1

SANSKAR SARJAN EDUCATION SOCIETYS

D.T.S.S COLLEGE OF COMMERCE
KURAR VILLAGE, MALAD (E), MUMBAI-400097,
Accredited by NAAC with B grade
Permanently Affiliated to University 0f Mumbai
An ISO 9001:2008 Certified College.

PROJECT REPORT OF
INFRASTRUCTURE OF FINANCE
SUBMITTED BY
BIPIN .R. YADAV
52
T.Y.B.B.I
SENESTER- V
PROJECT GUIDE
Prof. Kanduri nagraju
SUBMITTED TO
UNIVERSITY OF MUMBAI
Academic Year
(2016-2017)

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DECLARATION
I, (BIPIN .R. YADAV), Student of Bachelor of Commerce T.Y.B.B.I
Semester v, DTSS College of Commerce, hereby declare that I
have Complete the Project on (INFRASTRUCTURE OF FINANCE)
in the academic year 2016-2017.
The information submitted is true and original to the best of my
knowledge,

DATE:
BIPIN .R. YADAV
ROLL NO: 52
Seat NO:

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ACKNOWLEDGEMENT
To list who are helped me is difficult because they are so
numerous and the depth is so enormous.
I would like to acknowledge the following as being idealistic
channel and fresh dimension in the completion of this project.
I take this opportunity to thank the (University Of Mumbai) for
giving me chance to do this project.
I would like to thanks my principal, Dr. M.S. Kurhade, for
providing the necessary facilities required for completion of this
project.
I take this opportunity to thanks our Co-coordinator Mr.
kanduri Nagraju, for his moral support and guidance.
I would also like to express my sincere express gratitude toward
my project guide prof. kanduri nagraju whose guidance and
care made the project successful.
I would like to thanks my college library for having provided
various reference books and magazines related to my project.
Lastly, I would like to thanks each and every person who
directly or indirectly helped me in the completion of the project,
especially my parents and my peers who supported me
throughout my project.

BIPIN .R. YADAV

D.T.S.S COLLEGE OF COMMERCE

SR.NO

TOPIC

PG.NO

1.

INTRODUCTION.

6-9

2.

Long Term Financing of Infrastructure.

10-12

3.

Infrastructure Financing in India.

13-16

4.

Bond Market for infrastructure financing.

17-19

5.

Specialized Infrastructure Financial Intermediaries.

20-23

6.

Direct Government interventions.

24-27

7.

Private capital for infrastructure finance: An overview 28-31

of the possible alternatives.

8.

The market for infrastructure debt.

32-38

9.

The market for infrastructure equity.

39-40

10.

The market for infrastructure equity.

41-44

11.

RISK mitigation and incentives for infrastructure

finance.

45-62

12.

Conclusions.

63

13.

Bibliography.

64

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Executive summary
The global financial crisis has brought changes in the bank lending market that
may, in time, make some global banks view the long-term lending typically
required for infrastructure projects as less attractive. However, there is increasing
interest in, and appetite for, private sector infrastructure financing. Indeed, the
2015 European Commission and European Investment Bank (EIB) proposal for a
315 billion European Fund for Strategic Investments (EFSI) depends heavily on
private sector investment (see section 3). At the same time, capital markets
investors have considerable untapped financial firepower committed to investing in
the asset class.
This Guide aims to unlock the potential for infrastructure financing by informing
public sector authorities as grantors of various types of public
concessions/contracts first time sponsors and project companies
interested in raising debt for infrastructure projects1. In particular, it focuses on the
debt component of financing, rather than equity (which is outside of the scope of
this Guide), and describes the relative merits of the bond markets and bank
financing and particular considerations to be taken into account by public
procurement authorities and private sector entities, as well as considerations
relevant to procurement and planning. While not primarily written for investors,
this Guide also sets out key credit considerations for project bond investors.
The Association for Financial Markets in Europe (AFME)2 and the International
Capital Market Association (ICMA)3, each of which represents a variety of capital
market participants, are committed to supporting the expansion of capital markets
financing for all types of infrastructure projects, in line with the European
Commissions goal of bolstering economic growth through long-term financing. It
is with this common goal in mind that AFME and ICMA have produced this Guide.
Underlying this Guide are four key considerations that should be taken into
account early in the financing and planning process. The potential assessment and
impact of these considerations should ease the path to efficient and competitive
financing, while balancing the interests of the relevant parties vital if the full
potential of competitive private sector financing is to be realized:

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1. INTRODUCTION
Traditionally, infrastructure investments have been financed with public funds.
Governments were the main actor in this field, given the inherent public good
nature of infrastructure and the positive externalities often generated by such
facilities. However, public deficits, increased public debt to GDP ratios and, at
times, the inability of the public sector to deliver efficient investment spending,
have in many economies led to a reduction in the level of public funds allocated to
infrastructure.
Budgetary pressures have been compounded in some cases by the need to repair
bank balance sheets and rebuild capital and liquidity buffers, owing in part to
strengthened prudential regulation in the banking sector. As a consequence, it is
increasingly acknowledged that alternative sources of financing are needed to
support infrastructure development. In this context, much attention is being
focused on the institutional investor sector, given the long-term nature of the
liabilities for many types of institutional investors and their corresponding need for
suitable long-term assets. For various reasons, including a lack of familiarity with
infrastructure investments, institutional investors at present allocate a very small
fraction of their investments to infrastructure assets. These investors have
traditionally invested in infrastructure through listed companies and fixed income
instruments.
Infrastructure can be financed using different capital channels and involve different
financial structures and instruments. Some, like listed stocks and bonds, are
market-based instruments with well-established regulatory frameworks. Banks
have traditionally been providers of infrastructure loans. Efforts are underway to
develop new financial instruments and techniques for infrastructure finance2.
These efforts appear to be having some success. Data indicate, for example, that
developments in the equity market for investments in infrastructure are promising
and that the creation of a liquid market for project bonds can be a good
complement to syndicated loans for project finance. Done properly, the
securitization of bank loans could help support lending and diversify risks, while
also assisting in the development of transparent capital market instruments.

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Many investors nonetheless perceive a lack of appropriate financing structures.

Only the largest investors have the capacity to invest directly in infrastructure
projects. Smaller pension funds in particular require pooled investment vehicles.
Collective investment vehicles have been available, such as infrastructure funds,
but problems with high fees, potential mismatches between asset life and fund
vehicle, and extensive leverage mean that these investment options may not be
suitable for all investors. Yet the market is evolving to address some of the
concerns. Several newer unlisted equity funds in the market are offering longer
investment terms.
Infrastructure financing can present particular challenges owing to the nature of
infrastructure assets. The following are some common characteristics of
infrastructure assets that differentiate them from other assets:
1. Capital intensity and longevity: Capital intensity, high up-front costs, lack of
liquidity and a long asset life generate substantial financing requirements and
a need for dedicated resources on the part of investors to understand the risks
involved and to manage them. Infrastructure projects may not generate
positive cash flows in the early phases, which may be characterized by high
risks and costs due to pre-development and construction; yet they tend to
produce stable cash flows once the infrastructure facility moves into the
operational phase. Some infrastructure assets, where users do not pay for
services, do not generate cash flows at all, requiring government intervention
in order to create investment value.
2. Economies of scale and externalities: Infrastructure often comprises natural
monopolies such as highways or water supply which exhibit increasing returns
to scale and can generate social benefits. While the direct payoffs to an owner
of an infrastructure project may be inadequate for costs to be covered, the
indirect externalities can still be beneficial for the economy as a whole. Such
social benefits are fundamentally difficult to measure. Even if they can be
measured, charging for them may not be feasible or desirable.
3. Heterogeneity, complexity and presence of a large number of parties.
Infrastructure facilities tend to be heterogeneous and unique in their nature,
with complex legal arrangements structured to ensure proper distribution of
payoffs and risk-sharing to align the incentives of all parties. The uniqueness
of infrastructure projects in terms of the services they provide and their
structure and potential complexity makes infrastructure investments less
liquid.
4. Opaqueness: Infrastructure projects tend to lack transparency due to opaque
and diverse structures. This also applies to Public Private Partnerships (PPP)
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models. The information required by investors to assess these risk-structures

and the infrastructure market in general is lacking or highly scattered, creating
uncertainty. The lack of a clear benchmark for measuring investment
performance is also seen by many investors as one of the main barriers to
infrastructure investment. The lack of transparency and adequate data increase
risks for those engaging in infrastructure financing.
The potentially large information asymmetries that may exist in infrastructure,
along with the long-term nature of infrastructure investment, may lead parties to
deviate ex post from ex ante decisions, a risk which among others may impede
private financing.
To attract institutional investors to the full spectrum of infrastructure assets, such
assets need to be structured as attractive investment opportunities, providing riskreturn profiles that match investors return expectations and liability structures.
Some projects are clearly and unequivocally commercially viable and these
projects are typically able to attract private sector finance. However, for other
projects where the rate of return may be insufficient to compensate private sector
investors for the level and/or character of risk, various risk mitigation techniques
and incentives may be employed to manage risks and/or enhance returns. Any
government intervention to these ends may, however, generate unintended
consequences, such as moral hazard and market distortions, which should be
addressed ex ante in policy design to the extent possible. Generally, the expected
benefits of providing risk mitigants should be balanced against their costs, and
their provision should serve to supplement market-based approaches to
infrastructure finance.
This report provides a structured framework for understanding the range of
instruments and vehicles for infrastructure finance along with risk mitigation
measures and incentives that may be used to support such financing. By providing
a structured overview and description of instruments and incentives for
infrastructure finance, it can serve as a starting point for further discussion and
analysis of infrastructure financing and related challenges, including the
development of analysis on the advantages and disadvantages of these instruments
and incentives and guidance on the various options for their use.
Financial market infrastructures (FMIs) that facilitate the clearing, settlement, and
recording of monetary and other financial transactions can strengthen the markets
they serve and play a critical role in fostering financial stability. However, if not
properly managed, they can pose significant risks to the financial system and be a
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potential source of contagion, particularly in periods of market stress. Although

FMIs performed well during the recent financial crisis, events highlighted
important lessons for effective risk management. These lessons, along with the
experience of implementing the existing international standards, led the Committee
on Payment and Settlement Systems (CPSS) and the Technical Committee of the
International Organization of Securities Commissions (IOSCO) to review and
update the standards for FMIs.1 This review was also conducted in support of the
Financial Stability Board (FSB) initiative to strengthen core financial
infrastructures and markets. All CPSS and IOSCO members intend to adopt and
apply the updated standards to the relevant FMIs in their jurisdictions to the fullest
extent possible.
The standards in this report harmonise and, where appropriate, strengthen the
existing international standards for payment systems (PS) that are systemically
important, central securities depositories (CSDs), securities settlement systems
(SSSs), and central counterparties (CCPs). The revised standards also incorporate
additional guidance for over-the-counter (OTC) derivatives CCPs and trade
repositories (TRs). In general, these standards are expressed as broad principles in
recognition of FMIs differing organisations, functions, and designs, and the
different ways to achieve a particular result. In some cases, the principles also
incorporate a specific minimum requirement (such as in the credit, liquidity, and
general business risk principles) to ensure a common base level of risk
management across FMIs and countries. In addition to standards for FMIs, the
report outlines the general responsibilities of central banks, market regulators, and
other relevant authorities for FMIs in implementing these standards.

