Infrastructure Bonds underwriting Europe's growth agenda

Transcription

1 Infrastructure Bonds underwriting Europe's growth agenda 1 Briefing note October 2013 Infrastructure Bonds underwriting Europe's growth agenda In August of this year, the successful 1.4 billion Euro bond refinancing of a Spanish gas storage facility marked the first successful deployment of the European Investment Bank's Project Bond Credit Enhancement (PBCE) product, designed to deliver the European Commission's Project Bond 2020 initiative. This transaction, together with the anticipated use of the capital markets in other recent infrastructure financing proposals such as the recently announced UK Government Guarantee Scheme, illustrates possible ways of tackling some of the perceived impediments to capital markets funding of infrastructure. Since the 2008 financial crisis, the absence of monoline insurers from the project bond market has left a significant gap in capacity, as well as posing a number of practical and technical challenges to the use of the debt capital markets to finance infrastructure, such as achieving attractive credit ratings, investor enfranchisement and timely decision-making. At the same time, tighter capital constraints imposed on banks as a result of CRD IV have acted to reduce long-term bank lending to the sector. Many commentators have identified broader use of bond financing as key to the development of infrastructure assets. A range of products and solutions has been proposed. Proposals from the private sector include PEBBLE (Pan European Bank to Bond Loan Equitisation) which, like the PBCE product, involves credit support in the form of a tranche of subordinated debt. The UK Government has gone a step further with its own infrastructure guarantee scheme, the details of which were published earlier this summer, proposing full guarantees of senior debt. Whilst we are yet to see a significant volume of closed transactions from these initiatives, the successful recent completion of the Castor Gas Storage Facility bond refinancing, the first transaction to deliver EIB's PBCE initiative, offers hope that public sector support can act as a catalyst for sustainable private sector investment. Bridging the Divide As European economies look to recover from the aftermath of the financial crisis, it has become axiomatic for policy makers to highlight the crucial importance of infrastructure investment in delivering future growth. As European Investment Bank President Werner Hoyer stated: Unlocking the support Key issues Infrastructure investment remains a crucial part of Europe's policy agenda Governmental and supranational support is aimed at expanding the availability of bond financing Sustainable private sector investment requires the right balance between risk mitigation and investor engagement with the underlying assets Legal and structural solutions are available to meet the practical challenges of bond financing, particularly in terms of creditor control and effective decision making of institutional investors to provide long-term investment in European infrastructure is crucial for stimulating

2 2 Infrastructure Bonds underwriting Europe's growth agenda economic growth and creating new jobs". The successful refinancing of the Castor gas storage concession, in which Clifford Chance acted for EIB, comes at a time when these longstated policy objectives are beginning to be met by significant expressions of interest and commitment from insurers and pensions funds looking to enhance yield, diversify exposure and match long-term liabilities with stable income streams. In an interview with The Sunday Telegraph, Legal & General Chief Executive Nigel Wilson suggested that the firm's additional infrastructure investment could amount to an additional GBP 12 billion over the next ten years. Whilst the long-term investment case has been clear for some time, the market has hitherto been lacking the catalyst to turn those anticipated trends into delivery. Both the PBCE and the UK Guarantee hope to provide this stimulus, by supporting the ratings of project bonds in order to make them appeal to a broader investor base. Increasing Credit Ratings - Scope of Credit Support Whilst many potential capital markets investors are looking for a public rating of A- or better, the structures, contract packages and sponsor support commonly seen in the project finance market tend to produce ratings below this level. Proposals to reinvigorate the infrastructure bond market have thus far focussed on providing financial credit support to senior bonds, rather than changing this traditional project model. The PBCE covers a maximum of EUR 200 million per project or 20 per cent of senior debt capacity (whichever is lower), and can be structured for each transaction either on a funded basis through the provision of a subordinated loan, or on an unfunded basis through the provision of a standby letter of credit in favour of a trustee and a corresponding subordination of the EIB's rights of subrogation and indemnity in the event of a claim being made. The PBCE is intended to deliver a rating enhancement to the senior bonds, covering initial losses without entirely removing the need for investors to have an understanding of the underlying project. The PBCE (in both its funded and unfunded formats) has a fairly broad remit, available to provide payments to cover construction shortfalls, scheduled debt service and (following receipt of termination payments from the procuring authority), accelerated payments. The PBCE can also be fully injected in certain scenarios, including the breach of certain ratio triggers, thereby enabling a delevering of the project from the perspective of senior debt. A ratings uplift for support of around 20 per cent. would seem appropriate in light of Moody's latest research into recoveries following project finance defaults (published in February this year), which found that ultimate recovery rates are 80.3% on defaults as defined by Basel II and 78.6% on defaults as defined by Moody's. On the Castor Gas transaction, a standby letter of credit was provided covering EUR 200 million initially, with this amount declining in line with the amortisation profile of the senior bonds. The senior bonds were rated BBB+ by Fitch, which reflected a "shadow rating" of BBB- for the underlying project, and a 2 notch uplift for the credit enhancement provided by the PBCE facility. The UK Government Guarantee Scheme, which has been developed for bond financing but can also be adapted to cover a wide range of investments including loans, takes a somewhat different approach to the level of credit support provided. As was the case with typical monoline policies, the UK Guarantee will cover 100 per cent. of the originally scheduled payments of principal and interest, even where an event of default or prepayment event under the terms of the bond (or other credit facility) creates an immediate repayment obligation for the project company. For the investors, much of the project risk is therefore substituted by government risk, and a full substitution of the government's own credit rating is envisaged. As an added benefit of this scheme, bonds guaranteed by the UK Government should attract a zero risk weighting under the provisions of Solvency II, providing a strong investment incentive for insurers who may otherwise have limited appetite for bonds with longer maturities due "Unlocking the support of institutional investors to provide long-term investment in European infrastructure is crucial for stimulating economic growth and creating new jobs " (EIB President Werner Hoyer)

