Date post: | 02-Jun-2018 |
Category: |
Documents |
Upload: | purav-shah |
View: | 225 times |
Download: | 0 times |
of 45
8/11/2019 Global Infrastructure and Project Finance Outlook
1/45
Management of Financial Services
Infrastructure and Project Finance
A GLOBAL OUTLOOK
Term paper submitted in partial fulfillment of assessment in the subject of
Management of Financial Services
Submitted by: Submitted to:
Purav Shah Prof. Rituparna DasRoll No. 963 Assistant Dean,
B.B.A. LL.B. (Hons.) Faculty of Policy Science
8/11/2019 Global Infrastructure and Project Finance Outlook
2/45
TABLE OF CONTENTS
TABLE OF CONTENTS ............................................................................................... 2
ACKNOWLEDGMENT................................................................................................ 3
INTRODUCTION TO PROJECT FINANCE ............................................................... 4
BASIC SCHEME OF PROJECT FINANCE ................................................................ 5
COMPLICATING FACTORS UNDER THE SCHEME.............................................. 7
CREDIT RISK IN PROJECT FINANCE...................................................................... 8
RECENT DEVELOPMENTS IN THE PROJECT FINANCE MARKET ................. 10
THE KEY CHARACTERISTICS OF PROJECT FINANCING STRUCTURES ..... 12
GROWTH OF PROJECT FINANCE FROM THE CAPITAL MARKETS............... 15
FUNDING IN INRASTRUCTURE FINANCE .......................................................... 16
WHAT IS SPECIAL ABOUT INFRASTRUCTURE FINANCING? ........................ 18
GLOBAL INFRASTRUCTURE SPENDING ............................................................ 26
INFRASTRUCTURE FINANCING AROUND THE GLOBE .................................. 28
GLOBAL FINANCIAL CRISIS AND THE RECOVERY IN 2013 .......................... 40
CONCLUSION ............................................................................................................ 44
8/11/2019 Global Infrastructure and Project Finance Outlook
3/45
ACKNOWLEDGMENT
The note of acknowledgment is an indispensable part of the paper. The author would
like to give due credit to the people who have helped him through the course of this
project.
The author would like to thank the faculty of Management of Financial Services,
Prof. Rituparna Das for allotting him the very engaging and fascinating topic of
Infrastructure and Project Finance: A Global Outlook. The author would like to
extend his heartfelt gratitude to him for his pedagogy, which has been instrumental in
enhancing the authors learning.
The author would also like to thank the library staff which has been of immense help
to him in his research work.
8/11/2019 Global Infrastructure and Project Finance Outlook
4/45
INTRODUCTION TO PROJECT FINANCE
Project finance is the long-term financing of infrastructure and industrial projects
based upon the projected cash flows of the project rather than the balance sheets of its
sponsors. Usually, a project financing structure involves a number of equity investors,
known as sponsors, as well as a syndicate of banks or other lending institutions that
provide loans to the operation. They are most commonly non-recourse loans, which
are secured by the project assets and paid entirely from project cash flow, rather than
from the general assets or creditworthiness of the project sponsors, a decision in part
supported by financial modeling. The financing is typically secured by all of the
project assets, including the revenue-producing contracts. Project lenders are given a
lien on all of these assets and are able to assume control of a project if the project
company has difficulties complying with the loan terms.
Generally, a special purpose entity is created for each project, thereby shielding other
assets owned by a project sponsor from the detrimental effects of a project failure. As
a special purpose entity, the project company has no assets other than the project.
Capital contribution commitments by the owners of the project company are
sometimes necessary to ensure that the project is financially sound or to assure the
lenders of the sponsors commitment. Project finance is often more complicated than
alternative financing methods. Traditionally, project financing has been most
commonly used in the extractive (mining), transportation, telecommunications
industries as well as sports and entertainment venues.
Risk identification and allocation is a key component of project finance. A project
may be subject to a number of technical, environmental, economic and political risks,
particularly in developing countries and emerging markets. Financial institutions and
project sponsors may conclude that the risks inherent in project development and
operation are unacceptable. Several long-term contracts such as construction, supply,
off-take and concession agreements, along with a variety of joint-ownership structures
are used to align incentives and deter opportunistic behaviour by any party involved
in the project. The patterns of implementation are sometimes referred to as "project
delivery methods." The financing of these projects must be distributed among
multiple parties, so as to distribute the risk associated with the project while
simultaneously ensuring profits for each party involved.
8/11/2019 Global Infrastructure and Project Finance Outlook
5/45
A riskier or more expensive project may require limited recourse financing secured by
a surety from sponsors. A complex project finance structure may incorporate
corporate finance, securitization, options (derivatives), insurance provisions or other
types of collateral enhancement to mitigate unallocated risk.
BASIC SCHEME OF PROJECT FINANCE
Suppose Acme Coal Co. imports coal and Energen Inc. supplies energy to consumers.
The two companies agree to build a power plant to accomplish their respective goals.
Typically, the first step would be to sign a memorandum of understanding to set out
the intentions of the two parties. This would be followed by an agreement to form a
joint venture.
Acme Coal and Energen form an SPC (Special Purpose Corporation) called Power
Holdings Inc. and divide the shares between them according to their contributions.
Acme Coal, being more established, contributes more capital and takes 70% of the
shares. Energen is a smaller company and takes the remaining 30%. The new
company has no assets.
Power Holdings then signs a construction contract with Acme Construction to build a
power plant. Acme Construction is an affiliate of Acme Coal and the only company
8/11/2019 Global Infrastructure and Project Finance Outlook
6/45
with the know-how to construct a power plant in accordance with Acme's delivery
specification.
A power plant can cost hundreds of millions of dollars. To pay Acme Construction,
Power Holdings receives financing from a development bank and a commercial bank.
These banks provide a guarantee to Acme Construction's financier that the company
can pay for the completion of construction. Payment for construction is generally paid
as such: 10% up front, 10% midway through construction, 10% shortly before
completion, and 70% upon transfer of title to Power Holdings, which becomes the
owner of the power plant.
Acme Coal and Energen form Power Manage Inc., another SPC, to manage the
facility. The ultimate purpose of the two SPCs (Power Holding and Power Manage) is
primarily to protect Acme Coal and Energen. If a disaster happens at the plant,
prospective plaintiffs cannot sue Acme Coal or Energen and target their assets
because neither company owns or operates the plant.
A Sale and Purchase Agreement (SPA) between Power Manage and Acme Coal
supplies raw materials to the power plant. Electricity is then delivered to Energen
using a wholesale delivery contract. The cash flow of both Acme Coal and Energen
from this transaction will be used to repay the financiers.
8/11/2019 Global Infrastructure and Project Finance Outlook
7/45
COMPLICATING FACTORS UNDER THE SCHEME
The above is a simple explanation which does not cover the mining, shipping, and
delivery contracts involved in importing the coal (which in itself could be more
complex than the financing scheme), nor the contracts for delivering the power to
consumers. In developing countries, it is not unusual for one or more government
entities to be the primary consumers of the project, undertaking the "last mile
distribution" to the consuming population. The relevant purchase agreements between
the government agencies and the project may contain clauses guaranteeing a
minimum offtake and thereby guarantee a certain level of revenues. In other sectors
including road transportation, the government may toll the roads and collect the
revenues, while providing a guaranteed annual sum (along with clearly specified
upside and downside conditions) to the project. This serves to minimise or eliminate
the risks associated with traffic demand for the project investors and the lenders.
