Introduction

1.1 The Clean Energy Finance Corporation (CEFC) was established under the Clean Energy Finance Corporation Act 2012 (CEFC Act) ‘to facilitate increased flows of finance into the clean energy sector’ (section 3). It has been provided with access to $10 billion in capital through a special account.

1.2 Section 58 of the CEFC Act states that the function of CEFC is to invest, directly and indirectly, in clean energy technologies, which are defined in section 60 as:

• energy efficiency technologies;
• low emission technologies; and
• renewable energy technologies (under subsection 58(3), from 1 July 2018 at least half of the funds invested are to be in renewable energy technologies).²

1.3 The CEFC is prohibited from investing in technology for carbon capture and storage, nuclear technology and nuclear power.

1.4 As at 30 June 2020, the CEFC had investment commitments (deployed and contractually committed capital) of $5.95 billion. The breakdown of commitments by industry sector is shown at Figure 1.1. Most investments were in the utilities (35 per cent), commercial buildings (15 per cent) and other (15 per cent) sectors.

Figure 1.1: CEFC investment commitments by Industry sector as at 30 June 2020

Source: ANAO analysis of CEFC data.

1.5 Section 64 of the CEFC Act provides for responsible Ministers³ to give the Board directions about the performance of the CEFC’s investment function and the policies to be pursued. These directions together constitute the ‘Investment Mandate’.⁴ The current Investment Mandate (May 2020) requires the CEFC, among other things, to:

• target an average return (before operating expenses) of the five-year bond rate plus three to four per cent per annum over the medium to long term as the benchmark return of the Corporation’s core portfolio (section 7);
• in targeting this return and operating with a commercial approach, seek to develop a portfolio across the spectrum of clean energy technologies that in aggregate has an acceptable but not excessive level of risk (section 8);
• consider the potential effect on other market participants and the efficient operation of the Australian financial and energy markets and not act in a way that is likely to cause damage to the Australian Government’s reputation (section 12);
• include in its investment activities a focus on technologies and financial products as part of the development of a market for firming intermittent sources of renewable energy generation, as well as supporting emerging and innovative clean energy technologies (section 13); and
• outside of its ‘core’ investment activities, make available funds for investment in clean energy projects and businesses through five nominated Funds and Programs (section 14):
  • the Clean Energy Innovation Fund (up to $200 million) where technologies have passed beyond the research and development stages but require start-up support;
  • the Sustainable Cities Investment Program (up to $1 billion);
  • the Reef Funding Program ($1 billion over 10 years to support delivery of the Reef 2050 Plan);
  • from 2020, the Australian Recycling Investment Fund (up to $100 million over ten years); and
  • from 2020, the Advancing Hydrogen Fund (up to $300 million in concessional finance).⁵

1.6 Section 13 of the Investment Mandate also encourages the CEFC, in supporting clean energy technologies, to prioritise investments that support the reliability and security of the electricity supply.

1.7 The CEFC’s role in facilitating investment in clean energy is summarised in its policy statement as shown in Figure 1.2.

Figure 1.2: CEFC’s investment role in transforming clean energy investment

Source: CEFC Investment Policies, February 2019, p. 12.

1.8 A statutory review of the CEFC, commissioned by the Department of the Environment and Energy and published in October 2018⁶, found that:

• the CEFC had been effective in facilitating increased flows of finance into the clean energy sector projects it supported although, given the nature and relative immaturity of a number of projects it supported, it was difficult to measure the full impact of the CEFC’s involvement in the clean energy sector more broadly;
• the CEFC invests in different industries and sectors across the economy, but with a concentration of most of its investments in the energy, property and industrial sectors;
• in making investments in clean energy, the CEFC had tended to invest in lower risk financial instruments, including senior debt (debt that takes priority over other unsecured or otherwise more ‘junior’ debt owed by the issuer); and
• in 2016–17, the CEFC’s actual investment return and forecast lifetime investment return was 4.5 per cent and 5.4 per cent respectively, both below the target range of 5.8 per cent to 6.8 per cent.

Rationale for undertaking the audit

1.9 The CEFC was established in 2012 and an audit of CEFC’s investment program was included in the Australian National Audit Office’s Annual Audit Work Program 2019–20.

1.10 The audit provides assurance to Parliament on the effectiveness of the CEFC’s selection of investments, including determination of an appropriate risk level and investment return. The audit also provides assurance over the ongoing management of the portfolio of funded projects, and the extent to which the CEFC is meeting its function of funding clean energy technologies through energy efficiency, low emission and renewable technologies.

Audit approach

Audit objective, criteria and scope

1.11 The audit’s objective was to assess the effectiveness of the selection, contracting and ongoing management of investments by the CEFC and the extent to which the CEFC is meeting its legislated objective.

1.12 The following high level audit criteria were adopted:

• Does the CEFC have effective arrangements in place to assess potential investments and manage and report on the performance of its investments?
• Has the CEFC effectively met its objective under the Clean Energy Finance Corporation Act 2012 consistent with legislative requirements and directions?

1.13 The audit examined the financial performance of the CEFC’s investment portfolio since its inception in 2012 and the CEFC’s selection and management of investments from 1 July 2017 to 31 December 2019.⁷ In relation to externally managed ‘green funds’ (aggregation programs maintained by other institutions designed to fund ecological/environmental projects) in which the CEFC has invested⁸, the audit did not examine individual investment decisions, but examined arrangements the CEFC has in place to manage risks associated with such investments.

Audit methodology

1.14 The audit methodology comprised:

• collection and analysis of CEFC documents on investment policies and strategies, consideration and approval or rejection of investment proposals and the ongoing management of its investments;
• analysis of a sample of 23 investments (informed by statistical analysis) approved from 1 July 2017 to 31 December 2019⁹, stratified by type of clean energy technology, investment sector and investment instrument as to how well they have met the CEFC’s legislative requirements and obligations under the Investment Mandate. This included analysis of how the CEFC manages investments to achieve the targeted rate of investment return set by the Investment Mandate;
• analysis of potential investments from 1 July 2017 onwards that were under active consideration, but had not proceeded;
• analysis of the performance of the CEFC’s investment portfolio since its establishment in 2012;
• interviews with the Australian Renewable Energy Agency (ARENA), the Department of Industry, Science, Energy and Resources and the Department of Finance;
• consideration of the statutory review of the CEFC’s investments and other relevant reviews, including internal audit reports, and the implementation of relevant recommendations or other actions taken to address their findings/conclusions; and
• interviews with CEFC staff.

1.15 The audit was conducted in accordance with ANAO Auditing Standards at a cost to the ANAO of $458,147.

1.16 The team members for this audit were Michael White and Resolution Consulting Services Pty Ltd.

2.1 In assessing the effectiveness of the CEFC’s arrangements for selecting investments and reporting on their performance once selected, the audit examined whether the CEFC has:

• suitable arrangements in place to assess and approve investment opportunities and enable it to meet its investment performance obligations;
• implemented sound contractual and other partnership arrangements for the selection and management of its investments;
• appropriate arrangements in place to manage its investments; and
• reported accurately on the financial and non-financial performance of its investments, including the relevant requirements under section 74 of the CEFC Act.

Does the CEFC have suitable arrangements in place to assess and approve investment opportunities and enable it to meet its investment performance obligations?

2.2 To review the effectiveness of the arrangements that the CEFC has implemented to assess and approve new investments and to enable it to meet its legislative and Investment Mandate obligations, the audit examined:

• the governance, policy and other arrangements in place; and
• the processes for the assessment of individual investment proposals using a sample of investments approved from 1 July 2017 to 31 December 2019.

Arrangements that the CEFC has in place to assess and approve investments

2.3 Arrangements to assess and approve investments include: the overall governance arrangements for assessing and approving and later managing investments; the CEFC’s investment policies and strategy; and arrangements to manage potential conflicts of interest.

Governance arrangements

2.4 Under section 16 of the Investment Mandate, the CEFC must have regard to ‘Australian best practice’ in determining its approach to corporate governance principles.¹⁰ The Public Governance, Performance and Accountability Act 2013 (PGPA Act), which establishes rules for financial management and also for the broader governance, performance and accountability for the Commonwealth public sector, applies to the CEFC.

2.5 The CEFC’s governance structure is summarised in Figure 2.1.

2.6 All proposed investments other than those relating to the Clean Energy Innovation Fund are reviewed by the Executive Investment Committee before they are submitted to the Board for consideration.

2.7 The Joint Investment Committee reviews proposals relating to the Clean Energy Innovation Fund. The Australian Renewable Energy Agency (ARENA), a separate Commonwealth entity, is represented on this committee, as the Innovation Fund sponsors may also receive grant funds from it. Once investments have reached financial close¹¹, they are monitored and managed by the Asset Management Committee or, in the case of Clean Energy Innovation Fund investments, the Joint Investment Committee.

CEFC investment policies

2.8 Section 68 of the CEFC Act requires the CEFC to prepare and publish on its website policies on:

• its investment strategy;
• benchmarks and standards for assessing the performance of investments and of the CEFC itself; and
• risk management for CEFC’s investments and for the CEFC itself.

2.9 Section 16 of the Investment Mandate also requires the CEFC to develop policies with regard to environmental, social and governance issues.

2.10 The CEFC has formulated investment policies and published them on its website since 2013.¹² The CEFC has also published separate complementary guidelines on complying investments under the CEFC Act, which provide more information on investments the CEFC is permitted to make.

2.11 The policy statement notes Investment Mandate requirements. It provides broad descriptions of the CEFC’s legislative, governance and risk management frameworks. It also includes a description of the CEFC’s investment strategy. The CEFC advised that the description of its investment strategy allows for different technologies and industry focuses to be adopted over time as technologies mature and become more commercial.

2.12 The policy statement only briefly mentions (on page 24) the section 16 requirement in the Investment Mandate for it to develop policies with regard to environmental, social and governance issues. It states that:

the CEFC will act as any prudent investor would in seeking to encourage the adoption of good governance practices within the CEFC itself as well as in the businesses and projects in which it invests.

2.13 It does not indicate what its policies are in relation to environmental, social and governance issues. The CEFC has advised that it does have a number of discrete policies/methodologies that cover different aspects of environmental, social and governance issues (for example, employment, work health and safety, modern slavery and carbon abatement).

2.14 Given the requirement in section 16 of the Investment Mandate for the CEFC to develop policies on environmental, social and governance risk management, a more comprehensive statement of its policies on these issues is required.

2.15 The CEFC has advised that it engaged a consultant in May 2020 to develop a more holistic consolidated environmental, social and governance policy.

CEFC investment strategy

2.18 The CEFC’s investment approach and strategy are summarised in the CEFC’s policy statement, corporate plan and strategic plan.

2.19 The current 2019–20 corporate plan covers the four financial years commencing on 1 July 2019 and ending on 30 June 2023. It summarises the CEFC’s investment approach and investment strategy¹³ at a high level.

2.20 The strategic plan covers the period 2018–19 to 2021–22. It lists a number of strategic themes, including:

• transitioning from transaction volume for scale to seeking greater emissions impact from new investments;
• having an enhanced focus on emissions reduction outcomes from the CEFC’s existing investments;
• supporting nationally significant energy infrastructure projects that underpin the energy transition; and
• supporting energy innovation businesses and venture capital market through the Clean Energy Innovation Fund.

2.21 The strategic plan forecasts a portfolio mix of investments in 2021−22 in which large scale solar, grid and storage will each comprise 23 per cent of the portfolio, property 20 per cent and infrastructure and transport 10 per cent.