3 Infrastructure Bonds underwriting Europe's growth agenda 3 to the additional capital costs imposed. The drawback to this fully guaranteed approach is that it reduces or arguably removes the requirement for bondholders to evaluate and assess project risk, and therefore has the potential to constrain the longer-term capacity growth for investment in project bonds as an asset class. This is often cited as one of the reasons why the monoline-wrapped project bond market did not also foster a stronger unwrapped market. Prospectus and Obligations Disclosure Continuing Some sponsors have been concerned about accessing capital markets funding for their projects due to disclosure requirements, both in terms of the prospectus disclosure that is required for initial marketing and in relation to the continuing obligations by which the relevant obligors are bound under contracts and regulation once the bonds have been issued and sold. Offering Documents As regards the prospectus disclosure, the exact requirements will of course vary depending on where the bonds are to be admitted to trading or offered to the public, but for a limited recourse project it can be expected that summaries of each project agreement will be required for inclusion in the prospectus. It is worth remembering however that for many projects, such as those involving government concessions or contracts, information (including contract pricing) may already be in the public domain and therefore its inclusion in the prospectus should not be a concern. Where projects are supported by the UK Guarantee Scheme, the briefing document published by Infrastructure UK "The UK Guarantees Scheme for Infrastructure Projects", suggests that an approved prospectus will not be required in connection with either a public offer or an application for admission to trading on an EEA regulated market. This is based on the assumption that the bonds will fall outside of the Prospectus Directive (Directive 2003/71/EC, as amended) regime in such circumstances as they will be "irrevocably and unconditionally guaranteed" by the government of an EU Member State within the meaning of Article 1 (2)(d) of the Prospectus Directive. There are however certain explicit exclusions from the scope of the UK Guarantee, including prepayment amounts, make-whole amounts, and any default interest or indemnity payments. Whilst papers published by both Moody's and Standard & Poor's in light of the publication of the draft UK Guarantee do not suggest that these exclusions will be material from a ratings perspective, it will be important to ensure that the Financial Conduct Authority (or other competent authority) is comfortable that the scope of any unguaranteed payments is not sufficiently broad or significant as to compromise the exempt nature of the securities for the purposes of the Prospectus Directive. Projects that employ the PBCE product will still require Prospectus Directive compliant offering documents if the bonds are to be listed on a regulated market in the EEA, as the PBCE does not provide a 100 per cent. guarantee of the bond payments. Continuing Disclosure Continuing disclosure obligations will include both contractually agreed reporting requirements and any regulatory requirements, such as the requirement under the Market Abuse Directive (and relevant implementing measures) to publish non-public price-sensitive information. The trend for contractual reporting requirements in capital markets transactions follows those in bank financed deals, with regular reports to be made available containing detailed financial reporting and modelling, including forward-looking projections. Against this backdrop, the regulatory requirements may not appear onerous, although sponsor reluctance to share the details of models and projections with a public community of bond investors may require some careful navigation through the Market Abuse landscape in order to avoid risks of asymmetric disclosure. For those projects with the benefit of the UK Guarantee public disclosure requirements may be more limited, as arguably the greater the bondholders' exposure to government (rather than project) risk, the less likely it is that facts and circumstances affecting the underlying project could constitute "inside information" and the less likely the bondholders are to require detailed reporting on the project. It may therefore be possible effectively to negotiate reporting requirements with the UK Government, and mitigate the reporting burden on sponsors. The downside to this from a market perspective however is that bondholders are not being required to take an active interest in credit evaluation and monitoring - skills that will be essential to the development of a broad and sustainable market for infrastructure bonds. The fact that the PBCE does not provide a full guarantee means that investors in projects with PBCE support are still

