Regional passenger rail transport in Germany
The regional passenger rail transport sector in Germany (Schienenpersonennahverkehr, SPNV) has been fully liberalised, enabling privately-owned train operating companies (TOCs) to compete with the incumbent state-owned operators. Given that, in general, regional public passenger transport is not set up to be self-funding through passenger receipts, the German Federal Government (via the local public transport authorities (PTAs) of the Federal States) provides financial support to regional public passenger transport (so-called "regionalisation funding"). In order to provide a level playing field for competing TOCs during the tender process, the PTAs provide financial support for the financing of the acquisition of rolling stock, particularly when the PTA requires the TOCs to use new rolling stock rather than the rolling stock which is currently being used on that particular network. This is because the PTAs want potential TOCs to compete on the basis of providing better services to passengers rather than on the basis of their funding terms, and providing financial support for the acquisition of rolling stock takes the financing terms out of the equation. If that were not the case, the state-owned TOCs would have a considerable competitive advantage over the privately owned ones. For example, Deutsche Bahn AG, Germany's leading train operating company, is 100 per cent owned by the German Federal Government and therefore benefits from the AAA rating of the Federal Government. Deutsche Bahn AG could theoretically finance its operations on the capital markets under German public bond conditions (i.e. at a coupon close to zero).
A peculiarity of the German SPNV is driven by European regulation and the specifics of the German market for rolling stock. Under European procurement rules, the concession period for regional passenger rail transport services in Germany is, in principle, limited to a maximum of 15 years – whereas the typical operating life of the rolling stock used for public transport is between 25 and 35 years depending, in particular, on the traction system adopted. As there is no secondary market for used passenger rolling stock in Germany, a bidder for a concession faces significant residual value risk, i.e. the risk that, if the bidder does not win the bid for the subsequent concession period, it will be left with a fleet of rail vehicles it can no longer use (even though the rolling stock can technically still be used for another 10 to 20 years) and which it is unable to sell. However, most of the 26 German PTAs support the financing of new rolling stock in a way that deals with the residual value risk and provides comfort for the financiers, as will be explained below.
Dieselnetz Ulm
Following a competitive bidding process, in February 2018, Bayerische Eisenbahngesellschaft mbH (BEG), the PTA of the Free State of Bavaria, selected DB Regio AG (DB Regio), a 100 per cent subsidiary of Deutsche Bahn AG, to operate regional passenger transport services on the diesel rail network around the Bavarian city of Ulm (Diesel Network Ulm or DNU) for a concession period from December 2020 until December 2032. The tender documents required the TOC to operate the passenger services using newly-purchased diesel multiple-units (DMUs).
There is no uniform approach in Germany to the type of financial support provided for the acquisition of new rolling stock for regional public transport systems. In fact, each of the 26 PTAs has its own distinct approach. The BEG decided to support the financing of the acquisition of the new DMUs in Ulm with a redeployment guarantee in combination with a waiver of counterclaims.
Redeployment guarantee
Under a redeployment guarantee the PTA guarantees the funders that it will require the TOC which is awarded the contract for the subsequent concession period to use the same DMUs on the same terms as for the first concession period. In other words, the PTA guarantees the use of the DMUs for approximately 25 years. This therefore allows funders to put in place financing arrangements whose term matches the operating life of the rolling stock.
Waiver of counterclaims
A waiver of counterclaims can be described as follows: (i) the PTA allows the TOC to assign to the funders the fixed element of the payments due to the TOC under the payment mechanism for operating the passenger services (i.e. the element relating to the funding costs of the rolling stock financing); and (ii) vis à vis the funders, the PTA waives any counterclaims it may have against the TOC in relation to such assigned portion. The effect of the waiver of counterclaims is that, even in the case of a default by the TOC of its obligations to the PTA under the concession, the funders are still paid out. If the performance of the TOC deteriorates to the extent that the PTA is required to terminate the concession, the PTA would replace the TOC and require the new operator to assume the financing arrangements. In this way, project termination risk is taken away from the funders, who can rely on the solvency of the PTA instead of the TOC when assessing the likeliness of payment default.
The BEG, however, is set up as a private limited company owned by the Free State of Bavaria. A claim for the assigned payment therefore, would not be a direct claim against a public body – a significant factor in the resulting financial solution, as will be explained below.
Financing environment for regional passenger rail transport in Germany before DNU
European and German policy has been attempting, for a number of years, to support the financing of infrastructure by institutional investors. For instance, Solvency II (the regulatory regime which has applied to insurance companies in Europe since 2016) introduced the concept of "qualified infrastructure", privileging investment by insurance companies in public infrastructure. At first glance, financing German regional passenger rail transport looks like the perfect investment for long-term and risk-averse investors such as life or health insurers, given its long-term and low-risk profile. Notwithstanding this fact, until DNU closed, there had never been a financing by institutional investors in this area. The reasons for this were three-fold:
Firstly, the financing of German regional passenger rail transport was the domain of the German semi-state-owned banks (Landesbanken). The Landesbanken were able to purchase an assigned payment claim against a PTA under a receivables purchase agreement and issue a covered bond backed by the claim against a public body. Even though no public bond exists covering the full length of rolling stock financings, the banks offered the TOCs public bond conditions for the entire term, thereby outpricing other financing sources.
