The global financial crisis has fundamentally altered the urban investment landscape. Before the crisis, capital markets were used readily as a source of financing for infrastructure projects, with insurance companies guaranteeing the full credit risk of senior lenders.
Since the Crisis, however, few new guarantees have been issued by the insurers, which combined with the impact of the sovereign debt crisis and the increased pressure on the balance sheets of banks in the light of the Basel III accords, has contrived to create an infrastructure investment deficit in excess of €4trn, since 2007.
In response to the investment deficit, the European Investment Bank has launched the Europe 2020 Project Bond Initiative. The funding instrument has been designed to create the conditions to attract additional private sector financing for individual infrastructure projects. Rather than replacing traditional instruments, the initiative is designed to complement them as a means of closing the infrastructure financing gap.
How does infrastructure financing through project bonds work?
Project bonds, as part of the EIB’s wider Europe 2020 strategy, aim to increase debt financing availability for large scale infrastructure projects within the transport, energy and broadband sectors.
By providing credit enhancement to project companies raising senior debt through bonds, the initiative is intended to encourage more institutional investment from pension funds and insurance companies who are investing over the long-term and have regulated rating requirements for their investments.
The improvement of the credit rating of infrastructure projects will be facilitated by separating the debt of a prospective project company into senior and subordinated tranches. The financing of the subordinate tranche will take the form of a loan or a credit line which can be utilised if revenues from the project are not sufficient to ensure senior debt service.
With the EU and EIB agreeing to share the risk, and co-financing the subordinate tranche, other creditors would be given priority for reimbursement, making the investment more attractive to institutions. In addition, the EIB expects that its expertise in the field will also serve as an attraction to potential institutional investors.
Rolling out the Europe 2020 Project Bond Initiative
The initial pilot phase of the project bond initiative, subject to approval by the European Parliament and the Council, is expected to begin in August 2012 and will last until 2013. The intention is to test the concept before the implementation of the next EU multi-annual financial framework, 2014-2020, and the Connecting Europe Facility (CEF).
The pilot programme will utilise €230m of EU budgetary under spend, which will facilitate the borrowing of further investment on the capital markets, enabling a total investment of €4.6bn. If the pilot is deemed successful, full roll out of the initiative will occur in 2014, once the new EU budget has been agreed.
Image: Flickr-Niccolò Caranti