IFR Asia Asian Development Bank Roundtable 2019: Part 2

IFR ASIA: The deal we’ve just been talking about from Clifford Capital was in US dollars. If you try to bring project financings to the local capital markets, who are the investors there? Where does the money come from?

KYOSHI NISHIMURA, CGIF: As I said earlier, project bonds are not so common in developing countries or ASEAN bond markets, except for Malaysia. However, in the last few years actually we have also seen some good examples of project bonds in other ASEAN countries. In Indonesia there have been a number of project bonds issued in the rupiah bond market. We did the project bond transaction I mentioned in Philippine pesos, and that was followed by a project bond for a hydro power company. Also in Thailand we see a number of project bonds, so it’s coming but still limited.

I think Clive made a very good point about single asset project bonds. If you look at the global project bond market, the total size even including developed markets is about US$40bn–$50bn per year. That means, of all the projects financed in the world, only 10%–15% are done by project bonds and 85%–90% are by banks. This ratio hasn’t really changed in many years. One reason is that you cannot expect normal bond investors to become project finance experts; they don’t have the internal capability to analyse project finance risk and manage these risks.

Some global institutional investors, insurance companies or big pension funds have set up special teams for project finance, hiring project finance bankers from commercial banks, but those are very limited examples. If you look at the range of investments these institutions manage, you cannot really expect them to become project finance bankers.

The portfolio approach that Clive has explained really takes project finance risk and structures it in a way that a wider group of institutional investors can invest in infrastructure projects. I think it makes a lot of sense. This may also be applicable in emerging bond markets, where institutional investors may not be as experienced or – I don’t want to use this word – sophisticated as bond investors in more developed markets.

We’ve also seen some ASEAN infrastructure companies issue normal corporate bonds, after their projects are completed. If the project is stable and their rating is high enough, local institutional investors can invest in normal corporate bonds issued by project companies, sometimes even on an unsecured basis. The two major toll road companies in the Philippines are good examples. We also this year saw a very similar example in Thailand, where power projects of B Grimm also issued normal corporate bonds after originally using project finance from the bank market. So that’s maybe another way to develop the capital markets for infrastructure.

IFR ASIA: Question to you on that, Katharine: if I’m an investor, how do I know that my money is going towards sustainable development, and not a company’s next coal plant?

KATHARINE TAPLEY, ANZ: That’s a good question, because money is fungible, so it does all go into one pot. The principles around green and sustainability bonds are very clear in making a very strong recommendation to provide regular reporting and transparency on how the money has been used. Certainly our experience is that investors are pretty demanding on this. Investors are not just sitting back and getting themselves into green bonds and then not following up on the reporting.

They will want to see reporting at least annually, sometimes twice a year, not on just how proceeds have been used but also what the impact of that money has been. The concept of understanding the impact of their investment is gaining a lot of currency.

“There is an increasing role for structured finance in terms of facilitating the transfer of project finance loans from bank balance sheets into the capital markets and thereby crowding in institutional debt.”

Actually the sustainable development goals are increasingly becoming a framework, if you like, through which investors are actually measuring that impact. So you’ve seen a rise in bond issuance aligned to the SDGs. A borrower might choose a collection of the SDGs that best match their business and demonstrate how their borrowing matches that. That really does give investors the ability, to some degree, to measure the impact of what it is that they’re investing in.

IFR ASIA: If you are issuing green bonds, as a company do you need to be proving how much you’re saving from your emissions over the course of that deal?

KATHARINE TAPLEY, ANZ: That’s one measure of impact. It goes back to what I was saying before, when you asked me if anyone can issue green bonds. An issuer really does need to have an agenda around this. Often if you’re dealing with an organisation that has a really strong agenda, they’re probably already reporting those kinds of impacts anyway.

Maybe to bring this to light with an example, we issued a green bond and we produced our first impact report about 18 months ago. We looked at a number of impacts around that. Obviously carbon emissions reduction was one because we’re talking about a portfolio of wind farms and solar farms. We also looked at the equivalence of households powered by renewable energy as a measure as well. Jobs created is another one that’s a co-benefit coming off the back of these deals. It just gives some flavour to the kinds of impact metrics that you can pull out of transactions.

IFR ASIA: What more can be done to stimulate sustainable financing? What kind of incentives have been effective in this part of the world?