2.22 While the strategic plan is at a relatively high level, detailed investment plans have been presented to the Board. For example, in October 2019, the CEFC outlined its renewable energy strategy for 2019–20. This included a selective approach to solar projects (one to two utility scale projects) addressing market gaps and attracting capital. It also included one to two wind deals and supporting early stage projects and specialist development companies to bridge gaps in development funding and facilitate the next wave of projects. Similar presentations were provided to the Board in November and December 2019 on the CEFC’s proposed property and listed equities strategies.

2.23 As noted at paragraph 1.2, subsection 58(3) of the CEFC Act requires the CEFC to ensure that at least half of its invested funds are in renewable energy technologies. The CEFC does not set targets for each of the other technology groups — energy efficiency and low emissions.

2.24 The corporate plan’s list of key performance indicators do not include the need for the CEFC to target the key mandated benchmark rates of return, which are set by the Investment Mandate and are expected to be met over the medium to long term. There is an opportunity for the CEFC to indicate in the corporate plan specific strategies to enable the target benchmark returns to be met. Performance against the target benchmark rates is considered further in Chapter 3.

Management of conflicts of interest

2.25 The CEFC has developed and implemented appropriate arrangements to manage potential conflicts of interest, including:

• a conflicts and material personal interests policy, which requires all CEFC officials to declare their personal interests and specifies arrangements to manage any conflicts. This includes reporting to the Audit and Risk Committee and the Executive Risk Committee how any material personal interest conflicts are being managed;
• a conflicts of interest register that records employees’ declared conflicts of interest and is kept up-to-date; and
• routinely requiring those attending Board or committee meetings to declare any potential conflicts of interest and, if necessary, to absent themselves from the meetings during consideration of any investment proposals for which there may be a potential conflict.

Assessment of individual investment proposals

2.26 To consider the CEFC’s process for assessing investment proposals, and how well it assesses proposals against its obligations in the CEFC Act and Investment Mandate, a randomly selected sample of investments that were approved between 1 July 2017 and 31 December 2019 was examined. These were stratified to enable a range of clean energy technologies, investment instruments, sectors and locations to be examined. There were 23 investments in the sample.

Process for assessing investment proposals

2.27 The investment lifecycle, including the process for considering investment proposals, is depicted in Figure 2.2.

2.28 Investment opportunities can arise in different ways. These include direct approaches from clean energy investment sponsors (such as clean energy technology companies, manufacturers, financial institutions, property developers, state and local governments and universities), initiatives by the CEFC itself to help address gaps in the clean energy market and indirect responses to market offerings, such as bonds.

2.29 Since inception, a large number of potential investment opportunities have been recorded by the CEFC. Only a small proportion of these were selected and approved (174 out of 1414 or 12 per cent).¹⁴

2.30 Analysis of the 23 approved investments in the sample showed that they mainly resulted from:

• direct approaches from sponsors — 11 projects, where the CEFC committed $776.5 million;
• the CEFC working with investors to develop project proposals — seven projects, of which two were considered strategic projects for the CEFC, where the CEFC committed $453.7 million;
• flow-ons from joint work with ARENA — three projects, where the CEFC committed $138.5 million; and
• projects previously financed by the CEFC with the same sponsor — two projects, where the CEFC committed $93.6 million.¹⁵

2.31 The CEFC undertakes detailed assessments of investment opportunities that it evaluates as having merit. Where there is a need to obtain in-principle support for an investment proposal, an initial assessment of the proposal (a ‘pre-screen’ paper) is submitted to the Executive Investment Committee or the Joint Investment Committee. If endorsed, it is then submitted to the Board for consideration. Pre-screen reports were prepared for 19 of the 23 investments reviewed by the ANAO. Depending on the nature of the proposal:

• the Board may approve the proposal at the pre-screen stage, subject to further detailed analysis and consideration by the Executive Investment Committee or Joint Investment Committee (through a ‘detailed screen’ paper), and delegate final approval to the Chief Executive Officer (the Board is later briefed on the outcomes of these proposals); or
• await later receipt of the detailed screen paper.

2.32 For the 23 investments examined, the main reasons identified in the screening papers for supporting the projects (more than one reason can be advanced for a project) were:

• the clean energy merit of the project (level of carbon abatement, innovative or significant clean energy product, supporting energy from waste) — 16 projects;
• influencing other providers and industry (market influence, improved leverage and standard setting) — 12 projects;
• a need for the CEFC to be involved (CEFC assessment that the investment was too risky for the private sector alone, that CEFC investment is needed for co-lender involvement and accelerating project development) — 10 projects;
• support for sponsors and clients (strong previous relationship with client, supporting the CEFC’s relationship with key parties, the client’s wish to maintain its existing banking group, support for a green energy client in difficulty, working with state governments and universities and refinancing on current market terms) — 14 projects;
• CEFC portfolio issues (diversification of the investment portfolio, meeting the 50 per cent renewables target and support for a target Fund, such as the Clean Energy Innovation Fund) — seven projects; and
• other reasons (energy security and reliability, increased consumer awareness and knowledge and data sharing) — five projects.

2.33 Once approval is given to a proposal, the CEFC will prepare and conclude the necessary contractual documentation to proceed with (‘close’) the investment. After financial close¹⁶, progress in relation to all executed investments, except Clean Energy Innovation Fund investments for which the Joint Investment Committee has responsibility, is overseen by the Asset Management Committee (see paragraphs 2.85 to 2.104).

2.34 Governance arrangements implemented by the CEFC for management of its investments, including consideration of investment proposals, were appropriate. The CEFC Board and oversight committees have met regularly, and clear records of their meetings (including management of potential conflicts of interest) have been kept.

2.35 In January 2020, the Department of Finance published a Resource Management Guide on Commonwealth investments. The CEFC procedures are broadly consistent with the relevant principles in the Guide.

Consideration of performance obligations in assessment of individual investment proposals

2.36 The CEFC’s performance obligations are set out in the CEFC Act and Investment Mandate. The Investment Mandate reflects the requirements of the responsible Ministers and includes matters that the CEFC must follow as well as other matters that the CEFC is encouraged to pursue in its investments. ¹⁷

Complying investments

2.37 Under section 59 of the CEFC Act, the CEFC is only permitted to invest in ‘complying investments’, namely energy efficiency, low emission and renewable energy technologies. For the sample of 23 investments, the CEFC sought to ensure that the investments complied with section 59 of the CEFC Act mainly by:

• reviewing proposals at the outset to ensure that they will comply;
• working with investment sponsors to tailor projects or components of projects to requirements and requiring that the funds will only be used to invest in the specified complying purposes; and
• implementing arrangements, such as having a representative on the project’s board or funding committees or undertaking sample audits of aggregation programs, to provide continuing oversight.

2.38 The CEFC has suitable arrangements in place to confirm compliance with section 59 of the CEFC Act. Compliance analysis is initially completed at the pre-screen level and the General Counsel confirms compliance with section 59 of the CEFC Act. In the sample of 23 investments, all pre-screen papers included statements that the investments would comply with the CEFC Act and 21 of the 23 detailed screen papers also included such statements. The 23 investments examined in the sample complied with the CEFC Act.

2.39 The screening papers included analysis of compliance with section 59 of the CEFC Act.¹⁸ The CEFC advised that its practice, consistent with guidance issued by the Australian Institute of Company Directors and Governance Institute of Australia¹⁹, is only to record outcomes on an exception basis (that is, where the Board or committee has a concern about the certification in the screening documents) and where further work is needed. For this reason, the CEFC advised that the records of decisions of the Board, Executive Investment Committee and Joint Investment Committee do not routinely mention the Board’s or committee’s express satisfaction with this assessment.

2.40 Complying technology investment requirements are considered further at the portfolio level in Chapter 3 (paragraphs 3.3 to 3.12).

Carbon abatement

2.41 Under section 6 of the Investment Mandate, the CEFC should have regard to positive externalities and public policy outcomes when making investment decisions and when determining the extent of any concessionality.²⁰ The screening documents typically include estimated reductions in emissions of carbon dioxide (CO2-e) in this context.

2.42 The CEFC’s estimates of reductions in CO2-e by projects take a consistent approach, the main features of which are:

• establishing a counterfactual case, estimating emissions under ‘Business As Usual’ (for instance, estimating emissions when electricity is made by the grid);
• identifying the reduction in emissions that would result from the proposed project (for a solar power project, the reduction would be compared with the CO2-e had the same amount of electricity come from the grid)²¹;
• summing the CO2-e saved over the life of the project (say, 25 or 30 years for a solar power project²²); and
• reporting all the reductions from the project.²³

2.43 The CEFC’s calculation methodology is based on industry practice (such as accounting for the gradual decline in emissions savings as the emissions intensity of the grid is forecast to decrease over time) and official published data (such as the national emission intensity conversion factors). Where the estimates rely on forecasts (such as forecast levels of electricity generation), the CEFC’s calculations are conservative (based on the most likely outcome) and subject to quality assurance of the estimated amount of energy generated (a key variable in the carbon abatement calculation) by a qualified externally contracted party.

2.44 The ANAO reviewed the calculations for carbon abatement outcomes for the 23 investments in the audit sample and concluded that the methodology and calculations for determining overall carbon abatement were sound.

2.45 The CEFC considers a range of measures (that is, not a single metric) to provide a balanced approach to achieving a cost effective outcome for carbon abatement.²⁴ However, in its annual performance statements, it only reports the cost of carbon. This is a net cost of less than $0 and results in a net return to the CEFC per tonne of CO2-e abated.

2.46 The CEFC uses two methods to calculate the net cost of carbon per tonne of CO2-e abated, both of which produce similar results:

• cost to CEFC of investment (calculated as expenses and the cost of capital (based on the five-year government bond rate²⁵) less investment income), divided by the lifetime tonnes CO2-e abated (Method A); and
• cost to CEFC of investment (calculated as expenses and drawdowns less repayments and applying a discount factor), divided by the lifetime tonnes CO2-e abated (Method B).

2.47 The CEFC also considers, but does not publish, a capital efficiency measure, which compares investments based on capital investment per tonne CO2-e abated (that is, the upfront capital investment divided by the tonnes of carbon abated). There would be merit in also publishing performance against this measure, since this represents the opportunity cost of capital in terms of carbon abatement.

2.48 The following illustrates the results for two projects (Project Lafite, an equity investment of $85 million in a property investment fund, with an internal rate of return of 8.5 per cent and with around 38,000 lifetime tonnes CO2-e abated; and Project Coogee, a senior debt investment of $38 million in a wind farm with a return of 5.12 per cent and 8,222,072 lifetime tonnes CO2-e abated) using the cost of carbon measures and the capital efficiency.

• For Project Lafite the net cost is a negative value of around $1500 per tonne²⁶, compared to a negative value of under $1.00 per tonne²⁷ for Project Coogee. By this measure, Project Lafite has the higher financial return to the CEFC per tonne of carbon abatement. However, the CEFC advised that it favours a cost number closer to $0 while remaining negative (best carbon outcome for the return) rather than a higher negative number.
• For Project Lafite, the capital efficiency is over $2500 per tonne, compared to less than $5 per tonne for Project Coogee. By this measure, Project Coogee is the more capital efficient project for carbon abatement.

2.49 The carbon abatement estimated to be delivered by each of the key sectors of the CEFC’s investment portfolio as at 30 June 2020 is shown at Figure 2.3. Investments in wind and large scale solar projects have delivered lifetime CO2-e abatement of 78.44 and 58.58 megatonnes respectively, while a comparable commitment in property investments has produced 3.13 megatonnes of carbon abatement.

Figure 2.3: Lifetime carbon abatement by commitment amounts for key industry sectors, 30 June 2020

Note: The horizontal axis is logarithmic to encompass the very wide range of carbon abatement.

