Why bonds are vital to Asia infrastructure amid bank liquidity
Renewable energy resonates in Asia, with offshore wind projects in Taiwan garnering attention
co-founder and partner,
head of project finance and advisory department, Cathay United Bank
senior director, group treasury and
project finance, CLP Holdings
chief executive officer,
Credit Guarantee &
regional head of operations for East Asia Pacific and head, Hong Kong,International Finance Corporation
credit, political and security risks,
Asia, JLT Specialty
managing director, Logie Group
director of finance, PT Jasa Marga
joint general manager and head of project and export finance for Asia, Asia investment banking, Sumitomo Mitsui Banking Corporation
Managing editor, The Asset
Asia's project finance market is awash in liquidity as investor appetite for infrastructure investments grows. But the region is likely to see a much higher level of liquidity if the projects could attract interest from institutional investors
Asia has an abundance of capital for infrastructure projects. Sponsors can easily secure funding as investor appetite for infrastructure investments is strong. But there could be a much higher level of liquidity in the region if more institutional investors were to fund infrastructure projects.
Luca Tonello, joint general manager and head of project and export finance for Asia, Asia investment banking, Sumitomo Mitsui Banking Corporation, says that the bank market remains the major funding avenue for infrastructure projects in Asia. For now it is very much a "club" market where banks tend to participate in primary deals, driven by relationships.
“Asia is still a relationship-driven bank market, which tends to price deals below what the institutional investors would like to see,” Tonello points out. “That gap has discouraged them from participating in financing infrastructure projects, despite having a lot of interest in this sector.”
Fundamentally, the infrastructure sector should be one where banks finance the early stages of a project, says Tonello. Institutions participate in the latter stage of the project and are incentivized to take long-term risk.
For now what is fuelling bank market liquidity is the entry of additional lenders. Japanese regional banks, according to Tonello, are increasingly participating in infrastructure projects. Chinese banks, which are very active in the loan syndication market, also contribute to market liquidity.
As in most Asean countries, the bank market poses as the biggest challenge for Credit Guarantee and Investment Facility (CGIF) in promoting the bond market as an alternative source of infrastructure funding. “It is awash with liquidity, which makes it difficult to encourage the project companies to access the bond market because they can easily secure funding from the local banks,” says CGIF CEO Kiyoshi Nishimura. “Just trying to explain the benefits of accessing the capital markets is already a challenge.”
This comes as institutions including pension funds, insurance companies and asset management companies often will choose to invest in government bonds than in infrastructure projects.
“The pension funds and insurance companies are just investing in government bonds and the typical example is Vietnam, where the 10-year government bond yields have already come down to less than 5% as a result,” notes Nishimura. "They should be used to finance infrastructure projects.”
CGIF, which supports the growth of the local currency bond market, has been working to promote the concept of project bonds in Asean countries. Unlike other multilateral development banks, CGIF has no mandate to back infrastructure development. But it has been working to improve infrastructure projects' access to bond markets for funding.
When CGIF started its operations in the Asean region about five years ago, project bonds only existed in Malaysia. But that changed dramatically in the past two years. Today, project bonds are helping fund infrastructure projects in Indonesia, Thailand and the Philippines.
“We are very encouraged by this development and we want to extend our support to these markets,” says Nishimura. “The bond market will have more role to play in the Asean countries to finance infrastructure projects. This is very crucial because infrastructure projects need long-term funding in the local currency to which revenues are peg.”
Andrew Kinloch, managing director of Logie Group, agrees that there is a huge amount of appetite to invest in infrastructure. He says: “There is a large amount of liquidity with financial institutions around the world, all looking for reasonably safe, long-term, reliable, inflation-linked – all the good things – infrastructure assets. But in this part of the world, these are in fairly short supply.”
So why is the project finance market in Asia isn't growing fast enough? Kinloch says there are fairly a number of reasons Asia's project finance market isn't growing as it should be. Finance experts say the host governments are partly the reason.