8/11/2019 Global Infrastructure and Project Finance Outlook
8/45
Minority owners of a project may wish to use "off-balance-sheet" financing, in which
they disclose their participation in the project as an investment, and excludes the debt
from financial statements by disclosing it as a footnote related to the investment. In
the United States, this eligibility is determined by the Financial Accounting Standards
Board. Many projects in developing countries must also be covered with war risk
insurance, which covers acts of hostile attack, derelict mines and torpedoes, and civil
unrest which are not generally included in "standard" insurance policies. Today, some
altered policies that include terrorism are called Terrorism Insurance or Political Risk
Insurance. In many cases, an outside insurer will issue a performance bond to
guarantee timely completion of the project by the contractor.
Publicly funded projects may also use additional financing methods such as tax
increment financing or Private Finance Initiative (PFI). Such projects are often
governed by a Capital Improvement Plan which adds certain auditing capabilities and
restrictions to the process.
Project financing in transitional and emerging market countries are particularly risky
because of cross-border issues such as political, currency and legal system risks.[3]
Therefore, mostly requires active facilitation by the government.
CREDIT RISK IN PROJECT FINANCE
For decades, project finance has been the preferred form of financing for large- scale
infrastructure projects worldwide. Several studies have emphasized its critical
importance, especially for emerging economies, focusing on the link between
infrastructure investment and economic growth. Over the last few years, however,
episodes of financial turmoil in emerging markets, the difficulties encountered by the
telecommunications and energy sectors and the financial failure of several high-
profile projectshave led many to rethink the risks involved in project financing.
The question whether longer maturities are a source of risk per se is crucial to
understanding the distinctive nature of credit risk in project finance. Large- scale
capital-intensive projects usually require substantial investments up front and only
generate revenues to cover their costs in the long term. Therefore, matching the time
8/11/2019 Global Infrastructure and Project Finance Outlook
9/45
profile of debt service and project revenue cash flows implies that on average project
finance loans have much longer maturities than other syndicated loans.
This special feature argues that a number of key characteristics of project finance,
including high leverage and non-recourse debt, have direct implications for the term
structure of credit risk for this asset class. In particular, a comparative econometric
analysis of ex ante credit spreads in the international syndicated loan market suggests
that longer-maturity project finance loans are not necessarily perceived by lenders as
riskier compared to shorter-term credits. This contrasts with other forms of debt,
where credit risk is found to increase with maturity, ceteris paribus.
Financing high-profile infrastructure projects not only requires lenders to commit for
long maturities, but also makes them particularly exposed to the risk of political
interference by host governments. Therefore, project lenders are making increasing
use of political risk guarantees, especially in emerging economies. This special
feature also provides a cross-country assessment of the role of guarantees against
political risk and finds that commercial lenders are more likely to commit for longer
maturities in emerging economies if they obtain explicit or implicit guarantees from
multilateral development banks or export credit agencies. This is shown to further
reduce project finance spreads observed at the long end of the maturity spectrum.
After a review of the history and growth of project finance, we need to the specific
challenges involved in financing large-scale capital-intensive projects, while the third
section explains how project finance structures are designed to best address those
risks. An analysis shows how the particular characteristics of credit risk in project
finance are consistent with the hump-shaped term structure of loan spreads observed
ex ante for this asset class.
8/11/2019 Global Infrastructure and Project Finance Outlook
10/45
RECENT DEVELOPMENTS IN THE PROJECT FINANCE MARKET
Project finance involves a public or private sector sponsor investing in a single-
purpose asset through a legally independent entity. It typically relies on non- recourse
debt, for which repayment depends primarily on the cash flows generated by the asset
being financed.
Since the 1990s, project finance has become an increasingly diversified business
worldwide. Its geographical and sectoral reach has grown considerably, following
widespread privatization and deregulation of key industrial sectors around the world.
In the years following the East Asian crisis (199899), financial turmoil in emerging
markets led to a global reallocation of investors portfolios from developing to
industrialized countries. New investments, notably in north America and western
Europe, more than offset the capital flight from emerging economies, such that total
global lending for project finance rebounded from a two-year slump, reaching a
record high in 2000 (Graph 1).
8/11/2019 Global Infrastructure and Project Finance Outlook
11/45
Since 2001, the general economic slowdown and industry-specific risks in the
telecoms and power sectors have led to a substantial decline in project finance lending
worldwide (Graph 2). The power sector has been particularly hurt by accounting
irregularities and high volatility in energy prices: the debt ratings of 10 of the leading
power companies fell from an average of BBB+ in 2001 to B in 2003. Telecoms
firms have been penalized for sustaining onerous investments in new technologies
(like fibre-optic transmission or third-generation mobile licenses in Europe) that have
not yet generated the expected returns. Over 60 telecoms companies filed for
bankruptcy between 2001 and 2002 as overcapacity led to price wars and customer
volumes failed to live up to overoptimistic projections.
Despite the recent downturn, the long-term need for infrastructure financing in both
industrialized and developing countries remains very high. In the United States alone,
between 1,300 and 1,900 new electricity generating plants need to be built in order to
meet growing demand over the next two decades.
8/11/2019 Global Infrastructure and Project Finance Outlook
12/45
THE KEY CHARACTERISTICS OF PROJECT FINANCING STRUCTURES
In project finance, several long-term contracts such as construction, supply, off-take
and concession agreements, along with a variety of joint-ownership structures, are
used to align incentives and deter opportunistic behaviour by any party involved in
the project. The project company operates at the center of an extensive network of
contractual relationships, which attempt to allocate a variety of project risks to those
parties best suited to appraise and control them: for example, construction risk is
borne by the contractor and the risk of insufficient demand for the project output by
the off-taker (Graph 3).
Project finance aims to strike a balance between the need for sharing the risk of
sizeable investments among multiple investors and, at the same time, the importance
of effectively monitoring managerial actions and ensuring a coordinated effort by all
project-related parties.
Large-scale projects might be too big for any single company to finance on its own.
On the other hand, widely fragmented equity or debt financing in the capital markets
would help to diversify risks among a larger investors base, but might make itdifficult to control managerial discretion in the allocation of free cash flows, avoiding
8/11/2019 Global Infrastructure and Project Finance Outlook
13/45
wasteful expenditures. In project finance, instead, equity is held by a small number of
sponsorsand debt is usually provided by a syndicate of a limited number of banks.
Concentrated debt and equity ownership enhances project monitoring by capital
providers and makes it easier to enforce project- specific governance rules for the
purpose of avoiding conflicts of interest or sub- optimal investments.
The use of non-recourse debt in project finance further contributes to limiting
managerial discretion by tying project revenues to large debt repayments, which
reduces the amount of free cash flows.
Moreover, non-recourse debt and separate incorporation of the project company make
it possible to achieve much higher leverage ratios than sponsors could otherwise
sustain on their own balance sheets. In fact, despite some variability across sectors,
the mean and median debt-to-total capitalization ratios for all project-financed
investments in the 1990s were around 70%. Non- recourse debt can generally be
deconsolidated, and therefore does not increase the sponsors on-balance sheet
leverage or cost of funding. From the perspective of the sponsors, non-recourse debt
can also reduce the potential for risk contamination. In fact, even if the project were to
fail, this would not jeopardize the financial integrity of the sponsors core businesses.
One drawback of non-recourse debt, however, is that it exposes lenders to project-
specific risks that are difficult to diversify. In order to cope with the asset specificity
of credit risk in project finance, lenders are making increasing use of innovative risk-
sharing structures, alternative sources of credit protection and new capital market
instruments to broaden the investors base.