4 4 Infrastructure Bonds underwriting Europe's growth agenda compelled to take an active role in the monitoring of these assets. Decision-Making Control and One practical problem with a senior financing group dominated by bondholders is the difficulty in ensuring timely decision-making (and, given "inside information" concerns, effective preliminary dialogue), particularly during the construction period when restrictions imposed under standard covenant packages may require the project company to seek numerous consents and waivers. The practical day to day decisionmaking that was devolved almost entirely to the monolines as "controlling creditor" does not sit so easily with unwrapped bonds where the voting power rests with a diverse group of holders. Those holders may also have varying commercial interests, particularly in a distressed or underperforming project, where the original investors may have traded out of the bonds to be replaced with more opportunistic creditors. Some steps forward have been taken through a fresh approach to the somewhat lengthy and staid meeting procedures that have long been a feature of English law Eurobond documentation. Bondholder decisions need to be taken at a full meeting of bondholders, which typically require a notice period of 21 clear days and a physical meeting. By reducing some of the timeframes for decision making, and allowing for the direct recognition of "electronic consents" delivered through the messaging systems of the relevant clearing systems, Eurobond documentation has gradually adopted a more flexible approach (although by no means universally so). Although the benefits of such an approach are clear (and arguably ripe for adoption in more conventional Eurobond financings) they do not necessarily offer a complete solution where a decision is actively sought by the project company/obligors. Whilst bondholders are accustomed to participation in liability management exercises, including consent solicitations, where there are fee payments or other incentives available, they do not necessarily share the more relationship-based approach of bank lenders or financial guarantors. One option to ease decision-making issues is to reduce the number of decisions required, by relaxing the covenant package and giving obligors more flexibility to run the project as they see fit. Whilst this approach may be observed in typical investment grade Eurobond terms, it has yet to find favour in a project finance market now used to extensive restrictive covenants. Achieving efficient decision-making (rather than fewer decisions) therefore remains the current focus of innovation. On multiparty financings, such as recent whole business securitisations of infrastructure companies, electronic consents have been combined with "snooze-lose" provisions and low quorum requirements, so that votes can pass even where a significant number of bondholders do not vote within the relevant time period. Monitoring Advisers Another possible method for streamlining the decision-making process, is the appointment of an appropriately skilled third-party (who is not necessarily required to hold an economic stake in the transaction) to make certain determinations on behalf of creditors. On both Castor "the UK Guarantee will be structured such that, from the beneficiary's perspective, the UK Government.is effectively substituted for the Company. As a result a Beneficiary may conclude that it needs little to no contractual recourse against the Company" (Infrastructure UK: The UK Guarantees Scheme for Infrastructure Projects) Gas and the UPP university accommodation bond programme, Trifinium Advisors (UK) Limited was appointed as "Monitoring Adviser", acting as bondholder representative and determining or recommending certain courses of action to the bondholders (on the basis of skills and expertise developed through the surveillance and management of the infrastructure investments of the monoline insurer MBIA). On both transactions, a number of decisions can be made by the Monitoring Adviser on its own initiative, without recourse to bondholders. At the other end of the scale, the most significant decisions, including amendments to payment terms, the release of security and the taking of enforcement action, are always subject to a bondholder vote. In between these two extremes, different approaches were taken on the Castor Gas and UPP transactions. On UPP, the majority of matters are subject to a negative consent mechanism, whereby the Monitoring

