Advances in Infrastructure Finance 9819904390, 9789819904396

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Advances in Infrastructure Finance Raghu Dharmapuri Tirumala Piyush Tiwari

Advances in Infrastructure Finance

Raghu Dharmapuri Tirumala · Piyush Tiwari

Advances in Infrastructure Finance

Raghu Dharmapuri Tirumala Architecture, Building and Planning University of Melbourne Melbourne, VIC, Australia

Piyush Tiwari Melbourne School of Design University of Melbourne Melbourne, VIC, Australia

ISBN 978-981-99-0439-6 ISBN 978-981-99-0440-2 (eBook) https://doi.org/10.1007/978-981-99-0440-2 © The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2023 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors, and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Palgrave Macmillan imprint is published by the registered company Springer Nature Singapore Pte Ltd. The registered company address is: 152 Beach Road, #21-01/04 Gateway East, Singapore 189721, Singapore

To Our Families

Acknowledgments

This book was possible due to the support and sincere contributions of many people to whom we are gratefully indebted. We have immensely benefitted from many conversations with friends and industry colleagues who shaped the thought of assimilating the developments in the infrastructure financing sector. A special mention is due to Saravanan Santhanam, whose thoughts on how the market for infrastructure financing evolved gave us a toehold to begin from. Our deep thanks go to Kruti Mihir Upadhyay, Dr. V. Sathyanarayana, and Smitha Budhhavarapu for their unfailing support in the documentation of this book. Kruti did a great job of helping with a lot of data gathering and production aspects of the book. Dr. Sathyanarayana patiently reviewed the drafts written and provided his input for improvement. Smitha has, as ever, been a pillar of support through her ideas and encouragement, and ensuring that we kept going on the book. All the financial instrument innovations highlighted in this book involved multiple rounds of discussions with a cross-section of stakeholders and obtaining their inputs through informal discussions. The people who stand out in our mind as having made especially substantial contributions are Shivamurthy Y. M., Abhijit Bhaumik, Anouj Mehta, Ravi Peri, Hidayathullah Baig, Shashwat Tewary, Tarun Bansal, Komal Seshagiri, Rodrigo Martinez, A. S. Harinath, Martin Unzueta, Shubhagato Dasgupta, Karthik Iyer, Anjula Negi, G. Narayanan, Jagan Shah, Ravikant Joshi, and Praveen Sanjeevi. We extend our sincere thanks to all

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ACKNOWLEDGMENTS

the experts for their interest and time in supporting this book. A special thanks to Ganga Charan Gopisetty for sharing his thoughts on broader financial markets that helped to improve the book in material ways. We would like to acknowledge the support of the editorial and publishing team at Palgrave Publishers. They had remained steadfastly supportive of the idea of this book for their patience during our lengthy writing process. The funding support of the Faculty of Architecture, Building and Planning, the University of Melbourne, for the outreach of this research is gratefully acknowledged. Without our families standing by our side, we are sure we could not have accomplished this feat. Our utmost thanks and sincere gratitude to them for their continuing support and affirmation of our work, balancing our research with everything else. The views expressed in this book are entirely our own. Any errors or omissions are our responsibility. Raghu Dharmapuri Tirumala Piyush Tiwari

About This Book

The financing of infrastructure has moved beyond traditional government funding, multilateral assistance, and project finance to a diverse set of innovative approaches, increasing participation from private, institutional, commercial, and philanthropic investors. The book looks at advances in financing infrastructure projects and related topics, synthesizes the developments to date, and generates new understandings and concepts. The book is an attempt at a comprehensive treatment of different elements of infrastructure financing and will be of interest to academic institutions, higher degree research scholars, industry stakeholders, including public and private sector financial institutions, consulting firms and policy research institutions in the finance, development economics, public policy, business management, and project management domains to name a few.

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Contents

1

1

Introduction

2

Project Finance Transformation

17

3

Multilaterals Leading the Innovation Path

47

4

Exponential Growth of Sustainable Debt: Green Bonds Surge

79

5

Diverse Applications: Thematic Bonds Catching Up

107

6

The Appeal of Land-Based Financing Instruments

135

7

Growing of Age in Risk Mitigation: Funded and Unfunded Participation

159

8

Unlocking Value Through Asset Recycling

187

9

Private Market Infrastructure Funds

209

Index

241

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About the Authors

Dr. Raghu Dharmapuri Tirumala is a Senior Lecturer in the Faculty of Architecture, Building and Planning at the University of Melbourne. Previously, as the Professor and Director at RICS School of Built Environment (Noida, India), he had set up the School of Infrastructure and designed the M.B.A. program in Infrastructure Management. Prior to that, he was the CEO of Infrastructure Development Corporation (Karnataka) Limited, a joint venture of the Government of Karnataka, IDFC, and HDFC at Bangalore, India. His research covers the areas of innovative finance, public, private partnerships (PPPs) in infrastructure, project, and property finance. Dr. Piyush Tiwari is a Professor of Property at the University of Melbourne, Australia. Before his current position, he was Director, Policy at Infrastructure Development Finance Company (IDFC), India. He was responsible for formulating policies for private financing of urban infrastructure in close cooperation with national and state governments. He was also editor of India Infrastructure Report 2011 on Water. Earlier, he was Senior Lecturer (Property) and Program Leader, MSc (International Real Estate Markets), at the Business School, University of Aberdeen, UK. In addition, he has held positions at the largest mortgage company,

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ABOUT THE AUTHORS

HDFC, India, and the University of Tsukuba, Japan. His research interests include infrastructure policy, housing economics and mortgages, commercial real estate investment, and financing infrastructure in developing countries.

Abbreviations

ACGF ACT ADB AFC AFD AfDB AIF AIFM AIFMD AIIB APEC AR ARI ASEAN ATI|ACA AUM BADEA BANOBRAS BMGF BMRCL BNDES BOO BOOT BOT

ASEAN Catalytic Green Finance Facility Australian Capital Territory Asian Development Bank Africa Finance Corporation Agence Française de Développement (The French Development Agency) African Development Bank ASEAN Infrastructure Fund Alternative Investment Fund Managers Alternative Investment Fund Managers Directive Asian Infrastructure Investment Bank Asia-Pacific Economic Cooperation Asset Recycling Asset Recycling Initiative Association of South East Asian Nations African Trade Insurance Agency Assets Under Management Arab Bank for Economic Development in Africa The National Bank of Public Works and Services—Banco Nacional de Obras y Servicios Publicos, S.N.C. Bill and Melinda Gates Foundation Bangalore Metro Rail Corporation Limited Brazilian Development Bank Build-Own-Operate Build Own Operate Transfer Build-Operate-Transfer xv

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ABBREVIATIONS

bps BRI BRICS BROT CAR CBD CBI CCS CDC CDM CDO CDS CEFC CERs CFADS CGIF CIB CLO CPE CPPIB DBFOM DBJ DBOT DBS DCF DEG DFI DIAL DIBs DMCs DSCR EBID EBITDA ECA EIB EMDEs ESG EU EUGBS FAR FDI FMO

Basis Points Belt and Road Initiative Brazil, Russia, India, China, and South Africa Build-Rehabilitate-Operate-Transfer Contractors All Risk Central Business District Climate Bonds Initiative Cross-Currency Swap CDC Group plc (UK) Clean Development Mechanism Collateralized Debt Obligation Credit Default Swap Clean Energy Finance Corporation Certified Emission Reductions Cash Flow Available for Debt Service Credit Guarantee and Investment Facility The Canada Infrastructure Bank Collateralized Loan Obligations Contractors’ Plant and Equipment Canada Pension Plan Investment Board Design-Build-Finance-Operate-Maintain Development Bank of Japan Design-Build-Operate-Transfer Development Bank of Seychelles Discounted Cash Flow German Development Finance Institution Development Finance Institutions Delhi International Airport Limited Development impact bonds Developing Member Countries Debt Service Coverage Ratio ECOWAS Bank for Investment and Development Earnings Before Interest, Taxes, Depreciation, and Amortization Export Credit Agencies European Investment Bank Emerging Markets and Developing Economies Environmental, Social and Governance European Union EU Green Bonds Standard Floor Area Ratio Foreign Direct Investment Dutch Development Bank

ABBREVIATIONS

FONADIN FSB GBP GBS GCC GCF GDP GEF GFC GGGI GP GSIA GSS Bonds GSSS Bonds GTFP HUDCO ICMA IDA IDB IDF IEA IFC IFI IIFCL IIGF ILO IMF INDC InvIT IPP IRR IRS IsDB JBIC JICA KfW KODIT KPI LC LDCs LEAP LIBOR

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Mexico’s National Instructure Fund (Fondo Nacional de Infraestructura) Financial Stability Board Green Bond Principles Green Bond Standard Gulf Cooperation Council Green Climate Fund Gross Domestic Product Global Environment Facility Global Financial Crisis Global Green Growth Institute General Partner Global Strategic Investment Alliance Green, Social and Sustainability (GSS) Bonds Green, Social, Sustainability, and Sustainability Linked (GSSS) Global Trade Finance Program Housing and Urban Development Corporation International Capita Market Association International Development Association Inter-American Development Bank Infrastructure Debt Fund International Energy Agency International Finance Corporation International Financial Institutions India Infrastructure Finance Company Limited Indonesia Infrastructure Guarantee Fund International Labour Organization The International Monetary Fund Intended Nationally Determined Contributions Infrastructure Investment Trust Independent Power Producer Internal Rate of Return Interest Rate Swap Islamic Development Bank Japan Bank for International Cooperation Japanese International Cooperation Agency German Development Bank Korea Credit Guarantee Fund Key Performance Indicators Letter of Credit Least Developed Countries Leading Asia’s Private Sector Infrastructure Fund London Interbank Offered Rate

xviii

ABBREVIATIONS

LP MDB MDGs MIGA MLA MRO MSCI NAIF NBFC NDB NDCs NGOs NIIF NSW O&M ODA OECD OPEC Fund OTC PBoC PE PF PFI PIDG PL PPA PPI PPPs PRC PRG PRI R+P model RBP RDBs REITs RFR RICS ROMT SBP SBTs SDG SEBI SEZs

Limited Partners Multilateral Development Bank Millennium Development Goals Multilateral Investment Guarantee Agency Mandated Lead Arranger Maintenance, Repair and Overhaul Morgan Stanley Capital International Northern Australia Infrastructure Facility Non-Banking Finance Companies New Development Bank Nationally Determined Contributions Non-Governmental Organizations National Infrastructure Investment Fund New South Wales Operations and Maintenance Official Development Assistance Organisation for Economic Co-operation and Development OPEC Fund for International Development Over The Counter People’s Bank of China Private Equity Project Finance Private Finance Initiative Private Infrastructure Development Group Public Liability Power Purchase Agreement Private Participation in Infrastructure Public Private Partnerships People’s Republic of China Partial Risk Guarantee Political Risk Insurance Rail Plus Property Co-Development (R+P) Model Results-Based Payment Agreement Regional Development Banks Real Estate Investment Trusts Risk Free Rate Royal Institution of Chartered Surveyors Renovate-Operate-Maintain-Transfer Social Bonds Principles Science-Based Targets Sustainable Development Goals Securities and Exchange Board of India Special Economic Zones

ABBREVIATIONS

SFDR SIBs SIDS SLB SLLs SOFR SPT SPV SRCC SWF TA TLFF TOD TOT UN UNEP UNFCCC UNPRI VGF WB WBG WEF WWF

Sustainable Finance Disclosure Regulation Social Impact Bonds Small Island Developing States Sustainability-Linked Bonds Sustainability-Linked Loans Secured Overnight Financing Rate Sustainability Performance Targets Special Purpose Vehicle Strikes, Riots and Civil Commotion Sovereign Wealth Funds Technical Assistance Tropical Landscapes Finance Facility Transit Oriented Development Toll-Operate-Transfer United Nations United Nations Environment Programme United Nations Framework Convention on Climate Change UN Principles for Responsible Investment Viability Gap Funding World Bank World Bank Group World Economic Forum World Wide Fund for Nature

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List of Figures

Fig. 2.1 Fig. 2.2 Fig. 2.3 Fig. 2.4 Fig. 2.5 Fig. 3.1 Fig. 3.2 Fig. 3.3

Fig. 3.4

Fig. 3.5

Fig. 3.6

Cumulative number of infrastructure projects from 1994 to 2019 (Source Authors based on data from Rao [2020]) Cumulative investments in different sectors (in $million) (Source Authors based on data from Rao [2020]) Total investments by the private sector ($Billions) (Source Fakhoury [2022] and World Bank [2021]) Infrastructure investment with private participation (Source Authors based on data from GI Hub [2020]) Six-month LIBOR rate at year close from 1987 to 2021 (Source Authors based on data from MacroTrends [2022]) Outflows of MDBs from 2010 to 2018 (Source Authors’ calculations based on OECD Stat [2022a]) Concessional and non-concessional finance (Source Authors’ calculations based on OECD Stat [2022a]) Current investment and projected gaps in infrastructure (Source Authors based on Miyamoto and Chiofalo [2016]; Note Developing nations only [2015–2030]) Geographical distribution of infrastructure investment needs (Source Authors based on Miyamoto and Chiofalo (2016]; Note Developing nations only [2016–2030]) Non-concessional lending from multilateral organizations (commitments) (Source Authors based on OECD QWIDS [2022]) Blended finance structure (Source Authors based on Convergence [2021])

28 28 29 30 35 58 58

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63 68

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LIST OF FIGURES

Fig. 3.7

Fig. 4.1

Fig. 4.2 Fig. 4.3

Fig. 5.1

Fig. 6.1

Fig. 6.2

Fig. 7.1 Fig. 8.1

Cumulative growth of blended finance from 2007 to 2020 (Source Authors based on Convergence [2021], Mutambatsere and Schellekens [2020]) Cumulative green bonds issuance from 2007 to September 2022 (in $billion) (Source Authors compilation from various annual reports of Climate Bond Initiative) Green bonds issuance process (Source Authors based on ADB [2021], ICMA [2021]) Exchanges with dedicated green bonds window (Source Authors based on CBI [2022b], Green Finance Platform [2021]) SeyCCAT Blue Fund (Source Authors based on [Bolliger & John, 2020; Pouponneau, 2015; The Commonwealth Blue Charter, 2020; World Bank, 2017]) Percentage of world population (A) 2016 and (B) 2030 (Source Authors based on data from [United Nations Department of Economic and Social Affairs Population Division, 2016]) Types of land-based financing instruments (Source Authors based on data from [Abiad et al., 2019; Blanco et al., 2016; Mehta, 2018]) Funded versus unfunded mobilization—a basic schematic (Source Authors based on Group of MDBs [2021]) Asset recycling program of Australia (Source Authors based on Varn and Kline [2017])

68

81 86

90

118

138

146 166 191

List of Tables

Table 2.1 Table Table Table Table Table Table

2.2 2.3 3.1 3.2 3.3 3.4

Table 3.5 Table 3.6 Table 3.7 Table 4.1 Table 4.2 Table 4.3 Table 5.1 Table 5.2 Table Table Table Table