Hybrid structures between project and corporate finance are being developed, where
lenders do not have recourse to the sponsors, but the idiosyncratic risks specific to
individual projects are diversified away by financing a portfolio of assets as opposed
to single ventures. Public-private partnerships are becoming more and more common
as hybrid structures, with private financiers taking on construction and operating risks
while host governments cover market risks.
There is also increasing interest in various forms of credit protection. These include
explicit or implicit political risk guarantees,6 credit derivatives and new insuranceproducts against macroeconomic risks such as currency devaluations. Likewise, the
8/11/2019 Global Infrastructure and Project Finance Outlook
14/45
use of real options in project finance has been growing across various industries.7
Examples include: refineries changing the mix of outputs among heating oil, diesel,
unleaded gasoline and petrochemicals depending on their individual sale prices; real
estate developers focusing on multipurpose buildings that can be easily reconfigured
to benefit from changes in real estate prices.
Finally, in order to share the risk of project financing among a larger pool of
participants, banks have recently started to securitize project loans, thereby creating a
new asset class for institutional investors. Collateralized debt obligations as well as
open-ended funds have been launched to attract higher liquidity to project finance.
8/11/2019 Global Infrastructure and Project Finance Outlook
15/45
GROWTH OF PROJECT FINANCE FROM THE CAPITAL MARKETS
The notion that new financiers dominate infrastructure project finance is
misleading. Actually, 70 to 80 percent of all project finance deals are still funded by
commercial banks, although rated deals funded through capital markets are
increasingly being used as a substitute. The difference is that the rating agencies
conduct due diligence and debt is priced according to the rating assigned to the
transaction, which is said to measure levels of risk.
The first rating for a public project finance transaction was for a co-gen power plant
in Michigan and did not take place until 1991. The first cross-border, non-United
States transaction rating did not occur until 1994. So, the history is relatively short,
and project finance, as a financing tool or methodology is still in its infancy when
compared to corporate finance (in general) or public finance in the United States. The
industry remains in a state of flux, evolving as different players enter the market
bringing with them the methods used, for example, in municipal and public sector
finance, corporate finance, and structured finance.
There are several key trends in the evolution of project finance from the capital
markets. In terms of regional activity for rated project finance transactions,
approximately half of rated transactions between 1994 and 2006 took place in the
United States, although the use of this type of instrument is growing in Europe, Latin
America and the Middle East. Most project ratings tend to fall in the lowest
investment grade category (Baa3) with a persistent spike at the highest (AAA) level.
These transactions involve a monoline insurance guarantee. Rating methodologies for
target sectors are gradually evolving. Initially, rated deals were mostly for power
projects, but today toll roads are also being financed via the international capital
markets.
Growth in the rated project finance market can be explained by a combination of key
factors, some of which are focused on the capital markets. For example, interest rates
since 2002 have been significantly lower on average than the preceding fifteen years.
Not too many years ago, when toll roads were first rated in Chile, interest rates ranged
between 8 and 10 percent. However, a transaction in Chile was recently rated under 4
percent. In addition, liquidity in most markets has been quite high, increasing
8/11/2019 Global Infrastructure and Project Finance Outlook
16/45
financings via the capital markets. The yield and profitability of project finance is
currently higher than municipal and corporate finance. The interest in project finance
is also fuelled by the perception that infrastructure and project finance focus on
essential long term valued assets that provide stable cash flows. The globalization of
industry is also a factor in its growth because it brings more players into certain
markets, such as monoline insurance companies. The willingness of AAA-rated
monoline insurance companies to insure these transactions encourages investors.
Identifying risks is critical to the development of this market. However, the only way
that risks can be identified is if there is greater transparency; that is, if there are more
frequent flows of information on the financial and operating performance of the
assets. The benefit of financing projects through the capital markets as opposed to
commercial banks is that the rating process tends to force sponsors to provide
information that is consistent and comparable. Over time, as project financing through
the capital markets matures, it should lead to increased transparency for the entire
project finance industry, and lead to increased investment.
FUNDING IN INRASTRUCTURE FINANCE
8/11/2019 Global Infrastructure and Project Finance Outlook
17/45
It was not so long ago that infrastructure investment in India was financed almost
entirely by the public sector from government budgetary allocations and internal
resources of public sector infrastructure companies. In the span of 10 years, and
particularly in the past four, the private sector has emerged as a significant player in
bringing in investment (see Figure 1) and building and operating infrastructure assets
from roads to ports and airports and to network industries such as telecom and power.
Private investment now constitutes almost 20 per cent of infrastructure investment'.
Yet, total infrastructure investment remains low, at around 5 per cent of GDP. In
contrast, China spent an estimated 14.4 per cent of GDP on infrastructure investment
in 2006 and, contrary to popular perception, with little dependence on the state
budget. The Government of India aims to raise infrastructure investment to over 9 per
cent of GDP by the end of the 11th Five-Year Plan (2007-12), or an average of 7.4 per
cent of GDP a year during the plan, and projects a rise in the share of the private
sector to 30 per cent.
It is conceivable that the public sector can develop world-class infrastructure of the
magnitude envisaged as China and other countries have shown. But India has
embarked on a model that includes private participation in infrastructure. The
government recognises that public savings are not sufficient and also that the public
sector, given its limited implementation capacity, cannot meet the huge infrastructure
requirements to underpin economic growth of 9 per cent per annum. Moreover, the
private sector brings greater efficiency in service delivery. To attract the private
sector, the government has been putting in place the appropriate regulatory and
institutional frameworks. At present, private investment in infrastructure is barely 1
per cent of GDP and most of the investments are in greenfield projects in telecom and
energy, with concessions mainly in transport (Figure 2). Clearly, there is considerable
scope to increase this. Countries which had impressive private investment in
infrastructure in the 1990s had levels ranging from 4 to 6 per cent of GDP. Besides
purely private projects, the government aims to catalyse private investment through
public-private partnerships (PPP); the 11th Plan envisaged private infrastructure
investment to rise to 2.8 per cent of GDP by 2012. Private investment is expected to
constitute more than 65 per cent of investment in telecom, ports and airports, 26
percent in power and 36% in roads.
8/11/2019 Global Infrastructure and Project Finance Outlook
18/45
If we set aside institutional and governance issues and focus on financial aspects, the
problem may not seem insurmountable abstracting from the current financial
turmoil, which is temporary. After all, India has a high domestic savings rate which,
at almost 35 per cent of GDP (in 2006-07), compares well with that of East Asian
countries. Savings of the corporate sector have been rising steadily and were almost 8
per cent of GDP in 2006-07, while public savings also contributed, rising to over 3
per cent of GDP (from negative savings until 2002-03). What is of relevance, though,
is that of the total household sector savings of around 23-24 per cent of GDP, less
than half are in financial assets and more than half of the financial savings are in bank
deposits, leaving a limited portion in other financial instruments. Contractual savings
those that are in long-term financial instruments are just around 4 per cent of GDP
(Table 1). Thus, the issue is not the lack of domestic savings or even of foreign
capital, but that of financial intermediation, that is, how to channel long-term savings
into infrastructure.
WHAT IS SPECIAL ABOUT INFRASTRUCTURE FINANCING?
