Asia escaped the worst of the last global financial crisis, but a pullback in European lending highlights the need for a broader range of products for the region’s financial sector.
Source: Reuters/Cathal McNaughton
A sign is displayed on the door of the European Commission offices in Dublin
The global financial crisis has passed, but the fallout is still being felt in Asia. As if financing US$750bn of Asian infrastructure each year is not enough of a challenge, the European sovereign debt crisis has left policymakers facing the additional headache of having to do so without the support of many of their traditional lending partners.
Many of the European banks that had bankrolled projects across Asia before the European sovereign debt crisis have either cut their exposures to Asian infrastructure or pulled out of this part of the world altogether.
“We are, indeed, facing a difficult time for project finance,” said Lakshmi Venkatachalam, ADB vice president for private sector operations. “Major international project-finance banks have become more risk averse, suffering increased funding costs and feeling the impact of looming Basel III requirements. Consequently, long-term financing beyond seven to 10 years is looking less appealing to them.”
This threatens to pile the pressure back on the public sector, potentially derailing all manner of vital projects.
Recent experiences, however, have shown that, when one door closes, another may already be open wide.
While European banks have retreated, regional lenders are increasing their presence. The likes of Australia’s ANZ, Singapore’s DBS and Malaysia’s CIMB are all expanding, while Japan’s deposit-rich lenders are once again looking overseas to boost meagre domestic returns.
Commercial banks may be feeling the strain amid tougher capital requirements and their own funding costs, but institutional investors are flocking to the international capital markets – and many come with the kind of long-term focus that lends itself ideally to infrastructure projects.
As recently as mid-April, the Republic of Indonesia raised US$2.5bn from a Global bond issue that included US$500m of 30-year debt. The deal came at a yield of just 3.85% for 10 years and 4.95% for 30.
“In most Asian economies, the capital markets are still nascent, but there is a huge reservoir of long-term funds from insurance companies and pension funds that can be channelled into infrastructure,” said Venkatachalam.
Initiatives
These changing circumstances have forced project-financing specialists, such as the ADB, to develop new products in the hope of attracting other groups of private-sector investors.
The ADB’s traditional co-financing product – the A/B loan – remains available, but officials have noticed a decline in demand from commercial lenders. The typical B loan structure, where commercial lenders participate alongside the ADB and benefit from the latter’s preferred creditor status, is an obvious casualty of tighter bank lending.
Instead, the ADB is doubling its efforts to boost the use of public-private partnerships through risk-mitigation products, such as credit- or political-risk guarantees or currency swaps. It is also working hard on providing technical assistance to ensure that more projects come to market from more countries, and that the ones that make it to the financing stage are truly bankable.
“The challenge is to tailor the requirements of the member countries with the instruments and products on offer,” said Venkatachalam.
In the last 12 months, the ADB has formalised its own processes to “mainstream” PPP, redefining responsibilities within the bank with a business plan. The plan is in the final stages of development and calls for greater involvement in four key areas – policy advocacy, to encourage member governments to embrace PPP; enabling, by offering assistance on legal and institutional framework; project development; and project financing.
Recent achievements have seen the ADB expand the use of PPP to new – frontier – countries. It has provided assistance to the Government of Mongolia in preparing a concession law to support private-sector infrastructure projects. The bank also financed a feasibility study for a combined heat and power project in Ulan Bator, which will set a precedent for PPP in Mongolia. In addition, it is working in Cambodia to provide technical assistance on policy and pathfinder projects.
“The PPP operational plan is now being mapped out in a way that we can provide the right kind of support across the whole region, depending on the member country’s needs,” said Venkatachalam.
Expanding PPP to new countries and sectors, however, brings with it new risks. The ADB, for its part, recognises that private-sector participants will require additional risk-mitigation tools before they are comfortable investing either in new technology or in a country where the PPP framework has yet to be tested.
In order to mitigate technology risk, the ADB is working to back the first concentrated solar power plants in China and India. It has extended assistance to the first two solar power projects in India and agreed to a US$150m guarantee facility for commercial banks lending to small-scale solar projects.
In riskier countries, it has provided a political-risk guarantee of US$200m for a gas project in Uzbekistan, and extended partial credit guarantees for two wind projects in Pakistan, involving the ADB’s first-ever Shariah-compliant debt funding. The deal met two goals for the ADB, supporting renewable energy, while appealing to the local investor base through an innovative guarantee for an Islamic lease structure.
Other recent developments have seen the ADB support a Thai solar project through an unfunded risk participation, and also introduced behind-the-scenes refinancing guarantees, acting as a reinsurance provider to banks or insurers that provide credit enhancement, thus allowing lenders to offer longer-term loans. It also offers a guarantee for wholesale commercial banks to support micro-lending, having agreed a US$250m scheme in 2010. The ADB is expecting 50% of that facility to be used before the end of 2012.
“Where possible, we are working to bring together B Loans with guarantees in order to offer the broadest range of ADB resources to commercial lenders,” said Venkatachalam.
More to be done
Guarantee structures are likely to become more important as the capital markets become a more significant source of support.
However, there is much more still to be done.
“The ADB’s lending limits are fixed. If banks retreat, then the capital markets must be developed,” said Venkatachalam. “Efforts will have to be geared towards mobilising long-term funds available with pension funds, insurance companies and others.”
Asia’s diverse capital markets, however, are ill-equipped to support long-term infrastructure financing. Many local markets lack the broad investor base needed for longer-term debt, while shallow and expensive swap markets prevent international investors from getting involved.
The greater use of infrastructure-debt funds will help ease the shortage of long-term liquidity, and the ADB has already thrown its weight behind pilot schemes in India. State-run India Infrastructure Finance is putting the finishing touches to a US$1bn fund that has the backing of the ADB. Three others, namely HSBC, IDBI Bank and Life Insurance Corp of India, are in talks to join as commercial partners.
Project financing remains a rare sight in Asia’s bond markets, thanks mainly to the difficulty in obtaining credit ratings for a start-up project company without a track record. One of the most promising areas, however, for the ADB is the use of guarantees – rather than simply financing – to improve the credit rating of selected projects and allow them to then tap the capital markets.
“It’s not just delivering financial products, but really financial products embedded in a knowledge base that comes from our exposure to best practices,” said Venkatachalam.
