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3 November, 2018
In this article, we look at current trends in financing infrastructure in south and southeast Asia – from "hybrid structures" in the Philippines, to efforts to encourage the involvement of capital markets in infrastructure.
When it comes to emerging markets in Asia, the "infrastructure gap" term is all too familiar (the major gap between a country's infrastructure needs and the ability of its government to fund those needs). The Asian Development Bank (ADB) reported last year that Asia will need to invest US$26 trillion between 2016 to 2030 – equivalent to US$1.7 trillion per year – on developing its transport, power, telecommunications and water supply and sanitation sectors, to support its current predicted growth rates.1 If social infrastructure (mainly education and health) is also factored in, then the financing gap for infrastructure widens further.
Traditionally, financing for infrastructure in Asia has been dominated by public sector funding (whether through direct government budgetary funding, official development assistance or other concessionary loans at the sovereign level) although private sector financing has remained consistent in the power and telecommunications sectors. Private sector financing of transport, water and social infrastructure has not yet made a significant impact, in part due to the lack of a pipeline of bankable projects with a viable risk allocation. Motivated by the region's huge infrastructure needs (it has been estimated that private financing will need to increase fourfold to close the infrastructure gap) and with assistance from multilateral banks and platforms such as the G20 Global Infrastructure Hub, governments across Asia have sought to put in place the necessary legal regimes and programmes to encourage greater levels of private finance and investment in a wider pool of infrastructure classes. Examples include the public private partnership or build-operate-transfer legislation and/or programmes brought into effect in Thailand, the Philippines, Vietnam and Bangladesh (to name but a few) and the formalisation of supporting institutions and mechanisms such as the Indonesia Infrastructure Guarantee Fund.
The governments of emerging markets in Asia recognise the need to introduce private sector investment in infrastructure, such as public private partnerships (PPPs), in a way that recognises the unique characteristics of each country. Governments are not, therefore, simply lifting and adapting the PPP model from countries such as the UK, Australia and Canada, but are instead developing their own distinctive models for procuring new infrastructure in order to minimise some of the historical barriers to private investment.
In this article, we consider three discernible trends in the structuring and financing of infrastructure projects in Asia's emerging markets,2 as governments seek to accelerate the development of much-needed infrastructure:
- the increasing use of blended public and private financing models;
- the move away from pure demand risk payment structures in order to make projects more attractive to the private sector; and
- the increasing role for capital markets.
Given that the private financing of the power and telecommunications sectors in Asia is, for the most part, well-established, this article focuses on the financing options for the other infrastructure categories, including, transport, water and social infrastructure.
Blending public sector and private sector financing
Public sector funding remains the largest source of infrastructure financing in Asia. The ratio of public to private financing in Asia is 2:1 to 3:1, compared to 1:2 in Europe and North America.3 Asian governments are therefore under pressure to increase the level of private financing in order to meet the scale of infrastructure investment required as well as needing to implement projects quickly to keep pace with economic development and the demands of their population.
Official development assistance (ODA) and other forms of government-to-government (G2G) support have long played an important role in funding infrastructure in emerging markets in Asia and continue to do so, particularly in the context of China's "One Belt, One Road" initiative. In this context, an emerging trend in developing Asia is the increasing use of a blend of ODA and G2G financing alongside private financing to procure new infrastructure projects. Some examples of this emerging trend are described below.
"Build, build, build" – Funding infrastructure in the Philippines and Vietnam through a blend of ODA and private finance
In the Philippines, President Rodrigo Duterte's predecessor, President Aquino, launched the Public-Private Partnership Center of the Philippines in 2011, setting the tone for his government's focus on procuring infrastructure development under a design-build-finance-operate-maintain model or variations of the same.
With a strong pipeline of projects targeted for development, interest from international infrastructure sponsors and investors was high, particularly for such high-profile projects as the regional airports, NAIA Airport and the North-South Railway projects. However, the administration ran out of time and was unable to complete the procurement of these and other projects before the change of government in 2016.
