This article was originally published in the March 2021 issue of Infrastructure magazine which you can read here.
Infrastructure is the backbone of developed and emerging economies worldwide. Yet, even as many countries turn to infrastructure stimulus to help drive COVID-19 recovery, the $15 trillion global infrastructure financing gap stands as a stark reminder of what the public sector has not been able to achieve alone.
The latest Global Infrastructure Hub (GI Hub) report, Infrastructure Monitor 2020, shows declining private sector investment in new infrastructure, despite the appealing risk-return profile of infrastructure investments.
Private investment in infrastructure through primary market transactions is only about US$100 billion per year, down from US$156 billion in 2010. This figure is a drop in the ocean compared to the US$15 trillion global infrastructure financing gap that the GI Hub calculated in 2017 based on projections to 2040.
Currently, the industry is taking a hard look at its objectives and practices in light of what the pandemic has taught us about the role infrastructure plays in inclusivity, resilience and other essential aspects of society. This presents a unique opportunity for the public and private sectors to build on their alignment of purpose to increase investment and close, together, the financing gap.
Gathering momentum around social impacts
A 2019 Global Infrastructure Investor survey by GI Hub revealed that 97 per cent of investors now believe environmental, social and governance (ESG) factors are important considerations in infrastructure investment decisions, an increase from 86 per cent in 2016.
This widespread recognition by infrastructure fund managers, lenders and investors appears only to have strengthened since the global pandemic. There is a distinct shift in emphasis from viewing ESG factors as useful considerations to seeing them as future-focused must-haves. This can only work in infrastructure’s favour for attracting private investment.
Some challenges remain in attracting private investors
There are a few reasons why investors are looking the other way when it comes to investing in infrastructure. Firstly, there are limited opportunities for investment as the number of public-private partnerships (PPPs) shrinks globally.
Infrastructure Monitor showed that private participation in PPP projects has gradually declined as a share of private infrastructure investment – falling from 36 per cent in 2010 to 28 per cent in 2019. There is also a shortage of bankable projects and fewer privatisations coming to market.
Secondly, risk-adjusted returns have become less attractive over the last decade with returns dropping due to serious competition among providers. The risk of infrastructure projects for investors is perceived to be high, particularly if the private sector is being asked to carry the burden of excessive risk.
This perception is challenged by Infrastructure Monitor, as it found that infrastructure loans on average perform like an investment grade security by year ten in high-income countries, and by year 14 in middle and low-income countries, and even faster in PPPs.
From a performance perspective, our industry can raise awareness that infrastructure does not perform like other asset classes in having increasing default rates over time.
And increasingly, we have the data to show this. In addition to the composite view provided in our Monitor 2020 report, there are the annual Moody’s publication of default and recovery rates of over 7,000 projects, and the EDHECinfra infra300 index of how unlisted infrastructure performs.
The data is clear that once through the initial higher-risk phase (i.e. construction), infrastructure that is contracted or regulated by the state generally provides long-term, predictable and stable yields.
This finding is a clear signal to the world that infrastructure is a safe environment to play in, and the time is ripe for private investors to move away from focusing only on high-yield investment. By investing in infrastructure, the private sector can diversify its portfolio, have a longer retainer and have a social license to play.
Lastly, the industry can break barriers to private investment by understanding how the public sector can be a deterrent to private investment. Capital charges associated with infrastructure investment can push investors towards other asset classes, and low interest rates make investment by the state more attractive and affordable.
Finding a way forward
As part of our work for the G20, the GI Hub recently conducted a market scan to understand the key challenges to mobilising private capital. We spoke to more than 40 investors, policymakers and market experts globally and identified three primary actions associated with attracting investment into infrastructure.
1. Ensure the availability of programmatic pipelines
Governments need to develop a clear vision for their infrastructure development agenda and goals. Without the required clarity, they will not be able to develop a robust and properly prioritised pipeline of projects. A good example of an infrastructure project pipeline is the online Mexico Project Hub.
Launched in 2017, the pipeline aims to accelerate private investment in Mexican infrastructure development. The first of its kind in the world, it has quickly strengthened Mexico’s ability to fund multiple large projects across the nation.
2. Navigate regulatory, political and economic uncertainty
Infrastructure development is often politically complex, requiring the approval of multiple, diverse and sometimes competing stakeholder groups. Misaligned interests can inhibit projects. Therefore, governments need to create the proper regulatory frameworks and economically robust environments if they are to nurture trust in their infrastructure programs.
One government that succeeded in this is Azerbaijan. Our InfraCompass, which quantifies the strength of countries’ enabling environments, found it had the most improved regulatory framework of any InfraCompass 2020 country. In 2018, Azerbaijan made resolving insolvency easier by making insolvency proceedings more accessible for creditors and granting them greater participation in the proceedings, improving provisions on the treatment of contracts during insolvency and introducing the possibility to obtain post-commencement financing.
Then, in 2019, Azerbaijan made resolving insolvency even easier by providing for the avoidance of preferential transactions (transfers or payments made to unsecured creditors that result in a creditor receiving a preference over the remaining unsecured creditors at a time when the debtor was insolvent).
3. Develop projects with attractive risk-weighted return profiles
Governments can keep in mind two key principles in the creation of their programs and projects: value creation (ensuring all projects have strong revenue potential) and value capture (ensuring key risks are mitigated and projects are appropriately financed to secure profitability). Projects that do not include plans for the fair and equitable generation and distribution of revenue will struggle to attract willing investors.
Activating private capital is key to closing the global infrastructure financing gap. The industry currently has an opportunity to explore investment options and create stronger partnerships between the public and private sectors, helping drive economic recovery in the short term while also driving longer-term economic and social outcomes.