By Hamlin Lovell, NordicInvestor 

NordicInvestor interviewed Zurich-based SUSI Partners and Denmark’s AkademikerPension (AkP) to find out about the unique ways of structuring a private credit strategy in the energy efficiency space, which also reports under SFDR 9. AkP was an anchor investor in a recent fundraising.

Energy efficiency is vital to combat climate change, accounting for approximately 40% of the Paris agreement targets, which the world is lagging behind.

Whereas some forms of decarbonization involve financial costs, energy efficiency in many cases has “negative abatement costs”, or in other words it actually saves money. “For instance, LED lighting can save 60-70% in terms of energy consumption compared to conventional lighting, and up to 90% in terms of costs because on top of the obvious savings per unit of light, there are further savings from the ability to dim the light in the early hours of the morning, for example. LED lighting also helps to stabilize electricity grids by reducing peak demand,” says Alexander Hunzinger (pictured below), Head of Credit Investments at SUSI Partners, which is an acronym of Sustainable Investing and was founded in 2009. In addition, LED lighting and energy-saving measures in general can have geopolitical benefits in reducing dependency on foreign energy sources.

Yet increasing adoption of LED lighting has been a multi-year campaign, slowed down by complicated politics. “When we launched our first energy efficiency credit strategy 8 years ago, we talked to more than 120 finance directors of European municipalities to encourage them to switch to LED street lighting. It was a slow start and initially we got very few projects out of it. There were huge conflicts of interest because operators of street lighting in many cases also provide the electricity needed. But it is a no brainer that can save up to 90% of costs. Whereas conventional lighting emits 90% heat and 10% light, LED lighting does the reverse,” says Hunzinger.

Innovative financing and structuring

Regardless of politics, bureaucracy and lobbying, an energy efficiency deal with a private end customer can still be an intricate affair. “An energy efficiency retrofit of a single office building, for example, can be a complicated process: you have to consider owners and tenants, work safety measures, and five different technologies being applied. The energy efficiency market overall tended to be too granular to attract outside capital, so many projects that made a lot of sense technically, were not implemented for the lack of financing.” Thus, the energy efficiency market has unique characteristics that require innovative financing structures. “To tackle this complexity, we developed our tailor-made credit financing solution, where we work in a three-party constellation with us as the financier, an energy efficiency technology specialist, and the end client” says Hunzinger.

However, it is not straightforward to categorize SUSI’s deals. “The risk allocation is very particular in a way that each participant focuses on its own key competencies: the energy specialist designs, builds and operates the assets and provides a performance guarantee for the whole lifetime of the project; SUSI provides 100% of the required financing and assumes the credit default risk; and the end customers outsource the energy management and can focus on their core activities.” explains Hunzinger.

SUSI’s role from an investor perspective is providing credit financing, though the end client pays a blended cost that includes both financing and a long-term fixed energy price. “Our returns are designed to mimic the cash flow of a bond investment, while being secured with the underlying energy assets,” he continues.

Return targets

SUSI’s credit strategies typically targeted an IRR of approx. 6.0% in the past but recently target returns on new deals have increased to 7.0% or more while payback times can be shorter. To a certain extent, income can be quickly redeployed and reinvested to push up the IRR, rather than being distributed. The strategy is Euro based, though projects outside of the Euro zone can be considered opportunistically.

( SUSI also manages private equity strategies with higher gross IRR return targets, such as 10+% for equity infrastructure and 15+% for its Southeast Asia strategy ). Credit investors are mainly from Europe, though there are some private equity partners from Australia and Asia. Total investor commitments across all strategies are EUR 1.9 billion.

Aggregating small deals

SUSI has historically deployed about EUR 100 million per year into energy efficiency credit strategies, but in 2022 this reached EUR 130 million, and SUSI’s previous fund had fully deployed its capital one year before schedule.

In total, SUSI has invested around EUR 600 million into more than 3,500 single energy efficiency measures through its credit funds, which implies an average ticket size of EUR 170,000, with sizes usually ranging between EUR 100,000 and 3 million. To make this an attractive proposition for financiers, the single deals need to be aggregated based on long-term framework agreements. “For a German car manufacturer, we have accumulated lighting projects for a total volume of EUR 7 million based on single project sizes of EUR 300,000. We often work on different sites with the same counterparties. Aggregating these smaller tickets to attract institutional capital is our key task,” explains Hunzinger.

Case studies: carmakers, LED lighting, schools and offices

There is huge demand for energy efficiency measures from private clients these days, where energy costs doubling from 2-3% to 4-6% of their total production costs are a direct hit to their net income,” he adds.

An agreement with Dutch technology company, Signify, the largest LED lighting firm, formerly Philips Lighting, enabled more than 220 projects in 12 different countries across Europe. Signify retrofits lighting with LED and SUSI’s financing covers 100% of the upfront capital spending. The economics are a “win-win” situation because energy cost savings for the end client more than cover both Signify’s service fee and the SUSI fund’s investment return.

Another partnership, with eLight, which provides integrated energy services in the UK and Ireland, is helping UK schools to become C02 neutral through lighting retrofits, rooftop solar PV panels and other energy-saving measures. SUSI finances the capital spending and then eLight receives a monthly or quarterly fee for the ongoing solutions.

The credit default risk counterparty in this case is the UK Department of Education. “Overall, the proportion of state counterparties has come down from about 45% to 30% as corporates have shown more interest in fixing energy prices over the past 18 months,” says Hunzinger.

SUSI also financed the energy refurbishment of 60 buildings for the City of Ljubljana in Slovenia with its local partner Resalta – a project where the prize-winning work on potential savings was initially financed by the EIB.

