Germany: Qualifying infrastructure - and everything is cheaper?
14 November 2017
On 14 September 2017, Commission Delegated Regulation (EU) 2017/1542 of 8 June 2017 was published in the Official Journal of the European Union and came into force one day later ("QI-Update-Regulation"). This Regulation amends the Delegated Regulation (EU) 2015/35 concerning the calculation of regulatory capital requirements for certain categories of assets held by insurance and reinsurance undertakings (infrastructure corporates). The category of qualifying infrastructure investments was first introduced in Commission Delegated Regulation (EU) 2016/467 of 30 September 2015 ("QI-Regulation").
In the Solvency II Directive (Directive 2009/138/EC) and the regulations enacted in this context, the requirements on own funds for "large insurer", amongst other things, are made more precise. If such an insurance undertaking invests in particular infrastructure, this can have a positive effect on the equity capital to be kept available. Such investments are considered less risky, since QI-Regulation came into force, and the (expensive) capital requirement is lower.
QI-Update-Regulation brings about essentially the following reforms:
- The definition of "infrastructure assets" is extended to include "physical assets" and now covers other types of infrastructure such as rolling stock (Article 1 point 55a recast). It was previously not clear whether physical assets that use the infrastructure fall under the legal definition.
- The term "infrastructure project entity" (Article 1 point 55b before amendment) is replaced by "infrastructure entity" (Article 1 point 55b recast). The latter includes, in addition to individual (project) entities, also corporate groups in order to take into account structured project finance situations involving multiple entities of a corporate group.
- To cover entities that earn a substantial portion of their revenues through infrastructure activities, the wording of the revenue criteria is amended. The functions of the infrastructure entity is no longer limited to owning, financing, developing or operating infrastructure assets (see Article 1 point 55b before amendment). Further, pursuant to Article 1 point 55b recast, it is now sufficient that a substantial majority of the revenues (formerly: "primary source") are derived from owning, financing, developing or operating infrastructure assets. In order to assess such sources of revenues, the most recent financial year (where available) or a financing proposal (e.g. bonds prospectus or financial projections in a loan application) should be used.
- In Article 164a recast, mechanisms were established that enable other security arrangements in favour of debt providers. As a result, infrastructure entities that are unable, for legal or ownership reasons, to provide lenders with security on all assets are no longer outright excluded.
- Regarding the income, the criterion of so-called rate-of-return regulation – as an alternative to the large number of users – helps to avoid the requirements of contractual arrangements between the infrastructure entity and the consumer, which are intended as effective protection against losses (e.g. termination clauses).
- In the event of a debt investment in an infrastructure entity, the necessary security can be provided in such a way that the entity proves that security in the form of all assets and contracts required for the performance of the project is not necessary for the debt provider to effectively protect and recover its investment. In such case, it is sufficient if the vast majority of the investment can be effectively protected by other security such as the pledge of shares or step-in rights.
- Henceforth, claims from liquidity facility providers (e.g. banks) and trustees may be junior to the insurer's investments in bonds or loans provided to the infrastructure entity without an ECAI rating. This simplifies the financing structure.
- QI-Update-Regulation introduces the concept of "qualifying infrastructure corporate investments" (Article 164b). With this new category, the investment possibilities shall be extended from project financing to corporate financing. Infrastructure entities that may be financed in the future have a business object beyond a specific project. Thus, the business risks are higher for infrastructure entities than for (pure) infrastructure projects, but lower than for non-infrastructure entities or projects. In the future, this will be taken into account in the investing insurer's capital requirement via either equity or debt (stress factor 36% for equity investment without symmetric adjustment).
Differences from qualifying infrastructure investments result, for example, from the criteria used for the general diversification of revenues with regard to functions, locations or payers (with the exception of a so-called rate-of-return regulation or unconditional payment obligation) or business activity of at least three years for an entity without ECAI rating (where ECAI is available, it has to be at least CQS 3). The objective of these criteria is to ensure that only safe investments can profit from the low calibration.
Cheap infrastructure?! For a Solvency II investor, it can be an advantage, with regard to the capital requirement, to invest in a qualifying infrastructure (stress factor 30% or 36% for equity investments without symmetric adjustment). The (arithmetic) comparison, for example, to a security financing outside QI-Regulation ("normal" spread risk) should be made and can be more attractive in the individual case.
Back to top