Savings & Protection

So it has finally happened. I have been contemplating for a while whether to add my views on topics related to adulting: mortgages, finance, careers and all that jazz. I’ve been working on the series on infrastructure which honestly have been my niche. I want to be able to help young talents find their interests in areas of the new economy that is not just the usual data analytics, digital stuff.

Singapore is definitely in need of IT talents, in the digital space – there are many niche areas that offer lots of opportunities including kdb+ developers (finance-related, pays really well – I’ve got a friend in there), distributed ledgers (read: the technology powering cryptocurrencies which have tonnes of many other applications), cybersecurity and cloud computing. Wait a minute, almost all those I listed there have good and strong applications in finance which will pay well. But there are other areas as well; including full stack development (which essentially is web-development, ranging from web apps, portals for various industry use), graphic user interface designs, machine-learning (which involves a whole host of different niche areas that you can get into). The list goes on.

But infrastructure space has its opportunities too! The industry is seriously in need of people who are into finance but dealing with longer term capital deployment, appreciative of risks factors, not captured through understanding financial statements but translating them from real world elements. It requires a lot of technical skills involving engineering, design, and also the ability to manage projects, optimise operations. The usual soft skills in typical general management and middle management, or sales environment is necessary in business development for infrastructure because information tends to be lacking and one needs all the social skills one can muster to obtain information from people and through observation. Being a good analyst or Business Development Assistant/Support for an infrastructure developer would build up the skills for that.

What a detour from the original topic of this piece! Actually, I had wanted to talk about savings versus insurance and how we need to consider them separately. What I really want to leave with you in this article, is this: “Savings makes for poor protection/insurance, and protection/insurance makes for poor savings” So please don’t mix up the 2 despite what the life insurance industry in Singapore hopes for you to. This is not about the whole life versus term life debate but I may allocate some time to write a piece on that. But this is about savings which in some sense is ‘self-insurance’ versus getting insurance.

The layman have problems understanding insurance because you’re buying something you cannot see. The agent may tell you it’s buying a peace of mind and then start sharing hypothetical scenarios that disturbs that peace so that the insurance he’s trying to sell you seem to be worth so much more. Other times, we say insurance is protection; and the reason is that it helps ‘protect’ you from certain financial downsides when an adverse event occurs. So health insurance doesn’t protect you from ill health but it can provide a payout that protects you from the financial downside of an illness. Usually the protection won’t be full – either because there’s some co-payment element or that you did not get full coverage. That is fine, and it is normal. So what happens is that the remainder of the financial hit have to be borne by you. What do you use to cover that? Most probably savings.

So what happens when you don’t have the insurance at all? You will have to cover them with your savings (or borrowings if you lack sufficient savings). Now what are savings for? You parents may tell you, there’s different kinds: there’s the type for your education, or for your marriage, for your house, car, and one for… rainy days. That rainy day portion, is in some sense, your self-insurance. The more events where you have insurance cover for, the smaller your rainy day fund can be to tide you through most of life’s events. If you keep the rainy day fund small, and lack insurance, then of course you will have to drain down the savings for your car, house, etc when bad things hit.

And if you buy too much insurance, obviously, you may decide you don’t need to keep a rainy day fund. But quite likely, if that occurs, you might have bought too much insurance and the premium payment eats into the potential savings you can have, whether it’s for your dream wedding or dream house. So to a certain extent, your savings and protection draws from the same financial resources, but behaves slightly differently. Savings should ideally be targeted, directed at some goals, and with a reasonable amount for contingency.

Protection should and must be procured to prevent extremely adverse downside risks (Total permanent disability, critical illnesses, etc.) The time horizon of coverage needs to be determined; life and health insurances becomes increasingly expensive with age; and term life has a time limit. It’s true that many things have to be nailed down at the point of contracting and there’s little room for flexibility after that but the good news is you don’t have to commit big all at once. You could start small, with something affordable and then build up subsequently when spending power is higher.

