Impact on Project Lenders of New Shareholding Rules for Indonesian IPPs
As explained in our recent Client Alert, in July 2017 the Ministry of Energy and Mineral Resources (MEMR) issued Regulation No. 42 of 2017 on Supervision of Business Activities in Energy and Mineral Resources Sector (Reg 42). Reg 42 introduced restrictions with respect to changes in shareholding and board members of Indonesian independent power producers (IPPs) (namely, holders of electricity generation licences (IUPTL) and geothermal licenses (IPB)). Reg 42 raised significant issues for lenders to consider, not only in the context of financing future IPP projects, but also in relation to their ability to enforce security over existing IPP projects. On 3 August 2017, the MEMR revoked Reg 42 and replaced it with Regulation No. 48 of 2017 on Supervision on Business Activities in Energy and Mineral Resources Sector (Reg 48).
What's new under Reg 48
Transfer of shares
Reg 48 abolished the requirement under Reg 42 that any transfer of shares in the holder of an IUPTL had to be approved by the MEMR. Accordingly, share transfers can now be made without MEMR approval.
However, Reg 48 still maintains the requirement that a transfer of shares in an IUPTL holder that sells electricity to PLN must not be carried out until the power plant has reached commercial operation (COD). This restriction is exempted for transfers of shares to an affiliate in which more than 90% of the shares are owned by the transferring sponsor (ie, subsidiary). The subsidiary must be an entity established under Indonesian law and domiciled in Indonesia and is directly owned by the transferring sponsor.
What the above means is that after the power plant reaches COD, the shares in the IPPs are freely transferrable, whilst prior to reaching COD the shares can only be transferred to a >90% direct Indonesian subsidiary of the transferor.
Furthermore, transfers of shares to a >90% subsidiary prior to the power plant reaching COD must also satisfy the following requirements:
- The transfer must obtain prior written approval from the electricity purchaser, ie PLN.
- The transfer must be reported to the MEMR.
While the strict reading of Reg 48 is clear that the additional requirements, ie, approval of PLN and reporting to the MEMR, only apply to transfers of shares to a >90% subsidiary prior to COD, the officials at the Directorate General of Electricity at the MEMR - as can be seen from their public presentation on 10 August 2017 - have interpreted this to mean that the requirements apply to transfers before and after COD. Note, however, that the presentation is not a regulation and it does not have any legal and binding power.
IPB Holders, Contractors of Joint Operation Contracts and other forms of geothermal licenses
Reg 48 provides that IPB holders, geothermal mining license holders, Contractors of Joint Operation Contracts or the holders of other forms of non-IPB concessions (eg, Kuasa Pengusahaan Sumber Daya Panas Bumi) may carry out transfers of shares on the Indonesian stock exchange after the exploration stage (ie, through an initial public offering) - this follows the 2014 Geothermal Law - with prior approval from the MEMR.
Oddly, Reg 48 also states that MEMR approval is required for change of composition of shares listed on the stock exchange. As it would be an impossible task to control trading of shares on the stock exchange, this provision should not be interpreted to mean that any transfer of shares of a publicly listed geothermal license/concession holder is subject to MEMR approval. It is more sensible to construe the requirement for MEMR approval to apply to future rights issues conducted by listed geothermal license/concession holders.
IPB holders, geothermal mining license holders, Contractors of Joint Operation Contracts or the holders of other forms of non-IPB concessions (eg, Kuasa Pengusahaan Sumber Daya Panas Bumi) may transfer shares by means other than through the stock exchange. Such transfers must be reported to EBTKE Directorate General with a copy to the Electricity Directorate General.
While the 2014 Geothermal Law only provides for transfers of shares in the stock exchange (after exploration) and is silent on (but not restrictive of) other means of transfer, Reg 48 appears to be intended to clarify that any other means of share transfer is permitted and is not subject to approval of the MEMR. Accordingly, Reg 48 should be read to allow for any transfer of shares (i) conducted through initial public offering in the stock exchange with approval of the MEMR and (ii) conducted by any other method without MEMR approval (but only reporting).
Change to the board of directors / board of commissioners
Reg 48 no longer requires prior approval from the MEMR for changes to board members in IUPTL holders, IPB holders, geothermal mining license holders, Contractors of Joint Operation Contracts or the holders of other forms of non-IPB concessions (eg, Kuasa Pengusahaan Sumber Daya Panas Bumi). Changes to board members need only be reported to the MEMR.
As with Reg 42, Reg 48 applies to all existing projects and those to be awarded in the future. Similarly, Reg 48 also applies to all holders of an IUPTL, both temporary and permanent.
Key implications of share transfer restrictions
Future projects structuring
For IPPs, lenders invariably require security over all of the shares in the IPP, such that if a default occurs under the financing agreements the lenders can enforce their security and sell the shares in the IPP to new sponsors.
