European Commission's Consultation on the Europe ... - Eurelectric

<strong>European</strong> <strong>Commission's</strong> <strong>Consultation</strong> on
the Europe 2020 Project Bond Initiative
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A EURELECTRIC Response Paper
May 2011

The Union of the Electricity Industry–EURELECTRIC is the sector association representing the common interests of
the electricity industry at pan‐<strong>European</strong> level, plus its affiliates and associates on several other continents.
In line with its mission, EURELECTRIC seeks to contribute to the competitiveness of the electricity industry, to
provide effective representation for the industry in public affairs, and to promote the role of electricity both in the
advancement of society and in helping provide solutions to the challenges of sustainable development.
EURELECTRIC’s formal opinions, policy positions and reports are formulated in Working Groups, composed of
experts from the electricity industry, supervised by five Committees. This “structure of expertise” ensures that
EURELECTRIC’s published documents are based on high‐quality input with up‐to‐date information.
For further information on EURELECTRIC activities, visit our website, which provides general information on the
association and on policy issues relevant to the electricity industry; latest news of our activities; EURELECTRIC
positions and statements; a publications catalogue listing EURELECTRIC reports; and information on our events and
conferences.
EURELECTRIC pursues in all its activities the application of
the following sustainable development values:
Economic Development
Growth, added‐value, efficiency
Environmental Leadership
Commitment, innovation, pro‐activeness
Social Responsibility
Transparency, ethics, accountability
Dépôt légal: D/2011/12.205/24

<strong>European</strong> <strong>Commission's</strong> <strong>Consultation</strong> on the Europe
2020 Project Bond Initiative
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Focus Group Finance & Economics
Michael Laengle (AT); Chairman; Ignacio Martinez Del Barrio (ES); Vice‐Chairman
Jonas Akesson (SE); Said Salman Al Zaabi (AE); Olga Arutyunova (RU); Moshe Bachman (IL); Uldis Bariss (LV);
Jan Brozik (CZ); Constantin Chivulescu (RO); Abdelkader Choual (DZ); Erzsébet Darida (HU); Vittorio
D'ecclesiis (GB); Miriam Garcia Madruga (ES); Janek Gustavson (EE); Piotr Komosa (PL); Eric Mauer (LU);
Patrick Neuhaus (CH); Valeria Palmisano (IT); Javier Pastor Zuazaga (ES); Pavlos Pattichis (CY); Stefan
Petursson (IS); Miguel Ribeiro Ferreira (PT); Guy Ruelle (BE); Erika Sabova (SK); Anna Siganou‐Kamileri (GR);
Sabri Simsek (TR); Bengt Soderlund (FI); Ingvar Solberg (NO);
Focus Group Enterprise Risk Management
Vittorio D'ecclesiis (IT), Chairman; Michael Herrmann (DE), Vice‐Chairman
Peter Agh (SK); José Allen Lima (PT); Fredrik Arno (SE); Roberto Balzerani (IT); Michael Broustis (GR); Erik
Hagland (SE); Harald Hauer (AT); John Healy (IE); Walter Hollenstein (CH); Filip Hons (BE); Paavo Hyvonen
(FI); Iñigo Ibarrondo (ES); Murathan Kara (TR); Gabor Lavich (HU); Anne Le Lorier (FR); Heikko Mae (EE);
Ignacio Martinez Del Barrio (ES); Shahid Mirza (GB); Francisco Perez Thoden (ES); Thomas Polzer (AT);
Alistair Smith (GB); Marcel Steinbach (DE)
Contact:
Charlotte RENAUD, Policy Officer, Management Unit – crenaud@eurelectric.org

General comments
EURELECTRIC, the sector association representing the electricity industry at pan‐
<strong>European</strong> level, welcomes the consultation launched by the <strong>European</strong> Commission (EC)
and the <strong>European</strong> Investment Bank (EIB) on the “Europe 2020 Project Bond Initiative”
and welcomes their initiative to engage with stakeholders on this key issue.