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2. Long Term Financing of Infrastructure.

The strategy for the Twelfth Plan encourages private sector participation in
infrastructure directly as well as through various forms of Public Private
Partnerships (PPPs). Infrastructure investments increased from about 5% of GDP
during the Tenth plan period to 7.2% during the Eleventh Plan period. During the
Twelfth Plan period infrastructure investment is projected to increase to 8.2% with
9% in the last year, 2016-17. Almost 50% of the total infrastructure investment is
expected to be financed by private sources during the Twelfth Plan as against 36%
during the Eleventh Plan period. (Planning Commission 2013) It is expected that
private investment will not only expand capacity, but also improve the quality of
service and reduce cost and time overruns in implementation of Infrastructure
projects.
.

In a PPP, responsibility for both construction and operation of the project are
bundled together, which creates incentives to optimize resource allocation over the
lifetime of the concession, with the potential to reduce overall costs. The project is
implemented through a Special Purpose Vehicle (SPV) with a project sponsor,
usually a private sector developer or construction company. The government,
through a project authority, enters into a concession agreement with the SPV as the
concessionaire. The concession agreement provides specifications of the project
and services to be rendered as well as revenue sources of the SPV. For example, in
the case of a road project revenue would be in the form of tolls from users or
annual availability payments (annuities) from the government authority. The
concession agreement is usually long term, given the long useful life of many
infrastructure assets.
Over the life of a typical PPP contract unexpected events and contingencies, that
could not have been predicted when the contract was signed, will arise. It is also
likely that the parties will get into a dispute over how the contract should be
interpreted, or whether both parties have been performing as agreed. In some cases,
these disputes may result in early termination of the contract. Apart from the risks
of contract related disputes, renegotiation and possible termination, the major risk
in PPP financing is construction risk. In the typical PPP project there is a
significant drop in risk once construction is completed and the project is operating
smoothly. In some concession agreements some portion or all of the revenue risk
may be borne by the government.
The financial structure for a PPP project usually consists of 70-80% debt and 2030% equity. Equity is usually contributed by the project developer, construction
companies and facilities management companies in the SPV. The project sponsors
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would like to minimize their equity contribution since equity investment is usually
not their main business. However, debt investors would like equity investment
from the sponsors as a guarantee of their performance and commitment to the
project.
The high initial capital expenditure and long life of infrastructure assets require
long term debt
Financing. Financing by rolling over short term debt exposes the project to rollover
or refinancing risk. New debt may not be available or available only at high
interest rates leading to a situation of financial distress. Most of the debt financing
for infrastructure projects in India has come from banks. However, banks are
constrained in providing long term financing because of an asset liability mismatch
arising from their relatively short maturity deposits. While life insurance and
pension funds can provide long term funds their contribution has been limited
given the regulatory restrictions on minimum credit ratings of their investments.
Therefore, the main issue in the financing of infrastructure is the intermediation of
long term savings into infrastructure investment through low credit risk securities.
This requires financial intermediaries with adequate due diligence, monitoring and
structuring skills for infrastructure projects. The Indian government has taken
several steps through the market and banking regulators SEBI and RBI to
provide regulatory frameworks for specialized infrastructure financing
intermediaries. Regulatory frameworks have been put in place for a special
category of Non-Banking Finance Companies (NBFC), called Infrastructure
Finance Companies (IFC), and Infrastructure Debt Funds (IDF). Simultaneously,
the government has also set up a 100% government owned NBFC, India
Infrastructure Finance Company Limited (IIFCL), for providing long term
financing and credit enhancement for bond issues by PPP projects. Finally, in order
to enhance the supply of long term financing to public sector infrastructure
development companies, the government enables them to issue budgeted amounts
of long term tax free infrastructure bonds to institutional and retail investors.
However, there are more fundamental problems with PPP projects which cannot be
resolved with better financial intermediation. Gains from PPP projects come by
enhancing project viability by Sharing of risks between the government and the
private partner. However, infrastructure projects in India carry significant risks
largely outside the control of private parties. For example, in the case of power
generation projects the two major sources of risk are the poor financial and
operating condition of the largely state controlled power distribution companies
and the inability of the public sector Coal India to enter into long term contracts
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with generators to supply coal. Similarly, road projects face serious construction
risk because of problems related to land acquisition and environmental clearances
and in the post completion phase there are political problems related to toll
collections and periodic revisions as per concession contracts. These supply side
problems are well known and not covered in this paper.
This paper is organized as follows. Section 1 provides an overview of the current
state of Infrastructure financing in India. Section 2 discusses the experience of
bond markets in private financing of infrastructure in the UK. This highlights the
role of insurance and pensions funds in providing long term savings and of
specialized financial intermediaries in facilitating investment in infrastructure
projects. Section 3 discusses the creation of specialized infrastructure finance
Intermediaries - Infrastructure Finance Companies and Infrastructure Debt Funds.
Section 4 analyzes the role of direct government intervention through the issuance
of tax exempt long term infrastructure bonds by infrastructure related Public Sector
Undertakings (PSU). The government has also set up a 100% government owned
infrastructure NBFC, the India Infrastructure Finance Company Limited (IIFCL),
for channeling direct government financing and guarantees to infrastructure
projects. Section 5 concludes.

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3. Infrastructure Financing in India

The financial sector in India is dominated by banks. (IMF 2013) Commercial
banks are the largest group, comprising 58% of total financial assets, followed by
life insurance with 17% of total assets. There are a large number of NBFCs with
12% of total assets operating in specialized segments (leasing, factoring,
microfinance, infrastructure finance). Pension and provident fund assets account
for about 5.5% of total assets. Pension provision covers 12 percent of the working
population and consists of civil service arrangements, a compulsory scheme for
formal private sector employees, and private schemes offered through insurance
companies. Finally mutual funds account for 8% of assets.
Public ownership is a defining feature of the financial system. Majority publicly
owned banks account for three quarters of banking system assets. About 69 percent
of insurance premiums and 80 percent of insurance assets are accounted for by
public insurers. Most of the pension system is in public hands. The public life
insurance company and public provident fund are the two largest providers of
funds to the Indian capital market.
Given the pattern of household savings in India there is a scarcity of long term
savings. More than 50% of household savings is accounted for by physical
savings (investments in physical assets such as homes and more recently in gold)
and not subject to financial intermediation. About 55% of household financial
savings is accounted for by bank deposits, which are relatively short term in nature.
Life insurance and provident and pension funds account for the balance savings.
Investments Consistent with the pattern of household savings the main sources of
infrastructure financing are commercial banks, insurance and pension funds and
NBFCs. Table 1 below shows the projected sources of financing for the 12th five
year plan. Of the total planned investment the share of the private sector is about
48%. Almost 50% of the total investment is expected to be financed by
borrowings. The distribution of the 50% borrowings is 21% is from banks, 11%
from NBFCs, 3% from pension and insurance funds and 6% from external
commercial borrowings with a 9% gap.in equity, has been small, except during the
period just prior to the financial crisis.

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Bank financing
As shown in Table 2 below banks are the major source of debt financing for
infrastructure in India. However, banks are close to their maximum sector exposure
limit so that additional bank financing will be constrained by the rate of overall
credit growth.

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Banks also face an asset-liability mismatch if they provide long term loans
financed by relatively short term deposits. According to the RBI (2013b), while
banks have been meeting the needs of financing infrastructure currently, there may
be some further constraints on such long term financing once the Basel III bank
liquidity norms such as the Liquidity Coverage Ratio and Net Stable FundingRatio
are implemented. According to the Trends and Progress in Banking (RBI 2013c),
maturity mismatch has often been highlighted as a concern for the Indian banking
sector given the sectors increased exposure to long-term infrastructural loans
financed primarily from deposits of shorter maturities. Similar concerns have also
been expressed by rating agencies. (India Ratings andResearch 2013a)
A different view is expressed by the RBI (RBI 2013d),
Almost all banks rely exclusively on retail deposits to fund their advances
portfolio. The individual retaildeposits may not have an average tenor of more than
one year, whereas most of the big advances of the banks are long tenor, in the
range of 8-10 years. While on an individual basis, the retail deposit may be
considered volatile, on a portfolio level, these deposits are stable, which enables
banks maturity transformation action. Hence, my point is that if, as going
concerns, banks can rely on retail deposit to fund projects for 8-10 years, and they
might as well do so for 13-15 years.
Even if this assessment is true for the banking sector as a whole it is unlikely to be
true for individual banks.

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Concerns have also been expressed about banks due diligence and credit appraisal
of infrastructure projects. The Non-Performing Assets (NPAs) and the restructured
assets in this segment have increased quite substantially of late. The Gross NPAs
and restructured standard advances for the infrastructure sector together, as a
percentage of total advances to the sector, has increased from 4.66% as at the end
of March 2009 to 17.43% as at the end of March 2013. According to RBI (2013d),
There is enough evidence to suggest that a substantial portion of the rise in
impaired assets in the sector is attributable to non-adherence to the basic appraisal
standards by the banks.
Life Insurance and pension funds
Life insurance and pension funds are considered as the main source of long term
financing.
Life Insurance companies have three sources of assets under management - life
funds, pension and annuity funds and unit linked (ULIP) funds. It is the first two
which are suitable for long term investment. The government owned Life
Insurance Corporation of India accounts for almost % of the total non ULIP funds.
Life Insurance companies are restricted by minimum rating requirements
imposed by the Insurance Regulatory and Development Authority of India (IRDA).
They are required to invest 50% in government securities. Of the balance, 75% is
to be invested in AAA rated securities. Under the norms prescribed by IRDA,
insurance funds should invest 15% of their controlled funds in infrastructure and
social sectors.
Pension funds in emerging markets are small. (Group of Thirty 2013) For
example, in 2010, total pension assets were 20 percent of GDP in Brazil, 9 percent
in China, 7 percent in Mexico, and 5 percent in India, compared to 103 percent for
the United States. In India, the development of a specialized voluntary defined
contribution supplementary pension, the New Pension System, is in its initial
stages.
It is difficult for infrastructure projects to satisfy the rating requirements for
insurance and pension fund investments. This is especially during the construction
period when projects face risks related to construction, land acquisition, financing
and cost escalations, and enforcement of property rights. With these risks, projects
at inception typically get a low credit rating in the BBB- category. Even after
commercial operations begin, ratings may typically go up marginally at best, as
demand, off take and regulatory risks remain.
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4. Bond Market for infrastructure financing

