From lenders to conduits

For decades, the World Bank Group and the larger community of international financial institutions have been largely content using their resources to bring billions of dollars every year to infrastructure projects across the developing world.

But in recent years, the goalposts have shifted. The aim is now to mobilise trillions rather than billions of dollars in total investment. And with no chance of their resources multiplying at a similar rate, these banks have begun to focus increasingly on creating opportunities for private capital.

“There is a bit of an agreement now that deploying lots of infrastructure in emerging markets is no longer only a question of volume,” Thierry Déau, chief executive of French fund manager Meridiam explains.

Instead, multilateral development banks are looking towards risk mitigation, credit enhancement and other means of bringing the private sector into projects investors and lenders would otherwise stay away from. These instruments have long been in MDBs’ toolboxes, but de-risking projects is becoming increasingly central to the institutions’ missions.

“There is a sense that there is no public-sector capital growth out there, but there is a lot of private-sector capital,” Bernard Sheahan, director of infrastructure for the International Finance Corporation, tells Infrastructure Investor. “There was a trend that was beginning to build, but now it is becoming main stage.”

A FUNDAMENTAL CHANGE
In emerging and developing economies alone, the global infrastructure financing gap is estimated to be between $1 trillion and $1.5 trillion.

Meanwhile, institutional investors such as insurance companies, pension funds and sovereign wealth funds hold trillions of dollars in assets with an appetite for infrastructure in emerging markets. The number of such investors in infrastructure has more than doubled since 2011, according to the World Economic Forum, with the average allocation to infrastructure increasing from 3.5 to 4.3 percent of assets under management. And many of these investors – 43 percent of sovereign wealth funds investing in infrastructure, for example – are looking towards emerging markets.

“[International financial institutions] are trying to find more targeted solutions that make projects feasible and then letting the capital markets fill the rest of the gap,” Cherian George, managing director and head of Fitch’s infrastructure group for the Americas, explains. “It seems to be very prudent.”

World Bank President Jim Yong Kim outlined his organisation’s approach in an address to the London School of Economics on 11 April. “Given the low returns so many owners of capital are receiving from their investments, there should be potential for many win-win scenarios where capital earns a higher return and developing countries receive much-needed investment and expertise,” Kim said. “Our top priority should be to systematically de-risk both projects and countries to enable private sector financing, while at the same time ensuring that these investments benefit poor countries and poor people.”

For at least two years, the World Bank has been striding in that direction. In April 2015, prior to the UN’s Sustainable Development Goals conference in Addis Ababa, Ethiopia, a report released by several MDBs looked to move the discussion from billions of dollars to trillions. And since no one held the illusion that these institutions would see their funding multiplied, this required changing the way they engaged the private sector.

For these banks, lending off their own balance sheets has both downsides and limitations. At worst, lending can crowd out private investment if money is put into bankable projects. But even lending to worthwhile projects has its clear limits, since there is only so much MDB funding to go around.

Risk mitigation and credit enhancement is not a new role for IFIs. The Multilateral Investment Guarantee Agency, an arm of the World Bank Group which provides political risk insurance to lenders and investors in the private sector, has issued more than $28 billion in guarantees since its inception in 1988.

But recent years have seen an expansion of this role. The IFC, a part of the World Bank Group focused on supporting the private sector in emerging markets, launched MCPP Infrastructure, a spin-out from its Managed Co-Lending Portfolio Programme, last year. The syndications programme gives large insurers a vehicle to co-invest alongside the IFC in infrastructure debt, providing guarantees to cover a limited first-loss tranche.
And in December 2016, the International Development Association included a $2.5 billion private sector window in its $75 billion replenishment, the first time in its 57-year history that it has targeted private sector resources.

Attracting private sector capital to developing countries requires several conditions to be met. For starters, the conditions on the ground must allow for successful development. Creating a positive enabling environment, as these conditions are called, is an increasing focus of MDBs, as risk-mitigation efforts will often be fruitless without first seeking government reforms.

“A big chunk of [IFC infrastructure] resources are now being devoted to working with the World Bank and governments on these enabling environment type of questions,” Sheahan says. “I would say we are easily putting in at least five times as much effort on this as we were four years ago.”

Another role of these institutions is to do much of the legwork in preparing projects in developing countries. As Sheahan puts it: “Insurance companies and pension funds aren’t going to go to Myanmar or Indonesia and say, ‘Let me roll up my sleeves and spend the next three years making sure this thing is shaping up properly.’”

Once a project clears these two obstacles, risk mitigation can be the key to securing private sector capital, either from commercial banks or from institutional investors. MIGA, for example, provides insurance against risks related to currency invertibility and transfer restriction; expropriation; war, terrorism and civil disturbance; breach of contract; and failure to honour financial obligations.

“When MDBs look in their tool bag of credit support instruments they can combine credit enhancements to deliver transactions that would not otherwise be financeable in challenging jurisdictions,” Andrew Davison, senior vice-president of project & infrastructure finance for Moody’s, says. “When you look at all of these different elements working together, the credit story becomes very robust.”

TURKISH DELIGHT
In Turkey’s Eastern Anatolian region, in the Elazig province, an example of the new multilateral model can be seen in a hospital campus now under construction. The €360 million Elazig Integrated Health Campus, a 1,038-bed project, was financed by a €288 million green and social infrastructure bond.