5.3 6.1 6.2 8.1

Private sector financing in the infrastructure sector by instrument type from 2010 to 2020 Project financing deals for 2019 and 2020 Top 10 infrastructure debt funds (as of February, 2022) Share of lending categories across MDBs Instruments offered by MDBs MDB investments by instruments Investment instruments used by MDBs for years 2015–2020 Investment instruments used by MDBs/DFIs (2015–2020) Developing country infrastructure by source of finance and by sector Processing times of MDBs Top five country issuers for 2021 as per bond category Emerging economies’ green bond issuance for top ten countries—2020 and 2021 Sector wise use of proceed breakup of green bonds Sustainable bonds issuance in 2020 and 2021 Market size of various thematic markets for 2020 and 2021 Characteristics of different thematic bonds Human settlements and population (2016 and 2030) Sample Indian projects with land-based financing elements A few prominent asset recycling projects from Australia

30 31 33 57 59 60 60 60 63 72 82 83 83 109 110 111 137 152 192

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LIST OF TABLES

Table 9.1 Table 9.2

Table 9.3 Table 9.4 Table 9.5 Table 9.6 Table 9.7 Table 9.8

Unlisted capital raised by value and volume Median current allocation to infrastructure (As a % of Assets under Management (AUM)) and infrastructure investors’ mean commitment size by investor type Largest institutional investors infrastructure sector for 2019 and 2021 Largest infrastructure funds based on their AUM in Euro millions Infrastructure indices A few funds established by development financial institutions InVITs transactions in India Infrastructure categories

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213 214 215 217 218 221 225

CHAPTER 1

Introduction

We have to find ways to finance infrastructure that gets it done fast and creates a return. —Gordon Brown, Chair, World Economic Forum Global Strategic Infrastructure Initiative Innovation must lead infrastructure for a simple but compelling reason: Innovation produces new types of products and markets, and it is virtually impossible to know how to run those markets efficiently before they are created. —Myron Scholes, Financial Economist and Nobel Laureate

Infrastructure continues to hold the imagination of governments, financial institutions, the private sector, and the general public for a variety of reasons and in different contexts. The infrastructure that countries and cities build today will bring economic and climate benefits in the years to come (Bhattacharya et al., 2012). The availability of quality infrastructure is a prerequisite for the economy to achieve a higher growth trajectory on a sustained basis (Aschauer, 1990). Yet, the challenge of providing adequate infrastructure services to the world’s population is daunting, more so with frequent periods of dramatic change and economic turmoil. Inadequate infrastructure drags the economy down and has a debilitating effect on the quality of life. The need for improved infrastructure, and the ways and means to enable the same, has been the focus of © The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2023 R. D. Tirumala and P. Tiwari, Advances in Infrastructure Finance, https://doi.org/10.1007/978-981-99-0440-2_1

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policymakers at the international, national, and subnational levels. The scale of investments needed continues to escalate and requires bespoke resources in accordance with the stages of infrastructure development. The capacity of government stakeholders to pay for the development, rehabilitation, and operations and maintenance of the infrastructure is limited. They need support from other stakeholders such as multilateral development agencies and private sector as well. It is generally agreed that more than the traditional sources of infrastructure finance, government resources, and loans from multilateral development banks is needed in quantity or, as increasingly becoming apparent, in the format that is offered (Mckinsey Global Institute, 2016). A range of advanced or innovative financial instruments, structures, and mechanisms have emerged that transformed the way infrastructure is being financed. The participation of various players in financing infrastructure has been widespread and evolving continuously, sometimes in response to external events and in other instances in being competitive in the rapidly changing landscape.

1.1

Understanding Infrastructure

“You and I come by road or rail, but economists travel on infrastructure,” said the British Prime Minister, Mrs. Margaret Thatcher. She was implying that the understanding of the term “infrastructure” is vague and is described by the component sectors such as the roads and power plants. While there is no unanimous consensus on the definition of “infrastructure,” what most people seem to agree is that infrastructure enables pretty much everything (The New York Times, 2021) for a good quality of living (Aschauer, 1990) while supporting economic growth (PwC, 2022). From the water, sanitation, roads and bridges, to railways, ports, airports, telecommunication systems, broadband networks, energy, and pipelines, everything is considered infrastructure—a key driver of growth, employment opportunities and competitiveness (EBRD, 2022). Infrastructure is recognized as the backbone for trade, empowers businesses, provides livelihood opportunities by connecting people to their jobs, and protects countries from increasingly unpredictable environmental risks (Puentes, 2015). Countries have their own definitions of the project categories that qualify as “infrastructure,” which vary widely. Most countries agree on the core sectors, namely transportation, water, sanitation, waste management, schools, health facilities, housing, and other community services

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3

like parks, street lighting, libraries, etc. While the definitions in developed countries, such as the USA, UK, Australia, and Canada, are broader and include the core sectors, in contrast, the definition adopted by India not just includes the core sectors but also elaborates on the projects that are considered as social and commercial infrastructure (viz., logistics facilities, hotels, SEZs, etc.). China, on the other hand, explicitly mentions information, transmission, computing services, and software as infrastructure sectors (CPNI, 2021; NDRC, 2022; Wong, 2020). From all the various countries’ definitions of what constitutes infrastructure, the common link between infrastructure and quality of life (Aschauer, 1990) is well established. The striking difference between developed countries and developing ones is undoubtedly the discernible infrastructure (Miller, 2021), and perhaps why it is recognized as the backbone of a healthy economy. As per United Nations estimates in 2018, there were more than a billion people living in conditions that lacked basic amenities such as clean water, sanitation,, and lighting. More than 80% of these people were concentrated in three emerging economies, namely Southeast Asia, sub-Saharan Africa, and Central and Southern Asia (PwC, 2022). Population growth, rapid urbanization, and an increasingly warming world are forces driving the need for new and upgraded infrastructure on an urgent basis. Today, over 50% of the world’s population resides in urban areas. As per the United Nations estimates, this is expected to increase to about 70% by 2050. That translates to more than 6 billion people from the current 4.3 billion people who will live in urban areas. By 2030, China alone will have 1 billion people in its cities (Floater et al., 2017). As per ADB estimates, Asia would require about $1.7 trillion in investments in infrastructure annually to sustain growth, achieve the SDGs and effectively respond to risks from climate change. This is twice the $750 billion requirement that was estimated in 2009. Therefore, the gap in infrastructure and investments seems to be only widening (PwC, 2022). Typically, urban infrastructure investments are made for a period of a few decades, but the corresponding economic and efficiency gains are experienced over a much longer period. To a large extent, policy decisions can shape urban sprawl, transport systems, and built environments, locking in the economic, climate, and social costs over the long term. This is particularly important for cities, megacities, and metropolitan areas in emerging economies. For instance, the rate at which some of the cities in

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India are growing needs to build 70–80% of its infrastructure for 2050 (Floater et al., 2017). This includes not just traditional infrastructure built by public agencies but a combination of public and privately built assets that contribute to low emissions and that are climate-resilient and socially inclusive. Strong policy and governance initiatives that enable such infrastructure investments are extremely important for sustaining inclusive growth and delivering quality services to residents.

1.2

Importance of Infrastructure Financing

Whenever a new infrastructure project, for example, an airport, an SEZ, or a new water treatment plant, is developed, the benefit to the economy is direct by way of job creation during the development phase and, post that, by way of productivity gains. OECD and IMF have analyzed that for every dollar of investment that goes into infrastructure projects, such as transport, water and sanitation, energy, telecommunication, housing, and social infrastructure, the benefits are multiplied 1.6 times through the creation of jobs in the short term and efficiency and productivity gains in the long term (EBRD, 2022). Though the evidence is compelling, and there is agreement on the need for increased investments in infrastructure for a healthy economy, the G20 countries have reduced their investments since the global financial crisis in 2009. The importance of investments in infrastructure for the long term has not been paid enough attention. For example, the investments in broadband networks, railway networks, and the transition to a green economy have not kept pace with the anticipated needs. The world at large is experiencing a shortfall in infrastructure investments (World Economic Forum, 2014). Infrastructure investments (as a percent of the GDP of the country) of the developed countries have been declining over the period 1980s to 2008. On the contrary, the same has been rising in developing countries over the same period (McKinsey, 2010). Internationally, on average, China spends approximately 8% of its GDP on infrastructure, while European countries spend about 5% and the USA only about 2.4% of its GDP (BRINK, 2021). The deployment of public funds by different tiers of government varies across countries. For example, federal government funding on infrastructure in the USA is only about 25%, and the rest is funded at state and city levels. However, Europe relies mostly on its national government for infrastructure funding.

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Several studies and development institutions have estimated the gap in infrastructure investments for the decades to come. For instance, global consulting firm McKinsey & Company estimates that an additional $1–2 trillion is required from 2016 to 2030, for meeting the SDG 2030 agenda (Mckinsey Global Institute, 2016). Another study by GI Hub’s Global Infrastructure Outlook estimates that more than $97 trillion would be required by 2040 to provide access to growing populations in urban areas (GI Hub, 2017). The estimates vary substantially from $3.3 trillion annually to $6.9 trillion each year (Mirabile et al., 2017). This is reflective of the differences in the methodologies for the estimations. The differences arise from the elements that are considered for project costing, the project components per se, scope of the project, region of implementation, currency conversion rates, and other factors. Essentially, the estimations are based on the methodology adopted by respective institutions, and there is no accepted universal formula or approach. That said, the purpose of using investment numbers in this book is to illustrate the magnitude of investments required in infrastructure and recognize that the absolute values could vary significantly. Closing the infrastructure gap is a top priority on the global development agenda and is reflected as such in the G20 investment agenda, the Addis Ababa Action Agenda on Financing for Development, the 2015 Paris Agreement on climate change, and the UN Sustainable Development Goals (EBRD, 2022). Though enormous investments are required, there is no dearth of capital available if other sources of financing are carefully leveraged. Traditionally, investments have been coming from the public sector. The rationale being that public capital increases the productivity of private capital in a complimentary way. An increase in private capital increases labor productivity which means higher wages for workers and lower cost of borrowing (due to lower interest rates). On the contrary, if public spending increases, borrowing by the federal government increases crowding out private capital and lowering economic output (Penn Wharton Budget Model, 2021). However, not all projects are amenable to private sector participation. Exploring the feasibility and financial viability of infrastructure projects should be the starting point to determine the project development and financing structure. Infrastructure assets fundamentally differ in their characteristics from other asset classes. The sectors that form part of infrastructure have

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substantial differences in terms of business models, regulatory frameworks, policy instruments, market structure, technology, and its development, market players, and their characteristics. These also vary by region and time. The major events that disrupted the world economy, such as the Asian financial crisis (1997), the dot com bubble (2000), the global financial crisis (GFC) (2007/2008), and recently, the COVID-19 pandemic 2020 onwards, have incrementally changed the dynamics of the infrastructure landscape and hence the financing of infrastructure. Understanding these unique characteristics is important to address the financing challenges. Infrastructure projects are usually complex in their structures and involve multiple participants in a legal arrangement. The contracts require to be well-drafted, outlining clear responsibilities between parties and assigning risks to the parties that are best suited to address those risks. Also, infrastructure investments generate cash flows in the later stages of the project, making investments in the initial phases risky for private entities (Ehlers, 2014). Therefore, in many cases, some form of public support would be required to attract investments from the private sector. Since the investments are of an enormous magnitude, public sources alone cannot meet these needs. The multilateral development banks and international financial institutions (MDBs/IFIs) play an important role in bridging the financing gap. Though they cater to a small percentage of the financing needs, they play a catalytic role in leveraging other sources of capital in international markets as well as private capital. Other sources of capital are increasing in popularity, such as infrastructure bonds, commercial banks, retail investors, institutional investors such as pension funds and insurers, various infrastructure, and impact bonds.

1.3

Advances and Innovations

Projects are increasing in complexity, and there is no single formula for financing. Though a deep pool of capital is available, channeling it into infrastructure projects is a challenge. As far as investors are concerned, their revenue sources are either public funds or from user charges. To encourage private financing, clear and realistic revenue streams need to be established. Traditionally, a combination of debt and equity was required to finance infrastructure projects. However, the changing complexities of the project structures and the purposes they have been set up mean that the financing package needs to be customized. The projects increasingly

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have a combination of structured loans, project bonds, credit enhancements, and wrap-up guarantees, as can be observed from a few examples mentioned below. A11 Belgium motorway was the “first greenfield and first transport” project to receive benefits of the Project Bond Credit Enhancement initiative of the European Investment Bank (EIB). The cost of this project was around $731 million and one of the most expensive projects in Belgium’s infrastructure sector. It was also the first public–private partnership (PPP) project to get fully financed by a project bond. This project also received the benefit of a deferred drawdown structure for project bonds; that is, funds were drawn over the construction phase, thereby reducing the cost of capital. Credit enhancement from the EIB helped in improving the credit rating for the project, which in turn led to lower costs of financing the debt (Dockreay, 2014; EC, 2014; InfraPPP, 2014). Another example of an innovatively financed project is the one undertaken by the Department of Streets and Sanitation, city of Chicago. In a first-of-its-kind transaction, the Skyway Concession Company signed a concession to lease the project for a period of 99 years for $1.8 billion in 2005. Chicago skyway privatization helped the city authorities to improve the financial condition of the city by deploying the funds received from privatization transaction. Authorities paid off their existing debts on Skyway and the city. Also, a long-term reserve creation and fund allocation (“people, neighborhood, and business investment fund”) were undertaken. This project is a classic example where government authorities got benefitted from the privatization transaction by generating financial resources for other infrastructure projects (Bipartisan Policy Center, 2016; Dyble, 2013; US Department of Transportation, 2021). Land-based financing mechanisms such as land value capture, impact fees, and taxation are increasingly gaining popularity with cities to meet their infrastructure financing needs. An example of land-based financing is the development of Indira Gandhi International Airport (IGI Airport), New Delhi, India. Delhi is the busiest airport in India and IGIA is the first carbon neutral airport in the Asia Pacific region. It is an important hub and connects travelers to important business and leisure destinations within the country and outside (Magicbricks, 2018; Mint, 2007; Pandey et al., 2010). The Delhi airport handled passenger traffic of 69.23 million passengers and cargo of 1041 tons for the year 2018–2019 (DIAL, 2022). The airport was developed by a GMR-led consortium. Before this attempt, there were no significant efforts done to use the

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remaining land (post-utilization for aeronautical purposes) around the airport to provide better amenities to the passengers. It was an innovative way of revenue generation through land value capture methods. Delhi International Airport Limited (DIAL) was allowed to lease the land around the airport for non-aeronautical activities such as shopping malls, hotels, office spaces, and other commercial complexes for developing an aerotropolis. It is popularly known as Delhi Aerocity (Delhi Aerotropolis Private Limited). The financing of infrastructure has moved beyond traditional government funding, multilateral assistance, and project finance to a diverse set of innovative approaches, increasing participation from private, institutional, commercial, and philanthropic investors. The scale of infrastructure investments is huge, and this investment is expected over different phases of the project lifecycle. Though each stage is closely related to the other, the order of investments required is different. Capital investments are required in the construction stages whereas revenues from user charges, rentals, advertisements, etc., serve as revenue sources during the operations and maintenance phases of the project. Increasingly for PPP projects, funding sources are required both during the construction and operations phases. The conventional financing structures have been replaced with a range of innovative financial instruments and mechanisms. The gaps in debt and equity funding, for example, are being bridged by the multilateral financial institutions, infrastructure funds, and the institutional investors. Many governments have started playing a more active role in improving the attractiveness of the projects through a variety of credit enhancement projects. The approaches to investments in the projects included both indirect routes (through funds) and direct projectspecific transactions. Private equity funds, pension funds, and insurance companies have been making direct investments in infrastructure. For instance, Australian pension funds invest in infrastructure funds. Canadian pension funds are a popular example of direct infrastructure investing. The extent of private sector involvement depends on the project viability, market, and business opportunities.