KATHARINE TAPLEY, ANZ: We are seeing some incentivisation in Asian markets, so both Singapore and Hong Kong regulators have now put in place programmes whereby they will help pay the costs for issuers wanting to sell bonds out of Hong Kong or Singapore and list them on those stock exchanges. That’s very helpful to stimulate interest at least, even though it’s a little bit of a myth that these transactions come with extra costs. The costs are pretty minimal in terms of structuring – and I genuinely say that as an issuer as well as someone who is marketing these transactions to my client base. They tend to be very small when you amortise that over the life of the transaction and all the benefits that we’ve already talked about.

On the investor side, as I said before, I’m not sure they need a whole lot of incentivisation to come into these transactions. There is just not enough supply in the market. As I said earlier, appetite for sustainable or green investments is increasing, and fund managers are under pressure themselves to demonstrate their commitment there. I only see that going one way. That also creates an incentive on the borrower’s side because if you’re not playing in these sustainable finance markets then you may be putting yourself at risk of losing access to the capital markets in the long term.

IFR ASIA: Clive, is that something that you’ve seen as well, that there’s basically a lot of money chasing assets at the moment?

CLIVE KERNER, CLIFFORD CAPITAL: This is something that everyone talks about and it’s absolutely the case in Asia. There’s still too much liquidity chasing too few projects.

I think where it all really starts is that host governments need to do more to work out which projects are commercially viable and therefore can be offered to the private sector, and which are not and therefore should stay with the public sector. There are still occasions when some governments think it should be the other way round. I know the MDBs are spending a huge amount of time pushing this. People talk about US$6trn of demand for infrastructure in Asia. Clearly governments can’t fund all of that, so there’s a clear role for the private sector. That’s a really important initiative.

Coming back to the earlier question, I think there’s a big push factor as well that’s encouraging more sustainable development. You’ve got a situation now where the majority of banks are out of financing coal, and that in turn is going to encourage sponsors to turn their attention much more towards gas and renewables as well. Renewable energy is now reaching grid parity in certain segments.

IFR ASIA: What about the local markets? Nishimura-san, what’s next for CGIF in helping some of these infrastructure assets come into the capital market?

KYOSHI NISHIMURA, CGIF: CGIF’s original role has been to support the development of domestic bond markets by providing guarantees to corporate and project bonds. We didn’t have any particular industry focus on infrastructure, but that is the sector where long-term local currency funding is most needed.

Two days ago here in Fiji there was a meeting of ASEAN+3 finance ministers and central bank governors, where they agreed to a new medium-term roadmap for the Asian Bond Markets Initiative, ABMI, for the next four years. One of the new initiatives under this roadmap is what we call an Infrastructure Investors Partnership, or IIP. It is a very innovative facility to promote local currency finance for infrastructure projects, mainly in ASEAN countries, by mobilising institutional investors in both developed economies, like Japan, and in ASEAN countries.

Basically IIP aims to tackle two important policy issues. First is the need for long-term local currency funds for infrastructure investment. One of the reasons holding back long-term local currency funding is that the risk-taking ability of domestic financial players – pension funds, local insurance companies, local banks – is still limited. IIP will provide credit enhancement for local currency financing so that these domestic financial players can provide long-term funding for the infrastructure project.

Unlike CGIF, IIP will support only infrastructure projects, and it can also support local currency loans provided by banks to finance infrastructure projects, especially greenfield projects, where bank loans are probably a more suitable financing method compared to bond finance. IIP guarantees can be structured to encourage those greenfield project loans to be refinanced by long-tenor bonds after the construction is complete.

The second policy issue is the challenge facing institutional investors in developed economies when they look to invest in infrastructure in developing countries. They are very interested, because infrastructure is a long-term asset and because they can also benefit from the future growth of these developing countries.

However there are two hurdles. One, Clive mentioned already, is the rating. The credit ratings of most ASEAN countries are not so high, so project ratings in these countries are not acceptable for the institutional investors in developed countries, like Japan.

The second issue is the currency. As I said, many projects need funding in ASEAN currencies, but the Japanese pension funds don’t want to lend money in Indonesian rupiah or Vietnamese dong. So the IIP aims to tackle these two hurdles in an innovative way. In addition to the capital contributed by the governments, IIP will issue mezzanine bonds in developed bond markets, say in Japanese yen, with a credit rating at a level which is acceptable to Japanese institutional investors.

We have done a feasibility study and this concept seems to work. Hopefully we can start operations next year, because we still have to work on the details. We haven’t really decided about the size, but hopefully the pilot phase of IIP is going to be same as CGIF. Before the capital increase, CGIF’s total guarantee capacity was slightly less than US$2bn. We are looking at a similar capacity for the initial phase of the IIP.

