Fitch casts doubt over EU project bonds rating

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EU plans to create a market for project bonds to cover the €2 trillion of investment needed to upgrade the bloc's infrastructure by the end of the decade have received a positive evaluation from credit rating agency Fitch, but are unlikely to secure a top rating.

Fitch's announcement comes as a public consultation on EU project bonds draws to a close. It is set to expire on 2 May.

Project bonds have been identified as a key EU priority for the years to come to counter the negative effects of the financial and economic crises on credit markets.

The president of the European Commission, José Manuel Barroso, publicly launched the idea during his first State of the Union speech at the beginning of his second mandate in September 2010. He later reiterated his support for the initiative.

The project bonds plan seeks to boost private investors' participation in large European infrastructure schemes, such as railways, pipelines or broadband connections. Preliminary estimates point to up to €2 trillion needed by 2020.

The European Union is set to fund or guarantee part of these projects in order to reduce the risk of failure. The European Investment Bank (EIB) would play a key role in the process. 

To attract private investors, such as pension funds or large insurance firms, Brussels' stated credit target for EU project bonds was 'A'. "Ideally, the rating should be around 'A' or higher to allow the debt to be financed via project bonds," reads a Commission paper annexed to the public consultation.

Although Fitch reacted in a positive manner to the EU initiative, calling it "credit positive", it expressed doubt about the rating of project bonds. "Whether or not such benefits will justify a credit rating in the 'A' category is difficult to assess at this stage," said Olivier Delfour, global head of infrastructure and project finance ratings at Fitch.

Indeed, the credit rating agency does not usually rate European infrastructure projects in its top grade. "Fitch rates most EMEA (Europe, Middle East and Africa) infrastructure transactions in the 'BBB' category," reads a special report issued yesterday (27 April) by the rating agency in response to the Commission public consultation.

"The Commission will go ahead with its plans," commented an EU official after Fitch's announcement. A comprehensive proposal on project bonds is expected in June, when the Commission will also unveil its long-term budget, which will offer a first hint of the financial resources at the bloc's disposal in the coming years.

The plan's wild card

Fitch is not the only sceptical voice in the debate over project bonds.

"At this stage, when the Parliament's calls are of a general policy nature ahead of any specific detailed proposals, there certainly are some quarters that would like a wider application of project bonds with a specific part of the EU budget allocated for this. This is easier said than done," commented Sharon Bowles, chair of the European Parliament's economics committee.

Bowles criticised the general impact of EU reform of financial rules and its alleged excessive focus on building capital buffers. "Potential investors will be wondering what credit risk will be assigned to any bonds and how that will interact with all these prudential regulations," she said.

Commenting on the Commission plan, she added: "A further element in the mix also seems to be reference to ratings, to produce an 'A' rated bond, so just as efforts are made to rely less on ratings, maybe they are coming back in somewhere else."

It also remains to be seen how project bonds will impact upon public budgets. The Commission often refers to the initiative as debt-free because investment will be recovered when projects become operational and generate revenue.

But if things go wrong, EIB money would be lost and the effect on public budgets would surely be felt, as the EIB is funded by member states.

"Creating an artificial demand for projects such as those earmarked to be covered by these project bonds is not the appropriate way to cover the €2 trillion of investment needed to upgrade the European Union's energy and transport infrastructure," Isabella Besedova of CEE Bankwatch Network, a coalition of NGOs in Central and Eastern Europe monitoring the social and environmental impacts of international development finance, told EURACTIV.

"As already outlined in the Commission's proposal, project bonds would be earmarked for large infrastructure projects at the expense of smaller, more sustainable ones. The proposal would mean using scarce public funding to prop up only private sector projects which, to top it off, would have a lower credit quality and therefore higher risk of failure," Besedova said.  

"More importantly, the implications of this proposal are that in cases where these projects fail, public money would flow directly into the hands of the private investors (the bond holders) or financiers," she said.

"So once again, this proposal represents a failure to learn from and address some of the root causes of the financial crisis, instead adding to the problems they caused.  It would distort the financial market for such infrastructure bonds, by making them unduly more attractive to private investors and consequently driving up their demand, placing pressure for more such projects to be underwritten or guaranteed by the EU," Besedova explained.

"Worryingly, as it stands, scant detail is being provided on exactly how the EU/EIB guarantee or subordinated debt would work, while the idea that the EIB would not act as controlling creditor for these risky projects should be ringing alarm bells with all MEPs and European lawmakers," she warned.

"There is a real need to financially support sustainable projects which help to achieve the goals of a low-carbon economy and to support infrastructure projects in the key target areas of climate and resource efficiency objectives. As it stands, this proposal does not deliver on these needs. It simply delivers more scarce public funding to untransparent, risky private projects," she argued.    

The use of capital markets to finance projects has so far been a regular feature only in the UK among EU member states, but it is commonplace in the United States.

In Europe, large projects have usually been funded by public authorities, which on average account for a third of the financial coverage of a given infrastructure project.

One predecessor of EU project bonds is the so-called 'monoline insured bond', which sees bond issuers pay a premium to insurers that will offer a guarantee against the risk of failure. However, this model has virtually disappeared since the 2007 financial crisis.

To tackle the drying up of funding for large projects in the wake of the financial and economic crises, the European Commission launched a public consultation on EU project bonds at the end of February. 

  • 2 May 2011: End of public consultation on project bonds.
  • June 2011: Commission expected to publish proposal on project bonds.
  • 2014: Deadline for having project bonds operational.

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