Financing ITS

Many developed countries have development aid programmes for low income countries. Most aid programmes focus on capital works, targeted at construction and renovation of the infrastructure, not the on-going operation and maintenance of projects. Some aid programmes are tied to the donor, meaning that the beneficiary country will need to buy from the country providing the aid (the donor country). Some European countries, for example Norway and the UK, have moved away from tied aid programmes. These same countries have also increasingly provided multi-year aid programmes to include supporting operation and maintenance expenditure.

Grants are essentially gifts. Unlike a loan, a grant does not involve repayments to the provider (grantor) by the receiver (beneficiary) - repayments of interest on the loan and of the principal sum loaned.

Traditionally, very low income countries have attracted grants from multi-lateral institutions, such as the World Bank International Development Agency (IDA), to finance the capital cost of road improvements, with or without ITS.

The European Union provides various grants for ITS deployment to its Member States, some of which are among the richest countries in the world. The European Union also offer grants to Member States to help finance the capital works of ITS projects. These EU grants, which need not be repaid, typically require matching national financing. Some of the EU grants, such as the Cohesion and Regional Development Funds, are targeted at less developed EU regions and Member States. Other EU grants for financing ITS projects include:

• Trans-European Network - Transport Programme
• CIVITAS Programme
• European Cohesion Fund
• European Regional Development Fund
• ICT for Policy Support Programme

Multi-lateral institutions, such as International Bank for Reconstruction and Development, the  European Investment Bank (EIB)  and Inter-American Development Bank, are in the business of extending loans to finance road projects, including ITS projects, in their member countries. Multi-lateral loans typically come with a grace (repayment) period, competitive interest rate and market beating tenor. Loans of up to 25-30 years are a common phenomenon. This project financing instrument is well known to member countries.

Less well known is the opportunity for selected African, Caribbean & Pacific, Central Asian, Asia and Latin American, and EU Eastern Neighbours countries to borrow from the EIB - even though these countries are not member countries. The EIB can lend to these selected countries according to the mandates set by the European Union. (See EIB Regions) Projects with environmental benefits are particularly favoured.

Multi-lateral loans typically involve some form of sovereign guarantee by the borrower's country to repay the principal and interests.

Multi-lateral institutions have long been encouraging member countries to involve the private sector in the provision of infrastructure assets and services. Multi-lateral institutions have also developed private sector lending to projects on a non-recourse basis. The International Finance Corporation, which is part of the World Bank Group, is the most prominent in lending to private sector infrastructure. Other regional institutions are increasingly involved in lending on a non- or limited- recourse basis, for example the African Development Bank and the Asian Development Bank.

Traditionally many road projects - including ITS ones - are financed by the public sector. The financing may be allocated from the national budget pool, as in Canada, Singapore and the United Kingdom, or from a hypothecated road fund: for example Cote d'Ivoire and United States of America.

In recent years some governments have set up special purpose funds and/or national development banks to co-finance infrastructure projects, including road, involving private sector partners. Examples are:

• special purpose funds - Fonadin (Mexico), Instituto de Credito Oficial (Spain)
• national development banks - Banobras (Mexico), Corporación Financiera de Desarrollo (Peru)

Vendors of ITS products are often involved in the financing of the ITS assets and operations they sell. In essence the vendor provides some or all of the money required to build and operate the ITS project. The purchaser then repays the vendor over a period of time. The structure and amount of financing will depend on the contract type employed - System Leasing or Public-Private Partnership. (See Contracts) The latter case it is also known as sponsor financing and typically this only provides the smaller equity portion of the total project finance required.

Private Equity (PE) is the generic name for specialist financial asset managers  that invest in non-listed companies. Often these are out-of-favour and/or under performing. A common characteristic is the investment holding period - this tends to be short. Another is the financing structure employed - this tends to be debt laden, which means the equity portion of the total project financing is relatively small (5-25%).

With the growth in public-private partnership projects in the mid 1990s, some major private sector banks set up in-house PE units to co-invest in the equity of PPP projects. Following the 2007/8 Global Financial Crisis, many of these in-house PE units have been spun off as independent organisations, as they are now considered as non-core assets for the banks.

In the past few years traditional PE managers have started to invest in infrastructure, including ICT and roads. Some PE managers, such as 3i Group plc, Blackstone and KKR & Company LLP , have set up special-purpose infrastructure funds. PE managers typically invest in the equity portion of project finance.

An Infrastructure Fund is the common name for closed-end investment funds, which may be publicly listed and traded or or unlisted. Examples are:

• publicly listed and traded - examples are 3i India Infrastructure Fund, Infratil Limited, and International Public Partnerships Limited (www.amberinfrastructure.com)
• unlisted - examples are AMP Core Infrastructure Fund and Goldman Sachs Infrastructure Partners .

