10.6 ISIF Irish Portfolio risk categories

TABLE 10.6 ISIF Irish Portfolio risk categories

RISK CATEGORY DESCRIPTION

1

2

3 Debt backed by strong cash flows and assets, strong covenants in place; debt with low probability of default and high recovery rate Senior debt with standard covenants, backed by strong cash flows or assets Subordinated debt, stretch senior debt, mezzanine debt, and so on; debt with higher likelihood of default or lower recovery rates; infrastructure equity or equity supported by well-established or regulated cash flows

4 Growth capital to companies with existing revenue; deeply subordinated debt

5 Equity in start-up or distressed companies

Source: ISIF management. Note: ISIF = Ireland Strategic Investment Fund.

(for example, through contractual clauses or seniority in the capital structure) of each investment are considered. Investment limits are based on market value. ISIF’s total exposure, including market value and undrawn commitments, is also monitored as an indicator of the portfolio’s future evolution.

Limits are usually revised on an annual basis. The revised investment strategy published on February 1, 2019, is expected to skew the portfolio somewhat toward particular sectors (for example, real estate) and higher-risk-score investments—consistent with the refocus of ISIF’s investment activities on regional development, housing, indigenous businesses, climate change, and sectors adversely affected by Brexit.

ISIF can diversify its portfolio abroad, for example, by investing in global funds that are expected to then invest in Ireland. These fund investments can enable ISIF to reduce its domestic exposure while still generating an economic impact in Ireland. For example, a €50 million investment in a €500 million global fund that invests €100 million in Ireland will provide capital to Irish businesses while ISIF is exposed to a pro rata share of the global Portfolio’s financial outcome.

ISIF also performs an all-weather analysis to test the Irish Portfolio’s performance under different gDP growth and inflation scenarios, by examining the latter’s impact on the discounted cash flows of individual investments and subsequently aggregating results at the portfolio level.

At the individual investment level, ISIF conducts a detailed analysis and adopts a disciplined approach to the design of capital structures. The risk team produces the risk categorization for each investment. The investment proposal is passed to the NTMA risk function, which analyzes the risks and passes its feedback to the Investment Committee (and, for deals exceeding €150 million, to the board) prior to investment approval.

NTMA’s approach to risk management is based on the three lines of defense model and is designed to support the delivery of its mandates by proactively managing the risks that arise in the course of NTMA’s pursuit of its strategic objectives. As the first line of defense, the ISIF unit is primarily responsible for managing risks on a day-to-day basis, taking into account NTMA’s risk tolerance and appetite, and in line with its policies, procedures, controls, and limits. The second line of defense, which includes the NTMA risk, compliance, and other control functions, is independent of the ISIF unit’s management and operations; its role is to challenge decisions that affect ISIF’s exposure to risk and to provide comprehensive and understandable information on risks. The third line of defense, the internal audit function, provides independent, reasonable, and riskbased assurance to key stakeholders on the robustness of NTMA’s governance

and risk management, and the design and operating effectiveness of the internal control environment.

From a governance oversight standpoint, ISIF’s risk management framework has three key elements:

1. The board sets the risk management policy and framework and the risk appetite framework. The former defines mandatory risk management standards and definitions that apply to all parts of NTMA and all risk categories.

Detailed procedures discipline the application of these standards to the management of individual risk categories or processes. Board and management committees, including the Audit and Risk Committee and Risk

Management subcommittees, support the board in performing the risk management function. 2. The Audit and Risk Committee assists the board in the oversight of the risk management framework to ensure risks are properly identified, assessed, managed, and reported. 3. An Enterprise Risk Management Committee oversees the establishment of appropriate systems to identify, measure, manage, and report enterprise risk.

This committee comprises the most senior executive management team members (not the board). It performs a risk assessment twice annually for the purpose of identifying the main risks from an NTMA-wide perspective. These risks are then considered by the Audit and Risk Committee and the board.

ISIF has an increasing focus on monitoring investments in the Irish Portfolio as the fund moves into a more mature phase. Currently ISIF monitors investments on an ongoing basis (for instance, through quarterly calls and meetings), and this practice is formalized in quarterly reports to the Investment Committee and the annual control report that is presented to the Portfolio Management Committee. ISIF has recently appointed a Head of Monitoring with responsibility for monitoring all Irish investments.

