For good or for worst, I’m returning to another topic in finance though with the slant of focusing on infrastructure. I think this stems from the fact that Singapore is in fact a financial hub and this is an area that our players are strong in, and where they participate most in the infrastructure sector. On the other hand, infrastructure projects do require huge amount of capital in order to be implemented and hence finance is particularly important as a gate through which infrastructure projects must sail through.
If we talk about the evolution of infrastructure financing, I would say that capital markets, and asset securitisation is probably serving as the tail end of the string by which financing evolves. The most basic would be government financing, where the government takes it upon their budget, either directly or through government debt, take on the project. The next stage is for a private company, using its balance sheet but also the merit of the government long-term contract, to obtain financing from the banks (with corporate guarantee and hence recourse) to develop the infrastructure. Project finance comes after that, where the merits of the project alone together with the credentials of its stakeholders allows the project to be financed by a syndicate of banks. Capital markets would then take this further by taking over the financing from the syndicate of banks either when the project is completed or when the project has gone through due diligence processes.
Capital markets is essentially the market for capital – they exists in physical form commonly in stock exchanges where the prices of various capital instruments are listed, priced and traded. Project debt or equity can also be put up on the capital markets. The slight difference of course is that unlike companies which can be assumed to exist in perpetuity, projects tend to have a finite lifecycle so there might be a predictable route its value will take given the profile of its cashflow projections. Of course, surprise situations and external circumstances will still affect its value but in some sense, projects tend to be more stable, and hence amenable to issuance of debt instruments in the capital markets. Mostly in the form of project bonds.
Bonds are debt instruments, basically it promises a stream of payments that flows into the future. These payments are fixed and can involve a huge lump sum at a certain point in time or a multiple payments on a set schedule. They are issued by corporations, governments, and of course, projects. As I mentioned in the project finance article, a lot of upstream work involves the bank finding comfort and security in the asset itself. At the point when the project has been constructed and operating, with cashflow coming from the government, some of the major risks which exists at project conception have been removed, which means that now, the project might want to reconsider if the 10% rate of interest (it can be any figure, frankly, depending on the bank and the project) the project might be better off issuing a bond at 8% (assuming the market is able to take it) and use its proceeds to repay the project finance loan. That is essentially a refinancing activity, substituting one loan with another which is at a lower cost. The difference in returns goes to the equity owners of the project.
Accessing the capital markets is considered a ‘holy grail’ for most of infrastructure; not just because it gets the banks off the backs of project owners but because the risks becomes even more distributed and hence priced lower than if the risks was concentrated and sold. Of course, the capital markets can tolerate only the higher quality projects which are well-structured and with well-specified contracts where almost every contingency is spelt out so as to give the markets clarity and comfort. With the heightened interest by large institutional investor in green and sustainable investing, there had been rise in mention of ‘green bonds’ and debt instruments to support green (& blue) infrastructure such as renewable energy projects as well as water and sanitation projects. Whether these moves from conversations to widespread reality will still take much work.
For now, most of the projects that actually have successful accessed the capital markets are in Europe because of well-established standards both for debt instruments and also for infrastructure assets. Asia was on a growing trajectory of projects being refinanced using capital markets with these transactions ballooning from 1 in 2017 (the landmark Paiton Energy Bond issuance) to 2-digit number of transactions in 2019. Covid-19 probably made a huge dent on the trajectory, but this is most certainly a space worth watching.
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.