Conventional wisdom states that unless a sponsor has significant investment-banking relationships, it can be difficult and time-consuming for the company to access an overseas market in order to fund development and expansion. However, recent successful initial public offerings (IPOs) of foreign asset income trusts, also known as cross-border income trusts, have renewed hope for sponsors seeking to raise capital for development or acquisition. Canadian trusts, in particular, are gaining attention.
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 portfolio investments. At a time when renewable energy asset values in the U.S. may be lower than before the onset of the financial crisis, the Canadian trust is an attractive means for sponsors looking to raise funds to acquire undervalued renewable energy assets.
Canadian trusts have proven to be a way for U.S. sponsors to successfully raise capital in the Canadian IPO market much more quickly than is possible in the U.S. IPO market. The expected time for completion of an IPO on the Toronto Stock Exchange is two to three months, compared to six months or longer on the New York Stock Exchange.
Given the 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, so catching that window of opportunity is critical to a successful launch. Moreover, a shorter time to market also means that transaction costs would be significantly lower than in a U.S. IPO.
In addition to speed and lower transaction costs, the issuance size of a Canadian trust on a Canadian exchange can be substantially lower than that required for an IPO in the U.S. market. Several Canadian trusts have launched successfully in the Canadian market: Eagle Energy Trust raised $150 million, Parallel Energy Trust raised $400 million, Argent Energy Trust raised $212 million and, most recently, in November, CRIUS Energy Trust completed a $100 million 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 U.S.), the Canadian trust structure offers an attractive path to market for many sponsors and investors.
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 they were immensely popular with Canadian oil and gas companies, as well as with companies that invested in Canadian real estate, the Canadian income trusts eventually raised concerns among regulators. Chief among these concerns 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. In October 2006, the Canadian government introduced legislation that required that such publicly listed vehicles be taxed at corporate rates and that their distributions be treated as dividends subject to tax.
This measure removed the benefit of the Canadian income trust as a pass-through vehicle, and by 2011, such vehicles had all but disappeared from the market. However, the legislation did not impose such taxes on publicly listed trusts that generate their revenue from non-Canadian assets. Therefore, there is a growing interest in Canadian trusts as a means of raising capital or as a liquidity option.
Tapping the capital markets in order to raise funds for renewable energy assets is not uncommon. In February 2012, MidAmerican Energy Holdings issued $850 million in rated bonds to support the development of its 550 MW Topaz solar photovoltaic project. The three main rating agencies – Fitch, Standard & Poor’s and Moody’s – rated the bonds as investment grade.
It has been years since a renewable energy sponsor has tapped the capital markets for long-term project finance. The MidAmerican issuance was the largest such deal to date, with the initial issuance of $700 million reportedly oversubscribed by more than $1.2 billion, thus prompting the company to increase the issuance size to $850 million. 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.
Although the lender market boasted significant deals, the project finance loan tenors were becoming significantly shorter. For example, in April, Terra-Gen announced that it had tapped the bank lending market and raised $650 million for its 168 MW Alta Wind VII and 132 MW Alta IX projects, including construction and seven-year term financings and bridge loans for the cash grant.
In its simplest form, the renewable energy version of a Canadian trust owns renewable energy assets in the U.S. that are contributed to a U.S. limited partnership (USLP). The USLP is owned by a Canadian commercial trust, which is ultimately 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 the country, complying with Canadian securities laws and providing details about the renewable energy 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, it is important that the USLP has sufficient deductions to shelter taxable income from its renewable energy investments. One of the reasons why Canadian trusts have been successful in the oil and gas sectors is that those industries benefit from tax shelters from government-sponsored subsidies and tax deductions. The Canadian trust is entitled to benefits under the U.S.-Canada tax treaty and, if structured properly, should not be subject to U.S. withholding taxes on distributions by the Canadian trust.
To date, most Canadian trusts have been used to acquire interests in the oil and gas sector. However, there is no reason why its model could not be applied to the renewable energy sector. While the structure works best with operational assets, it is also possible to monetize the cashflow streams inherent in the financing of wind projects in the U.S. in order to accelerate the receipt of such cashflow.
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 U.S. ownership structure that will achieve tax-efficient results.
In the U.S., unless the assets qualify as operating assets under the Investment Company Act of 1940, consideration should also be given to structuring the U.S. ownership interests and to the method of offering the notes issued by the Canadian trust so as to ensure that registration of the U.S. acquisition entities as investment companies and registration of the issuance under U.S. securities laws would not be required.
Care should also be taken to ensure that the structure does not trigger U.S. anti-inversion rules that would deem the Canadian trust a U.S. corporation and, therefore, subject it to U.S. corporate taxes. The benefit of a properly structured Canadian trust is that it could be tax-neutral to a U.S. sponsor. The Canadian trust has made possible the retail distribution of investments in U.S. renewable energy assets, utilizing a tax-efficient structure.
Canadian trusts for U.S. assets are proving to be a path to liquidity that needs to be seriously considered by U.S. sponsors, especially in light of ongoing sluggishness in the U.S. financing and IPO markets. Attractive valuations, friendlier regulators, substantially similar securities laws and a well-regarded stock exchange for energy assets all bode well for more such offerings in Canada this year. w
Industry At Large: Project Finance
In Canada, They Trust: Looking North For Financing
By Jeffrey Scheine, Michael Smith & Madeleine Tan
Canadian trusts for U.S. assets are proving to be a path to liquidity that should be considered by U.S. sponsors, especially in light of ongoing financing challenges in the U.S.
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