1.4

Scope of the Book and Chapterization

The developments, when viewed from a financial business perspective, might appear to be driven by the innovative approaches of a vast array of stakeholders. However, the infrastructure sector, financing, in particular,

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is characterized by a web of relationships among the many stakeholders, including the policymakers, project proponents, financiers, developers, regulators, service providers, and consultants. The rapid developments in the practices in each sub-domain, enabling mechanisms created to address the local needs or in response to global challenges, efficient information dissemination, sharing of best practices, and capacity building have had a major impact on how the financing has progressed. Though there are several other characteristics of infrastructure projects that are equally important for a project to be successful, this book is dedicated to the advances or innovations in financing infrastructure. This book is focused on presenting the creative changes in financing infrastructure projects over the last two decades. Each of the chapters in the book will discuss advances or an innovation theme relating to the dynamism of project finance and capital markets, the diversification of multilateral assistance into various concessional and guarantee instruments, the surge of green and other thematic bonds, the role of land value capture, funded and unfunded risk mitigation options, asset recycling, and participation of private institutional investors. Each of the topics is vast in its concepts, application, and coverage and rightfully deserves the attention in many independent topic-specific research outputs, textbooks, industry reports and professional databases, and periodic summaries of developments. While there are books that touch on the related topics, there is no extant book that addresses all the elements in one place, and this book attempts to bridge that gap. The book does not hold itself to be an exhaustive treatise on each of the developments or the trends that took place over this period, rather attempts to synthesize the developments to date and generate new understandings and concepts relevant to various themes. It is intended to give initiation to the readers’ understanding of the advances in financing infrastructure and kindle their interest in further exploration. Developments in infrastructure financing are followed by many financial institutions, private developers, public sector policymakers, consulting firms, and academic institutions. A researched discussion on the innovative approaches, challenges, and applications will help the readers reflect on, compare, and contrast the emerging trends concerning their practice. This book contains further eight chapters that serve to sensitize the reader to the advances and innovations in infrastructure finance. Chapter 2: Project Finance Transformation discusses the dynamism of project finance structures in meeting the investment needs of global

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infrastructure. With the increasing importance of infrastructure development, and the need to have this sector in the asset portfolios, stakeholders want to have flexible and future-proof financing and funding arrangements. The chapter considers the basics of project finance and the evolution of concepts over the period. The chapter includes the developments around the GFC that led to the demise of monolines and the increased participation of infrastructure funds and other institutional investors. The broad trends in investment trends across various sectors and geographies are discussed, along with the emergence of newer themes such as Islamic finance and infrastructure debt funds. The chapter goes on to consider the changes that have happened in terms of the change in the basis from the London Interbank Offered Rate (LIBOR) to the Secured Overnight Financing Rate (SOFR), the changes seen to the debt-equity ratios over the period, and the changes in covenants to loan documentation. Chapter 3: Multilaterals Leading the Innovation Path traces the contributions of MDBs over the last few decades as they have been at the forefront in financing infrastructure in the emerging and frontier markets while also innovating their offerings over the period. The chapter discusses the aspect of sectoral eligibility of investments broadening from infrastructure to other productivity-enhancing industries in developing countries, and the offerings from the multilateral development banks have changed from conventional grant and long-term concessional loan products to a broader array of equity, B-Loan structures, guarantees, blended finance and creation of many contexts, region-specific funds, and facilities. The chapter discusses how co-financing opportunities are on the rise, which offers the developing member countries an opportunity to structure financing best suited to their local needs. The support has been extended toward policy-based outcomes and the results linked financing structures. This chapter summarizes the evolution of innovative financing instruments from multilateral development banks in the emerging environment. Chapter 4: Exponential Growth of Sustainable Debt—Green Bonds Surge discusses the evolution of the sustainable debt market, particularly the green bond market, applications, geographical spread, and the stakeholder sentiments driving the segment. The chapter sets out the rapid growth of capital markets in a few infrastructure sectors like renewable energy, building, transportation, etc. Initially propelled by European and American investors, the bond market is now witnessing

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a boom across multiple geographies and infrastructure projects. Sustainable debt has emerged as the new classification (comprising green, social, and sustainability (GSS) themes) quite rapidly in the infrastructure financing space. These products have been designed to raise funds targeted toward projects with positive environmental, social, and governance (ESG) impacts. The chapter presents the catalyzing role of the multilateral development agencies and how they influence the market. The importance of the taxonomies and the rigor needed for issuance of a green bond are discussed. The often-raised question of whether the green bonds offer a premium (“greenium”) is considered, along with the associated challenges in monitoring and reporting of the impact of the proceeds from the bond issuance. Chapter 5: Diverse Applications—Thematic Bonds Catching Up discusses the motivations for configuring other thematic bonds in the social, sustainability, and sustainability-linked areas. The chapter, while providing an overview of the scale of these instruments, also discusses the options for structuring that are being considered and the experiences of launching a few of the instruments. Blue bonds have attracted substantial international attention of late, with many players expressing willingness to participate in the blue economy investing. The chapter takes a deep dive into one of more prominent blue bond issuance, the Seychelles Blue Bond along with its debt-for-nature swap, to look at the subtle innovations that need to be brought in to launch a thematic bond. The chapter highlights the several possibilities for the adoption of thematic bonds in meeting the climate and sustainability goals. The chapter highlights the challenges involved in structuring different bonds and the need to balance environmental and sustainable goals with the financial aspirations of the investors. Chapter 6: Appeal of Land-Based Financing Instruments discusses the modalities and trends in using land value capture for financing infrastructure. An uptake in real estate prices has contributed to the growth of economies in many countries. The development of infrastructure has contributed to this phenomenon, which prompted many project proponents to capture a portion of the increase in land/ real estate value and use land-based financing instruments for infrastructure development. The chapter discusses how to land as a resource for financing infrastructure has been used. The chapter sets out the various land-based tools such as taxes, zoning, land use, and land value capture mechanisms. The chapter presents how the land has been used as a “sweetener” to bridge the

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viability in infrastructure projects. The chapter provides an example of India, where numerous land-based financing instruments have been used for infrastructure projects. The innovation in land-based instruments is prompting a wider debate on the achievement of sustainable development goals. Chapter 7: Growing of Age in Risk Mitigation: Funded and Unfunded Participation addresses the developments in various funded and unfunded risk mitigation strategies. There has been a greater understanding of risk in project finance transactions over the last two decades. Consequently, various risk mitigation products have been developed and used across the world. The chapter sketches various forms of risk mitigation instruments, both funded and unfunded, that are being made available to multiple public and private investors in infrastructure. Agencies, including the multilateral development banks and public sector proponents, have provided revenue guarantees, credit guarantees, protection for the first loss, and export credit guarantees. Private sector financial institutions have also been active in risk mitigation support to the infrastructure sector. The chapter delves into various types of credit enhancement mechanisms that are needed and prevalent in the industry. The market for derivative contracts such as interest rate swaps, forwards, and futures is an option that project companies are increasingly using to mitigate risk. There has been a substantial change in the contract design, including availability payments and off-take contracts that could mitigate potential business risk. Chapter 8: Unlocking Value Through Asset Recycling discusses the motivations for asset recycling, reservations expressed by stakeholder groups, and their role in financing infrastructure. Asset recycling, involving monetizing brownfield public assets through either sale or lease and redeploying the proceeds in new infrastructure assets, is considered an option in recent years to meet part of the global infrastructure financing needs. The chapter sets out how Australia has used this strategy in recent years and is regarded as a success. Combining the commonwealth and the state resources has provided the requisite leverage to take on additional infrastructure investments In Australia. The chapter discusses the various components needed for structuring an asset recycling financing scheme. This involves considering the future infrastructure needs, perceptions regarding the sale of public assets, the ability to attract competitive bids, and addressing national security concerns. This mode of financing can attract long-term investors such as superannuation and pension funds.

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Chapter 9: Private Market Infrastructure Funds discusses how private institutional investors participated in the infrastructure market and how their growth has been over the period. The importance of infrastructure as an alternate investment asset class in the portfolio of institutional investors has resulted in substantial financial and diversification benefits. The chapter presents a snapshot of the allocation to infrastructure in the broader portfolio of institutional investors, scale, and nature of players. The chapter sets out the different categories of infrastructure that align with the needs of different investor communities. The core, core plus, value add, and opportunistic categories provide a basis for investing community to align their expectations to the project categories. The chapter moves on to the role of pension funds in taking long-term positions on the sector, and the multilateral development financial institutions in establishing numerous funds targeted to specific themes and geographies. The chapter introduces the innovative financial structures as the Infrastructure Investment Trusts (InVITs) that are taking off in India as a means to broaden the stakeholder groups in participating in infrastructure finance. The chapter then introduces other advances, including the sustainable investing and crowd funding. The chapter highlights how the greater involvement of institutional investors broadened the definition of infrastructure and challenges in matching the participation routes of institutional investors with the expectations of returns. The chapter concludes with the potential that exists for increased participation and the transformation that the private market institutional investments have brought to the infrastructure finance.

References Aschauer, D. A. (1990). Why is infrastructure important? Conference Series [Proceedings], 34, 21–68. Bhattacharya, A., Romani, M., & Stern, N. (2012). Infrastructure for development: Meeting the challenge, Infrastructure for development: Meeting the challenge, policy paper, centre for climate change economics and policy. Grantham Research Institute on Climate Change and the Environment, G-24, Mimeo. Bipartisan Policy Center. (2016). Infrastructure case study. Skyway Bridge, https://bipartisanpolicy.org/download/?file=/wp-content/upl Chicago. oads/2016/10/BPC-Infrastructure-Chicago-Skyway-Bridge.pdf

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BRINK. (2021, June 27). How does US infrastructure spending compare internationally? BRINK—Conversations and Insights on Global Business. https:// www.brinknews.com/quick-take/how-does-us-infrastructure-compare-intern ationally/ CPNI. (2021, April 20). Critical national infrastructure. Centre for the Protection of the National Infrastructure. https://www.cpni.gov.uk/critical-nat ional-infrastructure-0 DIAL. (2022, September 21). DIAL: First carbon neutral airport in Asia-Pacific. Delhi International Airport Limited. https://www.newdelhiairport.in/corpor ate/our-company Dockreay, A. (2014). A11. IJGlobal. Dyble, L. N. (2013). Chicago and its skyway. Infrastructure and Land Policies. https://www.lincolninst.edu/publications/conference-papers/chicagoits-skyway EBRD. (2022). Why infrastructure matters. EBRD. https://www.ebrd.com/inf rastructure/infrastructure-matters.html EC. (2014, March 24). EIB backs A11 Belgian motorway link. European Commission. https://ec.europa.eu/commission/presscorner/detail/ en/BEI_14_66 Ehlers, T. (2014, August). Understanding the challenges for infrastructure finance. https://www.bis.org/publ/work454.pdf Floater, G., Dowling, D., Chan, D., Ulterino, M., Braunstein, J., Mcminn, T., & Ahmad, E. (2017). Global review of finance for sustainable urban infrastructure. http://newclimateeconomy.net/content/cities-working-papers GI Hub. (2017, November 6). Infrastructure continues to attract global investors. https://www.gihub.org/news/infrastructure-continues-to-attractglobal-investors/ InfraPPP. (2014, March 25). Innovative bond financing for Belgium’s A-11 PPP closes. InfraPPP by DT Global. https://www.infrapppworld.com/news/meg aproject-194-innovative-bond-financing-for-belgium-s-a-11-ppp-closes Magicbricks. (2018, March 19). Aerotropolis: Take off to the city of the future. Magicbricks. https://content.magicbricks.com/property-news/chennai-realestate-news/take-off-to-the-city-of-the-future/97778.html McKinsey. (2010). Farewell to cheap capital? The implications of long-term shifts in global investment and saving. https://www.mckinsey.com/~/media/mck insey/featured%20insights/global%20capital%20markets/farewell%20cheap% 20capital/mgi_farewell_to_cheap_capital_full_report.pdf Mckinsey Global Institute. (2016). Bridging global infrastructure gaps. Miller, T. C. (2021). Infrastructure: How to define it and why the definition matters. Policy Brief Mercatus Center George Mason University. https:// www.mercatus.org/system/files/miller_-_policy_brief_-_defining_infrastru cture_as_an_economic_concept_-_v1.pdf

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Mint. (2007, October 21). Govt nixes Delhi airport debt plan. Mint. https:// www.livemint.com/Politics/U9BfjlBB7OF4cpOlli3VKP/Govt-nixes-Delhiairport-debt-plan.html Mirabile, M., Marchal, V., & Baron, R. (2017). Technical note on estimates of infrastructure investment needs Background document to the report investing in climate. Investing in Growth. https://www.oecd.org/env/cc/g20-climate/ Technical-note-estimates-of-infrastructure-investment-needs.pdf NDRC. (2022, April 29). China revs up infrastructure investment to spur growth. National Development and Reform Commission (NDRC) People’s Republic of China. https://en.ndrc.gov.cn/news/mediarusources/202204/ t20220429_1324139.html Pandey, A., Raghuram, G., & Morris, S. (2010). Structuring PPPs in aviation sector: Case of Delhi and Mumbai airport privatization (IIMA Working Papers). https://ideas.repec.org/p/iim/iimawp/wp2010-11-03.html Penn Wharton Budget Model. (2021, June 15). Explainer: Economic effects of infrastructure investment. Penn Wharton Budget Model. https://budget model.wharton.upenn.edu/issues/2021/6/15/economic-effects-of-infrastru cture-investment Puentes, R. (2015). Why infrastructure matters: Rotten roads, bum economy. https://www.brookings.edu/opinions/why-infrastructure-mat Brookings. ters-rotten-roads-bum-economy/ PwC. (2022). Global infrastructure trends—Developments in financing. PwC. https://www.pwc.com/gx/en/industries/capital-projects-infrastructure/pub lications/infrastructure-trends/global-infrastructure-trends-financing.html The New York Times. (2021, April 26). Why the meaning of ‘infrastructure’ matters so much. The New York Times. https://www.nytimes.com/2021/ 04/26/opinion/infrastructure-definition-history.html US Department of Transportation. (2021). FHWA—Center for innovative finance support—Project profiles. US Department of Transportation. https:// www.fhwa.dot.gov/ipd/project_profiles/il_chicago_skyway.aspx Wong, D. (2020, August 7). How can foreign technology investors benefit from China’s new infrastructure plan? China Briefing. https://www.china-briefing. com/news/how-foreign-technology-investors-benefit-from-chinas-new-infras tructure-plan/#whatischinasnewinfrastructureplanHeader World Economic Forum. (2014). Global agenda accelerating infrastructure delivery new evidence from international financial institutions. https:// www.ebrd.com/sites/Satellite?c=Content&cid=1395254060082&pagename= EBRD%2FContent%2FDownloadDocument

