Forfaiting

Forfaiting contracting, in its purest form, involves the ESCO transferring the rights to future receivables – specifically, the payments expected from an energy performance contract—to a financial institution (FI). In exchange for this transfer, the ESCO receives a single lump-sum payment, which is discounted to account for the time value of money and the risk associated with the receivables. This arrangement does not require the ESCO to enter into an additional financing agreement, as the financial institution assumes the risk of collecting future payments. The structure of the contractual relationships involved in a forfaiting transaction is typically represented in a diagram that illustrates the flow of payments and the transfer of receivables.

Cession of contracting rates as security for credit- or lease-finance

Assigning contracting rates in this context is not a standalone financing method but can function as additional collateral for the financial institution (FI), potentially streamlining cash flow management.

Through a legal transfer (cession), the ESCO’s claims against the client are assigned to the FI. Consequently, the client remits the designated portion of the contracting payments directly to the FI, which then applies these funds to reduce the ESCO’s outstanding debt.

A garnishee agreement serves as an additional layer of security for the financial institution (FI), particularly when the assigned contract payments are required to be settled by the client, regardless of whether the Energy Performance Contract (EPC) is fully executed (non-recourse or waiver of objection).

ESCO clients are not obligated to assign the entire contract payment. A practical approach might be to assign an amount equivalent to the investment and capital cost portion of the contract rate. The remaining portion, which covers operations, maintenance, and associated risks, would still be paid directly to the ESCO.

From the ESCO’s perspective, it is beneficial if the FI agrees to take on certain risks under the garnishee agreement, such as the financial performance risk of the ESCO client. In this scenario, “non-recourse” indicates that the FI waives the right to claim against the ESCO, provided that the ESCO has met its contractual obligations, including the guaranteed energy savings outlined in the EPC (addressing technical performance risks).

The relationships between the three parties – ESCO, client, and FI – in the context of assigning payments as security for credit or lease financing are illustrated in the accompanying diagram.

Figure 12: Contractual relationships

Different types of receivable assignment include open, partially open, and concealed assignments, which vary based on the level of disclosure to the ESCO client. An open assignment involves full transparency where the client is informed and has agreed to the transfer of liabilities. A partially open assignment might involve some level of client awareness without full agreement, while a concealed assignment is a private arrangement between the ESCO and the financial institution, occurring without the client’s knowledge or consent.

Cession and forfaiting

Cession refers to the transfer of future receivables, such as payments under a contract, from one party (the cedent, which in this case is an ESCO) to another party (the buyer, typically a financial institution or bank). In this arrangement, the original creditor (the ESCO) assigns its rights to claim future payments to the new creditor (the financial institution), who then gains the right to collect these payments directly from the debtor (the ESCO’s client).

There are two main forms of cession:

1. Cession as additional security: In this form, cession is used alongside a credit or lease financing agreement. The receivables that are ceded (future payments) act as additional security for the financial institution. Here, the ESCO client is directed to pay the receivables, either fully or partially, directly to the financial institution.
2. Pure forfaiting: When cession occurs without an underlying credit or lease agreement, it is known as “pure” forfaiting. In this scenario, the financial institution purchases the future receivables at a discounted present value, which is paid directly to the ESCO. This approach is particularly beneficial when the cash flow from the project can serve as the primary collateral. Forfaiting becomes economically advantageous if the ESCO client has a stronger credit rating than the ESCO itself.

Forfaiting generally applies to receivables that arise from investments, goods, or services with a medium to long-term duration, typically ranging from six months to ten years or more. The receivables must be legally valid, undisputed, and confirmed, meaning that the ESCO has completed its work under the EPC and the amount of the future payments is agreed upon.

Factoring is another financial arrangement similar to cession but is typically used for short-term receivables or individual invoices. Factoring involves transferring the responsibility for payment collection, and in some cases, the financial risk, to a specialized financial institution. However, factoring is not suitable for EPC projects due to the shorter duration of receivables involved.

Leasing financing

Leasing provides a method for obtaining the right to use an asset without owning it. In the context of energy efficiency (EE) investments, which include Energy Conservation Measures (ECMs), Renewable Energy (RE) installations, or energy supply plants, leasing allows entities to utilize these assets by paying for the right to use them, rather than purchasing them outright.

Leasing is a contractual agreement between the asset owner (lessor) and the user (lessee), where the lessor grants the lessee exclusive rights to use the asset for a specified period, known as the basic lease term, in exchange for regular lease payments. These payments, often made as annuities, are paid to the leasing financial institution (LFI). The lessee could be an Energy Service Company (ESCO) or the ESCO client (the asset owner), as illustrated in the following examples.

