Electricity distribution networks operated by distribution system operators (DSOs) form the regional segments of the electricity grids. DSOs deliver electricity from the supra-regional transmission systems, operated by transmission system operators (TSOs), to end consumers. In Germany, there are only four TSOs (Amprion, 50Hertz, TenneT and TransnetBW), which manage a grid of around 37,000 km. In contrast, the distribution systems span more than 1.8 million kilometres and are operated by over 860 DSOs.
Ownership of and significant influence over DSOs lie predominantly with municipalities and their municipal companies (so-called Stadtwerke), and in some cases with private-sector utilities.
Distribution systems are especially important to municipalities, as they enable local participation in the energy transition, foster positive public perception, and generate revenue. Consequently, municipalities seek strong DSOs able to handle key tasks and meet expansion needs.
Investment needs of German DSOs are rising rapidly in the coming years, driven by electrification, e-mobility, heat pumps, data centres, and the large-scale expansion of renewable energy. A recent PwC report commissioned by the KfW Group estimates that approximately EUR250 billion will be required by 2045 for electricity grid expansion alone, and more than EUR535 billion for transformation investments overall, with heat generation and distribution as the main additional investment drivers. The lion’s share of investments will need to be made between 2030 and 2035. Beyond implementing the energy transition, municipalities face additional financial burdens—such as upgrading water and wastewater infrastructure and other essential public services. At the same time, municipal budgets are often tight: dividends from municipal utilities are required to support core budgets. Traditional municipal loans reach their limits when financing large-scale investment programs, which can affect credit ratings, leverage, and the choice of investor-compatible structures.
Consequently, financing the transformation cannot rely solely on traditional instruments—primarily internal funding from shareholders, loans from regional banks, and public subsidies. New, innovative models are being explored to close short- and medium-term financing gaps. At the same time, investors may use already proven structures developed in project financing of energy projects and other infrastructure sectors. In addition to plain equity participations, structured equity and debt instruments are emerging, designed to meet both municipal interests and investor requirements.
The following overview outlines the key regulatory framework, proven investment and financing structures, and practical implementation considerations. A concise market summary concludes this client alert.
Regulatory Framework
Electricity distribution systems can be considered natural monopolies and are regulated accordingly at various levels. Regulation under energy law—particularly the Energy Industry Act (EnWG)—primarily aims to ensure a secure, affordable, consumer-oriented, efficient, environmentally sustainable and greenhouse gas-neutral grid-based electricity supply for the public.
In addition to the requirement for a license to operate the grid (see (a) below), a distinctive feature of German regulation for distribution systems is the granting of concessions by the respective municipality (see (b)). Furthermore, DSOs are required to be independent to prevent discrimination against other players in the electricity market; to this end, specific unbundling requirements apply, mandating legal, organizational, informational, and accounting separation from other energy-related activities (see (c)). State aid rules are crucial in transactions with the public sector, and certain procedures have proven effective in ensuring compliance with them (see (d)). When dealing with municipalities, additional particularities must be considered, including varying municipal law requirements across the federal states (see (e)).
(a) Licensing requirement
According to Section 4 EnWG, commencing operation of an energy supply network requires a license issued by the authority responsible under the laws of the relevant federal state. This license can only be denied if the applicant is not sufficiently staffed, lacks the necessary technical or financial resources, or does not demonstrate the reliability required for long-term system operation in line with EnWG regulations. Importantly, the license must not only be obtained when a DSO starts its operations but must also be maintained at all times. Consequently, operators are expected to secure strong and sustainable funding to meet rising demand.
The specific powers granted to the German regulator differ between the supervision of TSOs and DSOs. While general regulatory guidelines apply to both, the law explicitly allows the regulator to mandate a capital increase for TSOs if required grid expansion investments are not carried out. Such forced capital increases could enable external investors to participate, potentially altering ownership structures and voting rights; the existing shareholder are not directly subject to funding obligations, though. DSOs, by contrast, are not subject to such statutory capital increase requirements. Nevertheless, regulatory interventions may have similar effects, such as imposing investment requirements or adjusting revenue caps.
(b) Concession requirement
To operate an electricity distribution system, a contract for the use of public transport routes is needed. These rights are awarded by the respective local authority through a competitive procedure, in accordance with Section 46 EnWG, via right-of-way agreements known as concessions. While these procedures are based on public procurement law principles, they are not directly governed by public procurement regulations.
