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A Scottish roads project financing could solve the problem of negative carry that has long blocked the infrastructure sector’s funding streams;
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The forward purchase bonds, which ease concerns of investors and sponsors, could lead to copycat deals;
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The deal features other firsts, including an unwrapped construction phase project bond pari-passu with an EIB loan.
A Scottish roads project financing could solve the problem of negative carry that has long blocked the infrastructure sector’s funding streams.
The £175 million project financing has created a deferred payment mechanism to remove the negative carry that results from low interest rates and the absence of monolines.
The project bonds – known as forward purchase bonds – created for the financing of motorway improvement in Scotland, are expected to pave the way for copycat deals.
"These financings typically incur a large cost of carry, putting a real brake on the development of the capital markets," said Julian Davies, partner at Linklaters, who led on the deal. "That problem has been solved by this deferred payment mechanism."
The bonds, issued by Scots Road Partnership Finance and acquired by Allianz Global Investors, comprise half of the entire project's funding. The European Investment Bank (EIB) provided the remaining 50% with a term loan.
The mechanism is needed for two reasons, said Davies. Despite the appeal of project finance's long dated annuity-type payments, institutional investors have largely avoided the sector since the collapse of monolines and their ability to guarantee bonds.
Secondly, project bonds traditionally feature a significant cost of carry for the sponsors, exacerbated by current low interest rates and long construction periods.
To work around this negative carry, advisors created forward purchase bonds, which were rated A- by Standard & Poor's. These allow the issuer to sell the bonds, buy them back at a fixed interest rate, and then re-sell them at that same fixed interest rate in portions throughout the project's lifetime. Negative carry is removed.
To guarantee the arrangement, a commitment agreement was created, called a Subscription Bond Purchase Agreement, or SBPA.
At the end of the three-year construction period, all bonds will have been sold and the Allianz investors will hold them for the next 28 years to their final maturity date. In effect the issuers now only draw what they need, and don't have to sit on any money, added Davies.
"This will completely open up the bond investor base for projects," said Davies. Which is lucky, he said, because it comes at a time when project-lending banks are dwindling, with major project bank lenders such as RBS and Lloyds recently pulling out of the market and creating a funding gap. "This should help fill it at just the right time," he added.
There is a pipeline too. Linklaters said they are already looking at two more deals. The challenge will be replicating the deals with multiple investors, with only Allianz, itself a major projects investor, and one UK pension fund featuring in the M8 deal.
Further reading:
Background on the EIB’s project bond programme
Project bonds fund construction of French PPP
Project finance’s brave new world
Pari-passu
The deal contained other innovations, notably the first use of an unwrapped construction phase project bond pari-passu with an EIB loan. It was another necessary breakthrough: although the EIB had completed deals alongside monoline-wrapped project bonds in the past that allowed the bank to deal only with the monoline and not the bondholders, the institution now needed comfort working directly with the bondholders.
"So we re-wrote the way in which bonds can reach a decision," said Davies. Lawyers created a new scheme that allows several different mechanisms, all of which means the bonds have to, and can, vote within 15-25 business days (depending on the subject-matter of the vote).
The financing will also provide a boost for the EIB’s project bond initiative. Although the deal didn't fall directly under the project bond guarantee that the EIB has been promoting since 2012, it is highly related to the initiative, said Davies.
"What underpins that initiative is the desire to insert bonds into projects. The EIB was very keen to get a voting mechanism in for bonds that works, and we've done that," the Linklaters partner told IFLR.
Monitoring advisor
Effective bondholder voting, one of the sector’s other lingering questions since the monolines disappeared, may have been improved by the deal too. The bonds utilised a so-called monitoring adviser that acted for Allianz, the bondholders. With Allianz seeking comfort that the product was scalable for bigger projects with more widely held bonds, the investors requested the role on the deal.
The monitoring advisor’s role is to facilitate the bondholder voting. The advisor, called Bishopsfield, will act as an intermediary between the project sponsor and the bondholders. If, during construction, sponsors suffer delays they will send information to the bondholders explaining the reasons for delay and what consent or waiver they are asking for. The monitoring advisor will then advise the investors on the best course of action.
Tear sheet
Linklaters acted for Allianz and the bookrunners, HSBC and Calyon. The firm also worked for the bond trustee and security trustee as well as Bishopsfield, the monitoring advisor.
Ashurst acted for the sponsors. Linklaters advised EIB on the project due diligence, with Allen & Overy advising on the intercreditor aspects.
See also:
Background on the EIB’s project bond programme
Project bonds fund construction of French PPP
Project finance’s brave new world