“Leverage at its Most Beautiful”

1 February 2017 Amanda Nicholls reports on why the EBRD’s credit enhancement scheme, seen for the first time on Turkey’s Elazig Health Campus, is a fairy tale for institutional investment in emerging market PPPs

Once upon a time there was a project that had all the hallmarks of a successful PPP. Turkey’s Ministry of Health had invited the great and good to bid for the latest project in its robust pipeline of hospital PPPs and eventually chose an established partner in the form of a joint venture between Meridiam and Ronesans.

But although the sponsors wanted to invite the attractive institutional investors, sadly they weren’t able to come to the party. With Turkey going through an unsteady political period, the Elaziğ Health Campus (pictured) was just too risky.

The European Bank for Reconstruction and Development (EBRD) would shy away from being described as a fairy godmother, but its credit enhancement product has managed to reintroduce the bond markets into a deal that would otherwise have relied on conventional funding routes.

According to Thomas Maier, managing director of the EBRD, the story begins in Davos several years earlier.

He explains: “At the World Economic Forum, Meridiam, EBRD, the IFC [International Finance Corporation] and other players came to the conclusion that we as IFIs [international financial institutions] need to do more to attract institutional investors into infrastructure.”

The drive for this was clear. “When you look at the emerging markets and the infrastructure gap, the consultants, the banking industry and the government all see it amounts to trillions of dollars a year,” Maier says. “And when you then look at the combined balance sheet capacity of all the financial institutions – the World Bank, IFC, the EIB [European Investment Bank], EBRD, even including the new players – you come to about $80bn, to a maximum of $100bn. In other words, IFIs could only address about 10% of this gap through their own balance sheets.”

The idea emerged that rather than using the EBRD’s balance sheet to provide private finance directly, it could instead provide risk mitigation to allow the more risk averse lenders to invest themselves.

“Luckily for us,” says Maier, “Meridiam, with whom we have worked with in Turkey and many other countries, and Ronesans, who we have worked with repeatedly, thought that this hospital project could be a good first example of such risk mitigation. This is how the story evolved.”

The Elaziğ Health Campus did look like a good fit. The project consists of a 1,038-bed integrated health campus comprising a general hospital, women’s and children’s hospital, psychiatric hospital, mouth and dental health centre, and additional support buildings and facilities. And as Meridiam’s third hospital deal in Turkey, the structure, contract and procurers were familiar territory.

The concept for this product, like the issue it addresses, is a simple one. Although the World Bank’s Multilateral Investment Guarantee Agency (Miga) is a triple-A rated organisation with a solid reputation, the market told Maier and his team that there was still a big issue in the long timeline from a non-payment issue arising, the Miga arbitration being resolved and payment being made. This could sometimes stretch to months or even years.

Maier says: “For an institutional investor it is not an interesting proposal in an emerging market, to be exposed to this potential payment gap, because they can’t convince their institutional credit committee to go for such a risk.”

Susan Goeransson, deputy director at the EBRD, explains that the product’s function is to provide liquidity in the event of a non-payment. This is structured into two parts.

“The first is the construction support facility – during the construction phase if there are replacement costs or liquidated damages, the facility will be called on and ensures the project stays on track,” she explains.

“Similarly, once the hospital is up and running we have the revenue support facility designed to enhance the counterparty risk, which in this case is the availability payment by the Ministry of Health. If for any reason the ministry doesn’t pay, this facility will kick in.”

The concept not only helped secure the first ‘green and social’ bond for a Turkish PPP, but resulted in Moody’s assigning a Baa2 rating, two notches above the current rating of Turkey itself. Christopher Bredholt, Moody’s VP-senior analyst and lead rating analyst for the project, says the rating “sets an important precedent for institutional investors seeking to plug the infrastructure gap in emerging markets” and shows that the EBRD product “demonstrates the tangible credit benefit”.

Investors were convinced and in November last year the project reached financial close with a €288m bond issue, with MUFG as bookrunner and HSBC as sole arranger.

The rating from Moody’s showed the EBRD that its concept was going to make a sizeable difference in introducing the capital markets to less stable economies.

“I have never come across such a rating differential before,” says Maier. “And it tells us that with a relatively small amount of EBRD standby promise, we can really make a difference for the institutional investor community.

“The success for us is bringing in close to €300m in financing without putting a single euro down ourselves in a funded product. This is leverage at its most beautiful.”

Game Changer

Since reaching financial close on the health campus, the EBRD has been busy promoting the product for future schemes. Maier is confident that the credit enhancement product “is going to be a game changer” for the right projects in the right markets.

He says that the procuring country must have a credible PPP programme, the operators need a track record and the construction company needs a good reputation. Where those conditions are met, the EBRD “can apply this product in a relatively straightforward way”.

The other side of this coin is that institutional and bond investors have to be interested in the country as an investment destination. Maier says it would be difficult to foresee a situation where such a product could be used in regions such as central Asia – but with around 60% of the G20 having an investment credit rating there is still plenty of scope for its use.

The EBRD is also hoping that such a credit enhancement product could be introduced on a global scale.

Maier explains: “Alongside Miga, we have decided to share this structure with other regional IFIs in a proactive way so that they can use this product in their geographies for similar approaches. We have reached out to the Asian Development Bank and so on. We are very, very active in making sure that this product doesn’t remain a one-off, but kicks off something bigger that the emerging markets clearly need.”

Although the EBRD won’t be drawn into where we are likely to see the second use of this product, Maier says there are many countries where it could work, including China, Kazakhstan, Brazil, South Africa, Botswana and Morocco.

Goeransson adds that she expects to see future projects outside the social sector, including water and transport. “Basically any type of availability transaction where you have a confined counterparty,” she says.

Although the scale and scope of how this product will be used is unclear, for Turkey and the Elaziğ project, this is one happy ending that is likely to be translated into many languages. 

This page was last updated on:
3 April 2017.

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