HOW FINANCE SUPPORTS COAL

Commercial banks, insurance firms and investment companies play an important role in enabling major coal projects such as coal mines, coal power plants and the associated infrastructure and allowing the coal industry to operate. This webpage describes the financial services that each of them provides to projects and companies in this sector.

Dedicated finance at project level

Coal projects come with striking price tags and are often financed through a financial package that combines both equity and debt. Both are paid back from the cash flow generated by the project.

  • Equity, a direct share of ownership of the project, is provided by investors which can be coal companies or institutional investors like pension funds.
  • Debt is provided by commercial banks, often operating together as a syndicate.
  • Public finance is also very common in project finance: loans from developments banks or guarantees from export credit agencies lower the financial risks of a project and facilitates the participation of private investors and banks in highly risky markets.

Commercial banks are not only instrumental in financing new coal projects through project finance or other kinds of dedicated finance; they also play an essential role in making projects bankable: Through advisory mandates starting at the early stages, one or two banks are usually responsible for making the project fly and for structuring its financing.

Insurance coverage at project level

In addition to funding, coal projects need insurance. Coal mines, coal-fired power plants and associated facilities (such as railways and coal ports) are capital intensive and face serious physical, technical, legal, political and management risks; as well as the risk that other parties to a contract will not meet their obligations. Few such projects would advance without some kind of insurance cover, which is required to secure project financing and obtain authorisation. Insurers thus play a critical role in new coal projects.

Beyond the construction coverage, property coverage for projects that are already built are necessary and insurers are also crucial in enabling the operation of existing coal projects. Cover can be provided on a project basis, through stand-alone insurance (also called single-site), or to several projects together. In that case, existing coal projects might be insured along with other types of assets.

Not all insurers underwrite the risks related to the coal industry. The market is quite concentrated, with few major insurers able to have the expertise required to insure such gigantic risky projects.

New coal projects tend to require reinsurance coverage, when insurers transfer all or part of the risks they underwrite to reinsurers (such as Swiss Re, Munich Re, Hannover Re, and Scor), mainly through facultative reinsurance.

Financial services at corporate level

⇒ Banks do not only finance specific coal projects or activities. Project finance accounts for a very small share of total financing to the coal sector. The bulk of finance is provided through corporate finance, when banks indirectly help companies to build and operate new and existing coal projects, either by providing corporate loans or by acting as their agent on the financial markets, allowing them to issue shares and bonds.

⇒ Insurers do not only insure the properties of coal companies. They also provide several other types of coverage to coal companies, such as liability coverage. Directors & Officers (D&O) cover protects the managers of coal companies from claims related to decisions and actions they take. Part or all of the risks can be transfered to reinsurers, usually along with a mix of other types of risks and/or assets, through treaty reinsurance.

Companies issue shares and bonds to raise capital.

● Shares represent an ownership interest in a corporation: shareholders are paid in dividends, the amount of which depends (among other things) on the corporation’s profits.

● Bonds are a form of long-term debt: while bondholders have no ownership in the company, the bonds they hold are paid back by issuers with fixed interest after an agreed period.

Institutional investors (pension funds, insurance companies, foundations, investment managers, investment banks, etc.) buy large quantities of shares or bonds with the aim of achieving a return on investment. The activities of institutional investors can be diverse and complex:

● Pension funds, insurers and foundations are considered to be asset owners: they are responsible for safeguarding pensions and other assets of individuals, and have a fiduciary duty to act in the best interest of their beneficiaries.

● Investment managers manage funds for third parties. Pension funds and foundations, for instance, mostly outsource the daily management of funds to investment managers through investment mandates.

● While some insurers rely on external investment managers, major ones also manage (part of) their funds internally. Additionally, they manage funds for third parties. Hence, insurers can be considered to be both asset owners and investment managers.

● Banks also combine different activities. While financing is usually their primary business, they are often also considered to be investment managers (managing funds on behalf of third parties, e.g. retail clients) and even asset owners (e.g. providing pension provision and insurance products to their employees).

See the Coal Policy Tool