In the market now, there are insurance products that includes saving components (such as endowment) or investment component (investment-linked products). My 2 cents is to get away from them. Reason is that protection is a poor way to save, and savings is a poor way to protect. And of course, don’t even think of insurance as investment. It isn’t. Insurance is an expense – it is something to prevent you from suffering extreme downside. Just as you buy elbow guards and knee guards for use when you are roller-blading, especially when you first start out. The roller blades may be considered an investment to pick up a new skill which would be useful, but those elbow guards and knee guards, they are there to protect you from hurting yourself too much. The analogy goes further: it doesn’t prevent injury completely, it just helps buffer you from the extreme downside. No one thinks they are investing in knee guards. But buying those guards sure allows you to have more confidence to roller-blade.

It used to be that the only reason you should get into an endowment product is when you have no discipline to save, and you need someone to take that money off your hands at fixed frequently to put it aside from you so you’ll eventually have a lump sum. But today, that’s not even a reason because you could use a regular savings plan with one of the banks that regularly invests a fixed sum of your choosing into an index fund or a blue chip. This provides a better return and has lower costs involved than getting an endowment. It gives you the flexibility of liquidating if you really need the money urgently (albeit with potential downside due to market timing) but has no fixed time horizon so you can keep growing your money if you have no need for the lump sum even when a certain time horizon is up. There are of course more sophisticated robo-advisors and all to help you do the same at a lower risk level than investing in a market fund. All of these serves as better instruments for savings than endowment.

Thanks so much for reading all the way to this point. It can be a really bland subject and I have no infographics for you. Hope to be able to improve this over time!

Love of Economics

In a recent coaching call, I tried to share the differences between doing Economics and Finance. It was not easy; somehow pre-University students feel rather muddled between finance and economics which came as no surprise to me. The thing is, both deals with business; but economics is a much broader topic of which finance is actually a subset. What we call ‘finance’ as a topic is actually ‘financial economics’. A word of warning – I actually love economics so maybe I’d sound a little biased here but I try to be balanced.

Economics deals very broadly with questions pertaining to the functioning of the economy both at the broad level (macroeconomics) and the industry or firm level (microeconomics). It has since applied those concepts and thinking into various other areas such as decision-making (basically cost-benefit analysis), behavioural sciences (extrinsic and intrinsic incentives, cerebral resource allocation, psychological biases and mistakes – okay I made up the second one up but you do get the drift). The focal point of economics, is not money; it is the ends behind money – the goods, services, psychological satisfaction, or ‘utility’ in Jeremy Bentham’s formulation.

Finance deals with money, in all its forms – cash, credit and many of the newer, colorful ways in which promises to pay are structured and secured as well as the flow/movement of it. It is generally focused on movement across legal/geographical boundaries (exchange rates), movement across time (interest rates), how to price those rates, how to value cashflows. From an economist point of view, finance is a means, to achieve the ends which is utility. But in finance, there’s no notion of utility, everything is simply measured in terms of money, which ever currency you define as the base and within the period/time-horizon of consideration.

Now the reason for asking the difference, was really to consider what kind of career options these degree programmes open up. The truth is, finance sector takes in graduates from economics as well, and even engineering (some banks actually prefer taking engineers); but of course, the finance graduates certainly have it better in banks and might be more comfortable with the jargons and methodologies required when they first start out. They might also be more motivated by the kinds of programmes that the jobs serve up to them because the degree programmes tend to also build those areas of skills that are useful in banking (yes I’m talking about tidying up your excel models, dressing slickly, speaking well and networking).

Economics is broader, in that it gives you the flexibility to apply the set of thinking tools that you learnt in many other areas in terms of jobs – public policy roles, strategy consulting, business consulting, business development and more. But the thing is that economics is so general all these other jobs can also be filled by students from various other (albeit slightly different) disciplines. So in a sense, there’s nothing really ‘unique’ about economics graduates. If one desires to devote one’s university life towards building one’s career post-university, then the best bets are to go for professional sort of degrees: accounting, law, medicine, engineering, actuarial science, architecture, urban planning. In all of them, follow through and obtain your professional qualifications, then practice. These will be your fall-back regardless of what work you eventually branch out into. I’ve friends who were lawyers or accountants becoming entrepreneurs but at least if things fail, they are able to go back to their professions and do reasonably well.

But honestly, what good is it to devote your degree and life in university to doing something you’re planning to do for the rest of your working life anyways? To me, it’s important to draw upon that time as one that challenges your mind in the manner you deem appropriate, so as to discover how you can use it to contribute to the world. Pick subjects asking the kind of questions you feel excited about and that you want to answer them but don’t know the answers to (yet). Pick subjects that allows you to fail in a way that you have courage to, and feel proud of, and can share your wild experiences with your grandchildren. Be practical, but use the time wisely and well – don’t allow yourself to be enslaved to the expectations of the society or the world.