Source: ANAO analysis of CEFC data.

Other externalities and public policy benefits

2.53 In addition to potential CO2-e abatement outcomes, CEFC screening documents frequently tabulate other potential externalities and public policy outcomes under the heading ‘Externalities/Public Policy Benefits’.

2.54 For example, the screening documents for a proposal to build facilities to a standard that would significantly reduce energy use and CO2-e included the benefits of demonstrating that the CEFC was a viable lender, as well as those of geographically extending the CEFC’s activities:

Investment in this Project would establish CEFC as a viable lender in concession based project finance transactions in this sector. The Project would be a strong precedent to pave the way for other similar student accommodation projects and their related energy efficiency/renewable outcomes.

There has been limited CEFC investment in the built environment in Western Australia. This Project is a significant investment amount, across multiple mixed use assets in a master planned site for WA’s largest university which will build CEFC’s profile in WA and the University Sector.

2.55 While the detailed screenings documents provided to the CEFC Board and decision-makers present a range of financial, environmental and other externalities for consideration prior to making investment decisions, it is unclear what consideration is given to these factors in decisions. There would be merit in recording this in decisions.

Financial outcomes

2.56 Section 6 of the Investment Mandate states that the CEFC should apply commercial rigour when making its investment decisions. The Mandate also provides that the CEFC is to target specified benchmark rates of return for its core portfolio (section 7), the Clean Energy Innovation Fund and the Advancing Hydrogen Fund (section 14).

2.57 For each of the investment projects examined, detailed screening reviews were prepared. The financial considerations focused primarily on the form of the CEFC investment (for example, equity or loan), other investors in the project, investment risk and risk mitigating strategies and the terms of the investment (for example, interest rate of loans). The business case presented in the screening documents is detailed and provides evidence of the application of commercial rigour in the assessment of proposals.

2.58 In considering investments, the CEFC has regard to market rates (for example, rates being offered by other lenders for loans with comparable terms and conditions) and rates it has offered on comparable projects. It does not consider how the expected return compares to the benchmark target average rates of return for the core portfolio, Clean Energy Innovation Fund and Advancing Hydrogen Fund.

2.59 Performance against these targets is only reviewed at the whole-of-portfolio level (assessed in Chapter 3) and it is acknowledged that simply because an individual transaction’s financing rate is lower than the benchmark, this is not an indication that the CEFC should not participate. Nonetheless there would be merit in also including in the screening documents a comparison with the relevant mandated benchmark average rate of return and any implications for the Corporation’s ability to meet the target over the medium to long term. Where the benchmark rates of return cannot be achieved, but the clean energy outcomes justify proceeding with the investment, this can be documented.

Market impact

2.60 While adopting a commercial approach, the CEFC is also to apply Australian Industry Participation (AIP) Plans, where required, and consider the impacts of its investment strategy when making investments.

Australian Industry Participation Plans

2.61 Section 11 of the Investment Mandate requires the CEFC to apply AIP Plans to projects in which the Corporation invests in accordance with the Government’s AIP Plan policy. In June 2013, the CEFC developed a protocol on the application of AIP Plans to CEFC investment projects, in consultation with the Australian Industry Participation Authority.²⁸ This protocol has been updated periodically, with the latest on 1 April 2019. Under the protocol, AIP Plans are only required for certain projects (as detailed in the protocol) involving CEFC financing of $20 million or more.

2.62 As part of its closure procedures of investment projects, there is a sign-off of AIP Plan requirements. This process is managed by the CEFC’s legal team. AIP Plan Implementation Reports are provided to the Department of Industry, Science, Energy and Resources for applicable projects.

2.63 The CEFC has efficiently implemented the protocols for the application of AIP Plans to investment projects. However, it is not usually clear from the screening documents whether an AIP Plan will apply to a project. In only three of the 23 projects examined was there any mention of AIP Plans. The CEFC could consider including information in screening documents on the application of the AIP Plans protocol to the proposed investment so that decision-makers are aware of whether the investment would need to comply with the policy and any implications for the implementation or cost of the project.

Other market participants and the operation of the Australian financial and energy markets

2.64 Section 12 of the Mandate requires the CEFC to ‘consider the potential effect on other market participants and the efficient operation of the Australian financial and energy markets’ when considering investment proposals.²⁹ It must also ‘not act in a way that is likely to cause damage to the Australian Government’s reputation’.

2.65 While the screening documents include a ‘Rationale’ section, which lists reasons for CEFC involvement, they do not include specific consideration of the potential effect on other market participants and the efficient operation of the Australian financial and energy markets. Specific consideration of these issues in the screening papers would provide a clearer consideration of the obligation in section 12 of the Mandate.

2.66 Assessing the potential effect on other market participants also involves examination of the need for the CEFC to be involved. Some of these factors are listed at paragraph 2.32. As set out in that paragraph, in the 23 investments examined there were 10 where the rationale included reasons (too risky for the private sector alone, CEFC needed for co-lender involvement and accelerating project development) that the project may not proceed, or not proceed as quickly, without CEFC involvement.

2.67 The need for involvement is reasonably clear where the CEFC has been approached by an investor who has first approached other financial institutions or where the CEFC is endeavouring to fill a gap in the market. In other cases, the CEFC may support an investment because of the demonstration effect on the market and so influence decision-makers to achieve higher rates of carbon abatement or other outcomes, such as where CEFC involvement would accelerate the commencement of a project, and where benefits might include earlier reductions in CO2-e.

2.68 Examples of investments in the audit sample that would not have occurred without CEFC involvement include:

• Project Nebula, a large-scale solar farm in New South Wales, and Project Firestar, a solar farm in Victoria, where the commercial banking sector was unwilling to invest because power purchasing agreements had not yet been negotiated; and
• Project Coogee, a wind farm in New South Wales, where CEFC involvement was needed to attract co-lender involvement.

2.69 Project Firestar arose from a joint initiative of the CEFC and ARENA. Under this initiative, called Project Alceste, ARENA conducted a competitive round of up to $100 million in grant funding to successful applicants for large-scale solar projects as part of its Advancing Renewables Program and the CEFC agreed to provide secured debt to the successful developers. Some projects, such as Firestar, were unsuccessful in obtaining grant funding from ARENA, but still proceeded with debt finance provided by the CEFC. The CEFC’s assessment of the Firestar project indicated that it would not have proceeded without the CEFC at the time.³⁰

Has the CEFC implemented sound contractual and other partnership arrangements for the selection and management of its investments?

2.76 This section of the audit focused on the effectiveness of the contracting arrangements from the time a proposal is selected for investment through to financial close (that is, when all conditions have been satisfied, documents have been settled and draw-downs are permissible). Following that, the audit reviewed the management of investment obligations through to the repayment of a loan or equity divestment. It did not include technical legal analysis of the specific clauses and content of the contractual documentation.

2.77 The CEFC has a General Counsel who manages an internal legal team and engages external legal advice as required. The internal legal team works with the deal team to financial close and to ensure the commercial terms negotiated with the counterparties meet the CEFC’s requirements and the CEFC’s standard terms are documented in the contract. It also provides appropriate legal support to the Asset Management Committee and the Portfolio Management team as and when required throughout the life of an investment.

2.78 Each investment made by the CEFC is bespoke. CEFC contractual documentation varies depending on the investment type and the obligations of the investment sponsor.

2.79 For example, equity investments typically follow the form of documents prepared by the issuer or its counsel, whereas debt documents will vary depending on whether the facilities are bilateral, syndicated, secured, unsecured, senior debt or subordinated debt and will depend on the nature of the facility.³¹ This can be contrasted to the ‘high volume, low value’ transactional work undertaken by the commercial banking sector which typically uses a standard suite of contractual documentation.

2.80 There can be large numbers of contract documents, and significant numbers of contract variations after execution of a project to address issues that arise during the course of a project. For instance, as at October 2019, there were 88 executed documents for Project Coogee, a wind farm in New South Wales.

2.81 Contractual documentation for the aggregation platform³² is typically limited to a program agreement. This sets out the framework under which the CEFC will invest in bonds or other debt instruments issued by the financial institution responsible for the program to provide the necessary capital for investment in clean energy technologies and the conditions on which the CEFC will make that investment.

2.82 Contractual documentation for equity investments varies on a case-by-case basis. It typically involves a form of subscription agreement under which the CEFC agrees to subscribe to certain equities and a side letter that sets out CEFC specific conditions to its investment being made. Investments in companies may be subject to a form of shareholders agreement, which regulates the relationship between shareholders or, in the case of an investment in a fund, a trust deed which sets out the terms of the trust in which the CEFC may hold units or shares as a beneficial owner.

2.83 In addition to contractual documentation for the CEFC investment, the CEFC may maintain a range of other contractual documentation that provides important supporting information. For example, the key project contracts for a large scale solar project may cover:

• engineering, procurement and construction of the solar farms;
• operation and maintenance of the solar farm;
• where ARENA is also involved, an ARENA Funding Agreement;
• an Asset Management Agreement to manage the day to day operations; and
• a Power Purchase Agreement.³³

2.84 The CEFC maintains two contract records management systems—the Contractual Rights and Obligations Management system (CROMs) and the Contract Management System (CMS). CROMs assists the CEFC in ensuring that the terms of the contract are regularly reviewed and the counterparty fulfils those terms at the agreed time, location, standard and the price.³⁴ The CMS supports the record keeping of contractual documentation, which is stored electronically on a secure database, to which there is restricted access.

Does the CEFC have appropriate arrangements in place to manage its investments?

2.85 In assessing the arrangements that the CEFC has in place to manage investments, ANAO examined asset management responsibilities, the CEFC’s asset management framework and monitoring and reporting on investments.

Asset management responsibilities

2.86 Portfolio management activity is reported to the Joint Investment Committee for Innovation Fund investments and to the Asset Management Committee for all other investments and ultimately, to the CEFC Board. Both the Asset Management Committee and Joint Investment Committee meet on a monthly basis.

2.87 Each executed investment is allocated a dedicated portfolio manager (and secondary manager). The Portfolio Management team works closely with the Investment team up until financial close and liaises as needed after financial close and throughout the investment period. Contractual obligations are recorded in CROMs³⁵, which enables a quarterly reminder to be sent to the Portfolio Management team alerting it to the contractual obligations that are due in the coming 90 days. The team then provides reminders to borrowers of the impending deadlines.

2.88 The key focus areas of each portfolio manager vary depending on the nature of the investments. For example, project finance projects have a high level of focus on the construction phase (that is, cost and time to complete) and formal sign-off on power purchase agreements, and the debt/equity funding required to achieve the key milestones.

2.89 Investment funds, green bonds and aggregation loans to major banks have a lower credit risk exposure.³⁶ The focus with aggregation programs is on monitoring compliance of the issued loans with the eligibility criteria stated in program agreements. Equity investments are monitored more closely with more detailed and frequent reporting requirements. Innovation fund investments are generally rated as higher risk due to being classified as venture capital and are managed by the Innovation team.

Asset Management Framework

2.90 The key aspects of the CEFC’s asset management framework for all investments where relevant include:

• analysis of business plans and strategies and challenging the direction/approach where appropriate;
• preparation of asset management plans³⁷;
• analysis of risks and opportunities;
• monitoring progress and reporting on performance of the investment and compliance with/progress on a counterparty’s sustainability commitments or obligations (where relevant);
• reporting to the Asset Management Committee, Joint Investment Committee and Board, including requesting necessary approvals;
• financial reporting and analysis;
• capital management strategies; and
• monitoring contractual obligations.