There is an almost unanimous view over the last two decades about the need for
developing a vibrant corporate bond market in India. However, while significant
efforts have gone into the development of corporate bond markets, substantial
progress has not been made yet (RBI 2013a). According to thePlanning
Commission (2013)
The market for infrastructure debt generically belongs to the corporate bond
market and without movement on the latter, movement in the former is not likely.
For several independent and interrelated reasons, in the Twelfth Plan, special
efforts must be made to ensure that the corporate bond market takes off.
Bond financing of infrastructure requires not only the availability of long term
savings with pension and insurance funds but also the presence of specialized
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financial intermediaries with due diligence, negotiations and structuring

capabilities for PPP projects. This is well demonstrated by the collapseof a thriving
bond market for PPP projects in the UK following the financial crisis in 2008
(EPEC 2010). The use of bonds to finance PPPs has differed widely among
countries in Europe. Accordingto the European PPP Expertise Center (EPEC),
bonds have been used most extensively in countrieswith significant private-sector
pension schemes which have long-term liabilities that need to bematched to longterm investments. Bond financing has been most prevalent in the UK since the
launch of the Private Finance Initiative (PFI)2 in the 1990s. In fact bond financing
was the dominant financing solution for large projects in the decade preceding the
financial crisis. The PFI benefited from an increasingly competitive finance market
with access to fixed rate, long term finance from both the banks and capital
markets. Banks provided long term floating rate loans which project companies
swapped into fixed rate loans using interest rate swaps.
In the UK, pension funds and life insurance companies were the main investors in
PPP bonds, either directly or through fund management companies. However,
unlike banks, these investors did not invest in due diligence capabilities for
infrastructure projects. Instead, they relied on the guarantee provided by
Monoline insurance companies3. Monolines were in the sole business of
providing a guarantee to investors of timely payment of principal and interest in
exchange for a fee, a process known as wrapping. This process of wrapping
converts the rating of the bond to the rating of themonoline, which is usually
maintained by the monoline at triple-A by holding adequate reserves. Thismade the
bonds suitable investments for pension funds and life insurance companies.
The monoline was responsible for conducting due diligence and structuring project
financings as wellas monitoring and administering the investments on an on-going
basis. Since the monoline took the front-line risk of project default, bondholders
historically ceded control of decisions to it. This controlling creditor role made it
easier for borrowers to obtain decisions in a bond-funded project because the
lender control was vested in a single entity irrespective of the nature of the
decision.
With the onset of the financial crisis monoline insurers lost their triple-A credit
ratings mainly because of their exposure to sectors other than infrastructure, such
as subprime mortgages.4 Reviving the bond market without the monolines has
been difficult since institutional investors have not built teams within their
organisations that are capable of structuring and negotiating PPP projectfinancings.
As pointed out by EPEC (2010), Most PPPs require many months, if not years, of
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involvement by funders which is not a justifiable expense for most fund managers
seeking to buy two or three PPP bonds per year. Simultaneously, banks have
become reluctant to lend long term because of Basel III additional capital
requirements for long term lending.
In response to these problems the European Investment Bank (EIB) has launched
the Project BondInitiative. (EIB 2012) The Initiative aims to provide partial credit
enhancement to projects in order to attract capital market investors. This is
achieved in two ways. In the funded format, the EIB will give a subordinated loan
to the project company from the outset. In the event of a default by the project
company losses will first be borne by the subordinate lenders, i.e. the EIB. Senior
lenders will be impacted only after the entire subordinate loans have been wiped
out. In the unfunded version the EIB will provide contingent credit line which can
be drawn if the cash flows generated by the project are not sufficient to ensure
Senior Bond debt service or to cover construction costs overruns. The credit
enhancement is available during the lifetime of the project, including the
construction phase.
The UK experience demonstrates that bond financing of infrastructure requires the
availability of longterm savings with insurance and pensions funds and specialized
financial intermediation services for due diligence, structuring and post financing
monitoring and renegotiations.

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5. Specialized Infrastructure Financial Intermediaries

Given the specialized nature of infrastructure PPP project structuring, due

diligence and monitoringthere is a need for specialized financial intermediaries.
NBFCs - Infrastructure Finance Company (IFC)
The RBI has created a separate class of non-deposit taking NBFC called
Infrastructure Finance Companies (IFC) satisfying the following conditions. (RBI
2010)
(i) a minimum of 75% of its total assets should be deployed in infrastructure loans,
(ii) net owned funds of Rs.300 crore or above;
(iii) minimum credit rating A or equivalent
(iv) CRAR of 15% with a minimum tier I capital of 10%.
With respect to credit concentration norms IFCs may exceed the concentration of
credit norms applicable to NBFC-ND-SI (Systemically Important) in lending to
any single borrower by 10% of its owned fund, that is up to a total of 25% of its
owned fund, and to any single group of borrowers by 15% of its owned fund, that
is up to a total of 40% of its owned fund.
IFCs are eligible to avail, under the automatic route, that is, without prior approval
of RBI, ECBs(External Commercial Borrowing) up to a maximum of 75% of their
owned funds, from recognized lenders under the automatic route.
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Infrastructure Finance Companies can maintain risk weight at 50% for assets
covering PPP and postcommercial operations date (COD) projects which have
completed at least one year of satisfactory commercial operations and which are
backed by a buyback guarantee by a designated Project / Statutory authority under
a Tripartite Agreement.
NBFC-IFC, given their concentration on infrastructure projects, will develop due
diligence,structuring and monitoring skills for infrastructure projects. Infrastructure
Debt Fund (RBI 2013e)
Infrastructure Debt Funds provide an alternative financial intermediation
mechanism for infrastructure financing and investment.

An Infrastructure Debt Fund (IDF) can be set up either as a trust or as a company.

A trust based IDFwould normally be a Mutual Fund referred to as IDF-MF; while a
company based IDF would be a Non-Banking Finance Company referred to as
IDF-NBFC. IDF-MF would be regulated by SEBI under rules applicable to Mutual
Funds while IDF-NBFC would be regulated by the RBI. IDF-MFs can be
sponsored by banks and NBFCs.
The IDF-MF is essentially a focused debt mutual fund. At least ninety percent of
the net assets of thescheme should be invested in the debt securities or bank loans
in respect of completed and revenue generating projects of infrastructure
companies or special purpose vehicle. In order to raise long term finance it should
either be a close-ended scheme maturing after more than five years or interval
scheme with lock-in of five years and interval period not longer than one month.
Since it is primarily
aimed at high net worth investors, the minimum size of the unit is Rupees ten lakhs
and the minimum investment from any investor is Rupees one crore.
IL&FS Financial Services Ltd (IFIN) launched the IL&FS Infrastructure Debt
Fund with the first setof three close-ended mutual fund scheme, having maturities
of 5, 7 and 10 years, respectively. The size of each scheme is Rs.500 crores. The
Debt Fund will be managed by IL&FS Infra Asset Management, a joint venture
between IL&FS Financial Services and India's largest insurer, Life Insurance
Corporation of India. Five public sector banks and the two joint-venture partners
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have contributed to the initial fund. (India Ratings and Research 2013b) The
funds strategy is to invest
around 20% of the portfolio in operational projects with established track record
and credible promoters; another 25% would be invested in take-out financing of
bank loans of completed projects; and 15% of the portfolio could be invested in
projects under construction. The Fund will rely on the IL&FS Groups investment
experience from infrastructure financing in selecting, credit appraisal, structuring
and monitoring investments in subordinated debt facilities, including funding to
promoter vehicles and investments in mezzanine debt instruments.
The IDF- NBFC will raise resources through issue of bonds of minimum 5 year
maturity and invest inbonds issued by the PPP infrastructure project company. The
project must have completed at least one year of satisfactory commercial operation
post the commercial operation date (COD). The project company will use the
proceeds of the bond issue to retire a portion of its senior debt, presumably from
banks.
The key aspect of the financing in the case of IDF-NBFC is the Tripartite
Agreement among the DebtFund, the Concessionaire of the PPP project and the
Project Authority, for ensuring compulsory redemption of the bonds held by the
IDF in the event of default by the Concessionaire. So far the cabinet Committee on
Infrastructure has approved the Model Tripartite Agreement (MTA) for the Road
sector with the National Highway Authority of India as the Project Authority.
(PlanningCommission 2012a) While the IDF has all the rights and entitlements as
the senior lenders, the IDF has the first claim on all termination payments.
According to the MTA, a default by the Concessionaire will trigger the process for
termination of the agreement between the Project Authority and Concessionaire as
specified in the Concession Agreement. The Project Authority will redeem the
bonds issued by the Concessionaire which have been purchased by IDF-NBFC,
from out of the termination payment. The IDF-NBFC will pay a fee to the Project
Authority as mutually agreed upon between the two.
The Tripartite Agreement is specific to the IDF-NBFC and does not apply in the
case of IDFMF.
India Infradebt is the first IDF-NBFC to start operations after receiving its license
in February 2013. Itis a joint venture, (shareholdings percentage in brackets),
among ICICI Bank (30%), ICICI Home Finance Ltd (1%), Bank of Baroda (30%),
Citicorp Finance (India) Ltd (29%) and Life Insurance Corporation of India (10%
per cent). While ICICI Bank, Bank of Baroda and Citicorp Finance will provide
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project finance and domestic and international fund raising services, LIC will be
investing in Tier-II capital and Senior Bonds issued by the Infradebt. India
Infradebt carried out a Rs.500 crore debenture issue in July 2013 which was rated
AAA by Crisil (Crisil ratings 2013).
Some questions have been raised about the viability of Infrastructure Debt Funds.
According toDr.K.C. Chakrabarty, Deputy Governor, Reserve Bank of India,
Having assumed the risk till the project comes on stream and starts generating
stable revenues, I dont understand why a bank would be willing to trade a good
credit risk for the risk of funding another greenfield project!. (RBI
2013d)However, the idea of the IDF is based on the premise that banks are not in a
position to provide long
term financing to PPP projects and will price their loans appropriately to cover the
higher risks of Greenfield projects.

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6. Direct Government interventions

The government has initiated steps to directly ensure availability of long term
funds for PPP projects.Over the last three years the government has provided in the
annual budgets for the issuance of long maturity tax free bonds by infrastructure
related public sector financial and non-financial undertakings. This enables the
infrastructure PSUs to offer suitable interest rates to attract long term bond
investors. The government has also established a wholly government owned NBFC
for
providing long term direct financing and credit enhancement for bonds issued by
PPP projects.
Long maturity tax free infrastructure bonds
The 2011-12 budget provided for the issue of Rs.30,000 crores of tax free bonds
which was increasedto Rs.60,000 crores in the 2012-13 budget. The budget for
2013-14 is Rs.48,000 crores. The total amount is allocated to various public sector
infrastructure related finance companies and infrastructure companies. The bonds
have maturities of ten, fifteen or twenty years. Since the issuers are all public
sector undertakings the credit risk of the bonds is negligible.
The coupon rate is capped at discounts below the Government security (G-Sec)
rate based on Issuerrating and investor category as shown in Table 3 below.
Investors are classified in four categories: Retail Individual Investors (RII),
Qualified Institutional Buyers (QIBs), Corporates and High Networth Individuals
(HNIs). Retail Institutional Investors include Resident Individual Investors and
Hindu Undivided Families applying for an amount aggregating upto and including
Rs.10 lakhs across all Series of Bonds in the Issue. Issuers have the option of
offering Retail Individual Investors a higher interest rate. The higher rate of
interest, applicable to RIIs, is not available in case the bonds are transferred by
RIIs to non-retail investors.