International infrastructure sponsors and investors therefore watched the transition to President Duterte's administration closely, looking for assurances that the programme of infrastructure projects would continue apace. In July 2017, President Duterte highlighted infrastructure development as a priority with the now well-known statement that: "In other words, we are going to build, build and build". Public spending on infrastructure projects is reported to be targeted to reach 8-9 trillion pesos (approximately US$154 to US$173 billion) between 2017 and 2022. Under what is now known as the "Build, Build, Build" programme, President Duterte's government plans to roll out 75 flagship projects, in sectors including ports, airports, roads and railways. With a focus on speed and on infrastructure development outside of the capital Manila, President Duterte has shown a willingness to blend financing structures and procurement models to develop what the Ministry of Finance in the Philippines refers to as the "hybrid PPP" model. The administration hopes to speed up the pace of the country's infrastructure development by funding it through a mixture of local taxes (for example, the new "Tax Reform for Acceleration and Inclusion" (TRAIN) is expected to fund approximately 25 per cent of the Build, Build, Build programme), ODA and G2G financing and private financing.
In the road sector, the government has fast-tracked two road projects, the Plaridel Bypass Road and the Central Luzon Link Expressway, through the use of its hybrid PPP model. As a result, the design and build will be financed through ODA while the operation and maintenance will be procured under a PPP-type arrangement. A similar approach is being adopted for the Clark Airport expansion. A key government objective in adopting such a hybrid model for "big ticket" projects is to speed up the procurement process following much publicised delays in the procurement process of early PPP projects in the Philippines. Under the hybrid PPP arrangement, the government can break ground on the design and build of a project, while the procurement process for the operation and maintenance under a PPP model takes place. A second key objective is to marry the benefits of utilising the lower borrowing rates of concession loans and grants to construct a project with the private sector's expertise in managing, operating and maintaining infrastructure assets. The structuring of the O&M concession may either be by way of availability payments to the project company or through the project company taking some elements of demand risk (and potentially receiving greater upside revenues as a result). Some observers may argue that this "hybrid PPP" is not in fact a PPP at all and that it brings with it other issues such as defects liability on government-built infrastructure, as well as interface risk during the early years of operations. The model also potentially removes a key benefit of traditional PPP development, namely having the project developed on a "whole of life" basis.
We understand that the PPP Center is looking to develop this model further by adopting a revised financing strategy under which the government would continue to utilise ODA to secure lower cost financing, but would then pass the funds to a private company, enabling the private company to construct as well as to operate and maintain the project. This differs from the existing "hybrid" scheme described above in that it attempts to retain the traditional benefit of "whole of life" design.
The Duterte administration has also been keen to emphasise that unsolicited proposals from the private sector for projects that are fully privately financed are still strongly encouraged, and that a number of major unsolicited proposals remain under consideration by the government.
Another nation experimenting with innovative applications of ODA funding is Vietnam. Recently, the Ministry of Planning and Investment announced a draft decree relating to the management and use of ODA and preferential loans from foreign donors, under which the private sector would be granted the right to access and use ODA and preferential capital. It is still too early to assess how this change will be perceived by the market, but the issue remains that loans to private businesses from ODA capital carry comparatively high interest rates as well as imposing strict requirements on ODA borrowers. Nevertheless, such loans may still prove very attractive to private investors unable to access other sources of capital, and in turn stimulate infrastructure development within Vietnam.
Infrastructure development through G2G partnerships – Bangladesh
In 2015, the government of Bangladesh passed the Public-Private Partnership Act, 2015 (PPP Act) as part of its Vision 2021 goal of procuring high quality public infrastructure in a fiscally sustainable manner. The purpose of the PPP Act was to provide a clear and transparent legal framework for the procurement of infrastructure on a PPP basis and thereby to attract international sponsors and lenders to invest in the transport and social infrastructure sectors as they have done in the power sector for a number of years.
