The Project Bond initiative is a joint initiative by the European Commission and the EIB.
Its objective is to stimulate capital market financing for large-scale infrastructure projects in the sectors of transport (TEN-T), energy (TEN-E) and information and communication technology (ICT). According to the Commission, the European Union’s infrastructure investment needs to meet the Europe 2020 objectives in these sectors could reach as much as EUR 2 trillion.
The Project Bond initiative is designed to enable eligible infrastructure projects promoters, usually public private partnerships (PPP), to attract additional private finance from institutional investors such as insurance companies and pension funds.
This will be achieved by providing credit enhancement to those promoters, whose debt will effectively be divided into two tranches: senior and subordinated.
The subordinated debt, or Project Bond Credit Enhancement (PBCE) can take the form of a loan from the Bank, with the support of the European Commission and is given to the promoter at the outset. It may also take the form of a contingent credit line which can be drawn upon if the revenues generated by the project are not sufficient to ensure senior debt service.
The PBCE underlies the senior debt and therefore improves its credit quality, offering peace of mind to institutional investors.
The bonds themselves will be issued by the promoters not by the Bank or the Member State in question. The support will be available during the lifetime of the project, including the construction phase.
According to the European Commission, the European Union’s infrastructure investment needs to meet the Europe 2020 objectives could reach as much as EUR 2 trillion in the sectors of transport (TEN-T), energy (TEN-E) and information and communication technology (ICT).
In his “State of the Union” speech in 2010, EC President J.M. Barroso proposed the “Europe 2020 Project Bond Initiative” to mobilise the necessary funding for project financing of 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 legal base of the Europe 2020 Project Bond Initiative was adopted in the summer of 2012 by the European Parliament and the ECOFIN Council and the instrument base was signed between the European Commission and European Investment Bank in November 2012.
The objective of the cooperation with the European Investment Bank is to build on existing experience with joint EU-EIB Group instruments and to utilise the EIB’s expertise in EU infrastructure financing.
Project bonds are one of the financial instruments foreseen under the proposed “Connecting Europe Facility” (CEF), which is part of the wider “Europe 2020” strategy. The aim of the CEF is to provide a longer-term financial framework ensuring that energy, transport and telecommunications projects are developed and implemented in a timely and effective manner.
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 from higher regulatory capital and other requirements (Basel II and III) have constrained other sources of long-term infrastructure financing.
There is therefore a need to find new ways to promote private sector financing of infrastructure projects without increasing direct public funding and therefore public indebtedness.
The Europe 2020 Project Bond instrument is designed to provide an alternative to financing projects through bank loans or public sector grants in order to close the infrastructure financing gap. If a project can be appropriately structured, grants and project bonds could potentially be combined.
Targeted investors are institutional investors such as pension funds and insurance companies, 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 asset class providing diversification and a solid rating, investors will also be interested in project bonds because of the EIB’s expertise and track record in infrastructure and PPP financing.
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 – namely the Project Bond Credit Enhancement (PBCE), provided by the EIB with EC support – 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 if the revenues generated by the project are not sufficient to ensure senior debt service.
The support will be available during the lifetime of the project, including the construction phase.
The proposed mechanism of the initiative will:
- have a maximum size of individual transactions of up to the lower of EUR 200 million or 20% of credit enhanced senior debt;
- as subordinated debt, target an up-lift of the project rating to A-AA rather than AAA;
- be based on the EIB’s capacity to deliver subordinated loans, not necessarily its rating;
- only target the EIB’s core business, i.e. infrastructure financing;
- only support robust projects
- benefit from the EIB’s proven due diligence, valuation and pricing methodologies.
In terms of projects targeted, the PBI is looking at those fulfilling defined sectoral eligibility criteria: trans-European networks in the fields of transport and energy, as well as broadband and ICT projects.
Based on market demand and opportunities, the EIB has identified and is working on projects that present reasonable prospects of successful closing within the pilot phase - and will engage in its usual due diligence process.
As certain projects currently under planning with national authorities will not be ready during the pilot phase, the EIB is also prepared to engage in up-stream project preparation work together with tendering authorities in order to position capital market solutions more generally for projects taking place in the period 2014-2020. Projects are subject to standard EIB appraisal requirements - and coverage under the EU-EIB Project Bond initiative will be subject to the relevant eligibility criteria and available budgetary commitments
Market and project opportunities are important factors when it comes to the geographical spread of the initial transactions. The first pilot projects will most likely be situated in one of the EU’s more advanced PPP/project finance markets, but the objective is to have standardised products enabling the Europe 2020 project bonds to fund projects throughout the Union and the EIB is looking to have as much diversification as possible of projects within the pilot phase.
In July 2012, the European Parliament and the ECOFIN Council approved the legislative proposal issued by the Commission in October 2011. The Cooperation Agreement between the EIB and the European Commission, defining the mechanism for risk and revenue sharing between the two institutions, was signed on November 6, 2012. Suitable projects will need to reach financial close between now and end of 2016, provided that the EIB obtains financing approval by its Board before the end of 2014.
By the end of June 2013, the EIB Board of Directors has already approved nine TEN-T and TEN-E projects in six different Member States as being eligible under the Project Bond Initiative. It includes motorway projects in SK, DE, BE and UK, grid connections to offshore wind farms in DE and UK and gas storage facilities in ES and IT. The first financial closures of these projects are expected in the second half of 2013.
The scope of the 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 multi-annual financial framework 2014-2020 and the implementation of the CEF (Connecting Europe Facility). This testing phase will be funded by means of re-deployment of unused EUR 230 million of EU budgetary resources from budget lines for existing programmes. The sectoral split is as follows: EUR 200 million and EUR 10 million is being dedicated to trans-European networks in the fields of transport and energy respectively; EUR 20 million to financing high-speed broadband projects. The budget of EUR 230 million should enable the EIB to provide financing to infrastructure projects worth more than EUR 4 billion across the three sectors.
Additional funding for the Project Bond Initiative (PBI) under the “Connecting Europe Facility (CEF) in the 2014-20 period would allow a further development of the initiative depending on budgetary allocations.
While the European Commission’s role is to define sector eligibility criteria and provide the EIB with the capital contribution required to enable the Bank to credit enhance project bonds, the EIB will:
- select and appraise the projects according to its normal standards;
- structure and price the credit enhancement instrument;
- monitor the projects thereafter.
Although the EIB will not be acting as a controlling creditor, a decision matrix governing project decision making is currently being developed and will need to be agreed on a project by project basis by the parties.