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The Europe 2020 Project Bond Initiative: the consultation by the Commission
Commission Européenne - MEMO/11/121 28/02/2011
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Brussels, 28 February 2011
The Europe 2020 Project Bond Initiative: the consultation by the Commission
Q1: What is the primary objective of the Initiative?
The main objective of the Initiative is to help the promoters of individual infrastructure projects to attract additional private sector financing. Guarantees and other type of credit enhancement measures would reduce the risk for such third party investors and thus act as a catalyst to re-open the debt capital market (currently largely unexploited for infrastructure investments following the financial crisis) as a significant source of financing in the infrastructure sector.
Q2: Why target infrastructure?
Large infrastructure projects are necessarily long term due to the long life of the physical structures involved. Even if they are financially viable in the medium to long term, they face short-term risks particularly in the construction phase and during the early years of operation, which make the analysis of the investment value challenging for most market participants. In addition, most infrastructure projects have a strong public good aspect, i.e. they have value to society at large, which is not necessarily quantifiable in monetary terms. Targeting such projects with EU funds will thus help overcome risk aversion and ensuring that valuable projects are implemented.
Q3: What are the differences between the Europe 2020 Project Bonds and the so called Eurobonds?
The aim of the EU Project Bond Initiative is to enhance the credit standing of private entities that need to raise private funds for the infrastructure projects they promote. This is fundamentally different from the idea of the so-called “Eurobonds", i.e. the joint issuance of bonds at EU level to provide general funding for Member States' government spending. Thus, neither the Commission nor the Member States will issue bonds under this initiative.
Q4: Will project bonds not simply shift financing of infrastructure from the budgets of Member States with excessive deficits?
No, the initiative will support companies to issue bonds and those infrastructure projects structured on a Public-Private-Partnership (PPP) basis. The PPP based projects are usually constructed, financed and run by the private sector. The completed project is expected to generate revenues, which may come directly from the public sector (e.g. a payment for making a piece of infrastructure available), are channelled through the public sector (e.g. where the public sector collects a toll, which it then forwards to the operator) or are collected by the operator or its agent directly.
Q5: Will the Initiative complement or replace existing sources of financing?
The Initiative will not replace the existing sources of project financing through bank loans or public sector grant programmes but rather complement these as a further means of closing the infrastructure financing gap. The aim is to expand the investor base for private debt funding of projects from loan providers to bond investors.
Q6: Will project bonds replace grants?
No. Project bonds will provide an alternative to bank loans for projects that have characteristics allowing them to be financed by the private sector. Even such projects will likely need grants for feasibility studies, impact assessments and the like.
Projects with low or no revenue that are nonetheless of great public interest will continue to need grants in all stages of their life. Thus grants will continue to play an important role and could potentially even be combined with project bonds if a project can be appropriately structured.
Q7: Who would provide the financial resources for the Initiative? When could it start?
The Initiative would be based on established risk sharing mechanisms between the Commission and the European Investment Bank (EIB). Other appropriately qualified financial institutions, willing to share the risks, could also participate.
The EU’s contribution to the Initiative would be funded under the next Financial Framework. Finally, it is important to stress that the EU budget contributions would be strictly capped and do not create contingent liabilities.
Q8: What is the role of the EC and the EIB? Will EIB’s expertise be used in project appraisal?
The EC will define the project eligibility framework and seek greater synergies between available EU grants and the use of specialised financial instruments.
The EIB Group is the natural partner for the Commission for the implementation of innovative financial instruments using the risk sharing concept (for example: Loan Guarantee instruments for TEN-T (LGTT) or Risk Sharing Finance Facility (RSFF) as well as other EIB/EIF based schemes). As the EU Treaty based Bank with the mission to support EU policies, it has, within the EU, a unique long-standing experience in the financing of infrastructure projects. Its share capital is held by the 27 member states, its role is long term financing in support of EU policy objectives and it reports to all relevant European Institutions; it is politically accountable to the European Parliament and subject to the control of the Court of Auditors where it is responsible for spending EU Budgetary resources. Therefore, it is natural that this Project Bond Initiative should build on the experience of EIB for structuring the implementation and early marketing and risk management.
