Bernard Sheahan is no stranger to tough times. The head of the International Finance Corporation’s infrastructure department earned his stripes in its Asian and Latin American departments, where he saw more than his share of developing economies struggle through booms and busts. At times academic, at times colloquial, he displays an almost encyclopedic knowledge of the Asian currency fiasco of 1997 – or what he calls “the first crisis” – when Thailand, Malaysia and several other large Southeast Asian economies lost steam after their currencies depreciated precipitously against the dollar.
As the conversation turns to today’s financial and economic problems, Sheahan quickly admits he’s learning on the job as much as anyone else. He says: “You know, I’d love to describe myself, or us institutionally, as being in a unique position here. But I think we’re like the rest of the world, saying, ‘ok, what’s the next shoe that’s going to fall and is it going to take more or less than the next 24 hours?’”
He vividly recalls September 2008, when the bankruptcy of investment bank Lehman Brothers and the US government rescue of insurance giant AIG effectively froze private capital flows to emerging markets. That threw the IFC – the World Bank subsidiary in charge of facilitating such inflows – firmly into crisis management.
“We scrambled as quickly as we could to say, ‘ok, how can we actually use what we’ve got here to do something to reverse what’s going on, to the extent that we understand what’s going on and to the extent that it doesn’t change in the next 48 hours?’” he recollects.
The idea of a creating a “crisis facility” to invest in infrastructure projects stranded by the financial hurricane was just one bullet point IFC heads floated past IFC member states. But it quickly gained traction and, within weeks, the IFC set about designing a $10 billion pot of money to get private capital flowing again into emerging market infrastructure.
As he discusses his vision for what goes by the name of “Infrastructure Crisis Facility” on a rainy Tuesday afternoon in Washington DC, Sheahan appears careful not to overstate its raison d’etre. He views it as a temporary way of mobilising other international financial institutions’ (IFIs) capital while commercial banks heal their wounds and rebuild their appetites for emerging markets. But with roughly $67 billion to $94 billion of emerging market infrastructure projects at risk of cancellation or postponement due to the crisis – and scarcely anyone willing to finance them – the facility is clearly a necessity. And Sheahan’s work is just beginning.
Not every crisis deserves a rescue package like this one. True – flip through the IFC’s 2007 “Private Participation in Infrastructure in Developing Countries” report and you’ll see 19 charts all telling pretty much the same story. Emerging market investment peaked in 1997, troughed five years later and hit all-time highs again in 2007. Now, of course, it has crashed once more. Same old story? Not quite. In 1997, there was only private capital at stake – and much less than in 2007. This time around, there’s public money at risk as well – and lots of it.
“If you look at the financing of private infrastructure in emerging markets before the first crisis, it was much more concentrated geographically. Looking at the last three to four years, one of the striking things is that you had a much larger amount of countries that were beginning to set up public-private partnership models or other programmes to try and encourage the private sector to come into infrastructure,” Sheahan says.
Not only are there more projects in need of financing than there were a decade ago, but they’re also more politically important. “Governments have made these political commitments, spent three to four years trying to develop these concessions and PPPs now can’t get them financed. And the countries that have been slower to go through the policy reform are now saying, ‘well, why should we go through this political fight now and then take three to four years to try to develop these projects if there is not going to be any private financing’.”
How many countries are asking themselves this question? Sheahan says the list is long, then picks Egypt as one of the countries that are most affected. Egypt he says has gone from essentially non-existent private participation in basic infrastructure to putting in place a programme that, if it reaches fruition, will be one of the largest in the emerging markets. From 1990-2004, Egypt saw 16 infrastructure projects involving investment commitments of $6.2 billion reach final close, according to the Egyptian Ministry of Investment. Many of them were pilot projects meant to demonstrate the viability of PPPs. Now, however, if similar projects fail to attract financing, that could give skeptics more ammunition to resist their implementation. And they already have plenty: the Asian crisis was largely the result of bad policymaking by the afflicted countries, whereas today the problem originated in the developed world. So mimicking the developed world’s policies is already a tough sell.
“One of the concerns from a policy standpoint now, which didn’t exist at the time of the first crisis, is that so many more countries that have recognised the potential benefits of getting the private sector involved in infrastructure will now pull back,” notes Sheahan.
