Storing the Future: Data Centre Financing in the United Arab Emirates
Financial Services Focus
In recent years, the UAE has grown as a hub for technology and innovation. Complementing this growth has been a surge in demand for data infrastructure, and along with it, the rise of data centre financing.
Law Update: Issue 365 - Financial Services Focus
Mark BrownPartner,Head of Projects
Kay NgAssociate,Banking & Finance
In recent years, the UAE has grown as a hub for technology and innovation. Complementing this growth has been a surge in demand for data infrastructure, and along with it, the rise of data centre financing. With this growing trend, we detail the typical financing structures, the key features of a data centre financing in the UAE.
Financing of data centres involves a spectrum of structures tailored to meet the unique needs of stakeholders. The choice of structures reflects investor dynamics, role of the operator, the offtake arrangements and risk being assumed by the financiers.
Corporate Debt Financing Model: Within this framework, the borrower enters into traditional debt structures from its relationship banks to fund its corporate objectives generally, which involves the development, expansion or acquisition of data centre facilities. Pricing of these transactions will be relationship, rather than project, specific. This conventional approach provides a reliable foundation for many operators.
Project Finance Model: A more intricate structure, project finance, hinges on lenders extending credit based on the anticipated cash flows generated by the offtake contracts of the project that the loan is funding without recourse to the sponsors of the project. Such loans are generally secured by the assets of the project company that is specifically incorporated to undertake the project. This type of financing is compatible with operators aiming to secure off-balance limited recourse financing with sufficient credibility and track record, along with the credit rating of the offtakers.
Real Estate Financing Model:In the UAE market, data centre financings are frequently structured following the real estate financing model, given the perception of data centre as an emerging real estate asset class. In this model, similar to a project financing, lenders place emphasis on the value of the property and cashflow and seek to ringfence cashflow and the business operation of the obligor group to safeguard its position (at the expense of constraints on the data centre operator). The finance documents will contain covenants, requirements and limitations related to the data centre. For instance, if the offtake terminates or the data centre is not constructed on time, the operator may find itself in default of the finance documents.
Sale-leaseback Arrangement: This is an arrangement under which the data centre operators opt to monetise existing assets by selling data centre facilities to lenders and subsequently leasing them back. This strategy injects capital into operations while allowing operators to retain operational control.
With that background, given its prevalence let’s focus on financing of a data centre based on the real estate financing model. Recurrent characteristics inherent in this particular financing approach include:
Debt Sizing:Debt sizing is closely tied to financial models and gearing ratios, often necessitating shareholders’ equity contribution commonly ranging from 20% to 30%+ of the total project expenditure with debt financing addressing the balance. The strength of the offtake arrangements and track record of the borrower underpin this analysis as well.
Security Package: The security package usually encompasses all the data centre assets, revenue, key contracts, the land rights on which the data centre is to be constructed, insurances and shares of the borrower or the operating company. Guarantees are also commonly provided by sponsors to cover the payment obligations and liabilities of the borrower – a key difference to non-recourse project financing.
Real estate: each Emirate of the UAE has its own set of real estate laws governing ownership and leasehold rights for both UAE and foreign entities, the development of real estate and the registration of real estate interests. The location of the data centre and the rights held by the borrower will dictate what can be secured to lenders. Real estate interests that are registrable freehold, usufruct, musataha or long-term leases and easements. Special approvals may be necessary where land is owned by the government and leased to a data centre operator for development.
Offtake Contract: The offtake contracts are of utmost importance as the primary revenue stream for data centre projects. These can be in the form of a lease or colocation agreement. Lenders will usually undertake a comprehensive due diligence, engaging technical and legal advisors to identify and address potential risks of these offtake contracts, including the payment obligations and early termination rights for the offtakers. The structure of offtake agreements becomes a pivotal question, with lenders often stipulating conditions like a minimum contracted capacity utilisation of the data centre or the necessity for additional offtake contracts as a prerequisite for funding. The nature of the offtake agreement will determine the suitability of the financing structure, the loan terms, interest rates and overall risk mitigation strategies.
Maturity Length and Repayment of Loans: The loan tenure typically ranges from 10 to 12 years. Lenders usually provide a grace period during the construction stage during which the obligor is not obligated to make principal repayments. This grace period reflects the time taken to complete the project, or a phase of it, and revenue commencement. The repayments are amortised over the term and can involve a substantial bullet repayment at maturity.
Financial Covenants: Typically, lenders in data centre financing commonly impose the ratios, such as debt service coverage, to suitably measure the ongoing feasibility of the project against the loan repayment.
Cash Sweep: A data centre financing often includes a cash sweep provision under which the cash is taken or swept from the operator’s bank accounts and applied to pay down its debt. Where all revenue from the project is ringfenced parties will agree an excess amount to systematically reduce the final repayments after the operator’s operating costs and regular debt service have been paid. The amounts can escalate progressively over time as the project moves from early operation to mature asset.
Distribution Test: Tied to the cash sweep is the amount lenders permit to be distributed to the sponsors during the term. While the priority is ensuring the debt load of the project is suitable, distributions to project sponsor are permitted after meeting distribution conditions tied to the performance of the project and the operator/borrower.
Direct Agreement with Offtakers: Lenders will typically seek a direct agreement with the offtaker and the data center operator, to provide contractual comfort to the finance parties in case of a default and in recognition of their security. The offtaker can commonly have a standard form of agreement they aim to use in these situations which balance the competing interests of lender and offtaker to preserve their own occupancy rights in the event of unforeseen circumstances.
Data centre financing in the UAE remains in its infancy. The establishment of new data centres and expansion of existing capacity is certain as the data needs of the country grow and data localisation by companies continues. As projects mature, we expect a broader use of financing models found in other jurisdictions where the industry is more progressed. Until then, there will be plenty of opportunities for banks to shape this corner of the market and be architects of a sustainable and resilient data centric future.
For further information,please contact Mark Brown and Kay Ng.
Published in February 2024
