Crises are tricky moments. No matter how much you plan for them, each new one seems to surprise you in unpleasant ways. And just when you think you have acted decisively to contain them, you quickly discover how many new threats can spring up, like a forest fire spreading on a windy day.
But crises are also the perfect playground for what American sociologist Robert K. Merton termed “unintended consequences”. This is what happens when you take action in a certain manner expecting certain results…and then watch as your actions produce something altogether different from what you expected.
I’m sitting in a sunny office in Luxembourg hearing Philippe Maystadt, president of the European Investment Bank (EIB), describe how the organisation came to be in the peculiar position of keeping the European public-private partnership (PPP) market afloat during 2009 and 2010. And I am reminded of just how unintended these “unintended consequences” can be.
“What was planned for was an increase in the EIB’s lending in 2009 and 2010. That was planned and was carried out at the request of our shareholders after the European Union approved its recovery plan in late 2008. But the share of PPPs within this increased lending was not planned. That’s because the EIB is neutral on the procurement choices of its borrowers,” says Maystadt.
In practice, though, the bank was transformed into member states’ go-to lender to keep their PPP programmes alive when commercial banks retreated from the market to lick their wounds post-Crisis.
Not that the EIB was any stranger to PPP financing: over the course of its life, the bank has financed over €35 billion of PPPs across Europe, with 2009 and 2010 representing only €5 billion of that total. But what happened in those two years catapulted the bank to the pole position of European PPP lenders.
“In 2009 it was clear that we had to act as a temporary substitute for commercial banks. And 2010 was a record year for the EIB, as we lent almost €3.5 billion to PPPs. So I think the bank has indeed played a role in supporting the European PPP market,” Maystadt modestly concludes.
Which brings us to another “unintended consequence” that might explain Maysdtadt’s furrowed brow when acknowledging the EIB’s newfound prominence. Now that the bank has stepped forward in such a big way to help sustain the European PPP market, will it be able to step back without disrupting a market which is dependent on its presence?
“What I always explain to governments is that you cannot expect that the EIB will continue to lend more and more and act as a substitute for commercial lenders. Governments must create the conditions in which commercial lenders can resume long-term lending. Because you cannot expect the EIB to totally take over – that’s impossible,” he states.
Lobbying for long-term debt
This dependency – not only on the EIB, but also on other forms of public support for PPPs – is very much a known fact. In a recent report, the European PPP Expertise Centre noted that European PPPs are becoming increasingly reliant on “governments and public international financial institutions [for] funding and financial support”.
“It’s clear that the financial crisis has deeply affected traditional funding sources for PPPs and indeed it has provoked a shift from commercial bank debt to public financing institutions,” Maystadt acknowledges. “But I’m not sure that this will remain so in the future, at least not with the same scale.”
He continues: “Fortunately, we have seen that there is some improvement, already experienced in 2010 and ongoing in 2011, with more commercial credit available, longer tenors, and a slow decrease in pricing. This will hopefully mean that there will be less need for government support to bring deals to a close.”
But what about upcoming regulations like Basel III, which threatens to make long-term lending harder and more expensive for commercial banks to provide?
“Basel III is certainly an issue. I’ve seen some statements recently from chief executives of commercial banks saying that the new Basel III regulations will be detrimental to long-term lending. Some are quite explicitly resisting this regulation, complaining they will only be able to lend for 10 years. This is a problem for PPPs, which need long-term financing,” Maystadt says.
Of course, the EIB is unlikely to be directly affected by Basel III, as it is already “very well capitalised”, as Maystadt puts it. But Basel III could still have an impact on the bank if it leads to a decrease in commercial bank funding for infrastructure.
“If, because of a decline in financing from commercial banks, the EIB would be forced to act as a substitute for these banks, as happened in 2009, and if this were to be prolonged, then of course Basel III would have an impact on the EIB. We also have our capital requirements,” he explains.
That’s why Maystadt, together with the heads of several European state-backed banks, such as Germany’s KfW and France’s Caisse des Depots, and other long-term investors, including the Ontario Municipal Employees Retirement System, have formed the Long-Term Investors Club (LTIC), to lobby for more long-term investment as a way to avert future economic crises.
“One of the objectives of the LTIC is to draw the attention of regulators on the necessity of taking into account the specificities of long-term lending. So the debate [on Basel III] is not closed and we still hope we will be able to get some adjustments,” Maystadt says.
However, the EIB is not waiting around to see what the future long-term lending capacity of commercial banks will be. The bank is actively working to make sure that a new source of liquidity is available for European PPPs in what is perhaps its most ambitious project to date: the creation of a European bond market for PPPs.
The so-called Europe 2020 Project Bond initiative is a joint plan between the bank and the European Commission that aims to move private sector infrastructure bonds out of the lower echelons of the investment grade category and into A-rating territory, where a larger number of institutional investors will be, in theory, more comfortable buying them.
