Update Magazine II/2021 DOWNLOAD THE COMPLETE MAGAZINE
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1  Financing of infrastructure: no longer just the task of governments

Three main factors have favoured the development of infrastructure financing (also known as “infrastructure debt”) as an asset class since the outbreak of the global financial crisis in 2008:

1. Falling investment from banks
   The global financial crisis has led to the acceleration and intensification of banking regulation, prompting banks around the world to switch out of classic, very long-term project financing.
2. Dwindling state budgets
   The sharp rise in government debt has reduced budgets for state-funded infrastructure and development aid projects, and caused many countries, particularly in the West, to look for new sources of financing.
3. Stagnating interest rates
   The low interest rates that have followed in the wake of the global financial crisis have led to changes in the investment needs and behaviour of institutional investors.

The banks were subsequently joined by institutional investors such as insurance companies and pension funds, which were looking for investments that would offer a yield mark-up compared with government or corporate bonds, for example, as well as having terms that matched those of the liabilities of these two groups of investors. Financing of essential infrastructure that is largely independent of demand, with public-sector operators with top-quality credit ratings (governments, cantons/federal states and other regional authorities or state-affiliated companies), has at least partially replaced other asset classes such as government or corporate bonds. Intermediaries with their own departments that structure project financing have become established partners of many large asset managers. This trend has been further boosted in recent years by favourable regulatory treatment of this financing under the EU-wide regulatory standard Solvency II. However, this development has taken place mainly in OECD countries. For a very long time this financing was exclusively in the investment grade range, and it is only in the last few years that it has gradually begun to shift out of this range.

2  Investments in the investment grade range

At the same time that this development has occurred, supranational and specialist development banks have had increasing difficulty in recent years performing their official duties in areas such as the financing of infrastructure projects in emerging markets. Demand far exceeds the funds made available to the development banks. This demand gave rise to the idea in 2015 and the following years of mobilising capital from private institutional investors for financing in general, and infrastructure projects in particular, in emerging and even frontier markets. However, institutional investors are dependent on providing financing in the investment grade range if possible, particularly when it comes to very long-term financing, if not for economic reasons then often for regulatory reasons.

The obvious solution therefore seemed to be for development banks, with their many years of experience and access to emerging markets, as well as the capacity to bear risk, to assume only part of this financing in future, and for private investors to take over a secured portion.

This has an advantage for both sides, as development banks will increase their financing capacity, while institutional investors will receive a high-yield, structured investment that also offers diversifying characteristics compared with the classic interest rate portfolio. However, the main focus is on the benefits for project sponsors and funding recipients in emerging markets. Without these expanded financing opportunities, some funding and infrastructure projects in emerging markets in the last five years would not have come about at all.

Last but not least, the conclusion of the Paris Climate Agreement in late 2015 not only added climate protection to the agenda, but also brought up the question with respect to emerging markets of how, for example, the United Nations’ 17 Sustainable Development Goals can also be applied to these countries in this way.

3  New financing vehicles

In the light of all these considerations, the first financing vehicles, in some cases worth billions, have been set up in the last few years through collaboration between various supranational and national development banks on the one hand, and large institutional investors on the other. For example, Allianz SE launched a joint vehicle with the International Finance Corporate (IFC) in 2017, and invested in the Emerging Africa Infrastructure Fund in 2018, and the Africa Grow Fund in 2019. A new asset class has emerged over time: “development finance”. Depending on which side we look at this type of financing from, we can describe it as indirect infrastructure financing (infrastructure debt) in emerging markets, or assign it to ESG-oriented investments as “impact investments”. There is justification for both.

This asset class is expected to develop further, and to become accessible to other groups of investors in the coming years, partly for the reasons mentioned at the beginning of this article. The Covid-19 pandemic has also accelerated this development, which has been further intensified by the rapidly growing trend over the last two to three years towards ESG-compliant investments.

A development finance vehicle allows a development bank to supplement with private capital each dollar it has available for financing projects in emerging markets by a factor of four to eight, and at the same time to agree ESG goals with both borrowers and lenders. Ultimately, that benefits all parties involved – and others besides.

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