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Europe 2020 Project Bond Initiative: Frequently asked questions
Commission Européenne - MEMO/12/525 05/07/2012
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Brussels, 5 July 2012
Europe 2020 Project Bond Initiative: Frequently asked questions
On 5 July 2012, the European Parliament adopted the proposal for a pilot phase of the Project Bond Initiative. Last October, the European Commission proposed the creation of project bonds for infrastructure investment, as a new tool to unlock private funding.
This initiative marks another building block in the European Commission's actions to revive growth through investment in the European Union. The basic principle underpinning this initiative is a better use of public banks better. In the case of the European Union, this is the European Investment Bank (EIB). The EIB and the EU budget can be used more effectively to achieve major leverage through limited risk-sharing with private investors. The legal provisions are being put in place, in order for the first project to be launched as early as this summer.
Q1: What are the main objectives of the Initiative?
The Project Bond Initiative aims to revive project bond markets and to help the promoters of individual infrastructure projects to attract long-term private sector debt financing by reducing the risks of the projects (see IP/11/236 and MEMO/11/707).The Initiative will essentially act as a catalyst to re-open the debt capital markets (currently largely unexploited for infrastructure investments following the financial crisis) as a significant source of financing in the infrastructure sector.
The Commission will launch a pilot phase in 2012 until the end of the current Multiannual Financial Framework in 2013. The Commission estimates that the project bonds could mobilise up to €4.6 billion of investment in this pilot phase. The Project Bond instrument will form an integral part of the Connecting Europe Facility for 2014-2020.
Q2: Why target infrastructure?
Over the next decade, record investments in Europe´s transport, energy, information and communication networks will be needed to underpin the Europe 2020 flagship initiatives to achieve smart, sustainable and inclusive growth by the end of this decade (http://ec.europa.eu/europe2020/reaching-the-goals/flagship-initiatives/index_en.htm).
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 the project. This makes the analysis of the investment value challenging for most market participants. Supporting such projects with EU funds will thus help overcome risk aversion and ensure that projects are carried out where they add value in an EU context.
Q3: What is the purpose of the pilot phase?
Project Bonds will be fully integrated in the next long-term budgetary period (the Multiannual Financial Framework for 2014-2020) as part of the Connecting Europe Facility (see IP/11/1200).
But now is the time to implement policies that help to enhance growth. This is the primary aim of the pilot phase that will start later this year.
From a more technical angle, EU-supported project bonds aim at forming a new class of securities. A pilot phase would facilitate their market introduction.
During the 2012-2013 pilot phase, stakeholders will be able to familiarise themselves with the bond structure. Feedback received during the pilot phase can then be used to fine-tune the terms of this financial instrument.
Q4: How would the pilot phase be implemented?
The proposal for a pilot phase will draw on the budget lines of the Trans-European Networks (TEN) and the Competitiveness and Innovation Framework Programme (CIP) up to a total of €230 million. €200 million and €10 million, respectively, will be available to support Trans-European Network transport and energy projects. And €20 million from the CIP ICT (Information and Communication Technologies) budget line to support broadband projects.
This funding from the EU budget will be used to provide capital contributions to the EIB in order to cover a portion of the risk the EIB is taking when it finances the eligible projects, as is the case with other existing instruments such as the Loan Guarantee facility for TEN-transport.
The EU budget would be used to provide capital contributions to the EIB in order to cover up to a third of the risk the EIB is taking when it finances the eligible projects. In other words, the EU budget will provide some risk cushion for the EIB to finance the underlying projects, while the EIB would have to cover the remaining risk. This means that when EU budget funds are combined with the EIB financing, a multiplier effect at this level of around three can be achieved. Through the EIB support of up to a maximum of 20% of project debt, a multiplier of at least five is achieved in terms of project bond issuance. The overall multiplier is around 15 to 20 and so the total budget amount of €230 million could mobilise investments of up to €4.6 billion.
It is clear that only a limited number of projects can be funded in the pilot phase. The reasons are two-fold: the budget available is limited and the projects would need to be very close to implementation. Therefore, the project selection would be made with the aim of providing support to approximately 5-10 projects, focussing on those that are at a relatively developed stage of the bidding and financing process or require refinancing after the construction phase, in one or more of the three sectors of transport, energy and broadband.
Q5: How does it function?
The following diagram shows how the Europe 2020 Project Bond initiative could function.