5 Infrastructure Bonds underwriting Europe's growth agenda 5 Adviser's recommendation is binding unless a significant minority of bondholders have signalled their objection to the proposal within the prescribed time period. This helps to mitigate the risk profile of the adviser, as well as giving investors the opportunity to over-rule decisions which they do not support (although this right will no doubt be exercised ever more sparingly as confidence and familiarity with the role develop). In the Castor transaction the Monitoring Adviser has a more limited role in these decisions, in the majority of cases publishing recommendations or advice for those that are willing to listen, but not necessarily exercising binding authority over holders as a group. Whilst this still requires the Obligors to engage with bondholders, and may therefore appear to lack some of the benefits of the broader negative consent approach described above, the provision of an expert opinion can still justify a reduction in the timescales within which bondholders are required to voice their concerns, as well as providing helpful insight to holders who are not as familiar with the project assets as some of their peers. The Monitoring Adviser role can therefore be a flexible tool, although it is unlikely ever to become a substitute for an engaged and enfranchised bondholder community as significant credit decisions are always likely to be reserved to the bondholder group. Decisions can be categorised and approaches for each category agreed for each transaction depending on factors such as the status of the project (greenfield or refinancing post completion), the covenant package, the circumstances in which decisions are likely to be required, and the engagement and preferences of the initial investors. In this respect it is also likely that market norms will develop as the role becomes more widespread. Public Sector as Controlling Creditor? Both the PBCE and the UK Guarantee raise the related issue of whether the relevant public sector institution is willing and able to act as controlling creditor, and take the lead in providing amendments, consents and waivers for matters affecting the rights of the finance parties. Both products lend themselves to this role from a structural perspective, because the relevant credit provider is acting either as sole guarantor in the case of the UK government (thereby replicating the typical monoline guarantee) or, in the case of EIB, because it is taking the first (and most likely the largest) share of any losses arising from default. In the Castor transaction, EIB specifically distanced itself from this role, in part in response to market concerns as to the inherent conflict in having a subordinated public sector creditor taking decisions on behalf of senior funders. EIB is however involved in any decision to enforce or accelerate the senior debt, consistent with its risk exposure as provider of the "first loss" financing, and is protected by a carefully constructed package of entrenched rights that limit changes to the common finance documents without the EIB's consent. By contrast, the Infrastructure UK's policy papers have a clearly stated objective for the UK government to exercise fully its voting rights in relation to the sums it guarantees. Similarly, the expectation is that the beneficiaries of the guarantee will have a very limited set of contractual protections. In practical terms, this is likely to be limited to a narrow set of entrenched rights that protect the bondholders against any amendments to the key payment terms of the bonds and the government's Guarantee. As the Infrastructure UK policy paper observes: "the UK Guarantee will be structured such that, from the beneficiary's perspective, the UK Government is effectively substituted for the Company. As a result a Beneficiary may conclude that it needs little to no contractual recourse against the Company". There is an obvious logic to this position in a fully guaranteed structure, as the UK government is bearing all of the risk of providing the bond debt, and will therefore have a detailed interest in the covenant package, security interests and project performance, given that it will be fully subrogated to the rights of Bondholders once the guarantee has been drawn. It could however become a significant resourcing commitment for the government to act as controlling creditor across a number of projects, given that the total potential commitment of the Government to the initiative may amount to some GBP 40 billion. In light of this, it may be that cofinancing with other enfranchised creditors, including bank or supranational lenders willing to take a lead role in decision-making, or the adaptation of the Monitoring Adviser role to consider UK Government interests, could offer a practical way for the UK Government to manage this potential burden. Looking Forward It is clear that infrastructure investment will remain a crucial part of Europe's policy agenda over the

6 6 Infrastructure Bonds underwriting Europe's growth agenda coming years, although in the face of different financing structures and investor preference, different approaches to delivery may continue to be relevant. The scope of governmental and supra-national support, and the way that it is deployed on individual projects, depends on striking the right balance between risk mitigation and investor engagement with the underlying assets. In the absence of a reduction in risk-weightings for projects benefiting from partial credit support, there may continue to be some tension between the twin objectives of optimising the economic case for investment and avoiding an intellectual dependency on public sector support. New forms of credit support also present a number of practical challenges, particularly in terms of information flows, creditor control and decision making. Successful transactions will undoubtedly help to generate a consensus in terms of the market response to meeting this challenge, and will help to validate the legal and structural solutions in the process of implementation. Clifford Chance Contacts: David Bickerton Partner, London david.bickerton@cliffordchance.com Eduardo Garcia Partner, Madrid eduardo.garcia@cliffordchance.com T: T: Clare Burgess Paul Deakins Jesús Quesada Senior Associate, London Senior Associate, London Lawyer, Madrid clare.burgess@cliffordchance.com paul.deakins@cliffordchance.com jesus.quesada@cliffordchance.com T: T: T: This publication does not necessarily deal with every important topic or cover every aspect of the topics with which it deals. It is not designed to provide legal or other advice. Clifford Chance, 10 Upper Bank Street, London, E14 5JJ Clifford Chance 2013 Clifford Chance LLP is a limited liability partnership registered in England and Wales under number OC Registered office: 10 Upper Bank Street, London, E14 5JJ We use the word 'partner' to refer to a member of Clifford Chance LLP, or an employee or consultant with equivalent standing and qualifications If you do not wish to receive further information from Clifford Chance about events or legal developments which we believe may be of interest to you, please either send an to nomorecontact@cliffordchance.com or by post at Clifford Chance LLP, 10 Upper Bank Street, Canary Wharf, London E14 5JJ Abu Dhabi Amsterdam Bangkok Barcelona Beijing Brussels Bucharest Casablanca Doha Dubai Düsseldorf Frankfurt Hong Kong Istanbul Kyiv London Luxembourg Madrid Milan Moscow Munich New York Paris Perth Prague Riyadh* Rome São Paulo Seoul Shanghai Singapore Sydney Tokyo Warsaw Washington, D.C. *Clifford Chance has a co-operation agreement with Al-Jadaan & Partners Law Firm in Riyadh.