CHAPTER 2

Project Finance Transformation

While many governments have taken steps to drive economic recovery through infrastructure development, additional investments through public-private partnership would be a welcome source of liquidity as countries continue to devote urgent resources to battle the pandemic. —Indranee Rajah, Second Minister for Finance and Second Minister for National Development, Singapore Our funding currently is project finance which is only 12 years and we are building an asset which will last 55, 75 or possibly 100 years and we would like to match that tenure. —Keith Edelman, Senior Vice President, CBRE

2.1

Introduction

One of the most critical sources of financing infrastructure projects the world over, particularly the large-scale ones, over the last four decades, is project finance (Garcia-Bernabeu et al., 2015; Pinto, 2017). The infrastructure investments needed to meet the requirements are massive, as estimated by different entities at different points of time. It is estimated that the global investments needed for the major sectors of transport, energy, water, and telecom are about $57 trillion to $71 trillion (McKinsey Global Institute, 2013; Stevens & Schieb, 2007). Europe requires about e1.5 trillion to e2 trillion by 2020 (Arezki et al., 2016). © The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2023 R. D. Tirumala and P. Tiwari, Advances in Infrastructure Finance, https://doi.org/10.1007/978-981-99-0440-2_2

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The governments across the world have looked upon the private sector to participate in the growth of the infrastructure sector. UK Government’s Private Finance Initiative (PFI) is one of the more prominent efforts to encourage increased private sector participation in the provision of infrastructure services. The private investment in the infrastructure sector has grown at 5% per annum over the past ten years (GI Hub, 2020). The increase in private sector participation was driven by secondary market transactions. Compared to 2010, when 64% of investment transactions took place in primary markets, in 2019, just 25% of such transactions took place in the primary market (GI Hub, 2020). The primary marketbased private investments in infrastructure projects in 2020 were $156 billion, which was equivalent to 0.2% of the global GDP. As a comparison, the actual requirement of financing is 5% of the global GDP to meet the infrastructure needs (GI Hub, 2021). The growth of project financing is directly related to private sector involvement in infrastructure projects. The concept of project finance became popular in period from the 1980s as private sector participants from developed countries introduced it to the developing world to build the requisite infrastructure assets (Yescombe, 2002). The project finance modality is also being used during that period for new infrastructure sectors such as social infrastructure (education, health, prisons) and civic services, in addition to the conventional sectors such as highways, and when the stakeholders intended to keep the financing off the balance sheet. The adoption of project finance was more visible in the European, Middle East, North Africa, and North America markets. The increased uptake of project finance was concurrent to the growing popularity of the public-private partnership (PPP) arrangements in the infrastructure sector. For many years, investors in infrastructure projects had a clear and straightforward way of structuring and categorizing deals. Non-recourse, special purpose vehicles (SPVs), off-balance sheet financing, and debtequity ratios may be unfamiliar concepts to many, but to project finance stakeholders, these were the pillars of this sizeable market. It is primarily utilized for capital-intensive projects such as power plants, roads, railways, and airports, which need comparatively long-term financing and those that have cash flows that can be estimated with reasonable certainty. The robustness of project finance is based on agreements between various stakeholders, the due diligence that is conducted on the project cash flows, the ability of each of the stakeholders, and the general risk management framework that is adopted across the transaction. These elements

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put together play a substantial role in assuring the stakeholders of the returns they expect from the project (Ballestero, 2000). While the fundamental tenets of project finance as adopted from the 1980s have remained intact, the rigor of the framework has increased many fold over the period.

2.2

Project Finance---A Primer

The traditional mode of financing infrastructure is heavily reliant on the public sector, supported by development finance institutions. The projects are financed conventionally through a combination of equity and debt. Mezzanine products and grants by the public sector have been increasingly used in recent years. The availability of public finance was scarce in relation to the infrastructure needs world over and has constraints in terms of having enough budgetary flexibility and limited by the tax and other revenue that the public sector can raise over a period. The public sector funding has also been criticized for the inability to allocate and disperse funds in a timely fashion and also the inefficiency related in planning and implementing the projects. On the other hand, if the private sector has to play a larger role in the financing of infrastructure, they need to be confident of recouping their investments with their return expectations. The role of the government would then transform to one of creating an enabling environment as well as financial structures that allow greater participation of the private sector (Gatti, 2014). The term “project finance” does not have any one definition that is universally adopted. However, broadly speaking, project finance means the financing of a project based on its future cash flows and, in turn, the capability to pay back the loan/debt taken to build the project. The project to be constructed itself becomes the collateral for the lender, along with the estimated cash flows over the period (Esty, 2003; Fabozzi et al., 2006). Hence, the financing of such projects does not depend on the sponsors’ reliability or creditworthiness or on the value of the asset that sponsors provide as collateral to the lenders (Pinto, 2017). Project finance has been utilized for reducing cost agency conflicts and for managing the risks in a better way (Garcia-Bernabeu et al., 2015). The financing is structured carefully to consider the whole-of-life costs and the assessment of risks that were likely to arise over the useful asset life. In a project finance transaction, the equity providers (the project sponsors and their associates) and the lenders (banks) invest in the project on the basis of a standalone valuation. In some projects, the governments

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may contribute with grant funds. The project is typically structured as a special purpose vehicle (SPV). The equity is usually provided off-balance sheet, and the debt is provided on a limited recourse or a non-recourse basis. The project cash flows and the assets of the SPV act as collateral. Ring-fencing of the cash flows (a mechanism that segregates the specific cash flows from the rest of system so that the same can be used for defined purposes and not diverted for general-purpose usage or other projects), roles, and responsibilities of the SPV is done to minimize the effect of project sponsors’ previous liabilities on the performance of the project. The debt-equity ratio of a typical project under project finance modality is usually high, in the range of 75–90%: 25–10% (Esty, 2004; Yescombe, 2002). The infrastructure debt is measured by the rate of recoveries and the defaults, and is compared with other fixed income securities, as there is a greater understanding of such instruments. The lenders evaluate the project from the perspective that the project cash flows should be sufficient enough to cover the debt provided for the project. When the lenders do not have any recourse to the project sponsors if the project financials do not work out as estimated, the approach is known as “non-recourse” lending. If there is some recourse to the project sponsors, the approach is known as “limited” recourse. The primary metric that the lenders look at is the debt service coverage ratio (DSCR) year or year, as well as the average DSCR over the life of the loan (DSCR is a measure that is widely used to assess if the project is generating enough cash flows to meet its debt obligations—interest and principal repayments. This is a ratio of cash flow available for debt service (CFADS) and sum of interest and principal repayments for that particular period). It is generally considered that a bankable project will have a minimum DSCR of at least 1.1 and the average DSCR of at least 1.5 (after credit enhancement as appropriate to the project). The debt for the infrastructure projects is provided by the commercial banks mostly as a consortium. The equity providers also expect that the project meets their hurdle requirements (internal rate of returns calculated at the total project level and at the equity level). Usually, the maturities of project financing are in line with the asset life or the off-take agreements, but have “miniperms,” i.e., bullet repayments due after a shorter period. The debt is structured estimating the cash flows for the project life and assuming the availability of long-term interest rate swaps. Risk management forms the bedrock of the project finance mechanism. The structure of an infrastructure project leads to many risks,

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often at the confluence of the interactions between the different stakeholders. The risks in the transaction could include the market (demand and price), construction, completion, financing (interest rate, currency), off-take, supplies (shortage), technical, legal, political, social, environmental, and governance aspects. A series of project development activities are usually undertaken, often with the help of experts/consultants, to identify, quantify, and suggest mitigation mechanisms for these risks. The studies address a wide range of technical, market, financial, legal, social, and environmental issues at different stages of the project life cycle. Given the financial commitments of each of the project stakeholders, it is often seen that independent studies are commissioned by different entities. In the case of a large and complex project financed by a syndicate or consortium of banks, independent expert opinions and detailed analysis for each of these issues will potentially be required. In some cases, different consultants may be needed to support each group of participants—sponsors and lenders. A financial model quantifying the project cash flows is prepared that feeds into the decision-making process of different stakeholders. The financial model includes the assessment of the capital expenditure, the recurring annual operations and maintenance (O&M) expenditure, the revenue projects, the financial statements, and the project viability metrics. A sensitivity analysis is conducted for several scenarios of changes in key project parameters, and the resultant impact on project metrics is observed (e.g., the lenders would like to see the impact of an increase in capital costs by, say, 20%, an increase in operating and maintenance expenditure by 20%, a decrease in revenues by 25%, delay in the project implementation period, or a combination thereof and observe the changes in DSCR and the support/cash required to service the debt and sustain the project performance). Suitable credit enhancement mechanisms would then be constituted (e.g., additional equity infusion, government grants, etc., to ensure that the project meets the desired metrics). The risks in infrastructure projects are very high during the construction period and taper off substantially after the initial operations period. Accordingly, the probability of default on infrastructure debt slows down after the construction period. The tenet that the private sector adopts is to participate in projects that are risk-manageable in relation to the expected revenues. This means that if there is an appropriate investment de-risking mechanism available for a particular project or sector, the interest of the private sector might be high to participate. They would avoid those projects for which the risks are

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perceived to be not aligned with the revenues that are likely to be generated. The investment de-risking mechanism by the government involves providing a guarantee to the project (for instance, a minimum pay guarantee or a debt guarantee) or providing funds to bridge the viability gap (e.g., the scheme of Viability Gap Funding formulated by the Government of India). This would imply that the private investment will flow to the projects which are appropriately de-risked, assuming that there is a sufficient private sector investment capacity. In practice, the public sector does not have the financial wherewithal to provide adequate de-risking to the projects. The events that have led to the market fluctuations, including the GFC, COVID-19, etc., and the changing macroeconomic conditions have shifted the risk perception of the investors to the infrastructure project investment. The increase in the de-risking initiatives undertaken by the governments means that they are not certain about the impact this will have on government budgets in the longer run. The experience of past projects indicates that charging appropriate user fees (that recovers the capital investment and the O&M expenditure) has been politically challenging. Most initiatives to de-risk a project depend on how much the project users can pay, either as taxes or as user fees. If there is not enough potential for this project funding, the financing cannot sustain. A commonly stated principle in infrastructure project risk management is that the risks need to be allocated to the stakeholder who is best able to manage the same (Beenhakker, 1997). The process of allocation of risks and other management techniques are influenced by the thoroughness of the project preparation and the subsequent project structuring. Thoughtful project structuring allows for appropriate risk management with minimal recourse to the sponsor, while providing for sufficient guarantees or other similar provisions for the lender to be comfortable with the credit risks (Pinto, 2017). The respective roles and responsibilities, authorities and permissions in an infrastructure project development, construction, operations, and maintenance are governed by a series of contractual documents. The foundation document providing the authority to provide an infrastructure asset is usually a license/permit/concession agreement between the public sector project proponent and the private sponsor (most often acting through the SPV). The public sector, in some cases, might also provide a “support agreement” stating any additional support that has been promised (in terms of financial incentives, obligations to provide ancillary services, credit enhancement structures, etc.). There

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are numerous other contractual arrangements between the SPV and the construction contractors, plant, equipment, and goods suppliers, and a firm operating and maintaining the public asset. In addition, separate contracts are entered with the lenders to the project and the sponsors. The infrastructure projects are covered by different types of insurance that aim to provide support against various risks including natural disasters, employer liability, construction and operations-related risks, contractor insolvency, and political and other public sector-related events (Ballestero et al., 2004). Public–private partnership (PPP) arrangements, which typically adopt a project finance approach, have been around for more than two decades in a variety of sectors. PPP is essentially a contractual arrangement between the public and the private sector, with an appropriate allocation of roles, responsibilities, and risks, to provide infrastructure services that could be measured objectively and paid accordingly (DEA, 2020). PPPs come with efficiency and know-how advantages for the delivery of services. Many developing countries have opted for PPPs as a tool to develop much-needed infrastructure assets which can accelerate economic growth for various reasons either for efficiency gains or for providing financial resources upfront which are recouped over a period of time (ADB, 2022). The success of PPPs across different sectors has been a mixed bag. Previous research indicates that having a sound understanding of the baseline situation, a clear expectation of the roles and the responsibilities, unambiguous outcomes which can be objectively measured, appropriate project development, equitable allocation of risks, adequate understanding and capacity of both public and private partners, and a conducive ecosystem play a vital role in the success of PPP arrangements (Dharmapuri Tirumala et al., 2020). In order to ensure that the PPP arrangements are successful, many project proponents have innovated in developing and structuring their projects to achieve sustainable outcomes. Institutional investors have started to take an interest in providing the debt to the infrastructure projects, and their participation is undertaken usually under the following methods. (i) The mandated lead arranger (MLA) identifies a group of interested institutional investors and originates a series of projects for investments. The MLA holds a predefined share of the investments, and the institutional investors, as part of the syndicate, get exposure to a series of projects. (ii) The SPV issues securities based on the infrastructure assets that it is developing, offering future

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cash flows as collateral. The securities can be structured for different categories of investors, commensurate with the risk and return profiles. (iii) Institutional investors participate in an infrastructure debt fund, which is professionally managed and is responsible for deploying the funds and generating the returns as desired, and (iv) institutional investors invest directly into individual projects after their due diligence process.