These funds typically invest in the equity portion of the infrastructure projects. Some more recent infrastructure funds are focussed on investing in the debt portion of infrastructure projects. Examples are the GCP Infrastructure Fund Limited and Sequoia Infrastructure Debt S.A. .  The rationale for debt focussed infrastructure funds is three fold:

• there are many equity focussed infrastructure funds - many have difficulties finding attractive projects to invest in
• infrastructure debt as an asset class is perceived to carry lower risk and thus appeals to a self select group of more risk adverse investors
• infrastructure debts tend to have long tenor and are perceived to have stable, predictable repayment capacity to match long term income need

The Global Financial Crisis of 2007/8 triggered a severe squeeze in the availability and price of debt for private sector financing of infrastructure projects. Consequently, the advent of debt infrastructure funds is particularly welcomed.

Infrastructure assets, such as roads, are increasingly considered appropriate for investment by pension funds. They are perceived as long life assets with predictable income streams to match the long term liability of pension funds to pay their pensioners. ITS projects are typically short to medium term projects (5-15 years) and therefore less attractive. Additionally, most pension funds are adverse to construction risk, which ITS projects have a plenty. Even so, ITS projects that are bundled into a wider road improvement project should still be attractive to pension funds.

In recent years some very large pension funds, particularly from Australia and Canada, have been active investors in road infrastructure assets. More recently, an investment platform for UK pension funds to invest in infrastructure has been set up. (See Pensions Infrastructure Platform Limited)

Prior to the 2007/8 Global Financial Crisis private sector banks were major providers of debt finance for PPP projects. Private sector banks are particularly helpful in private infrastructure financing because they are more willing to lend to projects with construction risk and to advance loans on a non-recourse basis, where the loan repayments are secured on project cash flow only. Compared with multi-lateral financial institutions, private sector banks charge higher interest rates - not only because they have to make a profit but also their lower credit ratings mean that their own borrowing costs are higher. They also tend to advance loans with shorter tenor - less than 15 years or shorter is not uncommon for infrastructure projects in developing countries, sometimes only 7-8 years.

Prior to the Global Financial Crisis it was common practice for a handful of private sector banks to form a syndicate to jointly lend to a major PPP project. Now banks club together as equals to jointly lend to a major project. This means longer bank terms negotiation and slower credit decision-making. All banks have to agree to whatever that is negotiated and agreed. The Global Financial Crisis has weakened the financial strength of many private sector banks involved in PPP infrastructure lending, and has exposed many of the banks' working assumptions as optimistic. Consequently, the availability of this particular source of project financing has reduced and the cost has increased. Recent international regulatory moves (known as Basel III - designed to make private sector banks more robust from failure) require banks to hold more capital against infrastructure lending. This is likely to further increase cost and reduce availability of bank loans for infrastructure projects.

Capital markets allow new and growing companies to raise equity and debt to finance their projects, and investors to trade in the secondary markets. Many PPP projects are organised as freestanding businesses. Some projects have used capital markets to raise the necessary project financing. For example, in Australia, equity for the Eastlink motorway in Melbourne and the Clem7 Tunnel in Brisbane was raised and listed on the Australian Stock Exchange. Another example, in Mexico, Structured Equity Securities (CKDs), which are fiduciary instruments aimed at financing the equity of one or more projects, were issued through and listed on the Stock Exchange of Mexico in 2009 to part finance the FARAC I motorway concession.

Capital markets have also played important role in infrastructure debt financing in the form of bond financing. One advantage of bond financing over bank loans is the longer tenor. Some bonds come with repayment guarantees underwritten by multi-lateral institutions and/or specialist insurers, known as 'monolines'. A disadvantage of bond financing for projects with a long construction period is 'negative carry' where the cost of financing exceeds the return on the investment. This results from the difference between the interest paid to bond holders and the interest received for the money deposited during the construction period awaiting disbursement.

Multi-lateral institutions offer a range of financial guarantees against various risks, ranging from political and regulatory risks to risk of shortfall in expected revenues. For example, the Inter-American Development Bank guaranteed 10% of the bond issue for the project financing of the Santiago-Valparaiso PPP toll motorway in Chile in 2002.

The Multi-Lateral Investment Guarantee Agency (MIGA) offers political risk guarantee, whereas the World Bank and Asian Development Bank and Inter-American Development Bank offer partial risk guarantees (PRGs) that cover regulatory and revenue risks.

In the mid-1990s the private sector began to offer guarantees for bonds, providing investors with the highest possible rating. These 'triple-A' rated specialist insurance companies provided comprehensive guarantees, known as 'monolines', that were in excess of the PRGs offered by the multi-lateral institutions. The objective was to ensure project implementation and cover timely payments to investors whatever the actual project performance. These monolines have been severely weakened by the Global Financial Crisis. All have lost their triple-A ratings and do not have the same capacity to underwrite financial guarantees as they did prior to the Global Financial Crisis.