IFR Asia Asian Development Bank Roundtable 2018: Part 1

IFR ASIA: Welcome to our session on the role of the capital markets in funding Asian infrastructure. Pierre, can I ask you to start us off on the state of play when it comes to financing Asian infrastructure, and what the ADB looks to achieve in the capital markets.

PIERRE VAN PETEGHEM, ADB: Thank you for the question, Steve. Let’s put a bit of background here. The ADB conducted a study and found that up to 2030 the region will need something like US$1.7trn a year to invest in infrastructure just to support growth. It also found that in order to make that infrastructure climate-resilient, and to address the challenges of climate change, that US$1.7trn includes a bit more than a quarter of a trillion dollars that should go to climate change resilience. About four-fifths should go towards climate change mitigation and one-fifth to climate change adaptation.

What is being invested so far? We’re talking about a bit less than US$900bn, so there is a gap of about US$800bn a year. The US$900bn is basically what countries are investing in their own infrastructure, and institutions like us – multilateral development banks active in the Asian region – and also other institutions, especially from the private sector. We need to play a very catalytic role, in order to attract more participants into the capital markets and plug that US$800bn gap.

IFR ASIA: I can see a couple of our panellists nodding at that. Siong, how do you see the funding markets when it comes to Asian infrastructure?

SIONG OOI, MUFG: I think private-sector funding has been, historically, very reliant on the bank markets. If you look at the Thomson Reuters data for last year, in terms of lending to the project finance sector, it’s about US$80bn per annum, and that was up about 20-odd per cent on the prior year. So, if you’re looking at the overall year-on-year requirements, it’s clear the bank market cannot supply all of the funding on its own.

To add to that, if you drill down one more level, the top 25 banks represent somewhere in the order of 70% of the lending. Banks obviously will continue to support project financing, but those 25 clearly have limited capacity.

There is a gap, and I think it’s on all of us to try and figure out how that gap can be plugged. There are a few different ideas we can discuss a bit later, but the key is to find new pools of liquidity. That could be the bond markets, so tapping institutional investors in various forms, as well as other pools of liquidity, like the Japanese market. There is a big pool of liquidity there chasing long-term assets.

There is definitely an opportunity for all of us to be involved in making sure we’re expanding the investor base to plug this gap. We can’t rely on the bank market to continue to fund this massive requirement on its own.

IFR ASIA: Olivier, perhaps that’s a good Cue for you to just update us on some of the recent developments that you’ve seen from your ratings?

OLIVIER DELFOUR, FITCH: Just to comment on what Pierre said, this funding gap is, firstly, a spending gap, right? This is what needs to be spent. There may be some difficulty in financing that, but – most importantly – the difficulty is in identifying and putting together the right projects. Even before getting to the financing stage there is a lot of project selection and project execution that needs to be resolved.

The actual financing is plentiful, all across the world. We see investors in Europe and in the US looking east, increasingly, just because they don’t have enough opportunities to invest in their home regions. There is some appetite.

We think the market has turned a point in the past few years, and this culminated with the Paiton Energy transaction in Asia last year. That was an international standard, well-defined project financing that was able to access the international capital markets. That was one of the first of its kind. Since then, we’ve seen a lot of queries and projects being put together to follow up on that, not only in the power sector but in transportation as well.

I am talking about the project financing angle here, but there is also a broader infrastructure debate. Big transportation assets that are run as corporate financings will also be, I think, a big part of the equation going forward.

KIYOSHI NISHIMURA, CGIF: Yes, there is a huge investment gap in Asia, as the ADB has pointed out, but at this moment there is not much of a funding gap. There is a lack of supply of projects, actually. If there is a good project, it is easily funded in current market conditions.

The second point I wanted to mention is that when you talk about public-private partnership type infrastructure projects, especially in emerging Asia, they are basically financed by local domestic financial systems. There is many data about this from the World Bank and the ADB, but really 70% or 80% of projects are financed by their local financial systems.

The question is whether the local financial systems can cope with more projects, once this investment gap is closed. My personal view is that it’s possible – though I may be biased!

By the way, I’m talking about emerging Asia, where the data is skewed by China and India. If you exclude China and India, and focus on South-East Asia, ASEAN countries, where we operate, I think that the domestic financial system actually can finance most of the infrastructure needs. There are exceptions for certain countries where there is still a shortage of local savings – like the less-developed ASEAN countries – but the main ASEAN economies have already a savings surplus. They have very established domestic financial systems, the banking sector of all ASEAN countries is about 130% of GDP, the stock market is about 100% of GDP and the bond market is about 60% of GDP. So if there is a mechanism to mobilise these domestic savings to a project, then I think it can be financed.

As it stands today, most likely the local banks are going to finance the projects, which creates some systemic risks to these markets. That’s why we like to promote the bond market to finance infrastructure projects.

Here, we are noticing a very encouraging development. When the CGIF issued its first guarantee five years ago, there were not many project bonds in ASEAN countries. Only Malaysia is a special case, where they’ve been using project bonds to finance even greenfield infrastructure projects. Now you see many project bonds in other countries.

