The problems of a graceful withdrawal

The EIB hopes that its project bond initiative will help it step back from the prominent lending role it has assumed following the global financial crisis. But the new initiative may originate another cycle of EIB-dependence.

“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 European Investment Bank (EIB), as we lent almost €3.5 billion to public-private partnerships (PPP). So I think the bank has indeed played a role in supporting the European PPP market.”

Thus spoke (rather modestly) Philippe Maystadt, EIB president, in an exclusive interview published in the July/August 2011 edition of Infrastructure Investor magazine. The truth is that without the EIB’s critical intervention, the European PPP market would have sunk with all the elegance and speed of a ton of bricks dropping into the ocean.

Of course, once you step forward so prominently into the lending arena, it’s not easy to exit centre stage. Maystadt, and many in the market, see a pick-up in commercial bank activity that should, in theory, allow the EIB to retreat from its current levels of lending. But it’s also worth noting that the bank this year has already lent €1.9 billion to transport PPPs in France alone, including two massive high-speed rail projects, one of which was the recipient of its largest-ever French loan.

Wisely, Maystadt and the EIB are not waiting around to see if governments and the market will allow the bank to step back from PPP funding. As such, the bank has seized the initiative to start promoting a new source of liquidity – a credit-enhancement mechanism that aims to move private sector infrastructure bonds out of the lower echelons of the investment grade category and into A-rating territory.

The idea is that A-rated bonds will transform larger numbers of institutional investors into senior debt providers for infrastructure. But there is a catch: the project bond’s success seems (again) entirely dependent on the EIB’s presence. The bank gets “reactions from some 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 have enough confidence [to buy them],” Maystadt stated.

The question of dependence is important because of the type of institutional investors the EIB’s initiative is targeting. Big institutional investors, like Dutch pension administrators PGGM (see interview on page 26) and APG, will not be interested in the project bond market until it reaches a certain critical size. In addition, they have their own dedicated infrastructure teams capable of conducting due diligence and deciding for themselves which projects they should lend to.

That leaves smaller institutional investors without dedicated infrastructure teams as the target audience for the EIB’s initiative, in which case the reaction outlined above by Masytadt is both comforting and worrying. Comforting because it shows how much investors trust the EIB; worrying because it suggests that, without the bank’s presence, the project bond market might not last long.

Of course in a perfect world, institutions should conduct their own due diligence before they conduct their investments, instead of just taking the EIB’s seal of approval for granted. In reality, though, these smaller teams are likely to be happy investing in project bonds as long as the EIB is around.

Formative influence

So once we establish the EIB’s presence will be necessary for some time if the project bond market is to have a chance to survive, the question then becomes: For how long does the bank want to keep supporting it, providing funded and unfunded subordinated debt tranches to credit-enhance these bonds alongside its senior lending activities?

Maystadt hinted that he would like the bank to have only a formative influence on this new market: “We would be quite happy to lend our expertise to the launch of this instrument, but once this instrument is known in the market, we really hope other financiers will come in and also play a role.”

The question is which institutions will be able to fill the EIB’s rather large shoes and engender the same kind of confidence. Will institutional investors trust commercial banks to structure this mechanism to suit their needs? And if not, what are the alternatives? Only time will tell. But the EIB should steel itself for what may turn out to be a rather protracted launch period.