A ground-breaking funding structure for greenfield projects in Europe hopes to overcome the hurdles that commonly deter institutional investors from participating in greenfield deals. Could it be replicated in Australia to help stimulate our project finance market?
Late last year, the International Project Finance Association (IPFA) adopted PEBBLE, an innovative structure for greenfield project financings. PEBBLE is a conduit structure that is intended to facilitate institutional investors such as superannuation funds, global pension funds and insurance companies in providing long-term project finance.
IPFA explains that institutional investors in projects are not attracted to greenfield opportunities due to:
- the "cumbersome decision-making process" in traditional bond issuances, and the administrative burden of managing a project in its construction phase; and
- the barely- or sub-investment grade credit rating of many projects under construction, meaning that institutional investors are unwilling to expose themselves (and their stakeholders) to construction risk on a greenfield project when they can achieve an equivalent or better return on a listed equity or commercial property investment.
While PEBBLE (an acronym of "Pan European Bank to Bond Loan Equitisation") has been devised with a European focus, 1 and has a distinctly PPP flavour to it, the reasons put forward by IPFA as to why institutional investors are not attracted to greenfield projects have currency in Australia. Further, as financing trends in offshore markets often migrate to Australia along with the flow of global capital we can expect that a change in financing structure in Europe will receive interest in Australia.
As Australian governments, project sponsors, commentators and academics continue to debate how to get super funds to lend more heavily to badly-needed new infrastructure, the PEBBLE structure may offer an alternative solution.
WHAT IS THE PEBBLE STRUCTURE?
The PEBBLE structure seeks to overcome the difficulties experienced by institutional investors by introducing a compartmentalised funding vehicle, and a senior tranche that is intended to be attractive to institutional investors.
The compartments of the PEBBLE vehicle are funded with the following tranches:
- amortising A Notes, subscribed for by institutional investors which have a long tenor (20-25 years) and rank senior to B Loans in a winding up situation;
- a first-loss B Loan, funded by commercial banks which are subordinated to the A Notes but has a much shorter tenor (8-10 years) and amortises in advance of repayment of A Note principal;
- a construction revolver facility, funded by commercial banks for the purpose of construction costs (including cost overruns) and periodically refinanced by A Notes and B Loans; and
- associated hedging, provided by commercial banks.
The real magic, however, is in the voting mechanics. Until the B Loans amortise by 35% of their original principal amount, the B Loan banks will have the right to control creditor decisions. Holders of A Notes will be bound by these decisions, unless the decision falls within a pre-agreed class that adversely impacts on the noteholders' ability to recover their principal (e.g. calling an event of default, changing economic terms, rescheduling debt).
Once the B Loans have amortised by 35%, A Notes and B Loans will vote their exposures together, with a "you snooze / you lose" clause to ensure abstaining creditors don't derail any votes. Holders of A Notes will appoint a servicer to advise them in the decision-making process. However, it is not anticipated that the servicer will have any fiduciary duties towards the noteholders.
The structure means B Loan banks can still deploy their project finance and agency teams to manage an exposure, holders of A Notes can take a more passive role (potentially improving liquidity), and all funders can choose the tranche(s) of debt in which they wish to participate.
IS PEBBLE AN APPROPRIATE MODEL FOR AUSTRALIAN PROJECTS?
Australia's project finance market is very different from Europe's. For one thing, if 2012 is any indication, there is no liquidity shortage for good quality, Australian PF deals. New money project finance (including PPPs) made up 29% of volume in the Australian loan market in 2012, up from 15% the previous year. 2
What the Australian market is suffering from is a dearth of good quality deal flow, and a correspondingly shallow pool of institutional investors and secondary debt traders. Those institutional investors that are active in the market are hungry for yield and volume.
From an intercreditor perspective, it used to be the case that subordinated debt in an Australian PF context was small in amount, provided by affiliates of the project sponsors, and often considered by senior banks as equity rather than debt. Further, first-loss tranches (like the B Loan creditors) were not permitted to amortise ahead of the senior tranches, and permitted payments to subordinated creditors were very limited and suspended entirely during a senior event of default. 3
The PEBBLE structure requires a re-think of the senior/subordinated creditor relationship, and most likely a re-categorisation of the relationship between A Note holders and B Loan banks as a super-senior/senior one. The A Note holders need to get comfortable that the B Loan banks can be trusted to control the decision-making process, and have a seat at the table in an enforcement scenario. B Loan banks will need to earn this trust if the A Note holders are going to vote with the B Loan banks in any restructure or enforcement.
Depending on gearing levels, the PEBBLE structure may also need some reconciliation to Australian market standards in relation to debt service reserve accounts (DSRA) and the buffer they provide for the A Notes and the B Loan. The PEBBLE intercreditor term sheet contemplates 6 months' interest on the B Loan and, prior to the B Loan maturity date, 12 months' interest on the A Notes. 4 By comparison, the senior DSRA in Australian PF deals is often modelled on 6-9 months of scheduled principal and interest. While PEBBLE's DSRA may be commercially defensible on the basis that the A-Note holders are being provided with a buffer against poor decisions of the B Loan banks, parties will need to consider the negative carry impact of a larger DSRA.
Finally, from the perspective of hedge providers, the PEBBLE structure anticipates that defaulting or downgraded hedge providers will slide down the payment waterfall on a pre-enforcement basis. As commercial banks are often both the bank debt and the hedge providers, this may be met with resistance in the Australian context.
Possibly one of the bigger hurdles that remains is a structural one. Namely, the need for Australian super funds to retain liquidity, as the MySuper reforms make super funds increasingly portable, and fund managers will need to be confident that their positions can be liquidated within 30 days, not 25 years.
It may be that for now the long-term holding of A Notes is a better fit with some of the larger Western European pension funds (where employees remain on defined benefit schemes and/or in pension funds that are centrally managed) or Canadian pension plans where pension funds are not as portable. This is distinct from the Australian superannuation landscape, which involves overwhelmingly defined contribution schemes, generally in accumulation phase, and a growing proliferation of self-managed super funds.
Australia's project finance market, including its pipeline of PPPs, face economic and political obstacles that are somewhat unrelated to the liquidity of the debt markets. Several non-PPP projects have been shelved due to macroeconomic uncertainty and dips in commodity prices; several PPPs have been slow to come to market due to the desire of governments to preserve their credit ratings.
As many of these projects will (eventually) come to market, it is encouraging to see project finance innovations like PEBBLE emerging to try and breathe life back into the project bond market. While PEBBLE may be used primarily to stimulate further public debate at this early stage, various players in the Australian market are keen to re-open the capital markets for energy, resources and infrastructure projects. Increasing the diversity of funding options for projects should be beneficial for a project's overall cost of capital, reduce the refinancing risk attached to projects financed with shorter tenor debt, and provide an acceptable conduit between institutional funds and Australian projects.
1 The €250 million Dutch N33 road widening PPP reached financial close in December 2012 using a finance pattern similar to PEBBLE.
2 Source: Thomson Reuters LPC. This proportion was somewhat skewed by two jumbo LNG deals (Asia Pacific LNG and Inpex's Project Ichthys), both of which had significant ECA tranches.
3 Or, at least, they are suspended for a pre-agreed period (e.g. 180 days) from the date a senior event of default occurs.
4 After the B Loan maturity date, this would change to 6 month's principal and interest on the A Notes.
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