The EIB and the European Commission are proposing to enhance a bond’s credit rating by providing either a fully funded subordinated debt tranche or an unfunded subordinated debt guarantee. Both mechanisms will be able to cover up to 20 percent of a project’s senior debt. Subordinated debt ranks below senior debt and above equity.
Using bonds to finance European PPPs is, of course, nothing new. From 2000 to 2007, a €100 billion European infrastructure bond market thrived, mostly in the UK. This was largely due to the presence of monoline insurers which guaranteed, or wrapped, these bonds, ensuring that institutional investors would take on little risk when purchasing them.
But when the monolines collapsed following the financial crisis, this chunky slice of liquidity disappeared from the European PPP market.
Ratings agency Fitch gave the thumbs-up to the new project bond initiative in a recent report, stating that “the proposed mechanism would improve a transaction’s credit risk”, although Fitch said a bump to A-rating would depend on projects’ individual characteristics.
The mechanism also has obvious advantages for the EIB, given how it has had to increase its PPP lending. As Maystadt explains, project bonds “will allow us to contribute to the financing of PPPs without consuming too much of our capital”. This doesn’t mean project bonds should be seen as a warning that the bank is preparing to retreat from its traditional lending activities.
“We will continue to lend senior debt to projects because some member states will prefer this method,” Maystadt explains. “So the intention is not to decrease our lending. But, as I’ve said, we cannot continue to increase it – we have limits. And that’s why, at the same time, we want to complement our lending products with new instruments, like project bonds,” he explains.
Despite the warm reception that the project bond initiative has been receiving throughout the industry, there are obstacles to its implementation. Firstly, infrastructure bonds have never quite been part of the mainstream of European infrastructure financing, even when the monolines were around. As Fitch summarises it:
“The use of capital markets to finance projects marks a new trend in Europe. Some infrastructure assets are already bond-funded, but typically in a corporate manner (i.e. short to medium term) and for issuers that are either large operators with historical access to markets, or UK-regulated utilities.”
Fitch elaborates: “In theory, capital markets appear more suitable for the long-term financing of stable and cash flow-generative assets, as opposed to the bank loan market; however, in practice, this is not the way in which the European market has evolved.”
What Fitch is saying, then, is that it will not be easy to wean the European infrastructure market off its dependence on commercial bank debt. Equally, it will take some effort to convince institutional investors to step out of their comfort zone and start financing infrastructure projects. But that’s precisely where the EIB can step in and make a difference:
“Each institution has its own characteristics and I think one of the assets of the EIB is technical expertise in the appraisal of infrastructure projects. I would not say the same in every domain [we operate in], but in infrastructure, I think we have that expertise. And what investors have told us, especially pension funds that do not have their own technical teams, is that they want to be sure the EIB is free to appraise projects autonomously and that we will not be forced to propose projects for investment if we are not absolutely sure of their quality,” Maystadt explains.
He continues: “We got reactions from some smaller investors saying that if the selection of projects [for the project bond mechanism] is not in the hands of the EIB, then they will not get enough confidence to participate. These reactions came mostly from funds that are considering investing in infrastructure for the first time,” Maystadt adds.
This trust in the EIB’s appraisal process – “We have got a track record with no defaults,” Maystadt states – speaks volumes for the bank’s reputation in the European infrastructure market. But it also poses an interesting question. For how long does the EIB intend to maintain a presence in the project bond market as these deals’ sole guarantor and/or financier?
“We would be quite happy to lend our expertise to the launch of this instrument, but once this instrument becomes known in the market, we really hope other financiers will come in and also play a role,” Maystadt answers.
Sooner, not later
For the time being, there is a more pressing problem the EIB has to deal with: the 2014 scheduled launch date means the bank risks losing some of the momentum that the project bond initiative has gained with this year’s announcement and its subsequent public consultation.
At a recent meeting in Brussels to discuss the mechanism the “room was too small to hold all investors,” Maystadt remarked. But will the bank and the European Commission be able to sustain this high level of interest between now and 2014, when the mechanism debuts?
“There is a lot of interest from investors, but there is also a fear that this is a project for beyond 2014,” Maystadt acknowledges. “Investors would prefer to be invited to assess some offers of project development earlier.”
“Personally, I think that it would be a mistake to wait until 2014 to launch the first [project bond] initiatives. I think that if we are to have this project bond initiative fully up and running in 2014, it would be in our common interest to apply this instrument to real projects before that date.”
Of course, the launch deadline is not completely arbitrary. To apply the project bond mechanism as it is currently described in the consultation documents requires some change to the European Union’s financial regulations, all of which takes time.
But Maystadt is undeterred: “I still think it might be possible to try some pilot projects with the current financial regulations,” he says, before adding: “But this is my personal view – I can’t speak for the European Commission.”