The objective is to select the bidder who is best suited to operate the system in the concession area safely, affordably, efficiently and with consideration for consumers and the environment. The concession is formalized by a comprehensive contract for long-term cooperation, often with terms of up to 20 years.
In practice, many concessions have been awarded around 2010, so that a significant increase in award procedures is expected around 2030 when many 20-year concessions will expire. The process for re-awarding the concession must be initiated by public notice two years before the end of the contract term. In several instances, award procedures have resulted in re-municipalization, as concessions were granted to companies ultimately owned by the municipalities, either alone or in partnership with other public or private energy companies.
Concession agreements frequently feature change-of-control clauses that require municipal involvement if there is a shift in operator control. As a result, when shareholder-level transactions impact DSOs, municipal officials need to be involved early on, including throughout the term of the concession agreements.
(c) Unbundling regulations
Unbundling is a central regulatory tool in energy law, requiring system operators to separate operations from generation and distribution. The EnWG mandates legal, organizational, and accounting separation, but the law grants more flexibility to DSOs than to the tightly regulated TSOs.
According to Section 7 EnWG, DSO operation may be carried out by a newly founded or existing company, provided it is separated from other energy supply activities. The EnWG requires legal unbundling, but not ownership unbundling, for DSOs—unlike TSOs. Municipalities are therefore free to choose whether to transfer ownership of distribution systems to a new company or simply lease the systems to it.
Section 7a EnWG specifies the details of unbundling, requiring actual independence through sufficient and independent personnel and organizational resources. In practice, this is often achieved by establishing independent DSO companies—an approach that facilitates investment in such special-purpose entities.
(d) Public procurement, state aid and antitrust aspects
The specific requirements for awarding concessions under Section 46 of the EnWG are supplemented or superseded by public procurement law—namely Sections 97 et seq. of the Act against Restraints of Competition (GWB)— only when the award involves the procurement of goods or services. This is not the case for standard concession awards under Section 46 EnWG. At the same time, there is a reliable presumption that the concession complies with the prohibition on granting state aid under Article 107 Treaty on the Functioning of the European Union (TFEU), because the procedures under Section 46 EnWG always require a competitive process.
(e) Local government specifics
Many distribution systems are owned by local authorities and their municipal companies. In this context, specific political and legal considerations must be addressed, including approval requirements from municipal bodies or supervisory authorities. Municipal codes regulate the conditions for economic activities and investments in companies. Detailed municipal law requirements vary between federal states.
For example, under Section 122 of the Hessian Municipal Code (HGO), a municipality may only participate in companies if its liability is limited and it retains an appropriate level of control. When holding a majority stake, municipalities are required to ensure proper economic planning and adherence to prudent financial principles. The municipality’s obligation to make additional contributions must generally be excluded or limited. Various transparency obligations relate to agreed arrangements. These may stem from the rights of municipal bodies or from transparency and freedom of information laws, which—depending on state law—can require disclosure of contractual agreements.
Participation structures
(a) Preliminary considerations
Structuring considerations typically start with an independent target company to which the DSO activities have been carved-out. If the assets are not yet consolidated in a separate entity, conversion measures (such as spin-off, demerger or merger) are advisable to benefit from universal succession; any continued joint and several liability resulting therefrom under statutory law is generally manageable. During this separation process, it is particularly important to ensure the viability and unbundling of IT systems.
(b) Participation of external shareholders
Once the distribution systems have been spun off into an independent system company, it is often easier for local authorities to admit external shareholders. The size of each shareholding can vary. Financially strong municipalities may pursue majority models or joint ventures to attract private capital and expertise. The joint venture agreement then governs management nomination rights and specifies reserved matters requiring approval from both shareholders. Another important topic is transferability of shares, further governed by transfer restrictions and specific exit procedures.
Often, a municipal minority participation of up to 24.9% is sufficient to maintain strategic influence, with the relevant provisions included in the joint venture agreement. In conjunction with guaranteed dividends in favour of the municipality, this structure can provide revenue security and predictability without relinquishing full control. In this context, the question arises as to whether deconsolidation of the participation—including the associated debt financing—is actually intended. Tailor-made solutions, such as preference shares with scheduled repayment of the investment, can offer a cash flow-oriented alternative with clear exit paths (e.g., put options or auction rights).
