Life After the European Investment Bank

Robert Franklin, legal director, Clyde & Co

The UK’s relationship with the European Investment Bank (EIB) is likely to change fundamentally when the UK leaves the EU.

However, it seems unlikely that the EIB’s commitments in respect of loans to the UK up to the point of withdrawal will be affected.

In June, the European Commission proposed that the UK should retain a contingent liability equivalent to its uncalled capital contribution of around €35bn, reducing over time in line with the amortisation of the EIB portfolio outstanding at the time of withdrawal. Shortly afterwards, Chancellor Philip Hammond stated that he would provide the EIB with the assurances required to sustain the flow of funding while the UK remains a member state.

As for the position post-withdrawal, while the Treasury maintains that all options remain on the table, it is difficult to envisage a scenario in which it would be EU policy to continue making new funding available for projects in the UK on a comparable scale. In 2016, 90% of the EIB’s new commitments were in EU member states (10% in the UK), 3% were in potential accession countries and 7% in the developing world.

Although EFTA countries are eligible for EIB loans, the value of loans made under this facility has been modest (none in 2016).

The EIB plays a major role in the delivery of UK infrastructure. Between 2012-16 it invested more than £31bn in the UK, predominantly in infrastructure. As well as providing senior debt to projects, it supplies risk mitigation instruments to facilitate access by projects to capital markets, as well as structuring and providing capital or risk mitigation to funds or other intermediaries in support of initiatives which may be infrastructure-related such as energy efficiency.

On 1 August, the Treasury announced the establishment of a new National Investment Fund designed to accelerate the scaling up of innovative start-up firms by “crowding in” private investment. One of the drivers for the new institution is the need to replace EIB investment, which accounted for more than a third of investment in UK-based venture capital funds from 2011-15.

Given the importance of investment in infrastructure to the economic growth which the government seeks to deliver, and the chancellor’s recognition that there has been a clear trend of underinvestment in the last decade, it is natural to speculate whether a similar consultation may follow for the infrastructure sector.

A range of issues would need to be explored in such an exercise, including:

• The need or justification for intervention;

• The nature and scale of the projected demand for funding and the procurement models to be used;

• The extent to which specific ‘market failures’ have been identified (or are anticipated) and their nature – eg mispricing of risk, lack of capacity, need for economies of scale;

• The potential for a government-backed infrastructure bank to stimulate growth by making capital or risk capacity available for infrastructure projects at sub-commercial market rates;

• Existing interventions and their effectiveness, such as the UK Guarantee Scheme, the Green Investment Bank and the National Productivity Investment Fund announced in the Autumn Budget.

The design of an effective intervention

• Clarity over the purpose of the intervention – is it to address a localised market failure or a general need across the sector;

• The reasons for market failures, eg shortage of skills, technology change, market structure, institutional constraints, etc;

• Implications for longer term market development – an intervention which eliminates asset risk for investors or which favours a particular class of investor may produce the lowest cost of funding initially, but may be inefficient in the longer term.

Practical constraints

• Affordability – the cost of achieving the requisite scale would be substantial. Despite the absence of a steady pipeline, EIB lending to the UK in 2016 was the second highest on record at €6.9bn. The nature of the human resources required could vary widely depending on the products which the bank would need to offer, the mode of interaction with commercial finance market and the pipeline.

• Accounting treatment – both guarantee schemes and government-owned banks potentially risk being consolidated onto the government’s balance sheet. It may be necessary to consider how this could be avoided.

• Capital structure and cost of funding – the EIB is able to raise funding cheaply in the bond markets. In the case of a new institution, the need to keep down the cost of funding is likely to be important.

• The nature of the UK’s future relationship with the EU – one element of any Brexit deal is likely to be continued compliance with the substance of the EU state aid rules, which would therefore apply to any new investment bank, whereas EIB funding into the EU would continue to remain outside the state aid regime. However, in principle a UK investment bank ought to be entitled to match EIB pricing.

Whatever the answer to the uncertainties briefly highlighted here, the implications of withdrawal for the UK’s relationship with the EIB should prompt a systematic consideration of the institutional finance framework for the future.