Private Asian infrastructure funding? Forget it!

IFR Asia 994 - June 3, 2017
7 min read
Asia

Chatter around Asia’s infrastructure funding gap has reached fever pitch, but I’m tired of the thrust of a discussion that’s shrouded in policy, politics and hope.

Everyone accepts the funding gap is too big for governments and multilaterals. But the lack of specifics - including at the recent Asian Development Bank annual meetings in Yokohama - as to how to engage private institutional capital at scale is astounding.

Can governments, banks, multilaterals, infrastructure funds, private equity firms, hedge funds and other market players collectively “productise” infrastructure financing - particularly early-stage? And can they originate enough debt and equity for institutional consumption (be it senior, mezzanine, securitised or hybrid) to make a difference?

My view? No.

Institutional investors typically don’t like project risk. It’s idiosyncratic, structurally complex and demands intense scrutiny.

The only way for Asian governments to finance infrastructure in the capital markets is through a dramatic increase in sovereign borrowing. The ADB supports it and it looks like a no-brainer: Asian economies typically have low debt-to-GDP ratios and can sustain an increase in their debt loads.

A combination of (predominantly) local currency government bonds sold domestically, regionally and globally plus some hard-currency sovereign and sub-sovereign debt will test the hypothesis - some see it as a myth - that Asia’s high savings can be recycled regionally. And what better way to test the Asian Bond Market Initiative, bringing together the ASEAN, China, Japan and South Korea with the support of the ADB, than with the challenge of funding regional infrastructure?

PARTIAL CREDIT GUARANTEES get a lot of attention as a way of covering project-specific risks. Aboitiz Power Corp’s Green bond for the Tiwi-MakBan geothermal plant in the Philippines is worthy of note: the P10.7bn (US$215m) 10-year bond came with a 75% multilateral guarantee and achieved a number of firsts when it emerged last year.

Finding ways to improve credit ratings is a crucial aspect and a lot will rest on altering the non-investment grade orientation of EM projects. The question, though, is whether partial guarantees are scalable. The ADB’s plans for a standby subordinated liquidity facility to support US dollar project bonds remains untested, as far as I can make out. But let’s also be clear: first-loss guarantees covering construction periods of greenfield projects are hardly the wand that will magically open the capital markets floodgates.

Everyone jumped on the numbers in the ADB’s recent Meeting Asia’s Infrastructure Needs report, but few seem to have stood back in horror at the sheer scale. I certainly did. The ADB’s 45 developing member countries need to invest US$26trn by 2030 (US$1.7trn per year) to maintain growth momentum, eradicate poverty and meet climate-change challenges.

The ADB estimates the region currently invests US$881bn annually. Not bad – until you realise that US$686bn of that is China, which will get its financing done through a combination of public and private sources. At the end of May, for instance, Deutsche Bank and China Development Bank signed a MoU that will see the pair support so-called Belt & Road Initiative projects worth US$3bn.

Including China, the regional infrastructure investment gap equals 2.4% of projected GDP, or US$459bn for each of the five years to 2020. Excluding China, however, the annual gap rises to US$308bn, equivalent to 5% of GDP.

Around 40% of the non-China portion can be bridged by fiscal reform, the ADB reckons. That’s a potentially unsafe assumption. But even if you buy it, it still leaves US$250bn a year to be filled by the private sector. That’s a four-fold increase every year on current levels of engagement.

AN EMBEDDED ASSUMPTION - probably a reasonable one - is that banks won’t appreciably ramp up project lending. They’re hamstrung by stricter capital and liquidity requirements and won’t want to distort their balance sheets with maturity mismatches that stem from project lending.

In this regard, Credit Agricole’s US$3bn Premium Green 2017-2 synthetic risk transfer note was a nice trade. In March, CA sold notes referencing a portfolio of its project and object finance loans to Mariner Investment Group, and will redeploy US$2bn in freed-up regulatory capital to extend Green loans. But even that sort of creativity won’t supply anything like the scale required.

It’s easy to extol the virtues of infrastructure as an uncorrelated asset class and a portfolio diversification play, and to salivate over the natural match of pension funds and long-term financings. It’s also easy to see vast sums of money sloshing around the system earning low returns. But to conclude that money will therefore gravitate to projects - and to EM projects at that - as a yield play is glib.

While it’s reasonable to imagine an increase in corporate borrowing with proceeds earmarked for infrastructure development, project bond issuance can only realistically happen in scale in the post-construction phase. Bond investors might be more willing to replace bank finance only once a project begins producing reliable cashflows.

In the meantime, project bonds will be episodic. For a start, they can take an inordinate amount of time to prepare: the Ps4.1bn (US$83m) 10-tranche hydropower project bond from Hedcor Sibulan, another Aboitiz unit - the first project in the Philippines financed by an uncovered stand-alone facility - took three years from concept to execution.

Even to get to the starting line, Asia needs regulatory and institutional reforms to generate a pipeline of bankable PPP projects, with strong bankruptcy laws, high-quality planning and confidence that projects will be done on time and within budget.

We’re also told Asia needs deep and liquid capital markets and a pan-regional credit culture and ratings schema. But you simply can’t conjure that up overnight.

All of which leaves us back where we started. If Asia is going to finance the infrastructure it so desperately needs, it’s time to open those sovereign bond floodgates!

Keith Mullin is founder of KM Capital Markets. He has spent over 25 years covering capital markets. Keith was editor-at-large of IFR until early 2017 and editor of IFR magazine 1996-2007.

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