Building infrastructure is a capital-intensive process, with large initial costs and low
operating costs. It requires long-term finance as the gestation period for such projects
is often much longer than, say, for a manufacturing plant. Infrastructure projects are
characterised by non-recourse or limited recourse financing, that is, lenders can only
be repaid from the revenues generated by the project. Thus, the market and
commercial risks, including uncertainty of (traffic) demand forecasts, assume greater
significance for lenders. Besides the usual project risks, infrastructure development
has other unique risks because of the public interest nature of most projects and the
interface with regulators and government agencies. These risks could include tariff
increase reversals due to public unacceptability of the tariffs determined, challenging
of environmental clearances, arbitrary reneging of contracts and non-payment by
(financially weak) monopoly public utilities.
As a result, complex risk mitigation and allocation arrangements are embedded in the
financial and contractual agreements amongst multiple partiesproject sponsors,
commercial banks, domestic and international financial institutions, and government
agencies. And infrastructure projects have significant externalitieswhere the social
8/11/2019 Global Infrastructure and Project Finance Outlook
19/45
returns exceed the private returns which call for some form of subsidization, such
as government guarantees or viability gap funding to make them attractive for private
sector involvement.
Infrastructure projects are generally executed through individual project companies
called special purpose vehicles (SPV). The main reason for this is to better protect the
parent company from possible adverse impact in the concession business. Separate
SPV projects are then held by the parent company or its subsidiary in a holding
company structure. SPVs typically do not have recourse to their parent companies
after the initial capitalization, nor do they have a credit history and strong balance
sheets. This naturally affects their ability to secure financing from outside.
Thus, infrastructure financing presents a number of challenges. The scale of
investment is large and investors have to be prepared for a long horizon for debt
repayment and return on equity. Many financial institutions are limited in their ability
to invest in very long-term illiquid assets. The non-recourse nature, the unique risks of
infrastructure development as well as the complexity of the arrangements also call for
special appraisal skills. Since the output is non-tradable (with revenues accruing in
domestic currency), infrastructure projects should generally be domestically financed
to avoid high foreign exchange risk, although there are financial instruments to
mitigate such risks in well-developed financial markets..
As a country's financial system matures and becomes more sophisticated it is able to
respond to these challenges in flexible, innovative ways. It can bring a range of
investors at various stages of the project. Investors with the requisite skills and risk
appetite are needed to provide the initial financing, but should then be able to offload
the assets to other investors when the projects start yielding revenues, thus moving on
to invest in new projects. By this time, the major risks (especially construction risks)
have already been borne by the initial investors and the projects have a prospective
stable revenue stream. A different type of investor may come in at this stage, thus
widening the pool of investors that can be tapped and lowering the overall financing
cost of the project.
8/11/2019 Global Infrastructure and Project Finance Outlook
20/45
LIMITS TO EXISTING FINANCING SOURCES
DEBT FINANCING
Notwithstanding the difficulties, infrastructure financing has grown rapidly over the
past few years in tandem with the increase in private investment in infrastructure.
This is because of the pivotal role played by commercial banks, primarily a few key
public sector banks that have been willing to provide the project finance. Table 2
provides indicative estimates of debt financing. Commercial bank lending to
infrastructure took off four years ago, in 2004-05, followed by specialized non-bank
finance companies (NBFCs), which are largely dependent on bank funding, in 2005-
06. The insurance sector, dominated by the Life Insurance Corporation of India (LIC),
has also steadily increased its financing of infrastructure. Data on foreign borrowing
are hard to come by but a (gross) disbursement estimate for 2006-07 indicates that
external commercial borrowings (ECB) account for less than 20 per cent of the total
debt finance to infrastructure. These are positive trends, no doubt. But the Planning
Commission's estimate of total debt needs for infrastructure investment during the
11th Plan-Rs. 984,500 crores (at 2006-07 constant prices) implies, on average, 2.5
times increase in the annual amount from Rs. 80,000-plus crores in 2006-07. After
projecting that the traditional sources of finance can expand to Rs. 825,500 crores, the
Planning Commission estimates a gap of Rs. 159,000 crores. Realising the overall
debt target is a huge challenge given the constraints to growth in each of the sources
of debt finance.
8/11/2019 Global Infrastructure and Project Finance Outlook
21/45
Commercial banks have driven the increase in infrastructure finance, both direct and
indirect. The first year of the plan (2007-08) recorded high growth but a continued
rapid expansion of such finance may not be sustainable as it is leading to a growing
concentration of risks on banks' balance sheets. These risks arise from the maturity
mismatch created by financing long duration infrastructure projects from the
essentially short-term nature of banks' liabilities. Within six years, between March
2002 and March 2008, total bank lending to infrastructure trebled from 3.1 per cent oftotal non-food gross bank credit outstanding to 9.2 per cent. The growing asset-
liability maturity mismatch on account of infrastructure has been exacerbated by a
concurrent rise in other long-term assets, in particular housing loans. Together, these
long-term assets now account for 21 per cent of total non-food bank credit (see Figure
3). In fact, the exposure of banks to infrastructure and housing is actually higher as
banks lend to NBFCs who on-lend to these sectors.
8/11/2019 Global Infrastructure and Project Finance Outlook
22/45
If we assume that non-food bank credit will grow at 20 per cent a year for the rest of
the Plan period, the Planning Commission's projections imply that bank lending to
infrastructure will account for about 13 per cent of total non-food bank credit by
2011-12. These are overall numbers; individual bank exposure would be significantly
higher for some, since many banks do not have the skills-set or balance-sheet size to
engage in infrastructure lending. Moreover, the share of housing loans in bank
portfolios is also likely to increase given the thrust on financing affordable housing.
Thus, the share of total long-term assets could very easily rise to above 30 per cent of
banks' non-food credit. The risks are higher on banks than evident in these numbers as
specialised NBFCs also rely on bank funding.
The increasing share of long-term assets comes at a time when the maturity of
deposits has been shortening, thus exacerbating the liquidity risk of financing long-term assets with short-term liabilities. Term deposits with maturity of three years and
above have declined from 32.9 per cent of total term deposits in March 2000 to 22.7
per cent by March 2007 (and only 7 per cent are at five years or more). Banks have
been dealing with this situation by relying on annual interest resets and put/call
options on the loans, thereby passing the market risks to the projects. However, if
projects are unable to bear all the risks, they could become a credit risk to banks. It
should be noted, though, that savings account deposits have been in the region of 24-
28 per cent of aggregate deposits for several years. Therefore, if we assume that 80
8/11/2019 Global Infrastructure and Project Finance Outlook
23/45
per cent of savings deposits are fairly stable and consider them along with term
deposits of maturity of three years and over, about 35 per cent of aggregate bank
deposits may be viewed as stable as of March 2007 (down from 40 per cent in March
2000). So, 35 per cent of total deposits (assuming that the share of long maturity term
deposits does not decline any further) would cover the projected 30 per cent of long-
term loans by 2011-12. However, it should be noted that the maturity period of the
loans is typically over 10 years and the bulk of the long-term deposits is in the three-
year original maturity period. In fact, only about 3 per cent of deposits have a five-
year or greater residual maturity as of March 2007.
Graph: Breakdown of Unlisted Infrastructure Debt Fund Universe by Primary
Geographic Focus
On its own, the maturity mismatch may not seem severe, but combined with other
vulnerabilities in the balance sheets of banks, it could lead to problems. Take, for
instance, the current situation. Banks had been lending at breakneck pace over the
past few years, with incremental credit-deposit ratios often of 90 per cent and over.
