Local solutions could fix Asean infrastructure financing
It is no secret that there is a huge need for capital to fund infrastructure projects in the developing economies of south-east Asia – a gap of more than $100 billion is not being met.
Although infrastructure delivery can be complex in south-east Asia, the funding is there, both in local currency savings and from institutional investors in developed countries – the two just need to be brought together and put to the same end.
The problem is twofold. Of the wealth of projects that need financing, most need long-term local currency. Although the Association of south-east Asian Nations (Asean) has seen rapid growth in savings, local institutions have little ability to take on risk and so struggle to put the savings to use.
“If somebody provides credit enhancement to cover their risk, these local savings can be mobilized to finance local infrastructure development,” says Kiyoshi Nishimura, chief executive officer of the Credit Guarantee and Investment Facility (CGIF).
For the institutional investors based in Asia-Pacific’s developed economies that are interested in financing emerging and frontier market infrastructure projects, the typically low sovereign credit ratings and foreign exchange risk are major hurdles.
“We have heard many times that there are trillions of dollars of savings in developed economies but that they cannot find good projects,” says Boo Hock Khoo, vice president, operations, CGIF. “The reality is you can’t find good projects that can deal with the currency mismatch.
“Often what is missing from discussions is, ‘what currencies are we talking about in terms of the savings expected to be loaned to projects?’”
As most of the targeted projects earn local currency revenues and hence require local currency debt financing, without a way to hedge the mismatch, no developing country’s infrastructure projects are a realistic option for international institutional investors when searching to lend to projects.
Now, the CGIF is developing a mechanism to deal with both investors’ problems – a new guarantee platform for infrastructure financing, the Infrastructure Investors Partnership (IIP).
The platform’s guarantees will fund developing markets’ projects using domestic savings, through the local bond markets. Guarantees for local bank lending are also available for greenfield projects when they are expected to be refinanced by the local bond markets after the projects’ completion. The resulting boost to the countries’ local financial markets will increase their capacity to absorb risk, essential for emerging and frontier economies’ infrastructure development plans.
To fund its guarantees, the IIP will raise capital from both the public and private sectors through an innovative public-private partnership. The public sector funds will come from ASEAN+3 countries (ASEAN countries plus China, Japan and South Korea), as CGIF was also established by these countries. However, unlike CGIF, these public funds will be used to form ‘first-loss’ equity, meaning that they take the first hit from a guarantee call due to a financial default by a project.
Using this first-loss equity as a buffer for the private sector it will sell mezzanine bonds – for which it is targeting a single A rating – to investors in developed economies either in their domestic or international currencies, thus eliminating the currency mismatch issue for them. The proceeds from the mezzanine bonds will boost the platform’s capital resources as they will be invested in risk-free bonds in the respective countries.
Such public-private partnership would be a first in the region and it would make the risk-reward profile of infrastructure investments in ASEAN countries far more attractive for investors both in ASEAN and also in developed countries in the region, given that the investors being targeted are expected to be among the more conservative in the private sector.
Contributor to beneficiary
For its mezzanine bond issuance, the IIP’s initial focus is Japan. The Japanese are prolific savers and have a whole host of giant private and public institutional investors, such as life insurance companies, asset management firms and pension funds, including the world’s largest, the Government Pension Investment Fund.
The country’s investors are itching to put their money to work and generate returns, but given that they are well known to be cautious, to expect a direct investment into an infrastructure project in an emerging or frontier market is unrealistic. IIP mezzanine bonds will offer an attractive option to engage in infrastructure investment in ASEAN.
As for which countries will benefit from IIP guarantees, while there are needs across the southeast Asian region, the first major ‘beneficiary countries’ are expected to be Indonesia and Vietnam.
“Both have huge infrastructure needs but their domestic financial systems are still at a relatively early stage of development compared to other ASEAN+3 countries,” says Kiyoshi.
Bond market boost
The IIP will be a new programme under the Asian Bond Markets Initiative (ABMI), which was established in December 2002 by the ASEAN+3 nations. ABMI’s primary focus is developing the respective countries’ local currency bond markets while boosting cross-border financial integration, and the IIP will be a part of that.
The new platform will guarantee both local currency bonds and bank loans. But its core objective is to help develop southeast Asia’s languishing project bond market. It will encourage bond refinancing for brownfield projects after the infrastructure construction period is complete, while incentivizing the sponsors of greenfield projects to switch from bank borrowing through various measures, such as a guarantee fee step-up mechanism.
The IIP, while still at a concept stage, is part of ABMI’s medium-term – 2019 to 2022 – road map.
“For the next four years, ours will be one of the programmes undertaken,” says CEO Kiyoshi. “We expect to be operational by the end of 2020. Our current plan is to start with a pilot phase comprising around $1.5 billion.”
The IIP will focus on sustainable infrastructure projects in the energy and transportation sectors. The initiative’s initial size is modest compared to the massive infrastructure investment needs of ASEAN+3 countries, so the region’s headline-grabbing billion-dollar projects are not yet on the table.
However, the planned size will still leave plenty of options for IIP’s pilot phase: “Renewable energy projects – solar, wind for example – are going to be a priority and they are often smaller, around $200 million, for example, so they are within IIP’s reach,” says Kiyoshi, adding: “If IIP is successful, I’m sure ASEAN+3 will consider increasing its size.”
CGIF is a multilateral facility established by the Association of Southeast Asian Nations (“ASEAN”) members, China, Japan, Korea (“ASEAN+3”) and Asian Development Bank (“ADB”). It is established as a trust fund of ADB with a paid-in capital of USD 1 billion from its contributors. As a key component of the Asian Bond Markets Initiative, CGIF was established to develop and strengthen local currency and regional bond markets in the ASEAN+3 region. CGIF commenced its guarantee operations on 1 May 2012 and seeks to provide credit enhancements, mainly in local currencies, issued by credit worthy ASEAN+3-domiciled bond issuers.