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Mobilising finance for infrastructure: a study for the Department for International Development (DFID) Summary of findings Mark Cockburn, CEPA Director Michael Obanubi, CEPA Principal Consultant 15th September 2015 Introduction: research brief CEPA commissioned to complete year-long study on the following research brief: Summary of research brief Is the main blockage to increased private infrastructure investment in DFID focus countries in SSA attributable to the lack of a pipeline of bankable projects and/or a lack of available finance? A. On bankable projects i. What are the main blockages to developing a pipeline of bankable projects? Are the principal barriers due to upstream or downstream issues? ii. B. What are the policy interventions to address the constraints? On access to finance i. What are the main types/ sources of finance for projects reaching close? ii. What are the principal barriers to increasing the provision of finance to infrastructure projects from both local and international financial institutions? iii. C. Could the provision of public subsidies support the increased provision of finance? We also considered the extent to which above questions differ in the case of regional projects. This presentation summarises the main findings on these research questions. Page 1 Introduction: focus of research The focus has been on the mobilisation of debt and equity finance from the private sector for the traditional economic infrastructure sectors in DFID-focus countries Our research has therefore been on: • The role of the private sector in financing projects through the establishment of public private partnerships (PPPs) which include at least some private sector equity finance. Pure public financed projects have been excluded from the research. • DFID-focus countries in SSA and with the exception of India, a more limited focus on South Asia. • The traditional economic infrastructure sectors: energy; telecommunications; transportation; and water and sanitation. Private sector projects which provide a public service have also been included. • Projects of a reasonable scale. Small local community infrastructure such as off-grid generation have been excluded. Page 2 Introduction: research completed in past-year The research has included a number of components Individual research studies will be publicly available on CEPA’s website www.cepa.co.uk . Research component Summary of research Literature review A systematic literature review was undertaken to identify the main existing research findings on the topic. Data collection Building on the World Bank PPI database, we collected publicly available data and information from the Infrastructure Journal on projects reaching financial close in SSA between 2010 and 2014. Country case studies Detailed case studies of the constraints to the provision of private finance in Nigeria, Kenya, Ghana and Mozambique. Comparator case studies We reviewed the market for private finance for infrastructure in both South Africa and India. International financial flows The barriers to the provision of private finance from OECD countries to infrastructure projects in SSA were assessed. Regional infrastructure A review of barriers specific to regional infrastructure projects in SSA. Policy options A summary of the policy options to address the constraints identified. Page 3 A: Bankable projects Annual flows have reduced over time, but with greater balance across sectors Project transactions in DFID focus countries in SSA • Prior to 2005, projects that had attracted private finance were largely in the telecoms sector • Since 2005 there has been a large increase in energy sector transactions, but with over close 95% of capital flowing to IPPs. • Renewable IPPs have attracted finance across the continent, particularly in South Africa as a result of its REIPPP programme. Source: World Bank PPI Database; CEPA Analysis Page 4 A: Bankable projects Outside of South Africa and non-energy transactions, Nigeria dominates Country shares in value of transport projects in DFID For transport, Nigerian projects accounted for 88% of total focus countries in SSA (2010-14) value in DFID focus countries in SSA for 2010-2014, all of which were in its ports sector, building on the earlier successes Country shares in value of telecoms projects in DFID focus countries in SSA (2010-14) Source: World Bank PPI Database; CEPA Analysis In telecoms, Nigeria accounted for 67% of transaction values for 2010-14, which has included large corporate finance transactions. Other countries with a relatively high amount of activity include Malawi, Mozambique and Zambia, who have been slower to Source: World Bank PPI Database; CEPA Analysis reform. Page 5 A: Bankable projects External donor support still required, particularly in countries without a track record • The best results seem to be where programmes of activity have occurred which have involved government origination of projects. Lessons can be drawn from South African renewables, Nigerian ports and recent developments in Kenya’s IPP sector. • These programmes often relied significantly on project preparation support, including from donors such as the World Bank (Nigerian ports, Kenya IPP transactions) and AfDB (Kenya’s geothermal IPPs). • In addition to project preparation support, many successful transactions have relied on Partial Risk Guarantees (PRGs), even in relatively advanced countries. This includes five out of seven IPPs in Kenya and four out of four energy sector projects in Nigeria since 2010. South Africa Renewables Nigeria ports concessions Under the REIPPP, private sector commitments of US$14bn Since the sector reforms in 2004, over US$7.2bn of were made in 64 projects, which are expected to generate investment has been made. Recent investments include the 3,922MW of power. Lekki Seaport (US$1.5bn) and Onne expansion (US$2.9bn). Page 6 A (i): Upstream constraints to bankable projects The key challenge is gaining acceptance that users need to pay for infrastructure services if they are to be provided at the volume and scale required • The challenge in SSA has been to gain broad-based acceptance of the need to pay for infrastructure services, whether publicly or privately provided. The implications of the absence of cost-reflective tariffs is profound: • For instance, many publicly-owned off-takers are close to insolvency: lenders are understandably unwilling to provide finance to such borrowers (at least without a government guarantee). • Where PPP arrangements have been agreed, such as the Lekki-Epe expressway concession, they have been unsustainable because of the inability to apply cost-reflective tolls. • Given increased economic growth in SSA, affordability is becoming less of a problem. Without a greater willingness to pay, however, the desired quantum and quality cannot be delivered. At its heart therefore, the question is as much one of infrastructure funding as financing. • Political economy barriers to PPPs are much more wide-ranging than just issues of securing cost-reflective payment for services. Governments may wish to hold on to state assets for either revenue or political reasons. • In most countries, network power infrastructure has not been opened up to private investment, and too often the private sector is seen as a last resort when government cannot find another way of delivering projects. • Unlike introducing legal frameworks and creating institutions, these problems are far less amenable to donor interventions. Page 7 A (i): Downstream constraints to bankable projects Key downstream constraints relate to the challenge of improving the capacity of public sector to develop projects and respond to unsolicited proposals • Our findings suggest that a key constraint is the availability of appropriate technical, legal, and financial skills both inside and external to government to support the necessary processes to facilitate project development. This needs proper resourcing. • Government originated projects are often inadequately prepared, failing to offer investors and lenders a fully bankable package, complete with appropriate risk mitigation / security requirements. • The lack of capacity within government leads to a reliance on unsolicited proposals (USPs). These are projects identified and promoted by the private sector, which can be opaque arrangements, not least in terms of how project rights – often worth millions of dollars – are acquired. • The lack of transparency makes it more challenging for donors to participate in their funding and financing. At a minimum this tends to delay project timelines, and at best the approach can produce one-off successes. Page 8 A (ii): Policy options to develop bankable projects In the short-term PPPs need the protection of guarantees to attract private capital. In the long-term a mix of policy reforms are required. • The likelihood is that most projects, particularly where there is not a track record of PPPs, will require guarantees. • PRGs are an effective tool as they allow specific risks to be targeted, which is not the case with credit guarantees. • They can also be used to support lower risk availability structures in more challenging transport sectors, where state entities are the payee (as opposed to transferring traffic risk). • PRGs can often involve concessional IDA and ADF resources which can be a cost effective use of subsidies in mobilising private resources. • In the longer term, governments need to implement a range of reforms to make the market more conducive for private finance, this includes: • Full (or at least partial) divestments of existing assets, to open up the possibility for the provision of private finance to existing assets with a track-record of performance (reducing greenfield risk). • Increasing tariffs to cost recovery levels (whilst focusing subsidies on the poor). • Sub-sector specific reform to develop structures that make the provision of private finance possible. For instance, the development of full power markets, which reduces single-off-taker payment risks. Page 9 B (i): Main type of finance for projects Research suggests a reliance on project finance approaches, with debt held to term. Also reliance on foreign exchange debt, creating exchange rate risk Projects in DFID focus countries 2010-14 (excluding South Africa and Telecoms) Total Finance category (US$m) Share of financing category Share of total financing • countries is dominated by project financing approaches, rather than corporate finance, reflecting the sub-sectors open to PPPs Debt DFI 1,800 47% Banks 1,892 49% Other 146 4% Sub-total 3,838 such as IPPs • 70% 199 14% 1,255 86% 1,454 Participants in transactions are largely project sponsors (equity); DFIs providing debt but increasingly commercial banks. Equity DFI Equity from private sources Sub-total Outside of telecoms, private infrastructure investment in focus • Most infrastructure projects in the case study countries have sought long term FX debt. This provides longer tenor, more competitive pricing and greater ability to fix rates than local currencies. 27% Mezzanine DFI 107 65% Other 58 35% Sub-total 165 3% Source: IJGlobal, World Bank PPI database, CEPA analysis Page 10 B (i): Main sources of finance for projects (2010-14) Banks from South Africa and Nigeria are playing an increasing role in financings Bank debt has been increasing African-based banks have provided the majority of debt Source: IJGlobal, World Bank PPI database, CEPA analysis DFI debt comes from a range of sources Source: IJGlobal, World Bank PPI database, CEPA analysis Source: IJGlobal, World Bank PPI database, CEPA analysis Mainly South African and Nigerian banks involved Source: IJGlobal, World Bank PPI database, CEPA analysis Page 11 B (ii): Barriers to increasing the provision of finance Limited evidence that access to long-term FX is a constraint, but there are constraints relating to the provision of long-term local currency debt • Given that many African banks have been able to access long-term US$ finance and the significant resources of DFIs relative to the number of project opportunities, access to long term FX finance is not a constraint for creditworthy projects. • However, there is an absence of longer term local currency finance. With the exception of some very rare examples, such as the Lekki toll-road in Nigeria, long term (> seven years) local currency financing has not been involved in transactions (although many telecoms projects have been part-financed with five to seven year local currency debt). • Commercial banks are heavily reliant on their short term deposits for their funding rather than longer term wholesale funding available in FX markets, creating a tenor mismatch with infrastructure loans. Shorter tenor finance also creates refinancing risks for projects