As a result, they had to borrow from non-bank sources. When the global credit crisis
broke out and domestic liquidity tightened due to capital outflows, the over-extended
8/11/2019 Global Infrastructure and Project Finance Outlook
24/45
banks had difficulties meeting their liabilities as short-term borrowing from the non-
bank sources dried up. And, as happens in times of crisis, the maturity structure of
bank liabilities shortens quicklyso if banks are vulnerable due to other factors, it
could lead to further stress in the banking system.
In addition, many banks are reaching exposure limits to infrastructure-related
borrowers (because of large project size relative to bank capital). Indian banks are
relatively small. Only 11 banks had equity above $1 billion in March 2007, of which
two were private sector banks. The largest bank, the State Bank of India, had just over
$7 billion of capital in March 2007. The next three public sector banks together would
be equivalent in capital strength to SBI. The total equity of the 82 scheduled
commercial banks (including 29 foreign banks) was $49.8 billion. Thus, there are
many small banks, most of which do not engage in infrastructure lending and the
handful of banks that are actively lending to infrastructure are likely to reach exposure
limits if they continue lending at this pace.
Specialised NBFCs have become a significant source of infrastructure finance but
their growth by their access to bank finance, in the absence of alternative wholesale
funding sources. Tighter prudential limits of bank lending to NBFCs have effectively
capped the latters access to bank lending funds. Even if there is some headroom on
bank exposure limits to NBFCs and bank resources are forthcoming, this would be at
a significantly high costs due to the incidence of a higher capital charge and
provisioning requirement on standard assets for bank lending to NBFCs. Moreover
banks are increasingly providing shorter tenor finance and have an annual reset in
interest rates, thereby passing the interest rates to the NBFCs.
8/11/2019 Global Infrastructure and Project Finance Outlook
25/45
Graph: Annual Infrastructure Debt fundraising (All Time)
EQUITY FINANCING
Supporting higher levels of debt requires more equity, with the amount varying with
the level of project risk. Equity is mainly provided by the project sponsor who, in
turn, may tap the primary market for capital. Infrastructure companies from IPO
raised substantial resources with the secondary market boom in recent years, peaking
in 2007-08 before drying up more recently due to the financial turmoil (see Table 3).
Clearly, developers have a limited amount of capital and have to tie it up for a
significant length of time for each project. It is therefore important to bring in
financial investors so that the promoters' risk capital can be recycled into other
projects. In recent years, financial investors have shown keen interest in India:
witness the number of private equity (PE) infrastructure funds formed6. However,
rules for sell-down of equity can be quite stringent and act as a deterrent to the entry
of more financial investors who would like greater flexibility in exit options.
Moreover, sales of unlisted projects, unlike listed investments, are subject to the full
weight of the capital gains tax. Since most infrastructure projects are unlisted, this
8/11/2019 Global Infrastructure and Project Finance Outlook
26/45
acts as a disincentive to equity investors in infrastructure. Also, equity investors
perceive termination payments for government agency defaults (for example, not
providing the right of way in road projects) to be inadequate in many concession
agreements. In some cases, the lenders are repaid whereas the equity holders suffer.
This encourages a greater use of debt.
The biggest constraint to the development of a strong domestic PE industry is the very
narrow base of domestic investors. Globally, PE firms rely on a mix of institutional
investors such as pension funds and insurance companies and contributions from high
net worth investors. In India, the ability of insurance firms and pension funds to
invest in alternative asset classes is still quite restricted and they will take some time
to take up this asset class.
GLOBAL INFRASTRUCTURE SPENDING
Infrastructure spending has begun to rebound from the global financial crisis and is
expected to grow significantly over the coming decade. That is the main finding of
Capital project and infrastructure spending after an in-depth analysis of 49 countries
that account for 90% of global economic output.
Chart: Investors Expected Capital Commitments to Infrastructure Funds in the
Next 12 Months Compared to the Last 12 Months
8/11/2019 Global Infrastructure and Project Finance Outlook
27/45
In developing this analysis, Oxford Economics used data sets to provide consistent,
reliable, and repeatable measures of projected capital project and infrastructure
spending globally as well as by country. Historical spending data is drawn from
government and multinational organization statistical sources. Projections are based
on proprietary economic models developed by Oxford Economics at the country and
sector levels. Worldwide, infrastructure spending will grow from $4 trillion per year
in 2012 to more than $9 trillion per year by 2025. Overall, close to $78 trillion is
expected to be spent globally between 2014 and 2025.
But the recovery will be uneven, with infrastructure spending in Western Europe not
reaching pre-crisis levels until at least 2018. Meanwhile, emerging markets,
unburdened by austerity or ailing banks, will see accelerated growth in infrastructure
spending, especially China and other countries in Asia.
And megacities in both emerging and developed marketsreflecting shifting
economic and demographic trendswill create enormous need for new infrastructure.
These paradigm shifts will leave a lasting, fundamental imprint on infrastructure
development for decades to come.
Graph: Amount of Fresh Capital Investors Plan to Invest in Infrastructure over
the Next 12 Months
8/11/2019 Global Infrastructure and Project Finance Outlook
28/45
8/11/2019 Global Infrastructure and Project Finance Outlook
29/45
Graph: Government fixed Investment in Infrastructure, % of GDP (CANADA)
Traditionally, infrastructure project finance in the United States has relied on
municipal bonds. However, infrastructure project bond activity has been growing with
programmes such as the Transportation Infrastructure Finance and Innovation Act
(TIFIA) and Private Activity Bonds (PAB). While TIFIA is a low cost federal
loan programme for up to 49% of the cost of PPP and conventional transport
infrastructure projects, it still requires the underlying project to be investment grade.
This requirement helps bring discipline/viability to the project selection and
development pipeline, and also mitigate the reputational risk inherent in such a high
profile programme. TIFIA has supported long tenors/average lives (including a 34
year loan on Virginia Midtown Tunnel, alongside a PAB) and pricing akin to
Treasuries. The governments position is subordinated until an event of default, at
which point it springs up. PABs are one way of making up the 51% not funded underTIFIA, but Green12 (as for TIFIA) only transport projects are eligible. In addition,
there is a ceiling on PABs of USD15bn at present. USD4bn has been issued and
another USD4bn is allocated to projects. As with municipal bonds in general, PABs
have tax advantages whereby the interest received is tax-exempt to the investor and
therefore the borrower can offer/pay a lower interest than would be the case. This is
effectively a tax allocation from the federal tax base to the municipality and the
infrastructure users. Outside of the transport sector, there is presently debate around
introducing a structure similar to TIFIA for potable water and wastewater projects
8/11/2019 Global Infrastructure and Project Finance Outlook
30/45
and, more generally, development of a loan and bond guarantee facility to states, local
governments and non-profit infrastructure providers in respect of transportation,
energy, water, communications and educational facility infrastructure projects. Lastly,
much of the markets growth potential lies in therenewables sector, which will
require about USD150 billion in new construction through to 2022. MidAmerican
Topaz one of the worlds largest photovoltaic solar farms raised USD850m in
privately issued 144A/Reg S 5.75% project bonds (due 2039) in February 2012, and
another USD250m in April 2012.