2.3

Evolution of Project Finance

The concept of project finance was used in the 1970s for projects in oil and gas, energy and mining sectors in the USA and Europe. It is generally considered that modern project finance started in 1980s, around the time of the USA’s initiative to revamp its power through the 1978 Public Utility Regulatory Policy Act (Garcia-Bernabeu et al., 2015). From 1980s to 1990s onwards, two trends were visible, first project finance started to get adopted in developing nations and second, the adoption of the mechanism in other new-generation sectors (Garcia-Bernabeu et al., 2015). The volume of project financing transactions is estimated to be $215 billion for 954 projects in 1996 and 1997, just before the financial crisis (IFC, 1999). Bank wrap financing was an old product from the 1980s when certain projects were eligible for tax-exempt debt. These projects included wastecoal-fired plants, waste-to-energy plants, and certain pollution control equipment incorporated into power plants. For this type of projects, only a portion of capital was qualified for tax-exempt debt. The remaining portion (non-tax exempt) debt was raised from the project finance lenders. They were supported by credit facilities that guarantee the issuance of tax-exempt bonds, usually structured as variable-rate low floaters. As most of the projects would not meet the investment criteria or have low ratings, banks’ letters of credit were a must for generating liquidity for tax-exempt bonds. Instead of pricing against the project risks, these bonds were priced against this credit of the bank fronting on the letter of credit wrap (IJGlobal, 2007). The infrastructure sector came back with a vengeance in the early 2000s, subsequent to the collapse of the USA’s energy market and the consequent downturn in project finance activity. PPP/PFI projects gathered pace and made it all the way to financial close while the market for buying and selling brownfield assets took off. Infrastructure has started to capture not only the imagination of private institutional investors,

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including pension funds and insurance companies, but also individual investors. The market’s response to the general public wanting to buy a bridge or a toll road was to set up infrastructure funds and float them in a stock exchange. However, most infrastructure funds are, in fact, unlisted and certainly are not the product of the new millennium. Several infrastructure funds dated back to the early 1990s. The equity for the infrastructure projects, till the mid-2000s, was provided by the project sponsors. While infrastructure funds are not an entirely new phenomenon, the type of assets they invest in has stretched the boundaries of what constitutes infrastructure. Traditional infrastructure projects have been bundled together with real estate assets and similar businesses under the heading of alternative investments (IJGlobal Equity Capital, 2007). The private institutional or retail markets for the equity infusion, either directly or through the capital markets, were not active, and the volumes were low. There was an active capital market in select regions, which was participating in the project bonds until the global financial crisis (GFC) period. Subsequent to the GFC, the monoline insurance companies (companies which provide insurance against a specific risk, providing a guarantee to debt providers in this instance), which were providing credit insurance to the project bond issuers, were downgraded, leading to their ultimate winding down. This effectively reduced the number and quantum of institutional investors participating in the infrastructure financing market. The GFC resulted in the debt crisis not only in the housing markets the world over but had a domino effect on sovereign debt, particularly in the European market and in the banks and other institutional investors. The response of many governments to get their economies back on the track included the launch of massive infrastructure development plans and injection of huge liquidity into the markets. The additional supply of money has squeezed the margins that the debt providers were getting in the past. There are not only limitations on the private sector to fully participate in infrastructure financing, but with governments in traditional project finance markets forced to bail out failing businesses, there is now additional pressure restricting state spending on infrastructure. The negative outlook is exacerbated by the precarious nature of the economic slowdown. PPPs have enjoyed a greater level of financing from governments and international development banks from the early 2000s. Equity investors are also beginning to raise their expectations for return rates. However, following the GFC, there was a considerable downturn in the project

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finance market. This has led to the emergence of infrastructure debt funds, which were willing to structure mezzanine and long-term debt solutions to augment the available capital for PPP projects. In fact, following the GFC, infrastructure funds have been providing long-term financing for projects across the globe, most notably in Europe, India, and many countries in Latin America. Monolines have played an important role in helping to raise debt financing bonds for infrastructure projects till the GFC. Monolines are basically insurance providers, who, as their sole business, repay the amounts due (principal and interest), in case of issuer default. Before the GFC, debt was usually supported/raised by commercial banks, who have been aggressive in their lending practices. This was to some extent due to the credit enhancements provided (government guarantees) and the notion that they are too big to fail. Banks used to purchase guarantees from the monoline insurers, which could also assist them in bypassing the capital requirements set by the regulators. The banks were able to free their capital by purchasing such guarantees as no capital charge was associated with the counterparty risk of insurers and allowed them to take on more risks (Acharya et al., 2009). As the GFC unfolded, the credit losses of the banks started to reflect on their balance sheets; they were becoming undercapitalized and were unable to live through the crisis without government support. The insurance companies had to step in to honor their guarantees, and given the scale, this impacted their ability to survive and emerged as a threat to the outstanding guarantees. The sequence of events entered a vicious cycle, which increased the probability of the default of many insurance companies, which in turn aggravated the crisis (Acharya & Richardson, 2009; Acharya et al., 2009). The activities of monolines continued to decline. In the first half of 2007, $3.3 billion worth of tranches were wrapped, but this was much smaller than the similar volume in 2006 first half ($10 billion) (Malinowski, 2007). GFC affected the monolines’ credit ratings which were their unique feature. Credit rating agencies’ working approach also came under scanner as they were expected to flag monolinerelated issues prior to the crisis, as none of the three top credit rating agencies highlighted/flagged the same. The business of monolines faded away subsequently. Post-GFC, credit rating agencies were also forced to bring in more transparency and accountability with the help of regulatory framework and oversight mechanisms leading to improved confidence in the rating agencies (Mahmudova et al., 2011).

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Lending by international financial institutions rapidly increased from US$5.5 billion in 2007 to US$19.5 billion in 2008. Private equity and infrastructure funds continue to actively target the infrastructure sector as an asset class with a stable revenue stream. In the beginning of 2009, many infrastructure funds were launched, for example, KKR $4 billion and Blackstone $2 billion. UBS had already closed a $1.5 billion fund in 2008 and was planning to launch a similar one in 2009 (Rey, 2009). Pension funds are playing an increasing role in project financing. The more interesting sectors for pension funds include rail, airport, utility, and grid assets as well as renewables. They favor less complex greenfield transactions or brownfield assets which are at the lower end of the risk spectrum, with a particular focus on PPP/PFI transactions. For example, the South Korean National Pension Service invested in a 12% stake in Gatwick Airport, Norway’s Pension Trust bought a 50% share of the Orkdalsvegen E39 road PPP in Norway, and Netherland’s state pension fund, ABP, has a sizeable exposure to infrastructure (Rey, 2009). The use of project financing has increased dramatically from $23.33 billion annually in 1995 to $305.9 billion in 2021. From 1995 to 2021, $4664.8 billion worth of total project financing deals took place and had deal volume of 13,733 deals. (Mohammadia, 2020; Refinitiv, 2020, 2021b). The USA, Australia, and UK were the top three countries accounting for a share of approximately 15%, 10%, and 8% of the investments between the period 1995 and 2018 (Mohammadia, 2020). The investments in infrastructure projects grew at the rate of 19.2% per annum between 2000 and 2008 (GFC), while the corresponding growth between 2010 and 2018 is 9.7%. The pre-GFC period witnessed 4325 loans with a cumulative sum of $1259 billion, while the postGFC period had 6262 loans with a cumulative sum of $2210.2 billion. India has attracted a large attention being ranked the global project finance leader in the years 2009–2011 accounting for 21–26% global market share (Mohammadia, 2020). The Middle East and North Africa region has experienced the lowest default rates and highest recoveries in infrastructure debt (GI Hub, 2020). The cumulative number of projects from 1994 to 2019 that were implemented in different sectors and the investments in each of the sectors are presented in Figs. 2.1 and 2.2, respectively. Oil and gas, and power were the two sectors that had substantial investments, while the renewable energy sector had the most number of projects configured over the period from 1994 to 2019. The loans

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Waste, water and sewerage 2% Telecom 4% Public infrastructure 2%

Health and Education 5% Transport(excl road) 8%

Renewable energy 38%

Road 8% Oil and Gas 15%

Power 18%

Fig. 2.1 Cumulative number of infrastructure projects from 1994 to 2019 (Source Authors based on data from Rao [2020]) 1000000 900000 800000

USD millions

700000 600000 500000 400000 300000 200000 100000 0 Public Waste, water Health and infrastructure and sewerage Education

Telecom

Road

Transport (excl road)

Renewable energy

Power

Oil and Gas

Fig. 2.2 Cumulative investments in different sectors (in $ million) (Source Authors based on data from Rao [2020])

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to the social infrastructure projects have experienced lower default rates than other infrastructure sectors (GI Hub, 2020). Figure 2.3 indicates the total investments by the private sector over the last decade in the low- and middle-income countries. The trend is declining, even though, in year 2021, private infrastructure investments have reached $76.2 billion, approximately 49% higher from the previous year’s investment levels across 240 projects (World Bank, 2021). Table 2.1 shows the private sector involvement in infrastructure projects by instrument type over the period 2010–2020. The financing of infrastructure was mostly through debt (77%) which comprised loans (87%) and bonds (13%). Commercial bank lending far exceeded the development finance institution loans. The green bonds, which came into prominence from 2007, had a great run and accounted for one-third of all bond issuances in the decade between 2010 and 2020. In the year 2020, most of the private financing in the infrastructure sector was by financial institutions such as commercial banks and investment banks. They provide almost 63% of the private financing. The second largest set of private financiers is developers (10.2%). They provide this financing mostly as equity (GI Hub, 2021). Figure 2.4 presents the infrastructure investments with private participation through the primary and secondary markets. The primary market $200 $178 $180 $160

USD Billions

$140 $120 $100

$132

$121 $124 $107

$104 $101

$95

$80

$76

$80 $60

$51

$40 $20 $2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Fig. 2.3 Total investments by the private sector ($ Billions) (Source Fakhoury [2022] and World Bank [2021])

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Table 2.1 Private sector financing in the infrastructure sector by instrument type from 2010 to 2020 Source

Sub category

Grant (2%) Equity (21%) Debt (77%)

Loans (87%)

Bonds (13%)

Private sector loans (87%) International Financial Institutions (IFIs) and government loans (13%) Non-green bonds (65%) Green bonds (35%)

Source Authors based on data from GI Hub (2021)

had a declining trend, while the secondary market accelerated over the period. The scale of private capital mobilization is better observed through the new security offerings, i.e., primary market transactions, as they indicate 600

500

USD billions

400

300

200

100

0 2010

2011

2012

Total Value

2013

2014

2015

Primary Market

2016

2017

2018

2019

Secondary Market

Fig. 2.4 Infrastructure investment with private participation (Source Authors based on data from GI Hub [2020])

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the incremental investments. Generally, the new primary market mobilizations have been low ($106 billion in 2019, 0.13% of GDP in comparison with $156 billion in 2010, 0.25% of GDP) (GI Hub, 2020). Most of the investment was in developed countries, indicating that the efforts to accelerate the investments in developing countries are yet to fructify. Table 2.2 shows the number of project financing deals and the investments in various sectors for the years 2019 and 2020. In recent times, most of the project finance deals consisted of renewable energy projects due to the greater appreciation of the climate adaptation needs and the push for cleaner energy. Some of the major deals that were closed in renewable energy sector include: Wind projects: Vineyard Offshore Wind Project (800 MW—$3900 million) in the USA, Courseulles-Sur-Mer (450 MW—$2500 million) in France, Codling Offshore Wind Farm (1500 MW—$2400 million) in Ireland, and Arcadis Ost 1 (257 MW) in Germany. Other major projects announced were Lotus Onshore Wind Power Project (144 MW) in Viet Nam and a new offshore wind power project on the cost of Yurihonjo City, Akita Prefecture (expected capacity of 819 MW) in Japan. Solar Projects: Intersect Power battery storage Athos III projects (310 MW and 453 MW) in California, Radian solar project (415 MW) in Texas, and Sudair solar (one of the world’s largest single-contracted solar photovoltaics) (Law Business Research Ltd, 2022). Table 2.2 Project financing deals for 2019 and 2020 Sector

Renewable energy Energy Oil and gas Transport infrastructure Mining Telecommunication Residential/commercial real estate Industrial real estate Water and sewerage Petrochemicals Source Authors collation from UNCTAD (2021)

Value in $ billions in 2019

No of deals

2019

2020

2019

2020

179 45 151 86 41 65 18 18 5 15

167 27 33 35 12 31 10 36 4 12

644 95 74 66 71 26 50 36 22 12

689 68 62 49 46 42 34 30 19 16

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2.4

Infrastructure Debt Funds

Due to the GFC, PPP projects faced increased refinancing and sovereign risks, which required better risk management and risk mitigation for sustainable project implementation and attracting private sector partners. Infrastructure debt funds (IDFs) emerged after the GFC to fill in the reduced appetite of the commercial banks. IDFs were willing to support the developers through mezzanine and long-term debt instruments and assisted in halting the decrease in available capital for the PPP projects (Mahmudova, 2010). Conventionally, the infrastructure funds have not participated in greenfield projects in a big way (for instance, the share of greenfield investments in 2011 was only 11% of the total fundraising) (Gatti, 2014). Institutional investors started to consider infrastructure as a separate asset class. The infrastructure debt behaves like an investment-grade security over a longer period (in ten years in developed countries and in fourteen years in developing countries) (Mohammadia, 2020). Many investors could not participate directly in projects as this would mean establishing specialized in-house teams for due diligence; hence, they relied on infrastructure funds to find the right opportunities (Lambert, 2014). The private debt funds performed well, delivering an IRR of 8.8% in the period 2009 to 2019. (The Internal Rate of Return (IRR) is the discount rate that makes the net present value (NPV) of a project zero. In other words, it is the expected compound annual rate of return that will be earned on a project or investment.) The private debt assets under management (AUM) is expected to be $1.46 trillion by 2025 from $848 billion in 2020 growing at a rate 11.4% per annum (Preqin, 2020). IDFs typically participate directly in the project debt instead of at the corporate level of the sponsor. As the project financing debtholders have very little or no recourse on sponsor’s other assets, these project finance agreements incorporate more protective covenants as compared to those of the standard corporate finance transactions. Investors have varied preferences in terms of type of projects chosen for participation. Though the history of the IDFs is still short, their performance was considered satisfactory. As per Deutsche Bank’s estimations in 2017, at a deal level, private investment-grade infrastructure debt provided approximate spread premium of 60–100 basis points (bps) in Europe and 60–130 bps on the USA as compared to their public equivalents (Cambridge Associates, 2018). Table 2.3 lists the details of a few notable IDFs.

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Table 2.3 Top 10 infrastructure debt funds (as of February, 2022) Asset manager

Headquarter

Capital raised ($ billion)

Total assets under management ($ billion)

Blackrock AMP Capital AXA Investment Managers Alts Macquarie Asset Management EIG Allianz Global Investors Global Infrastructure Partners Barings Rivage Investment Schroders

New York Sydney Paris

16.18 15.46 13.02

10,100 91.77 187.09

London

12.88

427

Washington Frankfurt

10.81 7.76

22.60 676

New York

6.04

79

Charlotte Paris London

5.64 4.92 4.45

387 7.95 65

Source Infrastructure Investor (2022)

The IDFs are in operation in many countries. In Colombia, to assist pension funds investing in the infrastructure sector, two IDFs were introduced in 2015. As per the prevailing Colombian legislations, pension funds could pre-commit future funds to private equity but not for bonds. Participation through IDFs allowed them to invest in debt and also had the professional support in appraising the investment proposals. In 2016, Pacifico Tres and Costera were the first two 4G highway projects to receive initial funding through bond issuance in both hard and local currencies (Garcia-Kilroy & Rudolph, 2017). In India, public sector contribution for infrastructure sector decreased from 63% in 11th fiveyear plan to 52% in the 12th five-year plan (Planning Commission, 2012). IDFs were introduced in 2012 to raise debt financing for the infrastructure projects and to provide relief to the government from committing larger resources to attract private sector participation (Agrawal, 2020). In India, IDFs can be established as trusts (mutual fund) or company (Non-Banking Financial Companies) (RBI, 2022).