Secondly, the Solvency II definition of qualified infrastructure does not explicitly include rolling stock. Therefore, at least until now, it had been the prevailing view among insurance companies that rolling stock did not quality as infrastructure within the meaning of Solvency II.
Thirdly, and most importantly, until DNU there had been no market precedent for a financing of rolling stock by insurance companies. Usually a bid is awarded between two and three years before the commencement of operations as the supply of a mid-sized fleet of vehicles takes approximately two years. Therefore, on average, the TOC has a maximum of six months to put its financing arrangements in place in order to be able to start the construction process in time. Against this background, the smaller, privately-owned TOCs in particular were hesitant about taking on the transactional risk and relying on insurance companies as counterparties, given that, at least in Germany, insurance companies have very limited experience of rolling stock financings.
DNU – a chance to try something new?
For Diesel Network Ulm the conditions were ripe for a new financing structure. Given that BEG is a private company, the assigned payment claim against the PTA would not qualify as a direct claim against a public body and, therefore, would not be eligible for a public bond. Hence, the semi-state-owned banks were not able to offer a covered bond financing for DNU.
In addition, DB Regio, the selected train operating company, knew that it would be able to rely on the financial strength of its parent company, Deutsche Bahn AG, if the finance deal had not completed in time and thus was willing to take the transaction risk. The DNU project provided an opportunity for DB Regio and its parent company to test a new funding model for railway infrastructure projects and to tap a new funding source in a highly competitive market. For the insurance companies the deal was an opportunity for them to gain a foothold to a new market.
As stated above, regional passenger rail transport in Germany is typically financed through the purchase of the assigned payment claim against the PTA by the financiers under a receivables purchase agreement (RPA). One of the reasons for choosing an RPA (rather than, for example, a loan) is that a loan governed by German law can be repaid without premium or penalty after 10 years, irrespective of whether the contractual term is longer than 10 years. Under Solvency II, however, insurance companies are limited in the type of investments they may make. An insurance company can only, as a direct investment, invest in loans, bonds or equity stakes: a financing by way of an RPA is not possible. Therefore, DB Regio had to implement a structure that has never been used before for SPNV transactions. Institutional investors offered new opportunities as an investor category, but on the other hand, the transaction had to meet further stringent criteria such as, in particular, the security principle laid down in § 124 (1) No. 2 of the German Act on the Supervision of Insurance Undertakings (Versicherungsaufsichtsgesetz – VAG).
Financial Close after three months
DB Regio instructed Joh. Berenberg, Gossler & Co. KG (Berenberg) to arrange a financing by way of a project bond with the insurance companies. Berenberg selected Ashurst LLP (Ashurst) as legal advisers to the investors, because Ashurst combined experience of project bonds on the one hand with sector knowledge of the regional passenger rail transport market on the other. In 2016, Ashurst's project finance team advised on the first German law project bond in the market (for the financing of the German A6 motorway PPP project). In the regional passenger rail transport market, Ashurst has a long track record of advising financiers and has particular experience of the financing of rolling stock in the Free State of Bavaria with the BEG as PTA.
The group of investors arranged by Berenberg consisted of German pensions funds and life and health insurers represented by their asset managers MEAG (acting for DKV Deutsche Krankenversicherung AG and ERGO Lebensversicherung AG) and Talanx (acting for HDI Pensionskasse AG and neue leben Pensionskasse AG).
Ashurst chose registered notes (Namensschuldverschreibungen, NSV) a favoured investment instrument often used by insurance companies but new to DB Regio.
Despite the fact that, for both the TOC and the insurance companies, the project represented a departure from well-trodden paths, financial close was achieved in less than three months.
Going forward
DNU has opened up a new financing source for TOCs active in the German regional passenger rail transport market and a new market segment for insurance companies. The long-term and stable cash flow generated, and the low-risk nature of the investment, may prove to be a perfect match for insurance companies.
The Hannover suburban railway network and the regional train network around Berlin (the Elbe Spree network) are currently out for tender, as are a number of others. Hannover and Elbe Spree rank among the largest concessions to have been tendered since the liberalisation of the SPNV. In both cases the financing is also supported by a redeployment guarantee and it is not clear whether the financings would be fully eligible for a public bond financing. The DNU transaction has shown that a financing with institutional investors in this sector is possible and has provided a market precedent. This increases the financing options for TOCs and may enable institutional investors to take a role in two of the largest infrastructure projects in Germany this year.