Graph: Government fixed Investment in Infrastructure, % of GDP (USA)
In Mexico, the central issue is insufficient pipeline as there is currently more funding
available than projects. The country has a sizable life insurance and pension industry
and government policies implemented in the mid and late 2000s increasinglyencourage funds to invest in infrastructure projects. Since roughly 2008, state-owned
Banobras has funded the relatively small number of projects, and subsequently
syndicated the debt. That said, as the project pipeline grows, it is unlikely that
Banobras will be able to meet rising demand and increasingly there are long-dated
project finance bonds. Notable recent issues included (in 2011) a MXN7.1bn
nonrecourse bond related to Sarre and Papagos prisons, the first fully commercially
financed greenfield social infra concession in Mexico. More recently, Banobras acted
as credit guarantor on the Red de Carreteras de Occidente concession sold to
8/11/2019 Global Infrastructure and Project Finance Outlook
31/45
domestic and foreign institutions for USD1.16bn in long-term, peso-denominated
notes to pay for the FARAC I toll road, and Mexico Generadora de Energia (MGE)
issued USD575m of long-dated BBB paperfor two gas turbines at T+388bps.
Brazil needs some USD50bn per year in infrastructure investment. As noted above,
the size of this pipeline is pressuring BNDES (funded by the federal government)
which has recently had very high lending levels. For example, in 2010 they disbursed
around BRL168.4bn.
In the rest of Latin America, as in Mexico, capital is generally available and the
problem is a lack of bankable projects. Chile is seen as a relevant model for the
region; it established a project bond market in 1999, and prior to the GFC institutional
investors were funding significant deal volumes in this fashion as much as 50% of
the total infrastructure pipeline. However, the retraction of monoline bond insurers
significantly impacted Chile, and the country has not seen any project bond issuances
since then.
The governments of several countries in the region, such as Argentina, Uruguayand
Peru consider pension funds as one of the key financing sources for enabling and
accelerating the execution of their current or future infrastructure programmes. This
policy choice resulted in a package of measures and tools (including political
pressure) to facilitate and stimulate pension fund involvement. For instance,
Columbia and Peru have recently made changes to their legal framework to spur
institutional investment into infrastructure. However, the lack of a pipeline has meant
that institutions have generally not had the business case to develop project finance
structures further. Recent issues in Peru include Terminales Portuarios Euroandinos
Paita which raised USD110m of long dated BB/BB- paperat c350bp over, and also
the Peru Hospital PPP (USD320m). The latter is a quasi-sovereign issue secured by
EsSalud. This issue also mitigates construction risk for investors through milestone
based issuance of EsSaluds obligations. In July 2011, Invepar issued PEN1.17bn in
inflation linked, private placement bonds to finance the 30-year Via Parque Rimac toll
road concession in Lima at VAC +650bp.
8/11/2019 Global Infrastructure and Project Finance Outlook
32/45
Graph: Global Infrastructure Spending by 2025
In the UK, after a long hiatus, the first half of 2013 has seen numerous greenfield (i.e.
with construction risk) project bond issuances in the university accommodation, social
housing and healthcare sectors. Notable issues in student accommodation include
Uliving@Hertfordshire (GBP143.5m of A- rated index-linked priced at 235bp over
index linked gilts) and University of Edinburgh which sold GBP31m each of
monoline-wrapped, index-linked and fixed rate tranches with spreads of 190bp and
215bp over gilts respectively. In social housing, the Leeds Little London and Holbeck
Housing PFI sold GBP102m of monoline-wrapped, fixed rate bonds at 235bp over
gilts. In addition, the Salford Pendleton Social Housing project issued senior fixed
rate bonds (at 190bp over gilts), supported by a subordinated tranche. In healthcare,
the Alder Hey Childrens hospital raised GBP110m via a private placement bond.
PwC advised on the Edinburgh, Leeds, Salford and Alder Hey transactions, giving us
unparalled insight into recent project bond issues.
The UK Treasury has also sponsored a cGBP40bn guarantee scheme. The scheme
was initially set up to provide credit enhancement to financiers where long-term
lending was expected to no longer be available. The significant decline in the volume
8/11/2019 Global Infrastructure and Project Finance Outlook
33/45
of infrastructure projects in the UK has meant that banks have so far been able to
finance most of the projects. The future use of the guarantee scheme is unclear, as
project activity declines and capital markets innovate to plug the bank gap. It is
possible that the guarantee will be targeted as projects that cannot be financed on a
stand-alone basis due to size or cost, hopefully without over exposing the tax payer to
project risk.
The Benelux countries (Belgium, Netherlands, and Luxembourg) and Germany
are very advanced in their application of project finance. Whilst traditionally bank
funded markets, there is active exploration of capital markets solutions. To date,
authorities procurement rules (particularly in the Netherlands) have required
committed finance and this does not sit easily with public bond book building
where the bond spread is only known just before the launch. As such, the market is
evolving more towards private placements (where investors have offered greater price
certainty) or bank to bond structures. Over the last 12 months, two out of three bids
on Dutch projects have included such structures. The N33 road in the Netherlands
features a EUR78m index- linked tranche which will partially take out (at a pre-
agreed price) the banks financing the transaction upon practical completion. In
addition, the EUR300m Zaanstad prison project in the Netherlands reached financial
close in September 2013. The hybrid structure includes an institutional investor
tranche alongside a subordinated, shorted dated senior bank tranche. PwC advised the
government on N33 and the consortium bidder on Zaanstad.
The A11 road in Belgium (currently at preferred bidder) is actively evaluating capital
markets solutions, either directly or via a bank to bond structure. In Germany, projects
considering the capital markets include the A7 road and UKSH hospital, and PwC is
advising bidders on both projects. In addition to the committed finance approach
described above, the Netherlands is expected to launch a preferred bidder debt
funding competition pilot project in the next 12 months. The rationale for this is to
increase the depth of competition in a constrained financing market.
In France, bank financing has been able to fund the pipeline of current projects thus
far. However, the market may be
at a tipping point, particularly given the recent
financial close of the Cit Musicale (July 2013) where the Dailly tranche of the debt
8/11/2019 Global Infrastructure and Project Finance Outlook
34/45
will be subscribedby an institutional investor who will refinance out the three banks
providing construction loans. Most institutional investors in France require relatively
high project credit ratings, which are often tough to achieve given construction risks
and other factors. On Cit Musicale, the investor coming in for the Dailly tranche post
completion means the credit risk they take is essentially local government rather than
project. However, institutional investors have demonstrated willingness to take
construction risk in the French market. For example, the Valence/Riom/ Lutterbach
Prison PPP closed in January 2013 with an insurer providing EUR100m of the debt
from financial close, and L2 Marseille bypass may also feature allocation of the
construction risk to the institutional investor.
Graph: Emerging markets account for half of global infrastructure spending
Arguably the recent developments of bond financing were possible only because the
bond investors became flexible on parameters that traditionally were deal- breakers
8/11/2019 Global Infrastructure and Project Finance Outlook
35/45
for this type of project, namely make-whole provisions and drawdown periods. PwC
advised the public sector on Cite Musicale and is currently advising the public sector
on L2.
Before the GFC, bank tenors in the Middle East were long. Most projects were
backed by government or government owned sponsors, making bank debt accessible
at relatively low cost. There have been some significant project bonds to date18, but
compliance costs associated with numerous securities laws and exchange listing have
discouraged some sponsors.
Post GFC, bank margins for 10+ year tenors remain high and tenors beyond 15 years
are a challenge. In response, some procuring authorities have relaxed committed
finance requirements, allowing the use of mini-perm financing to support bids.
However, large scale project finance in the Middle East now requires support from
external credit agencies, other forms of financing such as Islamic lending, and other
multilateral lending agencies which means the process is not as simple as it used to
be. Considerable guarantees and contractual commitments are required before such
financing can be secured, and these factors are increasing the attractiveness of project
bonds. In August 2013, Shuweihat 2 IWPP in Abu Dhabi became the first project to
be refinanced in the bond market with a USD825m A- rated 6% 2036 144a/Reg S
issue.
