global infrastructure and project finance outlook

8/11/2019 Global Infrastructure and Project Finance Outlook

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Management of Financial Services

Infrastructure and Project Finance

A GLOBAL OUTLOOK

Term paper submitted in partial fulfillment of assessment in the subject of

Management of Financial Services

Submitted by: Submitted to:

Purav Shah Prof. Rituparna DasRoll No. 963 Assistant Dean,

B.B.A. LL.B. (Hons.) Faculty of Policy Science


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TABLE OF CONTENTS

TABLE OF CONTENTS ............................................................................................... 2

ACKNOWLEDGMENT................................................................................................ 3

INTRODUCTION TO PROJECT FINANCE ............................................................... 4

BASIC SCHEME OF PROJECT FINANCE ................................................................ 5

COMPLICATING FACTORS UNDER THE SCHEME.............................................. 7

CREDIT RISK IN PROJECT FINANCE...................................................................... 8

RECENT DEVELOPMENTS IN THE PROJECT FINANCE MARKET ................. 10

THE KEY CHARACTERISTICS OF PROJECT FINANCING STRUCTURES ..... 12

GROWTH OF PROJECT FINANCE FROM THE CAPITAL MARKETS............... 15

FUNDING IN INRASTRUCTURE FINANCE .......................................................... 16

WHAT IS SPECIAL ABOUT INFRASTRUCTURE FINANCING? ........................ 18

GLOBAL INFRASTRUCTURE SPENDING ............................................................ 26

INFRASTRUCTURE FINANCING AROUND THE GLOBE .................................. 28

GLOBAL FINANCIAL CRISIS AND THE RECOVERY IN 2013 .......................... 40

CONCLUSION ............................................................................................................ 44


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ACKNOWLEDGMENT

The note of acknowledgment is an indispensable part of the paper. The author would

like to give due credit to the people who have helped him through the course of this

project.

The author would like to thank the faculty of Management of Financial Services,

Prof. Rituparna Das for allotting him the very engaging and fascinating topic of

Infrastructure and Project Finance: A Global Outlook. The author would like to

extend his heartfelt gratitude to him for his pedagogy, which has been instrumental in

enhancing the authors learning.

The author would also like to thank the library staff which has been of immense help

to him in his research work.


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INTRODUCTION TO PROJECT FINANCE

Project finance is the long-term financing of infrastructure and industrial projects

based upon the projected cash flows of the project rather than the balance sheets of its

sponsors. Usually, a project financing structure involves a number of equity investors,

known as sponsors, as well as a syndicate of banks or other lending institutions that

provide loans to the operation. They are most commonly non-recourse loans, which

are secured by the project assets and paid entirely from project cash flow, rather than

from the general assets or creditworthiness of the project sponsors, a decision in part

supported by financial modeling. The financing is typically secured by all of the

project assets, including the revenue-producing contracts. Project lenders are given a

lien on all of these assets and are able to assume control of a project if the project

company has difficulties complying with the loan terms.

Generally, a special purpose entity is created for each project, thereby shielding other

assets owned by a project sponsor from the detrimental effects of a project failure. As

a special purpose entity, the project company has no assets other than the project.

Capital contribution commitments by the owners of the project company are

sometimes necessary to ensure that the project is financially sound or to assure the

lenders of the sponsors commitment. Project finance is often more complicated than

alternative financing methods. Traditionally, project financing has been most

commonly used in the extractive (mining), transportation, telecommunications

industries as well as sports and entertainment venues.

Risk identification and allocation is a key component of project finance. A project

may be subject to a number of technical, environmental, economic and political risks,

particularly in developing countries and emerging markets. Financial institutions and

project sponsors may conclude that the risks inherent in project development and

operation are unacceptable. Several long-term contracts such as construction, supply,

off-take and concession agreements, along with a variety of joint-ownership structures

are used to align incentives and deter opportunistic behaviour by any party involved

in the project. The patterns of implementation are sometimes referred to as "project

delivery methods." The financing of these projects must be distributed among

multiple parties, so as to distribute the risk associated with the project while

simultaneously ensuring profits for each party involved.


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A riskier or more expensive project may require limited recourse financing secured by

a surety from sponsors. A complex project finance structure may incorporate

corporate finance, securitization, options (derivatives), insurance provisions or other

types of collateral enhancement to mitigate unallocated risk.

BASIC SCHEME OF PROJECT FINANCE

Suppose Acme Coal Co. imports coal and Energen Inc. supplies energy to consumers.

The two companies agree to build a power plant to accomplish their respective goals.

Typically, the first step would be to sign a memorandum of understanding to set out

the intentions of the two parties. This would be followed by an agreement to form a

joint venture.

Acme Coal and Energen form an SPC (Special Purpose Corporation) called Power

Holdings Inc. and divide the shares between them according to their contributions.

Acme Coal, being more established, contributes more capital and takes 70% of the

shares. Energen is a smaller company and takes the remaining 30%. The new

company has no assets.

Power Holdings then signs a construction contract with Acme Construction to build a

power plant. Acme Construction is an affiliate of Acme Coal and the only company


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with the know-how to construct a power plant in accordance with Acme's delivery

specification.

A power plant can cost hundreds of millions of dollars. To pay Acme Construction,

Power Holdings receives financing from a development bank and a commercial bank.

These banks provide a guarantee to Acme Construction's financier that the company

can pay for the completion of construction. Payment for construction is generally paid

as such: 10% up front, 10% midway through construction, 10% shortly before

completion, and 70% upon transfer of title to Power Holdings, which becomes the

owner of the power plant.

Acme Coal and Energen form Power Manage Inc., another SPC, to manage the

facility. The ultimate purpose of the two SPCs (Power Holding and Power Manage) is

primarily to protect Acme Coal and Energen. If a disaster happens at the plant,

prospective plaintiffs cannot sue Acme Coal or Energen and target their assets

because neither company owns or operates the plant.

A Sale and Purchase Agreement (SPA) between Power Manage and Acme Coal

supplies raw materials to the power plant. Electricity is then delivered to Energen

using a wholesale delivery contract. The cash flow of both Acme Coal and Energen

from this transaction will be used to repay the financiers.


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COMPLICATING FACTORS UNDER THE SCHEME

The above is a simple explanation which does not cover the mining, shipping, and

delivery contracts involved in importing the coal (which in itself could be more

complex than the financing scheme), nor the contracts for delivering the power to

consumers. In developing countries, it is not unusual for one or more government

entities to be the primary consumers of the project, undertaking the "last mile

distribution" to the consuming population. The relevant purchase agreements between

the government agencies and the project may contain clauses guaranteeing a

minimum offtake and thereby guarantee a certain level of revenues. In other sectors

including road transportation, the government may toll the roads and collect the

revenues, while providing a guaranteed annual sum (along with clearly specified

upside and downside conditions) to the project. This serves to minimise or eliminate

the risks associated with traffic demand for the project investors and the lenders.