AUDIENCE: You all mentioned that there is too much liquidity chasing too few assets, and it seems like green bonds would really benefit from that. What happens when the market changes or interest rates go up, how will green bonds work then?

KATHARINE TAPLEY, ANZ: We haven’t really seen yet a lot of stress where these bonds have been tested. Our view is that – and we have seen some evidence already – they do tend to perform better than existing vanilla bonds in a tough market. I think that speaks to the quality and the structure of the transactions, as well as the underlying nature of what the proceeds have been used for. I think it speaks to what investors want to be holding in their portfolios as well.

CLIVE KERNER, CLIFFORD CAPITAL: If you’re looking at assets that are already in portfolios, one tends to find for infrastructure assets – including renewables – that investors will buy these instruments on a hold-to-maturity basis.

IFR ASIA: Would something like your securitisation platform still be viable at a higher interest in the future?

CLIVE KERNER, CLIFFORD CAPITAL: Yes, good point. Our CLO structure actually is all floating rate. This could change in the future, but the way we structured the first deal was that all the loans coming into the platform were floating-rate loans, which tends to be the case for infrastructure financing, so they were either linked to three-month or six-month Libor.

What we sold to investors was a floating-rate portfolio. So that does provide protection of course against interest rate fluctuations.

AUDIENCE: Having lived in Malaysia in the 1990s, I am interested in what we can learn from infrastructure financing there. Here in Fiji, I feel like it’s vastly underdeveloped. What are the factors we could overcome to capitalise on that?

KYOSHI NISHIMURA, CGIF: That’s a good question. I think broadly the reason why Malaysia has been successful in developing an infrastructure bond market is first of all that they started early. They started to create a national pension system in ‘50s but in late ‘80s, or early ‘90s, the pension system was expanded and when you have a large national pension system you need a bond market to invest these pension assets. They have had a very holistic, comprehensive bond market development plan since the early ‘90s.

“The sustainable development goals are increasingly becoming a framework, if you like, through which investors are actually measuring that impact. So you’ve seen a rise in bond issuance aligned to the SDGs.”

Developing a bond market involves many government agencies and regulators, the central bank, securities and exchange commission and the ministry of finance. It’s also about creating local currency savings and how to manage these assets. You need a very comprehensive long-term plan, which Malaysia has done very well.

Sometimes people think the bond market is a technical issue, but it’s not. Even developing countries also need to think about how to create local savings, how to set up the pension system and the insurance industry. There has to be a coordinated effort. In the case of Malaysia, they set up the National Bond Market Committee, which involved very high-ranking officials in ministries. They’re all involved. This kind of holistic blueprint is needed first of all to develop bond markets.

AUDIENCE: It was interesting to hear about this new IIP vehicle that you have in mind. Issuing mezzanine bonds is quite expensive. How does the business plan work? How are you going to generate sufficient returns?

KYOSHI NISHIMURA, CGIF: Yes, that’s another good question. It’s part of the feasibility study to look at whether it’s economically viable. It really depends on what kind of leverage you can create. Altogether this capital, consisting of the first-loss piece from the public sector and the mezzanine bonds, is going to be leveraged to issue a higher amount of guarantees. Can the guarantee fees from the portfolio provide sufficient income to pay an expensive mezzanine bond? The economics will depend on what kind of pricing level is needed for the mezzanine bond, which is also linked to what kind of rating this bond will get, and to what extent you can leverage this capital.

We have done the initial feasibility study, and it seems to work. We believe it may especially work in the current Japanese context, but may or may not be in other markets, depending on market conditions at the time.

AUDIENCE: Are there attempts to develop a clear green taxonomy, actually what is considered green? And how do you deal with different shades of green when you issue a bond? Thank you very much.

KATHARINE TAPLEY, ANZ: That’s a good question. In the European Union, as you may be aware, green taxonomy has been legislated, to provide definitions around what that means. That’s come out of the high level expert group that’s been advising the European Commission about its sustainable finance action plan. You’re seeing those kinds of groups pop up in different jurisdictions around the world. The UK has a similar vehicle, the Canadians do, the Japanese do now and we’re seeing it in Australia and New Zealand as well. ANZ is involved in the Australian and New Zealand initiatives, and in both cases there will be a conversation around a taxonomy to give some definition and guidance to the market.

I think we have to be very careful about definitions. There’s a really fine line between too much definition and not enough, because you don’t want to create a situation where you suddenly close the market for some transactions because you’ve been too prescriptive. The other thing is that what’s green or sustainable in one jurisdiction – Germany, for instance – is very different to what’s green in a jurisdiction like Vietnam.