All the best!

Silencing the barks

Today we got to bring Dada to a pet cafe for lunch. It was a busy day at the pet cafe and there were lots of dogs around, just 1 cat who stayed inside its transparent enclosure. We were sitting in our corner at first but then a couple with a dachshund sat beside us, subsequently left and another with a maltese sat there. Many other things happened, such as people passing, trying to walk over him – yes, he was blocking the way slightly – and another terrier came walking about the cafe, even trying to go around chairs marking (thank God it was wearing some diapers) but then it also decided to poo on the floor, maybe 2 metres in front of Dada (the owner promptly cleaned it up).

The whole time we were at the cafe, Dada was just calmly lying there after having finished his bowl of boiled minced salmon. Only twice he got up with the intention of approaching a sheltie’s bowl but he was peacefully resting in the cafe despite all the noise, aggressive barking. Just look at him in this video I took:

Turn the sound on!

The video is so boring you’d think nothing is happening but turn the sound on and you realised what a stressful environment the pet cafe actually was! Yet Dada was just peaceful and calmly resting! Lest you think he is deaf (perhaps a little), he just got a shock when I dropped an empty plastic water bottle on the ground from the table despite back-facing me and also, the sound of the bottle falling was not as loud as one of those sudden barking.

It dawned on me how great it would be if we all in life learnt to be like Dada, able to silence the barks of other dogs, choosing to behave independently rather than being caught up in the frenzy of others of his own kind. Amidst these times of uncertainty, gloom and incessant ‘barking’ from others, let us learn to be able to choose our response. Intentionally or not, Dada was applying Victor Frankl’s findings, albeit it was better applied to humans.

Between stimulus and response there is a space. In that space is our power to choose our response. In our response lies our growth and our freedom.

Victor Emil Frankl

This dog have been quite a blessing through the Circuit Breaker period and whilst not the most affectionate (my wife would have preferred one with more energy), it’s really been the best dog for me (yes, I prefer old and boring). We are still learning a lot from him, having been a stray who has gone through so much (check out his instagram link to read his story).

Capital Markets for Infrastructure

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.

Careers in Infrastructure

Taking a bit of a break from the more heavy-going infrastructure topics and looking at another, perhaps more personally-important topic – careers! In this short article, I thought to just share generally what sort of work and roles are there in this sector, from what I’ve observed in my few years being involved in it. I think infrastructure can be thought of as an extremely interesting sector to build a career. And it also helps to break out of the traditional mould of thinking of a career within a single profession, or in a linear fashion. In the brave new world where linear progression is no longer the norm, infrastructure presents a new way of thinking about, and approaching future careers.

As I’ve mentioned previously, there are various different streams of work for any given infrastructure project; and the professions with expertise they require would include engineers, financiers/bankers, accountants, lawyers, business development managers, project managers, economic consultants, planners, technical designers, insurers. Of course, the different parties have varying degrees of involvement and at different times, but with this spread of requirements and different perspectives, there is opportunities for anyone to move around from specialist roles into more general roles, and also for generalist to look towards acquiring credentials and become specialists as well. In fact, I’m beginning to see a lot of specialists in the area of infrastructure making a career out of it by moving to more general management or investment roles. For example, a project finance banker can move into the developer firms to help with project development, build the case for investment internally and drive the project forward. An infrastructure lawyer can do the same, bringing his specialisation into the contracts negotiation and even the structuring of legal risks to protect the developer.

Engineers, on the other hand who might have experience operating infrastructure or even knowledge in the construction and technical solutions can hop over to the commercial team to assess the commercial viability, leveraging on their understanding of the technical requirements and solutions for the piece of infrastructure. Even as a bid engineer, one can grow to be a general manager overseeing the business development team. On the other hand, a general business development staff can build up their spreadsheet and modeling skills, and become a specialist in raising capital or financing for the projects they are working on. In that sense, building a career in infrastructure can be more than just about climbing the corporate ladder and moving to a higher place but getting more exposure on different sides of the deal and being better able to get it to close because your understand helps to de-bottleneck underlying issues.