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Minority owners of a project may wish to use "off-balance-sheet" financing, in which

they disclose their participation in the project as an investment, and excludes the debt

from financial statements by disclosing it as a footnote related to the investment. In

the United States, this eligibility is determined by the Financial Accounting Standards

Board. Many projects in developing countries must also be covered with war risk

insurance, which covers acts of hostile attack, derelict mines and torpedoes, and civil

unrest which are not generally included in "standard" insurance policies. Today, some

altered policies that include terrorism are called Terrorism Insurance or Political Risk

Insurance. In many cases, an outside insurer will issue a performance bond to

guarantee timely completion of the project by the contractor.

Publicly funded projects may also use additional financing methods such as tax

increment financing or Private Finance Initiative (PFI). Such projects are often

governed by a Capital Improvement Plan which adds certain auditing capabilities and

restrictions to the process.

Project financing in transitional and emerging market countries are particularly risky

because of cross-border issues such as political, currency and legal system risks.[3]

Therefore, mostly requires active facilitation by the government.

CREDIT RISK IN PROJECT FINANCE

For decades, project finance has been the preferred form of financing for large- scale

infrastructure projects worldwide. Several studies have emphasized its critical

importance, especially for emerging economies, focusing on the link between

infrastructure investment and economic growth. Over the last few years, however,

episodes of financial turmoil in emerging markets, the difficulties encountered by the

telecommunications and energy sectors and the financial failure of several high-

profile projectshave led many to rethink the risks involved in project financing.

The question whether longer maturities are a source of risk per se is crucial to

understanding the distinctive nature of credit risk in project finance. Large- scale

capital-intensive projects usually require substantial investments up front and only

generate revenues to cover their costs in the long term. Therefore, matching the time


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profile of debt service and project revenue cash flows implies that on average project

finance loans have much longer maturities than other syndicated loans.

This special feature argues that a number of key characteristics of project finance,

including high leverage and non-recourse debt, have direct implications for the term

structure of credit risk for this asset class. In particular, a comparative econometric

analysis of ex ante credit spreads in the international syndicated loan market suggests

that longer-maturity project finance loans are not necessarily perceived by lenders as

riskier compared to shorter-term credits. This contrasts with other forms of debt,

where credit risk is found to increase with maturity, ceteris paribus.

Financing high-profile infrastructure projects not only requires lenders to commit for

long maturities, but also makes them particularly exposed to the risk of political

interference by host governments. Therefore, project lenders are making increasing

use of political risk guarantees, especially in emerging economies. This special

feature also provides a cross-country assessment of the role of guarantees against

political risk and finds that commercial lenders are more likely to commit for longer

maturities in emerging economies if they obtain explicit or implicit guarantees from

multilateral development banks or export credit agencies. This is shown to further

reduce project finance spreads observed at the long end of the maturity spectrum.

After a review of the history and growth of project finance, we need to the specific

challenges involved in financing large-scale capital-intensive projects, while the third

section explains how project finance structures are designed to best address those

risks. An analysis shows how the particular characteristics of credit risk in project

finance are consistent with the hump-shaped term structure of loan spreads observed

ex ante for this asset class.


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RECENT DEVELOPMENTS IN THE PROJECT FINANCE MARKET

Project finance involves a public or private sector sponsor investing in a single-

purpose asset through a legally independent entity. It typically relies on non- recourse

debt, for which repayment depends primarily on the cash flows generated by the asset

being financed.

Since the 1990s, project finance has become an increasingly diversified business

worldwide. Its geographical and sectoral reach has grown considerably, following

widespread privatization and deregulation of key industrial sectors around the world.

In the years following the East Asian crisis (199899), financial turmoil in emerging

markets led to a global reallocation of investors portfolios from developing to

industrialized countries. New investments, notably in north America and western

Europe, more than offset the capital flight from emerging economies, such that total

global lending for project finance rebounded from a two-year slump, reaching a

record high in 2000 (Graph 1).


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Since 2001, the general economic slowdown and industry-specific risks in the

telecoms and power sectors have led to a substantial decline in project finance lending

worldwide (Graph 2). The power sector has been particularly hurt by accounting

irregularities and high volatility in energy prices: the debt ratings of 10 of the leading

power companies fell from an average of BBB+ in 2001 to B in 2003. Telecoms

firms have been penalized for sustaining onerous investments in new technologies

(like fibre-optic transmission or third-generation mobile licenses in Europe) that have

not yet generated the expected returns. Over 60 telecoms companies filed for

bankruptcy between 2001 and 2002 as overcapacity led to price wars and customer

volumes failed to live up to overoptimistic projections.

Despite the recent downturn, the long-term need for infrastructure financing in both

industrialized and developing countries remains very high. In the United States alone,

between 1,300 and 1,900 new electricity generating plants need to be built in order to

meet growing demand over the next two decades.


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THE KEY CHARACTERISTICS OF PROJECT FINANCING STRUCTURES

In project finance, several long-term contracts such as construction, supply, off-take

and concession agreements, along with a variety of joint-ownership structures, are

used to align incentives and deter opportunistic behaviour by any party involved in

the project. The project company operates at the center of an extensive network of

contractual relationships, which attempt to allocate a variety of project risks to those

parties best suited to appraise and control them: for example, construction risk is

borne by the contractor and the risk of insufficient demand for the project output by

the off-taker (Graph 3).

Project finance aims to strike a balance between the need for sharing the risk of

sizeable investments among multiple investors and, at the same time, the importance

of effectively monitoring managerial actions and ensuring a coordinated effort by all

project-related parties.

Large-scale projects might be too big for any single company to finance on its own.

On the other hand, widely fragmented equity or debt financing in the capital markets

would help to diversify risks among a larger investors base, but might make itdifficult to control managerial discretion in the allocation of free cash flows, avoiding


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wasteful expenditures. In project finance, instead, equity is held by a small number of

sponsorsand debt is usually provided by a syndicate of a limited number of banks.

Concentrated debt and equity ownership enhances project monitoring by capital

providers and makes it easier to enforce project- specific governance rules for the

purpose of avoiding conflicts of interest or sub- optimal investments.

The use of non-recourse debt in project finance further contributes to limiting

managerial discretion by tying project revenues to large debt repayments, which

reduces the amount of free cash flows.

Moreover, non-recourse debt and separate incorporation of the project company make

it possible to achieve much higher leverage ratios than sponsors could otherwise

sustain on their own balance sheets. In fact, despite some variability across sectors,

the mean and median debt-to-total capitalization ratios for all project-financed

investments in the 1990s were around 70%. Non- recourse debt can generally be

deconsolidated, and therefore does not increase the sponsors on-balance sheet

leverage or cost of funding. From the perspective of the sponsors, non-recourse debt

can also reduce the potential for risk contamination. In fact, even if the project were to

fail, this would not jeopardize the financial integrity of the sponsors core businesses.

One drawback of non-recourse debt, however, is that it exposes lenders to project-

specific risks that are difficult to diversify. In order to cope with the asset specificity

of credit risk in project finance, lenders are making increasing use of innovative risk-

sharing structures, alternative sources of credit protection and new capital market

instruments to broaden the investors base.

