Making the uninvestable investable

While bank debt remains the predominant form of project financing in Asia, the capital markets are increasingly being eyed for supplementary lending capability in a bid to address the region’s significant infrastructure gap.

In this context, project bonds are one of the solutions being considered to help provide additional liquidity for projects.

Project bonds, of course, are nothing new in the infrastructure space. In 2012, following the demise of Europe’s monolines, the European Investment Bank and the European Commission launched the Europe 2020 Project Bonds Initiative, which aimed to mobilise capital markets financing for large-scale infrastructure projects. So far, 10 transactions have reached financial close under the initiative’s pilot phase, with ratings agency Moody’s concluding it has provided a viable financing option for infrastructure projects.

THE ASIAN JOURNEY

With that in mind, it is not surprising to learn that project bonds are also on the rise in Asia. Banks in Australia, China and other markets with solid credit ratings have regularly issued green bonds for infrastructure projects over the last two years. For those with a weaker credit profile, multilateral banks are now coming to the rescue. The Asian Development Bank has a history of providing credit enhancement for loans and sovereign guarantees, but it was only in February 2014 that the ADB announced a similar initiative to the EIB’s project bonds. Importantly, only now, some two years later, has the bank managed to finally sign its first project bond financing (see A true pathfinder).

Unlike the EIB’s offerings in liquid currencies in Europe such as the euro and sterling, the ADB can offer credit enhancements both in US dollars and local currencies, targeting “two universes of investors”, according to Frédéric Thomas, senior investment specialist at the infrastructure finance division of the ADB’s private sector operations department.

The ADB’s initiative, he says, aims to adapt a US dollar version of the EIB’s product to the Asian markets, a product which has passed over 10 tests in Europe with investors, ratings agencies and project developers.

He notes that although some countries in emerging Asia possess an investment-grade rating, the underlying projects’ ratings are likely sub-investment grade. At the same time, international US dollar institutional investors are often mandated to select investment-grade assets. This is where credit enhancement can help broaden the investor base.

Local banks, corporates, pensions and insurance companies are also particularly keen to get involved in local currency project bonds with credit enhancement, Thomas points out. They are usually constrained to investing in local currency (typically above AA- local currency rating) while there are not too many highly rated local currency-denominated products on offer in the domestic market.

Regional banks, for their part, would benefit from the development of project bonds as they can diversify their lending portfolios with alternative products. With the money recycled from refinancing through project bond issuances, banks can continue to invest in new infrastructure projects where they can provide shorter-term debt to fund construction, better matching their appetite and skills.

“There are demands from professional investors from Europe and the US, but also in Asia as they are looking for long-term investment products [matching assets with their liabilities] with stable returns and these demands are exacerbated in the current low yield environment,” says Thomas, adding that US dollar project bonds could be particularly attractive to insurance companies and debt funds from developed regions.

“One of the key opportunities in Asia is the potential development of a project bond market to refinance construction, which could provide institutions like pensions and insurance companies with long tenor assets to match their long-term liabilities,” notes James Abbott, a Sydney-based partner from Allen & Overy.

“Apart from facilitating the opening of a non-bank funding market, credit enhancement products are useful on an ongoing basis in two circumstances – firstly, where the host country has a weak sovereign rating and secondly where the projects are riskier from a political, demand or even currency perspective,” says Tim Conduit, a London-based partner from Allen & Overy. He says one of the significant achievements of the EIB’s product has been breaching the sovereign rating ceiling on a couple of projects.

“What Asia could learn from Europe’s experience is really all about execution and delivery,” adds Conduit. “Also, having a multilateral providing support to a project could see a different dynamic around transaction enforcement and the approach of governments and sponsors.”

STRONG APPETITE

Currently, the ADB’s credit-enhanced project bonds are focused on the refinancing of brownfield assets. Following in the footsteps of the EIB, the ADB is likely to expand the scope of its credit enhancement initiative to cover projects under construction.

In fact, the Credit Guarantee and Investment Facility, an ADB trust fund which typically provides corporate guarantees, launched a new guarantee product in July called the Construction Period Guarantee, to address risk concerns from conservative long-term investors considering greenfield infrastructure projects. CGIF is currently in search of a suitable project in the ASEAN region for a pilot implementation.

Thomas also expects in the short term that most project bonds will be issued for brownfield projects in local currency in response to strong infrastructure needs and demand from local financial institutions, but also to international investors for a few select sectors that are US dollar-driven, such as port, airport, LNG or projects indexed to the US dollar, such as renewable energy. He adds that following the Paris agreement on climate change last year, the ADB can provide potential concessional financing to green projects like solar and wind power generation, and thus the related product bond offerings could be even more competitive.

“We have a strong appetite for project bonds with credit enhancement,” says one Asia-based infrastructure investor. From a risk/return point of view, the investor thinks credit-enhanced project bonds are an attractive alternative to fixed income products. He also says his firm plans to allocate about $1 billion for infrastructure investments in emerging markets, with a particular focus on debt.

With the ADB’s first credit-enhanced project bonds debuting in the Philippines, Thomas believes the project bond model represents an opportunity for issuers in emerging Asia. It offers them access to both domestic and international debt capital markets for projects that would not otherwise be connected with Asian savings. Time will tell if the ADB’s initiative will prove as successful as its European counterpart’s. But investor appetite seems to be there, and that is certainly an encouraging first step.

 A true pathfinder 

Earlier this February, the Asian Development Bank provided credit enhancement to Filipino firm AP Renewables, a subsidiary of Aboitiz Power, for the 676MW Tiwi-MakBan geothermal energy facilities. The PHP10.7 billion ($220 million; €200 million), 10-year bond issuance backing the project marks a number of firsts:

– The first credit-enhanced project bond in Southeast Asia (excluding Malaysia) since the Asian financial crisis in 1997;
– The first local-currency project bond in the Philippines’ power sector;
– The first credit-enhanced project bond in the Philippines;
– The first green bond in the country;
– And the first climate bond certified in emerging markets for a single project.

The initial purchaser of the bonds was the Bank of the Philippine Islands. The bank has been allowed to sell down a portion of the bonds to a limited number of primary institutional lenders, including insurance companies and pension funds. The transaction was also in line with existing regulations in the Philippines to assist in establishing the market for project bonds in the country.