Having given a fair number of examples on the mobility of the various different kinds of roles within the sector, I thought to lay out also the subject and topic areas that infrastructure calls for. That is perhaps the area which I found the most fascinating having been involved in the work myself close to 6 years now. Infrastructure is multi-disciplinary, and range from national level concerns to hyper-local issues. I’ve already mentioned the various areas of expertise required ranging from financial, legal, technical, economic, business-commercial, even strong understanding of environment and wildlife issues. Of course, these topic areas don’t have to be mastered by any single person and are generally parcelled out broadly to domain experts who have their distinct roles in the project. For example, the consultant group behind the environmental-social impact assessment reports may consists of anthropologists, biologists, scientists, putting together the report to be read by the financiers, insurers and other stakeholders. On the other hand, the banks will of course have the accountants, the financial modellers as well as the due diligence teams.

To a large extent, when you’re working within infrastructure, there is opportunity to hop around across the various relevant disciplines. And even more importantly, having both a private as well as public perspective in infrastructure is actually really useful because it ultimately takes both sides to work together to deliver on projects. To that extent, there should be no qualms about moving across both sides and gaining the experience to cover greater grounds. Of course, there’s added opportunities in the global organisations like the World Bank Group, Asian Development Bank and Asian Infrastructure Investment Bank.

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.

Is that Asset Recycling?

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.

Asset Securitisation

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.

Diagram Credit: Mizuho Bank

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.

What is Project Finance?

port infra

The topic of private sector financing of infrastructure cannot run away from the concept of Project Finance, which is really a financial structure that enables a projects to be financed solely based upon the cashflow expected from itself. In its purest form, it is non-recourse to the equity owners of the project; so the lenders cannot go after the owners of the project should the project itself fail to make payments on the loan. Often, project finance also provide higher leverage for the project sponsors than they could do at corporate level, which might be attractive even if the cost of debt is higher.

Maybe this already sounds like it is too much to take in. So bear with me a little while and allow me to take you from my credit-card application analogy to something closer, say, a mortgage loan. When you buy a house, you’d have no money to pay for it, and the bank would lend out the money to you, and for security/collateral, the bank gets your house. And the amount they would lend to you is based on the income that you make. Consider for a moment if the house is not yet built. So you commit to a loan, and the funds you are going to pay to the developers of the house, will be paid for by the bank, and the bank will be repaid by you, the customer, as the monthly payments are made. So did the developer actually borrow the money or was it you?

The bank must have a degree of trust in the developer, the project itself, and all the other things surrounding it, including the homebuyers’ ability to repay the loans for financing their homes eventually. And with all that in place, the home-building project itself actually can be financed largely by the lender rather than the developer themselves. An infrastructure project behaves very much the same way where the pre-commitments of the customer to that piece of infrastructure – very often the government – allows the lenders to take comfort that the project will be able to pay for itself over time.

This creates a very attractive structure for financing projects because it is self-contained, and parcels out various different risk factors to specific parties involved. For example, the developer takes care of the process to put together the parties and documentation required, the builders/contractors focus on bringing in execution capabilities, while the lenders bring in the much-needed capital and the users get their goods/services at a pre-arranged pricing schedule. Infrastructure is generally built for the long-term and last long. The demand for its services and payments to it are likewise long-term and repetitive; often also backed by the government as infrastructure often serves as public goods or at least club/common goods that are covered all or in-part by taxpayers. Project finance takes these advantages and enables benefits such as long-tenure financing (usually 15-20 years long repayment tenure, depending on the length of the concession contract), fixed interest rates over the long term (in some sense similar to a long-term sovereign bond), sometimes with repayment schedule sized according to the expected cashflow of the project (often part of ‘financial structuring’ of the loan).

This is last point is vital as infrastructure projects may be designed to accommodate growth over the next decade and therefore may be ‘overcapacity’ relative to the demand at time of commissioning. By sizing the repayments and managing the terms of the loan such that the lenders can tolerate lower payments in the beginning in exchange for higher payments at the end, the debt doesn’t become too overwhelming for the project to handle.

One final point I want to make is that project finance deals are often so large that a single bank would not want to take all the risks of lending to the project and would ‘syndicate’ with other banks or at least sell down part of their loan to another bank who would take the stream of payments down the line. This is another important feature of project finance as it allows multiple banks to partake in the risks of financing a single large project and be somehow acting as though they are a single lender  as opposed to having multiple lenders facing off a single project and doing their own evaluations separately.