Hybrid structures between project and corporate finance are being developed, where

lenders do not have recourse to the sponsors, but the idiosyncratic risks specific to

individual projects are diversified away by financing a portfolio of assets as opposed

to single ventures. Public-private partnerships are becoming more and more common

as hybrid structures, with private financiers taking on construction and operating risks

while host governments cover market risks.

There is also increasing interest in various forms of credit protection. These include

explicit or implicit political risk guarantees,6 credit derivatives and new insuranceproducts against macroeconomic risks such as currency devaluations. Likewise, the


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use of real options in project finance has been growing across various industries.7

Examples include: refineries changing the mix of outputs among heating oil, diesel,

unleaded gasoline and petrochemicals depending on their individual sale prices; real

estate developers focusing on multipurpose buildings that can be easily reconfigured

to benefit from changes in real estate prices.

Finally, in order to share the risk of project financing among a larger pool of

participants, banks have recently started to securitize project loans, thereby creating a

new asset class for institutional investors. Collateralized debt obligations as well as

open-ended funds have been launched to attract higher liquidity to project finance.


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GROWTH OF PROJECT FINANCE FROM THE CAPITAL MARKETS

The notion that new financiers dominate infrastructure project finance is

misleading. Actually, 70 to 80 percent of all project finance deals are still funded by

commercial banks, although rated deals funded through capital markets are

increasingly being used as a substitute. The difference is that the rating agencies

conduct due diligence and debt is priced according to the rating assigned to the

transaction, which is said to measure levels of risk.

The first rating for a public project finance transaction was for a co-gen power plant

in Michigan and did not take place until 1991. The first cross-border, non-United

States transaction rating did not occur until 1994. So, the history is relatively short,

and project finance, as a financing tool or methodology is still in its infancy when

compared to corporate finance (in general) or public finance in the United States. The

industry remains in a state of flux, evolving as different players enter the market

bringing with them the methods used, for example, in municipal and public sector

finance, corporate finance, and structured finance.

There are several key trends in the evolution of project finance from the capital

markets. In terms of regional activity for rated project finance transactions,

approximately half of rated transactions between 1994 and 2006 took place in the

United States, although the use of this type of instrument is growing in Europe, Latin

America and the Middle East. Most project ratings tend to fall in the lowest

investment grade category (Baa3) with a persistent spike at the highest (AAA) level.

These transactions involve a monoline insurance guarantee. Rating methodologies for

target sectors are gradually evolving. Initially, rated deals were mostly for power

projects, but today toll roads are also being financed via the international capital

markets.

Growth in the rated project finance market can be explained by a combination of key

factors, some of which are focused on the capital markets. For example, interest rates

since 2002 have been significantly lower on average than the preceding fifteen years.

Not too many years ago, when toll roads were first rated in Chile, interest rates ranged

between 8 and 10 percent. However, a transaction in Chile was recently rated under 4

percent. In addition, liquidity in most markets has been quite high, increasing


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financings via the capital markets. The yield and profitability of project finance is

currently higher than municipal and corporate finance. The interest in project finance

is also fuelled by the perception that infrastructure and project finance focus on

essential long term valued assets that provide stable cash flows. The globalization of

industry is also a factor in its growth because it brings more players into certain

markets, such as monoline insurance companies. The willingness of AAA-rated

monoline insurance companies to insure these transactions encourages investors.

Identifying risks is critical to the development of this market. However, the only way

that risks can be identified is if there is greater transparency; that is, if there are more

frequent flows of information on the financial and operating performance of the

assets. The benefit of financing projects through the capital markets as opposed to

commercial banks is that the rating process tends to force sponsors to provide

information that is consistent and comparable. Over time, as project financing through

the capital markets matures, it should lead to increased transparency for the entire

project finance industry, and lead to increased investment.

FUNDING IN INRASTRUCTURE FINANCE


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It was not so long ago that infrastructure investment in India was financed almost

entirely by the public sector from government budgetary allocations and internal

resources of public sector infrastructure companies. In the span of 10 years, and

particularly in the past four, the private sector has emerged as a significant player in

bringing in investment (see Figure 1) and building and operating infrastructure assets

from roads to ports and airports and to network industries such as telecom and power.

Private investment now constitutes almost 20 per cent of infrastructure investment'.

Yet, total infrastructure investment remains low, at around 5 per cent of GDP. In

contrast, China spent an estimated 14.4 per cent of GDP on infrastructure investment

in 2006 and, contrary to popular perception, with little dependence on the state

budget. The Government of India aims to raise infrastructure investment to over 9 per

cent of GDP by the end of the 11th Five-Year Plan (2007-12), or an average of 7.4 per

cent of GDP a year during the plan, and projects a rise in the share of the private

sector to 30 per cent.

It is conceivable that the public sector can develop world-class infrastructure of the

magnitude envisaged as China and other countries have shown. But India has

embarked on a model that includes private participation in infrastructure. The

government recognises that public savings are not sufficient and also that the public

sector, given its limited implementation capacity, cannot meet the huge infrastructure

requirements to underpin economic growth of 9 per cent per annum. Moreover, the

private sector brings greater efficiency in service delivery. To attract the private

sector, the government has been putting in place the appropriate regulatory and

institutional frameworks. At present, private investment in infrastructure is barely 1

per cent of GDP and most of the investments are in greenfield projects in telecom and

energy, with concessions mainly in transport (Figure 2). Clearly, there is considerable

scope to increase this. Countries which had impressive private investment in

infrastructure in the 1990s had levels ranging from 4 to 6 per cent of GDP. Besides

purely private projects, the government aims to catalyse private investment through

public-private partnerships (PPP); the 11th Plan envisaged private infrastructure

investment to rise to 2.8 per cent of GDP by 2012. Private investment is expected to

constitute more than 65 per cent of investment in telecom, ports and airports, 26

percent in power and 36% in roads.


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If we set aside institutional and governance issues and focus on financial aspects, the

problem may not seem insurmountable abstracting from the current financial

turmoil, which is temporary. After all, India has a high domestic savings rate which,

at almost 35 per cent of GDP (in 2006-07), compares well with that of East Asian

countries. Savings of the corporate sector have been rising steadily and were almost 8

per cent of GDP in 2006-07, while public savings also contributed, rising to over 3

per cent of GDP (from negative savings until 2002-03). What is of relevance, though,

is that of the total household sector savings of around 23-24 per cent of GDP, less

than half are in financial assets and more than half of the financial savings are in bank

deposits, leaving a limited portion in other financial instruments. Contractual savings

those that are in long-term financial instruments are just around 4 per cent of GDP

(Table 1). Thus, the issue is not the lack of domestic savings or even of foreign

capital, but that of financial intermediation, that is, how to channel long-term savings

into infrastructure.

WHAT IS SPECIAL ABOUT INFRASTRUCTURE FINANCING?