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One problem with tax exempt bonds is that they are considered a relatively costly
mechanism fordelivering a subsidy to the issuer of the bonds, because the revenue
forgone by the government in connection with the tax exemption is greater than the
subsidy received by the issuer. (US Treasury2011) A portion of the revenue
foregone by the government is captured by holders of tax exempt bonds whose tax
rates exceed the rate of tax on the marginal (or market-clearing) buyers of the tax
exempt bonds.
As the issuers of tax-exempt debt expand the pool of bond purchasers, until it is
sufficiently large toexhaust the amount of debt they are bringing to market, they
draw in bond buyers from lower income tax brackets by raising the interest rate
enough so that the yield on tax-exempt bonds is competitive with the after tax rate
of return on taxable instruments for investors in those lower brackets. As a result,
the marginal buyer of tax-exempt bonds will typically demand a tax-exempt yield
that exceeds what an individual in a higher income tax bracket requires to purchase
those bonds.
Suppose that a tax-exempt bond buyers preferred alternative investment is a
taxable bond. If taxablebonds paid 8 percent in interest and the market-clearing
bond buyer faced a 25 percent marginal tax rate, the yield on a tax-exempt bond
would be 6 percent which is equal to the after tax interest on the taxable bond. In
that case, the revenue forgone by the government (Rs.20 in lost income taxes based
on a Rs.80 interest payment taxed at 25 percent) would equal the interest savings
of the tax-exempt bond issuer (who pays 6 percent instead of 8 percent in interest).
However, some taxpayers who purchase those bonds would probably be in a higher
tax bracket andconsequently would produce a tax revenue loss that exceeded the
savings of the bond issuer. For example, if a taxpayer in the 33 percent bracket
purchased the tax-exempt bond bearing a 8 percent rate of interest, it would cost
the government Rs 27 (Rs.80 of interest income that would have been taxed at a 33
percent rate). In that case, the Rs.20 interest subsidy provided to the issuer of the
taxexempt bond would cost the government Rs.27.
According to several analysts in the US, only about 80 percent of the tax
expenditure from tax-exemptbonds actually translates into lower borrowing costs
for issuers, with the remaining 20 percent simply taking the form of a transfer to
bondholders in higher tax brackets. Using tax-exempt bonds to finance
infrastructure is also regressive, because the amount by which the benefits captured
by investors exceeds the issuers cost savings increases with the taxpayers
marginal tax rate.
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In February 2009, the US Administration and Congress passed the American

Reinvestment andRecovery Act of 2009 to address the economic contraction
caused by the financial crisis. The Recovery Act included the Build America Bonds
(BABs) program. The bonds issued are taxable for which the government pays a 35
percent direct subsidy to the issuer to offset borrowing costs. Payment is made
contemporaneously with each interest payment date under such bond. Since BABs
are taxable bonds which were sold without regard to tax status, they appeal equally
to investors that do not have tax liability, including pension funds and other long
term institutional investors, and to traditional investors of tax-exempt bonds. By
broadening the set of investors BABs helped to reduce issuer borrowing costs,
especially on longer maturity issues. In addition to broadening the market for
municipal bonds, BABs more efficiently deliver the federal subsidy for state and
local government borrowing because each dollar of subsidy goes directly to the
issuer.
In the case of Infrastructure Bonds in India the differential cap on interest rates
offered to investors, asshown in Table 3, may be motivated by similar concerns.
This may be considered as a form of price discrimination which allows the issuer
to capture some of the surplus which otherwise is captured by high tax bracket
investors in the case of uniform interest rates.
The India Infrastructure Finance Company Limited (IIFCL) was established in
January 2006 as awholly owned government company to provide long-term
financing for infrastructure projects.6 IIFCLs operating paradigm was governed by
The Scheme for Financing Viable Infrastructure Projects through a Special
Purpose Vehicle called the India Infrastructure Finance Company
Limited(SIFTI). (Planning Commission 2009) IIFCL commenced operations in
April 2006.
IIFCL funds infrastructure projects which are implemented through a project
company set up on anon-recourse basis, i.e., those set up as SPVs or those that are
units of larger corporate entities but whose cash flows can be ring-fenced. IIFCL is
required to assign overriding priority to PPP projects that are implemented by
private sector companies selected through a competitive bidding process,
preferably based on standardized or model documents approved by the respective
governments. In
order to finance its lending IIFCL raises long term finance against sovereign
guarantee for which it pays an annual guarantee fee. IIFCL also receives an
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allocation of the tax exempt infrastructure bonds. The government has provided the
entire paid up capital of Rs.2, 900 crores as on March 31, 2013..
IIFCL mainly provides long-term loans to project companies in association with
banks. As on March31, 2013 the total outstanding loans was Rs.18,921 crores out
of which Rs.16,351 crores was in the form of direct lending (IIFCL 2013).
Initially, IIFCL sanctioned loans based on the appraisal of the Lead Bank7.
However, IIFCL is progressively moving towards performing its own credit
evaluation, according to the ADB (Asian Development Bank 2012a).
IIFCL launched its Credit Enhancement initiative with a pilot transaction with the
support of ADB. (Asian Development Bank 2012b) Under this scheme IIFCL
plans to provide partial credit guarantee to enhance the ratings of project bonds
issued by infrastructure companies. With credit enhancement, infrastructure project
bonds are expected to become attractive investments for insurancecompanies and
pension funds. The projects under the facility will be expected to have a minimum
stand-alone bond rating without credit enhancement of BBB+, and should have
completed at least 2 years of commercial operation. The funds raised through the
issue of credit enhanced bonds will be used to prepay bank debt before its
scheduled maturity.
Under the pilot transaction, IIFCL enhanced the credit rating of a Non Convertible
Debenture (NCD)issue of Rs.320 crore by GMR Jadcherla Expressways Private
Limited (GJEPL). The company was incorporated in October 2005 as a SPV
owned by GMR Group of Companies. It was awarded a 20- year concession
through competitive bidding by the National Highways Authority of India (NHAI)
in
February 2006 to design, engineer, construct, operate, maintain, and expand into
four lanes the existing two-lane section of National Highway 7 from Farukhnagar
to Jadcherla and to improve, operate, and maintain the four-lane stretch of the
highway from Thondapalli to Farukhnagar on a build-operate-transfer basis. The
toll expressway began operations in February 2009.
IIFCL provided an unconditional and irrevocable First Loss Default Guarantee
(FLDG) to the bondholders to the extent of 24% of the NCD amount. On the basis
of the credit enhancement ICRA assigned a Rating of [ICRA] AA (SO) [ICRA
double A (Structured Obligation)] against a stand-alone rating of A. In the event of
default, after IIFCL pays its obligations under the guarantee, it will haverecourse to
the project assets.
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7. Private capital for infrastructure finance: An overview of the

possible alternatives
If we consider the point of view of a private investor, either a debt or pure equity
investor, infrastructure represents an interesting alternative asset class.
Infrastructure projects show interesting characteristics vis--vis more traditional
asset classes. We summaries them in Table 1.

Infrastructure can be financed using different capital channels. The evolution of

capital markets shows that financial innovation develops new financial tools able
to attract a larger amount of funds in response to supply (the infrastructure gap
shown in Section 1) and demand (the search for asset classes that are suitable for a
given asset allocation).
Figure 1 provides an overview of the different alternatives available to private
Investors. It first divides the instruments into equity and debt. Equity and debt can
be listed and traded on an exchange (public) or unlisted and traded over the counter
(OTC; private). In the case of listed equity and market-traded debt we make
reference to a traditional investment in listed infrastructure. This is the area where
mutual funds and exchange traded funds (ETFs) have developed products to be
included in the portfolios of retail investors, high net worth individuals and
institutional investors.

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Unlisted equity or OTC debt, instead, do not benefit from an active liquid
secondary market. For this reason, they are typical buy and hold asset classes,
suited to long-term investors with a clear preference for stable rather than
exceptionally high returns.
The lack of liquidity of these instruments implies that the universe of possible
interested investors is only a subset of the more general group of investors on debt
and equity markets. Not only is it a matter of volumes, but also of different
competencies required to assess the risk and return of this asset class. An investor
in unlisted infrastructure must be able to assess the risk/return profile of the
infrastructure throughout its economic life including its construction phase
(greenfield investments) and during the operational phase (brownfield
investments). This ability is even more important if the investment is made directly
in the equity of the project or if the investor lends
directly money to the project (see Section 3.2). However, the need for additional
and more sophisticated valuation skills remains also in the case of the indirect
investment in unlisted infrastructure (i.e. private equityinfrastructure funds or
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debt/creditfunds, see Sections 4 and 3.2 respectively). In fact, the risk analysis
process is carried out by the asset
management company/general partner on behalf of the investors that must show
specialised capabilities in the field.1
As a result of the liberalisation in the 1980s and privatisation of infrastructure
assets, infrastructure investments were often characterised as investments in
unlisted equity. Other options for investors have included investing in listed
infrastructure companies or listed indices, but the advantages of gaining exposure
to true long-term economic infrastructure through these products has been
questioned.
However, the most widespread financial technique that financial markets have
developed for the participation of private capital in unlisted infrastructure is project
financing. In project finance, equity investors, banks and other lenders invest
money on the exclusive basis of a stand-alone valuation of a single infrastructure
project. This single project is incorporated in a Special Purpose Vehicle (SPV). On
the equity side, the project is financed off balance sheet by industrial developers,
public bodies and financial investors(known as project sponsors) while debt is
provided on a no or limited-recourse basis. The assets of the SPV become
collateral for the loans although they play a secondary role compared to project
cash flows. Furthermore, rights and obligations associated with an investment
project are related to the SPV only. The separate incorporation of the project in a
specially designed vehicle is justified by the need of investors to enhance the
transparency of the valuation process. The existence of a SPV implies that previous
liabilities of sponsors do not reduce the credit rights of the lenders of the vehicle
and the no- or limited recourse clause excludes the co-insurance effect of a
traditional corporate finance transaction. The result is that investors interested in a
specific project can focus their valuation only on a given, well ring-fenced
transaction.
In the following sections, we provide indications about the development of the
market for debt and equity related to project finance starting from the debt side.
The reason is twofold. First, project finance is a structured finance transaction
characterised by a high debt/equity ratio, a factor in common with other structured
deals like securitisation and asset-backed securities. Hence, debt plays a
fundamental role for the financing of these transactions. Second, the market of
project finance of PPPs that can be considered asubset of this financial technique
if structured in the build-operate-transfer (BOT) or buildown-operate-transfer
(BOOT) form is in all aspects a segment of the syndicated loans market. This
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market played and still plays today a fundamental role in supporting infrastructure
financing. The equity portion, for a very long period of time, was provided by
industrial developers and before the mid-2000s institutional investors were almost
inexistent.
Starting from debt, then, is convenient for our purposes, also to frame the analysis
in a historical perspective.

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8. The market for infrastructure debt.

