EU project bonds: More smoke and mirrors at taxpayer’s expense

5 May 2011, EurActiv

European Commission proposals to introduce project bonds are beset by deficiencies and shrouded in commercial secrecy, write Isabella Besedova of the CEE Bankwatch Network in an exclusive op-ed for EurActiv.

This contribution was sent exclusively to EurActiv by Isabella Besedova of CEE Bankwatch Network, a coalition of NGOs in Central and Eastern Europe monitoring the social and environmental impacts of international development finance in the region.

“The European Commission’s proposal for project bonds suffers from several deficiencies. Firstly, it attempts to dress up riskier private sector projects for the benefit of investors by giving them an artificial boost with public money. Secondly, it earmarks large-scale infrastructure projects for special treatment at the expense of small renewables which are in more need of support.

Finally, and perhaps most importantly, the Commission and the European Investment Bank (EIB) would, in this scenario, be handing out taxpayers’ money to the private sector while at the same time taking a back seat and letting the private financiers and investors control what happens to this money when the projects go bad.

All of this [would] take place under a veil of commercial secrecy where the public will have little chance of ever knowing what truly happened to its money.

This initiative is aimed at providing funding support to sub-investment grade private sector trans-European energy and transport infrastructure projects (TEN-T and TEN-E), which are greater than EUR 200 million in size. The financial support proposed [would] take the form of either subordinated debt or a loan guarantee during the construction phase of the project, up to a maximum threshold of 20% of the project’s total funding needs.

The intent behind this is to improve the credit rating of such projects to enable them to raise the funding they need from the markets through project bonds. With an improved credit rating, such bonds could then be sold to private investors. No public sector infrastructure projects would be eligible for the same support.

The initiative has been reasoned to be necessary by the Commission due to the collapse of the private sector monoline business in the wake of the global financial crisis. The monolines had previously provided a form of financial insurance (through Credit Default Swaps) on the bonds issued by the project promoters and this insurance enabled institutional investors to purchase them.

This Commission proposal, however, essentially represents an unacceptable transference of private sector risk on to the public sector without any corresponding payoff. Public guarantees and public debt are valuable tools whose use needs to be evaluated carefully and restricted. If public money is to be poured into riskier private sector projects, let it be those which genuinely need the support and which have also been flagged as priority for funding by the Commission.

Small-scale projects that enable the regionalisation of renewables-based generation and consumption circuits could use such support. In the proposal, nevertheless, renewables are singled out and considered ‘challenging’ and the coverage of ‘new markets’ (e.g. smart metering, renewable energy electricity infrastructure for transport) is seen as problematic.

The fact that the projects most favoured for funding have been deemed uninsurable and perhaps even unbankable by the markets appears to have been overlooked by the Commission. For such lower-rated projects, additional scrutiny and expertise is needed to avoid potential future losses (this would normally have been provided by the monolines).

It is highly doubtful that the EIB would be up to the task of providing such expertise or indeed of properly assessing and mitigating the risks of such projects where the likelihood of financial losses under the guarantees and subordinated debts is greatly increased.

The EIB’s past track record of assessment on infrastructure projects gives cause for concern. To date, there have been several examples of infrastructure projects which were assessed and financially supported by the EIB and which turned out to be overpriced, not economically viable or had cost overruns. Notable examples include the London Underground Public Private Partnerships, the M25 expansion in the UK, Euro Tunnel, Sofia Airport and the D1 motorway in Slovakia.

Another significant issue with this proposal is the notion that the EIB would likely not act as controlling creditor under any project bonds. In a scenario where poor financial assessment is conducted and a subordinated debt position has been taken in the project, there must at least be the guaranteed ability for the EIB (and the public) to have a leading creditor role to ensure some control over the project and the public funding which has been committed in cases of a breach of covenant or default.

As it stands now, the EIB would not only poorly assess projects in the first place but would also be unable to control any process should these projects fail to perform financially and contractually. In such situations the public funding which has been committed would be at the mercy of decisions made by others, likely private financiers or creditors regarding the project’s future.

There is a worrying trend in this proposal of allowing sovereign debt to be subordinated in favour of private debt. This is unprecedented and presents significant risks should such projects fail. In these cases, it would be highly likely that such subordinated debt would not be recovered and that public money had in fact been directly used to benefit private bondholders.

However, it is even more likely that in providing such support, the EIB would insist on other kinds of guarantees to mitigate its financial risks and these would most likely come from the host state or other public body. So again a transfer of private sector risk, this time to the taxpayers of that state.

Providing such ill-conceived and one-off assistance to these projects as is being proposed here will simply distort the financial market for such bonds. By increasing their credit rating it will make them unduly more attractive to private investors, artificially driving up demand and [creating] pressure for more such projects to be underwritten or guaranteed by the EIB and the EU budget.

While it may be the case that without the monoline insurance, many large infrastructure projects would now struggle to find willing investors or financiers, this should be resolved through the greater participation of the public sector in building infrastructure of clear public interest and benefit.

The logic behind this proposal does not address the core issues at hand. Instead of integrating some of the lessons learned from the recent financial crisis and seeking to better monitor financial instruments and their use in the private and public sphere, it simply seeks to supplement the failure of the private sector by propping up uncertain private projects with public funding.”