There are more nuanced technicalities involved and I didn’t set out to write something that would just copy-and-paste textbooks or content from other sites so there’s some recommended possible readings to get deeper. Though they can indeed go quite in-depth into those nuances:

The last link contains an article that is very involved; and the geeky me kind of like how they even talked about fenus nauticum (sea loan) during the Roman empire as a sort of ‘pre-cursor’ to project finance today (which really started in 1970s and took off 1980s). Dentons do update this guide every now and then so the link may not be the latest. Googling ‘Dentons Guide to Project Finance’ should help to point you to something more updated.

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.

Growing, deliberately

coffee muse

I’m not sure about you but when I was young, I always wanted to grow up more quickly, to have more independence, to be able to decide things for myself rather than have the adults call the shots. And even when I am grown-up, I never quite regretted, as intimidating as the big decisions of life might be, I wasn’t too worried about ‘adulting’. I’m not sure if I’m last of my kind amongst the millennials – whom I don’t naturally identify with though by most definitions, I seem to fall into that generation.

The thing about being in the education system, following the mainstream, you’re like going downriver, the currents keep pushing your boat and you’re just trying to catch up with sights and sounds of both shores before they pass you by. And we all go through the various milestones almost naturally. From toddler to young child, you learn to see, hear, smell, taste, feel, then walk, talk, dance (albeit badly, in my case), relate to others. And then there’s school, subjects, outdoor activities, friends, rivalry; there’s science, arts, religion, politics, economics. And huge aspects and domains of life just opens up to you when just a while ago they seemed to all just fall into a single category: ‘things the adults would talk about’. There’s then the adulting stuff: jobs, finance, mortgage, marriage, careers, etc.

I realised though, I was a bit more deliberate about picking up the ‘adulting’ stuff and that it didn’t just come by as naturally as other things did. When my subjects went from ‘Science’ to ‘Physics’, ‘Chemistry’, ‘Biology’, it seemed natural and like a progress just flows. But to be honest, there was much more effort to go from ‘saving my pocket money’ to ‘managing personal finance’ or jumping further into things like mortgage, insurance, taxes. On one hand I think our education system made knowledge acquisition easy (though as kids we might think it was almost a chore to learn things); but on the other hand, it also didn’t prepare us for the non-linearity of the real world (this is a topic I intend to revisit again some day). That means that whilst we were in school, things had more clear-cut ‘right answers’; and we were more focused on learning answers than on learning the questions to ask.

When we were in school, the teacher throws up a series of questions, and we figure out the answers as we interrogate the body of knowledge we’re given to master. Teachers, study materials, and resources around us will be put together to help us answer those questions. We learn to engage those materials to answer the questions. But in life, we need to identify the questions and figure out what we’re trying to solve. This is because of the greater dimensionality involved in life, and the interplay of more factors (ie. no more ‘Ceteris Paribus’). More than half the battle is won by asking the right questions.

To take an example from insurance, we ask the questions like: ‘What is the best insurance policy? How much do I need to cover myself for? How does the coverage of this policy compare to another?’ Those are good questions, but they only deal with solving the superficial question of ‘which insurance policy should I get?’. There are other problems present – for example, isn’t the insurance agent just going to try and push me to select something that earns him the most, and which I’d most likely buy? Won’t he obscure any information? I realised it is more important to see the problem as ‘how do I get my agent to really work for me?’, bearing in mind that beyond optimising within your choice set, you’ve to solve a principal-agency problem as well. You need to flip the choice around and ask ‘how do I get the agent to sell me an insurance policy that works best for me and not himself?’

Examples of such questions I’d ask are: ‘How are your commissions aligned to my premium payments? How much of the money I’m paying goes into distribution costs? What are the mechanisms for the insurance company to return funds to the insured when the claims fall short of what you provisioned for?’ This is because, within the choice set you’re offered, there will always be a nudge towards some option that benefits the party offering you; getting the best deal is not always about just choosing between the options but questioning the choice set itself. Nevermind if your agent doesn’t know the answer to those questions, it challenges them to recognise conflicts of interest and to tread carefully, elicit greater empathy. In any case, if he tries to hand-wave these questions away, you should start doubting his sincerity about helping you.

