Regulated Covered Bond Market for Standardised Funding of Renewable Energy infrastructure
European Power Plants are very capital intensive investments, the New Electricity Grid is also very capital intensive. Feed-in tariffs and the transitional and round 3 UK offshore transmission lines are or will be the recipients of government-backed, stable income for 20 years. They are therefore very suitable as collateral for AAA bonds. A deep and standardised Green bond market should be created. A good model for this could be the Pfandbrief market (German Property Covered Bond Market, which has been stable for 300 years).
What is needed is a European or UK regulator to clearly define the rules of a green covered bond market – headline rules could be maximum loan to costs of approximately 45% and safe debt service cover ratios tested yearly. The key is to have a combination of low leverage combined with a standardised European legal interpretation of the feed-in tariff obligation or other subsidy that the market understands and considers quite uniformly.
Bond investors (institutional or retail) would invest in the AAA covered bonds that would be issued by a bank. In return, investors would receive 20 year annuity income. The covered bonds are secured at low leverage against the collateral of the infrastructure and its income, then further against the bank that issued the bonds. Therefore different banks would have different costs of funds within the market. Banks would access funds from the covered bond market and then use their balance sheet and/or the money market to increase the leverage available to the infrastructure project. The bank lends this debt to the project manager who also uses investors’ equity to pay for the infrastructure.
Pan European audit, legal and consulting firms would check that the project complies to the strict rules of the regulator, in terms of risk and income that govern the AAA covered bond market, and that the bank is lending in line with them. An initial detailed check would be performed followed by a short yearly report on the debt service cover ratio of the infrastructure.
The infrastructure project is funded in the diagram example in the following way; Covered bond: bank debt: equity – 45% : 25% : 30%.This market would produce large amounts of standardised and long dated low risk bond investments now required by pension funds and other investors to balance their long dated liabilities. It may be very useful for the fast growing bulk annuities market.
Jason Langley, AXA Real Estate Investment Managers