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WWW.BSCHOOL.NUS.EDU.SG/CAMRI
“The Opportunity in Infrastructure for Emerging Markets"
Alumni Homecoming 2017
3 November 2017
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Infrastructure Financing – An Overview
Infrastructure Financing
• Basic physical structures and systems of a business or a nation, such as:
• Transportation• Communication• Sewage• Water• Electricity
• Tend to be high‐cost investments
• Vital to economic development and prosperity
• The act of providing funds (capital) for business activities, making purchases of investing
• 3 main types of financing:• Debt • Equity • Some combination of the two
• Proper valuation of the project’s cost and future expected cash flows is crucial ‐ long‐term in nature
Source: Investopedia
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Infrastructure as an asset class
The present rise of infrastructure’s popularity as an asset class can be attributed partly to:
• Regulatory changes in the bank lending market following the global financial crisis reduces banks’ ability to provide long‐term financing required for infrastructure
• Present and persistent low bond yields pushing fund managers towards a ‘search for yield’. Yet most institutional asset owners are restricted from purchasing ‘riskier’ assets like infrastructure bonds!
Economic characteristics of infrastructure assets lead to an attractive value proposition
Source: CAIA
• Attractive returns• Low sensitivity to swings in the economy and
markets• Low correlation of returns with other asset classes• Long term, stable and predictable cash flows
• Good inflation hedge for certain long‐term projects• Hence a natural fit with pension liabilities (often
long‐term and inflation‐linked)• Low default rates if well monitored by an MDB• Socially‐responsible investing (SDGs, ESG, etc.)
The value proposition of infrastructure as an asset class
• High barriers to entry• Economies of scale, e.g., high fixed, low variable costs• Inelastic demand for services pricing power• Low operating cost and high target operating margins• Long duration
Economic Characteristics
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Infrastructure Investing in EM
The Positives The Negatives
✔ Emerging Markets are high economic growth areas
✔ Good infrastructure improves productivity, has a high social rate of return + positive externalities
• Trade and economic growth• Innovation• Spillover & network effects
✔ Trillions of dollars held by long‐term institutional investors (currently allocated to low‐return assets) could be channeled to infrastructure assets
✘ Poor ESG and/or SDGs track record & negative externalities
• Noise, environmental pollution• Congestion• Corruption
✘ Large cost overruns, white elephants (e.g. “bridge to nowhere”)
✘ Lack of proper maintenance
✘ Adverse selection and informational asymmetries leading to infrastructure markets breaking down
✘ Potential Moral Hazard• Private sector bidding low and then
renegotiating contracts/concession agreements along the way in typical “project holdup” fashion
Source: “A Unified Market Approach to the Infrastructure Finance Market ”, Ranjan Chakravarty, Joseph Cherian, Kiyoshi Nishimura & Wong Heang Fine, Working Paper, CAMRI Infrastructure Finance Initiative, October 2017
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Examples from around Asia1. JICA‐financed Gujerat‐Mumbai high speed bullet train, India
• 500km distance, estimated project cost US$17billion
• 81% financed by Japan International Cooperation Agency (JICA) via a 50‐year loan at 0.1% interest p.a.
• Remaining cost borne by the state governments of Maharashtra and Gujarat (via unlocking of urban land values)
• Initial funding for feasibility studies cost US$4.4Mil. Was 50:50 co‐financed by the Japanese and Indian federal governments
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• Defunct US Air Base being redeveloped into Philippines’ first green city
• JOIN of Japan & BCDA (local Base Conversion Development Authority) set up a Joint Project Company to manage the project
• Initial funding set aside for feasibility studies was US$3Mil, which was 50:50 co‐financed by JOIN and BCDA
• Located in Central Luzon with connectivity to Manila and the rest of the Philippines
2. Clark Green City restorative development project, Philippines
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3. Kyaukphyu Port & Industrial Park, Myanmar
• Chinese SOE CITIC leading the Chinese consortium for a US$10 billion
• CITIC takes 85% stake. Remaining stake contributed by local Myanmar companies on behalf of the local government as a passthrough
• Port will be BOT ‐ eventually transferred back to local government
4. PLUS North‐South ExpresswayMalaysia
• ~800km, approx US$4 billion value
• Financed via Conventional Loans (Term Loan, Government support loan), Issuance of PLUS Bonds, Redeemable Convertible Bonds and, finally, issuance of Islamic Bonds (Sukuk)
• Project Bonds purchased mostly by local institutions (asset owners and asset managers)
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The global infrastructure investment gap
Source: World Bank, Global Infrastructure Outlook, United Nations
• By 2040, the global population will grow by almost 2 billion people
• Rural to urban migration will continue• Urban population growth by 46% will
trigger massive demand for infrastructure support
• Global infrastructure investment needs to reach $94 trillion by 2040 to meet these demands
• Adding the UN’s Sustainable Development Goals (SDGs) of universal provision of clean water, sanitation, and electricity increases the total cost to US$97 trillion