All the more reason why the IFC, an investor in infrastructure since 1992, and which didn’t feel compelled to create a crisis facility ten years ago, now essentially has no choice. The trade-off is simple: lose a decade of political progress or inject billions of dollars to keep the faith in PPPs alive while markets recover. “These are the set of things that we and our shareholders set out to try and address in the crisis facility,” Sheahan says.
IFC shareholders didn’t start clamoring for the rescue plan until late 2008. Before then, despite the tight credit markets, projects were still attracting financing, as demonstrated by the IFC’s own numbers. Some $200 billion of private capital poured into emerging market infrastructure in 2008 – until Lehman Brothers went down.
“Post-Lehman, this essentially stopped on a dime,” Sheahan says. “Within really the first month after that, there was a lot of back-and-forth in the World Bank Group, particularly within our shareholders, saying, ‘ok, guys, what can you suggest to us to orient our attempts to help the developing country members?’”
The desire to help the developing countries among the IFC’s roster of 179 member states was no mere altruism. Many of the developed countries counted on robust demand in emerging economies to help lead them out of recession by driving exports, contracting opportunities, service provision, and other economic activity.
“Germany was obviously one of the first to say, ‘look, this is a big issue,’” Sheahan says. The world’s fourth-largest economy has for a long time relied on exports to emerging economies as its catalyst for growth. It’s a strategy that worked very well during bull markets, but now – with its GDP estimated to shrink by at least 5.4 percent this year – is proving very painful.
The idea of a dedicated pool for infrastructure was just one of a handful of solutions the IFC proposed to Germany. But it took off like wildfire. “We had literally over a 48-hour period an exchange between our CEO and president and top levels of the German government about this and got a strong signal back, ‘yeah, this is precisely the sort of thing that we’re looking for,’” Sheahan says.
In November, the crisis facility was presented at the G-20 meeting in Washington DC, where it received strong support. In December, it was ratified by the World Bank Group’s board. In late April 2009, Germany and France became founding members and the first countries to participate in the facility, pledging commitments of €500 million ($660 million) and €1 billion, respectively.
Both their commitments were mainly for the facility’s debt trust, which will provide loan co-financing for infrastructure projects. The IFC will also raise an equity trust and a pocket of funds to provide advisory services for deserving projects. All together, they hope to put together $10 billion across all three funds.
How, exactly, will the facility work? Suffice it to say that, were it a traditional private
equity fund with general partners who manage the fund and limited partners who invest in it, the IFC would be more akin to the fund formation lawyer setting up the fund than
either of the other two.
“The IFC is not going to be managing this trust. What we’re doing is designing it, creating it, setting up the mechanism of how it will work, and then we will become one of the IFIs [international financial institutions] originating it. But the trust will be run by the partners who put the money in,” Sheahan explains.
The trust works on a matching basis so that an eligible IFI vets the project and brings it to the trust for matching. This means that any investor wishing to tap the crisis facility’s resources, whether debt or equity, should work with the IFIs to get their projects noticed, vetted and financed.
“We’re leveraging on existing institutions, so the Macquaries or anybody else has to come through one of them to assess whether projects make sense, to do the due diligence and to look after the fiduciary issues that the providers of these funds worry about – environmental and social policies and so forth,” Sheahan says.
Picking out the institutions to work with is of course up to the investors. They can go through existing relationships or, where there are none, focus on the countries of interest to the IFIs who have committed financing. France, for example, will likely be interested in backing projects in Francophone countries.
“The prioritisation is in the hands of the partners, so the people who actually put up the money get to decide what they are bringing forward [for financing],” Sheahan explains. “To the extent that there is need for further prioritisation, then it is going to come through the board of the trust.”
Worst case scenario
Still, the trust will not be without some house rules. It will have basic allocation criteria, such as single country caps and limits on how many projects each IFI can originate.
“Within that, there will then be eligibility criteria, which now look like they will be fairly broad. There will be single project caps, in order to allow this money to be leveraged as much as possible and to have as broad an impact as possible,” Sheahan says. For example, no more than 25 percent of a project’s total costs will be eligible to draw on the facility’s resources.
