The funding of infrastructure projects by institutional investors is a topic being hotly debated right now. While the hurdles for institutional parties looking at such opportunities are many, there is a growing feeling that in such a low-interest-rate environment, their potentially high yields make them worth the risk and effort.

Reaching the point where institutional investors, like pension funds and insurance companies, invest significant amounts of long-term capital, and particularly debt-like instruments, in infrastructure may still be years away. However, the initiatives of the G20 leading countries and a number of multilateral development banks (MDBs) in the past two months, together with an unprecedented mobilisation of infrastructure lending anticipated in 2015, when the Brics New Development Bank and China’s Asia Infrastructure Investment Bank start operations, will at least bring the goal of infrastructure as a new asset class nearer.

Take the World Bank’s Global Infrastructure Facility (GIF), launched during the World Bank’s annual meetings in Washington, DC, in October, for example. Here, governments, MDBs and export credit agencies act as funding and technical partners, and the heads of some of the world’s largest asset management, private equity, pension and insurance funds and commercial banks – among them Amundi, Macquarie, BlackRock, HSBC and Citibank – act as advisors.

An open, global platform, according to World Bank officials, GIF will facilitate the preparation and financial structuring of a sample of public-private partnership (PPP) projects across different sectors and different emerging markets and developing economies. This will demonstrate how complex infrastructure projects can be made viable and are capable of attracting private and institutional investment.

Project shortfall

In this way, those behind GIF, along with other organisations, are attempting to address one of the key impediments to developing infrastructure as a new asset class, which is the dearth of bankable projects worldwide.

Jordan Schwartz, the head of GIF and a former World Bank infrastructure policy manager, says: “We’re focusing at GIF, at least for now, on energy assets that are climate-friendly such as mass transport [as well as] trade-enabling infrastructure; so large ports and heavy rail.”

But the novelty of the endeavour, he says, is that public and private investors will be involved, right at the outset, at the project planning stage, in discussions with governments, on the availability, design and use of risk management products and on their impact on the long-term financing and costs of projects.

Mr Schwartz says: “Having a more standardised approach on the risks that are common across sectors and on the use of these products and instruments, and how they can improve the value of a project [will] be immensely helpful.”

And, eventually, after preparing and structuring enough infrastructure investments, it should be possible to establish some risk-return profile for assets, across sectors and countries.

Meanwhile, at the G20 summit in Brisbane, Australia, in November, political leaders launched a Global Infrastructure Hub, a database that includes a set of voluntary 'leading practices' to identify, prioritise and deliver infrastructure projects that will provide more transparency and certainty to investors. According to a G20 release, political leaders will work to establish these practices throughout MDBs and the private sector, “to accelerate the development of infrastructure as an asset class”.

An unnecessary standardisation?

This means that another element of the move towards infrastructure becoming a new asset class – better standardisation in the legal and regulatory framework for private investment and PPPs throughout developing countries – is also starting to be tackled. However, such a one-size-fits-all approach to policy and sector reforms for low-income countries is highly ambitious and not necessarily desirable, according to some critics.

Nancy Alexander, a director at the Heinrich Boell Foundation in North America, which is linked to Germany’s Green Party, is concerned about what she sees as a weakening in previously accepted environmental safeguards and standards in the G20's proposed practices.

But Amar Bhattacharya, a senior fellow at the Brookings Institute and former director of the secretariat of the Group of 24 developing countries in Washington, says: “The more you can standardise such things in a way that investors can better understand and where there is due diligence and governance to meet those standards and good practices, the better off we will all be.”

Hung Tran, executive managing director at the Institute of International Finance, which is one of the GIF’s new advisory partners, says in order to build a new infrastructure asset class, institutional investors “really have to be assured before they commit money and buy this type of debt that they won’t be surprised by unreliable, unexpected or unpredictable legal or regulatory changes”.

He continues: “That’s very important. That kind of [political] risk differs from country to country but, overall, for this asset class to take shape there has to be a very reliable and very stable legal and regulatory environment.” 

Finding global favour

But why is the political momentum about infrastructure gathering now? The short answer is infrastructure has many benefits, now favoured worldwide.

In advanced economies, infrastructure investment is viewed as potentially providing a much-needed boost to demand by creating jobs, and is one of the few remaining policy levers left to governments to stimulate growth.

In developing countries, infrastructure raises living standards and productive capacity, and helps remove bottlenecks in rapidly urbanising countries such as China, India and Indonesia.

The gap in the financing of infrastructure – between the level of money needed to meet demand and what is actually being provided – is also acute. The World Bank estimates that an additional $1000bn to $1500bn needs to be invested in infrastructure each year up to 2020 if developing countries are to meet growth targets. It also estimates that in advanced economies, total infrastructure investment from public and private sources, as a share of gross domestic product, is the lowest it has been in the past 50 years.

Meanwhile, since the 2008 financial crisis, there has been a significant decline in public and private funding of infrastructure due in part to the high level of debt in Organisation for Economic Co-operation and Development countries. Simultaneously, commercial banks, which used to be key financiers, providing syndicated loans for project finance, have been reducing the total volume of their infrastructure lending and the tenor of that lending, thanks in part to the higher capital demands of Basel III.

