Conventional wisdom states that unless a sponsor is significantly large and well-known and has significant investment banking relationships, accessing an overseas market for funding development and expansion can be a difficult and time consuming exercise with limited certainty of success.
However, recent and successful initial public offerings (IPO) of foreign asset income trusts, also known as cross-border income trusts, have given new hope to sponsors seeking to raise capital for development or acquisition or to provide a global solution to refinance existing disparate project-by-project facilities. One particular bright spot are Canadian Trusts.
In addition to the potential for a sponsor to raise financing for expansion, the Canadian Trust structure provides monetization opportunities for private equity investors seeking liquidity for its portfolio investments. At a time when renewable energy asset values in the US may be lower than pre-financial crisis, the Canadian Trust is an attractive means for sponsors to raise funds to acquire undervalued renewable energy assets.
Canadian Trusts have proven to be successful vehicles that enable US sponsors to raise capital in the Canadian IPO market at much faster speeds than is possible in the US IPO market. The expected time to completion of an IPO on the Toronto Stock Exchange is two to three months as opposed to six months or longer on the New York Stock Exchange. Given current financing uncertainties, the faster speed to market is attractive to sponsors and underwriters alike. The IPO window in any market may be limited from time to time and therefore catching that window is important to a successful launch. Moreover, a shorter time to market also means that transaction costs would be significantly lower than in a US IPO.
In addition to speed and lower transaction costs, issuance size of a Canadian Trust on a Canadian exchange can be substantially lower than that which is required for an IPO in the US market. Several Canadian Trusts have successfully launched in the Canadian market: Eagle Energy Trust raised $150million, Parallel Energy Trust raised $400million, Argent Energy Trust raised $212million, and most recently, in November this year, CRIUS Energy Trust completed a $100million IPO. The Canadian retail demand for high-yield investments in the energy sector means that fairly robust valuations can be obtained for Canada-listed energy investments. Coupled with a much lighter post-IPO regulatory compliance burden (when compared to the US), the Canadian Trust structure offers an attractive path to market for many sponsors and investors.
“The expected time to completion of an IPO on the Toronto Stock Exchange is two to three months as opposed to six months or longer on the New York Stock Exchange.”
The predecessor of the Canadian Trust was the wildly popular publicly-listed income trust, which allowed Canadian companies to publicly list trusts or partnerships that owned Canadian assets and pass-through profits to investors; thus eliminating taxes at the entity level. These vehicles became known as Canadian income trusts. Although it was immensely popular with Canadian oil and gas companies as well as companies that invested in Canadian real estate, the Canadian income trusts eventually raised concerns among regulators. Chief among them was that such a structure, taken to the extreme, had the potential to reduce overall taxes paid by companies and ultimately negatively impact government revenue. Ultimately, the Canadian government introduced legislation in October 2006 which required that such publicly listed vehicles be taxed at corporate rates and their distributions be treated as dividends subject to tax. This effectively removed the benefit of the Canadian income trust as pass-through vehicles, curbing their utility and by 2011, it was reported that such vehicles have all but disappeared from the market. The legislation did not however impose such taxes on publicly-listed trusts that generate their revenue from non-Canadian assets. Hence, there is a growing interest in Canadian Trusts as a means of raising capital or as a liquidity option.
“Although it was immensely popular with Canadian oil and gas companies as well as companies that invested in Canadian real estate, the Canadian income trusts eventually raised concerns among regulators.”