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2.5

Islamic Finance and Sukuks

Islamic finance has been growing at a fast pace at about 10–15% per annum, making itself one of the leading financial services instruments (Biancone & Shakhatreh, 2015). It comprised nearly 40% of the Gulf Cooperation Council’s (GCC) project finance market in 2015, a steep growth from 12.5% in 2006 (Dar et al., 2016). Its growing presence in the Western world indicates its acceptance as a viable product by financial institutions, investors, and regulators alike (AbdulKareem & Mahmud, 2019; Biancone & Shakhatreh, 2015; Rusydiana, 2021). In Islamic finance, the objectives of a loan are treated as a financial help that is repaid without paying any interest on it and should not be related to prohibited activities such as gambling and sale of spirits. It is based on the ideology of Shariah Law that promotes benevolence and social justice. Islamic finance instruments must generate their profit from fees through trading (Lee & Son, 2013). The structuring of the instruments would involve modifications to the conventional lending practices as the ownership temporarily vests with the lender, who sells back the asset at a later stage. It is considered as an option which is comparatively less expensive and not part of the traditional interest-driven system. Various instruments of Islamic finance that are popular include profit-and-loss sharing (PLS), non-PLS contracts, and fee-based products (Hussain et al., 2015). Global Islamic finance assets stood at $3.374 trillion in 2020 and is expected to touch $4.94 trillion by 2025 (Refinitiv, 2021a). Islamic finance has grown in the Western countries due to a significant growth of the population who follow Shariah Law and with an objective to leverage on the financial resources available from the Gulf countries. Since 1990s, a range of Islamic finance instruments were available in the UK (Catak & Yılmaz Arslan, 2020). Currently, Luxembourg acts as hub for Islamic finance for Western countries. It has 30 Shariah compliant funds at the end of 3rd quarter of 2021, mostly in the form of mutual funds. Ireland has 16 funds a combination of both mutual funds and exchange traded funds. Jersey and Cayman Islands have respectively 13 and 10 active Islamic finance funds. Sukuk is one of the most preferred instruments from the Islamic finance arena. It has been used for financing infrastructure projects like transportation, ports, and airports. In 2020, more than half of the Sukuks were issued by sovereigns (53%). Corporates issued 37% and multilateral agencies issued 10% (Puri-Mirza, 2022). Many other countries outside of GCC are also issuing Islamic Finance

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instruments, mainly sukuks, including Nigeria, Senegal, and Indonesia to finance large infrastructure investments (Deloitte, 2022).

2.6

Interest Rate Basis: LIBOR/SOFR

The pricing basis for most of the infrastructure loans, as was popular with other commercial contracts, was the London Interbank Offer Rate (LIBOR), which was calculated based on the information submitted by a panel of 11 to 16 large banks on their hypothetical borrowing transactions (Mishler, 2020; UK Finance, 2019). The interest rates on infrastructure loans are usually expressed as a premium on the LIBOR (e.g., $100 million loan priced at 6-month LIBOR + 350 basis points (bps), 15-year tenor, with a two-year moratorium). As these submissions by the banks were non-market-based (hypothetical) and were in very fewer quantities, LIBOR was not totally reflective of the active market (Mishler, 2020). Figure 2.5 indicates the trend of the 6-month LIBOR from 1987 to 2021. LIBOR had gone down substantially as compared to its historical values. The rates and the trends led to allegations in 2008 that the market participants were manipulating the LIBOR. An investigation was undertaken that concluded that there was a lack of observable market inputs in LIBOR and that it was a judgment of major banks about the cost of borrowing instead of the actual cost of borrowing (UK Finance, 10.00% 9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 2019

2021

2015 2017

2013

2011

2009

2003 2005 2007

1999 2001

1995

1997

1993

1989

1991

1987

0.00%

Fig. 2.5 Six-month LIBOR rate at year close from 1987 to 2021 (Source Authors based on data from MacroTrends [2022])

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2019). Various alternatives were sought to replace LIBOR and the Alternative Reference Rates Committee (ARRC), convened by the Federal Reserve Board, endorsed the Secured Overnight Financing Rate (SOFR) to replace the LIBOR as preferred benchmark reference rate in 2017 in the USA. SOFR is based on the US Treasury repo market and is generated by the public sector, and hence perceived to be more transparent. The underlying transactions in SOFR are estimated to be more than $1 trillion per day (and considerably larger than many money markets), visà-vis the $1 billion daily trading that is based on LIBOR (Odayar, 2020). LIBOR was discontinued at the end of the year 2021 (Mishler, 2020; UK Finance, 2019; Yorio et al., 2022). Infrastructure projects were also affected by this transition. The interest rate basis used in the financial model has an impact on the project returns that are estimated. The risk-free rate (RFR) provides a foundation to quantify the return expectations and also to check if there are any hedging mismatches. There might be provisions in the contract that require consent or allow for challenges when the economic assumptions of the project undergo a change. There could be a situation that the basis risk may arise if the transactions under consideration are not amended accordingly. There was also an apprehension that the basis rate, if not properly incorporated in the contract, might lead to a mismatch of the actual costs. For example, tariffs payable as per the off-take agreement may have included a portion based on estimated project cost (which usually also includes interest costs). In this case, if the basis changes, then tariffs would no longer reflect the actual costs to the project. This can lead to renegotiation with the counterparties. Another challenge is coordinating a consent process among all the debt providers like commercial banks, multilateral agencies, export credit agencies, bond holders, and infrastructure funds, who may have entrenched interests (Clifford Chance, 2020). A minor modification in the project parameters can have serious impacts on the return expectations of the project stakeholders (Tikhomirov & Plotnikov, 2018). There was an apprehension that transactions with tenors of five to seven years, based on LIBOR margins, need to consider what the basis differential will look like once a replacement rate, such as SOFR, is put in place. The market seems to have taken in its stride that both the basis methods reflect the cost of funds and no major incidents were reported till date that substantially affected the performance. While the general lack of understanding of the new system,

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SOFR, was a worry for a while before the switch, LIBOR appears to have passed on unsung and unmissed.

2.7

Discussions

One change that the project finance modality witnessed is the change in the debt-equity ratios. In the early days of project finance adoption, it was common to have a 95:5 debt-equity ratio. Over the period, a better appreciation of the projects risks, importance of cash flow management, tighter bank lending, and credit crunch have progressively reduced the share of debt and equity to levels which are 70:30 and 80:20 (Gawlitta & Kleinow, 2013; Rey, 2009). Increasingly, the extent of debt is decided by the ability of the project to sustain a particular level (as measured by Cash Flow Available for Debt Service (CFADS)) and the extent of credit enhancement that the government is willing to provide. This perspective is spreading across all the sectors, initially dominated by the energy sector, and to all the regions including the Asia Pacific (Mahmudova, 2009). Lenders have become less restrictive in terms of financial covenants as compared to covenants applied two decades ago. Number of covenants in the agreements used in the project finance documents in the USA in 2016 has almost halved as compared to those in agreements drafted in 1997. This also has led to increased compliance of the covenants. For lenders, current covenants provide better chances to identify the borrower who may end up defaulting. Even though the number of covenants has decreased over a period of time, the quality of the currently applicable covenants has improved, which has led to better identification of the default situation of any borrower. Earlier, lenders adopted the covenants which relied on net-worth, quick ratios, current ratios, debtto-asset, and debt-to-equity which measures firm’s overall health from the balance sheet. In more recent times, the covenants are based on financial performance measurements such as borrower earnings before interest, tax, depreciation, and amortization (EBITDA). Also, new parameter and the shift from balance sheet to discounted cash flows (DCF) have played an important role in default identification (Griffin et al., 2018). The development of financial models has matured across the industry with greater sophistication and flexibility to assess various scenarios. The usage of probabilistic models (Monte Carlo simulations) has become commonplace to access the future uncertainties in various project parameters. The models, however, are usually proprietary to the financial

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institutions or the project sponsors concerned, and there is no commonly adopted template by all the entities. The diverse business models of projects in different sectors, geographies, and the economic context mean that the standardization is not very easy to achieve. Traditionally, the robustness and the comprehensiveness of the financial model are dependent on the skill of the person developing the same, and this could lead to the models becoming obsolete or not in tune with the project circumstances over the project life cycle. The models are developed with project appraisal being the primary objective and are not suited for monitoring the non-performing assets. Many banks have attempted to develop a single template that could cater to the needs of different projects or contexts. For instance, Vnesheconombank did a substantial work in improving their financial models during the period 2016–2018 (Tikhomirov & Plotnikov, 2018). The financial modeling continues to evolve and reflect the learning of various practitioners and academicians. The GFC period brought substantial changes to how project financing happens. The winding of monolines resulted in the near disappearance of project finance bonds, as has been seen in the UK. There were attempts to create unwrapped project bonds, particularly for economic infrastructure, but they did not find much acceptance. The global project finance market slowdown, apart from GFC, is also due to the lesser availability of credit and not enough ability to set the debt pricing. This was the time when the government and the multilateral agencies stepped in and supported the sector by providing $19.5 billion worth of debt. This was more than three times as compared to 2007 numbers and more than eight times as compared to 2006. Almost 39% share ($7.7 billion) was invested by European Investment Bank in the infrastructure sector (Mahmudova, 2009). The funding for the greenfield projects continues to be supported by the multilateral agencies and with government support through a series of credit enhancement structures (co-lending and guarantees) (Mahmudova et al., 2011). The overall economics of PPPs had changed as project risks, sovereign risks, and refinancing risks all rose. This led to risk management and mitigation playing an ever-bigger role in project financing. However, there are signs that indicate that money is returning to markets with tenors lengthening, liquidity and credit becoming available, and margins dropping. The banking sector seems willing and ready to finance wellstructured PPPs. It appears that there is a general lack of consistency in the terms and conditions that the banks require, as well as a high

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degree of selectivity on the part of banks. Although underwriting is taking place, there is still a requirement for club deals. Furthermore, the time for closing deals stretches from six months to two years, contributing to the difficulty in funding new PPP projects (Mahmudova, 2010). The downgrading of monolines in the wake of the subprime crisis, as their AAA ratings were essentially a selling point, and ultimately their demise, called in to question the modus operandi of the three main rating agencies (Malinowski, 2007). This has severely dented the longterm bond markets for infrastructure projects. There was a perception that monolines had a negative impact on debt pricing, which was found to be not substantiated post their demise. Monolines’ activity in a few sectors such as social and transport is more prominent than the other sectors, and they were perceived to have played a competitive check on the pricing of debt. The pricing pressure on the banks continued to be having a downward trend even after the demise of monolines due to various other factors, including a limited pipeline. The credit rating agencies did shoulder some of the accountability for the lack of pointing out the strength of monolines. However, the absolute belief in the ratings has been supplemented by more internal checks and balances. The regulatory changes such as the Dodd-Frank Act have also mandated that a robust oversight of rating firms will help build confidence. However, a longer time period analysis of the default rates for the investment-grade and speculative issuances clearly indicates the preference for investment-grade ratings. When the S&P data were analyzed, it was found that the cumulative default rate for investment-grade issuances over a period of 15 years was 4.3%, and in comparison, it was 20.1% for speculative issuances. Nearly 6% of the total issuance is defaulted, with more than two-thirds having a median rating of BB (speculative grade) (Boghossian & Walter, 2017).

2.8

Conclusions

Infrastructure doesn’t happen overnight and needs substantial financing to make that happen. The main concern for the future is the availability of capital needed to refinance the high volumes of debt that will mature in the short and mid-term, along with the capital required for future investment plans. In the face of the growing shortage of available capital and the changes in public policy, it would only mean that capital will become more expensive.

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Project financing has witnessed a transformation with participation across different models, taking place within a narrow circle of participants and becoming more localized where lenders and borrowers are familiar with each other or becoming broad based in the face of complex projects. Projects with strong sponsors, backed by contractual obligations with operators and off-takers, will have fewer problems in obtaining financing. Project finance lending terms will continue to evolve and become more stringent, and projects that require small leverage and have strong covenants with experienced sponsors who have long-term strategies are likely to be more resilient than others. Many governments continue to prefer, at least evaluate, the option of developing infrastructure through PPP arrangements, but the reality remains that the enabling frameworks are set on a regional basis. Further, it remains unclear what role commercial project finance will play in a country that has traditionally financed infrastructure with municipal bonds and public finance (Rey, 2009). Even though project financing has been one of the most preferred ways to raise financing for infrastructure projects, it comes with its own challenges. The project finance modality requires a complex transaction design and documentation, and even though it is standardized and been accepted for a while, the learning curve for the stakeholders is steep. There is a constant need to build the capacity to undertake appropriate due diligence and take effective risk management measures to ensure that the pricing is equitable. The borrowing costs for the project financing are considered to be relatively higher than traditional corporate financing, which constrains the development of new-generation projects. The negotiations related to project financing and operating agreements are, in general, way more timeconsuming (Bonetti et al., 2010; Esty, 2003, 2004; Fabozzi et al., 2006; Gatti, 2008). The project financing arena comprises an inclusive ecosystem of all the stakeholders from the government, regulators, project sponsors, commercial banks, multilateral development banks, export credit agencies, insurance companies, and a host of technical, financial, legal, social, and environmental consultants. The incremental transformation across all the relationships and practices continues to provide a stable platform for the growth of infrastructure development in the world.

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References AbdulKareem, I. A., & bin Mahmud, M. S. (2019). Infrastructure project financing through Sukuk as an alternative to conventional bond financing. Journal of Management and Operation Research, 1, 11. https://doi.org/10. 5281/zenodo.3229500 Acharya, V., Biggs, J., Richardson, M., & Ryan, S. G. (2009). On the financial regulation of insurance companies viral. https://web-docs.stern.nyu.edu/sal omon/docs/whitepaper.pdf Acharya, V. V., & Richardson, M. (2009). Causes of the financial crisis. Critical Review, 21(2–3), 195–210. https://doi.org/10.1080/08913810902952903 ADB. (2022). ADB’s focus on public-private partnerships (PPP). Asian Development Bank. https://www.adb.org/what-we-do/public-private-partnerships/ main Agrawal, R. (2020). Review of infrastructure development and its financing in India. Paradigm, 24(1), 109–126. https://doi.org/10.1177/097189072091 4096 Arezki, R., Bolton, P., Peters, S., Samama, F., & Stiglitz, J. (2016). From global savings glut to financing infrastructure: The advent of investment platforms (IMF working paper research department from global savings glut to financing infrastructure: The advent of investment platforms). https://www.imf.org/ext ernal/pubs/ft/wp/2016/wp1618.pdf Ballestero, E. (2000). Project finance: A multi-criteria approach to arbitration. The Journal of the Operational Research Society, 51(2), 183. https://doi.org/ 10.2307/254259 Ballestero, E., Benito, A., & Garcia-Bernabeu, A. (2004). Implementing a project finance initiative through “satisficing” off-take and limited recourse agreements. International Journal of Information and Management Sciences, 15(4), 41–60. Beenhakker, H. L. (1997). Risk management and implementation. Quorum Books. Biancone, P. P., & Shakhatreh, M. Z. (2015). Using Islamic finance for infrastructure projects in non-Muslim countries. European Journal of Islamic Finance. https://doi.org/10.13135/2421-2172/944 Boghossian, P., & Walter, I. (2017). The infrastructure finance challenge: A report by the working group on infrastructure finance stern school of business. New York University. Bonetti, V., Caselli, S., & Gatti, S. (2010). Offtaking agreements and how they impact the cost of funding for project finance deals: A clinical case study of the Quezon Power Ltd Co. Review of Financial Economics, 19(2), 60–71. https://ideas.repec.org/a/eee/revfin/v19y2010i2p60-71.html