Building infrastructure is a capital-intensive process, with large initial costs and low

operating costs. It requires long-term finance as the gestation period for such projects

is often much longer than, say, for a manufacturing plant. Infrastructure projects are

characterised by non-recourse or limited recourse financing, that is, lenders can only

be repaid from the revenues generated by the project. Thus, the market and

commercial risks, including uncertainty of (traffic) demand forecasts, assume greater

significance for lenders. Besides the usual project risks, infrastructure development

has other unique risks because of the public interest nature of most projects and the

interface with regulators and government agencies. These risks could include tariff

increase reversals due to public unacceptability of the tariffs determined, challenging

of environmental clearances, arbitrary reneging of contracts and non-payment by

(financially weak) monopoly public utilities.

As a result, complex risk mitigation and allocation arrangements are embedded in the

financial and contractual agreements amongst multiple partiesproject sponsors,

commercial banks, domestic and international financial institutions, and government

agencies. And infrastructure projects have significant externalitieswhere the social


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returns exceed the private returns which call for some form of subsidization, such

as government guarantees or viability gap funding to make them attractive for private

sector involvement.

Infrastructure projects are generally executed through individual project companies

called special purpose vehicles (SPV). The main reason for this is to better protect the

parent company from possible adverse impact in the concession business. Separate

SPV projects are then held by the parent company or its subsidiary in a holding

company structure. SPVs typically do not have recourse to their parent companies

after the initial capitalization, nor do they have a credit history and strong balance

sheets. This naturally affects their ability to secure financing from outside.

Thus, infrastructure financing presents a number of challenges. The scale of

investment is large and investors have to be prepared for a long horizon for debt

repayment and return on equity. Many financial institutions are limited in their ability

to invest in very long-term illiquid assets. The non-recourse nature, the unique risks of

infrastructure development as well as the complexity of the arrangements also call for

special appraisal skills. Since the output is non-tradable (with revenues accruing in

domestic currency), infrastructure projects should generally be domestically financed

to avoid high foreign exchange risk, although there are financial instruments to

mitigate such risks in well-developed financial markets..

As a country's financial system matures and becomes more sophisticated it is able to

respond to these challenges in flexible, innovative ways. It can bring a range of

investors at various stages of the project. Investors with the requisite skills and risk

appetite are needed to provide the initial financing, but should then be able to offload

the assets to other investors when the projects start yielding revenues, thus moving on

to invest in new projects. By this time, the major risks (especially construction risks)

have already been borne by the initial investors and the projects have a prospective

stable revenue stream. A different type of investor may come in at this stage, thus

widening the pool of investors that can be tapped and lowering the overall financing

cost of the project.


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LIMITS TO EXISTING FINANCING SOURCES

DEBT FINANCING

Notwithstanding the difficulties, infrastructure financing has grown rapidly over the

past few years in tandem with the increase in private investment in infrastructure.

This is because of the pivotal role played by commercial banks, primarily a few key

public sector banks that have been willing to provide the project finance. Table 2

provides indicative estimates of debt financing. Commercial bank lending to

infrastructure took off four years ago, in 2004-05, followed by specialized non-bank

finance companies (NBFCs), which are largely dependent on bank funding, in 2005-

06. The insurance sector, dominated by the Life Insurance Corporation of India (LIC),

has also steadily increased its financing of infrastructure. Data on foreign borrowing

are hard to come by but a (gross) disbursement estimate for 2006-07 indicates that

external commercial borrowings (ECB) account for less than 20 per cent of the total

debt finance to infrastructure. These are positive trends, no doubt. But the Planning

Commission's estimate of total debt needs for infrastructure investment during the

11th Plan-Rs. 984,500 crores (at 2006-07 constant prices) implies, on average, 2.5

times increase in the annual amount from Rs. 80,000-plus crores in 2006-07. After

projecting that the traditional sources of finance can expand to Rs. 825,500 crores, the

Planning Commission estimates a gap of Rs. 159,000 crores. Realising the overall

debt target is a huge challenge given the constraints to growth in each of the sources

of debt finance.


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Commercial banks have driven the increase in infrastructure finance, both direct and

indirect. The first year of the plan (2007-08) recorded high growth but a continued

rapid expansion of such finance may not be sustainable as it is leading to a growing

concentration of risks on banks' balance sheets. These risks arise from the maturity

mismatch created by financing long duration infrastructure projects from the

essentially short-term nature of banks' liabilities. Within six years, between March

2002 and March 2008, total bank lending to infrastructure trebled from 3.1 per cent oftotal non-food gross bank credit outstanding to 9.2 per cent. The growing asset-

liability maturity mismatch on account of infrastructure has been exacerbated by a

concurrent rise in other long-term assets, in particular housing loans. Together, these

long-term assets now account for 21 per cent of total non-food bank credit (see Figure

3). In fact, the exposure of banks to infrastructure and housing is actually higher as

banks lend to NBFCs who on-lend to these sectors.


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If we assume that non-food bank credit will grow at 20 per cent a year for the rest of

the Plan period, the Planning Commission's projections imply that bank lending to

infrastructure will account for about 13 per cent of total non-food bank credit by

2011-12. These are overall numbers; individual bank exposure would be significantly

higher for some, since many banks do not have the skills-set or balance-sheet size to

engage in infrastructure lending. Moreover, the share of housing loans in bank

portfolios is also likely to increase given the thrust on financing affordable housing.

Thus, the share of total long-term assets could very easily rise to above 30 per cent of

banks' non-food credit. The risks are higher on banks than evident in these numbers as

specialised NBFCs also rely on bank funding.

The increasing share of long-term assets comes at a time when the maturity of

deposits has been shortening, thus exacerbating the liquidity risk of financing long-term assets with short-term liabilities. Term deposits with maturity of three years and

above have declined from 32.9 per cent of total term deposits in March 2000 to 22.7

per cent by March 2007 (and only 7 per cent are at five years or more). Banks have

been dealing with this situation by relying on annual interest resets and put/call

options on the loans, thereby passing the market risks to the projects. However, if

projects are unable to bear all the risks, they could become a credit risk to banks. It

should be noted, though, that savings account deposits have been in the region of 24-

28 per cent of aggregate deposits for several years. Therefore, if we assume that 80


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per cent of savings deposits are fairly stable and consider them along with term

deposits of maturity of three years and over, about 35 per cent of aggregate bank

deposits may be viewed as stable as of March 2007 (down from 40 per cent in March

2000). So, 35 per cent of total deposits (assuming that the share of long maturity term

deposits does not decline any further) would cover the projected 30 per cent of long-

term loans by 2011-12. However, it should be noted that the maturity period of the

loans is typically over 10 years and the bulk of the long-term deposits is in the three-

year original maturity period. In fact, only about 3 per cent of deposits have a five-

year or greater residual maturity as of March 2007.

Graph: Breakdown of Unlisted Infrastructure Debt Fund Universe by Primary

Geographic Focus

On its own, the maturity mismatch may not seem severe, but combined with other

vulnerabilities in the balance sheets of banks, it could lead to problems. Take, for

instance, the current situation. Banks had been lending at breakneck pace over the

past few years, with incremental credit-deposit ratios often of 90 per cent and over.

As a result, they had to borrow from non-bank sources. When the global credit crisis

broke out and domestic liquidity tightened due to capital outflows, the over-extended


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banks had difficulties meeting their liabilities as short-term borrowing from the non-

bank sources dried up. And, as happens in times of crisis, the maturity structure of

bank liabilities shortens quicklyso if banks are vulnerable due to other factors, it

could lead to further stress in the banking system.