Under the powers granted in the PPP Act, in 2017 the Public Private Partnership Authority issued its Policy for Implementing PPP Projects through Government-to-Government (G2G) Partnership, 2017 (G2G Policy). The purpose of the G2G Policy is to provide a framework for infrastructure projects to be implemented with financial support from other governments. To the extent another government, with whom a memorandum of understanding has been signed, agrees to contribute financial support to a project by means of: (i) funding to the government of Bangladesh to be injected as equity or debt in the project; (ii) funding to one or more public authorities or state-owned entities or financial institutions to invest equity or debt in the project; or (iii) funding to sponsors to provide equity support to the project company, the other government may select state-owned or private entities to implement the infrastructure project on a PPP basis.
To date, memoranda of understanding have been signed with the governments of Japan and Singapore and others are under discussion. The G2G policy is not intended to deter sponsors and investors from those countries that may not yet have agreed such memoranda of understanding. It will only be utilised for projects that make sense in the context of a particular G2G arrangement (for example, six large PPP schemes have been identified in the memorandum of understanding with Japan). Undoubtedly this development will be watched closely by other governments in the region to establish how successful it is in fast-tracking the procurement of key infrastructure projects.
This financing approach is attractive to governments keen to support the success of their own domestic businesses in their export trade and overseas investments as it mitigates the risk of competitive bidding procedures. For the Bangladesh government, it widens its pool of available financing for infrastructure, while retaining the benefits of PPP, including risk transfer to a private sector party that is better able to manage those risks, innovation and cost certainty.
Achieving a viable revenue risk allocation
In the past decade, particularly following the global financial crisis of 2007-2008 and the failure of a number of demand risk projects across Asia (especially in the port and road sectors), there has been a general antipathy to the sponsoring and financing of projects that expose the project company to demand risk.
Traditionally, however, governments across Asia – including Indonesia, Thailand and the Philippines – have been keen to transfer revenue and demand risk to the private sector rather than retaining it as a public risk. This has seen, for example, a favouring of PPP models where the private sector is granted the right to collect and retain revenues (such as rail ticket fares or direct (real) tolls on toll roads), over availability payment regimes.
As governments across the region have become more sophisticated in their analysis of the value for money of projects and have listened to the calls of private financiers for projects with viable risk allocations in which to invest, there has been a growing acceptance and adoption of either full availability payment models (i.e. with full revenue and demand risk retained by government) or shared demand risk models (where the private sector takes some revenue and demand risk but also benefits from some downside protection from the public sector).
Such downside protection may be in the form of viability gap funding, i.e. capital payments during or at the end of construction to partly pay down the construction debt and thereby reduce the risk that future revenue receipts prove to be inadequate to repay such debt. It may also (alternatively or in combination with viability gap funding) take the form of a minimum revenue guarantee. In return for the government guaranteeing a minimum revenue, the quid pro quo is that any revenue receipts above a specified threshold are shared in some agreed proportion with the public sector. In other words, in return for sharing the risk of a downside demand scenario, the public sector is entitled to benefit from the upside scenario.
This increasing willingness by the public sector to take, or at least share in, revenue risk has been welcomed by sponsors as it allows them to more easily obtain project finance for a project rather than borrowing on a corporate finance basis, and to use a wider pool of financial institutions, including export-import banks, in order to obtain optimal pricing. This, in turn, increases the value for money for the public sector. Some examples of this are set out in the table below.
Capital Markets and Infrastructure in Asia: The perfect bond?
Even with the use of financing structures that blend public and private finance, and project structures that alleviate demand risk, traditional sources of infrastructure funding in Asia – i.e. the public purse and bank debt – are unlikely to ever be sufficient to bridge the infrastructure gap. Could capital markets be the answer? Investors are certainly interested: from infrastructure fund giants like Macquarie Infrastructure and Real Assets (which, earlier this year, closed a second Asia-focused infrastructure fund at US$3.3 billion), to more conservative institutional investors such as Japan’s Government Pension Investment Fund (the world’s largest pension fund, which has announced plans to increase its alternative investments, including in infrastructure).4 However, construction risk, sub-investment grade rating, and weak domestic markets can pose barriers to entry for traditional capital markets investors. When it comes to successful capital markets investment in south and southeast Asian infrastructure, the emerging theme is the need to manage these risks with the right project and the right project bond structure.
