What could be the future of project finance ?
Banks currently face a number of challenges, not least the impact of Basle III to their regulatory capital requirements. This is likely to make long term project financing less attractive and more expensive for banks.
In terms of the project finance market, the discussions across Europe have been increasingly focusing on how to bring the capital markets to finance projects.
The combination of the impact of Basle III, the poor fiscal position of European Governments, the increased risk of a further banking liquidity crisis in Europe and the enormous infrastructure investment required means that a sustainable financing solution has to be found.
I would suggest that whilst it is not true to say that project finance from banks is going to end, the increasing demand for infrastructure financing and a potential decrease in banks’ appetite to finance these projects means that a gap needs to be filled.
Many bankers agree with your analysis. Project bonds could really be an interesting product but banks are still very interested in long term project finance.
Exactly. The empirical evidence is that you can’t find a project that is currently not happening for a reason that the finance is not available. That’s why many banks are not concerned with bond market competition: they’ve got plenty of activity.
Do institutional investors have a real appetite for bond products ? Did they evolve to acquire some expertise in the infrastructure sector ?
There are two points on this:
- Even when we talk about the monoline insurance market that existed previously, this activity was limited from a European perspective and was mainly UK Sterling focused, European institutional investors didn’t generally invest in project bonds.
- Now we are seeing a growing interest from the larger European pension funds and insurance companies. But it is only the very large ones who have the resource to develop products for the market. The problem is – unless appropriate financial products are developed and real opportunities are presented to the investors – they’re not going to waste their time because there are too many other opportunities to invest their money.
What is the impact of the sovereign debt crisis on the infrastructure market ?
A year ago we perhaps thought the worse was over but during the summer a new phase began. I could paint a really pessimistic picture that leads to another acute banking liquidity crisis but I prefer to have a more balanced point of view. So I think the current crisis is slowing down the development of this market. I don’t see banks being increasingly more aggressive in the market.
In fact, if you step back from this it might seem odd to say but financing is a secondary issue. The primary issue is actually government funding, because the financing of bigger infrastructures has to be supported by payments from the users, or by government through payments over time.
Concerning larger projects you pointed this specific issue in the answer to the EU consultation on project bonds: to reach investment grade they need sovereign support
There are increasing efforts around the project bonds initiative. But fundamentally, the project finance model can’t address the whole of the infrastructure market. Some projects , like nuclear development are complex, the risks around them are so challenging that they will probably never be suitable to project finance during construction. Sadly, most of the problem returns to government funding or provision of support directly or indirectly. They have to consider how they intervene in the most appropriate way to develop these projects, and then be clear about their exit strategy. One of the models could be, if governments can afford to provide upfront funding, to find a way to develop these complex projects themselves, and then sell them to infrastructure investors when they are operational.
So sovereign insurance shouln’t be ignored when considering new solutions to finance infrastructure projects ?
Why is the bond market not responding ? Because there are risk issues that are suppressing the project credit quality. So I think the challenge is, how the governments can address the really large and risky projects ? They need to be a little bit more creative about how it can apply their sovereign support. That doesn’t just mean that they have to pay for it directly. They could provide direct guarantees or first loss funding. They should also think about what barriers are preventing the flow of financing, and what support can Governments provide to make private investments follow.
What is your opinion concerning alternatives to monolines, like Hadrian’s Wall Capital (HWC) in the UK ?
HWC (see below) is a good example of private sector innovation in the financial market although it has demonstrated the challenges in sourcing investors in the current market. The EIB and Aviva have already signed up as investors and more seem set to follow soon. The fact is, investors are quite rigid about their criteria and take a long term typically to make a decision.
And even when HWC finds funds, you have to get back to the original question: where will the deal flow will come from ? At the moment I don’t see a large number of greenfield projects desperate to come to the market. For small projects, the current bank market is active and the bond solution will find it hard to compete.
Secondly, for the average sponsor, for example Bouygues or Vinci bidding on a new project, these companies are not interested in complicated structures for the sake of it, they want the most economical efficient financial structure i. e. they want the cheapest cost of financing and the most appropriate solution possible for the project.
Closing the first project will be very important and possibly challenging. It will take a lot of hard work to get everything absolutely right in the first deal. Someone has to be brave to make the first deal and that will need complete government support.