In contrast, the amount of capital held by institutional investors is now estimated at a staggering $82,000bn, according to the G20. And institutional investors –pension funds, life insurance companies, sovereign wealth funds – are searching for yield in a low-interest-rate environment.

A good match?

So, in theory, the reliable, safe and often inflation-proof, cash flow of infrastructure, provided by tariffs for electricity or water utilities or tolls on roads, for example, and the long-term nature of such projects – 50 years or more – makes investing in these assets a good fit for the long-term debt instruments needed by institutional investors, given that it matches their long-term liabilities.

Mr Tran says: “The question [of creating an infrastructure asset class] is very relevant. However the answer is rather involved.” 

According to the World Bank’s Mr Schwartz, the choices are limited. “We can’t pretend that the MDBs will capitalise to the point where there’s no longer a need for any other form of financing. We can’t pretend the infrastructure gap isn’t there. We can’t wait endlessly for governments to finance a budget while also introducing enough market signals for infrastructure services to be offered efficiently,” he says.

But a major impediment for institutional investors is that, on top of the risks associated with the legal and regulatory framework of a country – such as the risk of a government changing a utility’s tariffs, which can completely alter a project’s cash-flow projections and calculations – and the importance of having the right sector economics, there are also different risks related to the different phases of a project’s cycle.

For instance, new projects in the planning or construction phase (greenfield projects) carry more risks than existing assets (brownfield projects), which have established operating histories and revenue streams. New projects tend to offer higher returns to compensate investors for the added risk.

Infrastructure assets are also, typically, natural or government-owned monopolies. So whoever is sponsoring and financing the project only really has one shot at correctly estimating, for example, how much electricity needs to be produced over the long term, or how much traffic will come onto a new road, or how willing drivers will be to pay for that service.

Meanwhile, bankers say, a fundamental reason for the gap between current infrastructure needs and investments is because, almost by definition, such projects have a public utility or 'public good' element, with features external to the initial investment. Examples are the need to provide universal access to a basic service such as transport, or piped drinking water, or tariffs that are lower than a cost recovery level, but their financing is the government’s or taxpayers responsibility.

Filling the gap

According to some bankers, to make these projects appealing to private investors, two things are necessary. The costs of the external features need to be made explicit and included in the project’s internal budget; and a link needs to be established between the project’s internal rate of return (the revenue to be raised over a project’s lifetime compared with the initial investment), which matters to a commercial investor, and the economic rate of return, which matters to society and the broader economy.

MDBs, commercial banks and private insurance companies have developed several products over the years to manage the various risks of project finance. For instance, there is the World Bank Group’s partial credit guarantees and political risk insurance, and Swiss Re’s newly developed natural disaster risk insurance for infrastructure investments in developing countries.

Meanwhile the European Commission and the European Investment Bank (EIB) launched an instrument in November 2012 specifically designed to bridge the gap between the yields and risks of EU infrastructure to attract institutional investors, which basically provides a credit enhancement to a project finance bond, and upgrades the credit quality of the senior bonds to an A or AA credit rating, because at that level the bond is more acceptable to pension funds, insurance companies and so on.

The EIB’s credit enhancement can be used by promoters throughout the life of an EU infrastructure project. However, Mr Schwartz says the thinking on GIF is that it may be preferable to adopt a cocktail approach, with different financial vehicles for different stages of a project’s life. Commercial banks, he says “are still willing to take on the construction risk and the financing of the first stage of an infrastructure project. But you don’t want those levels of return driving the capital cost structures of projects for long periods of time.”

Mr Schwartz adds: “Ideally, you’d take them out and put in something that’s longer, more patient, more risk averse but lower in terms of capital costs,” once construction is over and the project starts operating.

Mr Bhattacharya says: “There is greater certainty both with regard to the cost and revenue stream, and so it’s easier to securitise the project and spin it off.” 

Transfer issues

But taking a bank out and moving to an institutional investor, changing from one type of investor to another, is very challenging, as the ownership structure of the project and all the contracts, rights and obligations need to also be legally transferred. And all of this needs to be arranged at the project preparation stage for consumers to be able to plan and price the project.

For this reason, World Bank officials say, some credit enhancement or other instrument could well be necessary to cover the risks at this crucial junction point and facilitate the project’s financial transition.

Against this background, according to Mr Tran, another condition for the emergence of the new asset class is that the project bonds, or debt-like instruments, are marketable, as even long-term investors, such as pension funds, need to rebalance their portfolio, look at the risk-reward profile and their liabilities, and change assets.

There are also certain restrictions on what institutional investors can invest in. Also, for instance, the obligations of an insurance firm are quite different from those of a pension fund.

“It’s highly technical, and producing one asset class out of all these variables is going to take time, effort and patience,” says Mr Schwartz. However, an increasing number of people are starting to believe that it is still worth the effort.


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