Financial Assurance Reforms – Pooled funds and the new role for Insurance Bonds

Aug 2017

Introduction

Mine rehabilitation and financial assurance (FA) is a hot topic at the moment, with many discussion papers and inquiries being undertaken by various levels and departments within government, including:

  1. The Commonwealth’s senate inquiry into mine rehabilitation (as it relates to Commonwealth responsibilities);
     
  2. The recent Queensland Treasury Commission’s ‘Review of Queensland’s Financial Assurance Framework’ (QTC FA Review) that reviews the FA regime in Queensland and across many jurisdictions, and provides a recommended solution for Queensland known as the ‘Tailored Solution’;
     
  3. The Queensland Government’s discussion paper ‘Financial Assurance Framework Reform’ (FA Discussion Paper)1 which further considers the QTC’s Tailored Solution and seeks public comment on the recommendation; and
     
  4. The Queensland Government’s discussion paper ‘Better Mine Rehabilitation for Queensland’ (Rehabilitation Discussion Paper)2, describing the new and improved obligations on resource companies to rehabilitate land post closure, in conjunction with the FA reforms.

This paper aims to provide  detailed analysis regarding the proposed changes to Queensland's FA regime, with specific consideration of the operation of the new pooled rehabilitation funds and the expansion of products available to provide third party surety for FA obligations.

The ‘Tailored Solution’

The QTC FA Review, and the subsequent FA Discussion Paper, proposes an alternative way for mining companies to provide FA to the Queensland Government.  This model, known as the Tailored Solution, is intended to provide more flexibility to the market and be more reflective of the risk profile of industry participants.

The new regime will categorise companies into one of four types:

  1. Representative Resource Entities;
     
  2. Significant Resource Entities;
     
  3. Other Resource Entities; or
     
  4. Small Operators.

A company’s category is primarily based on its credit rating and the size of its rehabilitation obligation.  The table below summarises the different categories.

Once a company is classified into one of these four categories, then the corresponding FA arrangement will be one of the following options:

  1. Representative Resource Entities will contribute to a Rehabilitation Fund.

Companies classified as Representative Resource Entities will be required to pay into the Rehabilitation Fund.  To be considered a Representative Resource Entity, a company must have:

a)  a rehabilitation liability of less than $500 million; and

b)  a credit rating of a B- & above (S&P or equivalent). 

Where the company does not have a credit rating, it can provide relevant financial information to the regulator for assessment.  If the regulator confirms that the company’s financial risk profile is acceptable, then it will participate into the Rehabilitation Fund. If not, then the company will be categorised as an Other Resource Entity and be required to pay a third party surety.

Representative Resource Entities participating in the Rehabilitation Fund will be required to make an annual payment determined by calculating the estimated value of the company's rehabilitation obligation by a rate that is attributable to the company’s risk profile (between 1% and 2.75%).

Contributions made will be placed into the Rehabilitation Fund, and the State may use those funds to rehabilitate a mine site that is transferred back to the State (such as in the instance of company liquidation).

It is intended that this category will be the most common within the resources sector.

  1. Significant Resource Entities will enter into a Selected Partner Arrangement.

A company will only be considered for participation in the Selected Partner Arrangement where it has large rehabilitation liabilities (i.e. above $500 million) and an extremely low risk of financial failure. If a Significant Resource Entity slips below an A- rating, the company may also need to provide Third Party Surety.

Significant Resource Entities participating in the Select Partner Arrangement will be required to make an annual payment that will be determined by calculating the estimated value of the company’s rehabilitation obligation by a rate that is attributable to the company’s risk profile (less than 1%).

  1. Other Resource Entities must provide a Third Party Surety.

    Resource companies with an elevated risk profile will be required to provide a financial surety for the full amount of the estimated rehabilitation obligation.

  2. Small Operators will enter into the Small Operator Arrangement.

    Smaller Operators will fall into either the Third Party Surety or the Rehabilitation Fund requirements, depending on the company’s risk profile. However, the amount of the surety or payment required will be reduced in comparison to larger resource companies.

The table below demonstrates the different categories of company and which type of FA will be required.

Rehabilitation Fund

It is proposed that resource companies categorised as Representative Resource Entities will contribute to the Rehabilitation Fund.  Members pay an annual contribution based on the company’s estimated rehabilitation cost (which should reflect the life-of-mine plans that require progressive rehabilitation) and financial risk.

The Rehabilitation Fund will accumulate payment contributions made by Representative Resource Entities and the State may draw down to meet the rehabilitation costs where a site is returned to the State (usually, because of company liquidation). 

The use of the interest earned on these funds is subject to further consideration. One option is for the State to use interest earned for other projects, such as the Abandoned Mine Lands Program, which tackles the legacy issue of mines historically abandoned. 

Companies classified as a Significant Resource Entity will also be required to pay into a fund under a Select Partner Arrangement. An amount will be paid into a separate pool fund, similar to the Rehabilitation Fund. However, these funds will be directed to other environmental initiatives by the Queensland Government (such as the Abandoned Mine Lands Program) instead of being held to respond to the outstanding environmental obligations of a failed Significant Resource Entity. Essentially, the Queensland Government will take on the risk of any rehabilitation required in the event of a Significant Resource Entity failing.

