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16. Some Solutions

© New York University/Stern School of Business, CC BY 4.0 http://dx.doi.org/10.11647/OBP.0106.16

Infrastructure projects that meet sound commercial standards in terms of the returns and risks discussed in this study — including the sovereign dimensions — tend to find acceptable financing in the global debt markets. More such financing will become available as those markets become more capable of absorbing this asset class.

Projects that cannot meet these standards must rely on public finance and varying domestic or external guarantee structures. In many cases, this means explicit or implicit subsidies, or an assessment that the social returns and risks paint a significantly more favorable picture than purely market-driven assessments of the returns and risks. Such an outcome may be reasonable, but it places the burden of financing back on the public sector. The end objective is to shift the funding to the private sector in a sensible way whilst generating excess gains that the broader community of infrastructure stakeholders can share.

Given bank lending’s already dominant role, the greatest potential arguably lies in expanding the universe of infrastructure projects that can secure financing in the investment-grade bond market. A number of approaches to this end seem possible.

First, because investment-grade ratings would by definition be a prerequisite for projects to win broad-gauge bond market financing, credit enhancement techniques — such as interest and principal guarantees provided by bond insurers — offer one means of elevating some lower-rated high-yield international projects into the low end of the BBB ratings category.

If a higher-rated corporate sponsor is involved, a contingent financial guarantee might be possible. As noted, certain supranational agencies (e.g., the European Investment Bank) have begun to develop financing programs to bolster the credit ratings and institutional investor demand for targeted project finance bonds.

Possible credit enhancements suggest the key role that various multilateral development banks could play to unlock market-based financing for projects in the world’s poorest and in some cases most incompetently run countries. Because the problem of capital market access is heavily political, supranational financial institutions seem uniquely qualified to exert influence on member states and address the underlying governance issues that hold back such projects.

The World Bank, founded in 1944 as the International Bank for Reconstruction and Development to help finance post-war recovery, soon morphed into a key institution with the ultimate goal of eradicating world poverty. So far, the track record of this institution and its regional counterparts in reaching that overarching objective is decidedly mixed if the objective is a reduction in global poverty.

In 2014, a significant portion of the World Bank’s lending went to member countries that were already rated investment grade, with access to both developed local financial markets as well as the international bond markets. The Asia Pacific region, in particular, has absorbed a disproportionate amount of concessional credit from the multilateral lenders, on a scale largely inconsistent with the region’s already impressive development and growth performance.

To be sure, the World Bank and the other multilateral development banks have provided loans (typically early-stage) mainly to projects located in their member countries. Such lending has been limited in scope (typically 3% of total project debt) and has ranked super-senior in debt-service priority, based on these institutions’ preferred creditor status.

The halo effect from such project lending, however, appears to have been an insufficient catalyst to spur greater infrastructure development in poor regions, or even to preclude outright defaults on some of the projects bearing a supranational stamp of approval.

From an institutional investor’s perspective, having the World Bank or its cohorts able to exit and be paid off first is not as much of a “credit positive” as, for example, having the same type of capital invested in much greater volume on a junior basis. The latter exemplifies how the aforementioned EC/EIB credit enhancement program would work (i.e., a subordinated tranche of capital). Such junior debt or equity capital provided by the supranational agency would still be backed by the pledged capital from the member country where a particular project is located, helping to mitigate the lending institution’s risk of loss.

Although such a credit enhancement program would require a re-working of the various multilateral development banks’ stated mandates, as well as a reallocation of resources within these institutions, the potential benefits apparently justify the effort. Moreover, by having the supranational agencies exert a greater influence on specific projects through a more significant role in the capital structure, better governance standards should follow. For its part, the World Bank seems ideally positioned to invent clever enhancements that would kick infrastructure projects on the margin into the low investment-grade category and open up large, previously off-limits asset pools for such projects.

The World Bank recently created a Global Infrastructure Facility platform to encourage the sharing of best practices in PPP project development across the developing world. Having more of an equity-style ownership role in specific project financings would give supranational agencies much more leverage to ensure that these projects pursue the best international standards. Moreover, the strong support of an AAA-rated supranational agency might be sufficient to pierce the sovereign ceiling of lower-rated countries and achieve investment-grade ratings for specific projects.

The World Bank’s new rival is the China-dominated, 21-country, $100 billion Asian Infrastructure Investment Bank (AIIB). It is too early to tell whether this organization will follow the same pattern as the World Bank in focusing excessively on infrastructure projects in those countries that already stand the best chances of fending for themselves in world capital markets.

Individual OECD governments might also consider repurposing their sovereign credit agencies — which until now have been involved in infrastructure project loans on a limited, senior basis alongside multilateral and commercial bank lenders — to play a similar junior capital role in promoting specific projects in targeted countries. Such repurposing would move these agencies away from their historically narrow focus on specific trade-related initiatives and toward providing broader support for economic development in these nations’ key trading partners.

Additionally, the pool of available sovereign-related capital could be augmented in certain countries using re-channeled bilateral aid volumes from consumption to infrastructure development, as well as redirected investment capital from sovereign wealth funds interested in playing a catalytic role in global infrastructure.

The same infusion of best practices and good governance would likely follow if a government institution such as the US’ Private Export Funding Corporation, Export Development Canada, or Germany’s KfW Development Bank assumed a more prominent creditor (or even equity) role in infrastructure projects for developing countries, unlike the minimal, supplementary lending role these agencies have played in the past.

Some countries have considered national “infrastructure banks” that raise capital at or near sovereign rates or provide guarantees at below-market rates. There have been multiple calls for the creation of an infrastructure bank in the US — especially during the 2016 election cycle, and other countries have already deployed such institutions. In some circumstances, these special structures can reduce project costs by reducing the perceived risk for lenders and investors because they offer collateral, stronger creditor rights, and the like. They can also bring greater technical expertise to an infrastructure project and help shield it (for better or for worse) from the whims of local politics.

An infrastructure bank, however, could also turn out to be a cost-increasing end-run around local politics and would surely have higher financing costs than using straight sovereign debt in financing the same infrastructure. On the other hand, an infrastructure bank’s special debt class would likely not be considered part of a country’s “national debt” and might avoid “debt ceiling” political machinations.

Given the political realities, however, comingling private and public finance often does not end well — for instance, Fannie Mae and Freddie Mac in the US or the Economic Development Bank in Puerto Rico. The burden falls squarely on infrastructure bank advocates to make a convincing case that the benefits exceed the costs compared to market-based solutions.

Borrowing ideas from other areas of capital-intensive financing could also be productive. Consider the Cape Town Convention, which covers international financing of commercial aircraft and aircraft engines (2001), railroad equipment (2007), and aerospace assets (2012). It created international standards for registration of contracts of sale (including dedicated registration agencies), security interests (liens), leases and conditional sales contracts, and various legal remedies for default in financing agreements, including repossession and alignment with signatory countries’ bankruptcy laws. Its treaty came into force in 2004 and has been ratified by 57 countries.

By creating a common platform to secure lender rights, the Cape Town Convention moves key risks for registered equipment outside a nation’s sovereign domain and assures contracts’ enforceability, yielding common gains for signatory countries, air and land transport firms, lenders, and ultimately consumers.1 It has been highly successful in extracting gains for a broad range of stakeholders. Adapting this kind of innovation to infrastructure finance may be well worth considering.


1 See Saunders, Srinivasan, Walter and Wool (1999).