The two main types of leases relevant to Energy Performance Contracting (EPC) are operating leases and finance leases. The fundamental contractual relationships within a leasing agreement are illustrated in the accompanying figures.​

Figure 7: Contract relationships of a leasing agreement with the ESCO	Figure 8: Contract relationships of a leasing agreement with the ESCO Client

Comments to the figures:

• The ESCO is responsible for implementing the Energy Conservation Measures (ECMs) and assumes the associated technical, economic, and organizational risks involved in the Energy Performance Contract (EPC). Additionally, the ESCO often facilitates the financing required for the project.
• The Financial Institution (FI) manages the financial and administrative aspects of the project, bearing the related risks. The FI may enter into a framework and lease agreement either directly with the ESCO (sometimes involving a cession agreement for a portion of the contracting fees) or with the ESCO Client.
• The FI also enters into a construction contract with the ESCO for the execution of the ECMs.

Leasing models can be categorized based on how the financing is structured, particularly regarding the amortization of the leased asset. These include full-amortization contracts, where the total cost of the asset is covered over the lease term, and part-amortization contracts, which involve a residual value that remains at the end of the lease period. Additionally, leasing agreements may or may not require advance payments, with both options being viable for financing Energy Performance Contracting (EPC) projects.

Sale-and-lease-back arrangements are commonly utilized for financing comprehensive building renovation projects, beyond just the scope of EPCs. This approach allows entities, such as public institutions, to leverage existing assets by monetizing “hidden reserves” in their facilities. To ensure that such projects meet energy efficiency goals, it is advisable to establish minimum performance standards for thermal upgrades and to include guarantees—such as limits on energy consumption—within the project’s terms of reference.

The typical cash flow relationships of a leasing agreement are displayed in the following two figures.

Figure 9: Cash flow relationships of a leasing agreement with ESCO	Figure 10: Cash flow relationships of a leasing agreement with the ESCO Client

Comments on the figures:

• Role of the leasing Financial Institution (FI): In both scenarios, the Leasing FI is responsible for financing the Energy Conservation Measures (ECMs) while the ESCO handles the implementation and arranges the necessary financing agreements.
• Co-financing: The Leasing FI should also manage any co-financing arrangements, such as subsidies, that may be available to support the project.
• ESCO financing: If the ESCO is responsible for financing, the portion of the ESCO’s claims related to financing can be assigned to the FI. This allows the FI to directly handle the repayment of the ESCO’s debt.
• ESCO client financing: When the ESCO Client is financing the project, the share of the payment related to financing is paid directly to the Leasing FI as a leasing fee. The remainder, which covers operations, maintenance, and asset costs, should be paid directly to the ESCO.

Advantages of operating lease in EPC:

• The operating lease model provides several benefits to the lessee, such as off-balance-sheet financing due to the lessor’s capitalization, access to extended credit lines, and lower transaction costs.

Potential drawbacks:

• Only assets that qualify as leasable goods can be included.
• Early termination of the contract can result in disproportionately high costs.
• Despite leasing obligations not appearing on the balance sheet, they must be disclosed to potential creditors as pending liabilities.

Additional considerations:

• Financing term: For a lease to qualify as such, the lease term must not exceed a certain percentage of the asset’s useful life (e.g., 90% in Austria and Germany, 75% of economic life under US GAAP). According to IFRS principles, applicable in Moldova, depreciation is provided over the lease term or the asset’s useful life, whichever is shorter.
• Eligibility for financing: Not all investments in energy supply and ECMs are suitable for operating lease financing. The concept of fungibility or interchangeability of an asset (as required by tax laws) determines whether it qualifies for operating leasing. For instance, a containerized combined heat and power plant may qualify due to its portability, while building insulation would not. Generally, at least 80% of the total investment needs to be fungible to qualify.
• Practical application: Many EPC measures do not meet the criteria for operating leasing, whereas Supply Contracting measures might. There is, however, some interpretative flexibility, and certain Leasing FIs may adopt more creative approaches than others.
• Ownership structure: In an operating lease, the lessor retains both legal and economic ownership of the asset, while the lessee is granted exclusive usage rights in exchange for a predetermined leasing fee.
• Finance lease: A finance lease is essentially a hybrid between traditional credit financing and an operating lease, offering a mix of both arrangements.

Credit financing

Credit (or loan) financing means that a lender (Financial Institution – FI) provides a borrower with capital for a defined purpose over a fixed period. Borrowers in that case can be either the ESCO or the ESCO Client. A credit is settled over a fixed period, with a number of fixed instalments (debt service). These instalments must cover the amount borrowed, plus interest rates, as well as other transaction costs such as administrative fees. Loans are disbursed against proof of purchase in order to secure the earmarked use of the funds.

Credit serves in fact as an extension of the total amount of capital that an enterprise can use to do its business, i.e., deliver services. Credits are also referred to as committed assets or loan capital.

