The EU bank

This Initiative is to help promoters of infrastructure projects attract additional private sources of finance from institutional investors. This will be achieved by improving the rating of the senior debt of project companies, thereby ensuring that this can be placed as bonds with institutional investors.

Background

The European Union’s infrastructure investment needs could reach as much as 2 trillion euros in the sectors of transport (TEN-T), energy (TEN-E) and information and communication technology (ICT), according to the European Commission.

In his “State of the Union” speech in 2010, EU President J.M. Barroso proposed the “Europe 2020 Project Bond Initiative” (the “Initiative”) as an important initiative to mobilise the necessary funding for project financing in infrastructure: “An EU initiative to support project bonds together with the EIB, would help address the needs for investment in large EU infrastructure projects”.

The pilot phase of the Europe 2020 Project Bond Initiative will be launched by the Commission together with the European Investment Bank (EIB) in order to build on existing experience with joint EU-EIB Group instruments and the experience of the EIB in EU infrastructure financing.

Project bonds are also one of the financial instruments foreseen under the proposed “Connecting Europe Facility” (CEF) which in turn is part of the wider “Europe 2020” strategy. The aim of CEF is to provide a longer-term framework ensuring that projects in energy, transport and telecommunications are developed and implemented in a timely and effective manner.

Europe 2020 Project Bonds Initiative in short :

The objective : to increase debt financing availability for large scale infrastructure projects in the targets areas of Transport, Energy and Broadband.

How : the EIB - supported by the EU - would provide credit enhancement to project companies raising senior debt under the form of bonds to finance infrastructure projects.

Expected Results : increased availability of private sector financing from the capital markets to finance key infrastructure.

What was the reason for this initiative?

The main objective of the Initiative is to create the conditions to attract additional private sector financing for individual infrastructure projects.

In the past, capital market issues were an important source of financing for infrastructure projects. Monoline insurance companies guaranteed the full credit risk of senior lenders. However since the financial crisis there have been few new issues guaranteed by the monolines. Furthermore the sovereign debt crisis and pressure on banks’ balance sheets via the Basel regulatory authorities have constrained the other sources of infrastructure financing.

Accordingly, there is the need to find ways to bring back private sector financing of infrastructure projects without increasing direct public funding and therefore public indebtedness.

The Europe 2020 Project Bond instrument is not intended to replace existing sources of project financing through bank loans or public sector grant programmes but rather complement these as further means to close the infrastructure financing gap. If a project can appropriately be structured, grants and project bonds can even be combined.

Who are the investors?

Institutional investors such as pension funds, insurance companies etc, i.e.  investors with long-term liability structures and regulated rating requirements for their investments. For these investors Project Bonds represent a natural match for their long-term obligations.

Besides having access to a new/reintroduced asset class providing diversification and good rating, investors will also be interested in Project Bonds due to EIB’s expertise.

How does a credit enhancement work ? Why is it different from the bonds wrapped by monolines?

The Initiative aims to provide partial credit enhancement to attract capital market investors.

The mechanism of improving the credit standing of projects relies on the capacity to separate the debt of the project company into tranches: a senior and a subordinated tranche. The provision of the subordinated tranche increases the credit quality of the senior tranche to a level where most institutional investors are comfortable holding the bond for a long period.

The subordinated tranche can take the form of a loan, which is given to the project company from the outset, or a contingent credit line which can be drawn upon in case where revenues generated by the project are not sufficient to ensure senior debt service.

The support would be available during the lifetime of the project, including the construction phase.

In contrast to the monoline model, the proposed mechanisms of the Initiative will:

i) be limited in amount from the outset (capped at EIB and EC commitments under the instruments);

ii) not target an up-lift of the project rating to AAA (A-AA range aimed at);

iii) be based on EIB’s capacity to deliver subordinated loans, not necessarily its rating;

iv) only target core business of EIB, i.e. well known infrastructure financings;

v) only support robust projects with all the necessary structuring elements in place;

vi) benefit from EIB’s proven due diligence, valuation and pricing methodologies with a strong track record.

What is the timeline to start implementing the initiative?

The European Commission building on the encouraging feed-back received during the public consultation that took place in spring 2011 proposed to launch a pilot phase of the Europe 2020 Project Bond Initiative over the period 2012-2013. The pilot phase will start its operations once the European Parliament and the Council will have approved the legislative proposal adopted by the Commission on 19 October 2011, which is currently expected to occurr by end of July 2012. Following agreement by EIB's governing bodies, implementation of the pilot phase will start immediately afterwards in 2012.

What is the rationale for the “Pilot Phase? Are there potential projects identified?

The scope of this pilot phase is to test the project bond concept during the remaining period of the current multi-annual financial framework 2007-2013, before the next EU multi-annual financial framework 2014-2020 and the implementation of the CEF. This testing phase will be funded by means of re-deployment of EUR 230M of EU budgetary resources from budget lines of existing programmes.

As experienced with other financial instruments, stakeholders need to familiarise themselves with all issues of the structuring of a transaction bearing in mind the complexity of financing infrastructure projects. A pilot phase will therefore help to clarify a number of these issues.

Pilot projects will be within the eligible sectors (transport, energy and broadband). Based upon market demand and opportunities, EIB has been identifying projects that show reasonable perspectives of successful closing still within the period 2012-2013 and will be engaging into the usual due diligence process.

As a good number of projects currently under planning with national authorities will not be ready during the pilot phase, the EIB is also accomplishing up-stream project preparation work together with tendering authorities in order to position capital market solutions for the period 2014-2020.

Market and project opportunities are important factors when it comes to the geographical spread of the initial transactions. If the first pilot projects will most likely be situated in one of the more advanced PPP/Project Finance markets of the EU, the objective, however, is clearly to have standardized products enabling the Europe 2020 Project Bonds to fund projects throughout the Union.

For more information on the pilot phase, please refer to the related documents on the Europa website:

The pilot phase of the Europe 2020 Project Bond Initiative:  http://ec.europa.eu/economy_finance/financial_operations/investment/europe_2020/index_en.htm