The International Finance Corporation, part of the World Bank, says it has hit on a deal structure that will help bridge the enormous funding gap that Asian governments face as they struggle to build much-needed infrastructure.
The IFC on Wednesday signed a deal with Eastspring Investments, the Asian asset management business of Prudential Plc, to commit $500 million to a portfolio of emerging market loans for mostly greenfield infrastructure projects. German insurance group Allianz is also chipping in $500 million.
The investment arm of the World Bank hopes these deals will pave the way for other institutional investors to join in and raise $5 billion for future infrastructure projects across emerging markets and for other institutions to repicate the structure.
For China, which has been looking to its policy banks to lead infrastructure investments across countries covered by its Belt and Road Initiative, they also offer an alternative form of funding that will not add to the country's national debt at a time when it is seeking to purge its banks of non-performing loans.
The IFC is focused on engaging the private sector and making sure its projects are commercially viable.
“The region’s infrastructure problem won’t be solved by the governments taking on more debt. It must be led by the private sector if the approach is to be sustainable,” Jingdong Hua, vice president and treasurer of the IFC, told FinanceAsia in an interview.
The Philippines has just committed to spend as much as 7.4% of its GDP annually on infrastructure by 2020, compared with an average of just over 2% between 2011 and 2014, according to estimates from the Asian Development Bank.
Indonesia needs around $1.23 trillion of infrastructure spending between now and 2030. The ADB says just $23 billion was spent in 2015. In India, the combined force of public and private investment barely covers half of the $261 billion annual funding need.
The desire of institutional investors to enter the asset class is clear. Insurance companies have long-term liabilities and need to match their duration with equally long-term stable and predictable cash flows; but they are loath to venture outside their comfort zone of investment grade-rated products.
In mid-2016 AsianInvestor surveyed the top 300 institutional investors headquartered in the Asia Pacific region and found that 60% of these pension funds and insurers planned to raise their allocations to alternatives within a year, up from 37% in the previous year’s survey. Of the respondents, 22% ranked infrastructure as the most appealing asset class.
That is not insignificant. Whilst Asia’s investible assets are still small relative to the US, the pot is growing fast. In Asia ex-Japan and ex-Australia alone, assets under management doubled to $24.5 trillion between since 2008 and 2016, according to AsianInvestor’s survey.
“From an investment standpoint, with interest rates being as low as they are there are a lot of investors that want to get into the asset class," Virginie Maisonneuve, the chief investment officer of Eastspring Investments, told FinanceAsia. “But from a risk, structure, and liquidity standpoint it’s tricky.”
Even some of the biggest infrastructure investors in the world, such as the Ontario Teachers' Pension Plan, have been cautious about emerging market debt.
In its deal with IFC however, Eastspring feels comfortable to commit capital upfront to a series of future loans. It is a senior partner in the structure and the currency of the loans is US dollars, which eliminates some of the foreign currency risk.
IFC has a decent track record in the field. It is a AAA-rated institution and with its portfolio of many deals of different shapes and sizes, it offers investors diversification into almost B or BB-rated projects.
Through the programme called MCPP Infrastructure, IFC originates, approves, and manages the portfolio of loans that mirrors IFC’s own portfolio in infrastructure.
“It's like a CLO [collateralised loan obligation] for infrastructure,” Tony Adams, Eastspring's chief investment officer of infrastructure, said.
Eastspring said it had done due diligence on the default rates in IFC’s investments and found they compared very favourably.
“The overall default and recovery performance of IFC over the past couple of decades is very close to that of investment grade project finance,” Adams said.
IFC’s emerging market infrastructure investment returns are on average around 100 basis points better in emerging markets than in OECD countries on the basis of ultimate recovery. “There is a gap between the real risk and the perceived risk,” Hua said.
The money will be put to work mainly in 15 sectors across three years in emerging markets globally.
Eastspring expects the portfolio to yield the same returns as comparable corporate debt. Historically IFC’s infrastructure loans have yielded on average 450 basis points over Libor.
IFC also has skin in the game, alongside the institutional investors. It is putting in $56 million as a junior partner, that provides a first-loss tranche that Eastbridge judges is more than enough to absorb any potential shocks to the portfolio of investments.
The IFC also has support from the Swedish International Development Cooperation Agency (Sida).
“It creates a safety net that really helps us when we act on behalf of our insurance participants,” Maisonneuve said, “[so] you’ll see more deals.”
Bank retreat
In Asia, bank loans have been the traditional way to fund infrastructure. The idea of project financing being a limited recourse loan provided to a special purpose vehicle — as applied in Europe and the United States, for instance — has not taken off in much of Asia.
Instead, Asian banks have tended to make conventional loans to corporations, who then use that money to fund their projects.
However, as commercial banks retreat from long-dated investments, given the more onerous capital requirements of Basel III, IFC is looking to crowd in trillions of dollars from institutional investors.
“Our traditional partner was European banks and they have retreated. That space was taken over by Asian banks which had a lot of liquidity and were not as yet compliant with Basel III, but it is only a matter of time [before they go too],” Hua said.
Asset managers have been a port of call for these banks to offload their loans.
“We’re getting a lot of inbound calls from the Europeans and now even the Japanese,” Adams said, “[and] now they are interested in finding long-term partners to take on their assets.”
IFC started courting institutional investors about four or five years ago. The talks with Eastspring took around two and a half years.
PBOC Deal
IFC also created a vehicle for the China’s central bank, the People's Bank of China. This was a $3 billion investment but it did not ask for a first-loss buffer unlike Eastspring.
IFC put that capital to work within three years in over 30 countries, in 15 sectors and 70 projects. The diversification in this portfolio gave comfort to Eastspring to seal its own deal with the development institution.
Infrastructure spending remains a favoured path for Chinese policymakers to secure growth, although Premier Li Keqiang stressed at the opening of a World Economic Forum June 27 that China does not rely on massive stimulus. ANZ estimates that infrastructure investment will need to rise by 19% year-on-year in 2017 in order to help China achieve its 6.5% growth target this year.
However, analysis by analysts at ANZ suggests that there is a funding gap of CNY2.7 trillion to support
this infrastructure investment.
This funding gap may be filled by central bank’s support for loan growth and eased liquidity conditions in the banking sector or through government guidance funds, special construction funds and more local government financing vehicle (LGFV) bond issuances in the second half of the year, said ANZ.
“When governments are so indebted you don’t want to add more,” Hua said.
More than 1.2 billion people worldwide have no access to electricity. More than 660 million people don’t have a clean source of drinking water and one in three people worldwide lack access to sewage infrastructure. With the number of people living in cities in Asia estimated to double by 2030, the infrastructure deficit will only become larger.
According to a recent report from the Asian Development Bank, around $26 trillion of investment is needed between now and 2030. Outside China, the infrastructure gap for the next four years represents a whopping 5% of GDP.
Under the agreement, IFC will originate transactions and provide Eastspring with co-lending opportunities. There will be concentration-risk limits set by country, sector and the credit risk rating of each deal that goes into the portfolio.
To be sure, the IFC does have an asset management arm that regularly deals with third parties that are institutional investors on senior debt issuance.
“This is a ground-breaking, history-making transaction as [we] are creating a new asset class connecting institutional investors to emerging market infrastructure finance,” Hua said.
Additional reporting by Ann Shi