(c) Sale and leaseback
From an investor’s perspective, an investment focusing solely on fixed assets (“AssetCo”) is a viable alternative; operating units then remain under municipal control. Such structures, which separate ownership from operation (e.g., sale and leaseback), can enhance liquidity. However, they require close coordination with municipal authorities due to concession and regulatory considerations, and often involve new awards of the concessions or adjustments to right-of-way agreements.
(d) Bundling and scaling: platform models for smaller systems
For smaller municipal utilities that cannot meet investment requirements and necessary transformation on their own, platform solutions offer efficient scaling. Consolidating several systems into a joint holding company, in which municipalities hold proportional shares, creates investment capacity, improves access to capital markets, and facilitates the implementation of digitization and resilience programs. Existing structures—such as HanseWerk in Schleswig-Holstein or the Thüga model—demonstrate the practicality of such combinations, despite occasional regional resistance to change (Kirchturmdenken – “parochialism”).
Debt financing options for DSOs
To meet the considerable financing needs of DSOs in the coming years, debt financing through bank and capital market-oriented instruments will be required. The main options are outlined below.
(a) Bank loans and Schuldschein loans
Bank loans are the traditional and most widely used financing instrument for DSOs, particularly as bilateral or syndicated corporate financing at the DSO level.
In addition, project financing structures may be considered, if the distribution system is owned and operated by an independent system company, separating it legally and operationally from the owner’s other activities (e.g., a municipal utility). A key prerequisite for project financing is that system operations are sufficiently profitable to ensure the company’s debt servicing capacity throughout the financing period. In each case, the applicable municipal code must be reviewed to determine which restrictions apply to companies with municipal shareholders (e.g. strict limitation to activities permitted under municipal law) and which restrictions apply to the shareholders themselves, for example regarding the provision of collateral. Any collateral provided by public entities must meet state-aid requirements, such as the private debtor test or the EU Commission’s Guarantee Notice.
Larger DSOs, in particular, are broadening their financing mix by adding Schuldschein loans—a capital market-oriented type of loan—to specifically attract institutional investors.
The sale-and-leaseback structures outlined in section 2(c) are typically combined with a loan taken out by the purchaser and lessor. As with project financing, the borrower should be established as an insolvency-remote special purpose vehicle.
These forms of financing are well established in the market and have been thoroughly tested. They offer flexible and, in many cases, cost-effective options, especially when combined with public development loans and programs.
Nevertheless, given higher capital requirements and increased refinancing costs in the banking market, there is a noticeable reluctance to offer very long maturities. Given the high overall demand, it is expected that bank loans and Schuldschein loans alone will not be sufficient to cover the debt financing needs.
(b) Structured debt financing and securitization
In addition to traditional forms of bank financing, various types of structured financing may provide for viable alternatives, enabling DSOs to raise debt capital in the capital markets through capital markets instruments or special purpose vehicles (SPVs). With these structures, it may be advisable to mitigate high transaction costs by establishing a common platform for several DSOs or by creating platform solutions (see (c) below). As a rule, refinancing platforms should be designed to avoid liability connections such as cross-collateralization or mutual default guarantees—meaning each municipality and municipal utility will only be liable for the financing it has actually used. Such models have long been used in the capital markets, for example, in the securitization sector as multiseller structures.
In terms of instruments, structured financings using registered bonds or bearer bonds may be considered. Repackaging loans via SPVs and true sale securitizations through securitization SPVs are also possible.
When structuring individual transactions, both regulatory requirements and the specific needs of domestic and international investors must be taken into account. Regulated institutional investors—such as insurance companies, occupational pension schemes, pension funds, or professional pension institutions—are often subject to special investment requirements, for example under the German Investment Regulation (Anlageverordnung) or comparable statutes. They may have specific preferences or requirements regarding asset classes for investments via securitized capital markets instruments.
Genuine securitizations with tranched bonds (i.e., asset-backed securities, or ABS) create differentiated risk profiles for different investor segments but are associated with greater legal and documentary complexity.
Alternatively, EU debt funds can also provide direct lending, allowing for flexible allocation of investor capital to grid infrastructure.