NOTES

1. For the full text of the NTMA Act 2014, see https://www.irishstatutebook.ie/eli/2014 /act/23/enacted/en/html. 2. The National Surplus (Exceptional Contingencies) Reserve Fund to be established pursuant to the National Surplus (Reserve Fund for Exceptional Contingencies) Act 2019 upon the commencement of this legislation. 3. “Fund” throughout the case study is used in a general sense, as distinct from any particular legal sense. 4. Ownership of ISIF vests with the Minister for Finance. In determining and reviewing the investment strategy of ISIF, the NTMA consults with the Minister for Finance and the

Minister for Public Expenditure and Reform. 5. A description of the criteria can be found in ISIF (2015). 6. gDP is a measure of the market value of goods and services produced by organizations in an economy. gvA is the microenterprise-level measure of the value of goods or services produced, which—when aggregated across all enterprises and adjusted for taxes and subsidies—equals gDP. 7. Note that the term additionality as used by ISIF has a different meaning from the concept described in chapter 2 of this book and used throughout. 8. Although gvA is ISIF’s preferred metric, the NTMA Act 2014 requires the annual report on ISIF to include an assessment on a regional basis of the impact of investments on economic activity and employment. Additionally, it is difficult to capture the gvA of enabling investments and therefore useful not to focus exclusively on this metric.

9. ISIF’s definition of deadweight is, in essence, equivalent to the definition of additionality described in chapter 2 of this report and used throughout. 10. Senior ISIF team members responsible for making recommendations to the Investment

Committee and Portfolio Management. 11. Using Eurostat’s definition of cost of debt, which is based on the ratio of total annual interest cost to average sovereign debt outstanding. 12. Including goldman Sachs Asset Management, JP Morgan Asset Management, Irish Life

Investment Managers, Amundi Asset Management, and BlackRock Investment

Management. 13. Appointments are subject to the Department of Public Expenditure and Reform guidelines on Appointments to State Boards. 14. Prohibited investments under the Cluster Munitions And Anti-Personnel Mines Act 2008. 15. ISIF avoids the standard statistical approach to building portfolios, for example, calculating the correlation between categories or sectors. ISIF believes that lack of reliable Irish private markets data makes this approach unsound.

REFERENCES

Ireland, Department of Finance. 2018. “Minister Donohoe to Refocus the Ireland Strategic

Investment Fund to Better Meet the Needs of a Strong & growing Economy.” Press release,

July 5, 2018. https://www.gov.ie/en/press-release/a0cc86-minister-donohoe-to -refocus-the-ireland-strategic-investment-fund-to/. Ireland, Department of Finance. 2019. “Budget 2019. Review by the Department of Finance of the Ireland Strategic Investment Fund.” Department of Finance, Dublin. https://www .google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=&ved=2ahUKEwim6vnU5tL3A hWBjYkEHZO6CtcQFnoECC0QAQ&url=https%3A%2F%2Fassets.gov.ie%2F180689%2Fe e09022a-5b2f-45df-9e69-62e7ced3c553.pdf&usg=AOvvaw1fCDFADRk4K_dXSyaySBgA. ISIF (Ireland Strategic Investment Fund). 2015. “Investment Strategy: Executive Summary.”

National Treasury Management Agency, Dublin. https://isif.ie/wp-content /uploads/2016/03/ISIFInvestmentStrategyExecutiveSummaryJuly2015.pdf. ISIF (Ireland Strategic Investment Fund). 2017. “Economic Impact Report FY 2016.” National

Treasury Management Agency, Dublin. http://isif.ie/wp-content/uploads/2017/07 /EconomicImpactReport31December2016.pdf. ISIF (Ireland Strategic Investment Fund). 2018a. “Ireland Strategic Investment Fund H1 2017

Update: Including Economic Impact Report FY 2017.” National Treasury Management

Agency, Dublin. https://isif.ie/uploads/publications/ISIF-2017-Update-H1-2017-Economic -Impact-Report-22.01-Changes.pdf. ISIF (Ireland Strategic Investment Fund). 2018b. “Ireland Strategic Investment Fund H1 2018

Update: Including Economic Impact Report FY 2017.” National Treasury Management Agency,

Dublin. https://isif.ie/wp-content/uploads/2018/07/ISIF-H1-2018-Update-published.pdf. ISIF (Ireland Strategic Investment Fund). 2019a. “Investment Strategy 2.0: Towards 2040–

Investing Commercially and with Substantial Impact.” National Treasury Management

Agency. https://isif.ie/uploads/publications/ISIF-Investment-Strategy.pdf. ISIF (Ireland Strategic Investment Fund). 2019b. “Ireland Strategic Investment Fund H1 2019

Update: Including Economic Impact Report FY 2018.” National Treasury Management

Agency, Dublin. https://isif.ie/uploads/publications/ISIF-H1-2019FY-2018.pdf. NTMA (National Treasury Management Agency). 2018a. “Annual Report & Accounts 2017.”

NTMA, Dublin. NTMA (National Treasury Management Agency). 2018b. “Code of Conduct for Members of the

National Treasury Management Agency and its Committees.” NTMA, Dublin. https://www .ntma.ie/uploads/general/Code-of-Conduct-for-Members-of-the-National-Treasury -Management-Agency-and-its-Committees.pdf.

