Sustainable Finance and the Inflation Reduction Act: 5 Key Takeaways for Issuers and Investors

Posted on December 5, 2022

John Cameron
John Cameron
Manager, Equity Capital Markets and Corporate Solutions
Jennifer Li
Jennifer Li
ESG Solutions Specialist, Equity Capital Markets and Corporate Solutions
Anna Leckman
Anna Leckman
Associate, Debt Capital Markets and Sustainable Finance
The Inflation Reduction Act (IRA) was signed into law in the United States in August 2022 and directs nearly US$370 billion toward investment in sectors at the heart of the U.S. economy’s transition to a net-zero world. Modeling predicts that the climate and clean energy provisions in IRA would help bring the U.S. closer to its goal to reduce emissions by 50% by 2030. Before IRA, the country was on track for a 25%-30% reduction, and after IRA it’s now on course for over 40% in emissions reduction.1 What does the new law mean for companies and how can it support them in achieving their own decarbonization goals? 

In November 2022, Morningstar Sustainalytics organized a panel discussion on the law’s impact on companies, issuers, and investors across key sectors. Experts in sustainable finance from Nuveen, J.P. Morgan, and Cadwalader, Wickersham & Taft LLP joined the conversation and shared their thoughts on the potential opportunities that could come with the passing of the IRA. In this blog post we share the key takeaways from that conversation. For full details, watch the on-demand webinar.  

Key Takeaway One: IRA Tax Credits Make It Financially Beneficial for Companies and Consumers to Go Green

Green technologies will become more affordable to the masses with IRA tax credits, stimulating the green securitization market, and in turn making it financially beneficial for companies to “go green.” Making more sustainable purchasing decisions is commonly believed to cost more for the average person. However, the various IRA tax incentives for green technologies, such as solar and electric vehicles, could change this narrative and put greener choices within reach for consumers. There is also the opportunity for the cost of these technologies to decrease as a result of increased securitization of these assets. The use of syndicated loans to finance them could also bring down their costs and both trends could increase access to U.S. government funding programs such as the property assessed clean energy (PACE) financing.2  

Key Takeaway Two: Transferability of Tax Credits Offers Additional Incentives for Eligible Manufacturers 

Among the many new provisions enacted under the IRA, two stand out because of their benefit to companies. Under Section 45X, the advanced manufacturing production credit, and Section 48C, the manufacturing tax credits, manufacturers can elect to transfer eligible credits, in exchange for all or a portion of credits for a given year, to an unrelated eligible taxpayer for cash. In essence, cash payments would not be included in the transferor’s taxable income. This is a key advancement, as several developers historically relied on complex funding structures using tax equity for many of their projects. This transferability creates an option for smaller projects to be able to source alternative financing. 

Key Takeaway Three: IRA’s Direct Pay Provisions Could Reduce Financial Risks Associated With Green Projects

The IRA’s direct pay provisions could simplify the financial structures and reduce the financial risks associated with key green projects. The tax credit programs that corporations can elect to receive direct payments for are the clean hydrogen production tax credit, the carbon capture credit, and the advanced manufacturing production credit. Regulations to implement these provisions are currently under consideration with the U.S. Internal Revenue Service (IRS) and are being followed closely by the industry.  

As noted in the session, under the law, corporates without tax capacity (e.g., those corporates that would receive tax refund payments in excess of their tax liabilities) can elect to receive direct payments from the IRS for certain tax credits. This could potentially eliminate the need for complicated tax equity financing structures for key projects and reduce the credit risk associated with eligible green projects.   

Key Takeaway Four: IRA Offers More Opportunities for Hard-to-Abate Parties to Participate in the Labeled Issuance Market 

The creation of new provisions and the extension of existing ones under the IRA (such as Section 45Q – Credit for Carbon Oxide Sequestration), provides certainty around key tax incentives and government programs that will enable market acceptance of sustainable products.   

To broaden and maintain this acceptance, policies like IRA need to be scalable and inclusive of a range of players. For instance, oil and gas companies are among some of the largest allocators of capital in renewables and clean technology, however, they don’t issue thematic bonds (e.g., green bonds) because they wouldn’t qualify under current International Capital Market Association principles. The IRA gives these and other companies in hard-to-abate sectors more opportunities to go down a sustainable path. Companies in other industrial sectors, like steel or cement, and those involved in grid infrastructure also stand to benefit from many of the provisions in IRA.  

For companies in these sectors, the low-carbon transition will be very capital intensive. However, the IRA has earmarked over US$370 billion in tax credits and many of the incentives are uncapped, meaning this amount is just an estimate. In terms of the amount needed to finance the low-carbon transition globally – estimated at between US$4-6 trillion per year3 – the IRA could help the U.S. increase its fiscal contribution to these efforts over the next 10 years.   

Key Takeaway Five: Real Estate Tax Deductions Could Boost Developer’s Green Building and Efficiency Efforts 

The IRA includes a tax deduction for energy efficient commercial buildings that increases with higher levels of building efficiency — two cents per square foot for every percentage of efficiency above 25%. In addition, the law provides a wage requirement that enables developers who employ qualified apprentices to multiply their tax deduction eligibility by five. As an example, for a 50,000 square foot building that also complies with the wage and apprenticeship requirements, the minimum deduction could be US$125,000 if it reaches 25% efficiency gain, up to a maximum of US$250,000 at 50% efficiency. 

When it comes to real estate, institutional property owners and borrowers are competing to prove their ESG credentials. The credits serve as a way to reduce their operating costs and position themselves favorably among institutional investors. This can also be an opportunity to attract younger tenants and those who are interested in sustainability. Given that these tax credits apply to new construction and retrofits, they further encourage developers to make their buildings more efficient and greener.  

It is clear from our discussion that the climate and clean energy provisions in the IRA could go a long way in stimulating sustainability-focused projects and financing activity within the U.S. economy. To learn more or talk about how the IRA is impacting the projects you're working on, please reach out to our Corporate Solutions team at [email protected].  

 

References

1 Marcacci, S., 2022. “The Inflation Reduction Act Is the Most Important Climate Action in U.S. History.” Forbes.com. August 2, 2022. https://www.forbes.com/sites/energyinnovation/2022/08/02/the-inflation-reduction-act-is-the-most-important-climate-action-in-us-history/?sh=4e26019434db.

2 According to Investopedia, Property Assessed Clean Energy (PACE) loans are a type of financing available to make energy efficiency upgrades and renewable energy improvements at a commercial or residential property. For more details visit: https://www.investopedia.com/terms/p/property-assessed-clean-energy-pace-loan.asp.

3 United Nations Environment Programme. 2022. "Emissions Gap Report 2022: The Closing Window — Climate crisis calls for rapid transformation of societies." Nairobi. https://www.unep.org/emissions-gap-report-2022

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