As we have previously discussed, the European PPA market for corporate buyers is witnessing a dramatic uptick in activity in 2020, and is poised for continued growth in the coming years. U.S.-headquartered technology firms have been some of the first movers, but a variety of other buyers from different sectors and countries (spanning both the U.S. and Europe) are now beginning to transact. For any organization contemplating a PPA in Europe, there are some key accounting considerations to think through at the outset to help alignment across all of your stakeholders, including your finance and accounting teams.
Here are four key questions that corporate buyers need to ask themselves if they are evaluating a PPA in Europe.
Which accounting standard does your company report under: U.S. Generally Accepted Accounting Principles (GAAP) or IFRS (International Financial Reporting Standards)?
By nature, financially settled “virtual” PPAs (VPPA) are financial instruments structured as Contracts-for-Differences (CFD) where a fixed price PPA is settled against a floating wholesale index price. The accounting standards differ slightly under U.S. GAAP versus IFRS. Derivative treatment and mark-to-market accounting are inevitable under IFRS, whereas U.S. GAAP rules are generally less strict. This factor could influence an organization’s comfort and willingness to sign a VPPA in Europe, as PPAs with physical delivery do not require this treatment. It is worth noting there are ongoing efforts between the governing bodies, IASB and FASB, to reconcile the differences between IFRS and U.S. GAAP respectively, so this will be an important area to monitor.
If your company is U.S.-based, do IFRS standards apply for a European VPPA?
Not necessarily. If your organization’s shares are listed only on a U.S. exchange, it is more than likely that your consolidated annual financial statements (i.e. SEC Form 10-K) are issued only under U.S. GAAP. In situations where a company has dual listings on U.S. and European exchanges to raise capital in both markets, you may find yourself with added complexity to sort out when signing a VPPA in Europe, because your European business entity will be required to issue IFRS-compliant financial statements under European Union rules. IFRS reporting may also apply for certain foreign subsidiaries owned by a U.S. company operating in a foreign country where IFRS use is mandatory.
How will you value a VPPA over its term?
In IFRS mark-to-market accounting, you need to periodically analyze and revalue the derivative on your books to reflect its economic substance and meet the disclosure objectives under applicable standards. It’s important to consider how your company will go about tackling this exercise. Finance professionals are often accustomed to mark-to-market accounting of various types of hedges (commodities, energy, interest rates, etc.), but the long-term lengths of VPPAs and the volatility of wholesale electricity markets may introduce new complexities. Supporting long-term PPAs is typically not a core function within organizations, so a strategy to support ongoing monitoring and forecasting may be required to satisfy periodic revaluation of the contract on the books.
Is your organization already comfortable with hedge accounting under IFRS?
Many companies’ risk management practices already incorporate hedging activities. If this is the case for your organization, derivative or hedge accounting may be a routine activity for your finance and accounting teams. In this case, your challenge may simply be setting up the process to perform the periodic valuation of the VPPA.
Conversely, if your organization is new to hedges, it will have a steeper learning curve to overcome and you should plan accordingly in your procurement process. It can be helpful to work with an advisor who can perform post-execution monitoring services and understands typical needs when establishing these processes, ensuring end-to-end success in renewable energy procurements.
It’s exciting to witness the growth of PPAs in Europe, which can be a strategic option for companies looking to address their Scope 2 emissions in the region. However, this opportunity does not come without complexities and organizations that address these key accounting questions upfront will have a smoother experience executing these transactions. If your company needs assistance navigating these issues, please feel free to connect with us. We’d be happy to help.
Disclaimer: While 3Degrees is trusted commercial advisor for global renewable energy transactions, we are not a chartered accounting firm. We recommend that our clients engage their technical accounting staff and an external accountancy and auditing firm to achieve clear, actionable guidance.