In the Philippines, together with ADB, two years ago we supported the first Philippine peso project bond, done by the Aboitiz Group for a geothermal project company. After that Aboitiz also issued another project bond from a hydropower company, without any support from us.

More recently Indonesia has become the rising star. Last year we saw the first Indonesia rupiah-denominated project bond, issued by Jasa Marga, and two Indonesia rupiah-denominated asset-backed securities based on cashflows from infrastructure projects. This is all very encouraging to us.

IFR ASIA: Rocky, we just heard about bank liquidity around South-East Asia, and the Philippines is a good case here, I think. How does a project typically get funded in this country?

ROCKY REYES, SYCIP: It’s funded, basically, by commercial bank loans, so I don’t see any funding gap in that respect. We definitely need more infrastructure projects, but the local banks are able to finance them. Local currency funding is still the preferred mode because most of these projects earn revenues in local currency, not foreign currency.

The biggest problem is the lack of projects. It takes a while here for projects to be developed, especially in the PPP realm, and that’s perhaps why the government has been looking at the ODA [overseas development assistance] route to speed things up. There will be some inefficiencies there, but that’s the government policy at the moment.

IFR ASIA: What does that policy mean for private-sector investors and financiers?

ROCKY REYES, SYCIP: I think it would be a pity if they just abandoned the PPP model for infrastructure projects because the Philippines has been at the forefront of PPP for the last 30 years. We have a lot of experience in concession agreements and the allocation of risk. In fact, the Philippine government, in the beginning was one of the first to recognise which risks should be passed onto the private sector and which risks should belong to the government.

The problem, I think, lies in our laws. We do have a PPP law, the BOT Law, but it has become a little outdated since it was written in 1991, so we need to adjust that. Our basic laws on security, like mortgages, pledges and the kind of collateral you can offer to the lenders are also a bit dated – this time dating all the way back to the 1950s. We should modernise that.

Some lenders have been creative in the collateral aspect, but that’s risky in the sense that some of this collateral had not been tested in a bankruptcy scenario.

The other problem we have is that we have a lot of national requirements, and hopefully this present government will think about removing some of them. Most public utilities in the Philippines require 60% Filipino capitalisation – that’s a huge amount. We don’t need to have a nationality requirement. The Foreign Investment Act of 1991 says that foreigners can invest up to 100% in any project, except those on the negative list. The negative list is a five-pager, it’s single spaced and it’s full of things that you can’t invest in, down to even massage parlours and gambling houses. Mass media is 100% reserved for Filipinos, but, as we all know, you can watch CNN and the BBC wherever you have an internet connection.

We need to really study how much foreign investment we want to let into the Philippines. Our personal savings rate is actually very low. Only 1%–2% of the population participate in the stock market. The banks today can still do big infrastructure projects, but at some point we will need alternative sources. That’s why the development of the bond markets, especially in terms of ASEAN integration, would be very, very important for the Philippines. But, we need to change a lot of our legislation.

IFR ASIA: Thank you. I’d love to see a massage parlour bond in the capital markets, that would be quite entertaining!

Staying in the Philippines, could the kind of credit enhancement we saw here in the Aboitiz deal work for other companies?

KIYOSHI NISHIMURA, CGIF: The geothermal project, Tiwi-MakBan, was quite an interesting case. As Rocky mentioned, the Philippines is a really bank-dominated financial system but the reason why the Aboitiz Group wanted to issue a bond was that they were concerned about the single borrower limits.

There are other cases like that in the Philippines, because the economy is dominated by a limited number of conglomerates and the central bank is trying to reduce the systemic risk from that concentration.

The Aboitiz Group could probably borrow more cheaply from the banks, but they wanted to test the bond market.

IFR ASIA: That was a couple of years ago now. Was that a one-off?

KIYOSHI NISHIMURA, CGIF: At this moment the banks still have room to lend, so I think bank loans are still going to be used to finance infrastructure projects until those limits start to hit.

Looking at the project bond market in ASEAN countries in general, it is also a difficult question. The local bond markets are very different from global bond markets, where you can follow the template that’s already established in the market.

Six ASEAN countries have active bond markets, but each one is so different, in regulations, investor appetite and so on. It’s very difficult to bring in a standard template across the local markets, so you have to develop a template to suit each bond market.

IFR ASIA: Olivier, have you seen credit-enhanced deals around the world that could also work here?

OLIVIER DELFOUR, FITCH: Yes. My comments are mostly targeted to international markets more than the national markets, but when we are discussing the issue of credit enhancement we heard from investors that they are mainly concerned about three things when they look at new territories in Asia, specifically: currency risk; construction risk, and the stability of the framework.

I don’t think the market is seeking just a subordinated facility that can enhance the rating for the senior investors. It’s really about risk allocation and what sort of risk the foreign investors are really ready to take. Any credit enhancement that is tailored to addressing some of these specific risks would be good progress.

