Sharing the risk
Efforts to connect institutional investors with greenfield infrastructure projects have so far yielded few results, but the ADB and others are banking on new schemes to help share the burden.
Financing more infrastructure through the capital markets is a long-held ambition in Asia, where a trade surplus and infrastructure deficit has frustrated policymakers for years. Instead of channelling regional savings into US Treasuries, why not divert more of those resources towards lifting millions of people in Asia out of poverty?
The ADB reckons Asia needs to invest US$1.5trn a year to meet the region’s infrastructure needs and maintain its current pace of growth, rising to US$1.7trn to respond to climate change. Mobilising private sector finance alongside public resources will be key to meeting that daunting target, almost double current spending levels of close to US$900m.
Project bonds would help fit the bill nicely, offering infrastructure developers attractive long-term financing and Asian savers a steady source of income.
After a slow start, efforts to stimulate the product are intensifying. Asia’s institutional savings pool is growing, global banks are increasingly capital-constrained, and investors are increasingly focused on stable yields.
The trouble is that infrastructure investments require a degree of expertise and risk tolerance that few institutional investors possess. Pension fund managers, for example, need a stable income stream and cannot afford to take risks on infrastructure projects that may never become operational.
Enter the multilateral development bank.
“Many ASEAN countries are still very bank-centric, but at the same time you see rapid growth of non-banking financial institutions – insurers, pension funds and asset managers and various other institutions. If Asia is going to meet its infrastructure needs, you really need to mobilise these local resources, not just the banking sector.”
Supranational institutions such as the ADB spend a great deal of time and effort on their own due diligence before investing in a project. If they can share that knowledge in the form of risk mitigation, private sector partners may be more inclined to invest.
“There’s a lot of excitement around using multilaterals for credit enhancement, to lift the rating of an instrument to a level where it can be placed globally,” said Christopher Thieme, deputy director general of the ADB’s private sector operations department. “So far, there’s not as much activity as excitement.”
A variety of initiatives are underway to stimulate project bonds.
The 2015 bond for the Tiwi-Makban geothermal project in the Philippines came with a partial credit guarantee, proving the value of credit enhancement to local Asian financiers. In that case, the ADB and Credit Guarantee Investment Facility, a specialist ASEAN+3 fund, split a guarantee for 75% of a local currency bond sold to Bank of the Philippine Islands, allowing sponsor Aboitiz Power to leverage its investment and free up capital for other power projects.
The idea of supporting local currency infrastructure financings struck a nerve for Kiyoshi Nishimura, CEO of the CGIF, who hopes the concept can be extended to appeal to regional institutional investors.
“Many ASEAN countries are still very bank-centric, but at the same time you see rapid growth of non-banking financial institutions – insurers, pension funds and asset managers and various other institutions,” he said. “If Asia is going to meet its infrastructure needs, you really need to mobilise these local resources, not just the banking sector.”
“It’s a good example of how multilaterals can use their risk management capacity to help mobilise local savings to finance infrastructure development.”
Thieme at the ADB says the bank can offer multiple forms of credit enhancement for infrastructure debt, including tail wraps – covering, for example, the last five years of a long term financing – to bring down the overall interest costs for the developer. Refinancing, however, is a challenging proposition for multilateral lenders.
“We have a fairly high bar on these. We want to see significant delivered benefits,” said Thieme. “We’ve looked at literally dozens of prospects that don’t meet that bar.”
Greenfield projects rarely make it to the capital markets. Once the initial financing is completed in the bank loan market, banks tend to hold on to the project for life, even though its stable cash flows would make it an ideal candidate for fixed-income investors. A bond refinancing brings with it significant costs – often long-term swaps and hedges need to be unwound, and documentation can be expensive.
The European Investment Bank has led an EU initiative to change that under the Project Bonds 2020 programme. Using EU resources, it has pioneered the use of undrawn mezzanine loans to cover the first loss in a project financing and improve the rating of the senior debt. The first financing, for the aborted Castor underground gas storage complex in Spain in 2013, provided proof that the concept worked, and has since been replicated for road projects in Belgium and Germany, among others.
The ADB has proposed similar first-loss guarantees – for a wind power development in the Philippines, among others – and the Asian Infrastructure Investment Bank has said it is open to the idea. But the take-up in Asia has been slow.
Pricing that kind of enhancement in a long-term, fixed-rate bond is extremely complicated. Some big European insurance and pension funds have begun to devote resources to the sector, but Asian market participants believe the product is simply too complicated for Asia’s local markets, where bank loans are readily available.
“You have a fairly liquid and non-discriminating banking sector in most of Asia,” said Michael Barrow, director general of the ADB’s private sector operations. “Why go through the hassle of structuring something complex?”
“The endgame would be a greenfield, international public placement, but there are many steps along the way before you can get there.”
The latest initiatives focus on support during the construction period – the riskiest phase of any infrastructure investment – and aim to reduce the infrastructure sector’s dependence on capital-constrained global banks.
“The big issue is that most of the international banks just don’t want to lend long, and that’s going to creep across most of the market soon,” said Barrow. “The banks are comfortable assessing construction risk and structuring projects. They just can’t go out to 15 years.”
CGIF unveiled its construction period guarantee last year and is looking for its first project. The International Finance Corp is finalising the terms of a similar facility.
The ADB has also discussed the idea of a project completion guarantee that would work as a standby facility, absorbing additional costs due to unforeseen delays and keeping the project financing intact. Any funds drawn would be repaid over the life of the project.
The new breed of guarantees would protect investors from default risk for a limited period, potentially up to the first five years of a 15-year or 20-year financing. The guarantees would lapse once the construction period is over, but at that point the risk profile of the project would improve as it starts to generate revenue.
CGIF, rated AA (S&P), plans to insure 100% of principal and coupon payments during the construction phase, as long as the project meets a set of conditions.
“Construction risk is actually not well understood. A lot of the time it is confused with a project reaching financial close prematurely, before the land rights or procurement contracts have been completed,” said Boo Hock Khoo, head of operations at the CGIF.
The Triple A rated IFC may also offer 100% construction period insurance, but it is looking to syndicate that risk in the bank market, according to people familiar with its plans. Syndication, bankers said, would suit lenders who are looking to retain a role in the infrastructure sector but have limited appetite for long-term risk-weighted assets.
“We actually add the most value during the construction phase,” said one head of debt advisory for Asia at a European bank. “Once the project is generating cash flow, it’s basically a fixed-income story.”
By taking on the early-stage risk, the MDBs hope to drive a recovery in global growth by channelling excess savings into quality infrastructure projects. They also echo calls among institutional investors for long-term fixed-income assets at a time when yields in much of the developed world are languishing near record lows.
The “Trump bump” has also underlined Asia’s need for better capital markets alternatives. The surge in US markets that has accompanied the new President’s protectionist policies has sent more Asian savings chasing dollar assets, reviving calls for more productive options closer to home.
The challenge will be breaking Asia’s historic reliance on friendly local banks. In many Asian markets, companies are able to borrow at low rates for up to 10 years, so see little incentive for a fixed-rate, capital markets financing. Project bonds also don’t suit every greenfield development, especially where staggered construction payments mean high carry costs, or where the project is relatively simple and margins low.
The most likely pilot projects for the new breed of guarantees will come from under-banked sectors or countries. Renewable energy is a major focus for all the Asia-focused MDBs, as are frontier markets such as Myanmar and Pakistan.
Nishimura at CGIF believes there is a role for multiple different products.
“There is no silver bullet,” he said. “Many initiatives must be tried, because the needs are so huge.”
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