Project finance and loans
Project finance debt has started to be used in the United States since the early
1930s in oilfield development and later in Europe at the beginning of the 1980s. It
has been systematically used since then in a number of sectors in association with
large-scale infrastructure projects. Debt has been used in the form of syndicated
loans, with a pool of banks headed by one or more Mandated Lead Arrangers
(MLAs) that organise the financing package for a single borrower.
The development of the market has seen a period of very significant growth until
the outburst of the 2007-08 financial crisis. According to Thomson One Banker
data, in 2008 the global project finance loans market reached a record peak of USD
247 bn but then declined sharply in 2009, and recovered somewhat thereafter, to an
amount of USD 204 bn at the end of 2013. At the end of 2013, project finance
accounted for slightly less than 5% of syndicated loans worldwide after, again, a
peak of over 9% reached in 2008 (Figure 2).
Project finance is used worldwide to support infrastructure financing. The
geographic breakdown of loan volumes indicates a concentration of project finance
loans in four significant geographic areas Western Europe, North America, Africa
and Middle East, and South Asia which respectively account for around 19.2%,
18.5%, 14.4%, and 7.3% of the total value of project finance loans in 2013 (Table
2). These figures are pretty stable over
time.

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In terms of sectors where project finance loans are used, data show that developing
countries and emerging economies still adopt the technique for economic
infrastructure (energy and power, mining and natural resources, oil and gas,
transportation and telecoms), whereas industrialized countries increasingly use
project finance loans to finance also social infrastructure. Considering global data,
Thomson One Banker data indicate that power, oil and gas (54%, end-2013), and
transportation (20%) were the most representative sectors in terms of project
finance lending volumes (Table 3).
By looking at the data, project bonds still represent a limited amount of the total
debt committed to infrastructure financing, although increasing rapidly. During the
2007-12 period, the amount issued by SPVs via project bonds bounced between
USD 8.5 bn and USD 27 bn (Figure 3). 2013 registered a record amount of USD
49 bn in project bonds issues representing slightly more than 24% of the total debt
provided to infrastructure. The strong increase between 2012 and 2013 was in part
due to the overall decline of bond yields on all major asset classes and the
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consequent need for fixed income investors to find other investments with a better
risk/return profile than more traditional sovereign and corporate bonds. The
breakdown by geographical areas and sectors shows a clear concentration on some
sectors (infrastructure, power, social infrastructure, and oil and gas) and a
Polarization in United States/Canada, UK and Western Europe, with the latter
losing ground in the final part of the period under examination (Table 4 and Table
5).

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Compared to syndicated loans, project bonds present some contractual features that
make them more attractive to institutional investors rather than banks. First, bonds
are more standardized capital market instruments and show better liquidity if the
issue size is sufficiently large to generate enough floating securities. A higher
degree of liquidity can trigger a lower cost of funding vis--vis syndicated loans.
Second, larger issues can become a constituent of bond indices, adding further
interest for benchmark strategies of bond

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market investors. Third, project bonds can be issued with maturities longer than the
tenors of syndicated loans that banks normally accept.
However, existing evidence on the asset allocation strategies of institutional
investors regarding project bonds indicates that some characteristics of this
instrument make it not completely suitable for a traditional asset management
approach. Gatti (2014) indicates four factors: 1) investors seem more interested to
project bonds only if construction risk is over (i.e. brownfield investments); 2)
bullet repayments typical of bonds cannot be tailored to the cash flow pattern of
infrastructure projects; 3) the bullet repayment structure triggers a refinancing risk;
4) investors find it hard to assess the degree of risk of complex infrastructure
ventures and rely on the rating issued by external rating agencies. Although not
mandatory, rating is certainly a prerequisite to reach a broad base of bond investors.

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Recent initiatives in the debt market for infrastructure.

The increased interest of institutional investors for infrastructure investments,
coupled with a progressive retreat of banks from the project finance market due to
postcrisis deleveraging and higher capital and liquidity requirements under the new
Basel III rules, has forced financial markets to develop new financial techniques
able to attract capital also from more traditional asset managers with limited
knowledge about the risk assessment of an infrastructure project.
The most evident solution, although data on the trends are very scarce given the
very recent development of these investment strategies, is the emergence of an
originate-todistribute model that sees banks cooperating with institutional
investors in channeling debt funds to infrastructure. The available evidence
indicates three alternative structures:
1. The partnership/co-investment model.
2. The securitisation model.
3. The debt fund model and direct origination of infrastructure loans by
institutional investors.
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In the partnership/co-investment model, an institutional investor invests in

infrastructure loans originated by a MLA bank. The MLA organizes a syndicate
and retains a pre-agreed percentage of each loan in its loan portfolio, selling the
remaining portion to institutional investors. With this co-investment, an
institutional investor can build a portfolio of infrastructure loans and can rely on
the servicing of the loans in the portfolio provided by the originating bank. Recent
examples are the partnership set up between Natixis and insurance company Ageas
and the partnership between Crdit Agricole and Crdit Agricole Assurances.
The securitisation model is based on the creation of a SPV that purchases from
banks pools of infrastructure investments that become collateral for bond investors.
These investors buy asset backed securities (ABS) issued by the same SPV. The
resurgence of the originate-to-distribute model has raised the interest for the
securitisation model by institutional investors. The advantage of this model is that
these kind of loans structured as bonds can be tailored to the specific needs of
institutional investors given the flexibility
in creating portfolios originated in different sectors and countries (Buscaino et al.
2012). As an example of this technique, in 2012 Natixis has structured a
mechanism that enables institutional investors to invest in infrastructure loans via a
securitisation vehicle.
In the debt fund model, an institutional investor provides funding to a resource pool
(the fund) managed by an asset manager that acts, in all senses, as a delegated
agent for the investors with full responsibility for the selection/screening process
and monitoring of the investments. These funds typically define the asset allocation
strategy before the fundraising phase and, for this reason, show lower degrees of
flexibility compared to the securitisation or the partnership model. On the other
hand, this solution is probably also the easiest way to approach the infrastructure
market for less experienced institutional investors that do not have dedicated teams
to invest in infrastructure assets. Examples of the debt fund model are the
infrastructure debt platform of BlackRock, the Senior European Loan Fund of
Natixis AM and AEW Europe, the mid-market loan fund set up by Amundi, and the
MIDIS debt platform set up and managed by Macquarie.

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9. The market for infrastructure equity.

Trends in the infrastructure equity market.
Similarly to what has been shown for the market of infrastructure debt, the equity
market has also gone through a process of significant transformation in the past
few years.
Before the mid-2000s, almost all infrastructure projects received equity financing
by industrial sponsors, typically the offtaker, the Engineering Procurement and
Construction contractor, the suppliers or the operation and maintenance agent.
Starting from the mid-2000s, data reported by Probitas Partners (2013) indicate a
clear upward trend in global infrastructure fundraising for private equity
investments, from USD 2.4 bn in 2004 to the record peak of USD 39.7 bn in 2007,
representing 15% of total project finance loans in the same year. After the 2008
crisis, volumes were squeezed and at the end of 2012 they accounted for only
slightly more than 10.5% of total project finance loans available.
Table 6 reports the 10 largest infrastructure fund managers at the end of 2013.
These asset managers typically focus on brownfield investments and on developed
markets using equity, debt and mezzanine instruments.

Figure 4 and Figure 5 provide information about the geographical allocation of

funds raised and the type of investment breakdown in 2012. Global allocations or
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allocations to US and European projects still represent a large proportion but Asia,
Latin America and other emerging countries represent an interesting 37% of the
funds raised in 2012. From the point of view of the type of the investment,
brownfield (i.e. investments in infrastructure projects that have already completed
their construction phase) and mixed brownfield/greenfield represent more than
60% of the raised capital. The evidence indicates that financial investors still prefer
to concentrate their investments on less risky projects than Greenfield (i.e. projects
fully exposed to construction risk).

Pure Greenfield infrastructure fundraising is still very limited. At the end of 2012,
it stood at only 11% of total global infrastructure fundraising. However, there are
also clear signals of a growing interest of investors for this alternative asset class.
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10.

Institutional investors and infrastructure.

In recent years diversification benefits and higher expectations of investment

returns have increasingly been driving investors to alternative investments, such as
private equity, real estate and commodities. Alternative investments generally have
lower liquidity, sell inless efficient markets and require a longer time horizon than
publicly traded stocks and bonds. Infrastructure is often included in the alternative
investments part of the portfolios.
Institutional investors have traditionally invested in infrastructure through listed
companies and fixed income instruments. This still remains the main exposure of
institutional investors to the sector. It is only in the last two decades that investors
have started to recognise infrastructure as a distinct asset class. Since listed
infrastructure tends to move in line with broader market trends, it is a commonly
held view that investing in unlisted infrastructure although illiquid can be
beneficial for ensuring proper diversification. In principle, the long-term
investment horizon of pension funds and other institutional investors should make
them natural investors in less liquid, long-term assets such as infrastructure.
Infrastructure investments are attractive to institutional investors such as pension
funds and insurers as they can assist with liability driven investments and provide
duration hedging. These investments are expected to generate attractive yields in
excess of those obtained in the fixed income market but with potentially higher
volatility. Infrastructure projects are long-term investments that could match the
long duration of pension liabilities. In addition, infrastructure assets linked to
inflation could hedge pension funds liabilities sensibility to increasing inflation.
Unfortunately, a complete view of the total commitments of all these institutional
investors is not available. However, some partial evidence for the different groups
of investors does exist.

Pension Funds.
Inserts (2009) provides estimates of the total commitments of pension funds to
infrastructure for 2008. A raw estimate quantifies the total commitment in listed
infrastructure stocks at USD 400 bn. excluding utilities, the figure is estimated at
around USD 60 bn. The OECD Survey on large pension funds published in
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October 2013 (OECD, 2013b) shows that despite a limited direct average
allocation to infrastructure some funds are allocating important percentages to
infrastructure either in the form of (listed and unlisted) equity or fixed income.
Towers Watson and Financial Times Investor Survey 2014 reports that, out of the
USD 3.26 tn total assets under management (AUM) by the top 100 alternative
investment asset managers, USD 120.6 bn were invested in infrastructure (Figure
6). Pension funds, insurance companies and SWFs were the investors more
inclined to invest in infrastructure (9% and 10% of their AUM, respectively).
Insurance companies.
The information provider Preqin covers a group of about 200 insurance companies
worldwide with an asset allocation dedicated to infrastructure. The large majority
of the firms are located in Europe and the United States, with Asia representing
about 20% of them. The typical investment strategy (85%) is to commit funds to
unlisted infrastructure funds managed by external advisors, followed by direct
investments in SPVs and by investments in listed infrastructure funds. Insurance
companies typically invest in primary equity.
Sovereign Wealth Funds.
A recent paper by The City UK (2013) reports that, out of a total AUM value of
USD 5.2 tn at the end of 2012, USD 52 bn have been invested directly in
infrastructure between 2005 and 2012. Furthermore, 56% of Sovereign Wealth
Funds declare to allocate resources in infrastructure investments.
In 2013, data reported by the OECD (2013a) indicate that in a sample of the most
important SWFs worldwide, the percentage allocation to infrastructure is
remarkable with peaks between 10-15% in Temasek and GIC (Singapore), the
Alaska Permanent Fund (US) and the Albertas Heritage Fund (Canada) (Table 7).