For example, a transport project, such as a section of railway network, could be planned by a group of companies (sponsors) and tendered by public authorities. The sponsors create a project company to raise the financing, construct and operate the railway network for a period agreed with the public authorities. The sponsors provide own funds to the project company in the form of equity and shareholder loans. The remaining financing is raised by the project company in the form of debt, traditionally in the form of a bank loan:
Instead of using traditional bank lending, the project company could raise the senior debt through project bond issues. Capital market investors would buy the bonds if an investment grade credit rating, preferably at least A-, could be achieved.
In the pilot phase of the Europe 2020 Project Bond initiative, the EIB would provide a loan or guarantee (EIB facility) to the project company in order to raise the likelihood of timely repayment of principal and interest to bond holders during the lifetime of the bonds (therefore reducing the risk of such bonds and, consequently, increasing their credit rating). This EIB facility would rank between the equity and senior debt tranche.
The facility could cover all project-related risks affecting the cash flow generation from the start of the operating period, as well as any funding shortfall during the construction period.
Once drawn upon, the EIB facility would take the form of subordinated debt. This debt would be reimbursed by the project company over time from the cash resources available after senior debt service, but prior to payments to equity and related financing (shareholder loans, other subordinated loans).
Q6: Which projects would be eligible?
The eligibility of projects would be determined according to the relevant Trans-European Network guidelines for transport and energy - and policy guidelines of the Competitiveness and Information Framework Programme (CIP). The focus is thus on TEN-transport, TEN-energy and broadband projects.
As well as being economically and technically feasible, the projects would need to provide stable and strong cash flows. The EIB will evaluate these factors in view of the EIB's experience with infrastructure financing. Ultimately, bond financing will depend on investors being willing to purchase these bonds. Existing Commission grant programmes will, of course, continue to be available for projects that are not suitable for capital markets financing (see also Q8 and Q9). The EIB will be in charge of project appraisal and approval within the Commission's eligibility guidelines.
Q7: Who are the investors and why would they invest in the Bonds?
Institutional investors, such as pension funds, insurance companies etc, i.e. investors with long-term liabilities and regulated rating requirements for their investments need matching long-term assets. 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 class of bonds with good ratings, investors, often lacking the know-how in project finance, will also be interested in the bonds as they can rely on due diligence and monitoring carried out for the projects supported by the Initiative.
Q8: Will the Initiative complement or replace existing sources of financing?
The Initiative will not replace 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.
Q9: 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 etc. Projects with low or no revenue that are nonetheless of great public interest will continue to need grants in all stages of their life.
Q10: What is the difference between the Europe 2020 Project Bonds and the so-called Eurobonds?
The aim of the Europe 2020 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 to provide general funding for Member States' government spending.
Thus, neither the Commission nor the Member States will issue bonds under the Europe 2020 Project Bond Initiative.
Q11: What is the role of the European Commission and the EIB?
The European Commission will define the framework of the project bond initiative, especially with regard to defining the criteria for eligible projects, 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 instrument for TEN-T (LGTT) or Risk Sharing Finance Facility (RSFF) as well as other EIB/EIF based schemes). As the EIB is the EU Treat-based Bank with the mission to support EU policies, it has unique long-standing experience in the financing of infrastructure projects.
Q12: How does this Initiative fit in the ongoing preparation of post-2013 policy proposals?
The Initiative widens the current toolbox of available innovative financial instruments under the current financial framework (2007-2013), as there has not been yet an instrument that targets bond financing. In addition, the take up of the pilot phase and on the debt capital market developments in the EU in general will influence the budget allocated to projects bond within the Connecting Europe Facility from 2014 onwards.
A Commission communication on financial instruments for the post 2013 period has been published in parallel with this Initiative: "A framework for the next generation of innovative financial instruments – the EU equity and debt platforms" (COM(2011)662).
Q13: What are the next steps?
In May 2012, political agreement on the Initiative was achieved in the "trilogue" with the European Parliament and the Council of Ministers. After the vote in the European Parliament, the proposal has to be formally adopted by the Council of Ministers. Once the Regulation has been published, it will enter into force. At that point, the Commission and the European Investment Bank (EIB) will finalise the remaining administrative modalities so that the EIB can formally begin to implement the pilot phase. In preparation, the EIB has already started building a pipeline of eligible projects that are likely to be at an appropriate stage of development or tendering to enable them to be supported by the Initiative.
For further information:
Pilot phase of the Europe 2020 Project Bond Initiative:
EIB webpage on the Initiative:
Consultation Phase of the Europe 2020 Project Bond Initiative:
Conference on the Europe 2020 Project Bond Initiative (April 2011):
TEN-T Networks: http://ec.europa.eu/transport/infrastructure/index_en.htm
TEN-E Networks: http://ec.europa.eu/energy/infrastructure/tent_e/ten_e_en.htm
ICT guidelines: http://ec.europa.eu/cip/