A few short years ago, all infrastructure finance in Russia came through the federal or regional government budgets. However, as roads, railways, airports, power and water distribution networks begin to creak under the weight of demand from an economy that has grown by an average of 7.5% over the past few years, the Russian authorities have undertaken a major overhaul of policy and legislation to bring the private sector on board.
“The infrastructure market in Russia needs $1000bn over the next 10 years – it is certainly not an opportunity that can be ignored,” says Oleg Pankratov, head of infrastructure capital at VTB Capital, the investment banking arm of Russia’s second largest commercial bank. To attract that kind of investment, the Russian government passed a federal law on concessions, drafted with advice from international law firms such as Freshfields, to create a framework for public-private partnerships (PPPs).
To provide a coherent partnership structure on the public side of the equation, the government also began the merger of three state development banks and export credit agencies in May 2007, under the aegis of Vnesheconombank, headed by Vladimir Dmitriev. As of September, Vnesheconombank had committed to investments worth about Rbs392bn ($15.4bn) in 69 projects.
The bank now has a specific mandate to operate on a non-competitive basis to commercial banks, helping co-finance projects that would not get off the ground without state participation. In practice, says Vnesheconombank deputy chairman Anatoly Ballo, that remit means a particular focus on loans with maturities of at least five years, and sizes of Rbs2bn upwards, with the private sector to match each rouble from Vnesheconombank with three to four roubles of their own.
It also means rouble-denominated loans, which are vital for projects that will earn revenues in local currency. “It is much easier to arrange long-term financing on international markets in international currencies. Here, we don’t have so many sources of long-term financing in roubles, from local insurance or pension funds,” says Mr Ballo.
Russian lenders have also tended to prefer working with fixed rather than floating rates, due to their inexperience in risk-managing interest rate volatility on loan books. Mr Ballo says Vnesheconombank is helping find ways to offer repayment structures that more closely match the expected revenues and liquidity of infrastructure projects.
“We are using refinancing schemes where we provide a fixed rate for five years, with an amortisation schedule of 10 years or more. After five years, the borrower has the option to repay in full or to refinance at the prevailing rate for another five years, so we have a formula for a floating rate,” he explains.
Rouble financing
Mr Pankratov emphasises that financing – even in roubles – is increasingly available from the private sector. “The other large banks alongside VTB, Sberbank and Gazprombank, are capable of providing large amounts of rouble financing, but there is a big gap to the fourth-largest bank and so on, so they would have to write smaller tickets,” he says. The gap between the top three and other Russian banks was well demonstrated in September 2008, when investment bank KIT Finance was unable to meet margin calls on its repo loans after sharp falls in the stock market, and had to be bought out by Leader Asset Management, which is itself part-owned by Gazprombank.
This means foreign banks will need to fill the gap, and Australia’s Macquarie Bank last year set up a joint venture investment fund with Renaissance Capital. Vnesheconombank has agreed to invest around $200m in the fund, which is aiming for an initial size of $1bn to $1.5bn.
However, bankers note that there is some uncertainty over how the legal framework for concessions will operate in practice. “There are some legal limitations, for instance the arrangement for lenders to take charges over fixed assets, which is a cumbersome procedure,” says Mr Ballo. But he adds that the government has shown great willingness to respond to such concerns, and is confident that private sector involvement will grow rapidly once landmark transactions set a precedent for success.
Municipal development
Russia will not have long to wait for such landmarks. Individual local governments have drafted their own legislation to complement the federal law, and Mr Pankratov says the St Petersburg administration is leading the field. In this context, the city accounts for many of the PPP tenders in the first wave, including the High Speed Western Diameter motorway linking the city to Scandinavia, for which the bidding process was completed in June.
VTB is a part of consortia bidding for two other tenders that have yet to be awarded, to build the Nadex light rail system in St Petersburg and refurbish the city’s Pulkovo airport. “We are principal investors in infrastructure, and we are also an adviser to the consortia and can provide financial products such as interest rate and FX hedging, as well as non-recourse funding,” says Mr Pankratov. The bank was already involved in the construction of a third terminal at Moscow Sheremetyevo airport (alongside Vnesheconombank) as both a lender and an equity partner.
As Mr Ballo points out, there are also many opportunities for less capital-intensive investment banking activities that Vnesheconombank does not provide, such as cashflow servicing, mergers and acquisitions and initial public offering (IPO) transactions. The midsized and smaller private banks are beginning to seize those opportunities. KIT Finance and IFC Metropol both made important breakthroughs thanks to their involvement in the power sector unbundling that was completed in July 2008, and KIT is now an advisor to the government on the Moscow-St Petersburg highway PPP.
Power generation
Several of the successor companies, known as OGKs, to the former state power monopoly RAO UES have retained the two banks to help raise the funds necessary to meet their obligations for increased power output. “Some of the OGKs [generators] realise that, given high inflation in construction prices, their IPOs or new cash injections are no longer enough to cover costs, even with planned higher leverage, so they are considering secondary offerings, other strategic investors, or exchanging assets,” says Elnur Kurbanov, director of corporate finance at KIT. His bank is currently advising hydroelectric generator Hydro OGK (Rus Hydro), as well as helping the federal grid company FSK arrange financing to build distribution capacity.
KIT and Metropol are also both advising the sprawling state-owned Russian Railways. Mr Kurbanov believes the authorities may consider following a similar unbundling model to RAO UES, to capitalise the rail investment programme and increase efficiency. “The railroad would be the equivalent of the federal electricity grid, and they are already trying to isolate and sell other pieces such as cargo companies – the passenger transportation companies are less profitable at this point,” says Mr Kurbanov.
For Mr Ballo, work on the Russian railway network is a critical part of pushing investment from the commercial hubs in Moscow and St Petersburg out to some of the less developed regions. He notes that only 1% of trade between Europe and Asia currently transits through Russia, indicating an obvious growth opportunity for the economy.
The supervisory board of Vnesheconombank has approved the opening of three representative offices, at Khabarovsk in the Far East, Krasnoyarsk in Siberia and Pyatigorsk in the north Caucasus region, and projects in the regions are beginning to take off. The bank is investing in an airport expansion in the western exclave of Kaliningrad, and one of the most recent investments approved is for $750m in a $1.375bn project at Krasnaya Polyana in the Caucasus, to build an alpine ski resort in preparation for hosting the Winter Olympics in 2014.