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Recent initiatives in the equity market for infrastructure

A number of new initiatives have emerged to overcome some of the early
drawbacks of institutional infrastructure investment vehicles. The main drivers of
these initiatives to pool institutional investors capital have been the recognition
that each individual institutional investor might not have the resources and
expertise necessary to make direct infrastructure investments, and might also not
have the scale and risk appetite to invest.
Many investors also voiced concerns over the asset manager asset owner
relationship, and a desire to partner with other like-minded investors. It was felt
that asset managers (i.e. infrastructure funds) were not representing the long-term
interests of asset owners (i.e. pension funds) and there seemed to be a significant
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governance gap. Finally in emerging market economies additional solutions are

needed to address the large gap between investment needs and investment supply.
With regard to unlisted infrastructure funds, it is recognized that a spectrum exists
for the level of fees and terms and conditions of unlisted funds, similar to the
spectrum of risk and return characteristics that exists for the different infrastructure
investments. For example, funds investing in Greenfield projects in emerging
economies where risks are greater and the requirements for expertise are greater
would be expected to charge higher
fees than funds that invest in brownfield core economic infrastructure assets in
developed countries. As a result of growing investor dissatisfaction, investment
managers have had to make adjustments to the terms and conditions of their funds.
Investors in search of stable, predictable, low-risk returns from their infrastructure
investments must ensure that the underlying assets reflect the specific definition
that they have associated with the asset
Class.
Investors have also opted to build in-house expertise to strengthen internal
capabilities to invest directly or pool resources together into co-investment
vehicles. Co-investment platforms have emerged as a way for investors to align
interests, achieve larger scale and invest in assets without the expense of fund
managers. The United Kingdoms Pension Investment Platform (PIP), Canadabased Global Strategic Investment Alliance (GSIA) and Canada Pension Plan
Investment Board (CPPIB)-led syndicate model all provide examples of different
co-investment structures that may help institutional investors access infrastructure
investments more efficiently.
Recent initiatives have seen governments or development institutions
providingassistance in setting up infrastructure funds and contributing directly
through seed funds. Equity funds formed as partnerships of public and private
institutions could become important sources of finance and providers of
organisational capacity and expertise in support of the financing of infrastructure
projects. Initiatives such as the establishment of the Pan African Infrastructure
Development Fund, the Philippine Investment Alliance for Infrastructure fund and
the Marguerite fund in Europe provide examples of how funds can be set up with
government involvement to help attract institutional investment in the much
needed investment areas of the emerging economies and greenfield infrastructure.

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11.
RISK mitigation and incentives for infrastructure
finance.
Given the important role of private finance for infrastructure development and
desire to ensure effective and efficient policy interventions, there is broad
recognition among international organisations, governments, investors and
infrastructure operators of the importance of understanding the risks linked to
infrastructure investments. Also critical is an understanding of the strategies being
deployed to mitigate risks and enhance returns for infrastructure investment, along
with evaluating their efficiency and effectiveness.
Historically, government intervention to mitigate risks was applied to infrastructure
investment projects in emerging economies. More recently, these policies have
become a prominent feature of infrastructure projects in advanced economies
where investors are increasingly asking governments to mitigate specific risks,
which could serve to enhance the availability and/or reduce the cost of private
capital. This is especially true in developed economies that need to upgrade ageing
and sometimes failing infrastructure.
Infrastructure investment involves complex risk analysis, risk allocation and risk
mitigation, given the highly idiosyncratic and illiquid nature of such investment.
From an investor perspective, it is important to carefully analyse all risks that the
project will bear during its economic life, while determining an acceptable
compensation for bearing such risks. From a government perspective, the decision
to provide the infrastructure itself or in partnership with the private sector will be
based on a range of factors, including the nature of the infrastructure project and
the type and magnitude of related risks; insofar as the government provides risk
mitigants, their expected benefits should be balanced against their costs, and their
provision should serve to supplement market-based approaches to infrastructure
finance.
This part of the taxonomy seeks to classify infrastructure risks and incentives and
identify their relevance for infrastructure transactions. It describes the range of
strategies and instruments, both public and private, that serve to reduce risks and
enhance returns for infrastructure operators and investors, enabling these parties to
make the required high-quality and long-term investments in infrastructure.
Infrastructure risks are classified by their main source namely political and
regulatory, macroeconomic and business, and technical. Much of the literature
focuses on risk mitigants and incentives available for project finance this
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taxonomy covers a broader spectrum of infrastructure finance and, with this Part,
seeks to link strategies to mitigate risks and enhance returns to the financing
instruments and channels found in Part 1. This Part recognises that there are both
public and private sector risk mitigants that can increase the viability of
infrastructure finance. Policy actions designed to enhance project bankability, in
particular by addressing business risk, are discussed in order to define the range of
potential measures that could mobilise infrastructure financing.
Risks in infrastructure investment.
There is no single, consistent definition of risk in the literature on infrastructure.
Risk, sometimes called measurable risk, is defined as a case where there is a range
of possible outcomes that are each associated with an objectively (i.e. statistically
determined) or subjectively ascribed numerical probability. Formally, risk is
defined as the measurable probability that the actual outcome will deviate from the
expected (or most likely) outcome (see OECD 2008)25. Knights (1921) definition
of risk states that statistical (objective) probabilities reflect measurable risk while
subjective probabilities, which are largely based on opinion, represent
unmeasurable uncertainty (Holton 2004). Probability is often used as a metric of
uncertainty, but its usefulness is limited; probability therefore quantifies perceived
uncertainty (ibid).
Risk can be broken down into two essential components: exposure and uncertainty,
exposure being an important part of this definition (Holton 2004). In the case of
financial investments, downside risk (or the risk of loss), and its severity, are key
points to be made. For example, the probability of default on a debt is a distinct
risk with its own probability of occurrence. The recovery rate on the debt (loss
severity) depends on the credit exposure and resolution of default and is itself a
range of outcomes with associated probabilities. Loans to project companies are
non-recourse; recoveries in event of default are driven solely by the value of
collateral.
For infrastructure operators, economic losses can be incurred either through a
reduction of expected cash flows (due to a multitude of factors), or through the
default of a project counterparty to meet obligations. The various financial
instruments linked to infrastructure projects and companies expose investors to the
underlying infrastructure risks to differing degrees. Effective risk mitigants, which
may target aspects of infrastructure projects (e.g. operations, cash flows) or
financing channels, either alter exposure to risk and reduce potential severity of
losses, or reduce uncertainty. Risk mitigants or incentives may also increase
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prospective returns, which provide an acceptable compensation given a certain

level of risk.
For instance, a public guarantee on debt may not reduce the probability of default,
but it does alter the exposure to losses by ensuring either complete or partial
compensation. Similarly, insurance does not reduce the risk of an event occurring,
but it does cover losses. The provision of capital or credit support instruments
(subordinated debt increasing credit quality of senior debt) can reduce the severity
of loss given default for senior issues. Revenue grants and guarantees, and tax
breaks, can strongly affect the volatility of revenues and reduce project risk by
reducing potential losses to equity holders, or by increasing returns.
Classification of risk in infrastructure.
Risks linked to investment in infrastructure projects can be differentiated by their
source. Three broad categories can be identified (see Table 2 which shows a
classification of the main risks linked to investment in infrastructure projects,
grouped according to the project development phases), namely :
1. Political and regulatory risks: Arise from governmental actions, including
changes in policies or regulations that adversely impact infrastructure
investments. Such actions may be broad in nature (like convertibility risk) or
linked to specific industries or PPP contracts. In some cases, this risk may
emerge from the behaviour of government contracting authorities. Political
risks can be highly subjective, difficult to quantify, and therefore difficult to
price into infrastructure finance. Table 2 lists those risks that are closely
associated with infrastructure investment.
2. Macroeconomic and business risks: Arise from the possibility that the
industry and/or economic environment is subject to variation. These include
macroeconomic variables like inflation, real interest rates and exchange rate
fluctuations. An assets exposure to the business cycle, namely, shifts in
demand is a principle business risk of the asset. Finance risks (such as debt
maturity) are also a major part of business risk.
3. Technical risks: Determined by the skill of the operators, managers and related
to the features of the project, project complexity, construction and technology.
The risks associated with a specific infrastructure project generally arise from the
nature of the underlying asset itself, contracts with the public sector, and its
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exposure to the environment in which it operates. The magnitude of a risk varies

depending on the country (and its underlying investment climate), sector (and its
institutional maturity) and project (and its complexity).
Risks also vary across the life of the project divided into project development
phase (before submission of the bid and financial close), construction phase,
operational and termination phases. Certain risks may only be present at certain
stages of project finance, while others may be present at all stages. Some investors
perceive a higher risk in the first phases of the project i.e. bidding process and
construction. These considerations affect the optimum risk allocation.
Certain political and regulatory risks, though likely material in the event of
occurrence, are closer to the realm of subjective risks. For instance, the risk of a
new government gaining power and changing PPP legislature is an uncertainty and
difficult to price into assets. However, governments can take steps to mitigate such
risks. When covering political risk, a distinction between sovereign risk the
general risk that market conditions and creditworthiness change at the national or
municipal level and political risk at the project level should be made.
Government bond yields or credit default swaps on traded government issued debts
are efficient means to price sovereign risks into infrastructure finance. Other
political and regulatory risks that are more specific to infrastructure finance are
more difficult to correctly price and would not be completely captured by
sovereign spreads. Table 2 contains those political risks that are most associated
with infrastructure finance.

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Risk management environment.

Private investors, through the financial instruments described in Part I, are well
equipped to analyse and bear certain risks. Yet the financing of infrastructure often
requires large cash outlays and the assets themselves operate in heavily regulated
industries. Through economic development schemes, governments can help to
mitigate some of the risks described in Table 2 using various techniques and
instruments. Some incentives may provide compensation that increases returns to
investors, making investment more attractive. In order to attract private investment
in infrastructure projects, governments can influence the magnitude of these risks
and in some cases reduce the probability of their occurrence, or exposure to losses.
The objectives of risk mitigants and incentives are to correct certain market
failures or inefficiencies in the procurement of infrastructure investment and
delivery of infrastructure assets by private entities, or in the financing of
infrastructure investment
First, governments can influence political and regulatory risks by creating a more
conducive institutional environment, including making credible commitments to
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honor the terms of the agreement, developing reliable guidance on development

and construction costs, and tariff and demand definition and trends. This would
particularly help projects in the planning and construction phase. Actions may
entail:
i.

ii.
iii.

a stable long term plan for infrastructure development: enhanced

certainty and social acceptance regarding novel approaches to
infrastructure development (e.g., PPP, privatisation or pure private
development); enhanced transparency and accuracy of the infrastructure
pipeline; reliability of feasibility studies; credible commitment to provide
necessary authorisations; guidance on environmental reviews;
certainty of rules about, inter alia, public procurement, permits,
expropriation, taxation, litigation, and tariff definition; and
bilateral investment treaties and protection agreements that provide
international law protection from non-commercial risks associated with
cross-border direct investment.

