Europe’s funding conundrum

You would think that by now, the words ‘financial’ and ‘engineering’ used in combination would be such a pair of dirty words that it’s hard to believe the European Union (EU) has a whole section on its Trans European Transport Networks (TEN-T) website dedicated to advising member states on how to leverage private funds.

Unpleasant connotations aside, it’s clear there are many good reasons why such a section makes sense in the context of planning and financing the EU’s interconnected transport corridors.

In fact, there are 1.5 trillion good reasons, as in the €1.5 trillion the EU is planning to spend on TEN-T projects between 2010 and 2030, a massively ambitious amount given that practically all of the continent’s governments are cash strapped, with some currently living through their own sovereign debt nightmares.

Little wonder

Given the context, there can be little wonder that the EU is trying to attract private investment via public-private partnerships (PPPs) and other similar mechanisms.

On the face of it, the good news is that, from an investor point of view, participating in the funding of TEN-T projects is somewhat easier than funding the EU’s Trans-European Energy Networks (TEN-E).

The latter, requiring an even more ambitious €1 trillion in funding over the next decade, posits several challenges to investors, including the regulatory and political challenge of trying to convince national regulators to set tariffs that will go towards financing cross-border projects.

When it comes to transport infrastructure, things are simpler for the private sector and, in some ways, advantageous. Simpler, because PPP legislation and procurement processes across Europe are fairly similar; advantageous, because the EU is doing its best to make sure TEN-T projects get access to private financing, which translates into funding incentives and substantial participation from the European Investment Bank (EIB) in TEN-T PPPs.

For recent examples of the latter, look no further than the two massive high-speed rail deals that closed this year in France: the €7.8 billion Tours-Bordeaux link – billed by its sponsors as the world’s largest concession – and the relatively smaller €3.3 billion Bretagne Pays de La Loire PPP. Both projects are part of the TEN-T programme and, as a result, obtained a combined €1.75 billion in financing from the EIB.

Tours-Bordeaux actually became the first French project to make use of the EIB’s and European Commission’s (EC) €1 billion Loan Guarantee Instrument for Trans-European Network projects, better known by its acronym, LGTT.

Launched in early 2008, the LGTT mechanism was designed specifically to attract more private sector investment to TEN-T projects. The mechanism works through “improving the risk profile of senior lenders” by mitigating traffic risk for these projects, the EIB explains in a paper on the financing of the TEN-T programme. It does this through “partially cover[ing] these risks and consequently improve significantly the capacity of a project to withstand lower than predicted traffic levels”.

If the EIB helps fund TEN-T projects on the debt side, then the €1.5 billion Marguerite infrastructure fund is the EU’s solution to providing equity for these deals.

Launched in December 2009 with €600 million in seed capital from six European state-backed banks – the EIB, France’s Caisse des Dépôts, Italy’s Cassa Depositi e Prestiti, Germany’s KfW, Spain’s Instituto de Crédito Oficial and Poland’s PKO Bank Polski – the fund went on to add three new investors when it reached a first close in March 2010, with over €700 million in commitments.

One of these new investors was the EC, which contributed €80 million to the fund, equivalent to 1 percent of the TEN-T budget for the period 2007 to 2013.

Mostly focused on greenfield projects, Marguerite will lean heavily toward TEN-T projects, with about 30 percent to 40 percent of the fund to be invested in the transport sector. In late September, the fund provided a taste of what may be to come when it showed up alongside Spanish developers FCC, Sacyr and Comsa to lodge a bid for a €1.36 billion stretch of Spain’s A66 highway PPP, which crosses the country from north to south.

No love

Still, despite all these incentives it’s hard to view private sector participation in funding the TEN-T programme as anything other than a failure. In its mid-term review of TEN-T projects, published last October, the EC found that only four of the 92 projects due to be completed between 2007 and 2013 were being procured as PPPs.

Considering that the private sector is expected, by the EU, to fund between 20 percent and 25 percent – or between €78 billion and €97.5 billion – of the €390 billion required to fund the TEN-T programme between 2007 and 2013 alone, there is clearly some work to be done to make this happen.

It’s not just the private side of the TEN-T equation that is falling short, though. Between 40 percent and 50 percent of the 2007-2013 requirement needs to come from national budgets.

Last year, before the worst of the sovereign debt crisis occurred, Andy Carter, a special adviser to the European PPP Expertise Centre (EPEC), warned that the “TEN-T investment programme is so large that there are currently uncertainties relating to the scale of investment and the way it is to be financed”.

To the EU’s credit, it is not unaware of the obstacles it needs to overcome if it wants to have more private investment for the TEN-T programme. In a report published in May, EPEC highlighted that, while there is nothing officially stopping some €8 billion in TEN-T grants – not to mention over €300 billion of EU Structural Funds – from making their way into PPPs, there are some serious difficulties preventing this happening.

“One of the main reasons is that the majority of grant schemes have been designed for capital contributions, which may sit uneasily with some types of PPP models,” EPEC stated. This has led to most grants being used at the project preparation phase, to fund studies and the like.

In order for them to be applicable later on in the procuring process, the design of grants has to overcome three obstacles, EPEC pointed out. Firstly, EU funds have relatively low leverage: “the maximum co-funding rate for works is 30 percent for cross-border projects, the rate for a project in a single [EU] member state is 10 percent,” EPEC highlights.

There are other problems too. “EU funds are paid against receipts for the construction costs (ex-post) and may put the confidentiality of a PPP contract at risk,” EPEC explains. That is to say, since grants can only cover construction costs, the private sector would have to be comfortable with the idea of breaking down their availability payment structure in order to receive them. This “impinges upon the principles of [contractual] confidentiality,” EPEC added.

Last but not least, the application process for EU grants currently has a time window thoroughly inadequate for the structure of PPP projects. For example, grants covering availability payments have to start being used within three years of award. But as EPEC correctly pointed out, “if the grant is awarded before construction starts so that it produces a maximum leverage effect on the PPP financing, then complying with the three-year rule becomes very difficult”.

Additionally, grants are only available throughout the seven-year EU budgetary cycle, which is out of sync with the long-term duration of PPPs.

Tweaking needed

Even some of the instruments that are already successful – like the LGTT – could use some tweaking. As several sources have pointed out, the LGTT only covers projects with demand risk. But following the financial crisis, most transport PPPs are shifting to the availability payment model. Under the current rules, the LGTT cannot support these projects.

Unfortunately, as with all EU-related changes, these obstacles are not likely to be overcome quickly.

As EPEC acknowledged in its report, “the [European] Commission and EPEC have agreed to undertake work during 2011-12 in preparation for the next budgetary period with the aim of facilitating the combination of PPPs with Structural Funds. By then, conventional government co-financing may be even more difficult to find and there may be a wider political recognition of the benefits of PPPs.”

For those who already recognise the benefits, a frustrating lull awaits.