• The present shortfall in needed spending is US$18 trillion – 19% of the forecasted need
50.8
14.8
20.2
6.0 1.9
Asia Europe Americas
Africa Oceania
Regional infrastructure investment needs, 2016‐2040US$ trillion
More than 50% of global infrastructure investment needs are in Asia
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The infrastructure investment gap in Asia
Source: Asian Development Bank, BRINK Asia
Private investment needs to more than double (triple if including climate adjustments) to meet Asia’s future infrastructure investment needs
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Finance 101: Characteristics of infrastructure assets• Infrastructure is by nature a facility to which intrinsic, tangible and intangible values
are only realized at some point in the future
• Shortage of transparent data that can validate the expected risk and returns
• Few operational players can effectively marry financial and technical engineering aspects of infrastructure projects to “crowd‐in” private sector investment
• Dividend‐like cash flows, which can be:• payments in perpetuity;• stepped up bond‐like payments interspersed with windfall bullet payments;• or a hybrid of both
• Infrastructure assets are usually required at a scale where the surrounding economy is potentially deficient in some manner:
• Asset construction necessitates the intervention of sovereign, supranational and/or multilateral credit guarantors to enhance their viability
• Political risk is often the “straw that breaks the camel’s back”
Source: “A Unified Market Approach to the Infrastructure Finance Market ”, Ranjan Chakravarty, Joseph Cherian, Kiyoshi Nishimura & Wong Heang Fine, Working Paper, CAMRI Infrastructure Finance Initiative, October 2017
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Points to note on issues facing infrastructure finance
Scale, uncertainty, environmental impact, embedded flexibilities and externalities (both positive and negative consequences) should be considered and priced
1. Getting the valuation right
The forward‐start nature of infrastructure projects means discounted cash flow (DCF) techniques which incorporate quasi‐qualitative uncertainty parameters fall short as accurate measures
Real Options Analysis (ROA)• A realistic and appealing approach to valuation for forward‐starting projects with
embedded flexibilities • Appeals to the Black‐Scholes‐Merton option pricing technology for infrastructure resource
pricing by using stock market‐like volatility measures• Free of many biases that the traditional capital budgeting approach imbues, which could
lead to mispricing or underpricing, a.k.a. the project not being ‘bankable’• This expertise already exists in both the academic and practitioner worlds today
Source: “Building uncertainty, flexibility into infrastructure megaprojects ”, Michel Cardin & Joseph Cherian, The Business Times, 27 January 2017
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Points to note on issues facing infrastructure finance2. Bringing all the Right Instruments to Bright Light
Infrastructure asset structures that ROA valuation models should be applied to
Term loan‐type project bond structures
Straightforward bond (green or otherwise) with some form of a guaranteed payout
Convertible bond with a defined convertibility ratio and an equity‐type payoff
Deferred coupon long‐term version of the above securities• could offer tax benefits for taxable institutions in
certain jurisdictions through accrual accounting• This can lengthen the duration of holdings for the
wealth funds’ asset/liability management
Classic infrastructure asset‐backed security (i‐ABS) structure
• structure can issue a series of bonds with different tranches rated AAA to equity
• Tranches can be held by different investors with varying risk appetites
Fundamental building blocks
Supranational/ Sovereign/ Multilateral guarantees
Deferred stepped‐up equity dividend and/or project bond coupon payouts Securitization
Pooling of underlying real assets
Matching up of cash flows
Credit enhancement
facility
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Points to note on issues facing infrastructure finance
Sovereign in whose jurisdiction the asset exists or
is being developed
3. Origination: Bright‐lining Infrastructure as a Clear and Present Investable Asset Class
The asset manager who structures the asset’s finances on the sell‐side and books it
on the buy‐side
The sources of investible capital, which are mainly the
asset owners
Asset Ownership
Asset Management Investible Capital
Origination in the infrastructure business lies in
Global financial hubs need to facilitate the seamless
movement of investible capital into and out of infrastructure assetsTo encourage the proliferation of origination and structuring, and seamless trading and liquidity in
infrastructure assets
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Other key components of the infrastructure ecosystemLocal Long Term Savings1
Local Project Bond Markets 2
Enabling Role of the Multilaterals in Private‐Public Partnerships 3
The Exchange4
The Clearing Corporation5
Ratings Agencies and Liquidity Provision6
Several items to also note:The importance of recourse in the unforeseen event of failure
The provision of seamless connectivity and zero failure in power systems, information flow and connectivity
Access to cutting edge exchange and capital market talent, with financial technology enabling innovation, productivity gains and cost reduction in financial intermediation
…and last but not least, must be:
Lean,Clean,& Green!
