Alternative funding sources have emerged in the Asia-Pacific infrastructure market in recent years, with investors stepping in to bridge the gap left by traditional funders as demand for infrastructure investment in the region continues to far outpace the available supply of traditional credit sources.
Securing capital for infrastructure projects has often been a challenge, given the significant upfront capital expenditure and often long return period. As in the US and elsewhere, project funding for infrastructure projects in the Asia-Pacific region has traditionally been sourced from multi- lateral development agencies such as the Asian Development Bank (ADB) and the International Finance Corporation (IFC), official development assistance schemes funded by individual donor countries, commercial banks, quasi-governmental institutions (including export credit agencies such as Japan Bank for International Cooperation (JBIC) and the Export-Import Bank of Korea (KEXIM)), and directly from local and national governments.
Continued economic success and population growth in the Asia-Pacific region, however, has placed increasing pressure on the supply of capital available from such traditional sources of infrastructure investment. Traditional sources of capital have not kept pace with the burgeoning demand for investment in the region’s projects. Very few, if any, governments have the necessary capital at hand to fund all of the infrastructure needs of their economies. The needs for infrastruc- ture in the Asia-Pacific region span sectors from telecoms, toll roads, airports and energy grids to water and sewerage systems, hospitals, prisons and public buildings. The World Bank estimates that emerging Asia-Pacific countries alone need to invest US$26 trillion until 2030 — or approximately US$1.7 trillion a year — to maintain their current rate of economic growth. According to the World Bank, com- mercial banks, governments, export credit agencies and other quasi-public institutions simply cannot service this level of investment alone.
Given the widening shortfall in credit available from traditional sources for infrastructure funding in the Asia-Pacific region, alternative investor groups have already begun to identify the wealth of opportunities which are available to private capital solutions in a wide range of infrastructure sub-sectors. Private debt credit funds, in particular, have become an increasingly important source of infrastructure funding in the Asia-Pacific region in recent years, particularly since local bond markets have not yet been sufficiently developed to meet the complex needs of infrastructure investment.
BRIDGING THE GAP — ALTERNATIVE SOURCES OF INFRASTRUCTURE FUNDING:
In a world of continuing low interest rates — and against a backdrop of growing volatility in global financial markets — investment in infrastructure assets has become increasingly attractive to investors looking for steady, long term growth. According to PricewaterhouseCoopers, private money has poured into infrastructure in recent years. Globally, infrastructure funds raised US$65 billion in 2017, compared to US$66 billion in 2016 and US$44 billion in 2015. While Asia accounted for only about 15% of the total global fundraising pool over the past 10 years,1 this does not reflect the huge amount of dry powder that is available for infrastructure investments in the Asia- Pacific region, given the global mandate of many infrastructure funds. This is in line with the growth in opportunities in recent years, as infrastructure deals in the region have been picking up speed, accounting for more than a quarter of the global amount in 2017.2
In Asia-Pacific, the supply of suitable infrastructure projects remains strong, making investment in the region an attractive option for newer types of investor groups outside of the tradi- tional multilateral lenders and project financing banks funding from their own balance sheets. Sovereign wealth funds, pension funds and insurance funds such as GIC (Singapore), Khazanah Nasional (Malaysia), CalPERS, OMERS, CDPQ, and Ontario Teachers, among others, have entered as important and active sources of private capital.
Private equity funds have also been making headlines by raising eye-watering levels of capital commitments for funds dedicated to infrastructure deals globally and in Asia. For these investor types, the attraction of investing in infrastructure is clear. Infrastructure assets represent long-life assets with low volatility, protected downside and stable cash flows which are especially suited to institutional investors looking to hold long-term liabilities.
Investing in infrastructure also provides the opportunity to significantly diversify a fund’s portfolio. In Asia, funds such as Global Infrastructure Partners, I Squared Capital, Partners Group, the infrastructure arms of Macquarie Group, Brookfield Asset Management, JP Morgan, and more recently KKR, have been active in sourcing and executing highly successful investment and divestment deals in Asia’s telecoms and renewable energy sectors, among others. For example, Global Infrastructure Partners completed its $5 billion acquisition of Singapore- based Equis Energy in January 2018, the largest renewable energy generation acquisition ever. In 2017, I Squared Capital completed its HK$14.5 billion acquisition of Hutchison Global Communications, a Hong Kong-based fixed-line telecommunications business.
TRENDS AND OPPORTUNITIES IN ASIAN INFRASTRUCTURE ASSETS
Increased competition among investors in mature markets and reducing yields are driving infrastructure investors into new markets where they may access more opportunities with potentially higher returns. Accordingly, investors have identified Asia as a source of compelling investment opportunities, particularly given the region’s urgent need for basic infrastructure such as roads, bridges, hospitals and power plants as measured against the growing economic strength in the individualized economies.
