• Managing Risk Masthead


    The constraints in today's debt markets means that alternative funding models are needed to support infrastructure projects. Saab Mahil, Head of Structured Debt Syndicate, Loan Markets and Nick Hughes, Head of Structured Solutions, Risk Management Solutions discuss the opportunities and challenges.

    Debt in the UK’s project finance market, particularly for PFI social infrastructure, has traditionally been long tenor. A common scenario pre-2008 would see banks funding a three year construction period, before providing operational support for up to 25 years.


    Arranging debt over this period was not a problem, given that banks were generally comfortable mitigating construction risk and providing long tenor debt at competitive pricing.


    The new reality 

    However, uncertainty in the Eurozone alongside banks’ regulatory constraints, deleveraging and the effective exit of many from the project finance market for tenors in excess of seven to 10 years, has given rise to alternative funding models. 


    Consideration needs to be given to shorter tenor debt or mini-perm structures which require borrowers to refinance with bank facilities or bond issues within defined time frames. This structure does introduce refinancing risk, but has been successfully applied to economic infrastructure (e.g. airports, ports, regulated assets) where investment grade assets with long term, stable cashflows come to market.


    The longer term financing market is clearly at a point of transition, with much debate about how institutional investors – pension funds, insurance companies and fund managers – can operate alongside banks.  Infrastructure debt is a natural complement to institutional investors’ fixed income portfolios as it offers a cash yield, attractive liquidity premium and low correlation to other asset classes.


    However, institutional investors generally don’t like construction risk, preferring projects to be already operational. They also may have a preference for fixed or index linked debt, rather than floating rate which is how banks normally finance projects. In addition, institutional investors do not like debt to be repaid early and could penalise borrowers for doing so.


    Encouraging investment 

    The EU 2020 Project Bond Initiative has been designed to try and overcome some of these issues and will use credit enhancement techniques to potentially deliver in excess of €4.5bn when taken with other sources of funding. Governments are also developing infrastructure investment initiatives, such as the UK Guarantee Scheme, announced in July 2012.


    Regulation will continue to play a key role with discussions ongoing about whether infrastructure assets should be treated as a separate category under Basel III for banks and Solvency II for insurance companies. 


    There are a number of major initiatives being worked on but the market is clearly heading towards an environment where banks, institutional investors and capital markets investors work alongside each other to help provide the most appropriate piece of the project finance debt. The Loan Markets team within Lloyds Bank has a deep pool of knowledge in the infrastructure space, and will continue to develop the best solutions for our clients and funding partners.


    A leap of faith 

    We have seen a number of investors looking more closely at the project finance market. However, their ability to carry a project through a construction period, which for some of the larger transportation developments will be in excess of five years, has yet to be tested - hence the potential requirement for mini perm financing. 


    The derivatives market is very familiar with this mini perm style financing structure across a number of asset classes and, within our Risk Management Solutions team, we have significant experience in designing hedging strategies to mitigate the interest rate, currency and inflation based market ‘refinancing risk’. 


    Indeed, there are a number of approaches that have been fine tuned in the infrastructure acquisition space for corporates with infrastructure style assets. This has often taken the form of pre-hedging any future bond take outs, although invariably over a shorter time frame with the bank debt market focused on three and five year bank to bond style financing structures. Nevertheless this could point towards a sustainable funding structure for the PFI market and one that has prevailed in other jurisdictions.


    It is argued that a leap of faith is required for the market to move to this shorter dated financing structure, given that the project must be able to bear an adverse market move in loan or bond credit charges prior to any capital markets take out. This refinancing risk is difficult to quantify although there must be an argument that, given the prevailing level of loan margin requirements, refinancing risk has significantly reduced since the heady days of the market in 2005 and 2006, when loan margins were significantly tighter. Some in the market have suggested that utilising the Government guarantee to back stop this risk would accelerate investment in UK infrastructure.


    Mitigating risk 

    Given the evolving nature of the market it has become increasingly important to engage risk management services early and throughout the course of project procurement. This way, risks can be identified, managed and mitigated throughout the contractual structure associated with a project, helping ensure its long-term viability. Bringing together a joined-up and experienced team of rates, FX and commodities – such as those offered by Lloyds Bank – should also yield a bespoke and comprehensive risk management strategy for a project.


    The infrastructure industry is experiencing dynamic change. By analysing the trends and changes, we are able to offer the right hedging strategies to support ambitions within the sector. We are also continuing to build an experienced, sector-focussed team to ensure our clients’ investments benefit from very effective risk management.


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12/3/2020 7:08:12 AM