Infrastructure projects are seeing greater opportunities to access a wider and more diversified pool of potential capital. This is particularly clear in the context of a long-term contraction in bank lending and the increased pressure on alternative lenders to diversify portfolios and maintain stable yields — oftentimes within the bounds of a relatively conservative risk appetite.
Alternative lenders. Since the onset of the most recent financial crisis, banks have been subject to greatly increased regulatory supervision and higher capital requirements, leading to pressure to reduce their loan books, particularly in relation to longer term liabilities. This has created a funding gap, especially for developers of infrastructure projects, where shorter-term debt and/or hard refinancing requirements might not be attractive.
At the same time, non-bank institutions, such as insurance companies and pension funds, are facing pressures (for example, under Solvency II and other regulatory regimes) to diversify and ensure the profitability of their portfolios and to match investments to their long-term liabilities. The funding gap in markets traditionally dependent on bank debt has presented an opportunity for such institutional investors, and there has been a surge in their debt financing for infrastructure.
This is particularly true for established renewable energy technologies, where the risks are relatively well understood and government subsidies are encouraging investment. We have seen increases over the last few years across Europe in investment from non-bank lenders, in both the bond markets and private placements.
Private placements. A private placement is the method of placing debt with a small number of selected, sophisticated investors, either in the form of loans or bonds/notes — and if structured as bonds — may be listed or unlisted. Oftentimes, such investors are non-bank institutions, though not exclusively.The US has a long-established corporate private placement market, with standard form template documentation for US and non-US companies, both investment grade and leveraged financing. These take the form of unlisted loan notes, and usually benefit from a rating by the National Association of Insurance Commissioners (which is a pre-requisite for investments by US insurance companies).Across Europe, a few national private placement markets have slowly developed. For example, in Germany, there is an established Schuldschiendarlehen market, which takes the form of a bilateral loan. Typically investors have been German banks and insurance companies, and loans have been available to investment-grade German corporates, though this is widening to foreign and non-investment grade companies.A substantial market has also developed in France. Due to French regulatory restrictions prohibiting non-bank investors from extending loans, these have taken the form of bonds, primarily for French companies, arranged by French banks and placed with French insurers.In the UK, the market is less well established, with institutional investors more traditionally looking to the bond markets, or taking loan participations in the secondary market.
Development of a pan-European private placement market. Governments and industry bodies have recognised the benefits that a strong institutional investor market can have, promoting growth and increasing resilience in markets and economies.The European Commission’s investment plan for Europe outlines a series of initiatives aimed at promoting growth across Europe. The plan aims to encourage investment in key areas through targeted utilisation of EU funds and removal of regulatory barriers. In addition, the Commission is creating more diversified and integrated capital markets across Europe in the form of a Capital Markets Union. The European Commission is currently consulting on proposals for the CMU, including the development of a pan-European PP market.Other initiatives have also been introduced to facilitate development of a pan-European PP market, including: A suite of Pan-European private placement documentation published in January 2014 by the Loan Markets Association, which follows the already well-established LMA form of loan documentation and can take the form of a loan facility or notesA private placement market guide, published in February by ICMA, which aims to help promote the development of a proper pan-European private placement market by providing a framework for best practice.Although prepared principally for the investment-grade corporate debt markets, it is expected that these will evolve and will help to promote standardisation of documentation for private placements in other markets, including project financing. In turn, it is hoped this will lead to greater confidence from investors and borrowers, and help reduce the time and costs currently invested in negotiating agreements.
Assuming these initiatives have their desired effect, it seems probable that renewable energy assets will continue to benefit from the attention of institutional investors. Across Europe, incentives to increase investment in renewables remain prevalent.
In October 2014, the EU 2030 Energy Strategy set a target of a 40% cut in greenhouse gas emissions compared to 1990 levels, and a target of at least 27% at EU level for renewable energy consumption. Although national targets are currently a more contested issue,1 in order to achieve these targets incentives for investment at national level look set to continue.
An increased focus on efficiency and affordability is clear from agendas across the EU, and as new schemes, such as Contracts for Difference in the UK, introduce more competitive bidding arrangements to achieve these goals, institutional investors (and sponsors) will need to become familiar and get comfortable with the new market mechanisms. However, for those investors who are able to meet these challenges, the long-term, relatively stable returns these projects provide are likely to continue to appeal for investors seeking to match long-funded liabilities and secure stable returns.
As institutional investors become more established and experienced, and more familiar to developers, it is expected that the level of debt investment from alternative lenders in these markets will continue to increase, offering wider funding opportunities for these developers.