The race to recapture a larger slice of the capital markets for infrastructure debt financing gathered speed earlier today after European Union (EU) leaders released the first details of their initiative to back private sector infrastructure bonds with guarantees and subordinated loans.
The Europe 2020 Project Bond Initiative, as the plan is known, is the brainchild of the European Commission (EC) and the European Investment Bank (EIB) and may not be fully operational before 2014. A public consultation on the initiative was launched this morning with a view to canvassing stakeholder contributions by May 2, 2011.
At its heart, the plan aims to enhance the creditworthiness of infrastructure bonds issued by private sector concessionaires to investment grade rating. Infrastructure public-private partnerships (PPPs), especially those carrying construction risks, rarely make investment grade until they are fully operational.
The prize is to capture the €100 billion European infrastructure bond market that thrived from 2000 to 2007, but disappeared in the aftermath of the financial crisis, when the monoline insurers went bust. It also aims to use the capital markets to provide the sort of lower cost, long-term funding that banks are increasingly unable to lend to infrastructure projects.
In order to kick-start the market, the EC/EIB partnership proposes to use two mechanisms, according to the needs of specific projects. It will either fund a subordinated debt position within these infrastructure bonds to “absorb much of the risk of insufficient cash being available to service the senior debt, thereby raising [their] credit quality,” the EC explained in a paper.
Or it will provide a debt service guarantee, perhaps taking “the form of a contingent credit line provided to the project entity by the EIB, which would inject funds into the entity if the project were unable to generate sufficient cash in the short to medium term to service its debt for any reason,” the EC said. The guarantee could cover a maximum of 20 percent of the total bond funding for individual projects, the EC added.
The two mechanisms will not be free, however, with the EC and the EIB to charge a one-time upfront fee to compensate their risk taking. While the EC did not disclose an amount, it said the fee charged will be set “at a level where it does not deter the bond financing it tries to support”.
The plan also hopes to leverage the EIB’s AAA rating and its vast experience as a funder of PPPs to assuage institutional investor concerns regarding the different risks these schemes carry. As such, “the EIB would subsequently carry out the due diligence and financial appraisal in the structuring phase, price the guarantee or loan and monitor the project thereafter,” the EC stated, adding: the “EIB may also be prepared to act as controlling creditor”.
The amount of money the EC will be able to deploy to the Project Bond initiative will be capped annually, the EC said. Philippe Maystadt, EIB president, said during the presentation that the bank will pay close attention to the impact of these risk-taking pieces. But he added the EIB’s capital adequacy ratio stood at 27 percent last year, “much more than any commercial bank”. Maystadt also remarked that the initiative, if successful, should allow the bank “to spend less money funding projects”.
As it stands, the EIB provides mostly senior debt for PPPs, having lent €3.4 billion to European PPPs last year and a total of €24.2 billion from 2000 to 2010. To see how the Project Bond may work, please check out the diagrams below.