11/10/2013: In Europe, as usual, everything is a legal fudge...

Remember the EU 'Project Bonds' idea? Ok, the premise sounded great - you are a sovereign in an economy that can't raise funding for much of big ticket infrastructure etc building. You go to the markets with a sovereign guarantee to cover the shortfall on a specific project returns, plus a sub-guarantee from the EU... More precisely, here's how the scheme was designed to work:

The Guarantors of project finance were supposed to be: European Investment Bank (EIB) and the national governments. These were supposed to supply 'credit enhancements' to debt issues that covered two tranches: senior debt and subordinated debt. The sub-debt (or Project Bond Credit Enhancement, PBCE) were to take a form of an EIB loan backed by EU Commission, to be issued to the promoting entity at the onset of the project financing. Or it could take a form of a contingent credit line 'drawn upon if the revenues generated by the project are not sufficient to ensure debt service'. The PBCE was supposed to underlie the senior debt and act as credit enhancement for investors. The promoting entity were to issue actual bonds - in other words, project owner was to do so, not the EIB or the Member State. The EU conditioned the scheme that the 'support will be available during the lifetime of the project, including the construction phase'.

According to the original plan (see http://www.eib.org/products/project-bonds/):

"The proposed mechanism of the initiative will:

1. have a maximum size of individual transactions of up to the lower of EUR 200 million or 20% of credit enhanced senior debt;
2. as subordinated debt, target an up-lift of the project rating to A-AA rather than AAA;
3. be based on the EIB’s capacity to deliver subordinated loans, not necessarily its rating;
4. only target the EIB’s core business, i.e. infrastructure financing;
5. only support robust projects
6. benefit from the EIB’s proven due diligence, valuation and pricing methodologies."

The first project approved by the EIB for investment was the Spanish Castor offshore submarine gas storage facility. This has now failed due to lack of proper technical oversight in design (insufficient seismic risks evaluations), clearly putting into question the claims (v) and (vi) above.

Furthermore, the Spanish Government is now attempting to exit its contractual guarantee obligations, just to make sure that the entire Credit Enhancement Mechanism is exposed as a total farce.

Details are here: http://www.euractiv.com/euro-finance/eu-project-bonds-may-see-value-d-news-531021?utm_source=EurActiv%20Newsletter&utm_campaign=5ff216b9d6-newsletter_daily_update&utm_medium=email&utm_term=0_bab5f0ea4e-5ff216b9d6-245613326

All of which just goes to prove that in Europe, Government guarantees are worth about as much as the paper on which they are written... Enhance that, if you want.