to permit lending and equity investments, disconnected from other obligations or activities of a company. For example, a utility forming a joint venture with a partner will use an SPV as a clean legal structure for the enterprise. From a bank perspective providing project finance into an SPV can ensure it has uncontested rights over the assets, an equity investor will invest into an SPV often restricting its obligations to that SPV company and not linking it to the ownership of other activities of the investor.
Subordinated debt : The debt below the senior debt, which is, however, senior to equity.
Technological risk : each renewable energy technology will be assessed in the light of its maturity, operating history, fitness for purpose and warranties. The assessment will be undertaken by appropriate specialists often working closely with the technology supplier.
Tranche : A piece or slice of a company’s debt with specific characteristics in terms of seniority etc.
Underwriting and Syndication : A lead bank agrees to provide a large bank debt facility to a client for a particular project, but the loan will be larger than the bank itself can provide on its own for the long term. The bank receives a fee from the client for providing, or underwriting, the whole facility at the outset and taking the risk that it can “sell” pieces of the agreed loan to other lenders required (“syndication”), on terms and pricing already agreed with the client. The underwriting bank takes the risk that it has achieved the right balance of risk and return to attract enough other lenders into the transaction.
Venture Capital : focused on early stage or growth stage (depending on how far from the laboratory and commercial roll out) technology companies.
Wholesale : the sale of securities among broker-dealers and to large institutional investors. Securities sold at wholesale go for slightly lower prices than those paid by individual investors.
Wrapped : Another term for guaranteed