In recent years, we have seen only limited issuance of project finance capital market debt in EMEA, with the vast majority of infrastructure funding requirements being met by bank lending.
This is primarily due to the failure of the business model, whereby insurers provided a strong investment-grade guarantee to bonds issued by projects. Investors typically require a project to have an ‘A’ category rating before they will invest. This has been difficult to achieve since the crises.
Project finance is seen as one of the riskiest bond investment classes. Hurdles to financing projects depends on Solvency II regulations that makes it more difficult for insurers to make direct investments in infrastructure deals, given the amount of capital they are required to hold in case of default.
The traditional project finance model is to create a project company, that is funded with equity equalling 20-30% of the total funding need, and guarantees of off take of the investment, in order to make the project company bankable.
However it has been a challenge for some time, also to get infrastructure project finance funding through the traditional banking system.
This void in market funding has arisen partly because the large banks are busy deleveraging their balance sheets and because alternative forms of financing have taken time to develop. Basel III regulations force banks around the world to hold more capital against loans and restrict their ability to lend over a long period.
However according to an article in Financial Times this morning, this seems to be changing. Faced with low returns from investment grade corporate bonds and Treasury bills, demand from institutional investors like pension funds, which need long-term returns to match their long-term liabilities, is according to FT now yielding action. The FT quotes:
“The market has sprung back this year because there is strong institutional investor demand for this type of debt and there is a need to put money to work. That’s what’s changed – compared to yields on sovereign and corporate debt and volatile equity markets, infrastructure bonds can appear very attractive.”
– Mike Wilkins, senior project finance analyst at Standard & Poor’s