In addition, many banks are reaching exposure limits to infrastructure-related

borrowers (because of large project size relative to bank capital). Indian banks are

relatively small. Only 11 banks had equity above $1 billion in March 2007, of which

two were private sector banks. The largest bank, the State Bank of India, had just over

$7 billion of capital in March 2007. The next three public sector banks together would

be equivalent in capital strength to SBI. The total equity of the 82 scheduled

commercial banks (including 29 foreign banks) was $49.8 billion. Thus, there are

many small banks, most of which do not engage in infrastructure lending and the

handful of banks that are actively lending to infrastructure are likely to reach exposure

limits if they continue lending at this pace.

Specialised NBFCs have become a significant source of infrastructure finance but

their growth by their access to bank finance, in the absence of alternative wholesale

funding sources. Tighter prudential limits of bank lending to NBFCs have effectively

capped the latters access to bank lending funds. Even if there is some headroom on

bank exposure limits to NBFCs and bank resources are forthcoming, this would be at

a significantly high costs due to the incidence of a higher capital charge and

provisioning requirement on standard assets for bank lending to NBFCs. Moreover

banks are increasingly providing shorter tenor finance and have an annual reset in

interest rates, thereby passing the interest rates to the NBFCs.


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Graph: Annual Infrastructure Debt fundraising (All Time)

EQUITY FINANCING

Supporting higher levels of debt requires more equity, with the amount varying with

the level of project risk. Equity is mainly provided by the project sponsor who, in

turn, may tap the primary market for capital. Infrastructure companies from IPO

raised substantial resources with the secondary market boom in recent years, peaking

in 2007-08 before drying up more recently due to the financial turmoil (see Table 3).

Clearly, developers have a limited amount of capital and have to tie it up for a

significant length of time for each project. It is therefore important to bring in

financial investors so that the promoters' risk capital can be recycled into other

projects. In recent years, financial investors have shown keen interest in India:

witness the number of private equity (PE) infrastructure funds formed6. However,

rules for sell-down of equity can be quite stringent and act as a deterrent to the entry

of more financial investors who would like greater flexibility in exit options.

Moreover, sales of unlisted projects, unlike listed investments, are subject to the full

weight of the capital gains tax. Since most infrastructure projects are unlisted, this


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acts as a disincentive to equity investors in infrastructure. Also, equity investors

perceive termination payments for government agency defaults (for example, not

providing the right of way in road projects) to be inadequate in many concession

agreements. In some cases, the lenders are repaid whereas the equity holders suffer.

This encourages a greater use of debt.

The biggest constraint to the development of a strong domestic PE industry is the very

narrow base of domestic investors. Globally, PE firms rely on a mix of institutional

investors such as pension funds and insurance companies and contributions from high

net worth investors. In India, the ability of insurance firms and pension funds to

invest in alternative asset classes is still quite restricted and they will take some time

to take up this asset class.

GLOBAL INFRASTRUCTURE SPENDING

Infrastructure spending has begun to rebound from the global financial crisis and is

expected to grow significantly over the coming decade. That is the main finding of

Capital project and infrastructure spending after an in-depth analysis of 49 countries

that account for 90% of global economic output.

Chart: Investors Expected Capital Commitments to Infrastructure Funds in the

Next 12 Months Compared to the Last 12 Months


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In developing this analysis, Oxford Economics used data sets to provide consistent,

reliable, and repeatable measures of projected capital project and infrastructure

spending globally as well as by country. Historical spending data is drawn from

government and multinational organization statistical sources. Projections are based

on proprietary economic models developed by Oxford Economics at the country and

sector levels. Worldwide, infrastructure spending will grow from $4 trillion per year

in 2012 to more than $9 trillion per year by 2025. Overall, close to $78 trillion is

expected to be spent globally between 2014 and 2025.

But the recovery will be uneven, with infrastructure spending in Western Europe not

reaching pre-crisis levels until at least 2018. Meanwhile, emerging markets,

unburdened by austerity or ailing banks, will see accelerated growth in infrastructure

spending, especially China and other countries in Asia.

And megacities in both emerging and developed marketsreflecting shifting

economic and demographic trendswill create enormous need for new infrastructure.

These paradigm shifts will leave a lasting, fundamental imprint on infrastructure

development for decades to come.

Graph: Amount of Fresh Capital Investors Plan to Invest in Infrastructure over

the Next 12 Months


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Graph: Government fixed Investment in Infrastructure, % of GDP (CANADA)

Traditionally, infrastructure project finance in the United States has relied on

municipal bonds. However, infrastructure project bond activity has been growing with

programmes such as the Transportation Infrastructure Finance and Innovation Act

(TIFIA) and Private Activity Bonds (PAB). While TIFIA is a low cost federal

loan programme for up to 49% of the cost of PPP and conventional transport

infrastructure projects, it still requires the underlying project to be investment grade.

This requirement helps bring discipline/viability to the project selection and

development pipeline, and also mitigate the reputational risk inherent in such a high

profile programme. TIFIA has supported long tenors/average lives (including a 34

year loan on Virginia Midtown Tunnel, alongside a PAB) and pricing akin to

Treasuries. The governments position is subordinated until an event of default, at

which point it springs up. PABs are one way of making up the 51% not funded underTIFIA, but Green12 (as for TIFIA) only transport projects are eligible. In addition,

there is a ceiling on PABs of USD15bn at present. USD4bn has been issued and

another USD4bn is allocated to projects. As with municipal bonds in general, PABs

have tax advantages whereby the interest received is tax-exempt to the investor and

therefore the borrower can offer/pay a lower interest than would be the case. This is

effectively a tax allocation from the federal tax base to the municipality and the

infrastructure users. Outside of the transport sector, there is presently debate around

introducing a structure similar to TIFIA for potable water and wastewater projects


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and, more generally, development of a loan and bond guarantee facility to states, local

governments and non-profit infrastructure providers in respect of transportation,

energy, water, communications and educational facility infrastructure projects. Lastly,

much of the markets growth potential lies in therenewables sector, which will

require about USD150 billion in new construction through to 2022. MidAmerican

Topaz one of the worlds largest photovoltaic solar farms raised USD850m in

privately issued 144A/Reg S 5.75% project bonds (due 2039) in February 2012, and

another USD250m in April 2012.

Graph: Government fixed Investment in Infrastructure, % of GDP (USA)

In Mexico, the central issue is insufficient pipeline as there is currently more funding

available than projects. The country has a sizable life insurance and pension industry

and government policies implemented in the mid and late 2000s increasinglyencourage funds to invest in infrastructure projects. Since roughly 2008, state-owned

Banobras has funded the relatively small number of projects, and subsequently

syndicated the debt. That said, as the project pipeline grows, it is unlikely that

Banobras will be able to meet rising demand and increasingly there are long-dated

project finance bonds. Notable recent issues included (in 2011) a MXN7.1bn

nonrecourse bond related to Sarre and Papagos prisons, the first fully commercially

financed greenfield social infra concession in Mexico. More recently, Banobras acted

as credit guarantor on the Red de Carreteras de Occidente concession sold to


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domestic and foreign institutions for USD1.16bn in long-term, peso-denominated

notes to pay for the FARAC I toll road, and Mexico Generadora de Energia (MGE)

issued USD575m of long-dated BBB paperfor two gas turbines at T+388bps.

