China’s recent promotion of the public-private partnership (PPP) format for some 80 infrastructure projects has been hailed by industry professionals as “unprecedented,” as Beijing launches a fresh infrastructure push with the economy set to register its slowest full-year performance in 2014 for the past two decades.
As much as they are excited about the opportunities that may ensue, foreign infrastructure funds may want to play it slowly this time. In the past, a lack of PPP legal and regulatory frameworks and market transparency has been a hurdle for the Chinese government in attracting large global infrastructure funds which have instead tended to focus on North America and Europe.
China’s top economic planning body, the National Development and Reform Commission (NDRC), said in a late May statement that it welcomes private equity to “participate in the construction and operation” of a total of 80 infrastructure projects in sectors including railway and ports construction, information technology, oil and gas and chemical industries, as well as renewable energy such as solar, wind, and hydro.
Private investors can take full or partial stakes in those projects, the NDRC added, though the specific nature and value of the projects considered are yet to be determined.
‘Positive and encouraging’
“I think it is a very positive and encouraging sign. And it’s just part of the evolution of the China investment landscape… it’s smart for any economies or governments to create models for the capital to be able to build infrastructure and drive growth,” says Ben Way, head of North Asia for Macquarie Infrastructure and Real Assets (MIRA), the asset management arm of Macquarie Group.
Macquarie manages the Greater China Infrastructure Fund, which had $870 million under management as of end-2013, and has owned infrastructure assets in China at least for the past six or seven years, Way says, adding that the fund has acquired positions in eight portfolio companies in the past two years.
Maurice Hoo, Hong Kong-based global head of mergers and acquisitions at law firm Orrick, Herrington & Sutcliffe, calls the proposed PPP format “a bold step” for the Chinese government because it “suggests that the government is prepared to open its books to be reviewed under an international standard”. Hoo says his firm has advised a few infrastructure funds that have invested in China, mostly in alternative energy projects.
There is frequently a lack of transparency in the Chinese infrastructure sector in terms of the financial and operational information that foreign investors would want to look at and evaluate when they make investment decisions.
“So to me, beyond the capital, the government may be more interested in the financial and operational discipline that foreign PE investors might be able to bring to the table which, as an SOE (state-owned enterprise) you may or may not need to have…in that process, essentially improving the efficiency (of both the sector and the broader economy),” Hoo says.
In many respects, China is no different from the rest of the world. It is generally challenging for private funds to invest in infrastructure assets globally as certain assets are not available for private investment and many countries have regulatory risks that can be costly.
“If you try to buy JFK (John F. Kennedy International Airport) or Singapore’s Changi Airport, that doesn’t work; similarly, if you want to buy Shanghai’s Pudong airport, that doesn’t work either,” says James Chern, managing director of Asia for I Squared Capital (ISQ), an infrastructure fund set up by former executives and partners from Morgan Stanley’s infrastructure fund.
For China in particular, one “challenge (for foreign infrastructure funds) is that the legal framework and structure for each investment needs to be designed in a way that can deal effectively with all of the issues,” says Lynia Lau, a Hong Kong-based partner at UK law firm Clyde & Co.
There is no existing PPP law and regulation in China, and the relevant PRC laws and regulations can sometimes be contradictory between the state and provincial levels, according to Lau.
As a result, each project needs a specific legal framework in order to accommodate the investment objectives of each of the parties involved in the project, including investors, operators, sponsors, users, and regulators, Lau adds.
To be sure, however, China has seen foreign investors involved in some infrastructure areas, such as water and waste treatment, as well as ports, where concession agreements have been signed.
For example, Veolia Water, a unit of the French company Veolia Environment, which provides water, waste, energy and transport services, has been in China since the 1990s, and has provided full water services to large cities in China. It has a 50-year joint venture in Pudong, Shanghai whereby it manages water production, distribution, customer services and billing, and a €1.6 billion 30-year concession agreement with the municipal government of Lanzhou city in Gansu province, according to its website.
In recent years, a number of European countries have changed their regulatory frameworks for PPPs in ways that have led to an increase in overall investor risk, so “regulatory risk is a key infrastructure investment risk that is pervasive all over the world, and not just unique to China,” Chern says.
Laws need strengthening
Still, “for infrastructure investment projects, China needs to strengthen its PPP-related laws and regulations, like the UK has done,” Lau says.
Currently, infrastructure funds usually choose areas that have fewer regulatory risks in China, lawyers and fund managers say.
Despite potential risks and a slowing economy, China remains an attractive market to foreign infrastructure funds thanks to the sheer size of its economy and the long-term steady return stream infrastructure assets can bring.
As Beijing spearheads the transformation of its economy, it is broadening pools of capital available to private companies, state-owned enterprises and government to enable an infrastructure build-up. One standard measure in many markets is to sell down existing assets to recycle capital that can be put into new projects,” says Way.
“China isn’t a perfect money-making market, but on balance, it offers very good returns to investors for the risk profile. It does offer a lot of opportunities and that’s a real positive because the best market for investors are those where there are lots of deal opportunities, so that you have more choice, which means you can buy better,” Way insists.
Way’s point is echoed in a recent report on Greater China Private Equity from Bain & Co. which said a transitional China offers lower but stable growth in the future.
The report listed infrastructure as one of the least attractive industries in China for this year, but Chern disagrees: “What China has is that, even though you can’t invest in all infra assets, in very selective sectors you pick – such as renewable energy and the environment – the sector is very large simply because of the size of the country, its demographics and its urbanisation. For example, China has more toll roads by length than any other country in the world.”
Compared with other developing countries, China appears to be lagging behind in infrastructure investment. Figures compiled by Infrastructure Investor Research and Analytics show that the country closed $2.4 billion worth of infrastructure projects last year, compared with $3.8 billion in India and $7.8 billion in Brazil.
Way says there are a number of sectors in China that are seeing an infrastructure deficit. “A good example is water, and that’s certainly an area we’ve made a number of investments. In quite a number of large cities, there is just not enough water infrastructure for the average citizen in terms of treating water and water recycling.”
Despite the inability to offer the double-digit returns seen five or ten years ago when the Chinese economy was booming, returns in China are still “very favorable compared with more advanced economies in terms of their IRR (internal rate of return)”, and a more mature and stable economy leads to “less volatility to the returns,” Way says.
This should be enough to keep investors interested – especially at a time when the government appears to be rolling out the welcome mat.