Source: AIIB
Screenshot of CAMRI website
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CAMRI initiatives in infrastructure
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CAMRI’s involvement in infrastructure finance 1. Infrastructure Working Group (IWG) of the Pacific Pension & Investment Institute (PPI)CAMRI Director serves on the IWG headquartered in SF. Workshops discussions with asset owners and managers have focused on:
• Identifying best practice, suitability and feasibility studies to ensure the delivery of bankable projects with real value
• Standardization in contracts, financing documents, specsStructuring
• Getting asset owners, asset managers, MDBs, Infrastructure Finance Institutions, and other Subject Matter Experts to cooperate more closely to make things happen
Greater Cooperation
• IWG particularly wishes to see more Public‐Private‐Partnerships (PPP) that are scalable, resource efficient, environmentally sustainable, promotes good governance, mitigates corruption, and maintains high quality
Implementation
• Political will of sovereigns and long‐term patience of the private sector are needed to invest jointly in capital intensive infrastructure projects, along with asset ownersPolitical will
• Understanding the needs and economics of Infrastructure projects will need specialized knowledge and trainingFinancing
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CAMRI’s involvement in infrastructure finance 2. UNDP’s Social Impact Investing FundCAMRI Director serves on the UNDP/UNSIF Research Steering Committee headquartered in NYC
• Showcase infrastructure impact investing management’s best practice & research across multiplesectors, industries, and geographies with a focus on learnings for the Asia‐Pacific region. explorecommonalities and variances in approaches, as well as identify how stronger alignment can beachieved in impact management processes
Mission
• ESG / SDG‐compliant impact investing covers all facets of the value chain: (a) Internal (pensionfund’s internal practices being ESG/SDG best practice‐compliant), (b) External (companies & serviceproviders the pension fund invests in and engages with), (c) Industry (educate, promote and engageindustry & value supply chain on the merits and efficacy of ESG‐based investment strategies)
Primary Components
• Involve extant & new qualitative & quantitative providers of financial data & info• Stimulate financial product innovation in the asset mgmt. industry, e.g., SDG/ESG Indices & ETFs• Showcase fund managers with ESG/SDG‐complaint practices & portfolios• Research, backtest & build ESG/SDG screens into our CAMRI US and Asia Equity Multifactor Models
Improved Methodology
• The way Tencent & Alibaba have used big data & intelligent analytics, machine learning, AI, NLP,Deep Learning 2.0, etc., to revolutionize the payment system in China, the new world order intechnology can also be applied in the field of ESG/SDG financing and investing
Harness New Technologies
• Increasing efficiencies & improving valuation methodologies• Sustainability: From infrastructure investing to food waste to carbon dependency• Reduced corruption, environmental pollution, congestion, etc.• Improves economic well‐being for all, risk‐adjusted returns for investors, and, yes, human rights!
Outcomes
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Making projects bankable via creative yet practical means
1. The state govt makes a reasonable set of fixed payments to the BOT project developer for a fixed number of years
2. Ticket sales / revenues beyond that will be on a 80/20 sharing basis in the developer’s favor
3. Since urban rail corridor/alignment is very tight for any further commercial development, the state govt, which owns 90% of the land in the state, will offer prime land to the project developer for commercial land‐use development (hotels, condos, malls, etc., hence unlocking urban land values)
4. The metro/heritage areas zoned for Congestion Charges (e.g., 6 am to 12 midnight) ‐ only those having a “SmartTAG” autopass for Electronic Toll Collection of Congestion Charges allowed in
5. Well‐lit car parks with 24/7 high security will be built in strategic hub stations and locations so “Park n Ride” commuters‐residents, as well as drive‐in tourists, can leave their cars in these secure parking lots and ride the tram/ultra‐light rail into the city and/or their hotels instead
6. The state govt’s 15 – 20% co‐investment / financing could come from state land‐use property rights (sales, lease, etc.) per Item 3’s “unlocking urban land values” option
3. Points proposed to a Malaysian state govt and developer to make the Urban Rail Project (est. project cost of US$500mil) bankable:
“The Opportunity in Infrastructure for Emerging Markets"
Q&A
WWW.BSCHOOL.NUS.EDU.SG/CAMRI
Appendix: Other key components of the infrastructure ecosystem
• A critical missing piece is availability of long term savings in local currencies to match the financing needs of long term infrastructure
• Servicing foreign currency debt is untenable to project companies and economies
• If the savings are intermediated by banks, the risks and costs of using short term deposits to lend long term make it an inappropriate mode of intermediation
• Boosting long term local currency savings to finance infrastructure directly via the local bond markets ties well with the need for prudential limits to single borrowers and sectors
• Possible measures to take include:• Introducing mandatory national retirement savings• Reforms to the life insurance sector to push for traditional life insurance products need to
be promoted to provide insurers with the discretion to invest in more complex long term project finance bonds
• Introduction of strong tax and non‐tax incentives to invest in long term project bonds• Funneling routinely rolled‐over short term fixed deposits in the domestic banking sector to
switch to long term project bonds either directly or via commingled funds can help to immediately mobilize existing domestic savings to finance infrastructure
Local Long Term Savings1
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