4.1. FACTSHEET-FINANCIAL INSTITUTION GUARANTEE

A financial institution guarantee is a guarantee provided by a financial institution (e.g. a bank or surety) to pay if an operator defaults on its obligations. This includes ‘bank guarantees’ and ‘letters of credit’, ‘surety bonds’ and ‘performance bonds’. Issuance of a guarantee by a financial institution is generally supported by the payment of a premium and/or through the deposit of cash, securities or other assets for all, or a percentage of, the value of the guarantee. If the operator, known as the principal, defaults on its obligations to the regulator, the financial institution pays or performs according to the contractual arrangements instead of the operator up to the amount of the guarantee.

A financial institution guarantee is common for foreseen liabilities. While it can be used for unforeseen liabilities, usage is generally limited because of the requirement for collateral.

ADVANTAGES

DISADVANTAGES

✓ Should not be affected by negative changes in the operator’s financial strength or its dissolution provided the policy provides that it is payable in the event of the operator’s insolvency or dissolution.

✓ Available from the time it is issued, meaning that the risk of waiting for funds to accumulate is avoided.

✓ Creates an incentive for operators to minimise the risk of environmental damage by introducing or maintaining an environmental management plan in order to access guarantees.

X Must generally be renewed on a regular basis (usually between one and five years). There is a risk that the operator may not be able to renew if their financial circumstances have worsened.

X Providers are likely to require collateral, such as shares, cash or real estate, as security, meaning that these assets are not available to the operator for ordinary commercial purposes (e.g. for working capital or used to raise debt finance from a lender).

X Delays and legal expenses may be incurred if there is legal challenge when the guarantee is called upon.

Important considerations – financial institution guarantee

Basic considerations	The provider must be authorised to provide that guarantee in the jurisdiction. The institution’s financial strength. Whether the FP provides for the estimated environmental liability Whether the FP is payable to the regulator on demand Whether the FP provides protection against insolvency or dissolution of the operator and is protected from inflation.
Documentation	The following documents are generally required: legally binding FP document, details of the amount of cover and the cost profile, evidence of authorisation of the institution or parent to provide the FP and evidence of any supplementary cover required to cover gaps in the primary cover, guarantee, evidence of financial strength of the financial institution guarantee provider. Template documents can help ensure the key aspects are covered.
Documentation specification	Generally, the documents will specify: the triggering event, that the regulator may make a demand in the case of a triggering event or insolvency or winding up, requirements in relation to reporting, notifications of cancellation/expiration and replacement and inflationary adjustment and specification that the regulator may require provision of alternative FP upon cancellation/expiration, that the regulator may make a demand in the case of non-renewal, how the guarantee can be drawn down with reference to the cost profile of the operation.
Reporting and monitoring	This will include: triggering events, developments that affect ability to ensure provision, withdrawals or demands, performance of the institution/fund/asset, environmental compliance, the level of the liability against the value of the FP, restoration progress reports, notification of cancellation, expiration, renewal or non-renewal and expiry dates, progress on cost profiles and restoration and expiry dates of the guarantee.
Enforcement	A demand will be made on the FP if the triggering event arises. The regulator may need to take enforcement action in the event of declining financial health, value or performance or where the required reporting is not provided. The regulator will need to make sure that the financial guarantee is maintained/renewed/acceptable or require a replacement provision and may need to act in the case of declining performance of the institution.