Well, maybe this is not so much about infrastructure than ‘finance for infrastructure’. But given how much infrastructure generally costs, it is not quite possible to ever run away from the issue of financing. I mentioned before about the Equator Principles in article on feasibility studies and it just goes to show how much financing affects the selection of projects and the manner by which projects are developed. You realised in my previous few pieces, I was always dwelling in one way or another about finance; and the trend continues here.
Drawing private sector involvement into new, unproven greenfield (not-yet-built projects) can be challenging because they have not seen operating revenues coming online, and they don’t know how established the demand may be for the projects. Even the most sophisticated feasibility studies and advanced projections can have significant room for errors and the degree or extent of these errors often depends on the level of optimism the developers have for the projects. Yet the government will always need to build new infrastructure or expand capacities. To avoid ever-increasing debt load on the government, one way to involve private sector capital to inject financing into infrastructure is to get them involved in the existing portfolio of assets.
The government often already hold a portfolio of infrastructure ranging from utilities, toll roads and bridges, to ports and airports. These infrastructure can be cashflow generating and already have proven demands. If these existing pools of cashflow can exchanged for a lump-sum of capital, then the government have access to new pool of funds to develop new infrastructure. In an ideal world where there is no issue of government corruption and projects are executed properly with governments assessing the risks involved carefully, as well as to perform the proper economic cost-benefit analysis, this process can be repeated. While this may have been called ‘privatisation’ from the Thatcher era, the ‘new-ish’ idea here, which involves more than just straight-out sale of the asset, is called ‘Asset Recycling’.
Asset Recycling essentially depends on existing, brownfield assets that are already on the books of the government, where they are carrying debt on the asset, as well as equity share in them. They could also have large amount of people on their payroll trained to operate the asset. The possible ways in which asset recycling is done determines how much the government ‘gets out’ of the picture as capital from private sector is unlocked upfront. There’s (1) straight out sale of equity; (2) issuance of project bonds; (3) asset securitisation. Of course there are also customised approach that governments can take on under brownfield ‘Public-Private Partnership (PPP) Schemes’ but we will not dwell on that today.
Sale of Equity (aka divestment or privatisation)
By having the private sector take over the asset (often by just hiring the same group of people over) and exchanging the longer term cashflow for an immediate lump-sum of money, the government is essentially making the private sector be the ones borrowing the money against a long-term, safer stream of cashflow. Since the cashflow is somewhat proven, if it was an infrastructure where the user-pays, there might no longer be a need for government to guarantee the revenues and that means that the responsibility of the government in keeping the project viable is only to the extent they deem it strategic. No hard commitments anymore. There is also arguments that the private sector might be able to operate the asset more efficiently than the government – something I’m neutral about. I think that the profit motive is no more powerful than the desire to serve the customer well in getting a job done efficiently.
Privatisation has its share of critics and at the end of the day for each of those options, there must be safeguards that they are performed properly, priced carefully so that the taxpayers are not shortchanged in the deal.
Issuance of Project Bonds
Project bonds, which perhaps deserves an article in its own right is basically the bond version of project finance. I mentioned in that previous article a point about banks grouping together to lend to the single project. Imagine now then that instead of having banks group together, we have investors, either public or private (retail investors, or institutional ones) coming together to lend to that single project. And with these debt instruments traded, it provides liquidity for the debt-holders to more easily sell their debt down to another party should they decide they suddenly need a lump-sum of cash rather than a stream of steady cashflows.
This allows the risks to be more diffused in the market rather than concentrated in the hands of a few banks or institutions and is touted to make the system safer, especially as the world steps up capital regulation and requires banks to hold more ‘safe’ capital. In Asia, infrastructure debt are still generally classed as risk capital which banks have significant caps on in their books. There’s insufficient data indicating to banking regulators that Asian infrastructure is ‘reliable’ or stable enough in performance in order to allow them to be classed as lower risk capital.
Again, with the project already having proven cashflow the bonds can be designed for maximum ease of serviceability by the project and that will ensure a good performance. Further reading of this Deloitte article might be helpful.
This is probably the most novel and somewhat complex way of asset recycling. In fact, some legal jurisdiction makes no room for asset securitisation or do not have sufficiently nuanced regulation and laws to enable this. Simply put here, asset securitisation takes selected or all of the revenue streams attributed to an asset and transfers it into a separate vehicle which is owned by a separate group of owners. Mizuho Bank has a really simple diagram to illustrate this and I’m just going to use it here shamelessly and have the diagram link back to its page.
The asset itself continues to be owned by the government and management control remains in the hands of the government. Contracts are signed between the revenue-collecting vehicle to somehow restrict the actions of the project owners so as not to jeopardise the cashflow. But that effectively allows you to ‘sell the cashflow but not the asset’.
This article is part of a series I’m working on to make topics in infrastructure a little more accessible to students and people from outside the industry who might want to get involved.
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