Signs of growth: recent successes in Asian infrastructure bonds
The south and southeast Asian infrastructure project bond market is attractive for a number of reasons. As has been seen in the US and Europe, infrastructure can be well suited to capital markets investment. Project bonds offer institutional investors such as infrastructure funds, pension funds and insurance companies a predictable income over the medium to long term, which neatly aligns with the liabilities of such investors and, as infrastructure investments are usually less affected by stock market cycles, project bonds offer an opportunity to balance and diversify portfolios. In addition, emerging markets can offer higher yields than more stable developed markets, making south and southeast Asia of particular interest to investors.
In the last few years there have been some notable success stories utilising bonds to fund south and southeast Asian infrastructure, although these have been primarily to fund operating power projects rather than transport or social infrastructure:
| The Philippines: In 2016, the first Asian green bonds were issued by Aboitiz Power (Pesos 12.5 billion/US$ 252 million), to fund the operation and rehabilitation of the Tiwi Makban geothermal plant, with the bonds being backed by a credit enhancement guarantee from ADB (a concept discussed further below) to raise the overall rating to investment grade. | Indonesia: In August 2017, PT Paiton Energy (Paiton), a major independent power producer in Indonesia, attracted domestic and international investors with its two-tranche US$ 2 billion project bond, the largest rated amortising international project bond in Asia in nearly 20 years. | Macau: Studio City Company Limited's 2012 bond issuance to fund a casino project in Macau is a compelling example of a "true" project bond, used to fund greenfield construction. A key feature of this bond was the use of an escrow mechanism where proceeds were retained from the issuance to service the debt during construction. |
Structure for success: managing barriers to capital markets investment
However, there remain barriers to increased capital markets investment in Asian infrastructure. Bankability, construction risk, credit ratings below investment grade, and weak domestic bond markets make many projects less attractive to capital markets investors. These problems are not insurmountable, but for capital markets funding to really take hold in the south and southeast Asian infrastructure market, the right structures and strategies need to be put in place.
The first consideration is bankability. Capital markets investors, like traditional debt lenders, will look for viable projects with certainty of revenue stream. The efforts to reduce demand risk outlined above – either through an availability payment arrangement or mitigants such as minimum revenue guarantees – are essential in attracting longer term capital markets investors.
Construction risk is also key. Infrastructure projects typically have lengthy, high-risk construction periods, which can be unattractive to a capital markets investor seeking stable, predicable revenues. One solution is to use project bonds for brownfield projects or to refinance the project after completion (see, for example, the Paiton bond and the Tiwi Makban bond, mentioned above). Another option could be a corporate issuance to fund a portfolio of both operational and completion stage projects. Properly structured, project bonds can also be used to fund greenfield projects. For example, the Studio City casino high-yield bond used an escrow mechanism where proceeds were retained from the issuance to service the debt during construction, an option that can make sense for companies in certain industries or certain financing environments – which is more of a challenge for the build phase of a road project in India or a power project in the Philippines.
Infrastructure projects in emerging Asia may also struggle to achieve the credit rating required to attract capital markets investors. Certain institutional investors only have a mandate for investment grade projects and, in some jurisdictions, the requirements may be as high as requiring a local AAA rating. Many south and southeast Asian projects struggle to achieve investment grade rating due to their high level of construction risk or reliance (either through a sovereign guarantee, the procuring authority taking demand risk, or a government entity off-taker) on a government party which has a low credit rating.