Brazil needs some USD50bn per year in infrastructure investment. As noted above,

the size of this pipeline is pressuring BNDES (funded by the federal government)

which has recently had very high lending levels. For example, in 2010 they disbursed

around BRL168.4bn.

In the rest of Latin America, as in Mexico, capital is generally available and the

problem is a lack of bankable projects. Chile is seen as a relevant model for the

region; it established a project bond market in 1999, and prior to the GFC institutional

investors were funding significant deal volumes in this fashion as much as 50% of

the total infrastructure pipeline. However, the retraction of monoline bond insurers

significantly impacted Chile, and the country has not seen any project bond issuances

since then.

The governments of several countries in the region, such as Argentina, Uruguayand

Peru consider pension funds as one of the key financing sources for enabling and

accelerating the execution of their current or future infrastructure programmes. This

policy choice resulted in a package of measures and tools (including political

pressure) to facilitate and stimulate pension fund involvement. For instance,

Columbia and Peru have recently made changes to their legal framework to spur

institutional investment into infrastructure. However, the lack of a pipeline has meant

that institutions have generally not had the business case to develop project finance

structures further. Recent issues in Peru include Terminales Portuarios Euroandinos

Paita which raised USD110m of long dated BB/BB- paperat c350bp over, and also

the Peru Hospital PPP (USD320m). The latter is a quasi-sovereign issue secured by

EsSalud. This issue also mitigates construction risk for investors through milestone

based issuance of EsSaluds obligations. In July 2011, Invepar issued PEN1.17bn in

inflation linked, private placement bonds to finance the 30-year Via Parque Rimac toll

road concession in Lima at VAC +650bp.


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Graph: Global Infrastructure Spending by 2025

In the UK, after a long hiatus, the first half of 2013 has seen numerous greenfield (i.e.

with construction risk) project bond issuances in the university accommodation, social

housing and healthcare sectors. Notable issues in student accommodation include

Uliving@Hertfordshire (GBP143.5m of A- rated index-linked priced at 235bp over

index linked gilts) and University of Edinburgh which sold GBP31m each of

monoline-wrapped, index-linked and fixed rate tranches with spreads of 190bp and

215bp over gilts respectively. In social housing, the Leeds Little London and Holbeck

Housing PFI sold GBP102m of monoline-wrapped, fixed rate bonds at 235bp over

gilts. In addition, the Salford Pendleton Social Housing project issued senior fixed

rate bonds (at 190bp over gilts), supported by a subordinated tranche. In healthcare,

the Alder Hey Childrens hospital raised GBP110m via a private placement bond.

PwC advised on the Edinburgh, Leeds, Salford and Alder Hey transactions, giving us

unparalled insight into recent project bond issues.

The UK Treasury has also sponsored a cGBP40bn guarantee scheme. The scheme

was initially set up to provide credit enhancement to financiers where long-term

lending was expected to no longer be available. The significant decline in the volume


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of infrastructure projects in the UK has meant that banks have so far been able to

finance most of the projects. The future use of the guarantee scheme is unclear, as

project activity declines and capital markets innovate to plug the bank gap. It is

possible that the guarantee will be targeted as projects that cannot be financed on a

stand-alone basis due to size or cost, hopefully without over exposing the tax payer to

project risk.

The Benelux countries (Belgium, Netherlands, and Luxembourg) and Germany

are very advanced in their application of project finance. Whilst traditionally bank

funded markets, there is active exploration of capital markets solutions. To date,

authorities procurement rules (particularly in the Netherlands) have required

committed finance and this does not sit easily with public bond book building

where the bond spread is only known just before the launch. As such, the market is

evolving more towards private placements (where investors have offered greater price

certainty) or bank to bond structures. Over the last 12 months, two out of three bids

on Dutch projects have included such structures. The N33 road in the Netherlands

features a EUR78m index- linked tranche which will partially take out (at a pre-

agreed price) the banks financing the transaction upon practical completion. In

addition, the EUR300m Zaanstad prison project in the Netherlands reached financial

close in September 2013. The hybrid structure includes an institutional investor

tranche alongside a subordinated, shorted dated senior bank tranche. PwC advised the

government on N33 and the consortium bidder on Zaanstad.

The A11 road in Belgium (currently at preferred bidder) is actively evaluating capital

markets solutions, either directly or via a bank to bond structure. In Germany, projects

considering the capital markets include the A7 road and UKSH hospital, and PwC is

advising bidders on both projects. In addition to the committed finance approach

described above, the Netherlands is expected to launch a preferred bidder debt

funding competition pilot project in the next 12 months. The rationale for this is to

increase the depth of competition in a constrained financing market.

In France, bank financing has been able to fund the pipeline of current projects thus

far. However, the market may be

at a tipping point, particularly given the recent

financial close of the Cit Musicale (July 2013) where the Dailly tranche of the debt


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will be subscribedby an institutional investor who will refinance out the three banks

providing construction loans. Most institutional investors in France require relatively

high project credit ratings, which are often tough to achieve given construction risks

and other factors. On Cit Musicale, the investor coming in for the Dailly tranche post

completion means the credit risk they take is essentially local government rather than

project. However, institutional investors have demonstrated willingness to take

construction risk in the French market. For example, the Valence/Riom/ Lutterbach

Prison PPP closed in January 2013 with an insurer providing EUR100m of the debt

from financial close, and L2 Marseille bypass may also feature allocation of the

construction risk to the institutional investor.

Graph: Emerging markets account for half of global infrastructure spending

Arguably the recent developments of bond financing were possible only because the

bond investors became flexible on parameters that traditionally were deal- breakers


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for this type of project, namely make-whole provisions and drawdown periods. PwC

advised the public sector on Cite Musicale and is currently advising the public sector

on L2.

Before the GFC, bank tenors in the Middle East were long. Most projects were

backed by government or government owned sponsors, making bank debt accessible

at relatively low cost. There have been some significant project bonds to date18, but

compliance costs associated with numerous securities laws and exchange listing have

discouraged some sponsors.

Post GFC, bank margins for 10+ year tenors remain high and tenors beyond 15 years

are a challenge. In response, some procuring authorities have relaxed committed

finance requirements, allowing the use of mini-perm financing to support bids.

However, large scale project finance in the Middle East now requires support from

external credit agencies, other forms of financing such as Islamic lending, and other

multilateral lending agencies which means the process is not as simple as it used to

be. Considerable guarantees and contractual commitments are required before such

financing can be secured, and these factors are increasing the attractiveness of project

bonds. In August 2013, Shuweihat 2 IWPP in Abu Dhabi became the first project to

be refinanced in the bond market with a USD825m A- rated 6% 2036 144a/Reg S

issue.

