‘The brownfield party may soon be over’
Thierry Déau, president and chief executive officer, Meridiam Infrastructure, Paris
The biggest obstacle to optimal infrastructure financing today is the limited availability of long-term sources of financing in the market, or perhaps the limited access of those sources to infrastructure deal flow.
On the debt side, if you exclude the short-term leveraged buyout (LBO)-type debt which may become available again and is quite suited for acquisitions of brownfield infrastructure assets, bank debt maturity has shortened as a result of the financial crisis and the euro crisis to no more than 20 years.
Bank debt represents a large portion of infrastructure financing and an even larger portion since the demise of the monoline industry (exceptions are the US and Canadian markets that can access deep capital market financing under certain conditions). Twenty years is certainly not a match to the life of most infrastructure assets, which generally exceed 30 years.
The mismatch between the source of financing and the asset life has created an additional refinancing risk to those assets and introduced an additional factor of volatility to those stable cash flows which are the key feature of good infrastructure assets.
One might wonder whether the current pool of banks seriously involved in the sector will be able to sustain or maintain their commitment under Basle 3 or other regulatory constraints. The European Investment Bank or the US Federal programme TIFIA or the future US infrastructure bank, whilst being able to sustain the market during the crisis, may not being able to cope with these requirements.
The solution may sound simplistic, but long-term money is available in large quantities in institutions like pension funds and sovereign funds which have liabilities that can afford to be patient and are seeking more certain, uncorrelated real returns for their portfolio.
The main issue is access. Let’s focus on one part of the infrastructure market, namely greenfield PFI-type projects (financed through availability payments) which represent a significant part of the debt requirement.
In exchange for being a little bit patient for a few years of construction, a long-term investor sophisticated enough to structure a project bond could benefit from a underlying government backing and a rating initially investment grade but quickly moving to AA to AAA rating – and all for a remuneration of 200 to 300 basis points over long-term rate. Should the revenues be protected against inflation, this could represent a real return of 5 to 6 percent. Many long-term investors would love to access such returns.
Access, however, is far from easy. To begin with, government will need to improve inflation protection to attract such investors. Investors often cannot afford to build the necessary resources and skills to structure the deals. Is it not it a wonderful opportunity for a new business model for the monoline or the former teams of the monolines?
Equity investors will also need to take a long-term view to optimise financing. Transforming a long-term operating cash flow into a quick capital gain is possible but introduces a number of risks, changing the balance within infrastructure assets. Most equity investors find it easier to operate in brownfield infrastructure – and, indeed, wonderful opportunities can be found there if investors back the right manager.
There are, however, a few limitations to this model. First, an LBO approach to this sector assumes that assets currently available have potential for indefinite growth. With the exception of those infrastructure businesses that are no different to private equity /LBO targets and operate in a market of diversified opportunities, infrastructure monopolies may not always grow forever and it becomes difficult after the third or fourth trade to find additional value to extract for a vendor.
Second, the attraction of brownfield assets tends to put pressure on price and will eventually create a bubble and some disappointment. In order to sustain the brownfield market, significant new greenfield assets will need to be developed and built to match the demand for assets. In other words, the brownfield party may soon be over if some of us do not take the long-term view and let the public sector repossess the greenfield market due to lack of investor appetite.
Long-term money is available in large quantities in institutions like pension funds and sovereign funds
‘Traditional banks and financiers must step up’
Andrew Alli, chief executive officer, Africa Finance Corporation, Lagos
At Africa Finance Corporation (AFC), we believe that the single biggest drag on private sector infrastructure financing growth in Africa is a combination of: challenging legal and regulatory environments for project development in many African jurisdictions; the lack of sufficient early-stage development risk investment appetite for African projects; and the dearth of sponsors with sufficient capacity, resources and experience to attract financiers.
All these factors contribute to a lack of well-structured, bankable projects supported by very strong sponsors, which is the major bottleneck. We have seen this combination of challenges in our dealings with power projects in Nigeria and elsewhere in Africa; transport projects (ports, rail and road) across the continent; as well as heavy industry (petrochemicals, cement and metals) projects.
Oil & gas and telecoms infrastructure projects like our Seven Energy and Main One investments respectively have been able successfully to deal with these challenges, obtaining finance not only from AFC but from other first-class financiers such as the African Development Bank.
Obviously, macroeconomic and business climate factors also have a major impact on the financing environment for infrastructure projects. We think, however, that the combination of policy deficiencies, investor risk aversion and sponsor quality factors are the biggest obstacles at the moment.
There are ways around each of these factors. Policy, macroeconomics and business climate are clearly areas where government action is required to improve the business climate. Private operators have an important role to play however, as advisers, advocates and champions of international best practices across the continent.
