Alternative Asset Classes for Pension Funds Transforming Need into Opportunities: Financing Infrastructure Trough Capital Markets –The Inca Model

National Pension Commission of Nigeria and The IFC Abuja March 2008

Johan Kruger

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Topics The Democratisation of South Africa The Rationale for an Intermediary The INCA Model Prerequisites for Pension Fund

Investments In Infrastructure The Advantages of Infrastructure

Investments Possible Intermediaries Conclusion

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The Democratisation of South Africa

Pre Democratisation Local Authorities White, Black, Indian,

Coloured White -economic base –strong cash flow-

institutional capacity-good infrastructure-Government support – no problem accessing capital markets

Black etc - no economic base-grant dependant=weak institutional structure-inadequate infrastructure-no private funding

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The Democratisation of South Africa

Post Democratisation Priority amalgamation of local authorities Investor withdrawal

Service Boycotts Tremendous Backlogs Lack of policy framework

Fruits of the new South Africa has to be delivered

Market gap in private sector infrastructure funding

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Rationale For Inca Local authority portion minute in

comparison with total contractual savings institution’s portfolio (0.2%)

Lack of understanding of local government

Uncertain policy environment But

Private sector know they must invest or jeopardise stability of Country

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Inca Started in 1996 with $10 m Peaked in 2004 at of $1000 m Portfolio Started in response to government appeal

to private sector Structured as intermediary between

infrastructure providers and capital markets

Listed and rated bonds on market Created two subsidiaries:non profit

capacity building fund and distressed bond company

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Basic Business case

Classic aggregation/disaggregation intermediary

Issue bonds in domestic market and conclude international loans to raise money

Pre approved credit limits Provide funds to borrowers

Amortizing or bullet/coupon Bulk is on balance sheet lending

Provide assistance trough an non profit company

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The Inca Model Offers investors

Understandable financials of single entity Opportunity for social investment Market related return - listed and AA-

rated bond Liquidity by market makers Diversified risk and equity/reserve buffer Dedicated expertise & risk assessment Second corporate bond in South Africa

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The INCA Model (2) Offers Local Authorities

Access to private sector finance Reasonable rates given risk profiles Transparency Assistance

Offers Shareholders Opportunity to invest at market related rates Benefit of participation

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Structure of Inca Choice of shareholders

Financial institutions Empowerment and gender partners DFI’s ( political insurance and credibility)

Rated (AA-) Back to back bonds in inception phase

no interest rate risk No expensive treasury Government stock hedging

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Structure of Inca (2) General obligations Computerised credit model

Pre assessment Shadow rating Turn around time 3 weeks Determines capital requirements Determines pricing Caveats

Limited but incentivised staff Non banking entity International Funding

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Capital Structure Of Inca Equity

Mezzanine debt

6%• Return

Govt plus 12-14%

23.5%• Return

Govt plus 2- 3.5%

70.5% • Return Govt plus 0.8-2.0%

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Credit ModelSolvencyLiquidityTurnover

StandardizationIncome

Cash flow

Diversity of taxGrowth indicatorsPhysical factors

ManagementCompetence

Dispute resolutionsBacklogs

Payment levels

Financial position

Economic environment

Institutional capacity

Socio-economic analysis

Environmental PoliciesPractices

Score

Peer Deviation

Potential problem areas

Shadow rating

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Capital,pricing,caveats

Typical Projects

Funding of: Municipal and regional

infrastructure Roads Sewerage Water Electricity other

Parastatal infrastructure14

Performance Portfolio peaked in 2004 at more

than $ 1 Billion Defaults never exceeded 0.2% Return to shareholders always in

excess of 20% Capacity building fund had a major

Impact

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Prerequisites for Successful Intermediaries

Rule of law –fair and timely Decentralised authority and autonomy Creditworthy or credit enhanced borrowers Acceptance of cost recovery principles and/or

appropriate subsidy where required Developed capital market – access - yield curves to

price risk- tradability Risk/reward in balance Clear policy framework Capacity to deal with defaults Trust from investment sector in management Credible shareholders

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Prerequisites for Pension fund Investment in

Infrastructure Pension fund’s first responsibility is to

their members Risk must be acceptable Reward must be market related and

competitive Appropriate listed and rated tradable

instruments must be available Long term yield curves Must be socially acceptable projects

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The Advantages of Investment in Infrastructure

Natural match between long term fixed rate requirement of infrastructure funding and the long term needs of the contractual savings sector

Diversification opportunity Higher yields possible Stimulates economic growth Benefits members

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Risks for Pension Funds

Failure of infrastructure providers Failure of intermediary Market risks Reputational risks In Nigeria administration problems

with intercepts

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Possible Borrowers and Intermediaries

State governments Local authorities Utility Companies Private sector intermediaries

UDBN Banks Spv’s

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Conclusion

Infrastructure is a natural area for the pension fund industry and Inca

in South Africa has proved the viability of investment in

development

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