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Re-thinking Strategies to Accelerate Institutional Capital Allocation to Infrastructure Financing
Barriers to institutional investor participation
If the abundant untapped capital of institutional
investors can be put to work effectively, it
could provide the key to boost infrastructure in
Latin America and worldwide. However, there
are a number of hurdles to greater private
sector participation.
Historically, institutional investors have been
averse to investing in greenfield infrastructure
projects — especially in emerging markets —
for several reasons. These include a lack of
in-house expertise in understanding/managing
construction risk and long-dated currency risk
(which exists for most projects). In addition,
there is a lack of documented benchmarks
and precedents that tend to limit knowledge
transfer of best practices and access
to information on successful project
finance experiences.
Institutional investor capital has flown to a
narrow universe of projects, most of which
are brownfield assets with a proven track
record in developed countries. This reflects the
perception among institutional investors that
infrastructure investments should be low risk,
low beta, and offer a stable cash flow. Investors’
concentration on such a limited range of assets
has helped compress returns significantly in
recent years.
Finding workable solutions
In order for institutional investors’ capital to
be put to work where it is needed — greenfield
projects in emerging markets — investors,
sponsors, banks and governments must
find ways to address issues such as proper
allocation of construction and currency risk
and be able to access information about best
practices in infrastructure investing.
Already, advances have been made to overcome
some of the barriers to greater institutional
investor participation in infrastructure funding.
Institutional investors are making increasing
use of third-party managers with proven track
records in order to augment their expertise.
Since 2009, third-party managers have raised
$172 billion in equity and debt.
4
While most of
these investments have focused on developed
markets and brownfield assets, institutional
investors’ willingness to engage external
expertise is encouraging.
Meanwhile, DFIs have started to develop
structures and solutions to facilitate improved
segmentation of construction risk, such as the
Europe 2020 Project Bond Initiative,
5
developed
by the European Investment Bank (EIB) and
the European Commission. Under the initiative,
the EIB enhances the credit quality of senior
debt (project bonds issued by the sponsor)
by taking a first-loss position either through a
subordinated loan or a contingent credit line
that can be drawn to cover senior debt service
if required. This tool is similar to the formerly
successful monoline insurance model and could
help wrap construction risk, and eliminate
refinancing risk by bringing long-term investors
into the financing structure from the start.
If successful, and replicated by DFIs in other
regions, this idea could become a powerful tool
for DFIs to support infrastructure financing.
Alternatively, DFIs could continue to fund
projects during the construction phase and
support debt refinancing through bonds once
the asset is operational. DFIs can provide
guarantees to enhance the marketability
and liquidity of bonds, making them more
attractive to institutional investors. Depending
on the depth and liquidity of the local capital
market, bonds can be issued locally and attract
domestic pension funds by providing them with
greater portfolio diversification options. This
strategy is not suitable for all markets. However,
where it is applicable, it can help accelerate the
recycling of DFI capital for greenfield projects,
mitigate currency, political and liquidity risks
and contribute to the development of local
capital markets with the introduction of new
instruments and asset classes. The concept
of DFIs recycling their balance sheets and not
4
Preqin and Citi estimates
5
European Investment Bank, “The Europe 2020 Project Bond Initiative- Innovative Infrastructure Financing”,
www.eib.org/products/blending/project-bonds/index.htm; last accessed 09/18/2015