When international regulators drafted the Basel III Endgame regulations as a response to the 2008 financial crisis, they aimed to curb risky bank investments, but their one-size-fits-all approach threatens to dismantle the traditional tax equity structure and has created a wave of concern that has swept through the renewable energy industry, among financial institutions and developers alike.
The rules as proposed would adversely affect many tax equity investors, who have historically driven $20 billion of annual investment in renewable energy projects.
Under the Basel III Endgame regulation, these banks would be required to quadruple the risk-weighted capital held against investments in renewable energy projects. The rules effectively make what was an attractive way of reducing their tax liabilities far less appealing. As a result, the successful implementation of Basel III could drastically change project financing and therefore potentially slow our clean energy transition.
However, there is a possibility that these initial fears may turn out to be more shadow than reality.
Federal Reserve Chairman Jerome Powell indicated this spring that there will be “broad” and “material” changes before the standards take effect on July 1, 2025. The changes are likely to reflect comments submitted during the comment period after Basel III Endgame was announced, which ended in January of this year. These changes may alter the risk-weighting for banks, which handle over half of these deals.
However, even if these revisions are not implemented, the Basel III Endgame regulations will not leave our industry powerless.
Basel III Endgame’s impact on renewable energy
The American Council on Renewable Energy (ACORE) and the Solar Energy Industries Association (SEIA) quickly raised objections to the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC): The three organizations that will implement the policy domestically. So, too, did the American Bankers Association and the Bank Policy Institute, which said these changes “would, in most cases, make the investments uneconomic for banks.” More than 100 members of Congress also voiced their displeasure with the proposal.
Without Basel III Endgame, ACORE projected the tax equity market in renewable energy would surge to more than $50 billion annually. But if it is implemented as currently proposed, these investments could plummet by a staggering 80-90%.
Although traditional tax-equity financing might be in the crosshairs, the Inflation Reduction Act introduced a new way by which developers can now monetize their projects’ ITCs and PTCs. Transferability offers a lifeline for developers and tax equity investors alike by offering them the ability to sell tax credits.
Transfer deals offer an increasingly appealing alternative
Direct transfer transactions offer developers access to capital without the complexities of a tax-equity structure. They also offer developers who may have historically lacked access to the tax equity market (either due to project size or type) a new way by which to monetize these credits. These deals allow developers to circumvent the need for partnership structures by selling tax credits directly to taxable entities. Buyers can benefit from credits valued as high as 50% of the eligible cost of the project while reducing their exposure to operational project risk.
However, the shift from tax equity to direct transfer deals isn’t without its tradeoffs. If a developer opts to directly transfer their credits, they forgo a potential step up in project value which is possible when a developer sells an asset to a partnership. In addition, these credits are typically sold at a discount to their full dollar value.
The good news for developers is that transferability does not only provide new potential financing structures for them, but for tax equity investors as well. Tax equity investors can now structure their deals so that they have the option to sell credits out of the partnership, thereby reducing their overall financial exposure to the transaction while at the same time offering their banking clients a new potential financial product: tax credits. In this way, tax equity investors can continue providing the majority of benefits of this partnership to developers while simultaneously reducing their risk in the event Basel III Endgame is implemented in its current form.
Both structures open the door to a more diverse pool of financing parties, including those who previously considered tax equity structures too complex or risky. They may attract smaller banks, corporations, insurance firms, and utility companies to renewable energy investments. And, in addition to bridging financing gaps, this influx of fresh capital could also potentially lead to competition that helps drive down costs across the sector.
As the industry embraces these types of financing structures, it’s clear that renewable energy development will continue to thrive, regardless of whether Basel III Endgame closes the book on traditional tax equity deals.
An industry known for resilience
The renewable energy industry has weathered its fair share of regulatory storms, and Basel III Endgame is just the latest on the horizon. We’ve continually adapted to shifting policies, including tax credit value changes and new regulatory frameworks, and found innovative ways to structure deals, draw in an expanding pool of investors, and keep projects moving forward.
Over the years, our industry has become adept at crafting flexible project financing structures that fit changes in policy and legislation, and the amount of renewable energy in this country continues to grow steadily. All told, the U.S. generated 238,121 gigawatt-hours (GWh) of electricity from solar last year, an increase of 16% compared to 2022.
With the upcoming administration changes set to take place in the new year, there is added fear that the odds will be stacked against the industry. While we remain hopeful for potential exceptions in the Basel III Endgame regulations, we must be proactive and continue to innovate on new financing structures by capitalizing on what transferability allows for. This is the kind of approach that will underscore our resilience and commitment to advancing clean energy across America.
Hannah McGovern is vice president of Structured Finance at DSD Renewables.
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