(c) Other financing components
Capital markets bonds issued by municipal utilities remain a relevant component of financing, but they are subject to issuer ratings, prospectus and follow-up obligations, and are typically more expensive than bilateral loans. Mezzanine instruments offer subordinated financing options that are close to equity, but they are associated with higher costs and increased requirements for financial covenants, including leverage and rating. Citizen participation models primarily contribute to public acceptance and local engagement, but do not meet large-volume debt or equity requirements. Overall, a robust equity base remains key to favorable refinancing and access to institutional capital. In addition, investment-friendly grid fee regulation with an appropriate return on equity can mobilize additional capital.
(d) Platforms
Market-entry barriers and follow-up obligations under capital markets law are generally higher for structured financings using capital markets instruments than for traditional loan financings, such as loans from a relationship bank or syndicated loans. For example, issuing a bond or other capital markets instrument typically involves more effort and higher costs for DSOs than traditional loan financing.
To facilitate access to capital markets, it is advisable to establish platform solutions that create synergies through standardized documentation and, where applicable, the provision of issuance platforms. These platforms can include securitization vehicles and other SPVs, granting DSOs easier and more cost-efficient access to capital markets. Successful practical examples of such support models in the refinancing of SME or housing loans include the securitization platforms for banks (PROMISE & PROVIDE) established by Kreditanstalt für Wiederaufbau (KfW) in the late 2000s. Similar investment brokerage platforms could now also be established to enable efficient capital markets refinancing for DSOs. With backing from the public sector or associations, these platforms would facilitate access to capital markets for the refinancing of energy infrastructure projects.
Market overview and trends
The German distribution system sector is characterized by strong municipal influence, 20-year concession cycles, and a significant ramp-up in investment. From an investor's perspective, six key developments are shaping the market:
- Public funding: Uncertainty remains regarding the extent and form of actual support for financing the transformation. While the German government's infrastructure package includes several announcements, they have so far not created the desired momentum due to lack of details and clarity around its implementation.
- Ownership and control structures: Municipal sole or majority shareholdings predominate, occasionally supplemented by minority shareholdings of private utilities or financial investors. Municipalities generally seek to retain strategic influence, which is simplified when relevant assets are already carved-out into a single company. Joint venture agreements can secure municipal influence rights, transparent reporting, and change-of-control mechanisms.
- Expansion and digitization: Electrification, growth in renewable energy generation, and increased grid connection pressure are driving the need for substantial grid expansion. Simultaneously, grids are being modernized with smart grid functions, controllable local system transformers, advanced measurement technology, and enhanced IT/OT resilience.
- Renewables and grid connection offensive: DSOs are experiencing a sharp rise in connection requests for photovoltaics, storage, and charging infrastructure. Bottlenecks are being addressed through standardization, accelerated approvals, and forward-looking grid development planning. Flexible feed-in and demand-side management concepts are gaining importance. The "first come, first served" principle is intensifying competition for grid connections and causing some market distortions.
- Consolidation and platform models: Smaller municipal utilities are pursuing economies of scale in procurement, financing, and digitization through regional platforms, joint ventures, and holding structures. Bundling facilitates access to capital markets, enhances professionalism in project implementation, and supports regulatory compliance.
- Financing trends and investor demand: In addition to traditional banking and Schuldschein markets, structured solutions are emerging, such as SPV/bond setups with fronting banks, capital markets debt instruments, ABS-like tranche structures, and debt fund financing. These broaden the investor base and enable precise allocation of risk/return profiles, in line with regulatory requirements and municipal transparency standards. Long-term infrastructure funds seeking stable, regulated cash flows are increasingly active, with ESG characteristics serving as additional drivers of demand and pricing.
Conclusion
The market is experiencing a clear acceleration in capital expenditure (CAPEX) programmes, digitization and the integration of renewable energies across all ownership structures. Expanding and modernizing distribution systems calls for pragmatic participation and financing structures that work for local authorities. Both equity solutions—minority stakes, preferred equity, and joint ventures— as well as debt solutions—fronting/true sale structures, capital markets debt, ABS, and debt funds—broaden access to capital. For investors, this creates strong investment opportunities.
Deal certainty improves with early analysis of concession and state aid issues, as well as thorough unbundling due diligence. Documentation needs to focus on governance, distribution policy, CAPEX control and restructuring mechanisms, tailored to municipal transparency requirements. On the financing side, the options outlined point to broader investor participation, including institutional investors seeking trancheable cash flow profiles and ESG-oriented strategies.