Electricity is key to a secure, sustainable and competitive future energy supply. Indeed,
our sector is facing a huge challenge up to 2020 and beyond. The priorities set in the
Europe 2020 Strategy clearly pinpoint the electricity sector as a key vehicle for the
transition towards a low‐carbon economy and a motor for sustainable growth.
The <strong>European</strong> electricity sector is determined to play this role but insists that the right
policy framework should be provided. Europe is at an unprecedented energy crossroads,
facing an urgent need for sizeable power generation and grid infrastructure investments
in the near future – an estimated one trillion euro by 2020 as indicated in the <strong>European</strong>
Commission Infrastructure Package 1 published in November 2010.
Carrying out these investments in a timely manner is essential if Europe is to meet its
energy and climate targets.
In this perspective, EURELECTRIC welcomes the “Europe 2020 Project Bond Initiative” in
the belief that it could help attract private sector investors and mobilise private savings
to support the EU’s strategic infrastructure needs and large projects of <strong>European</strong> interest.
Using funding from the EU budget as well as EIB guarantees and expertise could provide
powerful leverage to enhance the credit ratings of bonds issued by project companies
and to increase the attractiveness of long‐term investment for private sector participants.
1 Communication “Energy infrastructure priorities for 2020 and beyond – A Blueprint for an integrated <strong>European</strong> energy network”
(COM/2010/677).
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General questions
1) Is the chosen mechanism likely to attract private sector institutional investors to
the sectors of transport, energy and ICT in particular? If you are an investor,
would you be prepared to buy such project bonds?
EURELECTRIC believes that in the coming years capital markets will probably become
tighter and fierce competition for access to financing facilities is likely to grow.
EURELECTRIC believes that there will be a growing tension within capital markets due to,
on the one hand, increasing financing needs, and on the other hand, the probable
progressively restrictive monetary policy following governments’ exceptional measures to
stimulate the economy after the recent financial crisis.
EURELECTRIC believes that the increasing financing needs are related to a concurrent
demand for funding coming from both the private and public sectors. As far as the private
sector is concerned, the industrial sector, and in particular the energy sector, is
developing one of the most ambitious infrastructure plans, both in production and in
transmission/distribution, that will require an unprecedented financial effort to deliver a
low‐carbon and secure energy supply. Meanwhile, the financial sector will be heavily
impacted by more stringent capital requirements that will ultimately force financial
institutions to use a substantial part of their cash facilities to reinforce their own balance
sheets. At the same time, the public sector will also seek additional credit, with most
governments struggling to comply with their debt ratios. All these growing financial
needs will most likely occur in a phase of restrictive monetary policy when international
risk‐free base rates are expected to increase.
In this context, the launch of a <strong>European</strong> Project Bonds scheme appears to be an effective
instrument for attracting private capital for two main reasons:
• Such a mechanism will incentivise the participation of new private
institutional investors in the above‐mentioned sectors by improving the
projects’ credit profile in a context where huge amounts of capital will be
needed to develop the <strong>European</strong> energy, transport and ICT infrastructures.
Given the constrained situation in the capital markets, some type of public
guarantee will be helpful to attract private investment. The public
guarantee will contribute to the economic feasibility of projects and may
be justified on the grounds of the positive external effects that these
infrastructure projects will involve.
• Such project bonds, which represent a new asset class per se, will offer a
large range of investors, such as sectoral funds, hedge funds, private
equity, pension funds, etc., the opportunity to diversify their portfolio and
to better shape the reward/risk profile of their assets.
EURELECTRIC believes that rating agencies will play an important role within such an
initiative. Clearly, EU‐supported credit enhancement, which would guarantee the debt
service obligations of special purpose companies/project companies to investors in
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project bonds, will be a prerequisite for issuing such project bonds (being otherwise non‐
resourced) at all; in unregulated businesses investors will require more guarantees than
in regulated businesses with stable cash flows. However, the attractiveness of such bonds
will largely depend on how rating agencies will factor any EU‐supported credit
enhancement into the rating of project bonds. Generally speaking the higher the
guarantee from the EIB or other EU‐backed partners the more attractive the project bond
will be for investors.