According to the OECD Principles for Public Governance of Public-Private

Partnerships27 three elements are useful to define governments support of PPP
and therefore create a suitable institutional environment: i) establish a clear,
predictable and legitimate institutional framework supported by competent and
well-resourced authorities; ii) ground the selection of Public-Private Partnerships
in Value for Money; and iii), use the budgetary process transparently to minimise
fiscal risks and ensure the integrity of the procurement process.
Political risks like changes in taxation, legal environment, and issues of
expropriation are uncertainties, described earlier as subjective risks. These risks are
hard to quantify and can have potentially large impacts on the profitability and
viability of investment. In some instances they may even be barriers to address
before a finance package can be secured.
Business risks should, where possible, be managed by private players, both in a
PPP and under privatisation of private developments (due to the fact that such risks
can be both endogenous or exogenous in nature). However, in some circumstances,
governments may introduce specific instruments, even with a temporary validity or
for a specified range of assets, to make infrastructure investments more appealing
and financially viable. In recent years, policymakers have introduced a number of
actions/instruments to cope with the infrastructure investment gap and the shortage
of traditional financial resources, especially on the debt side (specific examples are
described in a later section).
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Technical risks should be better mitigated through the know-how of specialized

operators and should be shifted to the private sector in order to generate an
incentive for effective project delivery. However, some technical risks could be
retained, even partially, by the public sector without compromising performance as
they are external to private sector control and/or their impact on the economic case
for the project. This is the case of archeological and environmental risks, especially
in PPP/concessions, where the authority should be aware about the condition of the
designated land for the investment.
Risk management of infrastructure asset cash flows.
Focusing more on business risks, government may play a role in working with the
private sector to manage certain risks. Once the risks of a project are analysed and
understood, the risk management process should identify the strategies to mitigate
the impact of risks on project cash flows. This process is important for all
infrastructure assets and sectors, but in particular, is important in project finance
since lending facilities are often non-recourse and solely based on the ability of the
asset to generate cash flows.
The first option to control the risk is to retain it and to try to limit its effects on the
infrastructure by means of well-designed internal risk procedures. For existing
corporations, risk retention as a risk management policy is more effective than for
SPVs operating an infrastructure investment. This is because in standard corporate
finance, operational risk can be diversified over the entire portfolio of real assets
managed by an existing firm. This is not the case for an SPV that is only dedicated
to a single project.
Risk retention is a common practice in established corporations because a firm
considers risk allocation to third parties too expensive or the cost of insurance
policies excessive compared to the effects determined by that risk. For this reason,
the unallocated portion of risk plays a key role in the credit spread and debt/equity
ratio setting and represents the most relevant variable that financial investors look
at when deciding to commit capital to a given infrastructure. Internally managing
risks is a continual process of monitoring project progress and asset performance,
requiring competent managers and governance procedures.
Risk transfer by means of nonfinancial contracts is the most used risk management
strategy in project finance and is based on an intuitive principle. Key contracts
signed by the SPV (supply, purchase, O&M agreements, agreements with
regulatory authorities) allocate rights and obligations to the SPV itself and to its
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respective counterparties. These contracts can be used as business risk mitigation

techniques if the counterparty best able to control and manage the risk is
considered responsible for the effects of risk occurrence on project cash flows. If
the risk occurs, some form of indemnification must be paid to the SPV. If a risk
arises and it has been allocated (transferred) to a third party, this same party will
bear the cost of the risk without affecting the SPV or its lenders (risk passthrough).
Risk mitigation instruments and techniques for infrastructure finance.
Described in the following section are specific policy actions and tools that may be
employed by governments to mitigate risks (principally business risks) and attract
capital into this industry (external private sector risk mitigants are also described
where appropriate). These actions are grouped into six main categories and are
specifically oriented to reduce or eliminate the demand risk, increase and/or
stabilize free cash flows, and sustain the projects bankability or may be targeted
toward specific finance instruments (Hellowell et al. 2014). Each measure can then
be articulated in specific instruments. Table 3 summarizes these types of measures
and instruments. These policy actions and tools may have potential costs and side
effects, which should be taken into account and may require some form of
compensation.

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Instruments can directly reduce objective risks, those risks that incur economic
losses to an asset by either a reduction in project revenues, or through the default
of a counterparty; or they can reduce subjective risks. Other instruments may not
serve to mitigate risks directly, but instead may partially offset risks or share risks
with the public sector on an equal basis.
Figure 2 is a stylized chart summarizing the forms of public and private supports
by showing their effects on the main components of the project cash flow
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(revenues, capital costs, capital expenditures, operating costs, corporate taxation,

interest on debt and FX losses), and financing instruments. Risk mitigants may be
targeted to specific financial instruments, or to the project SPV in general
(operations/cash flow), which can dampen exposure to commercial risk.
A guarantee on project loans or bonds explicitly protects creditors, although
guarantees directed at debt instruments can also impact the financial viability of
the entire project by increasing credit quality and lowering the cost of finance,
which in turn enhances cash flow by reducing interest expense. Minimum revenue
guarantees and grants can directly reduce the volatility of cash flows, enhancing
credit quality and cash flows to equity holders. Reduced corporate tax rates free up
cash flow for other purposes and enhance return to equity holders; higher cash flow
also supports creditworthiness. Reduced tax rates on dividends and capital gains
enhance returns to equity holders.
Lump sum grants, land grants, or grants tied to project milestones are more closely
related to direct financing instruments they reduce the need for privately-sourced
capital expenditures for the project and can also reduce initial outlay. This has the
effect of enhancing returns to investors and can also enhance creditworthiness and
viability of the financing structure.

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The provision of finance through debt instruments with below market interest rates
reduces interest expense, enhancing project returns. Debt subordination, debt
covenants, and efficient capital structures can also improve project viability,
protecting against commercial risk and aligning managements interests with
equity owners.
Also included in Figure 2, are private sector mitigants such as insurance and
derivatives contracts which can also be used to mitigate risks. Insurance contracts
can cover many of the issues described by guarantees, such as the default of
counterparty(bond insurance), political and regulatory risk, and certain business
risks. Incidentally, the most active insurance underwriters have started to propose
non-payment insurance solutions in response to the demise of monoline
intervention in project finance (wrapped bonds). These insurance packages
represent unconditional obligations by the insurer to guarantee the debt service of
the borrower (the SPV) to bank creditors or bondholders. De facto, the insurer
takes a typical lender risk in addition to the standard risks underwritten under more
traditional insurance policies28. Derivatives contracts are useful for hedging
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specific financial risks like interest rate risks, currency, or credit. They essentially
function like a type of insurance: at a market priced premium, holders of
derivatives contracts receive a payment in the event that the contract is triggered.
Impact of instruments on financial viability.
Governments use different mechanisms to overcome constraints and barriers for
higher institutional investor involvement, including fiscal incentives, capital
pooling platforms and risk mitigation mechanisms (guarantees, insurances, credit
enhancement, currency risk protection, and other instruments). (OECD 2014,
OECD 2014b29) Similar mechanisms are tried for renewable energy and green
infrastructure (Kaminker and Stewart 2012, OECD 2015).
In this context it is relevant to understand and assess the effects of these measures
and in particular their capacity to attract private capital without generating or
increasing moral hazard and adverse selection phenomena, thus safeguarding the
microeconomic benefits produced by the involvement of private capital and
competencies. Policy makers should prioritize those instruments that enable the
projects bankability, incentivizing at the same time the private sector to correctly
assess investments and to reach desirable level of project efficiency, without
unduly creating untenable market distortions.
Multilaterals, national development banks and export credit agencies in particular
have a catalytic role to play in leveraging private sector capital in both developing
and developed countries. This will require a different level of risk taking, new
resources and expertise at the level of these institutions and the use of new
financial instruments such as mezzanine finance and project bonds.
Risk mitigation
instruments.

and

incentives

descriptions

of

The following section reviews the main risk mitigation instruments available for
the financing of infrastructure. Recall that in Part I, the various financial
instruments were presented, along with the channels of investment. Risk mitigation
techniques may at times be unique to project finance such situations will be
noted in the description. Otherwise, risk mitigation instruments are available to all
types of investors including public and private equity, and the various debt
investment instruments.
Public sector guarantees and insurance.

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Public sector guarantees can come in many forms, including revenue guarantees,
credit guarantees on debt instruments, or export credit guarantees. They may be
disbursed either by governments, or sub-sovereign entities like MDBs.
A minimum revenue guarantee (MRG) may be suitable for projects considered
commercially viable, but where uncertainty about future revenue substantially
reduces the available financing. The amount of revenue usually covered under the
guarantee is the amount necessary to cover debt payments. However, a project
constantly relying on the guarantee to complete revenues might be more vulnerable
to political risk, or if the guaranteed revenue would also be used to cover equity
investors, it would diminish the incentives to deliver quality facilities and service,
and thus create moral hazard. Furthermore, if the public entity takes on the revenue
risk, there should be excess-revenue sharing as compensation (Yescombe 2014).
An MRG may not be appropriate if it is clear that the project cannot generate
enough revenue to be viable (ibid).
Long-term investors, when investing in a project with MRG, essentially assume a
credit exposure to the guaranteeing authority. Minimum revenue guarantees can be
used for transportation assets such as toll roads where high traffic uncertainty may
make a project unattractive. Certain tariff subsidies can also fall into this category;
in this arrangement, user fees themselves can be subsidized by contracting
authorities. The effect is to boost revenue, but unlike in an MRG, the project
company still bears usage risk (Yescombe 2014). A sliding scale can apply to
subsidies based on overall usage.
In some cases, countries have established guarantee funds to help back MRG
commitments. For example, the Indonesian Infrastructure Guarantee Fund was
established in 2009 to back guarantees by contracting authorities. The fund
undertakes its own monitoring and due diligence of projects and has the effect of
increasing the creditworthiness of a project (Yescombe 2014).
Besides revenue guarantees, public entities can issue guarantees, letters of credit,
and insurance contracts on infrastructure finance instruments. Guarantees on debt
differ from other risk mitigation instruments in that public funding will only be
provided to service debt held by third-party investors if the project does not
generate enough revenue to cover interest or principal payments. The cause of the
default does not play a role and the procedure to call on the guarantee is usually
simple and the payment occurs in a timely manner. Typical guarantees are a
contracted minimum payment or guarantees in case of default and guarantees in
case of inability to refinance the loan at maturity. Credit guarantees can be applied
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to many different types of infrastructure projects and come in two main forms, but
in general are bespoke to meet the requirements of specific projects:
Full

credit guarantees (FCG) (wrap guarantee) cover the entire amount of debt
service in the event of default, or the entire amount of specific tranches of debt.
Such guarantees are useful to increase the credit quality of a projects debt
financing package. Other guarantees can have first-loss coverage providing credit
support for senior tranches. As examples, first-loss guarantees are available in the
U.S.s SIB, TIFIA, and in Europe, The Europe 2020 Project Bond Initiative30
(Yescombe 2014)
Partial

