What is the difference between a ‘Euro-bond’ and an ‘EU project bond’?
This is question that has become pressing since José Manuel Barroso, the European Commission’s president, used his ‘state of the union’ speech to the European Parliament this month to promote the idea of ‘EU project bonds’.
As a targeted response to a specific challenge facing Europe’s economy, it is an idea that merits study. But it has, instead, elicited a hostile response in some quarters.
The challenge is this: Over the next decade, Europe will need to invest enormous sums into its infrastructure, from ‘smart’ power grids to urban transport systems. Around €450 billion will be needed just for trans-European transport networks. But, as a result of the financial crisis, nearly all European countries face budgetary constraints.
In the past, the private sector was heavily involved in financing infrastructure projects. Banks provided loans. Long-term institutional investors (such as pension funds and insurance companies) invested in bonds issued by the companies involved in projects. Virtually all of these bonds were guaranteed by insurers, so‑called monolines, that kept the risks for bond subscribers at acceptable levels.
Many of the same projects now struggle to get off the ground. Substantially less long-term finance is available than before the crisis. Loan syndication has dried up. Monoline insurance for project bonds is practically non-existent.
International financial institutions can help bridge the gap. Indeed, at the request of its shareholders, the EU’s 27 member states, the European Investment Bank (EIB) – the EU financial institution – last year increased its total lending by nearly 40% to a record €79bn euro, of which €26bn was for major energy and transport projects.
But even that exceptional level of activity is modest in relation to Europe’s total infrastructure finance needs. Europe needs therefore to find ways to encourage other long-term investors, such as pension funds or sovereign funds, to help shoulder the burden.
The ‘EU project bond’ initiative could be part of the solution. It is best described as a mechanism for enhancing the credit rating of bonds issued by project companies themselves. There are various ways this could be achieved: one possibility is for the EIB to provide higher-risk subordinated debt finance to credit enhance the bonds issued by a project company. This could be done under a risk-sharing arrangement with the EU budget, similar to that which is already used to guarantee certain risks associated with transport projects. Irrespective of the means of credit enhancement, the final objective is the same in all cases: creating a class of high quality bonds that institutional investors would feel comfortable to buy.
So why has the reaction in some quarters been hostile? I think this is due to confusion between ‘project bonds’ and the various types of ‘Euro-bonds’ that have been proposed at EU level in recent years.
As way to achieve the internal market, the Commission’s then president, Jacques Delors, proposed in 1993 that the EU use the backing of its own budget to borrow money for large infrastructure projects by issuing bonds on capital markets. As a means of creating more flexibility in the use of the EU’s multi-annual budget, the idea may return again in the context of negotiations on the next EU budgetary period starting 2014.
Another entirely different use of the term ‘Euro-bonds’ is applied to the idea that eurozone countries could pool some of their national debt to improve borrowing conditions.
Unlike these concepts, ‘project bonds’ would not be issued by a sovereign or EU entity. The EU’s role would be limited, as stated, to providing credit-enhancing instruments for the bonds issued by project companies themselves. This is an important distinction.
Institutional investors are looking for long-term assets in which to invest. But they often lack the capacity to appraise projects and they are relatively risk-averse. Project bonds could help match the needs of these investors with the EU’s own infrastructure needs.
Philippe Maystadt is the president of the European Investment Bank.
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