Fund Solutions

All-purpose Financing Clause Ratchets Down CO2

Adaptable open-source mechanism creates demonstrable link between emissions reduction and finance costs.

Businesses in transition to net zero may be able to access cheaper capital as a result of a standardised clause in financing agreements linked to reductions in CO2.

The ‘Interest Ratchet Clause for Carbon Saving’ was originally designed to be inserted into loan agreements involving Field, a UK-based battery storage company, and Triple Point Energy Transition (TENT), one of its investors.

The companies, plus legal partner The Chancery Lane Project (TCLP), have now declared the clause ‘open source’, so that any company and its financial backers can use it.

Elspeth Vincent, General Counsel at Field, said: “We’ve always talked about the importance of aligning capital with the planet – and this is our next step forward in showing that’s possible.”

Key to the ratchet clause is an agreement between borrowers and lenders that progress in reducing carbon emissions is rewarded by a reduction in borrowing costs. While the incentive to the borrower is clear, the lender – or, with a twist, the institutional investor or venture capitalist – can point to a quantifiable contribution to net zero as part of their own decarbonisation strategy.

Objective measurement

Promoters of the ratchet clause claim it is the first such loan condition that is scientifically based, and thus verifiable. In the case of the Field lending, the clause used National Grid data on the grid’s carbon intensity before and after Field’s batteries discharge renewable energy.

Field has already benefited from the ratchet clause, in that it will pay less interest on its £47 million debt facility with TENT. Although parties to the clause can agree an interest rate reduction proportional to the carbon emissions reduces or avoided, the clause used by Field uses one of the highest carbon saving ratchets available. TENT expects to expand this to other battery storage operators over the next year, to encourage them to maximise the environmental credentials of storage assets.

Other versions of the ratchet clause, using measurable and scientifically verifiable data for carbon reduction, will be devised to suit different industries. Likely applications include renewable energy generation, microgrids and electric vehicles. Further, it is expected to be adapted to other sorts of financing arrangements including equity and debt capital.

In a statement, the three partners said: “A user-friendly template of this clause will exist in the TCLP climate clause library, which any individual can access to lift sustainability clauses that are peer-reviewed by a global collective of legal professionals directly into any of their contracts.”

They say the ratchet clause is unique in two ways, first in being open source and second in providing objective measurement of companies’ reduction in carbon emissions.

Test case

TCLP is an expanding network of lawyers and others “working to rewire contracts to combat the climate crisis”, it said. Becky Clissmann, Managing Director, said the ratchet clause “represents a shift towards data-driven ESG mechanisms that encourage private companies to decarbonise”.

Jonathan Hick, Investment Director and Fund Manager at TENT, said the company had deliberately sought out a battery storage company that shared TENT’s commitment to accelerating the transition to net zero. “We were delighted that Field agreed to become our first test case for the interest margin ratchet and we hope to continue to put this in place for future investees in the storage space and other sectors as we invest to achieve the transition to net zero.”

Focused on battery storage in the UK at present, Field intends to expand both geographically and across a wider range of energy infrastructure “which is renewable and profitable as standard”.

Both the loan and bond markets have developed mechanisms to tie the cost of funds to climate-related and other ESG performance metrics, but in both cases these have experienced teething problems.

In August, international law firm White & Case said: “As more issuers look to include ESG ratchets in borrowing documentation, guidelines around ratchets and ESG reporting will become more rigorous and standardised. Borrowers will need to do more work to take advantage of the opportunity.”

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