The depth of corporate bond markets varies considerably across Asia, making it
difficult to categorise the entire region. In particular, Malaysia has a vibrant bond
market which contributed approximately half of the countrys private infrastructure
investments between 1993 and 2006. The Malaysian government took some notable
steps to spur this market, including mandating the use of credit ratings for corporate
bonds as of 1992. In addition, the Republic of Korea has a substantial corporate bond
market which has previously financed infrastructure. Other regionally significant
corporate bond markets include China, Japan and Thailand. Export credit agencies
and multilaterals such as the Asian Development Bank are active in supporting
infrastructure finance, including through credit guarantee programmes. However, with
the exception of Malaysia, Singapore and the Republic of Korea, the OECD estimates
that total assets held by pension funds, life insurance companies and mutual funds are
8/11/2019 Global Infrastructure and Project Finance Outlook
36/45
small relative to GDP in East Asian economies. As such, in many Asian countries the
preconditions are not yet in place to support private project bonds.
Spains fiscal challenges are well - publicised, but a gas storage project (Castor) in
the country has recently given the EIB its first financial close using the PBCE
instrument. In addition to providing the PBCE facility (akin to a long term letter of
credit, ranking junior in order to credit enhance the senior bonds), the EIB also bought
EUR300m of the senior bonds. The project was a refinancing, meaning investors did
not take construction risk, and reached financial close in July 2013. The large size and
long tenor of the issue (EUR1.4bn, 21.5 year bonds) arguably favoured the public
bond route. The issue was rated BBB+ at launch22, one notch above Spains
sovereign rating of BBB. For investors requiring investment grade (i.e. BBB-), a
sovereign rating of BBB doesnt leave much room in the structure for project risks
hence the importance of PBCE or other credit enhancements. Without such
enhancement, investor appeal may be relatively narrow, suggesting that project bond
gearing levels and/or underlying risk may need to remain relatively low until Spains
sovereign rating improves.
Most Central and Eastern Europe (CEE) countries have virtually no market for
non-bank infrastructure project finance, and in some cases (particularly Russia)
project finance remains the preserve of state-owned lenders. Many countries have low
sovereign credit ratings, pension funds that are primarily state-sponsored, a lack of
well-prepared and recurrent infrastructure projects and political uncertainties which
lead to regulatory risks. While there has been significant improvement in putting the
right enabling legislation in place, much of it remains untested. In addition,
multilaterals such as the EIB and European Bank for Reconstruction and
Development (EBRD) provide significant amounts of infrastructure finance in the
region.
In some stronger CEE countries, particularly Poland, international banks are willing
to lend to domestic projects. Until recently, significant amounts of infrastructure have
been funded with EU structural resource and domestic public money at both the
central government and municipal levels. This has crowded out private finance. This
however may change as EU funding principles may become more commercially/debt
8/11/2019 Global Infrastructure and Project Finance Outlook
37/45
oriented and government budgets are stretched. The demand for new sources of
infrastructure finance may be potentially met by insurance companies, government
initiatives such as PIR (the Polish Development Investment Fund) and inflows from
international infrastructure funds that already have a foothold in the market (e.g.
power sector, sea logistics). Major infrastructure financing may also come from or
through large corporates, especially in the power and chemical sectors.
Graph: Infrastructure spending evolves with a regions economic growth
As a result, while CEE countries indicate that they are open to capital markets
financing for infrastructure, we dont anticipate that this market will take off until the
concept becomes more established in Western Europe. This may change if
governments force pension funds to invest a minimum proportion of their portfolios
into infrastructure
(i.e. mandatory minimum sector limits). Progress in individual
countries may vary as significantly as their relative macro- economic performance
does. In general, we expect the Polish corporate bond market to grow strongly.
8/11/2019 Global Infrastructure and Project Finance Outlook
38/45
However, from a project bond perspective, secondary markets are relatively immature
and issuers may find the liquidity premia required by investors unattractive.
Akfen and PSA in Turkey have recently launched a seven year bond refinancing
Mersin International Port. However, project bonds at a PPP level have a way to go
yet. There are relatively few domestic institutional investors and the corporate bond
market is not yet very deep. In addition, the post-termination debt assumption
agreements that apply to PPP transactions above a certain size cover bank (but not
bond) transactions.
As such, bond investors have less certainty of recovery in a default scenario than bank
lenders for the same project risk. The market remains very corporate and relationship
driven, and when sponsors do access the bond market they often do so decoupled
from specific projects. Turkey acknowledges the need to increase the average life of
its debt financing at a sovereign/quasi-sovereign level. Using long-tenor project bonds
to privately finance key infrastructure may be one way to deepen the market, but this
will be challenged by the lack of suitably long duration sovereign debt pricing
benchmarks.
In India, privately funded infrastructure is done via bank debt rather than bonds. The
largest global project finance lender for Thomson Reuters Project Finance
International is the government owned State Bank of India. The countrys 12th Five
Year Plan (which covers 2012 through 2017) considers that insurance and pension
funds will be a key source of infrastructure finance. Such funds have grown in the
past decade due to favourable demographic trends, but remain proportionately small.
Yet there is effectively no project bond market thus far. During the 11th plan, nearly
half of all infrastructure finance came from public-sector capital, and another third
came from commercial banks and non-bank finance companies (NBFCs).
Over the longer term, however, we do not think that banks will be sufficient to fund
the entire pipeline. The banking sector cannot lend more than 15% of their net worth
to a particular sector (and 25% to a particular group). However, bank credit to the
infrastructure sector has reached 13.5%. There are however numerous policy and
market structure challenges. Infrastructure companies are not frequent issuers in the
8/11/2019 Global Infrastructure and Project Finance Outlook
39/45
corporate bond market, investors are generally unable to fund infrastructure SPVs due
to their typical structure as unlisted private companies and investor rating
requirements can preclude widespread participation in infrastructure. There are two
broad options to overcome these challenges: one being to refinance out banks at stable
operations (although the banks have shown little inclination to exit, despite Basel III)
and the other to create an infrastructure debt fund for pension funds/insurers.
The second option is a challenge for greenfield projects as Indian institutions are
traditionally not comfortable with construction risk. While some overseas investors
may be more comfortable with this risk, Indias current international sovereign rating
of BBB- leaves little to no headroom for project risk, particularly for investors that
require investment grade. This suggests that domestic investors will need to get
comfortable with construction risk, BBB being the lowest category of investment
grade.
The first option is still challenged by the minimum rating requirements for pension
and insurance managers to invest (typically domestic AA or AAA), well below the
typical BB structured project. Traditionally there have been no credit wrappers to
bridge the ratings gap. However, the India Infrastructure Finance Corporation (IIFCL)
and the Asian Development Bank (ADB) have recently signed credit enhancement
documents for the GMR Jadcherla Expressway as a pilot project. The purpose of the
guarantee is to raise the rating to a point that the project can refinance in the bond
market when the bank facility matures or reaches a price reset point.
In Africa, many countries need to deepen sovereign and multilateral bond issuance as
a precursor to corporate and project issuance. Across most of the continent, reforms to
date have focused on getting sovereign bonds issued, often to finance infrastructure
development. Many sovereigns are not rated, and those with natural resource revenues
often need to set up a sinking fund committing future revenues to secure financing.