2.91 Portfolio management of debt finance investments focuses on the governance and compliance processes associated with the contractual obligations. The main areas of focus are ensuring that payments are made in accordance with the interest and debt repayment schedules and that the borrower meets the reporting requirements.

2.92 Indirect investments such as investment funds, green bonds and aggregation loans are monitored regularly.³⁸ Aggregation programs focus on monitoring compliance of the issued loans with the eligibility criteria stated in program agreements (which is based on technical and compliance reviews conducted by an independent third party³⁹) and monthly compliance reports from the banks.

2.93 Equity investments⁴⁰ have a higher risk profile and are monitored more closely with more detailed and frequent reporting requirements than debt finance and indirect investments. The CEFC monitors the overall business performance of the investment including, profitability, liquidity and solvency.

2.94 Under its Valuation Policy, the CEFC undertakes or procures the valuation of direct equity investments⁴¹ that it manages. Equity interests (direct or indirect) that are managed by third party investment managers are subject to the specific manager’s valuation policy (although the CEFC does undertake analysis and assess the performance of these other investments). According to the CEFC’s Valuation Policy, the valuation of equity investments should consider the nature and outlook for the industry, maturity of the underlying assets, current market conditions, quality, reliability and availability of the source data and assumptions. This approach also applies to the Clean Energy Innovation Fund’s equity investments^.42

2.95 A review of the acquisition financial model for Project Mistral was undertaken to ensure that the model aligned to the CEFC Valuation Policy.⁴³ The spreadsheet-based model was accurate, robust and repeatable, and included reasonable assumptions. However, the model could be enhanced by documenting or referencing the methodology, formal review and approval procedures, change logs and a control sheet (section 4.2 of the Valuation Policy).

2.96 Asset Management Plans aim to provide a holistic overview of equity investments and inform the allocation of the CEFC’s asset management resources.⁴⁴ The plans are initially developed by the Portfolio Management team with input from the Investment team responsible for originating and executing the transaction. The plans assist the teams to better understand the nature of the CEFC’s investments, how the profiles change over time and industry developments, and facilitate the proactive management of the CEFC’s investments.

Monitoring and reporting on investments

2.97 The Asset Management Committee receives a comprehensive suite of monthly/quarterly reports. These include:

• two portfolio level reports — portfolio commitment dashboard reports and portfolio investment quarterly reports;
• quarterly sustainability performance reports;
• performance rating reports — each investment is given a Performance Rating (PR) and any changes in the status of investments and analysis of the underperforming investments are reported to the Asset Management Committee for consideration;
• monthly updates on the progress of investments (such as wind and solar power generating facilities) under construction; and
• progress reports on approved projects under the aggregation partnership programs that have reached financial close.

2.98 Regular financial update reports are also provided to the Audit and Risk Committee and the Board. These provide financial analysis of revenue, expenditure, operating results, retained earnings, portfolio benchmark returns, and special account and portfolio investment assets by product line and business platform.

2.99 Each investment is reported on to the Asset Management Committee separately at least annually, with updates included in the other reports.⁴⁵

2.100 Consent and waiver requests are assessed and negotiated by the responsible portfolio manager or Innovation Fund lead with the decisions being made in accordance with the relevant debt and equity and fund portfolio management authorisations and the Innovation Fund authorisations. Most reported contractual breaches relate to reporting requirements, with few financial breaches and a low level of write-offs to date.

2.101 The minutes of Asset Management Committee meetings record any approved corrective actions for an investment that are approved by that committee.⁴⁶

2.102 The Chief Asset Management Officer is responsible for determining the approach for managing the portfolio, including reducing the level of investment or exiting the investment. Much of the CEFC senior debt investments are still early within their period of legal tenor and equity investments are still maturing. Most investments have not yet reached the point where consideration of whether to refinance (by a counterparty) or sell down (by CEFC) an investment has been made for a number of reasons, most notably relating to the investment’s lifecycle.⁴⁷

2.103 Financial analysis on the CEFC Special Account completed in September 2019 indicated that the CEFC was likely to be able to maintain current investment levels into the future without additional funding from government.⁴⁸

2.104 The analysis indicated that the CEFC would have no less than $1.965 billion of headroom within the existing $10 billion appropriation at any point over the next five years, with no active recycling.⁴⁹ The CEFC has developed a Capital Management Strategy which includes an option to recycle (sell) assets in order to maintain sufficient funds for investment.

Does the CEFC accurately report on the financial and non-financial performance of its investments, including the relevant requirements under section 74 of the Act?

2.105 The CEFC is expected to meet reporting requirements in both the PGPA Act and the CEFC Act. These requirements and the assessment of performance against them are considered here.

Reporting requirements

2.106 The Finance Secretary direction under subsection 36(3) of the PGPA Act sets out the requirements for performance information to be included in Portfolio Budget Statements (PBS)⁵⁰, including a strategically focused set of high-level performance information.⁵¹ Section 39 of the PGPA Act requires Commonwealth entities to prepare annual performance statements and include those statements in their annual reports. Commonwealth entities are to report, through the annual performance statements, the extent they have fulfilled their purpose(s) as articulated at the beginning of a reporting year in their PBSs and corporate plans.

2.107 In addition to the requirements of the PGPA Act:

• paragraph 68(1)(b) of the CEFC Act requires an investment policy to define benchmarks and standards for assessing the performance of the investments and the CEFC itself;
• section 74 of the CEFC Act lists a number of matters that are to be included in the annual report; and
• section 15 of the Investment Mandate requires the CEFC, as part of its annual report, to report on the non-financial outcomes of all of its investments, including those for the nominated funds under section 14 of the Mandate.

2.108 As required by section 15 of the Investment Mandate Direction 2016 (No. 2), the CEFC, in consultation with the then Department of the Environment and Energy, agreed a range of performance indicators against which to report these non-financial outcomes, and advised the responsible Ministers of those indicators on 10 July 2017. This information is reported in the CEFC’s annual report.

2.109 The CEFC has met its reporting requirements under the PGPA Act and the CEFC Act, but there is scope to include other performance information to more fully inform users about the performance of the Corporation.

Annual performance statements

2.110 The CEFC provides a set of high-level performance information in the PBS. A comparison of the performance targets and reported information for 2018–19 was undertaken.⁵² They were found to be consistent, although the level of detail varies. There is an opportunity to add a supporting table reconciling the components of the CEFC’s investment portfolio to the total portfolio commitment value.⁵³

CEFC legislative obligations and other key performance indicators

2.111 The CEFC reports on the matters required by section 74 of the CEFC Act. These include compliance with the 50 per cent renewable energy technologies requirement (discussed at paragraphs 3.6 to 3.12) and a benchmark comparison of operating costs and expenses. To meet the latter requirement, the CEFC provided a benchmark comparison against the Future Fund, Export Finance Australia and Northern Australia Investment Fund.⁵⁴ The commentary explained the nature of each comparator and the differences between them, and provided horizontal analysis using a percentage comparison for each cost pool.

2.112 The CEFC has a single efficiency measure in its performance framework — operating expenditure as a percentage of the deployed portfolio balance. There is scope to include other measures, such as the time taken to close projects after approval. The average time to commitment per project has increased significantly from 189 days in 2012–13, 171 days in 2013–14, and 228 days in 2014–15 to 382 days in 2018–19.

2.113 There is an opportunity to include benchmarking data on clean energy outcomes with another green bank.⁵⁵ There are other green banks with readily available comparative performance data, although comparable green banks are much smaller than the CEFC.⁵⁶ Possible performance measures include percentage of total energy generation, cost per tonne of carbon abatement (MtCO2e), reduction of greenhouse gas emissions, renewable energy generation, leveraging private sector capital (discussed in Chapter 3) and waste to energy conversion. Benchmarking performance against other green banks would enhance the available performance information and indicate the relative maturity of the Australian green energy sector.

2.114 A comparison of CEFC performance against other green banks using published results since inception to 2018–19 indicates that the CEFC’s performance in the sector is at the lower end for funds leveraged (see Figure 2.4). The Green Finance Organisation (Japan) is an outlier with 11:1, Connecticut Green Bank (US) 5.5:1, Green Investment Group (UK) 3:1, and NY Green Bank (US) 2.5:1. This result is consistent with the benchmarking completed in 2017 as part of the statutory review.

Figure 2.4: Leverage ratios since inception for the CEFC and other green banks to 2018–19

Note: Dates of inception were: Energy Efficiency and Renewable Sources Fund: 2004; Connecticut Green Bank: 2011; CEFC: 2012; Green Investment Group: 2012; NY Green Bank: 2013; and Green Finance Organisation: 2013.

Source: ANAO analysis.

2.115 A number of qualifying factors in funds leveraged are:

• with the exception of the Green Investment Group (UK), total investments by the other green banks are substantially below the CEFC’s investment⁵⁷;
• differing investment mandates influence the amount of leverage able to be achieved. For example, some green banks are able to provide grant funding as well as investment capital which influences the ability of the bank to invest in clean energy projects; and
• there are differences in leverage calculation methodology which impacts the comparability of reported leverage and may overstate the leverage achieved as compared to the CEFC’s approach.

3.1 To assess the effectiveness of the CEFC in meeting its legislative obligations, the following were considered. Whether:

• the investments made by the CEFC are consistent with its obligations under the CEFC Act and Investment Mandate;
• the CEFC has met its investment performance obligations under the Investment Mandate, including those related to the target average rates of return and the risk profile of its investments;
• the CEFC has leveraged increased levels of funds into the clean energy sector from the private sector and other sources; and
• the investments in the clean energy sector that were partly financed by the CEFC would have occurred without its involvement.

Are the investments made by the CEFC consistent with its obligations under the Clean Energy Finance Corporation Act 2012 and Investment Mandate Directions?

3.2 The CEFC Act and Investment Mandate specify the technologies in which the CEFC may invest and requirements to make available up to specified amounts for investment in nominated Funds and Programs. This section considers the CEFC’s compliance with these obligations.

Complying technologies

3.3 This section outlines the requirements relating to complying technologies, how the CEFC determines amounts invested in renewable energy technologies and the CEFC’s management of compliance with the 50 per cent target for renewable energy technologies.

Complying technology requirements

3.4 As noted at paragraph 1.2, under section 59 of the CEFC Act the CEFC is to invest, directly and indirectly, in clean energy technologies, which are defined in section 60 as:

• energy efficiency technologies;
• low emission technologies; and
• renewable energy technologies.

3.5 Examination of the 23 investments in the audit sample indicated that they met the section 59 requirements. The CEFC also advised that there have also been no instances where it has become aware that the investments were non-complying or had become non-complying and:

• the counterparty has not taken corrective action; and/or
• the CEFC has found it necessary to divest itself of the investment, as required by section 59 of the CEFC Act.

3.6 Under subsection 58(3) of the CEFC Act, from 1 July 2018, at least half of the funds invested are to be in renewable energy technologies. A breakdown of total CEFC investment commitments (deployed and contractually committed capital) by permitted clean energy technologies and the percentage reported by the CEFC for renewables as at 30 June of each year since its inception in 2012 are shown at Table 3.1.

3.7 While not required to meet the 50 per cent threshold before 1 July 2018, the CEFC reported that, since its inception, it had invested more than 50 per cent in renewable energy in each year with the exceptions of 2015–16 and 2016–17, with 53 per cent of CEFC finance reported to have been committed to renewable energy technologies as at 30 June 2020.

CEFC’s management of compliance with the 50 per cent renewable energy technology requirement

3.8 The CEFC manages compliance with subsection 58(3) of the CEFC Act at a whole-of-portfolio level. The status of the portfolio is reported against the 50 per cent requirement at each Board and Executive Committee meeting. Progress in meeting the 50 per cent requirement is also monitored regularly by the Executive Investment Committee.

