Getting comfortable with risk

One rather large dark cloud has loomed large over the project finance market in recent times: the apparent inability of institutional investors such as pension funds and insurance companies to get comfortable with construction risk.

In an interview with Infrastructure Investor in May last year, ING banker Michael Dinham expressed his surprise at this. “I can’t understand why construction risk is such a problem,” he said. “In 20 years of infrastructure lending on greenfield projects we have barely encountered a problem with construction risk. I’ve had a few problems with commissioning, with getting something to work. But getting things built is rarely a problem.”

Perhaps institutional investors have been worrying about the wrong kind of projects. In a submission for a “Myth-busters” feature in the upcoming November 2013 issue of Infrastructure Investor, Anne-Christine Champion of Natixis says institutions have been nervous of large construction cost over-runs frequently reported in the press.

However, these overruns, she points out, normally relate to publicly procured projects. Moreover, the debt aspect is immune from such developments since the cost overrun would be borne by the contractor.

Furthermore, a Fitch Ratings report out this week (focusing on project completion risk rather than construction risk) highlighted the very different levels of complexity depending on the type of project. The report is highly granular, so I hope the authors don’t mind me distilling it down to a simple point for current purposes: building a major bridge or tunnel works is a hell of a lot more complicated than a school building or solar farm. For many types of infrastructure asset, construction risk is actually fairly negligible.

It seems that institutional investors may now be getting the message. Many banks have vacated the long-term infrastructure debt space, leaving the gap behind that needs to be filled by the institutions. But in terms of analysing, advising, structuring and servicing deals, the banks can still play a vital role in helping the institutions to get comfortable. Through innovations such as ING’s PEBBLE platform or joint ventures such as that between Natixis and CNP, institutions are now willing to show a willingness to come to the table.

Ultimately, institutions overcoming fear of construction risk is important not only for the health of the long-term infrastructure debt market but also – as highlighted in a recent EDHEC Risk Institute study – for achieving diversification within their own debt portfolios.