Nonetheless, 2012 and the first half of 2013 saw significant Eurobond issuances,
notably Ghana (USD750m 10 year bonds), Rwanda (USD400m 10 year bonds),
Zambia (USD750m 10 year bonds), Tanzania (USD500m seven year private
placement) and Angola (USD1bn 7 year private placement). Although local capital
markets are dominated by dollar bonds, in February 2013 IFC issued a five-year, local
8/11/2019 Global Infrastructure and Project Finance Outlook
40/45
currency NGN12bn denominated bond (cUSD75m) in Nigeriaas part of a program to
deepen the domestic bond market across Africa.
In September 2013, Kenya issued its sixth infrastructure bond for KES20bn
(cUSD230m). It is important that African issuers appeal to investors by focussing on
the basics of increasing transparency in the financial markets and coordinating more
effectively across borders. The specific needs of each country vary, but commonly
needed reforms include deregulation, a lifting of capital controls and stronger
governance and disclosure.
South Africa has a developed bond market in place, and sizable life insurance and
pension markets. Some institutional investors have bought into projects post
completion, but have not yet shown much appetite for construction risk. The
infrastructure market in South Africa is dominated by state owned utilities such as
Transnet and Eskom who finance infrastructure on balance sheet. The largest project
finance programme to date is to support investment in the ambitious renewables PPP
program which the domestic banks have so far financed comfortably to the surprise of
some international investors. Nevertheless, the implementation of Basel III in general
and a growing pipeline of projects could spur greater demand for capital markets
financing. In particular, round 3 of the renewables program will drive cZAR30, worth
40bn across 1,000MW of capex.
GLOBAL FINANCIAL CRISIS AND THE RECOVERY IN 2013
The global financial crisis has had a profound effect on project finance for
infrastructure around the world. We have suffered from economic recessions and
country crises over many years, but not such a global crisis which has affected so
many countries, all at the same time.
For a period, people in the project finance industry had the view that if we held on,
things would return to normal, the cost of debt would return once more to a
reasonable level and the project deal flow would increase. The global financial crisis
has reduced the availability of private capital by increasing its cost and restricting its
availability. At the same time, economic policies adopted by many countries
concentrated on austerity and reduction in public expenditure as opposed to growth.
8/11/2019 Global Infrastructure and Project Finance Outlook
41/45
During this period of uncertainty, the demand for infrastructure development across
the world has continued to increase even though we are seeing reduced economic
growth in many countries. Demand for clean water, electricity, improved transport
systems, education and healthcare improvements increase, as the global population
expands. 2013 has been the turning point for a new certainty in infrastructure
development and governments recognize that investment in infrastructure (whether
public or private) creates jobs, which creates growth.
Looking back 2013 will most likely be classed a year of partial recovery. Although
the global project finance (PF) markets are far from mended, 2013 was a step in the
right direction and a definite cause for mild celebration following a poor 2012.
According to the World Bank, global growth hit 2.4 per cent in 2013, and is slated to
increase to 3.2 per cent this year and to 3.5 per cent by 2016. With confidence in the
global economy returning, 2013 showed signs that the darkest days of the financial
crisis for PF and infrastructure could soon be over.
The post economic crisis fear that project development has been stifled by a lack of
bank liquidity and the so-called funding gap, has been replaced by the common claim
that a scarcity of project pipeline is the main hindrance to the global PF marketplace.
The last year has shown signs that this complaint is also beginning to look outdated.
There was an uptick in deal flow across many parts of the globe in 2013, and whilst it
would be foolish to infer from this that the hard times are over, market pessimism
now looks similarly questionable.
8/11/2019 Global Infrastructure and Project Finance Outlook
42/45
Graph: Investors Intentions for Their Infrastructure Allocations over the Long
Term
In 2013, we have seen more and more countries using project finance to develop
infrastructure and adopting the PPP concept. Canada, with a strong and successful
PPP history, probably holds the record for speed of procurement; however, new
markets across South and Central America are developing quickly.
Brazil has a dynamic approach to PPP, with a PPP law in place since 2004 and a PPP
guarantee fund (whose assets are separate from those of the federal government)
which protects private parties against the contracting authority default risk for each
PPP contract. The federal structure of the country allows for PPP projects to be
tendered by both the federal government (which has the exclusive right to grant PPP
projects in energy and transport) and by the state and municipal government
(responsible for water sanitation and regional roads). Other countries in the region
with exciting PPP programs are Columbia, Peru, Mexico and Panama.
California is developing the PPP concept. In 2012 the Bay Area Council Economic
Institute in San Francisco published a report on job creation using PPP, and cites
findings by the Federal Highway Administration that each additional $1bn of
government infrastructure spending creates between 4,000 to 18,000 jobs. Moodys,
8/11/2019 Global Infrastructure and Project Finance Outlook
43/45
the ratings agency has demonstrated that in California, for every $1 invested in
infrastructure this produces $1.59 of gross domestic product and infrastructure
investment is seen as a key pillar of growth. In an economic downturn, it is especially
important to job creation and economic recovery.
Australia was another successful country for PPP in 2013. The Australian experience
illustrates potential life- cycle cost savings from the effective implementation of PPP
methods. In addition to improving time and delivery of projects plus accelerated job
creation, Australia has demonstrated on-budget delivery i.e. built on time and at cost.
The Netherlands has been extremely successful in the implementation of PPP. The
government sees private finance as a means to gain value for money for the Dutch
taxpayer and provides discipline and enhances risk management in projects. The
governments role is to provide a clear framework and to remove undesirable barriers
in contract documents and tender documents. If private finance becomes too difficult,
too complex or too expensive, the government would finance the projects themselves.
African countries are having increasing difficulties in putting PPP projects together on
both a country basis and on a project-by-project basis; the issues here are the same for
many emerging markets. The issues are:
Private sector investors return requirements are too high.
Lenders are trying to conserve capital and rebuild their balance sheets.
Basel III is imposing additional capital requirements for project finance
lending, as well as requirements for lenders to match the duration of loans and
funding.
The service provided by the PPP is often unaffordable to the end user without
substantial grant subsidy.
In Africa, and other emerging markets, the consensus is a new model is required that
is simpler, quicker to deliver and more attractive to foreign investors (mainly
commercial banks). Initiatives, like the EIB Bond and Pebble development in 2013,
will continue to be developed in 2014.
8/11/2019 Global Infrastructure and Project Finance Outlook
44/45
8/11/2019 Global Infrastructure and Project Finance Outlook
45/45
domestic insurance companies and pension funds that otherwise would not be easily
persuaded to purchase these securities on a large enough scale.
With this in mind we offer the following salient recommendations:
Firstly, nurture the growth of securitisation mechanisms, albeit subject to
balanced regulatory scrutiny.
Second, urgent work must be done to deepen the corporate debt market by
attracting new participants. Specifically, measures must be taken to make it
easier for domestic insurance and pension funds as well as foreign institutional
investors to invest in a wider range of long-term corporate debt and simplify
procedures for primary issuance of debt securities. Measures to launch a
transparent trading platform for corporate debt linked to appropriate payment
and settlement systems must be accelerated as also measures to improve
liquidity, such as the introduction of repo transactions on corporate bonds and
the launch of a wider array of hedging instruments (interest rate futures and
credit derivatives).
Third, the government should act as a catalyst by transforming IIFCL into a
specialised government-supported institution that would at the very least
refinance infrastructure loans from banks and NBFCs or, if we are to be more
ambitious, which would purchase infrastructure loans, re-package them as
credit enhanced securities and sell them to other investors, notably insurance
companies and pension funds.