I have had to be more deliberate about growing up now that I’m grown-up because the system doesn’t help me with knowledge acquisition anymore. In fact, the economy has a myriad of incentive misalignments that encourage parties to obscure information from one another, generate false ‘knowledge’ to influence people. Realise now we’ve passed the river delta and reached the sea; the flow of the river is no longer pushing you along, now you have to adjust your sail and watch your surroundings. Where you want to sail towards is up to you. But sail you must, or you’ll be stagnant. Or you’ll be just going the way of drift wood, get beached or shipwrecked.

Age itself may imply more experience, but the worse thing that can happen is that age passes you by and you failed to grow. We ought to be more deliberate about our growth, deepening our thinking about what problems and challenges we are really trying to solve in our lives.

Feasibility of an Infrastructure

train infra

A huge part of infrastructure development work upfront is the feasibility study. What exactly goes into a full feasibility study and why is it so important? This article aims to explain that simply and more accessibly to people outside the industry. We’ll focus on the feasibility study rather than any documentation on projects generated prior to that (sometimes called pre-Feasibility Study – which could be considered a ‘lite’ version).

The feasibility study is like a professional evaluation of a business plan. For any infrastructure project, this is a comprehensive look into all the practical, legal, technical and commercial aspects of the project. Often, it will include social and environmental dimensions of the project in order to ensure that the lenders (ie. financial institutions providing debt to the project) is satisfied. In markets where there is significant social and environmental activism, the lenders are also on the receiving end of hate-mail, harassment and boycotts. Major project finance lenders internationally have therefore got together to be involved in The Equator Principles – a risk management framework that banks sign up to abide in assessing the environment, social risks involved in projects.

What then constitutes environment and social risks?

Infrastructure projects are physical, and will almost always require clearing of a piece of land to allow construction to take place. This would mean either resettling villages, people, farms, or redeveloping urban spaces, or even clearing swathe of rainforest. In cases of large hydropower dams, it will involve spaces not only for construction of the dam but also planned floodplains which can include multiple villages, broad swathe of forests. All of these impacts on human lives, biodiversity, alters natural landscapes.

Of course, the banks, developers, and builders care about people and rainforests. But beyond that, they are concerned about being harassed, haunted by NGOs, activist organisations trying to run them down reputationally for having been involved in projects that destroyed natural habitats for endangered species, upsetting livelihoods. These forms the environment and social risks; and the feasibility study tend to cover aspects of the social and environmental impact assessment, as well as to propose means to mitigate. Through that, the developers of the project also forms an idea how much resources they might need to expend to support resettlement, to help rebuild livelihoods destroyed.

How about practical and technical risks?

The feasibility study also goes into the technical and practical aspects of the project, including studying the possible technologies to deploy, the actual site conditions: whether the land can accommodate the infrastructure, whether there is actually sufficient demand for that infrastructure, and if the infrastructure has everything needed to service that demand – this could take the form of water supply pipe network, or an inter-connector to the national grid for a power plant.

The study needs to ensure that the proposed technical solution is able to deal with the problem statement at hand. For example, if we are using incineration for the waste, then we have to ensure that the waste stream is not too moist. If the waste is wet, the incineration system may not perform properly, which leads to potential technical breakdowns or stoppage.

And not forgetting the legal and commercial risks?

At the end of the day, the project will have to comply with the law of the land, and often, there will be a lot of permitting, licensing, government approvals that are needed for various components of the project. The feasibility study will investigate all of these and the developers will also do their best to make sure the requisite approvals and permits are obtain in advanced even often in parallel with the feasibility study just to make sure that the project is progressing in a timely fashion. These documentation will often be studied alongside the feasibility studies by the lenders.

Lots of parameters, and results from various aspects of the feasibility study would be captured into the financial model that is used to work out whether the project is commercially viable – that is, the total revenues/payments expected for the lifetime of the project is able to pay for its total cost over its lifetime. Governments may also undertake an economic cost-benefit analysis, to see if the total economic benefit of the infrastructure project is able to cover the total cost to society (more on this from a previous article I’ve written).