11 Case Study—The Marguerite Fund: An Infrastructure Fund Sponsored by Development Banks*

If you want to crowd in private investment with credibility, then you want to be as close to standard market practice as possible. Anything that deviates exposes you to being on unfair market terms: clauses that oblige you to go to board for exit, investors having a say on what the fund does, and so on. – Barbara Boos, Head of Infrastructure Funds and Climate Action Division, European Investment Bank To get a project to the stage where it can be built, project development skills are sometimes more important than capital. Many investors are unfamiliar with project development, whereas Marguerite has this capacity. So, to get projects off the ground, we engage closely with sponsors over time. – Nicolás Merigó, CEO, Marguerite Investment Management

BACKGROUND AND MISSION

The 2020 European Fund for Energy, Climate Change and Infrastructure (Marguerite I) and Marguerite II SCSp1 (Marguerite II)—collectively called Marguerite for the purposes of this study—are infrastructure funds founded by the European Investment Bank (EIB) and several national development banks (NDBs) of the European Union. Their mandate is to invest, on a commercial basis, in policy-driven infrastructure projects in the European Union and preaccession states, based on a list of eligible sectors and with particular focus on greenfield infrastructure. Although equity is the most commonly used tool, Marguerite can invest via equity, quasi equity, and mezzanine and subordinated debt. The funds are managed by an independent investment team. Marguerite I reached first close in December 2009, and Marguerite II did so in November 2017.

The idea to launch Marguerite I was conceived in 2008 by the EIB and the NDBs of three EU member states—France’s Caisse des Dépôts et Consignations, Germany’s Kreditanstalt für Wiederaufbau, and Italy’s Cassa Depositi e Prestiti.

*Research for this case study was completed between 2018 and 2019. The text reflects the circumstances at that time.

In the aftermath of the 2008 global financial crisis, infrastructure investment in Europe had significantly decreased. In this context, the goals of Marguerite’s founding sponsors were to stimulate greenfield infrastructure investments in the European Union, catalyzing private investment, and to set an example of long-term investment (by establishing a 20-year fund).

To ensure adherence with the policy mandate envisaged for Marguerite I, the sponsors decided to set up an independent investment advisory company rather than use an existing external fund manager. They hired McKinsey & Company to analyze the infrastructure funding gap and pipeline in the fund’s target countries, negotiated a term sheet among themselves, and sought legal advice from Allen & Overy. The term sheet struck a compromise between the investment objectives of various sponsors—some more inclined to pursue market-oriented investments and others more policy-oriented. McKinsey & Company estimated the optimal fund size at €1.5 billion. Allen & Overy assisted in setting up a closed-end investment fund in Luxembourg, where the EIB is headquartered (adopting a SICAv/SIF structure,2 supervised by Luxembourg financial regulator CSSF3).

In 2009 the sponsors initiated the competitive selection of a CEO, who was also to be the first partner of the fund advisory company and would be tasked with assembling the full investment team and delivering on the mandate.Nicolás Merigó, former head of Santander Infrastructure Capital, was selected and became proactively involved in defining an investment advisory agreement, fee structure, and long-term incentive plan aligned with the fund industry’s best practices. He started in early 2010, and the bulk of the investment team was hired that same year. The role of Marguerite Adviser was similar to that of a traditional private equity fund manager (GP), although the fund was structured as a corporate entity.4

The first fund, Marguerite I, was launched in the first quarter of 2010 with €710 million of capital committed. The four original sponsors were joined by two more state-controlled financial institutions, Spain’s Instituto de Crédito Oficial and Poland’s PKO Bank Polski. The six institutions invested €100 million each in Marguerite I (figure 11.1). The European Commission provided €80 million, and two other state-controlled financial institutions from Malta and Portugal provided the remaining €30 million.

Despite its stated intentions and a significant fundraising effort, Marguerite I was not able to attract private investors at the fund level. Possible reasons include the newly composed investment team’s slim track record, the perceived riskiness of the fund’s greenfield strategy, concerns over public influence on investment decisions, and the timing of the fund’s launch (right after the 2008 financial crisis). Although individual members of the investment team assembled by the CEO had proven expertise in infrastructure investing, the team lacked a shared track record. Governance rules were put in place to mitigate the sponsoring state banks’ influence on investment decisions; however, these rules were not sufficient to alleviate private investors’ concerns about investments being politically rather than commercially driven. In addition, risk aversion in the financial industry was still pronounced in the aftermath of the 2008 global financial crisis, and private investors were disinclined to invest in anything deviating from common practice, in terms of governance and investment strategy. Marguerite I was, however, successful in catalyzing private investment at the project level.