“I’ve just finished acting as an adviser for investors who were looking to build a gold mine and they struggled with the approval system, which was contradictory, ambiguous and had gaps in it,” Kinloch notes. “It was interpreted by different sections of the government in different ways and they had to fight their way through a whole load of arguments over time – and actually winning most of them.”
He adds: “Such a system exhausted time, money and in particular investor confidence on fighting their way through the approval process. So I would advise the governments to make their approval process a lot more straightforward and transparent because it is not covered by political risk insurance.”
Moreover, finance experts point to the inability of governments to support infrastructure projects, hampering project finance.
“There is very little discussion on how the government support can be structured in the first place and how it can fall away as the project proves itself such that the government does not end up with the most unimaginable amount of contingent liability,” he adds.
For its part, the IFC has developed a number of mechanisms to help harness private capital to finance infrastructure projects. One such major undertaking is the Managed Co-Lending Portfolio Programme (MCPP), which kicked off with a US$3 billion investment from State Administration of Foreign Exchange (SAFE) of China in 2013.
This year the MCPP has raised US$7 billion from eight global institutional investors, both from the public and private sectors. “MCPP builds a loan portfolio for an investor that mirrors the portfolio IFC is creating for its own account – similar to an index fund,” says IFC regional head of operation for East Asia Pacific and head for Hong Kong, Julia Brickell. “Therefore, investors are offered the opportunity to co-lend in every new loan that IFC originates that fits the investor’s criteria.”
It has been successful in helping investors get comfortable with the project and country risk in these markets. The investors are relatively passive partners under the programme with IFC leading on project identification and due diligence.
“Each investor has slightly different criteria to meet their own investment strategy and mandate,” notes Brickell. “IFC’s innovative investment model helps match institutional capital with emerging market infrastructure investment. This matchmaking is key to supporting the ongoing transformation of infrastructure in emerging markets.
The other scheme that the IFC has undertaken was its innovative partnership with global asset manager Amundi as they successfully launched in March this year the world’s largest targeted green bond fund focused on emerging markets. Amundi manages the fund, which has US$256 million in cornerstone commitment from IFC. The fund aims to increase the capacity of emerging market banks to finance climate-smart investments.
“With the fund focussing on green bonds, it has the same objective of mobilizing capital from the private sector,” adds Brickell. “Many investors are reluctant to invest on their own as many emerging markets lack the requisite risk-return profile."
For CLP Holdings, one of the largest power companies in Asia-Pacific, securing financing is not the ultimate answer in building its projects. CLP aims to come up with the most optimal way of funding its projects. “We like to come up with the right structure, trying to align the different interests of the stakeholders, and with the right terms in relation to tariff,” says Francis Ho, senior director for group treasury and project finance at CLP Holdings. “In doing so, we can tell the host government that this is what we can deliver at the most competitive terms.”
In choosing between local currency and G3 currency for funding, CLP relies on the entire project structure. Ho explains: “If CLP can get hard currency indexation conversion in the government concession agreement, then we are happy to follow that. But if the government does not have the intention to offer that and we see enough liquidity offered by local financial institutions and perhaps with the support of multilaterals, we can come up with the right coverage for local funding.”
To fund its projects, Indonesia’s state-controlled toll road operator Jasa Marga relies on debt and equity as sources of financing, using what it calls the 70-30 scheme. “We utilize 70% from debt or bank loan and 30% from equity that comes from the balance sheet to finance new concessions,” says Jasa Marga director of finance Donny Arsal. “We rely on various funding instruments to raise capital, not only conventional loans, but also mezzanine as well as equity participation.”
Last year, Jasa Marga arranged its first securitization transaction to raise 2 trillion rupiah (US$139.25 million) by securitizing the toll road revenue of its Jakarta-Bogor-Ciawi concession.
In what was a trailblazing transaction to further diversify its funding sources, Jasa Marga launched the first "Komodo" bonds in November 2017 – an offshore debt instrument denominated in rupiah, but settled in US dollar, both principal and interest.
At first, Arsal reveals that Jasa Marga was not that confident how to introduce the Komodo bonds into the market, being the first of its kind in the world. It conducted two non-deal roadshows before it launched the deal – the first one was to garner investor feedback about the company and about Indonesia.
