The last 12 months have witnessed a sea change for infrastructure investment in the UK and the EU. As new regulatory regimes such as Basel III and Solvency II have taken hold and the economic recovery has begun to gain momentum, a new and diverse landscape is emerging. Although not all fears regarding the future of bank debt for project finance have materialised, the appetite that is returning from this source of capital is a selective one. Structure is the flavour of the month, and robustness is rewarded with competitive pricing. Competitive, because the global appetite for infrastructure investment did not diminish while the banks were forced to go on a diet. Out of the financial crisis have emerged a number of new products designed to bridge the funding gap and facilitate Europe’s much-needed infrastructure upgrade, including the pilot phase of the European Commission and European Investment Bank’s Project Bond Initiative and the UK’s Government Guarantee scheme.
Three greenfield projects that Freshfields has advised on – the Thameslink Rolling Stock Project, the Belgian A11 PPP Project Bond and Mersey Gateway – offer case studies in recent market developments and what we believe to be the evolution of a ‘new normal’.
Testing the waters: Thameslink
Reaching financial close at the end of June 2013, the £1.8bn Thameslink Rolling Stock Project (TRSP) was the most anticipated transport deal of the year. Five years in the making, TRSP is a crucial component of the wider Thameslink Programme, which aims to improve connectivity between north and south London, create direct links to Crossrail and Eurostar trains, relieve pressure on overcrowded routes and provide for major refurbishment works at hub stations such as London Bridge.
TRSP comprises the design, construction, maintenance and leasing of 1,140 electric multiple carriages in 115 trains (providing passengers on the Thameslink franchise with over 15,000 extra seats). The project structure is complex, with a five-year manufacturing period, followed by a 30-year maintenance period (supported by warranties of up to 35 years). The leasing terms are tied to each successive operating franchise, bolstered by an underlying section 54 undertaking from the Department for Transport that the units will be used for a period of 20 years. TRSP also includes the construction and lease of two depots for a period of 20 years (with options to extend) that were financed separately via an additional c.£500m corporate facility from Siemens.
The TRSP financing demonstrated that the long-term bank markets were open to well structured, greenfield big ticket infrastructure deals.
Although the Department for Transport had initially intended to structure TRSP as a traditional leasing arrangement, the impact of the financial crisis on the public purse strings and the comparative depth of the PPP market resulted in the creation of a structure that combined rental streams familiar to traditional asset finance lenders with the PPP-style features of performance risk transfer and a compensation-on-termination regime. The objective was to deliver a structure recognisable to both markets – asset finance and PPP – and capable of accessing both markets for its capital requirement. The end result was a public-private partnership between the Department for Transport and the project consortium, Cross London Trains. Siemens entities, together with 3i and Innisfree, provided the £177m of equity and subordinated debt in the project company, alongside £1.19bn of senior debt from a group of 20 commercial banks (with a 25-year tenor) and £425m of EIB facilities.
The TRSP financing demonstrated that the long-term bank markets were open to well structured, greenfield big ticket infrastructure deals. But at the time the project structure was developed (in late 2008 and early 2009), there was no real post-monoline precedent for a greenfield project of its size to be funded through the capital markets and so there was a real nervousness at the likelihood of funding such a large deal in the bank markets. Achieving a robust (albeit complex) structure was of paramount importance to getting the deal across the line and, ultimately, in securing an A- rating. As a result of this, it is anticipated that the project will be refinanced in the capital markets.
TRSP set the post-crisis standard for the structures required by investors in large-scale greenfield infrastructure. Two more recent projects have shown how robust and innovative structuring is the key to reopening the capital markets to such projects.
The structure of the project – the mitigation of the negative cost of carry, coupled with the enhancement provided by the PBCE Facility – therefore presents significant benefits to both project companies and to those bond investors who are generally shy of taking ‘naked’ construction risk.
