Export credit agencies (ECAs) and multilateral banks are
considered the future of international project finance because
of commercial banks’ lending restrictions under
Basel III. But regulations affect the attractiveness of their
Commercial banks’ activity in project finance
has hit hurdles under Basel III. Longer-term capital is now
more expensive for banks, and products to take financings off
balance sheets – such as project bonds – have
been slow to take off in some emerging markets.
ECAs and multilateral banks were expected to make up some of
the shortfalls. But demand for their services, which involves
guaranteeing commercial banks’ loans, might change
following new Basel regulations.
"My sense is that the leverage ratio and liquidity standards
of Basel III have had the most impact on the project finance
market," said Azad Ali, counsel at Shearman & Sterling.
- Although ECA-backed funding is thought to be the
future of project finance post-Basel III, new regulations may
affect the attractiveness of guaranteed loans;
- The leverage ratio and the net stable funding
ratio are expected to affect commercial banks’
participation in the project finance market;
- Banks are expected to look to project bonds to
refinance long-term project finance debt.
Net stable funding ratio
net stable funding ratio (NSFR) has not yet received a lot
of attention because it will not be implemented until January 1
2018. However, Ali predicted that it will be crucial for
The NSFR requires that banks hold a minimum amount of stable
funding that matches up with the liquidity characteristics of
their assets and activities to reduce funding risk.
That’s difficult for project financings, which
are of longer duration and would require backing by costly and
longer-dated funding. "Instead of raising capital to strengthen
the capital base, we’ve instead seen disposals of
project finance portfolios," Ali added.
ECA-backed debt is not exempt. Sources agreed that ECAs and
multilaterals will come under closer scrutiny under the
" Not all ECAs are equal
under the new normal "
"Not all ECAs are equal under the new normal," said Gabriel
Mpubani, senior associate at Freshfields Bruckhaus
Under the Basel II regime, the major ECAs were generally
assumed to have the same risk profile as their sovereigns, so
their products were perceived to have no risk. But, he added,
the assessment is now more sophisticated. "If an ECA
doesn’t have a full legal backstop, its products
are independently risk-weighted – usually above zero
– making them less attractive to the market," he
Those with full backstops may benefit; claims on sovereigns
and multinational development banks can count as high-quality
liquid assets. If they receive a zero percent risk rating, they
can form part of a liquid assets buffer – assuming
that they have a sovereign backstop.
While Basel II largely focused on risk-weighted capital
allocation, Basel III’s new
leverage ratio doesn’t take into account
risk-weighting, said Mpubani. This has a potentially
detrimental effect on the capital cost attractiveness of
"The leverage ratio quite consciously ignores the de-risking
effect of ECA guarantees and insurance products, and that
ECA-covered debt has a better risk profile than
similarly-situated but uncovered debt," he added. As a part of
the leverage ratio, there’s no consideration that
the risk of default may be very low.
But Ali noted that Basel III doesn’t really
change the credit conversion factor applied to determine
credit-equivalent exposures of off-balance sheet assets
– such as guarantee commitments. "These conversion
factors are largely unchanged when measuring exposure values
for the purposes of the leverage ratio," he said.
He believed that there shouldn’t be much impact
in terms of risk-weightings because the standardised approach
to credit risk hasn’t changed from Basel II to
He expected regulatory arbitrage from individual
jurisdictions in determining the leverage ratio. Some
jurisdictions have more lenient constraints in terms of the
leverage ratio, and as a result their banks have been more
active in the space left by those who are reducing the size of
their project finance portfolios.
"It wouldn’t surprise me that the
multinationals are riding the crest of that wave by filling the
gaps created in the market," he said.
Project bonds are increasingly popular because they can
remove long-dated project finance assets from
banks’ books. While greenfield project bonds
remain innovative – especially in Asia –
they’re now used to refinance projects, which
avoids issues such as construction risk.
"Instead of going back to the bank market, borrowers are
moving to the bond markets," said Etienne Gelencser, partner in
Shearman & Sterling’s Tokyo office.
If some of those project bond tranches receive high ratings,
they are able to count for liquidity buffers – an
advantage of bonds over longer-dated financings.
Asian ECAs, however, will remain an important part of the
financing landscape. Mpubani said: "I would suggest that Asian
ECAs are, overall, in a better position than those European
ECAs that can only provide cover but still need commercial
banks to intermediate with that cover."
This is because those banks still have to count the cost of
Basel III on their capital costs and the wider attractiveness
of any ECA cover, particularly when lending over longer tenors,
he added. On the other hand, direct lending Asian ECAs can
deploy their capital directly and more comfortably take a
broader view on the capital regime.
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