By Iain Wilson, BloombergNEF editor. This article first appeared on the Bloomberg Terminal.

The rapid expansion of clean energy in Japan in the wake of the Fukushima earthquake and nuclear disaster almost eight years ago helped usher in a new way to finance infrastructure projects, according to Toru Inoue, a vice president with Goldman Sachs Group Inc.’s infrastructure and structured finance group.

Following Fukushima, Japan’s government brought in some of the world’s most generous feed-in tariffs for clean-energy projects. Renewables boomed, especially the utility solar sector, which grew almost 70-fold in terms of installed capacity from 550 megawatts the year before the new incentives to almost 38 gigawatts at the end of 2017, according to data compiled by BloombergNEF.

“The introduction of renewables changed the landscape somewhat because we never had a new business start growing as rapidly as we were seeing with renewables,” Inoue said.

In 2013, Goldman arranged its first project-backed bond in Japan. Two years later, the investment bank announced that it aimed to arrange $1 billion of renewable energy bonds in the country. Goldman is now in the market with its 18th bond, with a total issuance of about 90 billion yen ($810 million), Inoue said.

As the renewables landscape in Japan has changed, so has Goldman’s offerings. For example, the investment bank in April said it would finance solar farms with bonds that accelerate repayments instead of paying dividends, if grid congestion limits electricity generation. This reduces risks for debt holders.

It also helped Canadian Solar Inc. recycle capital in two photovoltaic projects via the sale to financial market investors of equity-backed securities, rather than by an outright sale of the assets to a third party.

“I started off trying to connect infrastructure and the market but now what we’re doing is connecting green energy with the capital markets as well,” Inoue said.

Inoue spoke to BNEF about the changing face of renewables finance in Japan. The following transcript is edited for length and clarity.

Q: Conventionally, how have solar projects in Japan been funded?



A: Japan is a relationship banking, corporate borrowing country. You don’t really have true non-recourse lending or project-backed lending outside of commercial real estate. Infrastructure or energy in Japan has historically been financed through government money or large corporates. The introduction of renewables changed the landscape somewhat because we never had a new business start growing as rapidly as we were seeing in renewables.

We went around talking to the newly springing-up renewables developers and told them that if they are having problems getting local non-recourse lending in Japan, we’re here to help. We worked with the rating agencies as well as lawyers and accountants and we turned this around faster than the commercial banks and we did our first purely non-recourse project backed bonds in 2013. Right now, project-backed lending is mostly occurring in renewables. It’s divided between our bonds and commercial bank loans.

Q: Goldman developed a product called the Japan Renewable Project Bond Trust targeting $1 billion of issuance. Where are you at in terms of issuance through the trust?



A: We’re in the market with our 18th bond and the total will be close to 90 billion yen, so we’re almost there.

Q: Why is this kind of financing more attractive to renewables developers as opposed to going to a big commercial bank?



A: In many cases, connecting developers with capital market investors makes more sense because the institutional investors have longer liabilities compared to banks and therefore are fundamentally better positioned to finance infrastructure from an ALM [asset and liability management] perspective. The institutional investors can also be more project-oriented and less swayed by the strength of the relationship with the sponsor [issuer] or the lack of it, and therefore be a more stable source of funds to a larger universe of developers.

Historically, Japanese infrastructure ─ not only energy but airports, toll roads, sea ports ─ has mostly been financed by the governments through taxpayers’ money or by large corporates, whether that be large listed rail companies, large listed utilities or large trading companies in some instances. It has not been financed on a truly project basis. That means Japanese investors didn’t have the opportunity to invest directly in infrastructure the way they would in Europe or North America.

When Fukushima unfortunately happened, that changed quite a lot. The country painfully realized the need for an alternative to nuclear energy and that realization kickstarted renewables in a way that had not been seen before. Suddenly, you had not only major Japanese companies collaborate in this effort but also many startups as well as developers from all over the world helping Japan quickly build renewables. We saw that there would be a tremendous demand for project-based financing from these developers because a lot of these players either did not have the banking relationships or would want to manage their exposure in a way that did not rely on corporate guarantees. The local banks were still trying to figure out the risk and whether they really could do non-recourse and it was taking time.

We are [now] somewhat able to do what we’ve been trying to do for decades, which is to connect Japanese infrastructure with Japanese capital markets money. Nowadays the opposition has weakened somewhat and the people that are trying to change the way Japanese infrastructure is financed are gaining more strength. I started off trying to connect infrastructure and the market but now what we’re doing is connecting green energy with the capital markets as well. Investors love our products twofold ─ we have access to stable infrastructure and we’re also satisfying our requirements to be more green.

Q: What types of investor does this kind of lending attract in Japan?



A: Traditionally, our investor base has been 60 percent to 70 percent life insurance companies and the rest are mostly regional banks and some leasing companies. Having such strong interest from regional banks was a surprise. We didn’t expect them to come in to invest in 20-year fixed-income, fixed coupon-rate bonds because it was too long and they traditionally prefer floating-rate investments. But regional banks are having a hard time satisfying their appetite finding good investment opportunities or lending opportunities. So as long as the power plant is in their area, in many cases they are keen to invest.

