Concession bonds

Concession bonds are infrastructure securities issued by a party to a concession agreement to attract financing for the implementation of the concession agreement.

There are two mechanisms for issuing concession bonds on the Russian market:
• fundraising by special project companies called concessionaires;
• fundraising performed directly by the contracting authority.

Features:
• A convenient and effective tool for attracting financing to PPP projects;
• Raising funds for a specific project;
• Government is always one of the parties to the concession agreement;
• The issuer is a special-purpose vehicle (SPV) with which a concession agreement has been concluded;
• Payments to bondholders are made from the profits generated by the project;
• Concessionary nature is set out in the issue prospectus;
• Concession bonds are included in the first and second levels of Moscow Exchange’s quotation list, and some issues are included in the Central Bank’s Lombard List;
• Project financing schemes existing on the Russian market are similar: cascading financing with the use bond tranches makes it possible to gradually attract all the necessary funds in full for a long time without excessive debt obligations;
• The duration of placement of concession bond issues is approximately half of the term of the concession agreement. On average, the circulation term of such securities is from 10 to 49 years, the volume of issues is to 8.5 billion roubles. Bonds for the implementation of transport projects are placed for a longer period (on average, 15–20 years); in case of non-transport projects, securities are usually issued for a period of 10–15 years;
• The coupon rate is combined: fixed and floating; the rate for the first coupon will be fixed and for subsequent coupons, it will be floating.
• Usually, the rate of the first coupon of a new issue determines the upper limit of the coupon rate in each of the periods and is assigned above the market yield (with a premium to the investor). The average coupon rate varies from 4 to 11% per annum;
• Then the coupon rate is linked to inflation, GDP growth rate, the key rate of the Central Bank, etc. The investor’s real income is 2–4% per annum;
• All concession bonds are coupon bonds and payments to bondholders are usually made on an annual basis;
• Coupon income is paid for all concession securities in circulation, most often, it is paid on an annual basis. Only three issues have semi-annual payments, but there are also two issues with quarterly coupons. Coupon rate is used in most cases;
• The main buyers of concession bonds are private pension funds, insurance companies, and banks.

Advantages for the investor:
• The issue of bonds for a specific project makes it possible to assess the feasibility of investment in advance;
• High safety and stability of the cash flow secured by the state guarantee, as well as the guarantee of repayment of the principal amount of the debt and accrued interest in the event of termination of the agreement stipulated in the concession agreement;
• Recoverability: the bond loan is repaid using proceeds from activities under the concession agreement;
• The rights of the bondholders take priority over the rights of the consortium’s shareholders when repaying the loan;
• Special concession events that give the holder the right to get early repayment of securities and receive accumulated coupon yield (for example, early termination of the concession agreement, changes in its terms, etc.).
• The yield on concession bonds exceeds the yield on OFZ-n by at least 1–2 percentage points.

Advantages for the issuer: • Raising funds for a long term at a low debt service cost in comparison with a bank loan;
• Concession bonds included in the Lombard List provide access to the Central Bank liquidity in a short period of time, which is especially attractive for banks that need to raise funds quickly.

Disadvantages:
• "Interconnection" of financing attributable to the Russian market of concession bonds: when issuers and buyers of bonds agree on terms in advance, as a result of which aninvestor’s "premium" may differ from the market premium. This makes its value unrepresentative for future issuers, making it difficult to attract bond financing on favourable terms.
• A shortage of projects for this type of financing, since traditionally, lending is provided as a type of financing, which initially limits the possibility of another way to raise funds.