with longer tenor requirements. Local currency is also typically more expensive than FX, due to higher prevailing interest rates in SSA countries. • In addition, the absence of term interest rate hedging markets means that projects are at risk from interest rate movements. Page 12 B (iii): Mobilising international institutional finance The current project financing model does not create many opportunities for institutional investors to provide finance • The types of infrastructure sub-sectors open to private investment, such as electricity generation, tend to be suitable for project financing approaches, which lock out opportunities for most equity and debt institutional investors. • This is because apart from in the case of highly specialised investors, institutional investors such as pension funds require operational and liquid assets, not greenfield, illiquid ones. This is not just the case in DFID’s focus countries, but also in developed countries. • If institutional investment is to be sought, particularly for larger projects, its requirements need to be built into financing approaches, which ideally will provide for a partial or full refinancing by institutional investors, once the project is operational. • The potential for this could be enhanced if DFIs were able to adapt more of a recycling of capital approach rather than one of coming in at financial close and holding to term. The former is the approach adopted by project finance banks internationally. • This could, however, represent a significant change to the DFI current operational approach, the consequences of which would need to be explored more fully. Page 13 B (iii): Mobilising local sources of finance There is a strong policy rationale for supporting local currency financing solutions, but it is challenging because of supply-side issues • Currency mismatches between a project’s receipts and out-goings – particularly between local currency revenues and FX financing costs – can undermine creditworthiness. Ideally, a project’s mix of financing should be matched to its revenues. • To increase the provision of local currency finance, as with FX lending, banks will need credit enhancements. In addition, if the tenors of local currency financing solutions are to be extended, liquidity risks will also need to be addressed. • Potential financing policy interventions include greater provision of liquidity instruments such as ‘put options’ by DFIs, which enable banks and investors to exit performing investments, if they need liquidity. DFIs could also to use their own balance sheets more to raise longer term local currency finance through local market issues, to on-lend directly to projects or else to provide wholesale funding to local banks. Where this creates additional risks, donors may need to risk share in this. • The other way to deal with currency mismatches is to utilise currency swaps, in which borrowers effectively borrow in local currency, but investors have exposures in FX. There is the potential for the an institution like the Currency Exchange Fund (TCX) to get more involved in infrastructure. Page 14 C: Regional infrastructure projects Regional projects face greater preparation challenges, but in some circumstances this scale can be an opportunity • The constraints faced by regional projects are similar to national projects, but with added complexity caused by the direct involvement/ interest of multiple stakeholders. • The number of stakeholders involved makes it more difficult to take a regional project to financial close, these are typically better originated by the public sector. • Implementation capacity among responsible institutions, including RECs and their specialist agencies was highlighted as a constraint, including requirements for both financial and human capital. • It is important that more political and financial investment is made up-front to support the development of the prioritised projects. We carried out case studies on three multi-country regional projects which highlighted need to create dedicated institutions with mandate to develop project. • Regional projects with a high-quality off-taker in place may provide greater opportunities for international institutional finance. Page 15 Conclusions The main challenge to mobilizing private capital to finance projects is a shortage of bankable projects • The projects that are developed are typically not creditworthy, first and foremost, due to the risk associated with their own revenue streams, which is ultimately due mainly to a lack of willingness to pay cost reflective tariffs. To deal with this issue projects need to be offered to the market with appropriate structures and support packages that mitigate these risks. • An option is to pursue the PPP model in which government is the ultimate payee so that projects can access PRG support. • Additional subsidies provided to fund MDB guarantee reserves so that they do not eat into IDA and ADF allocations could be explored for increasing guarantee capacity. In any event, the presence of an MDB in a financing structure helps to reduce the perceived risks to the project. Page 16 Conclusions Introducing more long-term debt from local and international institutions not only requires new products, but also new approaches to development finance • Constraints to finance depend upon the nature of the financing being sought: o Greater use of local currency financing would provide more opportunities for local investors and lenders. Moving towards greater corporate financing of existing assets would also open up opportunities (as has been the case with telecoms). o o Local currency debt financing helps mitigate exchange rate risk, but: - projects need to be able to accommodate any additional costs; and - banks may need liquidity support to extend tenors. International institutional finance needs scale and ideally investment grade credit ratings. Larger projects (including some regional) appear to be the most likely entry point; ideally through refinancing. o Investment in operational assets is the natural and more cost-effective entry point for institutional investors. o Recycling of capital approaches could help create more investment opportunities for institutional investors. Page 17 Contact us CAMBRIDGE ECONOMIC POLICY ASSOCIATES Queens House, 55-56 Lincoln’s Inn Fields London WC2A 3LJ Tel: 020 7269 0210 Fax: 020 7405 4699 [email protected] www.cepa.co.uk Page 18