3.9 On 23 July 2018, the responsible Ministers advised of their agreement to the approach the CEFC had proposed for managing performance against the 50 per cent renewable energy technology requirement. That approach was to target 55 per cent of ‘funds invested’ in renewable energy technologies, which would allow a margin of safety for unseen events (such as an unexpected early repayment of a renewable-related loan).

3.10 In maintaining the CEFC’s renewable energy component above 50 per cent of the portfolio, the CEFC indicated that it faces the following challenges:

• a slowdown in wind, solar and other renewable activities due to the perceived uncertain policy framework (post Renewable Energy Target 2020) and energy market issues (such as grid constraints, marginal loss factor reductions, grid connection delays, and merchant energy price volatility);
• earlier than expected refinancing and CEFC divestment of CEFC wind and solar transactions (usually as these projects come out of the construction phase and into operation). If a renewable facility has been de-risked through construction by the CEFC, and has obtained a Power Purchase Agreement since origination, then it is possible that the facility could be refinanced solely by the private sector; and
• difficulties in maximising the renewable component in projects that are largely energy efficiency focused (in the property and infrastructure sectors, or when developing new investment products in debt markets).

3.11 Investment in large-scale renewable energy projects increased significantly between 2016 and 2019. It is estimated to have accounted for nearly five per cent of non-mining business investment at its recent peak in 2018. This investment was completed almost entirely by the private sector, with large-scale renewable projects driving much of the strong growth in private sector electricity-related investment during this period.⁵⁸

3.12 The large-scale market has matured significantly during this period; there is now less demand for the CEFC to provide project finance for these projects as the private sector is directly contributing more finance. In addition, the CEFC’s Investment Mandate focus has shifted over time with the result that less emphasis is given to financing intermittent renewables.

Investments in nominated Funds and Programs

3.13 As noted at paragraph 1.5, the Investment Mandate requires the CEFC to make funds available up to specified limits for investment in nominated funds and programs. Only three funds and programs were included in the Investment Mandate up to November 2019 — the Clean Energy Innovation Fund, the Sustainable Cities Investment Program and the Reef Funding Program.⁵⁹ These are considered here, as well as the way the CEFC reports investments against nominated programs.

Clean Energy Innovation Fund

3.14 Subsection 14(1) of the Investment Mandate requires the CEFC to ‘make available up to $200 million [through the Clean Energy Innovation Fund] for debt and equity investment in emerging clean energy technology projects and businesses that involve technologies that have passed beyond the research and development stages but are not yet established or of sufficient maturity, size or otherwise commercially ready to attract sufficient private sector investment’.

3.15 As at 30 June 2020 commitments under the Program totalled $85.7 million.

3.16 The CEFC Board must target an average return of at least the five-year Australian Government bond rate plus one per cent per annum over the medium to long term as the benchmark return for the Fund, with performance being measured before operating expenses. The CEFC performance against the benchmark is considered at paragraphs 3.37 to 3.50.

Sustainable Cities Investment Program

3.17 The Investment Mandate (subsection 14(2)) requires the CEFC to ‘make available up to $1 billion of investment finance over 10 years for a Sustainable Cities Investment Program’.

3.18 The Explanatory Statement to the Investment Mandate provides for a wide range of potential investments in the Sustainable Cities Investment Program:

To make available up to $1 billion of investment finance over 10 years for clean energy projects and businesses that improve the productivity, accessibility and liveability of cities. Example investments could include loans to cities to finance innovative upgrades to street lighting and commercial buildings; equity or loans in privately funded co-generation installations in commercial buildings and manufacturing; and long-term loans to support community housing providers to build or retrofit energy efficient, affordable homes.⁶⁰

3.19 It was also agreed with the then Department of Environment and Energy in 2017 that:

• any CEFC activity within a ‘city’ could be counted against the Sustainable Cities funding program; and
• in deciding on the definition of a ‘city’ for the purposes of the program, the CEFC sought the advice of Cities Division (then within the Department of the Prime Minister and Cabinet) and the then Department of Environment and Energy. It was agreed to use postcodes (mapped to ABS significant urban areas), and to have a cut off for a city of around 25,000 people.

3.20 In its 2018–19 annual report the CEFC reported that it had ‘exceeded its $1 billion target, with the CEFC committing almost $2.9 billion to some 5000 Sustainable Cities opportunities at 30 June 2019’.⁶¹ The CEFC has also advised that, as at 30 June 2020, investment commitments in the Sustainable Cities Investment Program was $3.4 billion (including $790 million through aggregation partnerships).

3.21 However, since the Investment Mandate sets an upper limit on the amount to be made available, it could be argued that the CEFC has over-invested in the Program by a ratio of almost 3:1. On the other hand, since the CEFC can invest in projects eligible for inclusion in the Sustainable Cities Investment Program as part of its core investment activities, it may have been open to the CEFC not to have included some investments in the Sustainable Cities Investment Program.

3.22 The Department of Finance (Finance) advised ANAO that it raised with the CEFC its performance against the $1 billion requirement. Finance also advised that there may be issues relating to the classification of investments in the Program, since some investments could be classified against both specific investment programs and core investments.

3.23 While some investments in sustainable cities would be compliant with both the Sustainable Cities Investment Program and core investments, there is a need for the CEFC to obtain clarification of the $1 billion limit set for the Program in the Investment Mandate.

3.24 The CEFC is often not required as a cornerstone investor in property investments and the investment strategy is typically to influence the key decision makers to adopt higher sustainability outcomes. As at 30 June 2020, the Sustainable Cities Investment Program represented 57 per cent of total CEFC investment commitments (that is $3.4 billion out of $5.95 billion). Sixty per cent of CEFC investments in the Sustainable Cities Investment Program was in commercial and residential property development.

Reef Funding Program

3.25 Subsection 14(3) of the Investment Mandate requires the CEFC to make available up to $1 billion of investment finance over 10 years for clean energy projects and businesses that support delivery of the Government’s Reef 2050 plan.⁶² The Explanatory Statement to the 2019 Investment Mandate stated that:

Example investments could include projects or businesses that have a positive co-benefit for the health of the Reef (either directly by improving water quality, or indirectly by reducing emissions). The [Reef Funding Program] will focus primarily on projects located in (and businesses that provide services or products to) the water catchment areas that flow into the Great Barrier Reef World Heritage area.⁶³

3.26 Almost any clean energy technology project sited in the reef catchment area is eligible for inclusion in the Reef Funding Program. Reef Funding Projects are determined by reference to whether they the meet the specifications of the Mandate, including whether the relevant water catchment empties into the Reef areas.

3.27 In its 2018–19 Annual Report, the CEFC reported that, as at 30 June 2019, it had committed more than $370 million to about 410 transactions under the Reef Funding Program.⁶⁴ As at 30 June 2020, the CEFC advised that it had committed $386 million under the Program, including $51 million through aggregation partnerships.

Other nominated funds

3.28 Recent changes to the Investment Mandate have included requirements for the CEFC to make available up to:

• $100 million for an Australian Recycling Investment Fund to support recycling or recycled content projects utilising clean energy technologies, with a particular focus on waste plastics, paper, glass and tyres (November 2019); and
• $300 million in concessional finance for the Advancing Hydrogen Fund to support the growth of a clean, innovative, safe and competitive Australian hydrogen industry.

3.29 As at 30 June 2020, the CEFC had made no investment commitments in projects related to these Funds.

Reporting of investments against nominated programs

3.30 Investments may qualify under more than one designated program. In its advice of 10 July 2017 to responsible Ministers mentioned at paragraph 2.108, the CEFC stated that:

It is proposed that the investment’s non-financial outcomes should be reported under each program or fund for which it is eligible, therefore potentially being included under multiple funds or programs’. [CEFC] reports investments against the nominated programs in this way.

3.31 To ensure clarity on the attribution of investments between programs, the CEFC should include in the reports for each fund or program the amounts that had been included on other funds or programs.

Has the CEFC met its investment performance obligations under the Investment Mandate Directions, including those related to the average target rates of return on investments and the risk profile of its investments?

Investment Mandate performance obligations

3.36 The main performance obligations in the Investment Mandate relate to requirements for the CEFC to:

• target benchmark rates of return for its core portfolio and the Clean Energy Innovation Fund;
• seek to develop a portfolio across the spectrum of clean energy technologies that in aggregate has an acceptable but not excessive level of risk;
• limit the amount of concessionality in any one financial year to $300 million⁶⁵; and
• ensure that the limits on guarantees specified in the Investment Mandate are met.

Performance against the target benchmark rates of return

3.37 Assessing performance against the benchmarks requires:

• an understanding of the target benchmark rates of return set by the Investment Mandate for the CEFC’s core investments and on investments in the Innovation Fund (and newly established Advancing Hydrogen Fund);
• calculating the target benchmark rates of return for each investment;
• calculating the actual rates of return against the target benchmarks; and
• managing performance against the target benchmarks.

Definition of the target benchmark rates of return

3.38 Section 7 of the 2018 Investment Mandate (used by the CEFC for its reporting of performance in 2018–19) specified the CEFC’s obligation to target a benchmark rate of return of:

In relation to all investments other than those made under subsection 14(1) of this direction [Clean Energy Innovation Fund], the Board is to target an average return of the five–year Australian Government bond rate +3 to +4 per cent per annum over the medium to long term as the benchmark return of the portfolio. Performance against this benchmark will be measured before operating expenses.⁶⁶

3.39 Section 14 of the Investment Mandate also sets target benchmark return rates of an average return of at least the five-year Australian Government bond rate plus one per cent per annum over the medium to long term as the benchmark return of the Clean Energy Innovation Fund and the newly established Advancing Hydrogen Fund.

3.40 Since 2016, the Explanatory Statements to the Mandates have stated that:

It is expected that the Corporation will apply commercial rigour when making its investment decisions. By adopting a commercial approach, it is expected that the Corporation will invest responsibly and manage risk so it is financially self-sufficient and achieves the Portfolio Benchmark Return and the benchmark return for the Clean Energy Innovation Fund. In achieving this aim the Government has the expectation that the Board will take a medium/long-term outlook (ten years) when setting the investment strategy for the Corporation.

3.41 The average rates of return are therefore expected to be met over a period of 10 years.

Calculation of the target benchmark return rates

3.42 The portfolio target benchmark return rate and the Clean Energy Innovation Fund target benchmark return rate are calculated by the CEFC using a spreadsheet.⁶⁷ The Investment Mandate requires the CEFC to calculate an ‘individual reference rate for each investment’ and then add the one per cent, three per cent or four per cent for the relevant class of investments (Innovation Fund or core investments). The series is then to be used to determine an overall target for the core portfolio and the Clean Energy Innovation Fund. ANAO confirmed the benchmark rates that the CEFC has reported.

3.43 The target rates for the core portfolio were 5.95 per cent in 2015–16, 5.74 per cent in, 5.51 per cent in 2017–18 and 5.99 per cent in 2018–19. The Clean Energy Innovation Fund targets were 3.21 per cent in 2017–18 and 3.22 per cent in 2018–19.

Actual return rates

3.44 Reported rates of return for the CEFC’s core portfolio and the Clean Energy Innovation Fund for the period 2015–16 to 2019–20 are shown in Table 3.2. As at 30 June 2020, the core portfolio had achieved an inception to 30 June (seven years) average annual rate of return of 4.75 per cent⁶⁸ against a benchmark of 5.28 to 6.28 per cent. The Clean Energy Innovation Fund had achieved an inception to 30 June (two years) of -6.02 per cent against a benchmark of 3.15 per cent.