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Cambridge Associates. (2018). Infrastructure debt understanding the opportunity. https://www.cambridgeassociates.com/wp-content/uploads/2018/ 08/Infrastructure-Debt-%E2%80%93-Understanding-the-Opportunity.pdf Catak, C., & Yılmaz Arslan, S. (2020). Does Islamic banking have a future in Germany? Survey on German Muslims perceptions. Finance and Accounting (JEFA), 2, 187–197. https://doi.org/10.17261/Pressacademia.2020.1213 Clifford Chance. (2020). Libor transition for the infrastructure sector. https:// www.cliffordchance.com/content/dam/cliffordchance/briefings/2020/02/ libor-transition-for-the-infrastructure-sector.pdf Dar H., Azmi S., & Bushra Shafique B. (2016). Islamic financial policy. In Global Islamic financial report 2016 (pp. 259–278). Gerlach Press. http://www.gifr. net/gifr2016/ch_08.pdf DEA. (2020). Scheme and guidelines for forwarding proposals for financial support to public private partnership in infrastructure under viability gap funding scheme. Department of Economic Affairs, Ministry of Finance. https://dea.gov.in/sites/default/files/Notification%20of%20the%20Reva mped%20VGF%20Scheme%20-%20%20DEA%20OM%20dated%207%20Dece mber%202020%20regarding%20Scheme%20and%20Guidelines%20for%20f orwarding%20proposals%20for%20financial%20support%20to%20PPPs%20in% 20Infrastructure%20under%20VGF%20Scheme_0.pdf Deloitte. (2022). Project bonds—An alternative to financing infrastructure projects. Deloitte. https://www2.deloitte.com/za/en/pages/finance/art icles/project-bonds-an-alternative-to-financing-infrastructure-projects.html Dharmapuri Tirumala, V. R. R. S., Tiwari, P., Sawhney, A., & Kodumudi Pranatharthiharan, K. (2020). Analyzing configurational paths for successful PPPs in Indian urban drinking water sector. Journal of Infrastructure Systems, 26(3). https://doi.org/10.1061/(asce)is.1943-555x.0000557 Esty, B. C. (2003). Modern project finance: A casebook. Wiley. https://www.wiley. com/en-us/Modern+Project+Finance%3A+A+Casebook-p-9780471434252 Esty, B. C. (2004). Why study large projects? An introduction to research on project finance. https://ssrn.com/abstract=554951 Fabozzi, F. J., Davis, H. A., & Choudhry, M. (2006). Introduction to structured finance. Wiley. https://www.wiley.com/en-us/Introduction+to+Struct ured+Finance-p-9780470045350 Fakhoury, I. N. (2022, May 3). New data shows private investment lends a hand as public debt looms large. World Bank. https://blogs.worldbank.org/ppps/ new-data-shows-private-investment-lends-hand-public-debt-looms-large Garcia-Bernabeu, A., Mayor-Vitoria, F., & Mas-Verdu, F. (2015). Project finance recent applications and future trends: The state of the art. International Journal of Business and Economics, 14(2), 159–178. https://ideas.repec.org/ a/ijb/journl/v14y2015i2p159-178.html

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Garcia-Kilroy, C., & Rudolph, H. P. (2017). Private financing of public infrastructure through PPPs in Latin America and the Caribbean. https://doi.org/ 10.1596/26406 Gatti, S. (2008). Project finance in theory and practice—Designing, structuring, and financing private and public projects. http://www.untag-smd.ac.id/files/ Perpustakaan_Digital_1/FINANCE%20Project%20Finance%20in%20Theory% 20and%20Practice.pdf Gatti, S. (2014). Private financing and government support to promote Long Term Investments in infrastructure. https://www.oecd.org/daf/fin/privatepensions/Private-financing-and-government-support-to-promote-LTI-in-inf rastructure.pdf Gawlitta, M., & Kleinow, J. (2013). Analysis of infrastructure financing via debt funds in the European Union. SSRN Electronic Journal. https://doi.org/10. 2139/SSRN.2398020 GI Hub. (2020). Infrastructure monitor 2020 data-driven insights into selected G20 infrastructure priorities. https://cdn.gihub.org/umbraco/media/3241/ gih_monitorreport_final.pdf GI Hub. (2021). Infrastructure monitor 2021. Global Infrastructure Hub Ltd. https://cdn.gihub.org/umbraco/media/4306/gihub_infrastructu remonitor2021.pdf Griffin, T., Nini, G., & Smith, D. C. (2018, December). Losing control: The 20year decline in loan covenant restrictions. SSRN Electronic Journal. https:// doi.org/10.2139/ssrn.3277570 Hussain, M., Shahmoradi, A., & Turk, R. (2015). An overview of Islamic finance an overview of Islamic finance (IMF working paper WP/15/120). https:// www.imf.org/external/pubs/ft/wp/2015/wp15120.pdf IFC. (1999). Lessons of experience No. 7: Project finance in developing countries. International Finance Corporation. https://www.ifc.org/wps/wcm/con nect/publications_ext_content/ifc_external_publication_site/publications_lis ting_page/lessonsofexperienceno7 IJGlobal. (2007). Bank wraps back. IJGlobal. IJGlobal Equity Capital. (2007, September 19). Equity capital trends in infrastructure finance. IJGlobal. Infrastructure Investor. (2022, February 24). Infrastructure debt 30: Ranking 1–10 | Infrastructure investor. Infrastructure Investor. https://www.infrastru ctureinvestor.com/infrastructure-debt-30-ranking-1-10/ Lambert, D. (2014). Under construction: India’s infrastructure debt funds— Their importance, challenges, and opportunities (South Asia Working Papers, 29). https://www.adb.org/publications/under-construction-indiasinfrastructure-debt-funds

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Law Business Research Ltd. (2022). Market intelligence. https://www.milbank. com/images/content/1/6/v3/169258/2022-MI-Project-Finance-2022Global-trends.pdf Lee, K. H., & Son, S. H. (2013). Trends and implications of Islamic project finance: A study on the GCC region. SSRN Electronic Journal. https://doi. org/10.2139/SSRN.2320959 MacroTrends. (2022). 6 month LIBOR rate—30 year historical chart. https://www.macrotrends.net/2519/6-month-libor-rateMacroTrends. historical-chart Mahmudova, M. (2009). Debt funding in infrastructure 2009. Infrastructure Journal. Mahmudova, M. (2010, September 1). Global PPP Outlook 2010—Adapting to the new landscape. IJGlobal. Mahmudova, M., Sharma, G., & Rey, Y. (2011, February 14). Global FY 2010 league tables -Infra PF rebounds after 2-year decline. IJGlobal. Malinowski, M. (2007, August 15). Monolines review—Subprime to the rescue? IJGlobal. McKinsey Global Institute. (2013). Infrastructure productivity: How to save $1 trillion a year. https://www.mckinsey.com/capabilities/operations/ourinsights/infrastructure-productivity Mishler, M. D. (2020, August 1). End of LIBOR: How all industries, not just banks, can prepare. Journal of Accountancy. https://www.journalofacc ountancy.com/issues/2020/aug/end-of-libor-how-to-prepare.html Mohammadia, M. K. (2020). Trends of project finance in the world market and in Arab countries. Finance: Theory and Practice, 24(1), 24–33. https://doi. org/10.26794/2587-5671-2020-24-1-24-33 Odayar, T. (2020). SOFR, so good? IJGlobal. Pinto, J. M. (2017). What is project finance? Investment Management and Financial Innovations, 14(1–1), 200–210. https://doi.org/10.21511/IMFI.14(11).2017.06 Planning Commission. (2012). Twelfth five year plan Vol 1. https://www.niti. gov.in/planningcommission.gov.in/docs/plans/planrel/fiveyr/12th/pdf/ 12fyp_vol1.pdf Preqin. (2020). Preqin special report: The future of alternatives 2025. https:// oss.cyzone.cn/2021/0121/0126eb26887531b1621982b5191bbd19.pdf Puri-Mirza, A. (2022, July 13). Global Sukuk issuance by issuer 2020. Statista. https://www.statista.com/statistics/1264332/distribution-sukuk-iss uance-issuer-worldwide/ Rao, V. (2020). An empirical analysis of factors responsible for the use of capital market instruments in infrastructure project finance (ADBI working paper 1101). https://www.adb.org/publications/empirical-analysisc apital-market-instruments-infrastructure-project-finance

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RBI. (2022). Infrastructure debt fund—Frequently asked questions. Reserve Bank of India. https://m.rbi.org.in/scripts/FAQView.aspx?Id=90 Refinitiv. (2020). Full year 2020. Managing Underwriters Global Project Finance Review. www.refinitiv.com/dealsintelligence Refinitiv. (2021a, November 17). Refinitiv releases findings of 2021 Islamic finance development indicator. Refinitiv. https://www.refinitiv.com/en/ media-center/press-releases/2021/november/refinitiv-releases-findings-of2021-islamic-finance-development-indicator Refinitiv. (2021b). Full year 2021. Managing Underwriters Global Project Finance Review. Rey, Y. (2009, March 26). Equity investments in infrastructure 2009. IJGlobal. Rusydiana, A. S. (2021). Bibliometric analysis of journals, authors, and topics related to COVID-19 and Islamic finance listed in the dimensions database by Biblioshiny. Science Editing, 8(1), 72–78. https://doi.org/10.6087/KCS E.232 Stevens, B., & Schieb, P. A. (2007). Infrastructure to 2030: Main findings and policy recommendations. Infrastructure to 2030, 2, 19–106. https://doi.org/ 10.1787/9789264031326-3-EN Tikhomirov, D., & Plotnikov, V. (2018). The minimisation of risks in project finance: Approaches to financial modelling and structuring. MATEC Web of Conferences, 193. https://doi.org/10.1051/MATECCONF/201 819305069 UK Finance. (2019). Discontinuation of Libor UK finance guide for business customers. https://www.ukfinance.org.uk/system/files/LIBOR-Guidefor-Business-Customers-FINAL_1.pdf UNCTAD. (2021). World investment report 2021: Investing in sustainable https://unctad.org/system/files/official-document/wir2021_en. recovery. pdf World Bank. (2021). Private participation in infrastructure (PPI) 2021 Annual Report. https://ppi.worldbank.org/content/dam/PPI/documents/ PPI-2021-Annual-Report.pdf Yescombe, E. R. (2002). Principles of project finance. Yorio, G., del Carmen Bonilla, M., Espinosa, P., & Mendizabal, O. (2022). A road to efficiency in emerging local debt markets: The Mexican experience. http://www.publicdebtnet.org/export/sites/pdm/pdm/.content/attach ment/conference_052022/papers/Bonilla-Road-to-Efficiency-Paper-Mexico. pdf

CHAPTER 3

Multilaterals Leading the Innovation Path

International lending banks need to focus on areas where private investment doesn’t go Such as infrastructure projects Education and poverty relief. —Joseph Stiglitz Economist and Professor at Columbia University What we need are financial institutions to finance the project Not a group of contractors that eventually ask for funds from other institutions. —Fauzi Bowo, Indonesian politician and diplomat

3.1

Introduction

Over the last century, the financing landscape for funding large infrastructure projects has witnessed a huge transformation. In the initial years, funding for infrastructure projects and services was largely assumed by the government, especially in developing countries. This changed over time with many alternate delivery methods and financing mechanisms evolving. The end of the Second World War saw the rise of multilateral development banks (MDBs), bilateral development agencies and international finance institutions (IFIs), and in the 1980s, the shift began toward increasing private finance and investment in infrastructure projects. The role of © The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2023 R. D. Tirumala and P. Tiwari, Advances in Infrastructure Finance, https://doi.org/10.1007/978-981-99-0440-2_3

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government slowly transformed from a provider of infrastructure to be more of an enabler, and project risks were seen shifting from the government to those parties of the contract that were best suited to manage them (Brealey et al., 1996). The transformation to project finance accelerated the delivery of infrastructure services across the world. MDBs have played a critical role in assisting developing economies to address their public infrastructure funding challenges and achieve broader development goals through all the ups and downs of the infrastructure financing sector. With changing globalization forces, the MDBs are also swiftly evolving to meet the changing needs of developing countries. While ending poverty and promoting economic prosperity around the globe have been the primary objectives for the MDBs, over a period, they also modified their approach toward increasing private sector participation and investments in infrastructure to accelerate the development agenda. This has given rise to various process innovations and the creation of innovative financial instruments.1

3.2 Origins of the MDBs and Their Gradual Transformation The establishment of the first MDBs dates back to 1944 with the Bretton Woods Agreement (Federal Reserve History, 2013), to address postWorld War II reconstruction challenges. Representatives from around 44 countries reached the agreement to use gold as a universal standard in creating a fixed currency exchange rate. Gold then formed the basis for valuing the US dollar, and all other currencies in the world were pegged to the US dollar. The purpose was to regulate international trade and promote cooperation among countries that were recovering from the war devastation (Investopedia, 2022). What followed in 1945 was the creation of two important organizations, namely the International Monetary Fund (IMF) and what is now known as the World Bank Group (WBG). The IMF was created to monitor exchange rates and international payments to promote fair trade. The World Bank, referred to as the International Bank for Reconstruction and Development back then, was set up to provide financial assistance to countries (against sovereign guarantees) in the form

1 The issues discussed in this chapter apply to all types of MDBs, bilateral development agencies, and IFIs.

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of loans and grants to aid reconstruction efforts. Besides, MDBs have also provided non-sovereign guaranteed (NSG) loans. For example, the International Finance Corporation (IFC) was set up by the World Bank in 1956 to promote economic development through the private sector by providing loans, equity, and guarantees (without sovereign backing). After more than two decades, the Bretton Woods system collapsed in 1971, when the US dollar was seen to be overvalued, i.e., dollars in circulation exceeded the gold stock held by the USA. What that meant was the USA was no longer able to redeem dollars for gold at the official fixed price. The then President of the USA, Richard Nixon, ended the system of the dollar’s convertibility to gold, thereby allowing market forces to determine a country’s currency value relative to the value of other currencies. Despite the eventual breakdown of the Bretton Woods agreement, it provided the required economic stability for that period and left notable landmark institutions in the financial world. Both IMF and the World Bank continue to be important pillars for international capital financing and for promoting equitable global development through multilateral cooperation. In response to the oil price shocks in the mid-1970s, IMF adapted its lending instruments and established two oil facilities to address potential current account deficits and rising inflation from increased oil prices. During this time, it also created a Trust Fund to provide concessional finance to poorer countries. In the next decade, IMF created the Structural Adjustment Facility (SAF) to advance its concessional loan program, which went on to be succeeded by the Enhanced Structural Adjustment Facility (ESAF) in 1987. Eventually, the ESAF was replaced with the Poverty Reduction and Growth Facility (PRGF) to ensure programs were aligned on pro-poor principles and to ensure economic growth and poverty reduction. Tandemly, the World Bank complemented these efforts by providing loans and grants to governments with the objective of reducing poverty. The late 1980s and early 1990s witnessed a push for structural reforms in developing countries to promote the concept of free market economies, thereby reducing the extent of government intervention (Artecona et al., 2019). As a result, infrastructure projects attracted little support from MDBs like the World Bank who introduced “Development Policy Loans (DPLs)” as a new financing instrument to provide a quick source of funding to indebted countries. The policy loan disbursements were contingent upon countries undertaking certain policy and institutional

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reforms that were expected to attract private sector investments into sectors like infrastructure, where the public sector played a key role. In the latter half of 1990s, this approach to reducing the size of the public sector in financing and achieving growth and development was revisited. The Development Policy Financing (DPF) and program-for-results financing approach shifted focus toward improving the effectiveness and efficiency of public sector institutions in infrastructure provision and service delivery rather than diminishing the size and role of the public sector. By the beginning of the twenty-first century, developing countries were becoming more stable in fiscal and economic terms by way of reduction in fiscal deficits, inflation rates, and debt-to-GDP ratios, thereby improving their access to international and other sources of financing. On the one hand, demand for infrastructure, development, and social welfare continued to rise, while on the other, environmental concerns were becoming more serious. This was also a period when nongovernmental organizations (NGOs) were acknowledged by the United Nations, MDBs, and governments for their active role in tackling environmental and social issues (Jasanoff, 1997). These organizations exerted sufficient pressure on governments and MDBs to adopt sustainable policies and approaches alongside the development agenda. This was another important transition point for the MDBs as they reviewed their operations to strengthen development programs, partner with NGOs, and modify their policy focus to include environmental and social safeguards, especially for infrastructure projects. Accordingly, changes were made to their financing support as well. The conditions for disbursement of DPLs changed as multi-tranche loans with fixed conditions gave way to more flexible single-tranche and programmatic policy loans. In the case of single-tranche loans, conditions for loan disbursement had to be met by the borrowing country at the time of loan approval, whereas programmatic policy loans provided more flexibility for reassessing policy reform conditions over time, based on practical considerations. This improved dialogue and negotiations between the MDBs and the borrower countries, making the latter more accountable for implementing the policy reform agenda.

