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Asia-PacificJanuary 3 2017

Can institutional investor and multilateral co-investment meet infrastructure needs?

Risk-averse institutional investors have historically shied away from large-scale infrastructure investments in emerging markets, but new collaborations with multilateral institutions are now tempting public and private institutions into such projects. Stefania Palma reports.
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Multilateral institutions

One of the biggest unresolved questions in financial markets is how to mobilise institutional investors’ capital to fill the world’s biggest financing gaps, which are often found in emerging markets and especially in infrastructure. If the world wants to meet economic growth forecasts until 2030, it needs to invest the equivalent of Germany’s gross domestic product (GDP) in infrastructure every year, according to management consultancy McKinsey. But at $2500bn, today’s annual investment is $800bn short.

Risk-sensitive investment criteria have often stopped institutional investors from investing in emerging markets on any kind of scale. Co-investment platforms with multilateral institutions minimise risk, and China’s State Administration of Foreign Exchange (Safe) – which manages the country’s foreign exchange reserves – the country’s central bank and the State Oil Fund of the Republic of Azerbaijan (Sofaz) have pioneered co-investment funds between public institutional investors and multilaterals.

But now, a new International Finance Corporation (IFC) programme providing infrastructure loans to emerging markets is involving private institutional investors for the first time. Set to launch in February 2017, this partnership could finally provide a way to allocate the huge piles of cash currently on institutional investors’ books to the markets and sectors that need it the most.  

China steps up

In the past five years, Safe and China’s central bank, the People’s Bank of China (PBOC), have stood out for the significant sums of money they have placed in co-investment funds with multilaterals to facilitate investment in emerging markets, especially in infrastructure.

To explain China’s new collaborations, market participants point to institutional investors’ hunt for yield in a world of low interest rates. But these initiatives also suit China’s foreign investment policy. The PBOC has set up partnerships with the IFC, the Inter-American Development Bank (IDB), the African Development Bank (AfDB) and the European Bank for Reconstruction and Development (EBRD). These entities work in regions that receive high volumes of Chinese investment: Latin America, Africa and, more recently, central and eastern Europe.

In 2013, the PBOC allocated $2bn to its first co-investment fund with a multilateral – the IDB’s Latin America and the Caribbean co-financing fund, which focuses on infrastructure debt. “China was interested in driving the Latin America investment agenda and learning more about project finance in the region. Infrastructure is important to them, including sanitation, electricity, transport, wind and solar,” says Matias Bendersky, head of the IDB’s partnerships and resource mobilisation unit. So far, more than half of the fund has been committed and approved.

A year later, the PBOC entered into a $2bn co-financing fund set up by the AfDB, the Africa Growing Together Fund. This programme also focuses on infrastructure – mainly transport, water and energy – and will be disbursed over a decade, according to Charles Boamah, vice-president, finance, at the AfDB.

Partnership first

More recently in 2016, Safe became a cornerstone investor of the EBRD’s €350m equity participation fund (EPF). This is the first programme allowing institutional investors to make direct equity investments together with the EBRD. Previous collaborations had a fund of funds structure, whereby investors held portfolios of other investment funds.

The EPF does not focus on infrastructure, however, but gives Safe access to the private sector in a strategic region for China. “It is clear [our] region is [being] targeted through China’s One Belt One Road vision and the EPF could deliver on this vision. It is very important for [China] to combine investment and infrastructure into partnerships that can be beneficial to this new initiative,” says Hassan El Khatib, managing director, equity, at the EBRD.

Azerbaijan's sovereign wealth fund, Sofaz, joined Safe as the second cornerstone investor in the EBRD fund, with a contribution of €100m. Rovshan Javadov, director at Sofaz’s investment department, says private equity is the best way to capture growth potential in emerging markets as the public markets are not as developed.

Sofaz is not new to collaborations with multilateral companies, as it has partnered with the IFC on two equity funds in the past. In addition to helping develop emerging markets’ private sectors, these partnerships offer attractive returns, says Mr Javadov. This is crucial as Sofaz looks to loosen its investment guidelines, which limit debt investment only to investment-grade securities, to maximise yield. “Investing in developed markets, especially in currencies such as the euro, does not give you much return,” adds Mr Javadov.

Private investors’ historic debut

Significantly, in 2013 Safe pledged $3bn to the IFC for a syndicated loan programme, the managed co-lending portfolio programme (MCPP). In one-and-a-half years, $1.5bn was disbursed in 60 investments across the IFC’s portfolio in 30 different countries.

