Infrastructure: The new crossover between industry and finance Stefano Gatti Energy Infrastructures: Towards the Creation of a European Energy Union February 12, 2015 1
Agenda Where are we now? An international comparison Why is infrastructure an alternative asset class? Infrastructure and equity investors Project Bonds The 2020 Project Bond Initiative The 2014 European Fund for Strategic Investment 2
Where we are now? (I) Connecting Europe Initiative (European Union): about 2 trillion euro infrastructure needs within 2020 0.5 trillion euro TEN-Transport Projects 1.1 trillion euro TEN-Energy and Power The rest for broadband and ICT...plus social infrastructure Raising awareness of the link between economic growth and infrastructure development 3
Where we are now? (II) However, awareness of the constraints the European Union is facing High public deficits Increased credit crunch Increased need to attract private capital (PPPs: Public Private Partnerships) in the form of debt and equity financing The new imperative is to attract capital on infrastructure as an alternative asset class to traditional investments (stocks and bonds) 4
An International Comparison (I) Copyright SDA Bocconi 5
An International Comparison (II) 70,00% Public Debt to GDP % 60,00% 50,00% 40,00% 30,00% 20,00% 10,00% 0,00% China India Indonesia Malaysia Taiwan Thailand Serie1 39,30% 61,50% 26,10% 57,70% 41% 45,80% Copyright SDA Bocconi 6
An International Comparison (III) 200% Public debt to GDP % 180% 160% 140% 120% 100% 80% 60% 40% 20% 0% Greece Italy Portugal Ireland Cyprus Belgium Spain France Germany Austria Malta Slovenia Netherla nds Finland Slovak Republic Serie1 175% 133% 129% 116% 111,50% 101% 94% 92% 78% 74,50% 72% 70% 69% 55% 55% 35% 23% 10% Latvia Luxembo urg Estonia 7
Why is infrastructure an alternative asset class? Long term assets Stable cash flows Natural monopolies High entry barriers Regulated sectors Low demand elasticity Low correlation with traditional asset classes (good diversification potential) 8
Infrastructure and equity investors Growing interest of investors for this asset class: Infrastructure funds (greenfield, brownfield, secondary): mixed group with different risk/return profile Institutional investors with a typical long term investment horizon (Pension, Foundations, Life Insurance) Sovereign Wealth 9
Global infrastucture fundraising 10
Total AuM in top 100 Asset Managers Pension (2013) of Hedge Direct Hedge 1200 1000 800 3% 4% 2% 5% 22% Private Equity FoF Direct Private Equity Direct Real Estate 600 400 200 0 of Hedge Direct Hedge Private Equity FoF Direct Private Equity Source: Towerswatson (2014) Direct Real Estate Direct Commo dities Direct Infrastru cture Illiquid Credit Amount (bn $) 172,5 723,9 321,6 752,6 1020,6 78,6 120,6 77,7 31% 23% 10% Direct Commodities Direct Infrastructure Illiquid Credit Infrastructure is 4% of the alternative Investments (4.2% of total AuM of 3,268 bn USD) 11
Sovereign Wealth and infrastructure 100% Proportion of Sovereign Wealth Investing in Each Asset Class, 2012 vs. 2013 90% 80% 86% 82% 83% 82% 2012 70% Proportion of SWFs 60% 50% 40% 30% 56% 57% 54% 54% 57% 51% 38% 31% 2013 20% 10% 0% Fixed Income Public Equities Infrastructure Real Estate Private Equity Hedge 12
SWF s direct investments 2005-2012 (US$ bn) 13
Infrastructure debt funds (IDF) Investment vehicles in illiquid debt suitable to long term institutional investors Possibility to link funds availability with screening and monitoring skills of asset managers 14
Project Bonds (I) Traditionally, debt for infrastructure financing comes from bank loans (amounts in US$ mil.) 15
Project Bonds (II) Comparative advantages of bonds vs loans: Standardization Larger investor base Lower cost of funding (if well structured, mind that it is difficult to sell the construction risk) Less stringent covenants However: Negative carry Hard to market if the project is still under construction Solvency II not completely favourable (but EC is trying to find a solution) Hard tailor made repayment schedules Possible refinancing risk Hard to sell if rating level is not sufficiently high (in the region BBB+/A-) 16
The need of credit enhancement for project bonds 17
The 2020 Project Bond Initiative Set up by the European Commission and EIB Aimed at reviving the project bond market Essentially a credit enhancement tool Two alternatives: Funded: EIB subscribes a subordinated tranche that protects senior lenders and enhance the implied rating of the project Unfunded: EIB is a back up liquidity provider of a credit line that can be drawn in case of project troubles and then ranks junior to the senior loan Maximum 20% of senior debt Projects financed: Castor Gas Storage (Spain), Greater Gabbard offshore transmission link (UK), A11 (Belgium Greenfield) 18
The 2014 European Fund for Strategic Investments (I) Mr. Juncker s announced EFSI (European fund for strategic investments) Supported by 21bn public money (16 coming from EU funds connecting Europe and Horizon 2020 and the rest from EIB) Hypothesis: leveraging on private capital so to reach a total investment amount of about 315bn (15x) Public support in the form of a first loss guarantee: the back up can be drawn in case of emergence of losses. Not clear if in the form of equity or sub debt. 19
The 2014 European Fund for Strategic Investments (II) A Simple exercise 10-year cumulative default rate for PF loans: 11.5% (source Moodys) Average recovery rate on PF loans: 76,4% (so LGD is 23,6%) (Source Moodys) Expected loss base scenario: 2.714% Parameters of the EU: total value of projects 315bn; first loss absorption by public funds 21bn. The implicit expected stress loss rate is 6.66% (stress multiplier of 2.5x the base scenario expected loss) Is it tenable? 20