At present, Jasa Marga has 13 toll road concessions in its balance sheet. Under the new regulation, it has to establish a new company for every new concession that it will operate. So it invites partners, either state-owned or private sector companies, to join as minority partner in the project.
The company has other concession project targets in the pipeline, some of which Jasa Marga is considered as the so-called initiator. “We need partners to finance these projects because our balance sheet now is too heavy to undertake the financing,” says Arsal.
Focus on renewables
One of the prevailing trends in project finance in Asia that is attracting lenders and investors is the focus towards renewable energy. Taiwan is generating a lot of attention because of the prospects of offshore wind energy. As Tonello points out, Taiwan adopts a very transparent process, laying out which project will take place and when.
“That is why a lot of banks, including us, are looking at Taiwan, with its offshore wind, as a priority,” says Tonello. “The offshore wind projects require considerable amount of capital, which suits our business model. When it comes to solar, we are still trying to figure out how to play this market because solar projects tend to be smaller, and the initial stage of development is more of an equity play. It is when the transactions become bigger and can be aggregated into a portfolio that banks would come in to support.”
Billy Betts, head of project finance and advisory department at Cathay United Bank, says they are focused on supporting Taiwan’s growing renewable energy industry by advising and providing financing to a variety of solar and wind projects, including the large offshore wind projects under development.
Taiwan plans to add 5.5GW of total offshore wind installed capacity by 2025 and Betts says Cathay United has been actively involved in a number of these projects. The bank provided financing for the first two offshore wind turbines in 2016 that are now up and running. It recently closed the project financing for the next 20 turbines.
Betts notes the Taiwanese banks have more than ample liquidity to fund infrastructure projects in Taiwan and elsewhere in the region. For offshore wind projects, the concern of Taiwan lenders has been the acceptance of non-recourse project financing structures with long tenors for a new sector. With 20-year power purchase agreements, sponsors are seeking financing for up to 18 years for some of the projects, which traditionally has been difficult for local lenders.
“Since these projects are fully funded in Taiwan dollar loans, we are working with a number of international banks that have strong Taiwan dollar liquidity, and which also bring to the table their experience in financing offshore wind projects in Europe,” says Betts. “Given the extensive due diligence required for offshore wind projects, many local banks that are lending to this sector will look to the international banks’ experience on the due diligence aspect of the projects to properly structure the financing and allocate the project risks.”
Among the risks often highlighted for offshore wind projects in Taiwan are earthquake and typhoon risks, which are not present in European projects. These risks are something that both the international and local lenders need to fully understand with the support of the lenders’ technical, environmental and insurance advisers.
For international banks that are moving away from coal-related projects and are looking to participate in offshore wind projects, but cannot provide Taiwan dollar financing, Betts says they are working to find ways to create long-term hedging solutions
Loans covered by export credit agencies (ECAs) will also be helpful to ease financing for offshore wind projects in Taiwan. EKF of Denmark's participation in the project goes a long way towards helping address the financing concerns associated with the projects. “Of course, the projects are not 100% ECA-covered, but even a portion is helpful both from the technical and financing perspective,” he adds.
Indeed, renewable energy is a theme resonating in the project finance market in Asia. CLP plans to further expand its renewable energy portfolio. As at end-2017, 13% of its generation capacity comes from renewables and 23% from non-carbon sources, which CLP targets to raise to 30% and 40%, respectively, by 2030.
“We are looking to move to green and sustainable financing in a much faster pace with the CLP Climate Action Finance Framework, which resembles the green bond principles and conduct our power business in a more responsible way under the CLP Climate Vision 2050,” says Ho. “When we do projects in this region, we like them to fit into our climate vision.”
CLP, though, still has a couple of coal projects in Vietnam. “We believe that they cannot, at least in the interim, make a leap into renewables, so we want to assist them by building projects using clean coal technology or the supercritical coal,” adds Ho.
What is also helping attract lenders and investors into the project finance transactions in Asia is the participation of insurance companies through the provision of structured credit and political risk insurance.