The rebirth of the Project Bond: the A11
With the last of the large PFI monoline-wrapped greenfield deals reaching financial close in the Summer of 2007, the A11 PPP Project Bond in Belgium (the A11), which reached financial close in March 2014, was the first large-scale publicly- listed greenfield project bond to be brought to the market in almost seven years. The A11 is also the first greenfield project to have the benefit of the EIB’s project bond credit enhancement facility (PBCE Facility). A 12km ‘missing link’ between Brugge and Westkapelle in Belgium, the €700m project will take four years to complete and, with its two viaducts, three tunnels and a moveable bridge, presents significant construction complexity.
The PBCE Facility, a product developed by the European Commission and the EIB to allow infrastructure projects to access the capital markets in a cost-effective manner, is a subordinated instrument (either a loan or contingent facility) to support senior project bonds and enhance their credit rating. On the A11, the EIB provided a PBCE Letter of Credit facility of up to €115m that was particularly important given the construction risk involved and which resulted in a three-notch rating uplift on the bonds to A3.
The financing structure on the A11 also marked the development of an innovative approach to bond financing through the use of a €578m ‘drawdown bond’, avoiding negative carry and providing the project company with the same economics as bank debt. Although all bonds were listed on the Luxembourg Stock Exchange on the issue date, only a small amount were actually issued to investors, with the remainder being issued to the lead manager and sold back to the issuer at financial close. In return for a commitment fee, the investors are then obliged to purchase specified amounts of the bonds from the issuer on quarterly dates during the construction period. The structure of the project – the mitigation of the negative cost of carry, coupled with the enhancement provided by the PBCE Facility – therefore presents significant benefits to both project companies and to those bond investors who are generally shy of taking ‘naked’ construction risk, and is likely to prove popular with both sponsors and investors as the pilot phase of the EIB Project Bond Initiative progresses.
Although structurally complex, this multifaceted approach combining sources of debt from both the bank and the capital markets issued from a common platform with common terms is, we believe, the way forward for really large greenfield projects.
Gathering momentum: Mersey Gateway
The Mersey Gateway project in north-west England set a number of significant precedents. The £600m project to design, build, operate and maintain a new six-lane toll bridge over the River Mersey, which reached financial close in March 2014, was the first greenfield PPP project to benefit from the UK Government Guarantee scheme and it was also the first publicly-listed bond to use the scheme.
The guarantee provided by the UK Treasury (the HMT Guarantee) is an unconditional and irrevocable guarantee of scheduled principal and interest falling due but unpaid. With an Aa1 rating (ie the credit rating of the UK government), the credit strength provided by the HMT Guarantee has enabled this greenfield infrastructure project to access a broad range of fixed income institutional investors.
The HMT Guarantee guaranteed £270m of bonds listed on the Irish Stock Exchange. The capital structure also comprised £245m of senior debt provided by a group of commercial banks, and a capital grant facility provided by Korea Finance Corporation in addition to a £50m mezzanine facility, equity from the sponsor consortium, and, finally, a construction support facility to supplement and, in part replace, typical construction credit support. Although structurally complex, this multifaceted approach combining sources of debt from both the bank and the capital markets issued from a common platform with common terms is, we believe, the way forward for really large greenfield projects.
Full speed ahead: a bright future awaits
The financial crisis, with its bank bail-outs, demise of the monolines and increased regulation focused on ensuring liquidity of assets held by banks and institutional investors, saw massive constraints in the project finance bank market and a drastic reduction in credit for greenfield infrastructure projects. However, the world of infrastructure financing has shown itself to be pragmatic, flexible and innovative. As economic growth and stability in the banking market have returned and solutions developed as a response to the financial crisis have become available, the diversity of funding sources now available stands in stark contrast to the dark days of 2008 and 2009. What has emerged in this new world is a comprehensive and multifarious portfolio of products, allowing for structural sophistication, encouraging competitive pricing between products and promising deliverability to even the most complex of large-scale infrastructure projects.