This collaboration is particularly significant because the IFC used it as a template to launch the MCPP Infra, a platform on which private institutional investors and the IFC co-invest in infrastructure loans in emerging markets. This structure is unprecedented, as until now infrastructure funds involving multilaterals and private institutional investors have mostly focused on private equity-style investment.

Georgina Baker, deputy treasurer and director of syndications at the IFC, says: “We came up with this forward fund methodology [for private investors] after Safe allocated $3bn in the IFC. It worked very well for our clients. We were able to get financing to them quicker and in a more effective way. So we wanted to try this with private investors too.”

The IFC wants to grow this new platform to $5bn, an unheard of volume for partnerships between multilaterals and private institutional investors focusing on infrastructure debt. Today, the IFC has a view on $2bn. It has officially signed on insurance company Allianz for $500m, while insurer AXA, Eastspring Investments (the Asian arm of pension fund Prudential) and a further investor that wants to remain anonymous will finalise contracts with commitments of $500m each and sign up by February 2017, when the platform goes live.

A new asset class?

Pundits believe the MCPP Infra is a historic partnership as it could deepen the infrastructure asset class in an unprecedented way, if not create a brand new asset class in emerging market infrastructure. Nasser Malik, head of global structured debt at Citi, says: “We are seeing a broadening and deepening of the asset class beyond the traditional universe of highly developed markets.”

The investors involved in the programme will set up vehicles that will be invested in infrastructure loans originated by the IFC and syndicated through the MCPP platform. Importantly, the terms and conditions faced by the IFC will also be applied to private investors. “We book assets on behalf of investors who come in exactly on the same terms as the IFC. They earn the same spread and they come in at the same tenor. Their money is our money – we look after it in the same way,” says the IFC’s Ms Baker.

Indeed, the platform’s equal footing treatment has attracted investors. “We participated because we invest pari passu in every single project. If we invest $10m, the IFC invests $10m,” says Andreas Gruber, chief investment officer at Allianz Investment Management. And Emmanuelle Nasse-Bridier, group chief credit officer at AXA, adds: “IFC involvement in the structure was important for us. It provides a clear alignment of interest and enables us to reach our risk-reward [expectations].”

What is more, MCPP Infra offers a net yield pick-up over similar infrastructure investments in developed markets of 250 to 350 basis points.

To make investors even more comfortable, the IFC and the Swedish International Development Co-operation Agency offered a first-loss tranche of up to 10% for each partner’s portfolio. “Credit enhancement is a key aspect of the partnership. It makes a basket of underlying deals that might not be investment grade attractive enough for us to get involved,” says Tony Adams, chief investment officer, infrastructure, at Eastspring Investments.

Reducing the risk

Investors were also happy with the IFC being responsible for originating all projects. Having a multilateral with strong experience in emerging market investment and large teams on the ground to originate these deals reduces risk. “If you talk about infrastructure loan investments, you talk about 20- to 25-year maturities. A lot can happen in 25 years. The risk is not zero, but collaborating with the IFC reduces the regulatory risk, which we like,” says Mr Gruber.

Signing up to the IFC’s MCPP Infra also gives investors access to a large pool of deals that would otherwise be time consuming and costly to originate independently. “The IFC is providing a gateway into markets where it is normally difficult to mobilise capital quickly across many deals. It is homogenising the asset class so that institutional investors, through a single programme, can get exposure to bespoke deals in different countries that have taken years to put together,” says Mr Adams.

This is crucial, as one of the issues with mobilising private capital for emerging market infrastructure is how investors categorise this type of investment. “There is a big pool of money that is interested in investing in emerging market infrastructure but institutional investors have their own way of bucketing funds that doesn’t suit this asset class. So it is huge that Prudential and Allianz have stepped up,” says Ms Baker of the two investors that spearheaded MCPP Infra.

Meanwhile, for AXA, collaborating with the IFC will also support the insurer’s expansion in new markets such as Africa. “There are strong growth perspectives in these markets and we have a societal role to play as well,” says Ms Nasse-Bridier. The IFC partnership will also help AXA achieve its own goal of investing €10bn in infrastructure by 2018.

Helping multilaterals

But these new collaborations are also beneficial to the multilaterals setting them up as they offer development banks fresh capital to address enormous financing gaps in emerging markets. Normally, the IFC can contribute only about one-quarter of the financing for an infrastructure project, but through its MCPP platforms, it can provide infrastructure loans in full. This means having a stronger role in projects and moving things ahead quicker, says Ms Baker.

In the case of the EBRD, its EPF is helping central and eastern Europe address a widening private equity gap. “It is remarkable to see an advanced region such as central Europe still have private equity lacking capital,” says Mr El Khatib. “The challenge of fundraising is creating a vacuum in local mid-sized companies – the growth engines in our region. These are the ones we are really after,” he adds.

