By some estimates it will take around US$60 trillion in investment to bridge the emerging market infrastructure gap1. Banks, who have traditionally accounted for the lion’s share of debt investment, are starting to pull back; new regulatory capital requirements and accounting standards are making bank debt financing more difficult. Most bankers are looking to take emerging market infrastructure assets off their balance sheets; only a few are looking to increase their portfolios.
So where will the financing come from? “At the top of the list is infrastructure funds and pension funds who are looking for longer-term, stable investments,” says Ravi Suri, Global Head of Infrastructure Finance, KPMG. “Export credit agencies will also be a very important source of finance and project bonds will grow. We also expect to see increasing growth in local currency financing which every market needs in order to grow sustainably.”
While it is true that institutional investors and export credit agencies are becoming increasingly active in the emerging markets in their own right, it is also clear that the natural growth of these sources of financing is nowhere near fast enough to bridge the investment gap. More must be done to encourage these investors into the markets.
Innovation is taking place. In 2018, Clifford Capital, a specialist provider of debt financing solutions based out of Singapore, launched Asia’s first project finance loan securitization, worth US$458 million. Investors included a range of insurance companies, asset managers, pension funds and bank treasuries, some of whom were investing into the class for the first time.
“The securitization model is particularly well suited to Asia where banks are fairly comfortable taking on the construction risk but are keen to release more of their exposure once the assets are operational,” says Clive Kerner, CEO of Clifford Capital Holdings. “At the same time, institutional investors are looking for portfolios of operational assets at which point the risk profile of those assets is reduced. Securitization gives institutional investors the ability to access emerging market assets through investment-grade rated securities, achieved through the subordination structure of the notes and with the portfolio effect providing additional risk mitigation.”
While the securitization of infrastructure loans can help attract institutional investors to projects funded in ‘hard currencies’, there is still significant room for growth in local currency financing.
“Are local currency markets important for financings? Absolutely,” argues Ravi Suri. “Many of your payments will be in local currency and – in many emerging markets – it’s almost impossible to hedge the currency risk. It will never eclipse hard currency financing, but it is a critical part of the financing mix.”
As Janice Kotut-Sang, Regional Director East and Southern Africa for GuarantCo noted in our Emerging Trends edition of Insight magazine, “If part of the funding were to be secured in local currencies - either through banks or through the capital markets - you can start to de-risk a project to a point where it fits within an investor's criteria.”
Here, again, KPMG professionals are seeing significant creativity from those working to encourage investors into local currency bond markets.
The Credit Guarantee and Investment Fund (CGIF), for example, was created as a trust fund of the Asian Development Bank in order to encourage the development of ‘deep and liquid’ local currency and regional bond markets.
The organization’s main goal is to help companies find viable financing options without having to take additional currency risks onto their books. Since its founding in 2010, the organization has issued more than 40 guarantees across a wide range of ASEAN markets.
“We are already seeing companies that we supported early in their lifecycle starting to issue bonds in local currency markets on their own,” notes Anuj Awasthi, Vice President of Operations at CGIF. “That suggests there is demand for such paper in the market as savings in local currency are increasing. With support of the local regulatory institutions and under the Asian Bond Market Initiative, CGIF will keep working on innovative solutions to increase supply of local currency bonds in the region.”
Looking ahead, Anuj Awasthi sees numerous roles his organization can play in bringing together international and local currency financing sources for infrastructure projects. “For example, we are in discussions with Multilateral Development Banks about doing a risk participation approach on local currency bonds,” he notes.
The pool of local capital is certainly growing. China and India have long supported strong local currency markets predicated on a growing flow of personal savings. But other markets are also rapidly maturing.
“If you look at Vietnam just eight years ago, there were very few local currency bond offers taking place,” notes Anuj Awasthi. “Now Vietnam Dong bonds are seen as a vibrant long-term investment opportunity for local insurance companies and pension funds.”
Ravi Suri points out that there are emerging markets around the world where pools of local capital are growing. “I expect to see continued activity in markets like Malaysia, Philippines and Thailand where local currency financings have a successful track record. But also in Latin America – Brazil in particular,” he notes. “I think we are also going to see some activity catalyzed in Africa through increased bank-owned lending.”
While local currency financing can help solve some key currency risks, it is not the panacea to closing the emerging market infrastructure financing gap on its own. In part, this is because some local currency financing deals have gone horribly wrong in the past, forcing governments to bail out the banks that inked them.
“Local currency debt should come with appropriate risk mitigation measures,” adds Ravi Suri. “Local market financing will be sustainable if it’s structured with good discipline, good credit skills and good risk mitigation capabilities.”
Clive Kerner agrees. “I think one of the issues we often find in deep emerging markets is that local currency financed projects are often not structured to the same international standards as those financed in US dollars. Investors are often concerned about the way in which the underlying contracts are structured and risk allocations.”
Ravi Suri notes that risks are very often not being mitigated correctly. “You can’t ask governments to take the construction risk in a private PPP program. But you can ask them to take the payment risk off a utility if it doesn’t pay on time. If you put in the effort to allocate the risk correctly at the start, you can go to the capital markets and tap into deep sources of financing.”
The challenge is clear. “The intent is there but a lot more needs to be done towards creating the right structures and developing synergies between the various parties focusing in this area if we want to meet Asia’s infrastructure needs,” argues Anuj Awasthi. “But I’m convinced that local currency financings and alterative capital will become increasingly prevalent in the emerging markets.”
Those markets that can get it right should be able to tap into growing investor interest. “The private sector is certainly keen to participate both from an equity investing and debt perspective in infrastructure as an asset class, as long as the projects are well-structured,” adds Clive Kerner.
Ravi Suri is optimistic that significant alternative capital can be mobilized. “I predict that, within the next ten years, at least 30 percent of projects will be financed through alternative sources. Bank debt will become far less important for sponsors to finance their infrastructure projects.”