I actually think that thus far the market has done a really good job of self-regulating, with the help of the green and social bond principles. As I’ve said a couple of times previously a well-structured transaction will be aligned to those principles, with an independent opinion and regular and transparent reporting around how proceeds have been used.

Those principles have given really good guidance to the market place. Looking at the issuance that has been brought to the market this year – and we’re towards US$200bn or so already – there are very few deals that don’t have that level of integrity and robustness. It’s also still early days, in terms of where this market’s going and where it could project to.

IFR ASIA: We’ve mentioned the bank market several times. Is the changing appetite there also going to be a driving force in this part of the world, do you think?

KATHARINE TAPLEY, ANZ: I think so, absolutely. Clive’s already touched on this move away from, or increasing inability to lend to, the coal sector. With that is coming more scrutiny from regulators around what sits on balance sheets. You’ve also got the Task Force on Climate-related Financial Disclosures, which has become a very big driver of how banks are shaping their balance sheets. We’re all under pressure in terms of what our balance sheets need to look like to contribute to a sustainable future. That is definitely driving banks into the sustainable finance markets to find these transactions and to effectively replace and create and reshape their balance sheets. Certainly that’s a driver at ANZ. We have also been thinking more around our organisational purpose and we have some streams of work around environmental sustainability, housing and financial wellbeing. Those two things together are driving how we are shaping our balance sheet.

The bank loan market in this space is really exciting, because not everyone can actually issue bonds. We’ve touched on some of the hurdles around projects, but generally speaking most companies need to borrow money. Similar to the green bond market, there is now a framework for green loans, and the concept of incentive-based lending linked to an organisation’s sustainability performance is really interesting. That actually allows banks to play a really critical role in catalysing their clients’ transition and change. It’s about the banks actually taking a little bit of skin in the game.

At the moment there isn’t any capital relief from regulators around that, but you can probably foresee that that might come in the future. Again, that’ll catalyse even more bank balance sheet activity.

IFR ASIA: I’m just going to finish on a bit of a forward-looking spin here. Clive, how big can your programme get, and what do you hope to do in the future?

CLIVE KERNER, CLIFFORD CAPITAL: We concluded the first deal last year, but it was never intended to be a one-off. What we’re looking to do is create a new asset class and to build a programme over time. We have a number of things that we want to do to achieve that. The first one is to address the timing issue around how you identify and evaluate these assets, and we’re looking to to put in place a warehousing facility and a balance sheet that will enable us to identify assets and bring them on to the platform when they’re available. Then, when market conditions permit and there is sufficient critical mass, you can then do a series of securitisations off that balance sheet.

The second point is the importance of diversification to make a securitisation successful. We’re now engaged with the broader banking market to ascertain the extent of supply. We discussed earlier the longer-term issues around more projects needing to come to market, but in the short to medium term there’s a significant volume of assets already on bank balance sheets that the banks are willing to securitise to help them recycle their project finance loan portfolios. We’re in the process of developing an eligibility framework with banks so that when they close these transactions they’ll know which ones will be eligible to come on to the platform in due course.

Over time there also needs to be more pricing benchmarks for this asset class. We found with our pilot scheme last year that, because it was the first of its kind, investors didn’t really know how to benchmark it and they ended up pricing it against US corporate CLOs – which is clearly not an appropriate reference point. It led to, we think, pricing levels that were too high and of course there was a new issuance premium that we had to pay.

There needs to be more liquidity to facilitate trading, which, of course, you can only get with more issuance volume. Also in time there needs to be research. That’s more of a medium-term target.

The next point I would make is more around loan documentation, from the perspective of making it easier for loans to get transferred from bank balance sheets into a capital market structure. The two key challenges we found were first of all obtaining consents for transfers. We found that none of the export credit agencies that were providing support for some of the loans in the portfolio were willing to give their consent. While these institutions are comfortable for loans to be transferred among banks, they still are not ready to approve loans being transferred into a capital market structure. The way we got around that on the first one was to effect the transfers as sub-participations.

Allied to that, investors want more transparency. They want to understand more about the underlying projects..

The other idea we are assessing is expanding the investor outreach. The first deal we did was on a Reg S basis and we are considering the benefits of 144A issuance format in the future which would enable us to tap the US CLO investor base which is the world’s largest and most sophisticated.

IFR ASIA: Ladies and gentlemen, thank you very much for your attention.