Meanwhile, in Latin America, co-financing funds such as the one the IDB established with the PBOC are bridging the infrastructure gap. Public infrastructure investment in the region accounts for 2.5% of GDP on average, and the IDB believes the figure should be twice as large. “There is a huge financing and investment gap in infrastructure in the region, and we know that we cannot fill it alone. Any source of financing that follows our way of working in partnerships is more than welcome,” says the IDB’s Mr Bendersky.

Challenging set-up

While these new collaborations between institutional investors and multilaterals have enormous potential, setting them up can be complex. In the case of the IFC’s MCPP Infra, defining legal, regulatory and due diligence standards was no easy task. Finalising the framework took one-and-a-half years, which was longer than expected by the private investors involved.

“It has taken longer than expected to put the deal together. But we are confident that once our fund is up and running and the IFC is given the mandate, things will move very quickly,” says Eastspring’s Mr Adams.

“It is sometimes a challenge to combine the  constraints of both public and private institutions [regulations, objectives or time frame]. However, it is extremely important for us to co-invest with the IFC and have the opportunity to benefit from its unique know-how, local presence and sourcing capacity,” says Ms Nasse-Bridier.

To Mr Gruber it was essential to ensure both the IFC’s and Allianz’s return objectives were aligned. As a multilateral, the IFC is more focused on the developmental aspect of investments than an insurance company, which needs to guarantee returns to its policy-holders and shareholders. “We have to be a bit cautious that [the IFC] is not too socially oriented with its investments. We had many discussions and it convinced us it can combine both social and economic objectives,” says Mr Gruber.

Banks scale back

Yet these new partnerships are especially important now that commercial banks are scaling back their long-term lending, which has become more costly in capital terms under Basel III. “Banks have become very risk averse, which always means a reduction in tenor. It is much harder to bring banks into very long-term investments. Commercial banks’ appetite to co-invest in our projects is going down,” says the IFC’s Ms Baker.

Relying less on co-financers could even simplify matters in a debt restructuring scenario. “When restructuring debt for a struggling borrower, you need to ask banks if they agree, and sometimes they don't, which makes it an incredibly difficult process to manage. We can spend even six months negotiating a waiver,” says Ms Baker.

But according to Citi’s Mr Malik, this new trend does not replace commercial banks; it is complementary to them. “All being equal, banks today are still more comfortable with taking on risk than institutional investors. But institutional investors do have the ability of taking on long-term tenors that many banks no longer have the capacity to take,” he says.

Asian demand

The next step for multilaterals will be to get more private institutional investors involved in these new partnerships. But for now, only the larger, more sophisticated names in the sector are likely to be interested. “Some investors, still grappling with how to position infrastructure as an asset class within their allocation strategy, probably default to thinking of emerging market infrastructure just as general emerging market risk,” says Mr Malik.

Nonetheless, it seems likely that more partnerships similar to the IFC MCPP Infra are set to launch. Allianz, AXA and Eastspring have all been approached by other multilaterals, and demand for these schemes is particularly strong in Asia.

“Asian investors get the infrastructure story. They recognise the opportunity because they see booming infrastructure in their own countries. The story resonates with them. Some Asian countries have been suffering from a low interest rate environment and they are searching for yield,” says Mr Adams.

Japan is an example. More than two decades of deflation, low economic growth and today’s negative interest rates are limiting economic returns at home and the country's ageing population also means there is a large amount of pension money ready to be put to work.

Liberalising Solvency II

In the insurance space, relaxation of regulations could push more insurance companies to enter partnerships such as the IFC’s MCPP Infra. Under Solvency II, capital charges for infrastructure investment are particularly high as they are based on the potential volatility of the asset’s market price in addition to the maturity and rating of the investment.

Although regulators have cut the capital charge for infrastructure debt and equity, the current framework remains very conservative in terms of capital charge and approach, says Ms Nasse-Bridier. AXA is discussing this point with the regulators in the hope that regulation will loosen in the future.

A lack of data makes it hard for insurance companies to build their case for regulatory liberalisation, so if partnerships such as the one with the IFC are successful, they could help set a precedent.

It is hard to guess at what pace the emerging market infrastructure asset class will continue to deepen – a stronger US dollar, and potentially higher interest rates, might slow things down. But the innovation and potential of multilaterals’ new partnerships with public and private institutional investors is undeniable.

It will be interesting to see how US president-elect Donald Trump’s big infrastructure plans affect investment in developing countries. As Citi’s Mr Malik says: “Will this suddenly create a large amount of new infrastructure investment in the US and take dollars away from emerging markets? It’s still too early to say.” 

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