In December 2022, The UK Government is proposing to bring forward legislation for a new levy on UK electricity groups generating more than 100 Gigawatt-hours (GWh) per annum. The idea is to subject “Exceptional Generation Receipts” to a new 45 percent levy which importantly will not be deductible from profits subject to UK corporation tax. The levy will operate between January 2023 and March 2028.
The UK Treasury recently published their proposed calculation of the levy in their technical note. This calculation is as follows:
Less £75m* UK generation in Megawatt-hours (MWh)
Less a Group threshold allowance
Receipts subject to Levy at 45%
Source: UK Treasury Technical Note: “Electricity Generation Levy”
What is the problem?
As is common with hastily considered tax measures, the devil is always in the detail and there are usually unintended consequences. The consequences that we see in this instance are:
1. The Levy was sold in the press as a windfall tax. Unfortunately, it is not – it is a tax on a proportion of revenues not profits.
As a result, the measure risks taxing groups that have properly incurred costs which are subsequently not being offset in the calculation of the levy. By example, those generating electricity to offset usage within their groups need to create formal intercompany contracts rather than selling to the market as a hedge. Failure to do so risks incurring the levy with no offset on the market price paid by another part of the group. As prices rise, this lack of offset becomes punitive, particularly as the levy is not off settable for corporation tax.
2. The Levy risks distorting the market for renewable generating assets with the thresholds being introduced.
Whilst we think the allowances and generation volume thresholds are sensible to avoid bringing too many companies into the levy regime, there is a risk of market distortion as a result. The size, scope and post-tax nature of the levy, together with near term forward prices means that the levy will have a material valuation impact for some but not all current and prospective owners. Those groups with limited current generation will have a significant competitive advantage over the larger generator groups.
What is next?
The proposals are being drafted into law and will be available for view next month (December 2022) ahead of the levy being introduced in January 2023. Whilst we hope that some of the unintended consequences will be ironed out, we think it is unlikely that all of the issues will be addressed given the rushed timeframes.
If you have any questions please contact Geoff Knight, Managing Director – Centrus
As housing associations’ finances come under increasing pressure, how much will unsecured borrowing have a part to play? Gary Grigor of Devonshires and John Tattersall of Centrus Financial Advisors assess the situation
The housing sector has been hit by a number of challenges in recent months. What began as a cost inflation challenge quickly became a more acute operating margin challenge in the face of unspecified caps.
With borrowing costs now far higher than originally forecast, interest cover covenants are coming under increased pressure.
The pan-sector response is still in development, but capex is likely to slow in the short term and efficiency savings will be needed.
Liquidity requirements are likely to fall too, as the temptation to reduce facilities and save carry costs to optimise interest cover performance appeals.
This strategy has risks, though, particularly where it takes time to put new facilities in place should requirements pick up again.
It is in this context that unsecured borrowing may have a strategic part to play.
Unsecured borrowing allows registered providers (RPs) to dispense with providing and maintaining a ring-fenced pool of property security either via a security trust mechanism and/or direct charging to the relevant funder.
Instead, the organisation must maintain a pool of unencumbered assets for the life of the facility. The upside of this is that the time, effort and expense associated with pledging a ring-fenced pool of property security under conventional funding arrangements is dispensed with, paving the way for a quicker and more decisive funding solution.
Unsecured borrowing can also be scaled up and down far quicker than conventional secured funding.
While an unencumbered pool of assets must be preserved at all times, there are not the same rigorous due diligence requirements to be satisfied.
Provided that the unencumbered assets stack up to meet the minimum threshold from a valuation perspective, then that, in itself, will be sufficient.
As a result, the composition of the unencumbered property pool can also dynamically fluctuate over time, facilitating easier asset management and offering protection should asset values fall, as potentially forecast next year.
The Pros and Cons
Speed of execution: With no security charging process, facilities can be executed and available comparatively quickly. They can also be restructured and re-sized with greater ease. Unsecured facilities can offer strategic value where a debt capital markets programme is in train, but the timing is not quite right to launch.
Flexibility: Release and substitution mechanics do not apply, so managing the unencumbered asset pool is generally straightforward – helpful where stock rationalisation is under way.
Sweating the asset pool: Most portfolios have assets that wouldn’t otherwise be acceptable to a funder yet can still generate borrowing capacity via the unencumbered pool.
Cost of carry: Margins and fees tend to be higher for unsecured facilities, albeit the differential to secured facilities has meaningfully narrowed in recent years, particularly on an undrawn basis (as low as five to 10 basis points per annum in some cases).
Shorter tenor: To further offset the cost difference, most unsecured facilities tend to be structured on a three-year term, if with annual renewal/extension options sometimes available.
Overall asset cover efficiency: Higher asset cover ratios tend to apply in sizing the unencumbered asset pool rather than would otherwise be expected on charged security.
We have advised on £540m of unsecured facilities in the past 12 months, and in several instances, facilities have been scaled up with the additional funding available in less than three weeks from the initial request.
Who should be thinking about it?
Funders will, of course, make decisions on a case-by-case basis, but in our experience, it is likely that an RP with the following would potentially benefit from this financing route:
Reasonable scale: lenders have a strong preference to be one among many lenders, which favours larger treasury portfolios
A strong credit profile – potentially supported by an external rating with a rating agency
A diverse loan portfolio, which is looking to ‘right size’ liquidity, while baking in flexibility and the ability to scale dynamically if needed
A big enough pool of residual unencumbered assets seeking to ‘sweat their assets’ more efficiently
While initially led by some of the newer entrants looking to make a footprint, most commercial funders will now entertain the prospect for the right RP.
In debt capital markets, some institutional investors have also demonstrated their ability and willingness to provide unsecured finance where suitably compensated in the spread, but experience informs us that this tends to be reserved for some of the larger RPs.
If debt capital markets funding is likely to be drawn, the cost differential can also be wider than seen on standby liquidity lines.
This is not to say there isn’t value in unsecured debt capital issuance, particularly where a portfolio contains challenging or quirky assets that would otherwise be challenging to leverage.
The increasingly challenging operating environment may dampen the appetite for unsecured lending among banking institutions, particularly should there be a general reduction in the sector’s credit standing.
However, for the time being we continue to see term sheets offering attractive unsecured funding from a broad range of lenders on a regular basis.
On that basis we consider this a viable solution that deserves due consideration in RP business plans across the country.