Background
Key aspects of bail-out package
Personal scope of bail-out package
Measures under bail-out package: loans
Comment
The sharp increase in prices and price volatility in the energy markets, which has been observed since the end of 2021, has had significant impact on companies active in the electricity wholesale market. These companies sell their future electricity production years in advance to:
- mitigate market energy position risks;
- secure a certain level of profitability; and
- achieve more predictable cash flows.
Financial institutions act as clearing houses in transactions that require these companies to deposit a security (ie, a margin) to hedge counterparty risk. This security deposit is calculated based on the market prices and their volatility (ie, a initial margin), as well as the difference between the transaction price and the market value (ie, a variation margin). Thus, the required margin depends on the prevailing electricity prices and is usually paid for by the electricity wholesalers as cash collateral.
As a result of the increased price volatility and the resulting price markups, electricity companies face higher credit and liquidity risks. A sudden price shock could quickly lead to higher liquidity requirements such that electricity companies would no longer be able to deposit enough cash collateral in time. If system-critical electricity companies cannot fulfill these margin requirements, they risk an uncontrolled system failure. Additionally, third parties would have to find alternative electricity suppliers, which can be challenging in a high-price and low-liquidity environment. The initial failure of the system-critical electricity company to deposit enough cash collateral can therefore cause a chain reaction and jeopardise the electricity supply security.
Key aspects of bail-out package
On 18 May 2022, the Federal Council handed over its dispatch on a bail-out package for the electricity industry to parliament. The purpose of this proposed piece of legislation is to secure the electricity supply and to prepare for a situation in which, due to extraordinary market developments, risk of illiquidity or over-indebtedness materialises and, despite the measures taken by private system-critical electricity companies, their financing partners and their direct or indirect owners.
Personal scope of bail-out package
The proposed bail-out package applies to private system-critical electricity companies with a registered office in Switzerland. An electricity company is deemed to be system-critical if it has a power plant capacity installed in Switzerland of at least 1,200 megawatts (ie, if it holds a significant share of the domestic production plants) and participates in organised electricity markets. In particular, this covers functions such as power plant operation and balancing group responsibility. Electricity suppliers with limited self-production are not a priori deemed to be system-critical, as their failure typically exerts fewer negative externalities. Trading in organised markets excludes bilateral contracts and includes all contracts and derivatives for the supply, purchase or transport of electricity concluded, in particular, on the European exchange or broker platforms. In certain circumstances the Federal Department of the Environment, Transport, Energy and Communications (DETEC) may extend the scope to other private electricity companies that have their registered seat in Switzerland and designate them as "system-critical".
Measures under bail-out package: loans
DETEC may grant loans denominated in Swiss franc to a system-critical electricity company upon the company's request, either by means of an order or a public-law contract. The purpose of these loans is to bridge liquidity squeezes in case of extraordinary market developments. This means that a system-critical electricity company cannot freely use the proceeds. If DETEC issues an order, it unilaterally defines the basic parameters of a loan, whereas a public-law contract allows for more flexibility such that an electricity company can approach DETEC before liquidity risks materialise and negotiate terms that are acceptable to both parties.
A system-critical electricity company must submit a substantiated request as early as possible and at the latest when it is foreseeable that illiquidity or over-indebtedness is imminent. DETEC may also accept requests and grant loans if the system-critical electricity company is already over-indebted. However, the system-critical electricity companies and their direct and indirect owners are obliged to take the necessary measures to ensure the company's solvency and a sufficient capital base (eg, through capital increases, debt subordinations or debt write-downs). Any bail-out measure is subsidiary.
Content wise, an order will be structured as a framework that provides for the ability to obtain loans. This allows the respective electricity company to draw one or more loans at different times by placing a specific request with DETEC. The terms of the loan will provide for the maximum principal amount, which depends on the specific extraordinary market developments. The interest rates will be based on current reference rates, rates applied in similar financings and the company's credit ratings, taking into account any collateral provided by the borrower (ie, market interest rates). In addition, the loan will provide for an annual risk premium in the range of 4% to 8% of the outstanding principal amount in order to compensate the lender for its function as a "lender of last resort" and mitigate adverse incentives.
As long as the loan is outstanding and the risk premium is not settled, the electricity company will be subject to certain ongoing obligations. In particular, the company must carry out restructuring and divestments in such a way that neither the repayment of the loan nor the collateral can be jeopardised. Disposals of assets or restructurings that could jeopardise the repayment of the loan or any collateral are not permitted. DETEC must be informed of any restructurings or disposals of assets amounting to more than 50 million Swiss francs. Further, if a lender is required to pay compensation to cantons or municipalities in connection with the operation of power plants, the parties must negotiate a deferral of compensation and explore tailor-made solutions that serve to protect liquidity of the parties.
With regard to the collateral to be provided by the lender, an order may provide that the borrower, its direct or indirect affiliates, or the persons who hold participations in the borrower must conduct negotiations with DETEC with a view to concluding a public-law contract on the provision of collateral. This includes liens, assignment of receivables or third-party guarantees. DETEC may not unilaterally impose collateral obligations by means of an order. If appropriate, and legally valid collateral is provided, the risk premium explained above can be proportionally reduced. The reduction of the risk premium must be at least one percentage point but cannot fall below the limit of 4% of the outstanding principal amount.
The loans will rank equally with the borrower's existing debt. However, subject to an increase of the risk premium and under certain circumstances, DETEC may declare subordination for claims. The possibility to draw loans ends on 31 July 2026. If loans have been drawn, they must be repaid within the timeframe specified in the company's request and by the date specified in the order at the latest.
In order for DETEC to be able to provide system-critical electricity companies with loans, it needs a commitment credit. The Federal Council proposed a commitment credit in the amount of 10 billion Swiss francs. If the bail-out package is approved by Parliament (which is subject to a referendum), it will then decide on this commitment credit in the form of a simple federal decree (which is not subject to a referendum). In addition, system-critical electricity companies will have to pay an annual provisioning fee that will be based on the yield of a four-year federal bond and on the costs incurred for the execution of the bail-out package.
For more information please contact Marcel Meinhardt or Patrick Sattler at Lenz & Staehelin by telephone (+41 58 450 80 00) or email ([email protected] or [email protected]). The Lenz & Staehelin website can be accessed at www.lenzstaehelin.com.