At the end of the day, flagging out, assessing and then measuring these risks enables the developers, lenders, and the government to have a better picture of how viable the project really is, hence its feasibility – from the various risks perspective as well as the resourcing that can be availed to the project. Doing proper feasibility studies can also help government better plan areas surrounding infrastructure, whether it is to mitigate some of the impacts of the infrastructure, but also to see if developments around the infrastructure can help improve its feasibility (eg. a larger substation might have to be built in the area to be able to accommodate a large utility scale solar park which would not have been able to feed power into the national grid).

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.

What is Bankability?

infrastructure

I’m hoping to embark on a series of writing that will help the university students and young graduates appreciate the infrastructure industry better. I know this is likely the beginning but I’m not sure when it will end or how frequently I’ll be writing. For now, I thought I just want to get started and eventually when there is critical mass, I’ll be putting it up on a separate website.

For consumers, when we apply for credit cards, the bank taking in the application wants to know our income, our employer, age, and will probably scrub our current track records for payment on our other cards, as well as any outstanding debt we have. For businesses, the process involved in loan applications is somewhat similar. Banks look at the years it has been established, the revenue/sales track records, the profitability of the firm and or sometimes they are financing based on the invoices – payments that the firm will be receiving from its customer for goods sold.

And then there’s infrastructure projects; they are not yet built, there’s no cashflow or payments made to the infrastructure, sometimes the land is not even acquired yet (there’s no one providing funds to acquire the land!). The willingness of a well-established financial institution to lend money to the project at reasonable interest rates (ie. ‘bankability’) will depend a lot on factors that surround the projects which gives good indication of the ability of the project to repay its debt. Like consumer credit, the more data the banks have, about both projects of the type in general, and also specific data about the project to be financed, would help give them a better sense to assess if they should lend to the project.

So what kind of data? I’ll distinguish between the availability of data, and the outcome of the assessment on the data available. The banks need data on the reliability of the sponsors/developers (essentially the equity owners of the project), the engineering-procurement-construction (EPC) firms involved, the government or customer of the project (ie. the one who will be paying for the services the infrastructure provides), as well as the underlying project involved. For each of the entities involved:

  • Previous payment/financial performance – in the form of financial statements, records, etc.
  • For government, often some kind of sovereign rating
  • Track records in project execution (especially in terms of the construction in the case of EPC firms, and operating experience for the developer or whoever they might be appointing to operate the project)

Then for the underlying project, the sources of data that will allow the banks to make the assessment would be:

  • All the contracts involved in the project
  • Feasibility studies involving site survey results, data – independent studies verifying that the proposal is feasible, technical solutions can deliver expected results, etc.
  • Any documentary evidence of support by governments or other development financial institutions towards the project.

In essence, these things are basically like the payslip or appointment letter from your employer which you submit for your credit card application. They give proof that the project is able to be put together and generate the kind of cashflow worthy of the loan that it will be taking out. There will also be sophisticated financial models that are shared across the developers and the banks in order to work out transparently what is the cashflow expected from the project across its lifetime and how these cashflows will be divided amongst the various stakeholders.

Through the information, the bank determines how stable the cashflow is, the level of comfort they have with the creditworthiness of the various parties, and then work out the pricing (ie. interest rates) on the loan, which helps to update the financial models, and provide more clarity to all the parties involved on how the returns from the project are shared. The assessment of risks by the bank (which impacts on pricing and whether they would be interested to finance the project at all) will be based upon their internal due diligence on the various parties involved in the project, as well as the feasibility study, and the set of contracts underlying the project. It often depend critically on the government involvement in the project and how they are involved. Major project finance deals are often achieved with government providing a guarantee on the income stream of the project conditional on the performance of the project based on pre-agreed indicators. Once the bank is satisfied that the operators and developer is able to perform in accordance to the contract, they shift their attention towards the creditworthiness of the government who have promised to pay.

As a result of these complexities, infrastructure transactions themselves are not only big in terms of the investment but they do require big teams to put the transactions together whether it is on the developer side, the financial institutions or the consultancy teams. These teams are all combining various disciplines including accounting, finance, engineering, general management, project management, legal, etc. To that extent, we do think that the industry is a good generator of job opportunities. The challenge is that these projects are typically have activities in starts and stops (extreme busyness in one camp or another in different points of time). The skills required across the sector is quite wide-ranging though the topic tend to be more narrow and focused.

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.