3.45 The actual rates of return reported by the CEFC on its ‘core portfolio’ since inception have slowly increased from 4.15 per cent in 2013–14 to 4.75 per cent in 2019–20 over a time when benchmark rates have fallen. As a result, the CEFC’s core portfolio performance has risen from 1.3 per cent below the benchmark in 2015–16 to being 0.53 per cent below the benchmark in. The CEFC could consider including forecast returns up to the 10 year mark for the core portfolio and the Innovation Fund, until each has been operating for 10 years, recognising that the Explanatory Statement to the Investment Mandate defines the medium to long term over which the benchmark rates of return are to be achieved as 10 years.

Table 3.2: Reported rates of return against benchmark rates, 2015–16 to 2019–20

Note a: These cumulative rates reflect the annualised returns for all investments made since the CEFC was created.

Note b: The 2018–19 return of 5.27% has been adjusted from the annual report.

Note c: The negative returns on the Clean Energy Innovation Fund were due to the write-down in investments. In 2018–19 this was mostly due to a $10 million write-down in one investment. However, this write-down was sold at a profit 8 months later and the write-down was removed and the actual return then calculated.

Source: CEFC annual reports for 2015–16 to 2018–19 and CEFC advice for 2019–20.

3.46 The CEFC has advised that actual rates of return can only accurately be compared to expected rates of return at the very end of an investment cycle (and this can often be many years, with some debt extending to 17 years). This is because rates of return are calculated on a net present value/internal rate of return basis using cash flows.

3.47 Cash flows for loans are uneven over time, as fees tend to be received in advance and some facilities have ‘step up’ arrangements on interest rates to incentivise early refinance by the private sector. For equity investments, any rate of return calculations would be materially impacted by exit assumptions and therefore can also only be accurately assessed at exit.

3.48 The CEFC has yet to report a positive rate of return on the Clean Energy Innovation Fund. This partly reflects the fact that $64.2 million of the $69.2 million (93 per cent) of these investments as at 30 June 2019 were in the form of equities (venture capital), the final return on which will not be known until the investments are sold or written off. In its Portfolio Budget Statements, the CEFC has drawn attention to the risks inherent in investing in earlier stage technologies and that in practice this will involve some short-term volatility in the Corporation’s returns, including the possibility of losses in some years.

3.49 The CEFC’s Finance team calculates the actual return realised at exit of an investment and assesses any material deviation from the anticipated rate. The CEFC’s investment database (iMart) is then updated to reflect the final rate of return at the exit point.

3.50 The CEFC was not able to provide a standard operating procedure document for the calculation of returns. The spreadsheet provided by the CEFC included no instructions, references to source data or list of assumptions. The CEFC should document and validate the operating procedure for the calculation of benchmark rates and actual rates of return against the benchmarks for both the core portfolio and Innovation Fund, ensuring that the spreadsheets reference all source data and are regularly validated.

Managing performance against the benchmark return rates

3.53 The CEFC monitors performance against the benchmarks, but does not have strategies in place to seek to achieve them.

Monitoring performance against the target benchmark return rates

3.54 The monthly financial update reports to the Board mentioned at paragraph 2.97 provide a comparison of actual rates of return to the portfolio target benchmark rates of return. The CEO’s reports to the Board also provide information on how the CEFC is performing against the portfolio benchmarks.

3.55 Performance against the target benchmarks is reported to the Minister for Energy and Emissions Reduction and to the Department of Industry, Science, Energy and Resources on a quarterly basis and briefings are provided, where required. Performance is also reported in the department’s annual report.

3.56 While the Board is advised of performance against the benchmark, Board papers do not explain why the target benchmark rates of return were not achieved and the Board has not indicated its strategy to seek to meet them in the future. Instead, there appears to be an acceptance that this is simply a by-product of its investment activities and not targets that it actively needs to seek to meet. For example, the Board minutes of 23 August 2018 recorded that:

The Board discussed the portfolio benchmark return (PBR) and, in particular, the fact that the CEFC invests primarily for a public policy purpose and operates in a manner that seeks to crowd in private capital, not crowd out. While the business operates in a commercial manner that always lends at maximum possible a rate above the Government’s cost of funds, the actual return achieved is typically a consequence of the CEFC’s investment objectives rather than the primary driver, as it is in private sector organisations.

CEFC views on the appropriateness of the specified benchmark return rates

3.57 In May 2016, before providing a draft proposed Investment Mandate to the CEFC for consultation, Finance commissioned advice on an appropriate average target benchmark rate of return and acceptable level of risk for the Clean Energy Innovation Fund and for the investment portfolio of the CEFC. The advice provided to Finance reflected, among other things, the reduced expectations of returns in the investment market more generally as well as factors directly relevant to the CEFC:

We observe downward pressure on returns and expected margins across a wide range of investments, including private debt and equity funds, due to the low interest rate environment. [Our] expectations for future risk and return, as expressed in our ‘market aware’ risk and return assumptions, take account of the current market conditions and incorporate an expected reversion of asset prices towards what are now lower long-term means over a five-year to seven-year period. …

Our analysis of the investment framework for the investment portfolios identified factors which would serve to lower the potential returns and increase the risk from what might otherwise be expected in an unconstrained framework.

Therefore, we propose ranges which incorporate qualitatively lower returns than the targets nominated above. Our recommended benchmark returns are:

• CEFC: five-year Australian Government bond rate +3% pa to 4% pa over a rolling 10-year period.
• [CEIF]: five-year Australian Government bond rate +1% pa to 3% pa over a rolling 10-year period.

3.58 A revised mandate was subsequently provided for CEFC consultation, including proposed benchmark rates of return consistent with the advice provided to Finance, but without the suggested rolling 10-year period for achievement. This proposed that the Board target an average return of the five-year Australian Government bond rate of + 3 to +4 per cent per annum over the medium to long term as the benchmark return of the portfolio to be measured before operating expenses.

3.59 The CEFC commented on the proposed mandate, advising responsible Ministers that:

The Board notes that the Government has amended the Portfolio Benchmark Return for the CEFC’s core portfolio (i.e. investments other than those in the CEIF) to 3% to 4% over the 5-year Australian Government bond rate. While this is a minor reduction in the Portfolio Benchmark Return from the target set out in the two most recent Investment Mandates issued to the CEFC (in February 2015 and December 2015), the Board is of the view that this is still an unrealistically high return target for this market. It does not reflect the CEFC’s approach to risk and the proportion of public sector counterparties (universities and councils) within the current investment portfolio.

As participants in the financial markets are aware, global equity risk premiums as well as both credit and duration spreads on debt instruments are compressed and are at or close to long term lows. These market pressures, when coupled with the CEFC’s narrow investment universe of clean energy technologies in Australia, mean that the CEFC has limited ability to access higher yielding transactions. Consequently, as expressed in my responses to the last two Investment Mandates issued to the CEFC, the Board’s view remains that targeting such a high rate of return will require the CEFC to seek out-of-market returns, which will be difficult to achieve.

In relation to the benchmark return of 1% over the 5-year Australian Government bond rate set for the CEIF, the Board would also like to highlight to the Ministers that there is a very wide range of potential returns on the early stage long term investments anticipated for the CEIF. As the portfolio will be both concentrated within a single industry sector, and involve technologies that are not yet fully commercially established, the return outcome of the CEIF investments will range from full loss of the investment to a return of a multiple of the investment. This variability in investment returns will be more pronounced in the CEIF than in the core portfolio and while the benchmark return set for CEIF is lower than that set for the core portfolio, the Government should expect high volatility on a year-to-year basis from this developing portfolio of early stage assets.⁶⁹

3.60 The proposed target benchmark rate for the core portfolio was adopted unamended and remains unchanged.

3.61 Finance informed the ANAO that Ministers’ maintenance of mandated benchmark rates of return at the levels proposed in the consultation drafts indicates the Government’s continued expectation that the CEFC should strive to achieve the benchmarks. However, Finance also indicated there is a recognition that the CEFC’s primary policy objective is to increase flows of finance into the energy sector, and that the benchmark rates of return are to be achieved over the medium to long term and that the CEFC has not yet been operating for 10 years.

3.62 Some CEFC Board papers have noted the difficulty in achieving the benchmark rate of return for the core portfolio and also meeting other investment obligations, such as the requirement for 50 per cent of investments to be in renewable energy.

3.63 Given the requirement in the Mandate to target the specified rates of return over the medium to long-term, the CEFC should be actively seeking to achieve them by 2022 when it will have been operating for 10 years. It should keep responsible Ministers informed of the action it is taking to meet the target rates of return and any concerns it has about its ability to do so, while also meeting its overall legislative objective to facilitate increased flows of funds into the clean energy sector. As noted at paragraph 2.24, the CEFC’s corporate plan does not include action to achieve the target benchmark rates of return.

The CEFC’s management of portfolio risk

3.70 The requirements for managing portfolio risk are set out in sections 8 and 14 of the Investment Mandate. The CEFC has three mandated risk related responsibilities:

• the agreement of a suitable investment risk evaluation process;
• the periodic review of investment practices; and
• the development of a portfolio that in aggregate has an acceptable but not excessive level of risk.

3.71 The CEFC also needs to monitor portfolio risk and ensure that there is an acceptable but not excessive level of risk and have effective fraud control policies and processes.

Agreement to suitable investment risk evaluation process

3.72 Section 8 of the Clean Energy Finance Corporation Investment Mandate Direction 2016 of 5 May 2016 and the Clean Energy Finance Corporation Investment Mandate Direction 2016 (No.2) of 13 December 2016 included the following:

Within six months of the date of this direction the Board should agree a suitable investment risk evaluation process to assess the risk, and should advise the responsible Ministers of the process chosen.⁷⁰

3.73 Section 14 of the Clean Energy Finance Corporation Investment Mandate Direction 2016 (No.2) also provided, that:

Within six months of the date of this direction the Board should, in consultation with ARENA, agree a suitable investment risk evaluation process to assess the Clean Energy Innovation Fund risk, and should advise the responsible Ministers of the process chosen.

3.74 While similar provisions are no longer included in the Investment Mandate, the CEFC did comply with them. On 4 November 2016, and again on 10 July 2017, the Chair of the CEFC Board provided responsible Ministers with the CEFC’s risk evaluation processes in relation to governance, risk management, and investment risk. The advice also provided the CEFC’s response to the investment risk evaluation processes for the Clean Energy Innovation Fund. In those advices, the CEFC Chair stated:

The CEFC spends considerable effort understanding the creditworthiness of borrowers, the technology, the business case of the proposal, the security on offer, and what will happen to the CEFC’s funds in the capital structure if the proposal ultimately fails.

The CEFC diversifies its portfolio, seeking to avoid excessive concentration of risk in specific technologies, in exposure to single entities, in exposure to higher-risk finance in the capital structure, in exposure to merchant risk, in exposure to individual commodity markets and geographical areas.

The CEFC has instituted an extensive portfolio management function, systems and process.⁷¹

Periodic review of investment practices

3.75 Section 8 of the Investment Mandate provides that:

The Board is to periodically review its investment practices for the purposes of managing the risk of the portfolio over time and must advise the responsible Ministers of specific measures taken in this regard.⁷²

3.76 Section 14 of the Investment Mandate also provides direction on risk levels for the Clean Energy Innovation Fund. It provides that:

The Board, in consultation with ARENA, should periodically review its investment practices for the purposes of managing the risk of the Clean Energy Innovation Fund portfolio over time and must advise the responsible Ministers of specific measures taken in this regard.