The depth of corporate bond markets varies considerably across Asia, making it

difficult to categorise the entire region. In particular, Malaysia has a vibrant bond

market which contributed approximately half of the countrys private infrastructure

investments between 1993 and 2006. The Malaysian government took some notable

steps to spur this market, including mandating the use of credit ratings for corporate

bonds as of 1992. In addition, the Republic of Korea has a substantial corporate bond

market which has previously financed infrastructure. Other regionally significant

corporate bond markets include China, Japan and Thailand. Export credit agencies

and multilaterals such as the Asian Development Bank are active in supporting

infrastructure finance, including through credit guarantee programmes. However, with

the exception of Malaysia, Singapore and the Republic of Korea, the OECD estimates

that total assets held by pension funds, life insurance companies and mutual funds are


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small relative to GDP in East Asian economies. As such, in many Asian countries the

preconditions are not yet in place to support private project bonds.

Spains fiscal challenges are well - publicised, but a gas storage project (Castor) in

the country has recently given the EIB its first financial close using the PBCE

instrument. In addition to providing the PBCE facility (akin to a long term letter of

credit, ranking junior in order to credit enhance the senior bonds), the EIB also bought

EUR300m of the senior bonds. The project was a refinancing, meaning investors did

not take construction risk, and reached financial close in July 2013. The large size and

long tenor of the issue (EUR1.4bn, 21.5 year bonds) arguably favoured the public

bond route. The issue was rated BBB+ at launch22, one notch above Spains

sovereign rating of BBB. For investors requiring investment grade (i.e. BBB-), a

sovereign rating of BBB doesnt leave much room in the structure for project risks

hence the importance of PBCE or other credit enhancements. Without such

enhancement, investor appeal may be relatively narrow, suggesting that project bond

gearing levels and/or underlying risk may need to remain relatively low until Spains

sovereign rating improves.

Most Central and Eastern Europe (CEE) countries have virtually no market for

non-bank infrastructure project finance, and in some cases (particularly Russia)

project finance remains the preserve of state-owned lenders. Many countries have low

sovereign credit ratings, pension funds that are primarily state-sponsored, a lack of

well-prepared and recurrent infrastructure projects and political uncertainties which

lead to regulatory risks. While there has been significant improvement in putting the

right enabling legislation in place, much of it remains untested. In addition,

multilaterals such as the EIB and European Bank for Reconstruction and

Development (EBRD) provide significant amounts of infrastructure finance in the

region.

In some stronger CEE countries, particularly Poland, international banks are willing

to lend to domestic projects. Until recently, significant amounts of infrastructure have

been funded with EU structural resource and domestic public money at both the

central government and municipal levels. This has crowded out private finance. This

however may change as EU funding principles may become more commercially/debt


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oriented and government budgets are stretched. The demand for new sources of

infrastructure finance may be potentially met by insurance companies, government

initiatives such as PIR (the Polish Development Investment Fund) and inflows from

international infrastructure funds that already have a foothold in the market (e.g.

power sector, sea logistics). Major infrastructure financing may also come from or

through large corporates, especially in the power and chemical sectors.

Graph: Infrastructure spending evolves with a regions economic growth

As a result, while CEE countries indicate that they are open to capital markets

financing for infrastructure, we dont anticipate that this market will take off until the

concept becomes more established in Western Europe. This may change if

governments force pension funds to invest a minimum proportion of their portfolios

into infrastructure

(i.e. mandatory minimum sector limits). Progress in individual

countries may vary as significantly as their relative macroeconomic performance

does. In general, we expect the Polish corporate bond market to grow strongly.


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However, from a project bond perspective, secondary markets are relatively immature

and issuers may find the liquidity premia required by investors unattractive.

Akfen and PSA in Turkey have recently launched a seven year bond refinancing

Mersin International Port. However, project bonds at a PPP level have a way to go

yet. There are relatively few domestic institutional investors and the corporate bond

market is not yet very deep. In addition, the post-termination debt assumption

agreements that apply to PPP transactions above a certain size cover bank (but not

bond) transactions.

As such, bond investors have less certainty of recovery in a default scenario than bank

lenders for the same project risk. The market remains very corporate and relationship

driven, and when sponsors do access the bond market they often do so decoupled

from specific projects. Turkey acknowledges the need to increase the average life of

its debt financing at a sovereign/quasi-sovereign level. Using long-tenor project bonds

to privately finance key infrastructure may be one way to deepen the market, but this

will be challenged by the lack of suitably long duration sovereign debt pricing

benchmarks.

In India, privately funded infrastructure is done via bank debt rather than bonds. The

largest global project finance lender for Thomson Reuters Project Finance

International is the government owned State Bank of India. The countrys 12th Five

Year Plan (which covers 2012 through 2017) considers that insurance and pension

funds will be a key source of infrastructure finance. Such funds have grown in the

past decade due to favourable demographic trends, but remain proportionately small.

Yet there is effectively no project bond market thus far. During the 11th plan, nearly

half of all infrastructure finance came from public-sector capital, and another third

came from commercial banks and non-bank finance companies (NBFCs).

Over the longer term, however, we do not think that banks will be sufficient to fund

the entire pipeline. The banking sector cannot lend more than 15% of their net worth

to a particular sector (and 25% to a particular group). However, bank credit to the

infrastructure sector has reached 13.5%. There are however numerous policy and

market structure challenges. Infrastructure companies are not frequent issuers in the


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corporate bond market, investors are generally unable to fund infrastructure SPVs due

to their typical structure as unlisted private companies and investor rating

requirements can preclude widespread participation in infrastructure. There are two

broad options to overcome these challenges: one being to refinance out banks at stable

operations (although the banks have shown little inclination to exit, despite Basel III)

and the other to create an infrastructure debt fund for pension funds/insurers.

The second option is a challenge for greenfield projects as Indian institutions are

traditionally not comfortable with construction risk. While some overseas investors

may be more comfortable with this risk, Indias current international sovereign rating

of BBB- leaves little to no headroom for project risk, particularly for investors that

require investment grade. This suggests that domestic investors will need to get

comfortable with construction risk, BBB being the lowest category of investment

grade.

The first option is still challenged by the minimum rating requirements for pension

and insurance managers to invest (typically domestic AA or AAA), well below the

typical BB structured project. Traditionally there have been no credit wrappers to

bridge the ratings gap. However, the India Infrastructure Finance Corporation (IIFCL)

and the Asian Development Bank (ADB) have recently signed credit enhancement

documents for the GMR Jadcherla Expressway as a pilot project. The purpose of the

guarantee is to raise the rating to a point that the project can refinance in the bond

market when the bank facility matures or reaches a price reset point.

In Africa, many countries need to deepen sovereign and multilateral bond issuance as

a precursor to corporate and project issuance. Across most of the continent, reforms to

date have focused on getting sovereign bonds issued, often to finance infrastructure

development. Many sovereigns are not rated, and those with natural resource revenues

often need to set up a sinking fund committing future revenues to secure financing.

