Financial institutions have been increasing their infrastructure asset allocation over the last twelve months. This is good news because Standard & Poor’s Ratings Services has identified somewhere in the region of a $500bn funding requirement gap. Indeed, as governments and banks struggle to finance major infrastructure projects, the need to encourage private finance into the asset class is an urgent one.
Source: Standard & Poor’s Ratings Services –Global Infrastructure: How To Fill A $500 Billion Hole, January 16, 2014. Citing: McKinsey & Co.
There are natural hesitations, of course, and prudence is necessary. A leading risk is the political and regulatory environment: regulation can vary significantly from one authority to another, so investors must have both a strong understanding of political developments, and experience in assessing regulatory risk.
Liquidity risk is another factor as infrastructure debt tends to be illiquid and institutions like the security of liquid assets should things go wrong. Liquidity premiums can help mitigate this, but they are not always effective.
There is also a lack of infrastructure performance data in the current market place, but S&P Capital IQ is working to fill this need. “Project Finance Data Consortium members can leverage the S&P Capital IQ default and recovery database which has considerable coverage across each region,” says Arnold Gevero, Associate Director at S&P Capital IQ. “The database warehouses information for 7,596 projects, 29% of which are infrastructure-backed deals primarily domiciled in Western Europe.”
Source: S&P Capital IQ, 23rd October 2014. For illustrative purposes only.
Mr. Gevero adds that “closer data analysis suggests that since its peak in 2007, there has been a considerable decline in infrastructure originations globally. Recently closed transactions were primarily in the Transportation; the Water, Waste & Utilities; and the Public Services and Administration segments.” Furthermore, he says, “annual default rates demonstrate some volatility in recent years but have since rebounded and stabilized. The industry maintains a low 10-year cumulative default rate vis-à-vis low loss severities.”
Globally, the need to construct new or repair aging roads, bridges and other vital public infrastructure is unavoidably growing. However, amidst the budgetary and regulatory challenges miring global governments and banks today, additional sources to bridge the funding gap are clearly needed.
If the political landscape is right, the potential for infrastructure as an investment class is significant. Project sponsors, however, must be clear about where the boundaries are, what they will and will not change, and exactly what risks are being taken.
Read more about additional trends within the infrastructure finance market, in Plugging the Funding Gap – New Trends and Credit Risk Factors in Project Finance.