Under Reg 48, a transfer of shares in IPPs can only occur after COD. The only exception if the transfer were to occur prior to COD is where the transfer is to a >90% direct subsidiary of the transferring shareholder. Further, the transferee must be an entity established under Indonesian law and domiciled in Indonesia. However, as a practical matter, this exception is unlikely to be of any use to financiers in a default situation since the financiers' objective in such a situation would be to transfer to a new sponsor group (ie, non affiliate).
Reg 48 unfortunately contains no carve-out for transfers resulting from project financiers enforcing their security over the shares of an IPP. Accordingly, if the IPP goes into default during the construction period, the the lenders would not be permitted to enforce the pledge over shares in the IPP, since a change of shareholding is practically not permitted during that period.
This is obviously problematic for lenders and they will want to ensure that the corporate structure put in place by the IPP does not curtail their ability to transfer the IPP shares in an enforcement event.
Accordingly, we would expect lenders to insist on a two-tiered shareholding structure for IPPs they want to finance which would allow them take security at both levels of shareholding (ie, the shares in IPPs and in the shareholders). The two-tiered structure would give flexibility to lenders to enforce share pledges at any level of shareholding, and most importantly transfers of shares in the shareholders of IPPs will not be subject to Reg 48. In an example where the shares in an IPP are to be held 50/50 between a foreign sponsor and a local sponsor, if a default was to occur the lenders would be able to enforce their share security at the shareholders level without having to transfer any shares in the IPP itself. This structure would be consistent with Reg 48, which only restricts transfers of shares in the IUPTL holder (ie, the shares in the IPP itself).
Another ex ante structuring that lenders should consider before taking security over shares in IPPs is in the context of foreign investment limitation in the power sector in Indonesia. An IPP can be owned up to 95% by foreign interests or by a PMA (ie, the form of legal entity which a foreign person can incorporate and conduct business through in Indonesia) and the 5% must be owned by local interests. Without proper structuring, lenders may be caught in a situation were the market for transferring the project is limited to Indonesian sponsors.
As explained above, during pre-COD, in addition to limiting the possibility of pre-COD share transfer to a >90% direct subsidiary of the transferring shareholder, Reg 48 also requires approval of PLN - in its capacity as the electricity purchaser - as a pre-requisite for share transfers.
In a typical power project finance, there would be PLN consent letters (ie, direct agreements between lenders and PLN in relation to project financing) as well as sponsors agreements (signed by IPPs, sponsors and PLN regulating equity contribution) which contain PLN's consent to granting of security over the shares in IPPs (which should be construed to include the consequential enforcement of the security by way of sale of the shares). Given that Reg 48 does not stipulate in what form the PLN approval must be issued and considering that PLN in the PLN consent letters typically gives its approval to the lenders to take security over the shares in IPPs, it is more sensible to take the view that PLN consent letters issued in PLN usual form suffice to meet the pre-requisite for the pre-COD transfer and that a separate PLN approval is not necessary. However, PLN consent letters will not remove the requirement to transfer to the >90% direct subsidiary pre-COD, which is the most important issue.
Since Reg 48 applies also to existing IPPs, it would be prudent for lenders to try to implement the two-tiered structure as discussed above with respect to any existing IPPs they are financing.
Lenders may wish to review the terms of their finance documentation entered into with IPPs to evaluate whether certain provisions would (by their agreed drafting and scope) allow lenders to require the implementation of a new structure or whether certain potential drawstops and/or events of default that could be triggered as a result of the share transfer restrictions set out by Reg 48 would give them leverage to initiate discussions with the IPP. Provisions that should generally be reviewed would include:
- further assurances clauses under which lenders can require the implementation of new security arrangements for ''better security interest'' or ''ease of enforcement''
- representations, covenants and events of default relating to material adverse effect concept
- representations, covenants and events of default relating to enforcement of security
- information covenants with respect to change in law/regulations, default and/or material adverse effect
- provisions that may be included in equity contribution agreements or similar documents entered into with sponsors under which sponsors agree to fully collaborate with lenders for the enforcement of security over shares and/or to implement a new shareholding structure to assist with the security enforcement (typically, in transactions entered into by lenders on the basis of security being limited to the shares in the IPP, via the introduction of a two-tiered offshore structure).
Reg 48 is problematic for project lenders because their right to enforce security over shares in IPPs during construction period is now hampered. Limiting the ability to transfer shares in IPPs to only >90% direct Indonesian subsidiary of the transferring shareholder means that project lenders in effect cannot transfer the shares in IPPs pre-COD. While the two-tiered shareholding structure could offer a solution (but it is more viable for future projects only), the best way to deal with this issue is by amending Reg 48 to carve out pre-COD transfers resulting from project lenders enforcing their security over the shares of an IPP.