Credit-enhanced project bonds have taken time to reach the market, but a debut UK deal arranged by HSBC could set a useful precedent for financing offshore power transmission infrastructure.

Europe’s credit-enhanced ‘project bond’ has taken some time to gather momentum but deals are at last emerging from the pipeline. HSBC, which recently arranged the first such UK project bond, sees them as part of the continuing migration of infrastructure finance from the bank market to the capital markets.

As Europe lurched through the financial crisis, governments saw new infrastructure projects as highly desirable growth catalysts. They were less attractive to lenders and investors, however. Deleveraging banks didn’t want to incur new Basel III penalties for longer-term lending. Investors, who were used to buying project bonds wrapped in AAA monoline guarantees, lacked the skills to analyse the risks for themselves once the monoline insurers disappeared.

Those were the circumstances in which the European Investment Bank’s (EIB) Project Bond Credit Enhancement (PBCE) scheme was born. President of the European Commission José Barroso began talking about European project bonds as far back as 2010, but it was the summer of 2013 before the first deal appeared. This was a €1.4bn, 21.5-year senior secured issue for Watercraft, whose underlying project was Castor, a Spanish underground offshore storage facility. With a coupon of 5.756%, a 100 basis points (bps) premium to the Spanish sovereign, the notes benefited from €200m of PBCE, via a subordinated EIB letter of credit. The EIB also bought €300m of the bonds. The credit rating was accordingly boosted by two notches to investment grade, with Fitch rating it BBB+ and Standard & Poor’s BBB. Most agreed that without the uplift the deal could not have been done, at least not at that size.

European governments have been keen to see insurance companies and pension funds in particular move into the space being vacated by the bank market, emulating those Canadian and Australian institutional investors that have long held large positions in the sector. Some jurisdictions, such as the UK and France, have introduced their own guarantee schemes to support infrastructure debt. European pension funds already invest in infrastructure, but largely via unlisted equity and mostly via funds. When it came to debt, they have tended to stick to brownfield (established infrastructure) operational risk.

“The challenge has been to create the right infrastructure debt product for pension funds and third-party asset managers to invest in,” says Scott Dickens, HSBC’s global head of structured capital markets. “Banks still have a role and longer construction phases will probably continue to be bank-financed. But simpler credit stories with better credit characteristics are more suited to issuance in the capital markets. Everyone has a vested interest in a better balance of financing from the various sources of capital.”

Offshore wind

The UK’s offshore transmission (OFTO) asset class was designed from the start to be market-friendly. Encouraging electricity generation from offshore wind is part of the UK’s programme for getting 15% of its energy needs from renewables by 2020. Once the offshore infrastructure is built, however, it is a licensing requirement that the transmission assets – substations, cabling, electrical equipment – must be divested. The resulting OFTOs then offer a fixed 20-year inflation-linked revenue stream, underpinned by the licence. Crucially, revenues are not linked to generation and whether or not the wind blows. They depend simply on ensuring that the infrastructure is available to transmit power and are effectively paid by consumers, not by the wind farm.

The OFTO regime was set up in 2009 and the first licence granted in 2011. Until now, however, OFTO acquisitions have been financed in the bank market. The Greater Gabbard OFTO connects the 504-megawatt, 140-turbine Greater Gabbard wind farm off the Suffolk coast to the onshore transmission grid and was assigned a transfer value of £316.6m by the regulator. It was acquired by a consortium consisting of fund managers Equitix and AMP Capital, together with Balfour Beatty Capital, part of the large UK construction firm.

In late November, the consortium was able to announce it had placed a £305m, 19-year project bond to fund the acquisition. HSBC was sole arranger and joint bookrunner with Santander Global Banking & Markets. The bond was priced at 125 bps over gilts, with a coupon of 4.1377%. “A key advantage was the cost saving versus the bank market,” says Mr Dickens.

Setting precedents

The HSBC team worked on the issue for some 18 months. This was the first PBCE deal out of the UK as well as the first for an OFTO, so it needed to be absolutely right. “Because of the precedent it set, it was very closely scrutinised – by [the energy regulator] Ofgem, the EIB, by the clients and HSBC,” says Katrina Haley, HSBC’s head of structured bonds. “Hopefully, it has opened the market for future deals, but it inevitably takes time.”

HSBC didn’t go straight to the PBCE option. It considered both the bank market and the capital markets, with or without credit support. Having settled on the bond solution, it considered the inflation-linked market before rejecting it as insufficiently wide and deep, and occasionally unpredictable. “We could have done fixed-rate and inflation-linked, but that would have left us with two small bonds,” says Ms Haley.

The EIB was willing to deploy its PBCE to support the transaction. It provided a committed, undrawn and subordinated letter of credit for 15% of the transaction amount, which will not only provide additional liquidity if required but act as a first-loss piece in the structure. That allowed a rating uplift from BBB+ to A-. The development bank’s participation also acted as a seal of approval. “For a new asset class, a number of investors take comfort from the fact that the EIB has done a scrub-down of the transaction,” says Ms Haley.

It also helped that, compared with more difficult infrastructure assets such as waste to energy, nuclear power and offshore wind power generation, OFTO risk is fairly easy for investors to understand. After roadshowing in London and Edinburgh, the transaction was three times oversubscribed, distributed among nearly all account types but almost exclusively UK-based. “We had a lot of interest from Japan, Canada and Europe, but possibly the timing was wrong, or the exchange rate, or the low pricing didn’t appeal,” says Ms Haley.

Competitive pricing

The tight spread to gilts vindicated the decision to choose the capital markets over the certainty of the bank market. Only a month earlier, the London Array OFTO had raised £250m ($407m) of senior debt in the bank market at what was said to be a spread of 290bps.

On a broader front, HSBC believes the Greater Gabbard deal shows that the capital markets are now open for infrastructure deals. “There has always been a bias against the capital markets solution because it was considered less certain,” says Mr Dickens. “But a lot of that has changed. There is now a very sizeable level of committed demand for infrastructure, so the market should no longer be considered uncertain or volatile.” He adds that this investor base is developing globally and that it has a lot of catching up to do in terms of growing its allocation to the sector.

“That’s good going forward, because the first question asked by procuring authorities is ‘will the market be there?’,” says Ms Haley. “For OFTOs, here’s the proof.”

There will be a lot more OFTO funding to come, one way or the other, with an estimated £14bn in assets to be financed between now and 2021. HSBC reckons that the capital markets should have a strong competitive position in terms of all-in financing cost.

“In HSBC we have a considerable pipeline of future transactions that are highly likely to come to the bond market,” says Ms Haley. “There has been a huge development of institutional participation recently, off a low base. That confidence will generate an increase in all projects and a larger percentage of that increase will be bond-funded.”


All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker

For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Top 1000 2023

Request a demonstration to The Banker Database

Join our community

The Banker on Twitter