The concept of a Rehabilitation Fund has been generally supported by industry, but there are some concerns:

  1. The primary cause for concern is the relationship between these reforms and the regulator’s power under the Chain of Responsibility amendments. These amendments give the Queensland regulator the ability to require ‘related parties’ to undertake any required rehabilitation in circumstances of a company’s financial distress or failure.3

Notwithstanding that payment into the Rehabilitation Fund will be in lieu of a traditional security, it is unclear whether an amount paid into the Rehabilitation Fund will be used to respond, at all, to company failure prior to the site being returned to the State. It is possible that the regulator will rely more heavily on its new powers to require any related party, including company directors, management and financiers, to pay for the cost of a clean up or rehabilitation of a site where the company is unable to do so, rather than relying on the Rehabilitation Fund, or even amounts paid by the company into the fund.

  1. The fundamental benefit of the Tailored Solution to resource companies is that the Rehabilitation Fund represents a more cost effective means to secure its rehabilitation obligations. However, the amount that will be required to be placed into a fund, how that amount will be calculated, the initial provision of funds into the Rehabilitation Fund, and at what point existing securities will be released, are all currently unknown. More detail is required to allow resource companies the opportunity to understand and assess the potential impacts.
     
  2. The discussion papers do not provide detail regarding the treatment of unincorporated joint ventures, and in particular, the impact of joint venture parties having different credit ratings and therefore falling into different categories. The discussion papers also do not provide detail regarding how companies will transition into and out of the Rehabilitation Fund.

The concerns numbered 2 and 3 above will hopefully be resolved during the process of amending the legislation.  However,  the regulator is unlikely to will fetter its rights under the chain of Responsibility Legislation

Third party surety

For companies that are categorised as Other Resource Entities (and a subset of Significant Resource Entities and Small Operators), a third party surety will be required for the full amount of estimated rehabilitation costs.  Under the current FA regime, third party surety can only be given by bank guarantee, to be provided by limited Australian banks.

Under the Tailored Solution, a third party surety can be provided by a wider range of providers, including foreign banks and insurance bonds, on the following conditions:

  1. The surety is irrevocable, unconditional and payable on demand, and has wording acceptable to the regulator;
     
  2. The entity providing the surety has a credit rating of A- better;
     
  3. The entity providing the surety is regulated in a jurisdiction satisfactory to the regulator;
     
  4. Any legal disputes are dealt with under Australian law; and
     
  5. The surety providing entity is approved by the regulator.

Under the Tailored Solution, there is no discount scheme proposed to reduce the amount of FA required.  The total probable cost of rehabilitation will be required so that the FA held is equal to the actual estimated cost of rehabilitation.  However, it is anticipated that cost savings can be obtained by increasing the number of institutions that can issue FA, as well as the type of FA that can be provided. 

The QTC’s FA Review specifically discussed the possibility of using insurance bonds instead of traditional bank guarantees.  The FA Review states that in the United States of America, two-thirds of guarantees are provided by insurance companies.4  In addition, the FA Review quotes examples where a bank ‘fronts’ the guarantee with an insurance company sharing the risk ‘behind’ the bank.5 

It is anticipated that the introduction of offshore banking institutions and insurance bonds as possible traditional bank guarantee alternatives may result in cost reductions.  This is widely considered as a positive for the Queensland resources sector, however, there are some concerns:

  1. The high level of regulation within Queensland, and in particular, the Chain of Responsibility legislation, may dissuade new financial institutions (including both foreign banks and insurance companies) from providing financial products into the Queensland market.
     
  2. Companies classified as Other Resource Entities under the Tailored Solution may not have the financial wherewithal to be eligible to purchase the types of insurance bonds available within the Australian market. With the cost of traditional bank guarantees increasing,6 and the current discounting system scrapped, smaller or private operators may be left in a worse position than under the current regime if they cannot access alternative arrangements to satisfy FA obligations.
     
  3. The QTC FA Review and the proposed Tailored Solution do not consider the availability of insurance policies as well as insurance bonds, in order to manage the risk of the Queensland Government being responsible for rehabilitation and clean-up. Some Australian jurisdictions are considering the use of insurance policies and bank guarantees (or insurance bonds) together to manage environmental risk, subject to various conditions including:

a)  the regulator being able to activate the policy; and

b)  the policy responding where the business or company fails.

The ability to transfer some environmental risk that is offered by insurance policies should be further considered by Queensland’s regulators.

  1. Very few companies will have a rehabilitation obligation of less than $50,000 and therefore qualify for reduced financial assurance obligations under the Small Operator Arrangement.The value is too low, and should be increased to provide a financial benefit to the smaller participants in the resources industry.

Conclusion

The current FA regime in Queensland is outdated.  Feedback received for the purpose of preparing this article was clearly in favour of reform.  However, overwhelmingly, in addition to the concerns noted throughout this article, resource companies are wary that the Tailored Solution focuses on the ‘top end of town’ and will have a detrimental impact on the smaller scale and private resource companies.  As they say, the devil will be in the detail. 

We will keep you informed of all future developments.

....

1 For more information about the FA Discussion Paper, please refer to Part 1 of our article ‘Financial assurance, mine rehabilitation and closure – a new perspective on an old issue’, Johanna Kennerley and James Plumb.
2 For more information about the Rehabilitation Discussion Paper, please refer to Part 2 of our article ‘Financial assurance, mine rehabilitation and closure – a new perspective on an old issue’,Johanna Kennerley and James Plumb.
3 For more information, please refer to our newsletters, CoRA Guideline approved - But is it just a bandaid solution? and Has the Queensland Government overreached in its battle with Clive Palmer?
4 Queensland Treasury Corporation, Review of Queensland’s Financial Assurance Framework (2017) 21. The FA Review does not specify whether the insurance companies are providing bonds or policies.
5 Ibid.
6 Ibid 23.

This article may provide CPD/CLE/CIP points through your relevant industry organisation.