www.pwc.com/capitalprojectsandinfrastructure Capital Markets: Talking Points The Rise of Non-Bank Infrastructure Project Finance 3 Contents Executive Summary 1 Introduction 2 Some Banks Have Steadily Reduced Exposure to the Market 3 The Rise of Infrastructure Project Bonds and Non-bank Lending 4 Four Prerequisites 6 Market Segmentation 10 Green 11 Amber/Green 17 Amber 18 Red 20 Conclusion 22 Contacts 23 4 Executive Summary governments and project sponsors about how best to access the capital markets for infrastructure projects. This paper seeks to provide some clarity to the project bond concept. Firstly we have identified four critical preconditions that we think must exist for a project bond In recent years we’ve all seen market to take root: significant changes to the financing available capital outside of the of large-scale infrastructure projects 1 banking system; around the globe. The traditional route of long-term bank debt is still 2 sufficient governance and available in some markets. But transparency in financial reporting; with stiffer banking regulation, 3 Balanced tax and commercial it is questionable whether it can policies; and keep up should the project pipeline 4 project specific mechanisms to significantly expand. In many support credit quality. regions, institutional project debt may fill this need. Delineating this list allows governments to see where policy reform is required We believe that capital markets and how they should prioritise their involvement in financing infrastructure efforts if they wish to create a stronger projects outside of North America has now environment for infrastructure project reached a tipping point and will steadily bonds. In addition, we have categorised increase. Already in 2013 there have markets around the world by these been landmark transactions in Brazil, factors, so that bidders can identify the Spain, Holland, the UK and France. But most promising areas in which to tap markets around the world have varying the capital markets. We also set out degrees of receptivity to institutional some areas where investors may need to debt and different norms. There remains flex their approach in order to meet the a great deal of confusion among both specific needs of infrastructure projects. 1 Introduction There is a growing need for large-scale Demand for large-scale investment has infrastructure projects around the world. been complicated by the fiscal constraints In 2006, the OECD1 estimated that around in many countries. With shrinking 3.5% of global GDP, or approximately budgets, governments are increasingly USD2trn needs to be invested in electricity forced to choose between competing distribution, road and rail transportation, priorities. Economic infrastructure in telecommunications, and water particular can have a positive multiplier infrastructure annually or USD 53trn from effect on output and productivity. The 2010 to 20302. Adding in sectors such as challenge is finding innovative ways for ports and airports pushes the figure even value-adding infrastructure to be funded higher: including another USD11trn makes and financed4 in a manner that is the annual requirement USD3trn plus per sustainable for both governments and annum. In 2012, the World Economic infrastructure users. In this paper we Forum (in a report3 prepared in focus on the latter challenge, but note that collaboration with PwC) estimated global the former is top of mind for financiers as annual infrastructure investment and they evaluate the quality of infrastructure maintenance needs in excess of 4% of GDP. project opportunities. The needs are more concentrated in developing countries. If the OECD and Eastern Europe are removed from the average, the World Economic Forum figure rises to over 6% of GDP. In Africa and South Asia the estimated need is higher still at c10% of GDP. 1 OECD, Infrastructure to 2030, Vol 2: Mapping Policy for Electricity, Water And Transport. 2 OECD Infrastructure to 2030. 3 World Economic Forum, Strategic Infrastructure Steps to Prioritize and Deliver Infrastructure Effectively and Efficiently. 4 Financing is the time-shifting of infrastructure costs incurred, whereas funding is how the costs are ultimately repaid. 2 Some Banks Have Steadily Reduced Exposure to the Market Admittedly, the end of bank financing for Where governments are not directly infrastructure projects has been predicted involved in financing projects (e.g. in the past, and banks are still making regulated utilities) in some countries, loans. But it is clear that many banks government is nevertheless providing which have provided the bulk of private support through enhanced tariff project finance through long-term loans structures and potentially providing before the Global Financial Crisis (“GFC”) guarantees for investors and debt have steadily reduced their exposure to providers. the long-term infrastructure market. If this level of support drops away because Some governments have got deals closed of continued strains on government by reducing the bank debt required, finance, insufficient risk transfer or often by committing to significant because the transaction size and deal milestone payments (i.e. 40% to 50% of pipeline increase significantly, that will the capital value of the project) either increase the natural underlying pressure during construction or when the project to seek non-bank finance routes. is built out. This structure effectively prepays some of the availability charge that would otherwise be paid to the concessionaire, reducing the senior debt required whilst attempting to retain a suitable risk transfer. In other cases, governments have more formally co-lent into deals, or taken on project risk by offering guarantees to the lenders. In still others, reliance on multilaterals such as the European Investment Bank has significantly increased. 3 The Rise of Infrastructure Project Bonds and Non-bank Lending Given the market conditions we’ve central bank support, yields on quality described, we think there is a clear sovereign debt are still historically low. opportunity for the private sector to In turn, this creates demand from asset provide infrastructure financing via managers and investors seeking higher project bonds and non-bank lending. yield options, particularly where they After a number of false dawns (at least are trying to match longer duration or outside of the Americas, where project or inflation-linked obligations. Project bonds municipal bonds have been the norm for and non-bank lending could provide a infrastructure project finance), that trend flow of suitable highly rated assets direct is finally beginning to gather momentum. to pension plans and life insurance companies. One contributing factor is that activity in the overall corporate bond market has A major reason for the slow uptake of been high. For example, the second half of infrastructure project bonds is a lack 2012 saw record levels of corporate bond of clarity (amongst both governments issuance. Even in the context of reducing and project sponsors) regarding the Global volume by source of funding 2005 – H1 2013 US$bn 170 450 160 150 400 140 130 350 120 110 300 100 90 250 80 200 70 60 150 50 40 100 30 20 50 10 0 0 H105 H205 H106 H206 H107 H207 H108 H208 H109 H209 H110 H210 H111 H211 H112 H212 H113 IFI Govern loans Bank loans Bonds Equity Deal Count Source: Infrastructure Journal 4 feasibility of bond finance relative to No dominant project bond model has 2 A logical infrastructure project the “tried and tested” route involving yet emerged, and local conditions debt market would use short-term one or more of bank debt, multilateral will always vary. There are numerous bank debt markets e.g. construction finance and capital contributions. We financing solutions that are competing finance, with refinancing into the believe that infrastructure bonds have for investor and procurer attention, each long-term institutional markets, as substantial potential to expand beyond with different benefits and challenges. seen increasingly in the regulated the jurisdictions they are currently used, While the specific deal structure for each infrastructure utilities and leveraged but each such financing is still relatively market is likely to remain in flux, we think infrastructure acquisition markets. new and tied to the specific conditions the financing source for infrastructure The key risk with this model is what within individual markets. will increasingly transition from bank refinancing risk arises and who takes debt to institutional investors. While this it – users, investors, government, etc. Another traditional impediment – transition unfolds, we believe that both If this market were to evolve it would construction risk – is increasingly governments and project sponsors would reduce the need for institutional debt to being mitigated by targeted credit gain from a clearer understanding the take construction risk; and enhancements or (in some cases) priced prerequisites needed for such a market to A return, if any, of the securitisation in by sophisticated investors who consider take root. 3 market whereby banks would package the increased yield to be good value project finance loans and sell them relative to the risk taken on. This is A couple of words of caution: into the institutional markets, may particularly true of private placements obviate the need for institutions but increasingly public bond investors are Some of the institutional appetite is 1 to invest/lend directly to projects showing willingness to take