Furthermore, EURELECTRIC would like to stress that the main problem with regard to
these projects is their long construction period and the related pre‐financing needs,
which bondholders are not usually prone to fund.
EURELECTRIC would also like to stress that the “Europe 2020 Project Bond Initiative” will
not succeed in achieving its goal of attracting additional private sector financing if it is not
accompanied by the implementation of EU regulation focused on providing a higher
degree of standardisation among Member States, in order to avoid further efforts to be
carried out by potential investors based on the local specificities of each country.
2) Are there other sectors with large‐scale infrastructure financing needs that
should be included?
Although the same logic could be applied to other sectors with large‐scale infrastructure
financing needs, i.e. agriculture, automotive, water, waste water, and waste incineration
etc., EURELECTRIC is of the view that the sectors mentioned in the Stakeholder
<strong>Consultation</strong> Paper appear to be the most appropriate given the priority of their
infrastructural investments and the likely constraints of EU available credit lines, at least
at a first stage. An extension to other sectors could be developed once the scheme has
been successfully put in place for energy, transport and ICT in order to diversify any
potential impact on the EU budget by reducing risk through a cross‐sectoral “portfolio
effect”.
It would be worth stressing the eligibility of energy projects related to generation,
transmission, and distribution system infrastructure and energy efficiency (smart grids).
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Specific questions
3) Would the credit enhancement facilitate/accelerate the conclusion of financing
packages?
EURELECTRIC believes that the credit enhancement mechanism could be useful in
attracting private investment for infrastructure projects. Given the constraint that direct
public funding should not be increased, this credit enhancement becomes increasingly
important. As mentioned above, without this type of public support, some projects with a
high added‐value in terms of security of supply might not be commercially viable.
However, the benefits of the credit enhancement measures could in some cases be partly
offset by stringent EIB/EU procedures and will depend on two crucial drivers:
• firstly, the cost of the credit enhancement mechanism;
• secondly, the remuneration framework envisaged for the project.
Therefore, in order to enhance the efficiency of this instrument, EURELECTRIC believes
that it is crucial that a transparent and efficient eligibility framework is put in place for
the applications and that the due diligence, financial appraisal and pricing phases carried
out by the EIB during the selection process are clearly structured with a predefined
schedule and timely deadlines. In this respect, close cooperation between the EU/EIB (in
connection with the EU‐supported credit enhancement), the arrangers of the project
bond and the rating agencies will be required. Moreover, we refer to our comments
related to the funding during the construction period under question 1 above.
4) What minimum rating of the bonds would be sufficient to attract investors?
Bond investors are always in search of a correct risk/reward balance and there is always a
relationship between the bond return and its risk of default. Hence, as long as a correct
risk/reward balance is respected, there is a possibility to attract investors under certain
rating conditions. The problem is that in the absence of a certain public guarantee to
improve the rating, the necessary bond remuneration level may become too high to
make the project pay‐off possible.
The present “boom” of corporate bonds successfully issued during the last two years is
testament to a good appetite in capital markets for financing at investment grade
corporate (BBB‐,Baa3) or even at speculative grade. Therefore at current levels of risk‐
free base rate (ECB 1‐1,5%) an investment grade rating (BBB‐,Baa3) might be sufficient
for attracting financial institutions and specialised players such as private equity and
pension funds. Capital markets are likely to become more stringent in terms of rating
with a higher level of risk‐free base rate, since this would imply for financial institutions a
higher cost of potential defaults and more selectivity due to lower access to primary cash.
With an ECB rate of > 2%, the target rating would probably increase to a “good”
investment grade (A/A2).