That’s how we’ve traditionally done it and now we’re hearing interest from the pension funds. The pension funds initially took a wait-and-see attitude because they need more liquidity. This was a new product and they weren’t sure how deep the market would become. Now that we’ve been doing this for five years and it’s gotten more liquid and deep, we see signs of pension funds preparing to look into it.

Q: With the feed-in tariff rates coming down, the cancellation of a lot of solar projects and now curtailment risks, the conditions around renewable projects have changed. How does that affect lending?

A: The sponsorship of Japanese renewables has changed from a more mixed bag of players to a professional market. In the past, we rarely had truly professional people come and visit us. In the initial years, the rich feed-in tariff compensated for the inexperience of the developers. You had a situation where the inexperienced developers might have been using contractors that were very high in quality but also very high in cost because they didn’t really know how to make it cost-effective. It’s partly our fault too because we wanted everything done in an overly high-quality way. We weren’t totally comfortable with construction risk or civil work risk or other risks. We asked the developers, who themselves were inexperienced, to hire big corporates or large companies to do all the work. You ended up with a very expensive power plant but it was still okay because the tariff was very rich.

Now it’s the true professionals who are able to manage the costs to make these power plants feasible under a 14 yen, 15 yen [per kilowatt-hour] environment. Everybody has become more experienced and even under the current very different environment, deals are still feasible and financing is still doable, maybe not for all projects but still there are a lot of deals that can be done.

Q: The caveat to that might be curtailment. No one was talking about curtailment a few years ago and now there’s a concern that curtailment is making financing more difficult.



A: There’s one camp where people are overly cautious about curtailment. There’s another camp where people are saying it’s difficult to prove but their gut feeling tells them curtailment won’t be too serious. It’s a very delicate subject.

Q: In April 2018 Goldman offered to finance solar farms in Japan with bonds that accelerate payments if grid congestion limits electricity generation. Can you explain how the bonds work?

A: We took the approach that [curtailment] is dependent upon factors that are very difficult to objectively analyse, and therefore some expert reports that were based on officially announced targets and government announcements did not necessarily reflect what the researchers themselves felt would happen in reality. We won’t neglect what these expert reports have said about curtailment. We’ll run stress scenarios based on these models but we won’t start by putting a deep cut prematurely in the cash flow. We will start with a very moderate stress but we would keep monitoring the progress and, if there are early signs of curtailment actually picking up, then we will adjust. We will stop dividend payments and pre-pay a certain amount of debt at that point to adjust to a slightly higher curtailment risk environment. The idea is to catch the signs early and adjust before it’s too late and keep dynamically adjusting and always keep slightly ahead of curtailment. We have the feeling that there isn’t the need to do too much adjusting but we’ll put into place the safety bells and whistles just in case curtailment occurs to a significant extent.

Q: What kind of reception did the bond receive among investors?



A: Most investors agreed with our views and our structure. Some investors took a very conservative view and said they needed to have deep up-front stress and size the bonds against that. But it turned out that these were the exceptions and there were enough who agreed on our views and our structure.

Q: Do you feel this will be the model for curtailment and financing elsewhere?



A: Our structure works best when curtailment risk is gradual. Even if it reaches 60 percent, if it goes in a relatively gradual curve, the idea is that you can catch the signs early on.

Q: Are there any other mechanisms you’re trying out or looking at that would change the way renewables are financed in Japan or elsewhere?



A: Last December we closed an innovative deal where we securitized the equity parts of a solar power plant. It’s been six years since the feed-in tariff was introduced and some people are now moving to the next step, which is to flip their investment and exit. People are looking at the various avenues regarding the exit.

Canadian Solar, which is one of our important clients, wanted to monetize their equity in two power plants which were both debt financed by our bond product. They had two options. They could have put it in their listed vehicle or they could have sold it to someone outright. We told them that with the assets, here we have a deal that is leveraged with quality debt, meaning the interest rates are competitive, the leverage is high and it had rated bonds, which means the quality of the underlying assets were vetted by the rating agency in the market. Arguably, the equity position is very attractive and it should be attractive and stable enough to be sold into the capital markets directly rather than to another professional infrastructure player.

Our argument was that the quality is so high, if we can repackage it as equity-backed securities, I’m sure that the insurance companies or other capital markets investors would be happy to look at it as an alternative investment backed by quality and properly managed project equity. Because capital market investors have capital costs that are the lowest in the world, their return requirements would be competitive compared to selling it outright. If we were to compare this with an outright sale to a third party, this sale achieved for Canadian Solar the highest value per megawatt historically in Japan. It ended up to be an extremely efficient way for them to exit their investment. If we could find other deals that fit into the same criteria, this is an extremely efficient way to monetize equity.