credit guarantees (PCG) may cover a portion of debt service, up to a

certain predetermined amount, or certain targeted instruments in the capital
structure of a project SPV. Also called pari-passu guarantees, private lenders and
public-sector guarantors share in credit losses up to the amount guaranteed. Partial
coverage promotes risk sharing and can reduce moral hazard.
Export credit guarantees are a particular form of guarantees usually provided by
export credit agencies. They cover risks linked to the export of goods and services,
covering a percentage of both political and commercial risk. Usually the
nationality of the exporter plays a role in the availability of such a guarantee;
however some bilateral institutions may offer guarantees regardless of nationality
(Matsukawa and Habeck 2007).
Guarantees have been issued by national and subnational governments, multilateral
and bilateral institutions, development banks, and other public entities (Matsukawa
and Habeck 2007). For instance the Overseas Private Investment Corporation
(OPIC) provides both political risk insurance and loan guarantees, which are in
turn backed by OPICs own reserves and the US government (Weber and Alfen
2010). Some issuers of guarantees charge fees.
As an example of which risks may be covered, OPIC insures new ventures and
expansion projects, covering the full spectrum of investment instruments including
equity, loans, technical assistance agreements, leases and other instruments that
expose investors to long-term risks (ibid). Investors can purchase insurance from
OPIC in the following main risk areas31: currency convertibility, expropriation,
regulatory risk, and political violence.
Guarantee mechanisms can be set up in a number of different ways, involving
direct commitments form public budget or through a separate guarantee fund;
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commitments in turn can be funded or unfunded. The extent to which the public
entity guarantees repayment can also vary. PCG only cover a limited amount of
debt, while FCG or wrap guarantees cover all debt commitments. PCGs and FCGs
can be useful to mitigate refinancing risks, covering bullet payments at maturity.
They may also be useful to help extend maturities of issues, or to help project
companies raise debt through market channels such as project bonds. To the extent
that revenue streams are not completely smooth, and that forecasting long-dated
cash flows can be difficult, guarantees can help to mitigate these risks.
Furthermore, governments can also provide standby letters of credit (Gatti 2014,
Matsukawa and Habeck 2007).
Guarantees or insurance can differentiate between the cause of a default, usually
either political or commercial in nature. In such instruments, payouts would
depend on the cause of loss (Matsukawa and Habeck 2007). An insurance policy
would require filing a claim and waiting for the review process to complete prior to
payout.
The public guarantee reduces repayment risk and through this lowers the cost of
credit. The impact of the guarantee can be substantial and render the project
eligible to investment by institutions facing regulatory barriers, hence the better the
credit rating of the guarantor, the stronger the impact will be. The eligibility for a
guarantee scheme should be examined via a thorough examination process
followed by monitoring procedures to avoid negative consequences such as moral
hazard.
Private sector insurance and external credit enhancement.
Private insurance contracts, letters of credit, and guarantees also play a role in the
risk mitigation of infrastructure. Similar to public guarantees, insurance can come
in many forms including revenue guarantees (insurance against business risks),
credit guarantees on debt instruments (wrappers), or insurance against political and
regulatory risks. What differs is the manner in which payments are settled. The
process to draw on a guarantee is rather straightforward and payments are
disbursed relatively quickly. Filing an insurance claim and receiving settlements
can be a longer process than drawing on public guarantees (Matsukawa and
Habeck 2007). Banks can issue letters of credit that provide credit enhancement for
debt issues.
Private insurance contracts for business and commercial risks can be expensive;
such risks may be better managed by internal means and through operational
efficiencies. For instance, the diversification of business risks across multiple
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assets (corporate finance model) can effectively reduce commercial risk and reduce
the need for insurance.
Wrap insurance covers debt instruments written into the policy (usually senior
issues, but it could also include subordinate issues). Private monoline insurers were
a major player in providing credit enhancements before the financial crisis since
then availability has diminished, but is slowly returning. Monoline insurers
generally require that the issuing entity have at least an investment grade credit
rating. A drawback of monoline insurers, which became evident during the
financial crisis, is that guaranteed issues can only maintain a maximum rating that
is equal to the wrap entity. Thus a downgrade of the wrapper would translate to a
downgrade on wrapped issues.
From the private sector, guarantees can come in the form of certifying the
performance of new technologies like solar panels or wind turbines (OECD 2015).
In the clean energy sector, insurance products can protect investors against
construction and operational risks, certain market risks such as price changes,
weather related production risks32, and political and regulatory risks.
Insurance contracts are useful for mitigating exogenous risks and uncertainties that
are difficult to price into infrastructure finance. Force majeure, sovereign risk, and
project related political and regulatory risks are some of the main areas where
insurance contracts are used.
Hedging: Derivatives contracts.
Interest rate swaps, forwards, or other derivatives contracts can provide flexible
alternatives to alter the payment profile on debts. For instance, floating rate loans
and bonds are common instruments in project finance. In low rate environments,
managers may be inclined to lock-in fixed rates using derivatives, effectively
changing the payments on debt from floating to fixed, or vice versa. Derivatives
can therefore be used to hedge certain interest rate exposures and facilitate longterm planning security of future cash flows (Weber and Alfen 2010). More
complex hedging involving interest rate options can set caps or floors on financing
rates, facilitating financial planning. Like insurance, the buyer of interest rate
protection pays a premium to hedge risks.
Currency derivatives such as swaps, forwards, futures, or options can also reduce
financial risks in infrastructure by hedging currency exposures. These instruments
areparticularly useful if currency mismatches occur between revenues and liability
payments. Alternatively, to reduce currency mismatches, assets could be financed
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using local market instruments to match revenues; however, this is not always an
option if capital in local markets is not available. Derivatives can be used to hedge
market exchange rate fluctuations and to also hedge convertibility risks.
Credit derivatives such as credit default swaps (CDS) can hedge credit risks borne
by project financiers both debtors and creditors. CDS contracts can be written on
virtually any reference instrument such as a bond, note, or loan. Infrastructure
projects that bear credit risks from governments or corporate entities can buy
protection in the CDS market that could hedge the default risk of a counterparty.
Likewise, creditors to infrastructure projects could buy CDS contracts on the actual
debt instruments themselves. CDS in this sense work like a type of insurance, the
buyer of a CDS contract pays a premium to hedge an event of default. A
particularly useful characteristic of CDS is that the value of a contract will change
as the market perceived credit risk of a counterparty changes. Thus its ability to
hedge a risk is not just dependent on an event occurring (like insurance where an
event of default must occur to file a claim), but instead on the market perceived
probability of default. The buyer of a CDS contract written on a counterparty
would profit from a deterioration in the creditworthiness of said counterparty. CDS
contracts represent the uncoupling of credit risk from interest rate risk and
exchange rate risk which when combined cover a great deal of the financial market
risk borne by infrastructure investors.
Derivatives however are not a panacea. They are useful tools for hedging certain
risks, but OTC contracts themselves can create counterparty risks the limits of
which were tested during the financial crisis. Furthermore, the cost of derivatives
contracts may also not always allow for their use. The cost/benefits of hedging
must therefore be compared to the possible losses incurred to the infrastructure
asset, or to the impact on cash flow volatility.
Contract design: Availability payments and offtake contracts.
Availability payments are used by governments in cases where the underlying
infrastructure asset does not offer predictable direct revenue; for example when
end users do not pay for the use of public facilities via a user fee, but rather via a
broader tax pool. Instead, the contracting authority pays the counterparty for the
provision of the facility. In cases where the private entity is contracted to maintain
and operate the facility or provide additional services, the availability payment can
be complemented by fees paid by the public entity to ensure the delivery. Both the
availability payment and eventual fees can be tied to quality requirements as a
performance incentive for the private contractor in an effort to reduce moral hazard
risk.
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Output and performance measures are defined in the contract, while the means to
achieve this output (design, construction and maintenance specifics) is usually left
to the private contractor, which is thus accountable for any deficiencies in design
or delivery of the facility. The public sector thus transfers construction and other
risks related to the physical nature of the facility to the private sector, while taking
on the demand risk through the availability payment.
Availability payments are common in the social infrastructure sector, such as
schooling, social housing or hospitals, and can also be used for economic
infrastructure when the end user does not pay a usage fee (some roads, railways,
tunnels, or bridges). The public authority thus assumes demand risk from the
private partner (Gatti 2014). The term shadow tolls designates a payment
agreement where the user does not pay directly for the usage of a facility, but the
private company responsible receives payment from a public authority based on
usage volume - demand risk is thus not fully transferred to the public sector (this
structure has been used in the transport sector). Availability payments can be
complemented by other forms of payment such as financial incentives to provide
quality service to mitigate moral hazard risk.
Offtake contracts are common in power generation and infrastructures that
produce outputs (water included). Such contracts allow the project company to
supply output at a pre-agreed price, which can help to reduce future revenue
uncertainties. The regulation of public utilities companies is similar: in order to
deal with the monopoly position of utilities, regulated prices limit monopoly
power. Offtake contracts both limit the monopoly power of certain projects, but
also lock-in an agreed upon rate with regulators. Offtake contracts are signed with
contracting authorities. Limiting exposure to market risk has the effect of lowering
cash flow volatility and can lead to better credit rating (providing that leverage is
not too high)
Throughput contracts are another way to limit revenue volatility. Users of
infrastructures such as pipelines agree to use the infrastructure to carry not less
than a certain agreed volume, and would pay a minimum price for the usage
(Yescombe 2014).
Contract design can be effective at mitigating commercial risks such as the
business cycle, fluctuations in demand, and sometimes inflation risk if payments
are linked to prices. Revenue risk is a chief risk in modelling infrastructure
performance and valuation. Contracted payments are a method to reduce this risk
which would benefit both debt and equity holders in a project. While availability
payments are mostly discussed in the project finance context.
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12.

Conclusions.

Over the past decade institutional investors, such as pension funds, insurers and
sovereign wealth funds, have been looking for new sources of long-term, inflation
protected returns. Asset allocation trends show gradual globalisation of portfolios,
with increased interest in emerging markets and diversification into new asset
classes.
Historically, infrastructure investors have predominantly focused on what they
perceivedas safer, less risky developed economies of Europe, North America and
Australia. Diversification benefits and higher return expectations are increasingly
driving investors to emerging market infrastructure.
At the same time, governments have started to recognise that they need to
reconsider their approach to financing to secure new sources of capital to support
infrastructure development. With more governments privatising infrastructure
assets, a globalisation of the infrastructure fund market has occurred. Developed
and developing countries are in effect competing to attract institutional investors to
infrastructure.
Despite the theoretical ideal match between a large source of capital and an asset
class in need of investment, the overall level of investment in infrastructure by
institutional investors has been modest and insufficient to overcome the financing
gap.
Financial markets and intermediaries are required to play an important role in
shaping financial solutions able to attract the highest number of investors.
Infrastructure can be financed using different capital channels. The evolution of
capital markets shows that financial innovation develops new financial tools able
to attract a larger amount of funds in response to supply (the infrastructure gap)
and demand (the search for asset classes that are suitable for a given asset
allocation).
As the market continues to grow and information about the asset classes becomes
morereadily available, the existing vehicles will become more refined and new
offerings will emerge. A number of initiatives have been developed to pool the
financial and internal resources of large institutional investors to invest jointly in
infrastructure projects and assets. Some of these initiatives are market and investordriven, while others are government-driven.
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13.

Bibliography

1. www.googl.com
2. www. Infrastructure of financing.com
3.

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