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What Do the Proposed Basel III Endgame Regulations Mean for Investment in Transferable Tax Credits?

What Do the Proposed Basel III Endgame Regulations Mean for Investment in Transferable Tax Credits?

The year 2008 was notable for the United States. Barack Obama became the country’s first African-American president-elect, some of America’s best athletes participated in the Olympic Games in Beijing, China, and the Global Financial Crisis (GFC) occurred.

This financial emergency was the most severe worldwide economic crisis since the Great Depression, causing the U.S. housing market to bust and large amounts of mortgage-backed securities to plummet in value. Fears of another economic downfall rose in 2023 with the biggest bank failure since 2008, when First Republic Bank was taken over by JPMorgan after regulators took possession of its assets. And, not long before that came the collapses of Silicon Valley Bank and Signature Bank.

Financial experts who have reviewed the 2008 crisis postulate that it occurred because a lot of big banks had too little capital. Due to this, regulators both in the U.S. and around the world increased the minimum amount of capital banks must have.

In 2013, regulators in the U.S. began implementing a framework referred to as Basel III, which was developed by the Basel Committee on Banking Supervision (BCBS). Why the moniker Basel? The committee meets in Basel Switzerland.

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The Basics of Basel III

The set of measures BCBS developed and rolled out over the past decade or so are designed to strengthen the regulation, supervision and risk management of banks. Basel III applies a 100 percent risk weight to non-publicly traded equity under ten percent of a bank’s total capital.

The regulatory framework recently entered its end state, with the process often referred to as Basel III Endgame. In July 2023, the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) — the three agencies responsible for deciding on bank capital requirements — issued a Notice for Proposed Rulemaking (NPR) for Basel III Endgame. The initial deadline of November 30, 2023, for public comment was extended to January 6, 2024.

What changes would this proposal precipitate for the U.S. financial industry? Primarily, it would force many banks to increase their aggregate Tier 1 equity capital by 16 percent, ten percent for regional banks. The increase would be 19 percent for large global banks. For the eight largest banks in this country, Basel III Endgame would increase capital requirements by 20 percent or more. The FDIC estimates an aggregate 16 percent increase in common equity requirements for affected banks.

Another goal of Basel III Endgame is to close gaps in the regulatory requirements to prevent bank failures like those in 2023. The new rules mandate that banks quadruple the risk weights assigned to tax equity investments, a move that would force such financial institutions to markedly raise the amount of capital they set aside for renewable energy projects. Banks with values that exceed ten percent would apply a 400 percent risk weight.

The agencies responsible for the Notice for Proposed Rulemaking (NPR) for Basel III Endgame predict that the new regulations will improve the consistency of capital requirements across banks, better match capital requirements to risk, reduce their complexity and improve transparency of banks’ financial conditions for supervisors and the public. The Federal Reserve, the FDIC and the OCC are expected to vote on this final rule sometime in 2024, and it would take effect on July 1, 2025, with a three-year phase-in of the capital ratio impact through June 30, 2028.

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The Possible Impact of the Proposed Regulations

Opposition to the proposed Basel III Endgame proposal has been swift and broad, especially in the banking industry. Numerous advocacy groups and policymakers warn that its stricter capital requirements will raise the cost of credit while reducing access to it and negatively affect everything from mortgage loans to renewable energy projects and investments.

Investment in renewable energy projects typically relies on tax equity financing. The proposed new rules likely would reduce banks’ capacity for investing in such projects and decrease the effectiveness of tax incentives designed to spur projects promoting renewable energy.

The main objective of the tax credit transferability feature ushered in through the Inflation Reduction Act (IRA) is to provide more capital to developers of renewable energy. This transferability is reported to have represented up to $9 billion in renewable energy transactions in 2023 — only six months after the Internal Revenue Service (IRS) released its guidance on the program.

Before the IRA was enacted, the buyer of investment tax credits (ITCs) had to share in the project’s risk. Now, the buyer only has to be able to utilize the credits they purchase. It is a less complex approach compared to tax equity partnerships and decreases necessary documentation. Renewable energy ITC term sheets are at least one-third less lengthy than those used in tax equity transactions.

Increased capital requires more buyers than traditional tax equity investors, and the planned risk-weight rules of Basel III Endgame would make it more difficult for banks to deploy what traditionally has been invested in the past. The proposal also would present headwinds into the tax-equity investment market — JP Morgan Chase and Bank of America collectively have represented almost half of the approximately $20 billion worth of annual transactions.

Whether the tax credit transferability initiative along with new renewable energy project buyers will be able to make up the gap if the Basel III Endgame proposal is approved remains to be seen. Some large transferability deals have taken place recently, including a “first of a kind” transaction between Invenergy Renewables-owned Blackstone and Bank of America.

In this deal, Invenergy agreed to sell tax credits worth $580 million to Bank of America (BofA) and put those funds towards buying 14 projects from American Electric Power. If the Basel III Endgame proposal is put into action, it would most likely impact BofA’s future ability to purchase ITCs.

Bank of America acting as an intermediary in this transaction is notable. The enactment of Basel III Endgame regulations might impact such other large banks by moving them from purchasers of transferable renewable energy tax credits to intermediaries.

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REOX: Your Reliable Partner for Renewable Energy Projects

At REOX, we lead the charge in transforming the renewable energy market through our innovative exchange platform, driven by the IRA. By simplifying the tax credit market complexities, we empower developers and buyers, accelerating renewable energy adoption while fostering economic and environmental sustainability.

Stay updated on news about Basel III Endgame through REOX Insights.

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