Infrastructure bonds by Katie Kelly Contact: katie.kelly@icmagroup.org Bank loans have traditionally been the life blood of the infrastructure sector. However, a decline in long-term bank lending, together with the disappearance of many monoline insurers in the wake of the financial crisis, have massively affected the sector: first, bank financing is no longer as readily available; and second, the credit enhancement that a monoline insurer would have provided (in the form of a guarantee) no longer exists. Coupled with these factors is general austerity – public sector funding is generally being reduced owing to government cut-backs on infrastructure spending (although there are signs of revival, not least in the UK), all of which serves to hamper economic growth.

1. 31
Primary Markets
Issue 32 | First Quarter 2014
www.icmagroup.org
Infrastructure
bonds
by Katie Kelly
Bank loans have traditionally been the
life blood of the infrastructure sector.
However, a decline in long-term bank
lending, together with the disappearance
of many monoline insurers in the wake
of the financial crisis, have massively
affected the sector: first, bank financing is
no longer as readily available; and second,
the credit enhancement that a monoline
insurer would have provided (in the form
of a guarantee) no longer exists. Coupled
with these factors is general austerity –
public sector funding is generally being
reduced owing to government cut-backs
on infrastructure spending (although there
are signs of revival, not least in the UK),
all of which serves to hamper economic
growth.
From the point of view of the investor,
infrastructure bonds are seen as
fundamentally riskier than corporate
bonds with a dubious risk/return balance.
Although infrastructure bonds are longdated and will tend to be kept for the
duration, the construction phase – when
it may be unclear what the returns will
be, the extent of any cost overruns, or
the expected completion of the project
– is particularly risky. This phase was
traditionally financed by the banks, and
refinanced by the public or private sector
once the project was able to produce
tangible returns and when the risk profile
shifted to performance risk related to
actual cash flows generated by the project
compared with forecasts.
A further concern for investors is that,
owing to the long term nature of the
finance, regulations and legislation will
change over the period. Added to this
is the need for cross-party political
consensus, where there is little impetus
for gaining populist votes and therefore
little scope for political interference, for
instance with more controversial projects
such as windfarms.
Currently, a redoubtable obstacle
to infrastructure bond financing is
cumbersome procurement and planning
procedures. EU procurement law has
a “one size fits all” approach, which
does not lend itself to large, one-off
infrastructure projects. Added to this is a
disconnect in culture and modus operandi
between financing and procurement
departments, where there tends to be
a fundamental distrust of the capital
markets (maybe borne out of a reliance
on the more straightforward and less
volatile bank funding model). Additionally,
planning periods can be lengthy, and

2. 32
Primary Markets
Issue 32 | First Quarter 2014
www.icmagroup.org
It is clear that alternative ways of
funding infrastructure projects
are necessary.
the resulting consultation and resolution
processes can be complex.
However, in spite of the obstacles
highlighted, it is clear that alternative
ways of funding infrastructure projects
are necessary; in the UK for instance,
the Government recently announced
a projected £375 billion of planned
public and private sector infrastructure
investment over the next 15 or so
years. And in spite of investor concerns,
given that the differing risk profiles of
infrastructure bonds often conveniently
match the risk profiles of diverse investors,
it is clear that there is strong institutional
investor demand for the product and the
yield – not least from the insurance sector,
for which long-term investment is now
easier under Solvency II.
Nevertheless, the fundamental conundrum
remains that, on the one hand, greater
investment from the public and private
sectors will not only provide funding, but
will also reassure others to invest and
therefore encourage deal flow. On the
other hand, it may take more sustained
deal flow for the public and private sectors
to start considering infrastructure bonds
as a credible funding and investment tool.
One of the ways to reassure investors
is to enhance the attractiveness of
infrastructure bonds by way of credit
enhancement. Much has already been
achieved in this area, such as the EIB
Project Bond Credit Enhancement
initiative, where the debt of the project
company is split into a senior and a
subordinated tranche. The subordinated
tranche – namely the Project Bond Credit
Enhancement, provided by the EIB
with European Commission support –
increases the credit quality of the senior
tranche to a level where most institutional
investors are comfortable holding the
infrastructure bond for a long period. The
subordinated tranche can take the form
of a loan, which is given to the project
company from the outset, or a contingent
credit line which can be drawn upon if the
revenues generated by the project are not
sufficient to ensure service of the senior
debt. The support will be available during
the lifetime of the project, including the
construction phase.
Furthermore, replacing bank financing
with bond financing requires not only
a change in mind-set by the project
sponsors, but also a sound understanding
by investors of a field of finance which
differs from corporate finance. In this
regard, education of, and communication
between, the relevant bodies are both of
key importance.
Together with promotion of education and
communication, further initiatives such as
credit enhancement should continue to be
encouraged and expanded with a view to
ensuring growth of the infrastructure bond
market in the right direction – an objective
which has the support of ICMA. ICMA is
well placed and keen to make progress in
this area with other interested parties and
trade associations in 2014.
Contact: Katie Kelly
katie.kelly@icmagroup.org