“Historically, individual lenders have used political risk insurance to mitigate their own participation in long-term project finance loan facilities in situations where they are not comfortable with the political risk environment in a country or where the project included an offtake agreement with a state-owned entity, such as a power purchase agreement,” says Robert Cooper, regional director for credit, political and security risks in Asia at JLT Specialty.
Although there have been situations where sufficient capacity was available to cover all lenders to the project, there usually has been a finite amount of capacity available. Insurers have generally only been able to support one or two lenders to a particular project.
With the increased levels of capital flowing into the insurance market amid a low interest rate environment, and the resulting low rates being experienced in the propety and casualty class of business, insurers are looking to expand into more profitable classes of business where a smaller number of market participants operate. Property and casualty accounts for the largest part of the insurance market currently.
“One of those areas is structured credit and political risk insurance and we have, therefore, seen a significant increase in the number of insurers participating in this space over the past five years, as well as a greater level of liquidity for policy tenors of up to 15 years,” says Cooper.
As a result of this larger pool of insurers and liquidity, it is becoming more common for project sponsors, financial advisers and mandated lead arrangers and bookrunners to use the private market to arrange political risk insurance for an entire group of lenders participating in an uncovered or commercial tranche, sometimes alongside an ECA-backed facility.
“The availability of political risk insurance and the presence of an ECA usually provides lenders with additional comfort to lend to projects,” adds Cooper. “One point that should be highlighted in relation to political risk insurance is that the cover is not designed to provide some kind of a political risk wrap or make a bad project look good. It is there to provide comfort to lenders against defined political risk perils and when there is uncertainty over the long-term government offtake contracts involved."
Meanwhile, developing an infrastructure-related project in Indonesia faces some challenges as revealed by AIM Infrastructure, a Hong Kong-based company that offers project development, advisory and asset management services for infrastructure owners, promoters, investors and lenders across the Asia-Pacific region.
The company has been developing a cargo transportation project in Indonesia during the past two years. This is the first pure cargo roll-on, roll-off project in the country in line with the stated policy of the national government that promotes the use of the sea for the movement of cargo on trucks, rather than the current road routes. This is especially true for the huge cargo movements within Java island, and between Java and Sumatra islands.
“With fewer cargo trucks on the road, the government will see reduced emissions, and transporters will save time and improve cost-effectiveness,” says AIM Infrastructure co-founder and partner Mark Pankhurst. “It is a proven concept and is already prevalent in Japan, Europe and to a growing extent also in the Philippines.”
As a new business in Indonesia, the project faces a number of challenges. Government’s foreign ownership restriction is one of them. A ship calling between two domestic ports has to be at least 51% Indonesian-owned. The ships must fly the Indonesian flag and the crew must be 100% Indonesians.
“We do not have any argument with bringing in an Indonesian partner, even if they are the majority owner,” says Pankhurst. “But restricting the ships to fly the Indonesian flag and having an all-Indonesian crew means we cannot rent the ships. We have to buy and import them into Indonesia, which increases our cost of capital and the risk of the project.”
Another challenge is dealing with state-owned enterprises. The ships need a port of call and AIM Infrastructure’s first route is between Jakarta and Surabaya where the ports are controlled by state-owned Pelindos.
“We’ve been trying to explain to them the benefits of our business to their business, and get them to agree to use their assets and negotiate reasonable charges for our ships calling in their ports,” Pankhurst points out. “We’re still trying to sort this out and it remains an unfinished business.”
Government interference in an important market mechanism such as oil prices is an issue for AIM Infrastructure. State-owned oil company Pertamina has fuel monopoly in the country. For some reason, ship fuel cost is 25% to 30% higher than the benchmark price in Singapore. “That sort of premium is not justified by the route distance,” says Pankhurst. “It doesn’t just impact our business, but the whole shipping industry in Indonesia.”On the other hand, the government subsidizes diesel fuel for trucks, which makes it more challenging for AIM Infrastructure to charge the right tariff, especially in an environment of rising oil prices. “With three different challenges to overcome, it is a work in progress," adds Pankhurst.