Nonetheless, 2012 and the first half of 2013 saw significant Eurobond issuances,

notably Ghana (USD750m 10 year bonds), Rwanda (USD400m 10 year bonds),

Zambia (USD750m 10 year bonds), Tanzania (USD500m seven year private

placement) and Angola (USD1bn 7 year private placement). Although local capital

markets are dominated by dollar bonds, in February 2013 IFC issued a five-year, local


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currency NGN12bn denominated bond (cUSD75m) in Nigeriaas part of a program to

deepen the domestic bond market across Africa.

In September 2013, Kenya issued its sixth infrastructure bond for KES20bn

(cUSD230m). It is important that African issuers appeal to investors by focussing on

the basics of increasing transparency in the financial markets and coordinating more

effectively across borders. The specific needs of each country vary, but commonly

needed reforms include deregulation, a lifting of capital controls and stronger

governance and disclosure.

South Africa has a developed bond market in place, and sizable life insurance and

pension markets. Some institutional investors have bought into projects post

completion, but have not yet shown much appetite for construction risk. The

infrastructure market in South Africa is dominated by state owned utilities such as

Transnet and Eskom who finance infrastructure on balance sheet. The largest project

finance programme to date is to support investment in the ambitious renewables PPP

program which the domestic banks have so far financed comfortably to the surprise of

some international investors. Nevertheless, the implementation of Basel III in general

and a growing pipeline of projects could spur greater demand for capital markets

financing. In particular, round 3 of the renewables program will drive cZAR30, worth

40bn across 1,000MW of capex.

GLOBAL FINANCIAL CRISIS AND THE RECOVERY IN 2013

The global financial crisis has had a profound effect on project finance for

infrastructure around the world. We have suffered from economic recessions and

country crises over many years, but not such a global crisis which has affected so

many countries, all at the same time.

For a period, people in the project finance industry had the view that if we held on,

things would return to normal, the cost of debt would return once more to a

reasonable level and the project deal flow would increase. The global financial crisis

has reduced the availability of private capital by increasing its cost and restricting its

availability. At the same time, economic policies adopted by many countries

concentrated on austerity and reduction in public expenditure as opposed to growth.


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During this period of uncertainty, the demand for infrastructure development across

the world has continued to increase even though we are seeing reduced economic

growth in many countries. Demand for clean water, electricity, improved transport

systems, education and healthcare improvements increase, as the global population

expands. 2013 has been the turning point for a new certainty in infrastructure

development and governments recognize that investment in infrastructure (whether

public or private) creates jobs, which creates growth.

Looking back 2013 will most likely be classed a year of partial recovery. Although

the global project finance (PF) markets are far from mended, 2013 was a step in the

right direction and a definite cause for mild celebration following a poor 2012.

According to the World Bank, global growth hit 2.4 per cent in 2013, and is slated to

increase to 3.2 per cent this year and to 3.5 per cent by 2016. With confidence in the

global economy returning, 2013 showed signs that the darkest days of the financial

crisis for PF and infrastructure could soon be over.

The post economic crisis fear that project development has been stifled by a lack of

bank liquidity and the so-called funding gap, has been replaced by the common claim

that a scarcity of project pipeline is the main hindrance to the global PF marketplace.

The last year has shown signs that this complaint is also beginning to look outdated.

There was an uptick in deal flow across many parts of the globe in 2013, and whilst it

would be foolish to infer from this that the hard times are over, market pessimism

now looks similarly questionable.


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Graph: Investors Intentions for Their Infrastructure Allocations over the Long

Term

In 2013, we have seen more and more countries using project finance to develop

infrastructure and adopting the PPP concept. Canada, with a strong and successful

PPP history, probably holds the record for speed of procurement; however, new

markets across South and Central America are developing quickly.

Brazil has a dynamic approach to PPP, with a PPP law in place since 2004 and a PPP

guarantee fund (whose assets are separate from those of the federal government)

which protects private parties against the contracting authority default risk for each

PPP contract. The federal structure of the country allows for PPP projects to be

tendered by both the federal government (which has the exclusive right to grant PPP

projects in energy and transport) and by the state and municipal government

(responsible for water sanitation and regional roads). Other countries in the region

with exciting PPP programs are Columbia, Peru, Mexico and Panama.

California is developing the PPP concept. In 2012 the Bay Area Council Economic

Institute in San Francisco published a report on job creation using PPP, and cites

findings by the Federal Highway Administration that each additional $1bn of

government infrastructure spending creates between 4,000 to 18,000 jobs. Moodys,


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the ratings agency has demonstrated that in California, for every $1 invested in

infrastructure this produces $1.59 of gross domestic product and infrastructure

investment is seen as a key pillar of growth. In an economic downturn, it is especially

important to job creation and economic recovery.

Australia was another successful country for PPP in 2013. The Australian experience

illustrates potential life- cycle cost savings from the effective implementation of PPP

methods. In addition to improving time and delivery of projects plus accelerated job

creation, Australia has demonstrated on-budget delivery i.e. built on time and at cost.

The Netherlands has been extremely successful in the implementation of PPP. The

government sees private finance as a means to gain value for money for the Dutch

taxpayer and provides discipline and enhances risk management in projects. The

governments role is to provide a clear framework and to remove undesirable barriers

in contract documents and tender documents. If private finance becomes too difficult,

too complex or too expensive, the government would finance the projects themselves.

African countries are having increasing difficulties in putting PPP projects together on

both a country basis and on a project-by-project basis; the issues here are the same for

many emerging markets. The issues are:

Private sector investors return requirements are too high.

Lenders are trying to conserve capital and rebuild their balance sheets.

Basel III is imposing additional capital requirements for project finance

lending, as well as requirements for lenders to match the duration of loans and

funding.

The service provided by the PPP is often unaffordable to the end user without

substantial grant subsidy.

In Africa, and other emerging markets, the consensus is a new model is required that

is simpler, quicker to deliver and more attractive to foreign investors (mainly

commercial banks). Initiatives, like the EIB Bond and Pebble development in 2013,

will continue to be developed in 2014.


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domestic insurance companies and pension funds that otherwise would not be easily

persuaded to purchase these securities on a large enough scale.

With this in mind we offer the following salient recommendations:

Firstly, nurture the growth of securitisation mechanisms, albeit subject to

balanced regulatory scrutiny.

Second, urgent work must be done to deepen the corporate debt market by

attracting new participants. Specifically, measures must be taken to make it

easier for domestic insurance and pension funds as well as foreign institutional

investors to invest in a wider range of long-term corporate debt and simplify

procedures for primary issuance of debt securities. Measures to launch a

transparent trading platform for corporate debt linked to appropriate payment

and settlement systems must be accelerated as also measures to improve

liquidity, such as the introduction of repo transactions on corporate bonds and

the launch of a wider array of hedging instruments (interest rate futures and

credit derivatives).

Third, the government should act as a catalyst by transforming IIFCL into a

specialised government-supported institution that would at the very least

refinance infrastructure loans from banks and NBFCs or, if we are to be more

ambitious, which would purchase infrastructure loans, re-package them as

credit enhanced securities and sell them to other investors, notably insurance

companies and pension funds.

global infrastructure and project finance outlook

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