The IFC hopes the impact will begin to be felt soon. The debt trust is aiming to get its first loans out the door this month. Sheahan admits that “this is pretty ambitious”, but speed is a necessity if the facility is to make a difference at this time of need. “If you want to have funding available during the crisis there’s already a queue of 40-plus projects lined up with interest in accessing this. This is on the debt piece,” he explains.
On the equity side, the IFC has committed $300 million to the facility’s equity trust and is actively raising funds. Sheahan eyes a first close around September and hopes that the fund will attract capital both from institutions seasoned in infrastructure investment and first-time investors looking to seize the opportunity to enter the asset class. “Interestingly, part of what we’re finding is that whereas the traditional investors in emerging market infrastructure funds are much more reluctant than they were pre-crisis to commit funding, there are some non-traditional investors, non-traditional in that they have not been really in this asset class of emerging markets infrastructure, [that] are now looking at this and saying, this is a potentially attractive asset class.” Among the IFC’s target investors are US and European pension funds, as well as government-owned investment vehicles of some of the larger emerging market governments.
As to how the equity will eventually be deployed, that is still being determined. “This is primarily a mobilisation vehicle to get other funds in so it depends very much on what the other players are looking for”, Sheahan says.
Direct investment is obviously a possibility. But so is indirect investment via other funds. “One of the possibilities is a fund of funds, where essentially you’re raising a pool of capital and supplementing existing funds through some mechanism”, he says, cautioning that “some investors are not keen on that model because it tends to duplicate fees.”
Whichever structure will be used, Sheahan is sure that demand for the equity will outstrip supply. And even if it doesn’t it’s still a win-win. “I don’t think we are worried about the reception amongst investors. The worst-case scenario is one that we’d be extremely pleased about, which is the markets come back earlier and we don’t need this,” he says.
Over the long-term, though, more capital is needed for emerging market infrastructure than anyone can fathom. By the IFC’s own estimates, emerging markets demand $21 trillion to meet their infrastructure needs for 2008-2017. To put this number in perspective, it is roughly equivalent to the entire GDP of the United Kingdom ($2.3 trillion in 2008) each year over ten years.
Pare that up against the $10 billion the IFC is aiming to raise or the $180 billion of private capital earmarked for infrastructure globally – according to the most bullish estimates – and one can’t help but wonder: is the situation just plain hopeless?
Sheahan responds to this question by once again looking at both sides of the argument, as he has done throughout the entire interview. “It’s a little bit like the economist’s dream of full employment. Zero percent unemployment – you are just never going to get there; the $21 trillion – you’re never quite going to get there. But there is a huge difference between where we had gotten between 2007-2008, where you were able to make major inroads in a lot of countries on both publicly and privately delivered infrastructure and where we are now 6-12 months later.”
The key to overcoming this obstacle, he says, is to help countries maintain their infrastructure spending so that, even though they may not be meeting all their spending requirements, they’re at least achieving a healthier long-run equilibrium between their need and committed quotas.
“The real concern is that we go through what we went through in the last crisis, where you had Indonesia, which went from spending 8 percent of GDP on infrastructure down to 1 percent, and that you have this across the board in a lot of the economies, [with] knock-on effects on domestic economic growth, international trade, and therefore global economic growth. This is kind of the nightmare scenario for everybody, that these things all come together,” Sheahan says.
And here, again, is where the crisis facility comes to bear. Most developing countries simply can’t afford to keep up their public spending on infrastructure. With the notable exception of China, which made infrastructure a hallmark of its $586 billion economic stimulus package, few of them have been able to afford similar large-scale initiatives focused on infrastructure, à la the US or EU.
“This is a huge issue for governments because they are again in a situation where the crisis is reducing their ability to fund public sector infrastructure at the same time as it’s reducing the private sector’s ability to come in and finance private infrastructure,” Sheahan says. “[They’re] stuck on both sides.”
All of which indicates that multi-lateral institutions – the dominant source of debt financing in the emerging markets in the wake of Lehman’s collapse – will continue to play a major role in the recovery. As will initiatives such as the crisis facility, which focus and magnify their efforts.
Concludes Sheahan: “Getting the recovery going in infrastructure is really going to be a multilateral effort. It is not something that we, the IFC are going to do alone or that the World Bank Group is going to do alone. This is the kind of effort that’s going to need a lot of different people rowing in the same direction. We’re trying to put together something that is going to help all of these people row in that direction.”