Investors in the project, World Bank Group officials and ratings agencies have all touted the Elazig project as a breakthrough in MDB financing and a model replicable in future projects. Though Turkey is an OECD member, a failed military coup last July and a subsequent crackdown by the government have contributed to a drop in the country’s sovereign credit rating to non-investment grade.

At the advice of the World Bank Group, Turkish President Recep Tayyip Erdogan had embarked on a programme to leverage private investment to overhaul his country’s healthcare system. But the risks posed by Turkey’s instability now seemed likely to keep institutional investors – and their trillions in capital – out of the country.

For the Elazig project, the EBRD and MIGA developed a credit-enhancement mechanism to bump project bonds, issued by Meridiam and its local partner Ronesans Holding, to a Baa2 rating, two notches above Turkey’s sovereign rating. The deal was financed by three tranches of 18- and 20-year bonds. The first two tranches, of €83 million and €125 million, include EBRD credit enhancement while the IFC invested in the €80 million unenhanced tranche. Together, Meridiam’s Déau says, this had the effect of “basically delinking the project from the sovereign risk, which is really quite an achievement”.
Take a scenario where the Turkish government stops paying investors, who decide to take legal action. While the matter is being looked into, the EBRD would provide continued liquidity. If the ruling is against the government, but it still refuses or is unable to pay back lenders, MIGA would reimburse the bondholders through its Breach of Contract insurance.

Getting this formula down required some tough negotiation between the various parties and also required ratings agencies to be convinced that the bonds merited the Baa2 ratings.

“There were several times where the negotiations came to the point where they could have broken down, as we had to align the interests of multiple stakeholders,” Sarvesh Suri, MIGA’s director of operations, recalls. “The first time is always tougher because we had to work through the mechanics of how the structure would work, [and] the ratings agencies had to be convinced.”

Suri and others involved in the Elazig project see the risk-mitigation structure as a model for future projects in countries with sovereign risk ratings just below investment grade. “Elazig shows that the structure works,” Suri says. “We are now excited to replicate it in other countries and projects.”

In countries with sovereign risk ratings further from investment grade, a risk-mitigation package like the one used in Turkey is unlikely to give enough of a boost to bring in institutional investors. But the model can be used to boost still-riskier projects in these countries, making them more attractive for commercial banks.
In regions like Sub-Saharan Africa, risk guarantees are essential for large-scale infrastructure projects. “Most of the power plants we own in Africa have MIGA protection,” says Adrian Mucalov, a director for London-based Actis, which is active in the energy sector in Africa, Asia and Latin America.

Actis was a majority owner of UMEME, Uganda’s primary electricity distributor, from 2005 to 2014. UMEME saw the IFC step in as a lender, the IDA issue a partial risk guarantee, and MIGA provide political risk insurance.

“The project wouldn’t have happened without those protections, and it was hugely successful,” Mucalov says.

In Africa, the World Bank Group has launched its Scaling Solar initiative, which creates a template including credit enhancement and risk mitigation for privately funded solar projects. Such projects are now underway in Zambia, Senegal, Madagascar and Ethiopia.
And while the World Bank Group may be leading the way, the trend cuts across the MDB world. The Inter-American Investment Corporation, a member of the Inter-American Development Bank Group, has pointed to risk mitigation as a way to attract investors to public-private partnerships.

THE TRUMP FACTOR

While changes to the role of multilaterals are driven by their desire to do more, the election of US President Donald Trump has added an additional impetus since they may now have to do it with less money.

The US is a major shareholder of many of these institutions, including the IDA, EBRD and Inter-American Development Bank. In his budget outline released in March, Trump proposed a $650 million cut in funding for MDBs over three years, singling out the World Bank Group for cuts.

“There is less money to go around, in all likelihood, if the Trump administration implements its March 2017 budget blueprint,” Davison, of Moody’s, highlights.

This makes the shift towards mobilisation of third-party financing all the more important. But while success stories like Elazig have emerged, MDBs must find a way to use risk mitigation on a wider scale to begin to close the global infrastructure gap in emerging markets.

“What is striking is that there seems to be little standardisation and little complementarity across the formal IFI risk products offered,” a report issued last July by the World Economic Forum concluded. “What is also apparent is that the annual mobilisation contribution of these instruments has been extremely limited, making at best a marginal contribution to crowding in private-sector finance.”

Even Kim, in his April address in London, acknowledged that the World Bank itself still has a way to go to best tackle its mandate. “To be honest, we haven’t changed the way we do our work enough – not yet,” Kim said. “To succeed with the immense tasks ahead of us, we have to fundamentally change our approach to development finance.”

Déau believes IFIs have made progress in shifting their approach from focusing on the volume of capital deployed to getting the most value for their own money, particularly in the last year. Crowding out of private capital still happens, but it is happening less.

The Elazig model can be replicated, Déau says, only if IFIs take a bottom-up approach, engaging with the private sector in developing risk mitigation products. 

“There has always been a tendency, in a lot of multilaterals, to sort of create their own product and then try to push it down to the market,” he adds. “If you create products and just try to apply them down, I think it will fail.”