We’ve seen credit enhancement programmes elsewhere in the world but, again, with a slightly different logic. These were in countries where the bond market was already well established, standards were high, and currency risk was not really an issue – like in Europe. It was really about making the transaction, arguably, more bankable by raising the rating. I don’t think this is what investors are really looking for, at the moment.

Again, investors are fairly sophisticated; they have a lot of capital to deploy. I think they’d rather take a Triple B risk, well priced, than a Single A enhanced risk where some of the premium goes to the person who enhanced the risk. To me, the focus should really be on how to address the specific risks that stop investors from coming to a new market.

IFR ASIA: Pierre, you’ve had some experience opening new markets. What kind of limits do you need to overcome when you look to attract investors in the local markets?

PIERRE VAN PETEGHEM, ADB: That’s an interesting question. I would just like to react, first, to the issue of foreign exchange risk. Actually, some investors want to take exchange-rate exposure just to benefit from higher yields. That was the whole story until, let’s say, six months ago, when US dollar rates started going the other way – higher, not lower. Everybody was looking for higher yields, and where did you get them? In local currency.

When investors look at those markets, yes, they want higher yields, but they always want a nice macroeconomic story. They’re looking for stability – not only political stability, even though that’s important, but more than that, economic stability.

India is a good example – since we’ve talked a lot about ASEAN countries already. India has been able to develop the so-called Masala market, which is basically offshore Indian rupee issuances, which are settled in dollars but are linked to the rupee/dollar exchange rates. Supranationals, like ADB, have been quite active in that market, but now you also have corporates from India who are also issuing there.

Investors are also looking for flexibility. When investors look at local capital markets they want the rules to be, how can I say, friendly to them. They will bring the money in, but they also want to be able to take their money out. I’m not talking about only regulation here, but also about the liquidity of the market, which goes back to how to build critical mass through further integration and so on.

Sometimes in those markets you have multiple regulators. You have the Ministry of Finance, you have the central bank, you have the Security Exchange Commission, and then you have the regulators who actually control who can invest in the market and in what type of assets. For example, can the local insurance companies, the local asset managers or the local pension funds invest in bonds issued by foreign entities, and so forth?

There is a lot of work that needs to be done, and ADB is actually very active in advising governments and local regulators in order to enable those markets to be friendlier to outside investors.

IFR ASIA: Just staying on this idea of integrating the Asian markets, I understand it’s been pretty slow going so far. Kiyoshi, how difficult is it to move money across borders and bring the local markets up to that critical mass where they can fund a major infrastructure project?

KIYOSHI NISHIMURA, CGIF: That is one critical issue we are facing. If you aggregate the local currency bond markets across ASEAN it is almost US$1.2trn, which is a big number. The problem is the national markets are segregated. How to integrate is very difficult actually, simply because the nature of the bond market is very different in each country.

The ASEAN+3 grouping set up an ASEAN Bond Market Initiative to try to develop the bond market in ASEAN countries. One initiative there is to try to streamline the issuance process along the professional market. The wider public bond markets are going to be very, very difficult to make into an integrated market, but focusing on the professional investors market may be easier.

They have a programme called AMBIF, which is the ASEAN+3 Multi-currency Bond Issuance Framework. Currently, there are six countries that have joined that programme, which allows you to use one standard set of documentation to issue a bond in any market. It is a small step, but I think it’s a very important step.

IFR ASIA: I hope that paints the picture for you in terms of where we stand. I want to move on to potential opportunities for the future. Green finance is growing fast in Europe, but do you think that’s going to have a role to play in Asian infrastructure?

OLIVIER DELFOUR, FITCH: The approach we take to the ESG market, broadly speaking, is that we factor into our rating anything that relates to credit risk, and we don’t stamp a transaction as being Green or not. Most of the Green issuance has been in corporate bonds, not really project financings, although, arguably, when you invest in a solar developer or a wind power project it has to be Green by definition.

There is certainly some momentum there, and some investors are moving away from fossil fuels. That is desirable, but it is a slow process. It is not likely that Indonesia will walk away from coal and buy expensive fuel elsewhere. Maybe investment should be more focused on limiting the emissions. But, to be realistic, we don’t think that the market will stop supporting these types of projects.

IFR ASIA: Siong, is that something that you’ve noticed with the Japanese investor base?

SIONG OOI, MUFG: Yes, definitely. From an MUFG perspective we’re very focused on supporting financings for renewable projects, that’s certainly the case in Australia, for example. In our discussions with both bank investors and institutional investors in Japan, there are obviously negative biases, certain sectors that they’re not that keen to look at. But, flipping it on the positive side, they’re very keen to get more exposure to projects which do have a green element. There is a very strong demand for renewable energy projects, whether you talk to investors in Japan, Europe or the US. I would say it’s very much focused around refinancing at the moment. But I certainly expect that to transition into new projects as well.

The short answer is that even investors who don’t manage specific Green funds are pretty keen to look at projects which have a strong positive ESG element.