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A “good” investment grade (A/A2) should be the minimum target also if access to EU
project bonds is extended to the final markets of private investors/tax payers through the
intermediation of banks. The final market of private investors has historically proven to
be less interested in buying bonds from corporates falling within the lower range of
investment grade ratings and, on the other hand, governments are generally reluctant to
expose tax payers’ savings to default risk.
5) What degree of credit enhancement would be necessary to achieve this rating?
Creditworthiness of project finance is normally dependent on 4 main factors:
• Credit standing of sponsors/equity contributors;
• Predictability, quality and stability of cash flows;
• Level of technology/construction risk;
• Level of regulatory risk (related to permissions, concessions, licences, compliance
and stability of legal regulatory framework).
The credit enhancement required for achieving the desired rating will be a function of
each project’s specific characteristics in term of the project finance risks outlined above.
The due diligence phase performed by the EIB might include a specific task of running
sensitivities for the main risk drivers of the project, based on historical data of said risk
drivers and/or a Monte Carlo approach. These sensitivities should define a statistical
profile of expected cash flows from the projects, highlighting the probability of a cash
shortfall and, ultimately, the probability of default.
Having set the target rating, e.g. A/A2, with the associated probability of default, the EIB
could size the necessary credit enhancement accordingly: in fact the required credit
enhancement will be the amount necessary to reduce expected cash shortfall and
probability of default to the level of probability of default associated to the target rating.
In general terms, during the construction phase, the project company will draw most
financing facilities for capital expenditures (CAPEX) without producing much cash, and
during the operation phase most of CAPEX will have been already spent and the project
will starts producing cash flows,. One could expect that Project Bonds will be issued and
drawn at the start of the construction phase, that interests will be paid during the
construction phase and operating phase and that the bond will be reimbursed 100% of
principal at maturity. The construction phase, during which there are little cash flows, if
any, from the project to cover the interests to be paid, makes the whole project riskier
for the Bond holders.
EURELECTRIC therefore believes project bond holders might be fairly protected by sizing
the credit enhancement in order to cover interest costs for the whole duration of the
construction phase: this protection could be put in relation to the lower range of target
ratings.
A higher degree of protection for project bond holders could be achieved by sizing the
credit enhancement in order to cover interest costs for the whole duration of the
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project’s payback period: this protection could be put in relation to the higher range of
target ratings.
6) Which impact would the Initiative have on financing costs and on maturities?
The higher the guarantee provided by the EIB, the better for the financing cost of the
project. Providing a 100% guarantee would lead to the same rating as the EIB (AAA). A
lower guarantee implies lower ratings, while increasing the necessary equity of the
project and diminishing its leverage.
The credit enhancement guaranteed by EU Project Bonds would help to extend
maturities of financing facilities, thus reducing liquidity risk of the project. Maturity could
be expected to range up to 15‐20 years, especially if such an initiative is coupled with a
good predictability of cash flows and good credit standing of sponsors for a project that
does not present significant technological challenges in a stable legal/regulatory regime.
As far as the cost of financing is concerned the credit enhancement guaranteed by EU
Project Bonds will reduce the risk premium requested by investors, increasing the
financial viability of the project. The reduction of financing cost due to the lower risk
premium should be evaluated against the additional risk premium requested by the
EU/EIB for the risk‐taking and any other additional cost (e.g. legal, administrative,
consultancy fee, structuring fee, etc.) deriving from the application, due diligence,
financial appraisal, etc.
EURELECTRIC finally notes that project finance schemes in general, after an initial boom,
have been questioned in terms of actual benefits in financing costs due to the complex
and expensive structuring phase. Ultimately project finance has been considered an
alternative to corporate finance more for the benefit of the balance sheet than for that of
financing cost.
7) Is it essential that a single entity acts as controlling creditor?
For the sake of simplicity, as well as in order to minimise information flows and the
administrative burden, EURELECTRIC would advise that the controlling creditor role be
managed by one single entity.
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Union of the Electricity Industry ‐ EURELECTRIC aisbl
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