Private capital: developing project financing capacity beyond the DFIs
The greater fiscal constraints facing the world’s development banks are opening an opportunity for a role for the private sector in infrastructure project finance.
The current global economic climate is leading to in an increase in opportunities for private finance. There are, however, significant challenges when forming more rounded syndicates for projects in global markets, particularly in those deals that are structured without any development finance institution (DFI) partners. The absence of development banks often creates questions about the embedded political risk of projects that aren’t backed by the development banks that are traditionally seen as important in validating projects in various jurisdictions.
Partnerships with governments, DFIs and other multilateral organisations will be important, but the most vital partnership to be forged is with private capital: commercial banks, institutional investors and even private equity.
Institutional investors are emerging as a particularly liquid source of capital for infrastructure projects. Investment provided from insurance groups, pension funds, and asset manager funds is often naturally aligned with the long-term investments that are deployed to cover the operational phase in project financing (typically tenors of between seven and 25 years, depending on the deal structure and industry). This leaves commercial banks to cover the financing of the development and construction phases, which is not only much shorter (one-to-three years) but also implies more risk.
While some generalities can be drawn between different types of investors and their risk sensitivities, there is not a single, simple partnership model. Each project needs to be developed to meet the specific available pools of liquidity and expertise, particularly when structuring both debt and equity portions within individual deals.
The private sector is increasingly looking to diversify its exposure to long-term finance, and especially those infrastructure deals that can bring ESG benefits. But these risks often need the involvement of multilateral development banks to provide the guarantees that allow project risks to be viably priced (as well as often co-financing with their own capital) creating an acceptable risk/reward profile for private investors to enter the deal.
This also has practical implications for those facilitating project financing. Greater plurality in syndication creates complexities in aligning the economic and risk control requirements of all players – particularly when incorporating domestic and international players. Understanding the legal framework (trust-based or otherwise, or specific financial contracts such as Islamic structures) is also a critical aspect to safeguard that deal risk can be successfully passed to the private sector.
As multiple lenders are common in large deals, the lead investor or in-country largest investor will typically have the responsibility for the coordination between parties. However, there are sometimes smaller non-bank lenders that cannot fulfil that role, and the lead arranger bank role can become up for grabs – and is sometimes being performed by project agents.
Project agents play an important role in extending sponsors and financiers into expanding business in new jurisdictions. By leveraging expertise and having a presence supporting projects in South Africa (for example) the conceptual risk on moving elsewhere in Africa where the agent also has a presence becomes much more easily accepted.
Within Europe, there has been a notable trend over the past two years that agency mandates in project financings are often outsourced to independent providers. Arranging banks have sought to shed less profitable business, and even more so if there is no direct client link.
Meanwhile, the majority of developed markets (DM) projects are already largely de-risked when compared to those in emerging market (EM) jurisdictions. In DM, the major sources of risk are related to performance in new industry segments – and here data are increasingly being used as a pro-active management tool to safeguard that mitigations to project risk are initiated before (backward-looking) systemic process reviews would have shown projects were going off track.
It should be noted, however, that proactive warnings about approaching solvency thresholds – as well as the growing plurality of financing sources – are equally valid in EM, too, as are the common threads linking the evolution of project finance structuring around the world, be it in Europe, Africa, Latin America or the US.
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