Project bonds can be credit enhanced in whole or in part through various means, including:
• Guarantee: a guarantee of the Private Partner's obligations might be provided by a sponsor (if it has a suitably high credit rating), a bank or a multilateral agency. In some cases, a guarantee might equate to wholesale credit substitution (as distinct from enhancement).
• Wrap: this is the provision of insurance by a highly rated private sector financial guarantor (often a 'monoline' insurer), insuring the underlying principal and interest payments on a bond in return for a fee. Although not uncommon in Europe before the financial crisis, only one major international monoline insurer continues to operate. The insurer's credit rating is key to the rating of the bonds.
• Sovereign Guarantee: in some circumstances, it may be value for money for governments to provide a guarantee (typically in return for a fee). This may be part of a concerted programme to facilitate infrastructure investment.
• Multilateral product: the World Bank, MIGA and IFC have a long track record in providing guarantees for bonds.74 These guarantees generally focus on specific risks which the private sector is unable to manage (such as adverse government action) and are available to World Bank and IDA countries. MIGA insurance focuses on political risk. More generally, since the financial crisis, bodies such as the EIB and the Asian Development Bank75 have been considering ways to boost liquidity and incentivise capital markets investors to invest in infrastructure in both developed and emerging markets. Multilateral funding agencies and development banks are the ideal channel for this type of support because they have both the credit quality and the political influence to stimulate investor appetite.
The EIB Project Bond Credit Enhancement Programme (PBCE) was launched to provide support for capital markets financing of infrastructure and to broaden the investor base for infrastructure projects. It offers credit enhancement in two forms: funded (internal) involving EIB as an internal party investing in the capital structure, and unfunded (external). The unfunded form involves the provision of a standby letter of credit in favour of the bond trustee for 20% (now 30%, following the pilot phase) of the value of the bond. This allows the bondholders to draw down cash from the EIB which can be used to make principal and interest payments to the senior debt holders as well as financing a cost overrun or, in some cases, a revenue shortfall. The Private Partner pays interest on any drawdown and a commitment fee to the EIB. EBRD and MIGA have recently successfully partnered on a risk mitigation product used on a Turkish project. EBRD provided a liquidity facility for construction cost overruns and to keep debt payments current during operation and MIGA provided political risk insurance to insulate the project from the risk of certain adverse government action.
Ten projects involving the PBCE were successfully bond financed in its pilot phase. Moody's Investors Service76 reported that this demonstrated the effectiveness of project bond credit enhancement in improving projects' risk profiles, including in these cases by mitigating country-specific risk by achieving project ratings at or above the rating of the host sovereign77 (which the EBRD/MIGA product also achieved). Both the PBCE and the EBRD/MIGA products have therefore had the effect of making the project bonds into an investment as safe as, or indeed safer than, government bonds.
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| EMERGING AND DEVELOPED MARKET DIFFERENCES Credit support like the PBCE could be used to mitigate sovereign and macroeconomic risks as well as project-specific risks. It could benefit PPP Projects which are higher risk in stable creditworthy countries, as well as PPP Projects in countries with weak or challenging credit profiles. Many such credit enhancement tools are already available for this purpose from multilateral and bilateral institutions and their use is being gradually mainstreamed and increased. Credit support can also overcome basic unfamiliarity with non-bank funding for infrastructure even in more developed financing markets (e.g. the first Belgian project bond was a PBCE pilot project). |
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74 http://treasury.worldbank.org/documents/GuaranteesMatrix.pdf
75 In 2015, Asian Development Bank provided a 75% guarantee to a Philippine project bond.
76 Moody's Investors Service Sector In-depth (14 April 2016): Infrastructure Renewal and Investment - Europe project bond market set for growth after pilot initiative endorsed
77 As shown by the rating Moody's assigned the N25 in Ireland (Baa1 positive) and CAV in Italy (Baa2 stable).