Management of the Initiative within the eligibility framework agreed with the Commission would lie primarily with the EIB. Once a project is selected as eligible, the EIB would appraise the project, carry out the due diligence and financial analysis in the structuring phase, price the guarantee or loan and subsequently monitor the project.
Q9: Are other financial institutions excluded from the Initiative?
Other appropriately qualified financial institutions could also participate. This would be entirely consistent with the objective of opening new sources of private finance for projects within the EU. The EIB is expected to arrange for other institutions to contribute both funding and expertise.
Q10: Which projects would be eligible?
General eligibility criteria for the Initiative would be established by the Commission, in agreement with the Council and European Parliament under the legislative frameworks for the relevant policies.
The specific projects would need to provide stable and strong cash flows in addition to being economically and technically feasible. The EIB will perform an evaluation of these factors in view of its experience with infrastructure financing.
It needs to be understood that not all infrastructure projects are necessarily suitable for financing by the bonds. Such projects may still need to be funded via grants.
As with other financial instruments for attracting private investment, it will ultimately depend on investors which of the eligible projects would receive financing under this initiative. Projects that would not attract finance under this initiative could well be funded via other means (see Q5).
Q11: Will the Project bonds be used widely throughout EU -27; is there a geographic balance?
The objective is clearly to have standardised products enabling the Bonds to fund projects throughout the entire EU-27.
Market and project opportunities will largely decide upon the geographical spread of initial transactions with the first projects most probably in one of the more major PPP markets of the EU.
Q12: Who are these investors and why would they invest in the Bonds?
Institutional investors, such as pension funds, insurance companies etc, i.e. investors with long-term liability structure and regulated rating requirements for their investments. For these investors Project Bonds can represent a natural match for their long-term obligations.
Initially, these will most probably be European investors but interest from North American institutional investors and various sovereign funds can also be expected.
Besides having access to a new/reintroduced asset class providing diversification and good rating, investors, generally lacking the know-how in project finance, will also be interested in the Bonds as they can rely on due diligence and monitoring expertise carried out for the projects being supported by the Initiative.
Q13: Why do we need public money to enhance the credit rating of these Bonds? Are there not private providers of similar services?
Prior to the financial crisis, specialist insurers called monoliners, used to provide insurance for financial products, thus raising their rating. However, due to losses on subprime-related guarantees the monoliners have largely exited the financial insurance market generally . Following market and regulatory developments, it is unlikely that this business will revive in this form.
In contrast to this the proposed mechanisms of the Initiative will:
Q14: How does this Initiative fit in the ongoing preparation of post-2013 policy proposals?
The Initiative will widen the panoply of available innovative financial instruments under the debt platform introduced in the Budget Review. The proposals for financial instruments for the post 2013 period need to be smart, integrated and flexible. In other words, they need to be designed to cover financing gaps across the flagships. The Project Bond Initiative would support in particular the Resource Efficient Europe and Digital Agenda flagships, i.e. mainly transport, energy and broadband infrastructure projects.
Q15: How is the consultation going to work?
A public consultation website (put the link here – not available yet) has been set up where stakeholders can express their views. The website includes an online questionnaire, and also an entry point for the submission of written contributions. Member States have also been urged to promote an active participation among their own stakeholders.
On 5 April the Commission together with the EIB will organise a conference on the Initiative. The consultation will close on 2 May.
Q16: Why is a public consultation needed?
Before launching the idea of a new risk-sharing instrument which would aim at facilitating the debt raising activities of companies at capital markets, the Commission would like to test the idea and get the views of all participants in such infrastructure investments, public and private. The consultation will support the completion of an impact assessment before a proposal for its implementation will be done.