This is already happening in many countries, though the pace of change has sometimes been somewhat slow. In Nigeria, for example, AFC is working as technical adviser to the Central Bank of Nigeria on a major power sector investment policy initiative for the country.
Regarding investor appetite and sponsor quality, specialist infrastructure finance institutions like AFC are an important part of the solution, structuring transactions in ways that investors can get comfortable with, and helping to develop sponsors that meet the standards for successful project finance. This we are doing with power and oil/gas projects in West Africa, as well as supporting a variety of transport and telecoms projects elsewhere on the continent.
However, traditional banks and financiers must also step up, acquire the relevant sector expertise and help create solutions for governments, sponsors and investors. This is already happening across the continent, and the market for private infrastructure finance solutions looks set to grow at a faster pace in the next few years.
Calling all pensions
Partha Dey, president of infrastructure, ICICI Venture, Mumbai
To date, significant amounts of private sector investment, exceeding $100 billion, have already flowed into the infrastructure sector in India. However, so far, financing of infrastructure projects have been largely limited to the domestic banking market. It is critical that there is widening participation across the broader financial system beyond the domestic banking market to absorb the sheer demand for long-term capital going forward.
Further, the risk-return profile changes over the life cycle of projects, which calls for participation from different classes of investor with varying risk-return expectations at different stages of the project life cycle.
Various constituents of the financial system like pension funds and insurance companies need to participate in a meaningful manner so that a fair share of the large and rapidly growing contractual savings market can be leveraged for long-term infrastructure investment.
As the construction period of these projects come to an end, it will be possible to get them rated based on expected steady cash flows during the operating period. While the domestic banking system can continue to finance the greenfield stage of infrastructure projects, the long-tenor funds covering the remaining concession period will have to come from pension funds and insurance companies.
Moreover, the funding base can be further diversified with the recent easing of External Commercial Borrowing (ECB) guidelines by Reserve Bank of India whereby, after the completion of the project, refinancing of existing rupee loans with ECB has been allowed.
Who can replace the monolines?
Stéphane Ifker, partner, Antin Infrastructure Partners, Paris
There are probably several answers to the question posed. I consider that one of the biggest obstacles to an optimal infrastructure financing environment today is probably the absence of an efficient channel between infrastructure assets and debt capital markets investors, a role that was somehow played by the monolines when they were in business, especially in the euro markets.
We are aware of several initiatives, most often in the form of infrastructure debt funds, but to my knowledge none of them has really got started. This issue will become particularly critical to address the forthcoming 2012/2013 “refinancing wall” that the banking markets will have obviously difficulty in absorbing.
“Give us simpler regulations”
Sandeep Aneja, managing director, Kaizen Private Equity, Mumbai
Popular sentiment might lead one to believe that lack of resources coupled with regulation is the biggest challenge in infrastructure financing. However, we believe that, though resources are limited, the crux of the problem lies in the evolution of a model that makes undertaking infrastructure projects feasible for all stakeholders – including the government, financing agencies/investors, entrepreneurs and the public at large.
Infrastructure projects are characterised by high capital expenditure, long gestation periods, uncertain returns and some regulatory overhang. The core segments of most infrastructure sectors display these characteristics most often. Core segments include schools and colleges in the education sector; hospitals and clinics in healthcare; thermal power plants in power; and bridges and toll roads in highways.
Return risks may be minimal due to the large demand and supply gap, but addressing risks posed by other characteristics holds the key to the development of the sector. Given the nature of the projects, the requirement is to attract long-term risk capital that not only plays a vital role in the development of the country but also in the sustainable development of a sector.
Today, the education sector has several innovative models that are receiving private investment e.g., the BOOT model; the school/college management model; the asset heavy model; and the technology oriented learning model. Most are early in the maturation cycle and can attract the tens of billions of dollars worth of investments over the next few years that is so desperately needed.
One of the ways to address the financing challenge is through better risk management with the support of the government and a uniform regulatory framework that enforces quality and not the granting of licenses.
Addressing risks like huge capital expenditure and long gestation periods is partly being addressed by the PPP model in schools and vocational training, where existing schools and Industrial Training Institutes (ITIs) are being given to the private sector to help deliver quality education.
This does not address the need for adding capacity and building better infrastructure in the country. This can be addressed through a simplified regulatory framework that incentivises private sector growth e.g., single window approval processes; tax incentives for long-term projects; and liberalisation of controls over capacity, costs and fees.
This in turn can attract bigger, longer-term financing like foreign direct investment, venture capital, project finance etc. Steps towards setting up viability gap funding for education and other infrastructure projects along with easier access to infrastructure loans will also boost the growth of the sector and help address return risk, making the sector more attractive to investments.
The above steps cannot be seen in isolation, as it is a combination of measures that will help develop a model that is feasible for all stakeholders and will lead to sustainable and steady growth.