Raising funds for renewable energy assets by tapping the capital markets is not unheard of. For example, in February 2012, MidAmerican Energy Holdings issued $850million in rated bonds to support the development of its 550MW Topaz solar photovoltaic farm. The three main rating agencies, Fitch, Standard & Poor’s and Moody’s rated the bonds investment grade. It has been some years since a renewable energy sponsor has tapped the capital markets for long-term project finance. The MidAmerican issuance was the largest issuance to-date with the initial issuance of $700 million reportedly oversubscribed by more than $1.2billion, prompting the company to increase the issuance size to $850million. The bonds had a tenor of 27.5 years, which is 2.5 years longer than the term of the Topaz power purchase agreement with Pacific Gas and Electric. By contrast, while the lender market for 2012 boasted significant deals, project finance loan tenors are significantly shorter. For example, in April, Terra Gen announced that it had tapped the bank lending market and raised $650million for its 168MW Alta Wind VII and 132MW Alta IX projects which included construction and seven-year term financings and bridge loans for the cash grant.
“Raising funds for renewable energy assets by tapping the capital markets is not unheard of.”
In its simplest form, the renewable energy version of a Canadian Trust, would own renewable energy assets in the US that can be contributed into a US limited partnership (“USLP”). The USLP would be owned by a Canadian commercial trust which would ultimately be owned by a Canadian foreign asset trust that is listed on one of the public exchanges in Canada such as the Toronto stock exchange. The Canadian Trust is the issuer in Canada and has the responsibility for preparing and filing a prospectus in Canada, complying with Canadian securities laws and providing details about the renewable assets and other disclosures required by Canadian securities laws. In exchange for the IPO proceeds, the Canadian Trust issues interest bearing notes to its IPO investors. The IPO proceeds are then used to acquire units in the Canadian commercial trust, which in turn invests such proceeds in the purchase of interests in the USLP. Ultimately, the USLP uses such proceeds to acquire the renewable energy assets. From a tax perspective and to minimize U.S. corporate tax, it is important that the USLP has sufficient deductions to shelter taxable income from its renewable energy investments. This in part is why Canadian Trusts have been successful in the oil and gas sector since this sector benefits from tax shelters from government-sponsored subsidies and tax deductions. The Canadian Trust is entitled to benefits under the US-Canada tax treaty and, if structured property, should not be subject to US withholding taxes on distributions by the Canadian Trust. Care should also be taken also to ensure that the structure does not trigger US anti-inversion rules that would deem the Canadian Trust a US corporation and therefore subject it to US corporate taxes. The benefit of a properly structured Canadian Trust is that it could be tax-neutral to a US sponsor. The Canadian Trust has made possible the retail distribution of investments in US renewable energy assets, utilizing a tax-efficient structure.
To date, most Canadian Trusts have been used to acquire interests in the oil and gas sector. There is no reason however that its model cannot be equally applied to the renewable energy sector. While the structure works best with operational assets, it is also possible to monetize the cash flow streams inherent in the financing of wind projects in the US, to accelerate the receipt of such cash flow.
Needless to say in order for such assets to be publicly listed in Canada, sponsors and investors seeking liquidity will have to ensure that proper accounting records for the portfolio that it wishes to place in the Canadian Trust have been maintained and that proper tax advice is sought to implement an appropriate US ownership structure that will achieve tax-efficient results. In the US, unless the assets qualify as operating assets under the Investment Company Act of 1940, consideration should also be given to structuring the US ownership interests and to the method of offering of the notes issued by the Canadian Trust so as to ensure that registration of the US acquisition entities as investment companies and registration of the issuance under US securities laws, would not be required.
“In order for such assets to be publicly listed in Canada, sponsors and investors seeking liquidity will have to ensure that proper accounting records for the portfolio that it wishes to place in the Canadian Trust have been maintained.”
Canadian Trusts for US assets are proving to be a path to liquidity that need to be seriously considered by US sponsors, especially in light of continuing sluggishness in the financing and IPO markets in the US. Attractive valuations, friendlier regulators, substantially similar securities laws and a well regarded stock exchange for energy assets are a confluence of factors that bode well for more such offerings in Canada in 2013. Of course, as this is a cross border structured product in highly regulated industries, special care should be taken in engaging technical advisors, professional service firms and appropriate legal counsel.
This article originally appeared in the February 2013 issue of North American Windpower.