A high-yield bond may be attractive, despite a lower credit rating (for example, the Greenko high-yield bond was ranked at below investment grade), particularly in the context of refinancing project debt once projects become operational. Another alternative is to use "credit enhancement", where a third party provides a guarantee or other support to "enhance" the credit of the project. In Europe, for example, the Project Bond Initiative has provided this kind of credit enhancement since the financial crisis. Asian governments with strong credit ratings can provide credit enhancement through a sovereign guarantee (although this means that the government bears the guarantee on its books, negating some of the benefits of using private financing, and it is not an option for governments in emerging Asia with lower credit ratings). Multilateral agencies, such as ADB, may be able to step in to provide these credit enhancements, as was the case with the Tiwi Makban green bond. It remains to be seen whether such options can be deployed at scale.
Finally, the success of project bonds in south and southeast Asia may also depend on the strength of the local bond market. One of the key benefits for project sponsors of using capital markets investment is the ability to issue project bonds whose currency matches the project revenue currency. This requires a strong local bond market to fully fund the issuance. Local markets vary across south and southeast Asia: Korea, Japan and Singapore have sophisticated, established domestic bond markets, built off the back of their developed economies, established intermediary markets, rule of law, and robust bankruptcy systems. Malaysia and Thailand, though more volatile developing economies, also have strong local bond markets, primarily due to years of experience with capital markets and financing in general, as well as predictable legal systems.
However, local currency bond market capability in south and southeast Asia will need to expand in order to significantly increase capital markets investment for infrastructure projects in local currency.
The future: capitalising on capital markets
While government support (such as ODA funding or G2G arrangements) and bank debt remain the primary sources of project financing in Asia, capital market investment is on the rise. Recent successful projects show a clear trend emerging: it is a case of finding the right project for the right project bond. Overcoming the construction risk factor – either by managing negative carry or reserving project bonds for brownfield projects or the operations phase – is essential. A below investment grade bond may still be viable if the yield is high, or credit enhancement is available to improve the rating. Developing the experience and sophistication of the local bond market is also crucial to providing the framework to increase capital markets investment. Ultimately, financing through capital markets is unlikely to be the solution to all of Asia's infrastructure funding needs: instead it should be used in combination with government support and traditional bank financing to bridge the investment gap.
Opportunities and challenges
It goes without saying that challenges remain in developing and financing infrastructure projects in south and southeast Asia. To a large extent these depend on the type of project, as well as the social, political and economic environment of the relevant country where the project is located. However, in an environment where south and southeast Asian governments continue to announce ambitious plans to expand infrastructure networks, there are numerous opportunities for developers, investors and lenders. The fact that authorities in Asia are increasingly utilising alternative structures to fund projects — whether through the adoption of blended financing, hybrid PPP models or accessing funds on the capital markets — is helping to accelerate much needed infrastructure development in Asia. Ultimately, though, what is needed to attract the widest pool of financing is the oft-repeated refrain of a pipeline of bankable projects. The more frequent adoption of a viable revenue risk allocation is a positive sign that governments are adopting a more viable risk allocation overall. Sponsors, financiers, governments and the populations of Asia are watching the latest initiatives in infrastructure development in the region with great interest. If success comes, it may herald a new momentum for Asian infrastructure development and provide real progress in narrowing the region's infrastructure gap.
Co-authors: Harriet Gray, Associate; Alexis Rosenberg, Associate.
For further information, please contact:
Giles Ashman, Ashurst
giles.ashman@ashurst-adtlaw.com
- Asian Development Bank, "Meeting Asia's Infrastructure Needs" (February 2017).
- The range of countries across Asia and the differing levels of development, political appetite and investment incentives in the various jurisdictions prohibit a continent-wide discussion of every issue. This article therefore focuses on certain themes that are emerging for infrastructure financing in the developing countries in south and southeast Asia. In addition, China has been deliberately excluded from the review, as the size and diversity of its market merits an article in its own right.
- See http://oecdinsights.org/2017/02/03/more-private-capital-for-infrastructure-investment-in-asia/.
- See "Japan’s Government Pension Investment Fund eyes infrastructure", Florence Chong, ipe.com, 23 October 2017.