3.77 In June 2019, the CEFC’s 2017 risk management framework was reviewed, revised and approved by the Board. The revised framework specified the Board’s responsibilities for formulating written policies in relation to risk management for the CEFC’s investments, and ultimate responsibility for overseeing the efficient and effective operation of the CEFC. This included the oversight and governance of investment decisions, and risk management within the parameters of the CEFC Act and the Investment Mandate. Other Board duties included:

• providing direction to management in setting risk parameters and the CEFC’s investment strategy; and
• overseeing the CEFC’s governance structure and monitoring performance in terms of both risk and return.

3.78 In February 2019, in the course of the review, the CEFC formalised and recorded its risk appetite, setting the risk boundaries within which it operates, noting, among other things, that:

Excessive risk-taking will jeopardise our long-term financial sustainability, while an overly risk averse approach may inhibit the ability to maximise our public policy objective.⁷³

3.79 The Risk Appetite Statement approved by the Board lists risks that the CEFC will not tolerate (such as fraud), others for which it has some tolerance (including equity risks to the core investment portfolio); and risks that it tolerates (credit risk, concentration risk, interest rate risk, and technology risk relating to the Innovation Fund portfolio). In relation to the risks tolerated, the Statement noted that:

We are tolerant of certain risks because they are central to us being able to meet our objectives. Each of these risks is managed through implementation of controls such as limits and our governance processes that require review and approval before these risks are taken on.⁷⁴

3.80 Recognising this, the Board has set bounds on certain risks, including limiting equity exposure to 30 per cent of the investment portfolio and limiting floating rate exposure to not more than 20 per cent of total loans, while observing the $200 million limit on Innovation Fund capital.

Acceptable portfolio risk

3.81 In ascending order of risk, CEFC investments comprise debt investments; equity investments in managed funds; and direct equity investments.⁷⁵ CEFC investment commitments by investment type as at 30 June 2020 are shown at Figure 3.1.

Figure 3.1: CEFC investment commitments by type as at 30 June 2020

Source: ANAO analysis of CEFC data.

Debt investments

3.82 Debt investments are loans for which the principal is repaid and interest is charged. As at 30 June 2020, debt investments comprised around 77 per cent of the portfolio. The CEFC advised that that the level of risk of proposed debt investments is assessed according to the credit quality of the investment and the expected loss should the borrower default on the loan.

3.83 The CEFC uses its in-house shadow credit rating methodology to assess the likelihood of an investment default risk materialising. Several steps are involved. The assessed rating is then associated with a likely rate of default that depends on the time horizon of the proposed investment, based on Standard and Poors’ credit rating scale.

3.84 For each debt investment, the CEFC estimates the Loss Given Default (LGD), an assessment of the losses that it might bear should the investment counterparties default:

LGD is primarily determined by CEFC’s security position for each investment. … Implicitly, the LGD is a monetary indicator of the potential consequence of a risk of default materialising.⁷⁶

3.85 The potential monetary impact is estimated by the following Expected Loss calculation:

Expected Loss = Debt outstanding at default x Probability of default x LGD

3.86 While LGD estimates are investment-specific, shadow credit ratings are usually counterparty-specific.

3.87 Before a proposal is formally considered by the CEFC Board or its delegates, the risk assessment undertaken by the transaction team is reviewed for approval by the CEFC’s credit team.

3.88 Examination of the audit sample of debt investment proposals showed that the CEFC always applied the expected loss calculation to assess credit risk. This measure served for both assessing and considering investment proposals and, under the risk management framework, was intended to aggregate to a portfolio-level estimate of the CEFC’s risk capital:

Each of these pieces of data is utilised when evaluating a “risk capital” amount that is a quantification of the level of risk embedded in each transaction. This risk capital is aggregated at the portfolio level to evaluate and monitor the total risk in the portfolio at a given point in time. These inputs also assist in pricing transactions to ensure that the CEFC is being adequately remunerated for the risk it is bearing.⁷⁷

3.89 This approach has not been adopted and the CEFC continues to use the shadow credit rating approach and reports results in its audited financial statements, compiled and presented in Figure 3.2 below. The compilation illustrates changes to the balance of risk in the CEFC’s aggregate investment portfolio, such as the decline in the proportion of investments with an investment grade rating (BBB- or higher) since 2016–17, a trend that has occurred alongside improvements in the CEFC’s rates of return in recent years.⁷⁸

Figure 3.2: CEFC aggregate investments at 30 June each year by Shadow Credit Rating

Note a: The left axis shows the value of loans categorised by shadow credit rating indicated in the bar charts.

Note b: The right axis shows the value of investment grade rated loans (BBB- or higher) as a proportion of the total loans at 30 June each year.

Source: ANAO analysis of CEFC annual reports and other CEFC data.

3.90 Other portfolio risk indicators included in the CEFC’s financial statements include the spread of investments by value, and the relative size of the largest debt exposure, compiled in Figure 3.3 below. The compilation illustrates the growth in the CEFC’s total loan portfolio of loans of $50 million or more. Average loan exposure remains small at 1.1 per cent of the total loan portfolio and the largest loan exposure is now a smaller proportion of the overall exposure, indicating a favourable change in this aspect of the risk profile of the CEFC’s aggregate portfolio.

Figure 3.3: CEFC loan exposure at 30 June each year by size of loan

Note a: The left axis shows the dollar value of CEFC debt investments at 30 June each year, categorised by the loan amount in $ million.

Note b: The right hand axis shows the average CEFC loan amount as a proportion of all loans, and the relative size of the single largest CEFC loan.

Source: ANAO analysis of CEFC financial statements and other CEFC data.

Equity investments

3.91 The CEFC’s equity investments are held as shares in publicly-listed entities, units in unincorporated unit trust structures or direct holdings in unlisted companies. The CEFC has a non-controlling (minority) interest in each of its equity investments. As distinct from debt investments, equity investments aim to deliver dividends and capital gains.

3.92 By virtue of their diversification, equity investments in professionally managed diversified funds usually bear a lower risk than direct equity investments. Direct equity investors bear a higher risk, as they rank behind all other investors, such as lenders, in respect of claims over the cash flows and assets of the proponent. The higher risk is compensated for by a correspondingly higher expected rate of return.

3.93 The CEFC assesses the investment risk of its equity investment proposals in a similar fashion to debt investments, including detailed reviews by the CEFC’s Executive Investment Committee or the Joint Investment Committee before consideration by the Board. Equity investments differ from loans and are not usually able to be assessed in the same way (for instance, the CEFC does not assign shadow credit ratings to proposed investments in equities and units in trusts). When deciding on equity investments, the CEFC Board has relied on its consideration of the assessments provided by its investment committees.

Portfolio risk reporting and assessment

3.94 The CEFC Board receives regular Portfolio Reports, including quarterly Portfolio Reviews that provide information on portfolio risk. These reports set out aggregate investment commitments (along with changes in investments since the previous quarter, including new commitments, reduced or cancelled commitments), portfolio composition, portfolio yield, the extent of merchant energy price risk⁷⁹, and key portfolio risk indicators, such as:

• the total debt investments by shadow credit rating;
• a weighted average shadow credit rating;
• single investment, sector and technology exposures, merchant exposed capital at risk (MEPR) and property market risk;
• headline events and developments with a bearing on portfolio risk (for instance the report for the March quarter of 2020 highlighted matters such as re-financing arrangements and liquidity assistance arising from the impact of COVID-19); and
• project-by-project summaries of those investments that are underperforming.

3.95 Underperforming investments are assigned performance ratings of PR3, PR4 or PR5 in order of decreasing performance (with acceptable performance rated at PR1 or PR2). Management updates are provided for each underperforming investment, including steps being taken by the CEFC and other parties to improve performance, or steps to limit or mitigate the CEFC’s exposure to loss.

3.96 In addition to the Portfolio Reports to the Board, management also prepares a quarterly Enterprise Risk Report which is submitted to the Executive Risk Committee, Audit and Risk Committee and/or the Board. It covers the entire business, including key risk indicators and exposures and commentary on the main risks and industry outlooks. Importantly, it is an aggregated, holistic view of risk across the CEFC. It tracks operational, investment, strategic and regulatory risks in the CEFC’s risk register and changes in risks and risk ratings and hence the risk profile across the business.

3.97 The portfolio reports are provided to the Board for noting and, on occasions, Board minutes record discussion of particular matters rin the reports. However, the reports provided to the Board do not include a specific statement of its assessment of the risk of the CEFC portfolio at the aggregate level based on the risk indicators and other information provided.

3.98 Consistent with the guidance issued by the Australian Institute of Company Directors and Governance Institute of Australia, the Board’s practice is to note the reports. There is therefore no explicit statement of its consideration of portfolio performance in relation to risk, the key investment risk indicators, or its assessment of the portfolio risk at the aggregate level.

3.99 Reporting to the Board on portfolio risk does not include aggregate estimates of risk capital at the portfolio level. As noted at paragraphs 3.88 and 3.89, unlike the 2017 version of the risk management framework, the 2019 version no longer includes aggregation ‘at the portfolio level to evaluate and monitor the total risk in the portfolio at a given point in time’.⁸⁰ The CEFC advised the ANAO in May 2020 that the estimation of risk capital was no longer a metric of portfolio risk and that it had yet to adopt such a measure:

At the time the 2017 Risk Management Framework was revised, a “Risk/Reward” Framework was under development to facilitate portfolio risk quantification (for debt) and to assist with consideration of pricing, using a return on risk adjusted capital approach. The latter is incorporated in each investment paper, however, the methodology underpinning the former was not endorsed by the Executive Risk Committee. The business has instead pursued an approach to risk quantification based on scenario stress testing for material sectors. In particular, methodologies are in place for electricity market risk and property market risk. When the risk management framework was revised in 2019, references to risk capital were removed … [The CEFC] continues to refine and review approaches which to date have included an evaluation of [Value at Risk].

3.100 The CEFC has yet to put in place a metric that includes aggregation ‘at the portfolio level to evaluate and monitor the total risk in the portfolio at a given point in time’. This could better enable the Board to meet the requirement under section 8 of the Investment Mandate to ‘seek to develop a portfolio across the spectrum of clean energy technologies that has an acceptable but not excessive level of risk’. There would be merit in having such a metric.

3.101 The CEFC’s Annual Report 2018–19 only discusses implementation of the Investment Mandate with reference to general provisions for managing portfolio risk.

3.102 Indicators of portfolio risk, such as shadow credit risk ratings, are included in the audited financial statements appended to the CEFC’s published annual reports. However, in the body of its annual reports, the CEFC does not discuss these indicators or other measures of portfolio risk at the aggregate level or otherwise indicate that it satisfies the portfolio risk requirement of the Investment Mandate.

Fraud control

3.108 The CEFC’s Fraud Control Policy of August 2019 notes that:

In developing this Fraud Control Policy, the CEFC has considered the binding requirements of the [PGPA Act Fraud Rule], practices outlined in the Commonwealth Fraud Control Policy, and the Resource Management Guide No. 2018.

3.109 The CEFC’s fraud control policy is supported by subordinate policies and controls, including: security requirements and access control; a program to ensure compliance with anti-money laundering and counter-terrorism finance obligations; a Code of Conduct and Ethics; a policy governing Conflicts and Material Personal Interests; requirements for handling material non-public information; a policy governing the acceptance of gifts and gratuities and precluding the giving or receiving of bribes; a management process for identifying, minimising and preventing operational risk incidents; a Privacy Policy; a Procure to Pay Policy; and a policy governing Public Interest Disclosures.

3.110 The CEFC policy and supporting controls comply with the requirements of the Fraud Rule and include elements of good practice in addition to the requirements of the Rule, such as annual reporting to the Institute of Criminology.

