NEW YORK (S&P Global Ratings) May 6, 2019--As difficult as it often is for developed economies to build large-scale infrastructure projects, the hurdles that emerging markets face can seem insurmountable. From unfavorable political environments to funding shortfalls, the challenges that many projects must overcome is significant. Many investors see the risk-reward ratios on merchant or greenfield construction as inordinately high--which makes infrastructure projects costly to fund. This is particularly true for emerging markets, despite an abundance of private-sector capital.
Still, there are solutions in the offing, according to investment bankers and multilateral development bank (MDB) officials, and government representatives working with the U.N.-affiliated Closing the Investment Gap Initiative (CIG) who spoke at a roundtable of about 20 participants hosted by S&P Global Ratings in New York on April 26, 2019.
One key to emerging markets' success in developing sustainable infrastructure is to build a pipeline of projects—preferably similar in size and structure, and with some commonality of design—that make risk assessment and due diligence easier for institutional lenders.
To the extent that a project is developed in a rigorous way--ith solid contracts, etc.--the more likely it is to succeed. In the words of one roundtable participant, "the more baked it is and the more robust way it is put together, the easier it is for you to do your due diligence on that."
CIG is working directly with emerging markets countries to establish mechanisms to identify areas in which essentially the same project can be replicated in more than one country. For example, finding collections of cities across countries that need to swap out their old-world streetlights for more energy-efficient ones. Standard solutions easily blueprinted across regions can reduce investor due diligence, aid in speed to market, and provide potentially economies of scale.
Another challenge is developing projects with a target size that is big enough to draw investors' interest. "Where is the threshold that makes the effort more than just a bespoke engagement?" a participant asked. CIG is looking to set up groups of investors to share the risks of projects, and to build on characteristics of infrastructure investment and create a pipeline to facilitate liquidity.
Another way to gain scalability is through the bundling of infrastructure assets--an approach that is gaining momentum, driven by the needs of the diverse group of stakeholders involved in the supply, funding, construction, and maintenance of infrastructure. This includes governments, institutional investors, and contractors—each of which has different needs and motivations. (See "Bundling: A Growing Trend As Stakeholders Look To Unlock The Potential Of The Infrastructure Asset Class," published Jan. 31, 2017.)
We've seen instances in which governments have packaged assets into a single financing to meet scale requirements or to improve credit strengths by attracting larger, more experienced contractors. And while bundling can complicate the credit analysis of a transaction, we've observed that it can also, when executed, lead to the opening of new sources of capital for infrastructure.
At the same time, "you have to sell it to the bankers and investors—but you have to also sell it to the governments, and that doesn't always work," one roundtable participant said.
For emerging markets solving these problems could open up a deep source of investment capital. From a distance, it may seem that infrastructure is an asset class that investors are uniformly wary of, but it's more the barriers to investing that pose problems rather than the long-run riskiness of the asset, at least in developed markets. Infrastructure investing offers a number of attributes that institutional and private investors find attractive, such as comparatively lower default rates and higher recovery rates than those on corporate bonds. (See "2017 Inaugural Infrastructure Default Study And Rating Transitions", published Nov. 20, 2018, and "1995-2016 Global Bank Loan Unrated Project Finance Default And Recovery Report, published Nov. 20, 2018.).
But while there is significant capital interested in infrastructure, the perceived credit risk of many opportunities in emerging markets may not be attractive for institutional investors--and they have, as a matter of course, stuck mainly to investing in developed countries. S&P Global Ratings sees the comparatively elevated risks in emerging markets as including political and regulatory uncertainty, currency exchange risk, and policies that are often less developed and somewhat unpredictable
Financial ingenuity can also be key. Bankers have a talent for coming up with creative credit enhancements to get deals done, one roundtable participant said, and this poses an opportunity to encourage the private sector to deploy capital allocated to infrastructure across a wider spectrum of projects and geographies. Credit enhancement aims to mitigate specific risks of a project that may weigh on its overall credit profile and therefore make that project less appealing to private-sector participants (see "It's Time For A Change: The Role Of Credit Enhancement In Mobilizing Private Investment In Infrastructure," published Sept. 28, 2018).
As a first step to, it might be worthwhile for MDBs to explore the sale of some assets on their balance sheets to the financial markets to create liquidity in emerging markets make room to finance more bespoke projects in higher-risk countries. However, there are challenges to this for MDBs, and this idea has yet to gain much traction. Still, it may be necessary for many sustainable projects to succeed, one participant said.
For now, some banks are wary of doing emerging markets project finance because it's not economical to put their bankers on those deals given the limited pipeline, associated risks, and relatively high transaction costs. To address this, some MDBs are trying to build a debt pipeline of capital efficient cost-effective projects that together may justify banks' allocating those expensive resources, because the costs will be spread over a pipeline of projects rather than just a handful.
In short, identifying projects and financing mechanisms that will attract funding from the global investment community to put capital to work on the ground for real assets in developing countries is crucial.
Writer: Joe Maguire
This report does not constitute a rating action.
The reports are available to subscribers of RatingsDirect at www.capitaliq.com. If you are not a RatingsDirect subscriber, you may purchase copies of these reports by calling (1) 212-438-7280 or sending an e-mail to firstname.lastname@example.org. Ratings information can also be found on S&P Global Ratings' public website by using the Ratings search box located in the left column at www.standardandpoors.com. Members of the media may request copies of these reports by contacting the media representative provided.
|Primary Credit Analyst:||Trevor J D'Olier-Lees, New York (1) 212-438-7985;|
|Global Practice Leader:||Susan Gray, New York + 1 (212) 438 0040;|
|Media Contact:||Jeff Sexton, New York (1) 212-438-3448;|
No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.
Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.
To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw or suspend such acknowledgment at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.
S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process.
S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.
Any Passwords/user IDs issued by S&P to users are single user-dedicated and may ONLY be used by the individual to whom they have been assigned. No sharing of passwords/user IDs and no simultaneous access via the same password/user ID is permitted. To reprint, translate, or use the data or information other than as provided herein, contact S&P Global Ratings, Client Services, 55 Water Street, New York, NY 10041; (1) 212-438-7280 or by e-mail to: email@example.com.