There continues to be a serious infrastructure investment gap. As such, the long-term outlook for private infrastructure investment in Asia is highly positive coupled with the substantial demand for private capital.
The economic outlook in Asia remains positive, even against the backdrop of a global trade war, as trade flows adjust themselves naturally (e.g. the movement of lower cost manufacturing from China to Vietnam, Indonesia, Bangladesh or India), and will continue to sustain the demand for infrastructure projects in such developing economies. And yet, there continues to be a serious infrastruc- ture investment gap. As such, the long-term outlook for private infrastructure investment in Asia is highly positive coupled with the substantial demand for private capital.
As with other kinds of investments, investments in Asian infrastructure projects present particular risks and challenges. To mitigate these and other risks, investors should look to retain legal counsel with both international deal-making experience and local knowledge, expertise, and extensive experience with on-the-ground issues and concerns.
Milbank has experience with these types of regional infrastructure projects, and has advised on recent investment transactions including airports in India, renewable energy in India, the Philippines, Vietnam and Indonesia, telecoms infrastructure in Indonesia, Myanmar and the Philippines, and integrated logistics infrastructure in Indonesia, among many others.
KEY CHALLENGES FACING INFRASTRUCTURE INVESTORS
Some of the most pertinent risks to infrastructure investment opportunities in the Asia-Pacific infrastructure market include:
• Legal and Regulatory Concerns: An uncertain and constantly evolving legal and regulatory framework can create difficulties for private debt capital that aims to participate in infrastructure projects, particularly since investors require comfort and confidence in a market’s regulatory regime. This is a common concern in emerging markets such as Asia, where new regulations are promulgated often without warning, and sometimes with conflicting implications on existing regulations.
• Allocation of Risk: In Asian econo- mies, governments often view private sector involvement in projects as a way to transfer risks to another party, whether through PPPs (Public-Private Partnerships?) or other structures. As such, the risks and the price of assuming these risks, including risks associated with foreign currency movement and force majeure events, are critical considerations for inves- tors. Where risks are not allocated in a manner deemed equitable by the investor, such as when inves- tors or governments are unwilling to undertake certain risks or where compensation is inadequate for the risks assumed, such investment could be a challenge. An investor could then choose to dedicate its capital to other projects with a more equitable risk allocation structure or not invest its capital at all.
• Increased Investment Competition: Given the amount of capital available for investment globally and in Asia, infrastructure fund managers and investors face increasing competition for investible assets, which results in the inevitable rise of asset valuations and eroding investment returns. Record levels of fundraising, coupled with investors going direct, have created an abundant supply of capital competing for these limited invest- ment opportunities. It is expected that the demand and supply interaction will combine to push prices higher (or lower) and stretch valuations further.
• Fund Profiles: Investors may have mandates, strategies and preferences that differ from fund managers and/or investments in the Asia region whose risk profile, strategic and geographic focus may not align with their own investment mandates, risk appetite and horizons.
• Exit Options and Secondary Markets: Exit options are important to infrastructure funds and private equity investors looking to divest after a specific timeframe. Appropriate exit strategies may involve a refinancing or sale of an interest to another investor. The availability of a regional secondary market for infrastructure investments is essential to facilitate the recycling of capital, the matching of buyers to sellers, and the matching of investment and exit preferences. Currently, the secondary market in ASEAN is still in its nascent stage, and investors have to navigate the developing legal and regulatory environment, including dealing with limitations on foreign investment and ownership which impede foreign investors’ access to the region. This is especially prevalent within the infra- structure sector, which is often seen as a sector of national interest that should not permit total or majority foreign ownership. As such, this can prove an impediment to accessing private capital for infrastructure in these economies.
Notwithstanding the current backdrop of trade wars, global market volatility and greater local political instability in recent years, investments from alternative capital providers in the infrastructure space in the Asia region remains strong and is projected to grow in light of the acute funding gap for infrastructure investment in the region. If investment from such capital sources is to grow even further, barriers to investment will need to be addressed by the local governments in each economy to unlock even more opportunities in the region and to lower risk profiles for such investors. However, even in spite of these constraints, the infrastructure space in the Asia region remains rich with investment opportunities and the outlook for continued growth is overwhelmingly positive.
1. Source: Preqin data.
2. Source: http://www.reuters.com/article/us-kkr-infrastructure/kkr-expands-asia-infrastructure- business-with-new-hires-idUSKCN1NP0O1