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Ep344: Update on FEOC and Its Market Impact
00:13:18
Keith Martin, Norton Rose Fulbright partner, gives an update on the FEOC restrictions on use of clean energy tax credits, including compliance challenges, insurance constraints and how the market is responding.
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- [00:00]
A
Foreign. Welcome to Currents and Norton Rose Fulbright podcast. Today we're recording with my partner Keith Martin. He joins us to discuss the state of play on the fiat restrictions that were enacted as part of the one big beautiful bill and are now consuming a significant amount of our clients time and I guess ours too. Keith welcome back to the podcast. Todd.
- [00:24]
B
Thanks for having me.
- [00:26]
A
All right, so first, I know we're constantly being bombarded with questions about fiac, but not everybody is. So maybe just let people know, what are the FIAC restrictions?
- [00:38]
B
FIAC is a set of three restrictions on ability to claim tax credits on new projects. These restrictions do not apply to projects that were under construction by the end of 2024. There are the three restrictions are number one, a limit on the amount of Chinese equipment, other equipment provided by prohibited foreign entities that can be used in a project. This is called a material assistance limit. Number two is a ban on the ability of any US Taxpayer that has too much Chinese equity debt, debt or participation in management on claiming such tax credits. And then the third is a ban on claiming tax credits on projects that have contracts with majority Chinese owned entities that give those entities effective control over some aspect of the project. There are 13 contract clauses Congress said are forms of effective control.
- [01:44]
A
Okay, so we, you went into the detail there about the specifics, but. And you kind of touched on this already. But to which projects specifically do these apply? Is it only projects claiming ITCs? PTCs? How does, how does it work in terms of who knows who they who needs to be concerned about these fiat provisions?
- [02:03]
B
Anyone who is claiming a technology neutral tax credit, that's a tax credit on a project that is placed in service in after 2024. So in 2025 or beyond, it does. These restrictions do not apply though to projects that were under construction by the end of 2024 and are claiming what people call legacy tax credits. These were the earlier form of tax credits that still applied in some cases. The best way to think about FIAC is it's an effort by Congress to push the Chinese out of involvement in the US Renewable sector. So use of Chinese intellectual property, use of Chinese equipment, use of Chinese equity debt. All those things are potential challenges.
- [02:48]
A
And do all three prongs or all three types of restrictions apply to projects that start construction after 2025 or is there some type of phase in?
- [02:59]
B
There are two phases, two phase ins. Number one is if the project is completed by the end of 2025, it is not affected. I slowed down there a little bit because there could be a short tax year someone has in 2025, that could bring it into effect, but that would be a very unusual case. So if you finish in 2025, usually don't have to worry about FIAC. Of the three FIAC requirements, the first one doesn't apply to any project that started construction in 2025. So the limits on the amount of Chinese equipment, the limit does not apply to any project that was under construction last year.
- [03:39]
A
And what happens if you don't comply?
- [03:42]
B
What happens is you do not get the tax credits on the project. And that can be a big deal because these tax credits can amount to anywhere from 30 to 70% of the project cost.
- [03:54]
A
So it's not illegal, but it may mean that your project's not financially viable.
- [04:00]
B
Yes, that's right. You may not have a project.
- [04:02]
A
And how clear has the implementation of these rules been and how much guidance do we have from treasury at this point to implement the rules?
- [04:12]
B
That's a good question. The treasury issued a notice in February about the first part of the FIAC restrictions, the material assistance limits on use of Chinese equipment. The market is still waiting for guidance on the other parts. That guidance at the moment is not really expected until Q3 this year at the earliest.
- [04:34]
A
And so given one, that these are new kind of restrictions. Well, I know there were some FIAC restrictions before, but that in terms of how they're being applied to most of the projects that we work on, this is a fairly new thing that people are having to be concerned about. What are the kind of the pitfalls you've seen or what advice do you give to sponsors who are trying to comply with these rules to avoid in particular the effective control problem?
- [05:00]
B
Well, the two most common problems we have seen, and these both involve effective control, are general terms and conditions that apply to any equipment purchase contracts. So a developer would put out a set of general terms and conditions or agree to them in a master equipment supply agreement and then issue purchase orders under that master agreement over time. The most common problem is boilerplate language in those general terms that says the developer is entitled to use any intellectual property rights belonging to the vendor on a royalty free basis when in connection with the equipment it is purchasing. That is an automatic effective control provision if a purchase order that incorporates those terms is issued or was issued on or after July 4th last year. That's the most common problem. The second most common problem we're running into is most equipment vendors give warranties. Most warranties bar the customer from making repairs itself that will void the warranty. It is a problem under the FIAC rules, it's a sign of effective control if the vendor has an exclusive right to repair or maintain the equipment. As a practical matter, if the warranty will be voided if somebody else repairs it, that's an exclusive right.
