First announced a little over a year ago, the European Fund for Strategic Investment (EFSI) is now in full swing with an initial €21 billion investment from the European Commission and the European Investment Bank (EIB).
It is hoped that this initial funding, together with risk-bearing guarantees from the European Commission and EIB, will attract capital market investment in Europe’s strategically important projects, resulting in a fund worth an estimated €315 billion, with 75 percent earmarked for infrastructure investment.
So, why does European infrastructure need more flexibility in terms of investment? Part of the reason is that global bank and institutional investor appetites change over time. Given the dynamic funding landscape, procurement authorities and project sponsors need to be better informed of the full range of financing alternatives to secure the best overall value for money.
However, identifying the optimal financing route is not always clear. One reason is a lack of practical information on how to match infrastructure projects with the right type of financing. Another is the fact that information does not always cover the full gamut of financing options available beyond national parameters.
Another problem is that infrastructure is not clearly defined as an asset class, which risks exposing investors to disproportionate accounting regulations due to high capital charges. The European Commission and the European Insurance and Occupational Pensions Authority’s work on defining infrastructure as a separate asset class, including favourable capital charges for eligible projects, should go some way in addressing this risk.
Indeed, certain investors – among them, insurers and pension funds – have increased their capacity to invest in infrastructure. Insurance companies and pension funds are, in fact, ‘natural’ investors in infrastructure assets, since the long maturity and fixed rate nature of project bonds are a good match to their long-term liabilities.
When seeking to raise finance for an infrastructure project, it is important to take into account the following four considerations early in the procurement process.
CHOOSE FINANCING BASED ON PROJECT NEEDS, NOT PAST EXPERIENCE
No two infrastructure projects are the same. Greenfield and brownfield projects have different requirements; much depends upon the complexity of the project, and ideal market conditions cannot always be guaranteed. A level of flexibility to amend contractual terms may be fundamental for some projects, while others may require additional funding should costs overrun.
Bank loans and private placements can provide greater flexibility and tailor-made solutions, while public bond markets – though perhaps less flexible – can provide long-term funding and wide distribution at competitive rates, thereby reducing refinancing risk. In short, the nature of the project influences the funding route, and often a combination of various debt sources will provide the best solution.
ANTICIPATE LENDER AND INVESTORS’ NEEDS FOR CREDIT ENHANCEMENT AND RATINGS
Credit enhancement is valuable for projects that need to achieve an acceptable investment rating or credit profile. Planning for this early on can pay dividends in securing private sector investment. However, there is a need to avoid the ‘crowding-out’ effect of providing sovereign or other financial guarantees for projects that could be comfortably funded by bank loans or the public bond markets where there are no credit enhancement requirements. Such requirements reduce the yield investors expect to achieve. In other words, use credit enhancement where it is really needed or provides a tangible advantage.
CONSIDER MITIGATING DEMAND RISK WITH A USAGE GUARANTEE OR AVAILABILITY PAYMENT STRUCTURE
Some projects may not be financeable at all, or at a reasonable cost, without some form of usage guarantee or risk sharing mechanism provided by a government entity, for example, to mitigate long-term traffic risk on a motorway or rail project. In these cases, a balance should be struck between value for money and the need to guarantee minimum revenues for a project to be viable in the long-term.
CONSIDER THE IMPACT OF POST-CLOSING CHANGES IN LAW AND REGULATION
Retrospective changes in tariffs supporting a project financing structure (particularly if implemented after lenders have already provided funding on a different set of assumed project revenues) are a cause for concern for investors, who require certainty before committing to a long-term investment. Transparency, consistency and sustainability behind the regulatory framework supporting the project, while it cannot be guaranteed, should be encouraged among regulators.
At the end of the day, many considerations will affect the attractiveness and success of investment in an infrastructure project, each of which should be addressed on a case-by-case basis. What shouldn’t prevent capital market investment contributing to Europe’s infrastructure is a fundamental lack of understanding on the most efficient financing route.
In this respect, the Association for Financial Markets in Europe and the International Capital Market Association have co-produced a Guide to infrastructure financing to help those seeking to raise finance for EU infrastructure projects. The Infrastructure Guide gathers together practical guidance on securing funding across the UK and continental Europe – whether through loans, private placements or public bonds – in one place, rather than having to be sourced bilaterally or piecemeal from lenders, arrangers and investors. It also sets out practical information on, among other areas, the types of investors who provide debt and equity, implementation timelines and indicative costs, key regulatory and reporting requirements, investor and rating agency requirements.