Beyond Energy Efficiency

SUSI’s first credit fund started in 2014, and its second in 2019. They were focused on energy efficiency, while its third fund, which had its first closing of EUR 132 million in 2022, is expected to be 60-80% energy efficiency with some exposure to producing clean energy and enabling clean energy use. “However, the distinctions between these three objectives are becoming blurred as some projects will merge two or more of these elements together. For example, an energy efficiency retrofit nowadays usually involves installing a solar plant on the rooftop,” explains Hunzinger.

Default risk

Historically, default rates were below 1% and recovery rates were up to 100% since the financing is fully asset backed and there is often a second use case for the (built-in) assets in addition to other risk mitigants. “Default risk and potential losses can be mitigated by credit enhancements whereby technology partners who install and design solutions provide a first loss piece. The technology guarantees can include insurances. For instance, solar plants are usually insured by large insurance companies,” explains Hunzinger.

Thanks to these mitigants, the strategy has experienced zero write-offs and only one 30% write-down since inception of the credit platform in 2014. “We manage these cases very proactively,” says Hunzinger.

Regulatory risk

The energy efficiency strategy has thus far invested in 17 countries of which 16 are in Europe, and nearly all of them are well within reach for the Zurich-based team. Policy changes, price caps and windfall taxes can be a risk for some utilities but not for SUSI: “Energy efficiency projects neither need subsidies, nor are these small-scale projects sensitive to withdrawal of any subsidies. However, subsidies can sometimes accelerate the process.” says Hunzinger.

ESG and Carbon Reporting

The three key UN SDGs targeted are the environmental ones: 7 (affordable and clean energy), 9 (industry, innovation and infrastructure) and 13 (climate action).

Carbon reporting is a complex area which can seem akin to an “alphabet soup” of reporting standards and acronyms.

SUSI’s ESG and Sustainability team provided us with some coordinates to help map out the reporting standards they observe:

Our carbon reporting framework is currently being rolled out and is aligned with the GHG Protocol Corporate Standard by the Greenhouse Gas Protocol (2004), the Corporate Value Chain (Scope 3) Standard by the Greenhouse Gas Protocol (2011), and the Global GHG Accounting and Reporting Standard for the Financial Industry from the Partnership for Carbon Accounting Financials (2020). There is currently no universal standard that is applicable to our type of investments and standardization and benchmarking are very difficult. We have therefore developed our own framework together with an independent external advisor to ensure alignment with market best practices”.

SUSI estimates that its projects have avoided 3.4 million tonnes of C02 emissions to date, based on scope 1 and 2 emissions. This has all come from the projects themselves, and there has been no trading of offsets or emission credits, nor any investment in CCS (carbon capture and storage).

This PAE (Potential avoided emissions) metric allows SUSI to measure and disclose their direct positive impact towards climate change mitigation.  The team explain: “Quantifying and reporting “Potential Avoided Emissions” and GHG emissions according to our carbon reporting framework meets the requirements for climate disclosures of the relevant initiatives such as the Task Force on Climate-Related Financial Disclosures, the Science-Based Targets Initiative (SBTi), and the Climate Disclosure Project (2022).”

SUSI has been measuring avoided emissions for 8 years and the complex process is still evolving, with scope 3 reporting awaiting some data improvements:

“We currently account for emission reductions that occur during the operational phase of the project (i.e. reductions in Scope 1 and Scope 2 emissions) associated with investments in energy efficiency where the investment displaces or reduces the use of energy from fossil fuels. However, we plan to integrate Scope 3 emissions as part of our PAE calculations once a Scope 3 emissions inventory for baseline and project emissions has been developed by the Partnership for Carbon Accounting Financials”.

The strategy does monitor alignment with the EU taxonomy, though this is something of a work in progress: “LED is not yet included in the EU taxonomy,” says Hunzinger, who clearly feels that LED lighting should be included.

A pension fund perspective

Some SUSI strategies, such as its Asian fund and its first renewables fund, have received investments from development banks, but the third energy efficiency credit fund only has institutional investors.

Though the strategy clearly has positive impact, this does not imply any sacrifice of financial returns. “The one does not need to exclude the other. More sustainable mandates go hand in hand with higher returns. In the longer term, the sustainability reinforces the investment case,” says Kathrine Cecilie Schleisner (pictured on cover), Senior Portfolio Manager at AkademikerPension.

The strategy is attractive for both investment and ESG reasons. “The risk/reward profile is lower risk than we normally see and slightly lower return, but the ratio between the two is good. It is very differentiated versus other managers. It helps small companies, and municipalities finance, structure and execute projects. The benefits for society are substantial,” explains Schleisner. AkP due diligence on SUSI included questionnaires, interviews, analysis, financial, legal and tax due diligence.

AkP views SUSI as rather unique: “We selected SUSI as it is one of the first movers in the energy efficiency space and we did not find other suitable managers. There are not many managers in this area. In times of uncertainty and elevated energy prices, we expect high demand for these projects.”

The SUSI investment contributes towards AkP’s targets for 22.5% in green investments by 2030, discussed in this interview.

The ESG reporting matches AkP criteria: “ESG reporting is part of SUSI’s quarterly and annual fund reports. They also report annual C02 savings attributed to our investment. This is further complemented by the UNPRI reporting. We have on occasion requested additional information, but otherwise, their standard reports meet our requirements,” says Schleisner.

SFDR 9 reporting was not in fact an essential requirement, but is something of a bonus: “we do not want to force SFDR 9 on managers at any price as it is still very new. But it is a positive sign of being at the forefront of development and engagement,” she adds.