Credits require a creditworthy borrower. This means that credit has to be backed by the ability of the borrower to perform the debt service. It is assumed that this ability is linked to a certain level of equity capital, typically 20-30 % of the loan. The creditworthiness of a borrower (together with the project chances and risks) will be reflected in the number of securities needed to cover the lender’s risks associated with handing out credit. Where public entities are debtors or in cases where credits are backed by public entities, credit ratings are generally high.

The borrower is both the economic and legal owner of the investment made with a loan. Therefore, the investment is capitalized on its balance sheet which, in return, downgrades its equity-to-assets ratio. A reduced share in equity means less capital to do business with and a reduced ability to get further credits (credit lines).

Another factor that influences the borrower’s possibilities to receive credit is the fact that the clients are evaluated by international uniform criteria and divided into classes, which declare creditworthiness. It is expected that credits will be more difficult to obtain and that they will cost more, especially for SMEs. The following graphs visualize the basic cash flow relationships for typical credit finance.

The cash flows depend on whether the ESCO or ESCO Client is the lender for the credit. The cash flows depend on whether the ESCO or ESCO Client is the lender for the credit. Figure 5 shows the former case, Figure 6 the latter.

Comments to Figure 5:

In the model depicted in Figure 5 , the Energy Service Company (ESCO) undertakes Energy Conservation Measures (ECMs) and Renewable Energy (RE) projects, financing the necessary investments through a credit line. The ESCO’s client pays a contractual fee, which includes a portion allocated for financing, contingent on the ESCO meeting its guaranteed energy savings targets

The ESCO utilizes this contractual payment to service its debt obligations. Additionally, the ESCO has the option to transfer the financing component of the contractual payment directly to a financial institution (FI), allowing the ESCO’s client to repay the debt directly. This setup represents a conventional ESCO-third-party financing arrangement. However, it is important to note that while this model is widely used, it may not always represent the most optimal financing solution depending on specific project circumstances and market conditions.

This is the “traditional” ESCO-third party-financing model, which is not always the optimal financing solution.

The next figure displays the ESCO Client as lender of the credit:

Additional information and useful links

Climate Policy Initiative (CPI) provides comprehensive data and analysis of global climate finance flows, including sources, intermediaries, financial instruments, activities and sectors financed

https://www.climatepolicyinitiative.org/climate-finance-tracking/

https://www.climatepolicyinitiative.org/publication/global-landscape-of-climate-finance-a-decade-of-data/

https://www.climatepolicyinitiative.org/publication/global-landscape-of-climate-finance-2023/

International Renewable Energy Agency (IRENA) is a source of in-depth knowledge and reports (https://www.irena.org/Publications) on recent trends in renewable energy policies, technologies, resources and financing. Relevant examples of such reports are:

IRENA (2023), Low-cost finance for the energy transition

https://www.irena.org/Publications/2023/May/Low-cost-finance-for-the-energy-transition

IRENA and CPI (2023), Global landscape of renewable energy finance

https://www.irena.org/Publications/2023/Feb/Global-landscape-of-renewable-energy-finance-2023

Policy Learning Platform managed by Interreg Europe serves as support information and knowledge hub for RE and EE policy solutions in EU

https://www.interregeurope.eu/policy-solutions

Policies and Measures Database of International Energy Agency (IEA) provides access to information on past, existing or planned government policies and measures to improve energy efficiency, support the development and deployment of renewables and other clean energy technologies

https://www.iea.org/policies

Useful overview, descriptions and lists of international sources and institutions for financing of RE and EE projects could be found in:

Accessing International Financing for Climate Change Mitigation – A Guidebook for Developing Countries

https://www.uncclearn.org/resources/library/accessing-international-financing-for-climate-change-mitigation-a-guidebook-for-developing-countries/

Energy Efficiency Financial Institutions Group’s (EEFIG) Underwriting Toolkit is a valuable resource on financing of EE projects, extensively covering such topics as the types and nature of EE investments, their financing mechanisms, structures and contracts, EE project development and execution cycle, appraisal of risks and benefits of EE investments

https://valueandrisk.eefig.eu/introduction

De-risking Energy Efficiency Platform (DEEP) is the Europe’s largest energy efficiency project database, containing details on over 37,000 EE projects in buildings and industry

https://deep.ec.europa.eu/

The SECCA Project aims and expected outcomes

The SECCA Project aims to:

• Provide assistance in the development of regional and country-specific EE and RE policies
• Furnish technical assistance to the Central Asia countries for the development of replicable pilot EE and RE investment projects.

Expected outcomes:

• Strengthened public capacities for governance, strategy development, gender inclusive policy design and regulatory framework for EE and RE deployment
• Enhanced identification and accessibility of EE and RE investment projects, and the most appropriate technologies and innovative financing mechanisms
• In collaboration with the stakeholders and IFIs, bankable RE and EE investment projects identified and developed
• Business models for the small-scale RE projects developed
• Financing schemes and tailor-made financial products for the implementation of specific priority RE and EE projects developed.