How Basel III impacts ECA-backed project finance

Author: Ashley Lee | Published: 4 Jul 2014
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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 guaranteed funding.

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

The 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 project finance.

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 NSFR.

" 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 Deringer.

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 said.

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.

Leverage ratio

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 ECA-backed projects.

"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 Basel III.

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.

What’s next

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.

See also

Mapping the future of Asian project bonds

How US 5% leverage ratio could catch foreign banks

POLL: What do US leverage ratios mean for Europe?