- [06:24]
A
Okay. Shifting to how we manage that risk, of course we can get lawyers to look at these contracts, but one way that a lot of these risks have been allocated in the deals that we do is by going to the insurance market. So how. How has the insurance market responded to this risk? Are you able to get insurance to cover it? And if so, how does it work? Because the ramifications of not being compliant with fiat are so extreme.
- [06:53]
B
Let me take that in two steps. Bloomberg ran an article a month ago that suggested the tax equity market financings for projects with these sorts of tax credits has stopped. And that's not been our experience. Projects are still getting financed, but there are at least three tax equity investors who are not financing projects with potential FIAC issues for an unusual reason. They can't say conclusively that they are clean of FIAC issues. Many banks finance their operations by borrowing, and if they have 15% or more of their debt with Chinese lenders, then they have fiat problems that can't use the tax credits. Moving to the insurance Many, many companies sell the tax credits to other companies for cash. Reunion looked at all the public filings of the Fortune 1000 companies last year and found that 8.5% of them bought tax credits last year, up from 4.9% in 2024. Tax insurers are essential to sell tax credits unless the seller, the sponsor, has an investment grade parent who can stand behind indemnities to the tax credit buyer. Then you'll need a tax insurance policy. At the moment, the tax insurance policy is largely unwilling to insure FIAC risk. They put in an exclusion that says either this policy doesn't cover them or it is contingent on the treasury issuing additional guidance. That coverage is contingent on additional guidance. Not every insurer is in that category, but a large percentage of the insurers are.
- [08:39]
A
So maybe as the market develops and there's more clear guidance, it'll be possible to get insurance or you think this is going to be a long term situation?
- [08:47]
B
No, I think this is a typical pattern. When the domestic content bonus credit and energy community bonus credits first appeared, the tax equity market was not willing to price them into the deals, the sizing of the investments. But eight months later they were comfortable enough with it and in some cases went back retroactively and improved the pricing. This is a typical pattern whenever there's a new law. I think the reason the tax equity market is not as spooked by it is it uses counsel that have been are in the market day in, day out and have been reading this FIAC statute almost every day since May last year when it first started taking shape in the house. They feel by and large they understand it. The tax insurers are less engaged in the market, their counsel is not reading the statute as frequently and I think it will just take a little time for them to catch up.
- [09:43]
A
You touched on this also when you were talking about that Bloomberg article. But we've also seen now and I think the market's unsettled, exactly where it's going to wind up, but that borrowers have been asking lenders, and maybe tax equity investors too, to make representations that they are not going to cause a fiat problem and those parties are not used to giving reps. Usually they're the ones asking for reps, not making reps. So one, how important, how do you get the reps and to which projects do you think you really need the reps and where do you think this is headed in the market?
- [10:17]
B
I think it is important because the project owner will have to assess whether FIAC Part 2 applies to it. Is it a prohibited foreign entity, in which case it can't claim the tax credits? It would be if 15% or more of its debt is from Chinese lenders. So we have private credit funds, for example, that are pass throughs. Their, they're having to give certificates that once you look through, you're not going to see 15% or more of the debt coming from private, from Chinese lenders. Some of the banks that are tax equity investors are not in a position yet to give such representations and they're, they've, they're, they're stepping aside from the market for the time being. I would say the market is somewhat sluggish as a result this year because of the challenges with the tax insurers and to a lesser extent with some tax equity investors and lenders.
- [11:14]
A
So final question for you. More globally on the political stage. You know, there's some additional, you know, Trump is going to China and supposedly we think, and there's some, maybe some reordering of the chairs politically. Do you think there's any chance before the next election that any of this will be either made easier to comply with or if there's any way that some of this would be withdrawn or do you think there's just nothing's going to happen before November.
- [11:47]
B
I don't think it'll be withdrawn. I think the Trump administration is being a little kinder to China lately. Although he threatened 50% tariffs on any country supplying arms to Iran, he wants to have a good summit if one comes off in May. There was an interesting poll this morning that said that only 23% of Americans today have an unfavorable impression of China. So anti China sentiment is coming down, dropping rapidly. And I don't think the FIAC statute will be amended. There just won't be an opportunity this year in Congress. I do think the treasury has been looking for ways to make it workable. We saw that with the guidance that came out in February on the material assistance limits on Chinese equipment. We saw that last year in August, when the treasury was under pressure from Trump to make it very hard for new wind and solar projects to be considered under construction to lock in tax credits. The treasury resisted that and came out with something was workable.
- [12:42]
A
All right. Well, I guess only time will tell. Thanks for joining today, Keith.
- [12:45]
B
Okay, Todd. Always fun.
- [12:50]
A
You can find us online at www.projectfinance.law or send us an email at currentsnot jordanrosefulbright.com Please rate, review and subscribe on Apple Podcasts, Spotify or your preferred podcast app. Our show today was produced by Emily Rogers. Stay ahead of the Currents.