3.111 The Fraud Rule also requires:

• the regular conduct of fraud risk assessments, including when there is a substantial change in the structure, functions or activities; and
• as soon as practicable following a risk assessment, developing and implementing a fraud control plan that deals with identified risks.

3.112 The records of the CEFC’s Executive Risk Committee and Audit and Risk Committee show the review and approval of revised fraud control policies, including in 2017 and 2019. In August 2019, following the revision of the fraud control plan, the CEFC commenced a review of payroll fraud risk, and instigated staff training in fraud control policy. The CEFC conducts regular Fraud Risk and Control Review Workshops, most recently on 10 December 2019.

Concessionality

3.113 A concessional loan is a loan provided on more favourable terms than the borrower could obtain in the marketplace. Concessions are sometimes needed where there are considered to be public policy benefits, such as significant carbon abatement, but where implementation or take-up of the technology cannot be financed at market rates, generally because of the higher level of risk involved. Under section 9 of the Investment Mandate, the CEFC must limit concessionality of its investments to no more than $300 million in any one year.⁸¹

3.114 In its policy statement, the CEFC states that its approach in relation to concessional loans is:

• the CEFC considers public policy benefits in making investment decisions and in determining when it is justifiable to offer any form of concessionality; and
• offers of concessional finance will generally be limited to avoid unintended market impacts, distortions in the efficient operation of the capital markets, or other government policies and programs.⁸²

3.115 The CEFC uses a spreadsheet to calculate concessionality that employs the methodology stated in the Department of Finance’s Resource Management Guide No.5: Accounting for concessional loans, namely, a concessional loan ‘refers to a loan made by the government at a discount to the prevailing market rate to the borrower.’ This requires the CEFC to determine what the ‘prevailing market rate to the borrower would be’.

3.116 The concessional discount provided on a loan is calculated using a ‘market rate’ that is determined by the CEFC. On loans approved in 2018–19 the discount provided ranged from 0.2 per cent to 1.5 per cent (sample basis) and assessed market rates from 2.6 per cent to 9 per cent.

3.117 A sample of the CEFC’s spreadsheets, accounting papers and audited financial statements and the work papers of the financial statements auditors were reviewed, and no material issues were identified.

3.118 Market rate data for individual loans are not readily available, since financial institutions regard them as commercial-in-confidence. The CEFC therefore calculates an implied market equivalent rate to determine what is generally available in the market for known projects with similar terms and conditions, adjusted for known differences in tenor, credit rating, drawdown, repayment and security, applying a discounted cash flow analysis to determine the net impact. The CEFC acknowledges that the calculation of the concessional rate requires extensive judgment.

3.119 The CEFC’s reported concessionality charge each financial year has been well below the $300 million annual limit set in section 9 of the 2018 Investment Mandate — less than $12 million has been granted in any one year since inception (although the CEFC has advised that this may increase with the recent requirements for funds to be set aside for investment in the Advancing Hydrogen Fund and the foreshadowed Grid Reliability Fund).⁸³ The relatively small amount of concessionality granted indicates that the $300 million limit is an ineffective control.

Guarantees

3.120 As at 30 June 2020, the CEFC had provided no guarantees.

Has the CEFC leveraged increased levels of funds into the clean energy sector from the private sector and other sources?

3.121 The object of the CEFC Act as specified in section 3 is to establish the CEFC to facilitate increased flows of finance in the clean energy sector. The CEFC Act and supporting documentation do not provide any further guidance on how to assess effectiveness in achieving the object. In assessing the CEFC’s performance, the ANAO examined:

• reported financial leverage;
• the approach used by the CEFC to calculate leverage; and
• benchmarking with other green banks.

Reported leverage

3.122 The 2018–19 Annual Report (page 19) reported that, since inception to 30 June 2019, the CEFC had achieved $24 billion of total investment commitments into clean energy projects (see Table 3.3) based on $6.2 billion of CEFC active investments. As at 30 June 2020, the CEFC estimates that it had achieved $28 billion of total investment commitments into clean energy based on $5.95 billion of active investments.

Table 3.3: CEFC estimates of leveraged investment commitments into clean energy per year since inception

Source: ANAO analysis of iMART data.

3.123 The CEFC Board has set a target of 2:1 (that is $2 of non-government investment for every $1 dollar that the CEFC invests) for financial leverage and reports actual performance against the target in the Annual Performance Statements.

3.124 Figure 3.4 illustrates that the CEFC has reported that it had achieved the target leverage ratio for the portfolio for each year.⁸⁴

Figure 3.4: CEFC estimates of portfolio leveraged amounts per dollar invested by the CEFC by year since inception

Source: ANAO analysis of iMART data.

3.125 The estimated leverage ratio varies by product line. For the CEFC’s investment commitments of $6 billion as at 30 June 2020, the leveraged amounts for each dollar the CEFC invested are shown at. Project finance and equity have had the highest leverage ratio for product lines of around 3:1 compared to corporate loans and co-financing programs and subsidiary transactions with between 1.12:1 and 1.79:1. The aggregation programs managed by the banking sector do not attract any other investments and do not include the amount contributed by the bank customer to purchase the new vehicle or equipment as this data is not captured.

Figure 3.5: Leveraged amounts by product line (per dollar invested by the CEFC) as at 30 June 2020

Source: ANAO analysis of iMART data.

3.126 Estimated leverage by industry sector is shown at Table 3.4. Commercial buildings and utilities both have high commitment values and relatively high leverage ratios (over 4:1 for commercial buildings and over 3:1 for utilities).

Table 3.4: Leveraged amounts by industry sector (per dollar invested by the CEFC) as at 30 June 2020

Source: ANAO analysis of iMART data.

3.127 The statutory review in 2018 concluded that the CEFC has been effective in facilitating increased flows of finance into the clean energy sector. However, the review also noted that, given the nature and immaturity of a number of CEFC investments, it is difficult to measure the full impact of the CEFC’s involvement on private investment in the clean energy sector more broadly.

Calculation of financial leverage

3.128 The CEFC calculates leverage as the amount of funds (excluding CEFC funds and any government grants) included in a project’s costs where the CEFC has provided finance, divided by the CEFC investment.⁸⁵ The calculation of financial leverage by the CEFC is applied consistently across all product lines.

3.129 The CEFC’s approach to the calculation of financial leverage:

• does not include indirect increased investment flows to the clean energy sector that the CEFC may have been instrumental in influencing as a result of previous investments, such as where a bank issues climate bonds on similar terms to previous bond issues that involved the CEFC and where the CEFC is no longer required as an investor; and
• includes investments in projects where the CEFC is not a cornerstone investor and where it is likely that the investments would have progressed without the CEFC’s involvement, albeit with less favourable clean energy outcomes (such as Project Lafite, an equity investment of $85 million in a property investment fund with a claimed leverage of $471 million and where most of the leveraged funds would have been applied for the property development and not specifically for clean energy technologies). In such instances, the claimed additional funds for clean energy resulting from CEFC’s involvement are overstated.

3.130 Examination of the 23 survey projects identified examples where it was clear that the CEFC was a cornerstone investor and where it was reasonable for the CEFC to claim non-government investment amounts as leveraged funds. Examples are provided at paragraph 2.68.

3.131 While the CEFC has leveraged increased levels of funds into the clean energy sector, for the reasons stated at paragraph 3.129, it is unclear what level of increased funds has been generated.

3.132 The assessment of the CEFC’s effectiveness in facilitating an increased level of funding into the clean energy sector could be further improved by financial analysis of industry data on the overall flows of investment into clean energy projects. For example, the clean energy sector has matured in terms of projects having less risk (offtake agreements and construction) and generating more commercially acceptable returns without the need for concessions or grants. This has led to a surge in private sector investments in renewable energy projects to $9.1 billion in 2017.⁸⁶

Appendix 1 Clean Energy Finance Corporation response

 

Appendix 2 Glossary

This appendix provides definitions of the Clean Energy Finance Corporation’s financial instruments and business platforms.

Financial instruments

Common equity

Equity investments are amounts held by way of shares in publicly listed entities, units in unincorporated unit trust structures or direct holdings in unlisted companies where the group is not deemed to have significant influence.

Preferred equity

Fixed-income investments with equity-like features, which typically pay dividends, offer multiple rate structures, often have investment grade ratings, and are subordinated in the capital structure (above common equity and below debt).

Senior debt

Debt that takes priority in repayment over other unsecured or more junior debt.

Subordinate debt

It is a form of hybrid security which ‘ranks behind preferred/secured creditors, ordinary bank and trade creditors, and potentially other subordinated bonds that are expressed to rank in preference (and so therefore rank ahead only of ordinary shares in a winding up’).

Business platforms

The CEFC has two primary business platforms:

• direct investments; and
• indirect investments.

Direct investments include:

• project finance for electricity generation by renewable energy sources (e.g. large-scale solar farms, wind farms, grid reliability, energy from waste, storage batteries, and hydrogen); and
• corporate loans for energy efficiency, low emission and small-scale solar investments as subsets of larger projects (e.g. commercial and residential properties, infrastructure and transport, manufacturing and industry, agriculture and retail industry sectors).

Indirect investments include:

• aggregation finance provides small loans for SMEs and individual customers purchases of energy efficiency and small-scale solar assets;
• green/climate bonds provide capital funding for renewable energy, low emission and energy efficient projects; and
• investment funds provide capital funding for renewable energy, low emission and energy efficient projects.

Aggregation finance

This is the provision of CEFC finance via co-finance intermediary partners, to aggregate customer demand that would otherwise be too expensive to be serviced directly by the CEFC. Aggregation finance allows the CEFC to invest in smaller scale projects and provide a more efficient mechanism to reach high volume/low value customers through utilising commercial lender customer networks and typically targets specific sectors (e.g. agriculture).⁸⁷ The CEFC purchases bonds from the commercial lender/bank and earns a fixed rate of interest. Concessional rates of interest are offered to encourage customer purchases of clean energy technologies.

Corporate facility or corporate loan

This is typically a loan to a company (rather than a specific project) for smaller-scale projects, or a bundle of projects, often secured against the assets or operations of the corporate entity.

Green/climate bond

This is a specific type of green bond issued under the Climate Bond Standards and Certification Scheme.⁸⁸ This scheme aims to enable and mobilise debt markets to fund projects that contribute to environmental sustainability. Green bonds facilitate capital-raising and investments for new and existing projects which have environmental benefits and can mitigate risks associated with climate change. Green bonds are typically issued by banks, state governments and major corporations and can be invested in by the general investment community.

Investment funds

The CEFC has made equity investments in several investment funds ranging from funds with major investment managers to smaller funds. The investment funds tend to target specific industry sectors (e.g. agri-food technology or agricultural assets) and are set up to increase the funds available for capital projects. Investing in the larger trust funds provides an opportunity for the CEFC to influence the behaviour of institutional investors.

Project finance

This involves a large financial outlay using senior debt or equity at an early stage in the project lifecycle. This finance is for long-term financing of infrastructure and industrial projects (such as a utility-scale generator or an onsite generation facility) which will be repaid from the projected cash flows of the project without recourse to the balance sheets of the sponsors.

A key focus area for the investment decision is on the expected future cash flows and assets of the project. Project finance is typically provided with the CEFC as a cornerstone investor to assist the project at an early stage to get it off the ground.⁸⁹ The CEFC’s approach is to de-risk projects by investing at an early stage in the lifecycle by providing funding at a comparable cost (i.e. interest rate based on market price and risk) as the commercial lenders would when the project is de-risked.⁹⁰ When the project is commercially ready (i.e. commercial lender/investor can achieve a commercial rates of return) the CEFC exits the financing arrangement and allows commercial lender/s to provide the ongoing finance.