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The Expanding MDB Landscape: Role of Global, Regional, and Sub-Regional Institutions

Over the decades, several global events, such as the Cold War (1947 – 1991), trade liberalization (early 1980’s), and the Global Financial Crisis (GFC) (2007–2009), led to the creation of many MDBs in global and regional levels (Engen & Prizzon, 2018). Also, their role has expanded to include economic infrastructure, social, and productive sectors as key areas of focus toward achieving the United Nations Sustainable Development Goals (SDGs) 2030 agenda and the Paris Agreement on climate change (2016). Correspondingly, their offerings have also increased from traditional development finance to catalyzing private sector investments by way of innovative financing instruments and providing technical assistance to infrastructure projects. The MDB architecture has evolved in four distinct phases, and a fifth phase is rapidly emerging (Engen & Prizzon, 2018; Wihtol, 2014). Phase 1 can be seen as the creation of global MDBs, like the World Bank, which operates across geographies and several regions. It went on to become a role model for other MDBs to follow over the decades (Wihtol, 2014). By 1950s, the demand for infrastructure and investments was increasing from the developing countries, and the World Bank alone could not meet these needs. Also, there was a growing voice among the developing countries, especially Asia and Africa, for development financing that was more suitable to their needs. This provided the backdrop for the rise in regional development banks (RDBs), such as the Asian Development Bank (ADB), the European Bank for Reconstruction and Development (EBRD), European Investment Bank (EIB), African Development Bank (AfDB), and the Inter-American Development Bank (IADB) (Engen & Prizzon, 2018) which can be thought of as Phase 2 of the MDB architecture. The RDBs were structured differently from the World Bank in several ways, predominantly in their voting structure (limited to 40% for nonregional shareholders) and their focus on project and sector-specific investments rather than reform-based lending (Ray, 2019; Wihtol, 2014). The RDBs were also seen to be inadequate in meeting the infrastructure, and financing gaps in emerging countries and sub-regional development banks (SRDBs) were created in what can be construed as Phase 3. Some examples of sub-regional development banks are:, the Caribbean Development Bank (to cater to the specific requirements of small island

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countries), the Andean Development Corporation (comprising countries from Latin America, Portugal, and Spain), the Islamic Development Bank (IDB), and a number of smaller regional banks across Africa and Central America. These banks are expected to provide specific project and investment assistance in their respective subregions. A perceived inherent weakness of global MDBs was their countrybased approach, which led to Phase 4, marking the shift from a countrydriven approach to addressing specific issues of concern through the establishment of “Vertical Funds” (ODI, 2021; OECD, 2020a, 2020b). At this time, many specialized trust funds and private development funds began to rapidly pervade the financing landscape. For example, the food crisis in the 1970s led to the creation of the International Fund for Agricultural Development (IFAD) in 1977. The Global Environment Facility (GEF) was established in 1991 by the World Bank ahead of the Rio Earth Summit to make investments (through grants and blended finance) in projects that help address environmental-related challenges. In addition to project funding, GEF also serves as a financial mechanism for many international conventions related to biodiversity and climate change, including the United Nations Framework Convention on Climate Change (UNFCCC). Though the EBRD was set up in 1991 with a regional mandate, it is vertically specialized and focused on private sector development. The Global Fund was set up in 2002, with a specific focus on fighting AIDS, Tuberculosis, and Malaria. It mainly raises funds through public and private partnerships. Phase 4 also earmarked the growth of private development funds (OECD, 2018), which were more results-driven and focused on specific development challenges. The biggest global player in this space is the Bill and Melinda Gates Foundation (BMGF), established in 1994. The key focus areas for the foundation are healthcare and poverty reduction. BMGF is also a major contributor to the Global Fund. The beginning of the twenty-first century saw an emerging Phase 5, with the People’s Republic of China (PRC) becoming a key alternative player in the international development finance (Barbieri, 2020) landscape. PRC’s role as a development finance lender began after the GFC in 2007–2009 when it lent significant volumes to Africa, surpassing the concessional funding that was traditionally provided by the World Bank. The GFC ushered steep decline in the participation of commercial banks and hence the project finance market in 2007 onwards. The decline was to the tune of 7% in primary markets and 59% in secondary markets. The

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MDBs create a pivotal role in increasing the volume of lending to infrastructure during this time. The lending from the MDBs has increased from $5.5 billion in 2007 to $19.5 billion in 2008 (Mahmudova, 2009). PRC formally established the Asian Infrastructure Investment Bank (AIIB) in 2016 with the aim of providing financing for infrastructure projects in Asia. AIIB was a regional response to the growing discontent among developing countries with the governance structures and funding policies of traditional MDBs (Engen & Prizzon, 2018). This was the first time an emerging country spearheaded the shift in development financing to focus on infrastructure, especially the energy, water, and transport sectors. At about the same time, PRC also launched the Belt and Road Initiative (BRI), formerly known as One Belt One Road, with an ambitious infrastructure investment plan across 150 countries and organizations. The Bank’s existence also coincided with the Paris Agreement, which meant many countries in the Global South needed greater access to finance to meet their commitments to reduce climate emissions under the agreement. The AIIB has about 105 members today and is the second largest MDB after the World Bank (Gisela, 2021). The BRICS countries (Brazil, Russia, India, China, and South Africa) came together in 2014 and established the New Development Bank (NDB) to mobilize resources for infrastructure and sustainable development projects in their countries and other emerging and developing economies (Congressional Research Service, 2020). The NDB became fully functional in 2016 and supports public or private projects through a wide array of financing instruments including loans, guarantees, and equity participation. Many scholars regard the NDB to be a more innovative institution for its structure, operational flexibility, and adoption of a borrowing country’s system approach for environmental and social safeguards. Both the AIIB and NDB are headquartered in China (Shanghai and Beijing, respectively). The AIIB and NDB are institutional innovations in of themselves and are regarded as game changers in the global MDB architecture. To attract the participation of European countries, AIIB has set high social and environmental standards for projects. Another important feature of the AIIB is its approach to co-financing with other established MDBs to leverage the AAA credit ratings that these banks enjoy. Some experts argue that institutions such as the AIIB and NDB are necessary for developing economies. They provide access to capital in domestic currencies (minimizes borrower’s exchange rate risk) and are focused on infrastructure

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and less on policy reforms, which make them highly suitable to the needs of emerging economies (Engen & Prizzon, 2018; Mendez & Houghton, 2020; Reisen, 2015). Also, there are some experts, policymakers who are skeptical about the fit of these banks with the principles of traditional MDBs that focused on transparency, procurement, social and environmental safeguards, and incentivized lending that was based on a policy reform agenda (Barbieri, 2020; UNCTAD, 2018; Wihtol, 2014). While both arguments have their pros and cons, these regional development banks centered around infrastructure and sustainable investing are rapidly growing to occupy an important place in the global economy. They offer operational flexibility and innovation more suitable for emerging economies.

3.4

Financial Models of MDBs

The capital structure and financing policies of MDBs are driven by their founding principles to make capital available to lower-middle-income and middle-income countries at lower than market rates to improve their social and economic status (Gurria & Volcker, 2001). The capital commitments of these MDBs are backed by richer countries that can raise capital from international markets at a cheaper rate and make these funds available to poorer countries to undertake development activities. As some scholars have explained, MDBs can be thought of as cooperative banks that were set up by governments of large and wealthy countries with contributions from other governments and borrow a large part of their resources from private investors (Brugger & Humphrey, 2020). MDBs mainly lend to governments for their social and economic programs, such as education and health care, which are not immediately attractive to the private sector. The private sector is usually motivated by the financial returns from the projects that they invest in. The development agenda, however, has not been the primary criteria. The investments from the private sector have, hence, been largely directed to those sectors where the revenue models can reasonably be predicted such as the transport sectors of road, port, rail, and airlines. However, there are many infrastructure sectors that have a substantial economic impact but very limited cash flows or robust business models, such as the social infrastructure sectors and urban infrastructure. These sectors have been the focus and forte of the MDBs. The sectoral focus and the development agenda also influenced the way the MDBs are structured. The key factors

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that distinguish MDBs from other financial institutions and bilateral donors are in their multilateral shareholding structure, preferred creditor status, the capital base that is subsidized by donor contributions, and access to cheaper capital (Buiter & Fries, 2002). In addition to financing development, MDBs also provide the technical know-how in designing development projects and provide oversight support to manage implementation activities and proper use of funds (Brugger & Humphrey, 2020). For these reasons, MDBs are the preferred choice over private banks (Perry, 2009) for most developing countries. The four main funding sources for MDBs include (1) paid-in capital or subscribed capital, (2) callable capital, (3) retained earnings and accumulated reserves, and (4) preferred creditor status. The funding model also dictates the governance of these banks. The paid-in capital comes from the shareholders (governments of participating countries) in the form of equity capital or cash. The volume of contributions (both paid-up and callable) by each government determines their shareholding percentage and consequently their voting rights and control over the bank’s assets. As much as 60% of voting shares in MDBs are split between the five largest shareholders (Engen & Prizzon, 2018). This is the reason most global MDBs are dominated by donor countries in the west, whereas borrowing countries have a greater say when it comes to RDBs and SRDBs (RAY, 2019). Callable capital (Brugger & Engen & Prizzon, 2018; Humphrey, 2020) is guarantee provided by donor countries that MDBs can call on to meet their obligations in case of a financial crisis. Of the shareholders’ equity contributions, only a small fraction is in the form of paid-in capital, whereas the bulk of the capital is subscribed in the form of callable capital. This capital is subject to call only to the extent of meeting MDBs obligations on borrowings in the extreme event that MDBs default on their bonds. Though callable capital has never been used in the history of MDBs, even in the worst global financial crisis, this capital provides protection to purchasers of bonds issued by the banks (Fondad, 1995). Every dollar lent by creditors of MDBs is backed by an equal amount of shareholder’s equity. The reason for callable capital not being called in ever is reflective of the careful loan structuring done by MDBs that enables timely loan repayments, and the confidence reposed by investors in bond issuances. The net income from loans and investments (net of expenses and administrative costs) is referred to as retained earnings and is added to the

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capital base as accumulated reserves (Artecona et al., 2019). It is important to note here that member countries (borrowing and non-borrowing) do not receive any dividend, nor do they charge a fee in the event their callable capital is used as a guarantee (also referred to as “Free Funds”), thus subsidizing the capital base of MDBs. The bulk of the balance sheet of MDBs comprises accumulated reserves (e.g., about 65% of the World Bank). These reserves are helpful in offsetting the risk if callable capital is subject to a call (Fondad, 1995). Retained earnings are also invested by some MDBs in interest-earning assets such as concessional loans to poorer countries, while the RDBs may use some of this income to fund programs of regional interest. Another significant contribution to MDBs comes from borrowing countries in the form of an arrangement that grants MDBs the preferred creditor status (PCS) (Artecona et al., 2019). This status gives MDBs the priority for receiving debt repayments should the borrowing country declare bankruptcy or be under any financial stress. Also, creditors have a high degree of confidence in MDBs due to their PCS that the loans will be fully repaid (CEPR, 2014). Moreover, member countries of the Paris Club have exempted MDBs from the application of the comparability-oftreatment principle, which mentions that all creditors should be treated alike (Lazard, 2022; S & P, 2000). In the financial model of MDBs, countries that enjoy higher creditworthiness implicitly cross-subsidize those countries that have a lower credit score. This is because both borrowing and non-borrowing countries contribute to the capital base, but the financing is received only by borrowing countries that typically have low credit ratings.

3.5

Financial Instruments of MDBs

The traditional role of MDBs and other IFIs has been in funding large infrastructure projects and development programs, broadly under two categories, sectors and thematic areas (Güven, 2017). Mostly, MDBs have two lending windows or lending facilities. One lending window provides concessional finance to low-income countries in the form of grants and loans at below-market interest rates (concessional assistance). Through a second lending window, they provide non-concessional financial assistance to middle-income countries and some creditworthy low-income countries on prevailing market terms (Congressional Research Service, 2020) through loans, equity investments, and loan guarantees. Another category

3

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Table 3.1 Share of lending categories across MDBs MDB Asian Development Bank (ADB) African Development Bank (AfDB) Inter-American Development Bank (IADB) World Bank (WB)

Concessional (%)

Non-concessional (%)

Blend (%)

45

30

25

63

31

6

4

81

15

41

48

11

Source Authors based on Engen and Prizzon (2018)

of financing is on blended terms, which combines concessional, nonconcessional, and private investment. Besides financing assistance, MDBs also offer knowledge generation and dissemination services in addition to technical assistance and capacity building support (Artecona et al., 2019), though the financing component is the central piece of lending. The share of major borrowing countries across lending categories is provided in Table 3.1. Most borrowing countries from IADB are eligible only for nonconcessional financing (excluding Haiti), whereas a high percentage of borrowers from AfDB receive concessional funding. About a quarter of ADB’s financing is on blended terms. Overall, the volume of outflows on concessional and non-concessional terms has been steadily increasing over the past decade. Figure 3.1 indicates the outflows of various MDBs over the last decade. The World Bank Group has been the largest and witnessed a higher growth and other MDBs. Figure 3.2 indicates the extent of concessional and non-concessional finance from the MDBs over a period. The share of concessional finance has been steadily decreasing. The various instruments that are offered by MDBs include loans, grants, credit lines, technical assistance (TA), guarantees, and equity. As outlined in Table 3.2, all MDBs, RDBs, and SRDBs offer loans. Among the other instruments, equity and guarantees are also popular. Line of credit is the least common among the various financial instruments. The guarantees that the MDBs offer include partial credit guarantees, partial risk guarantees, policy-based guarantees, project guarantees, payment guarantees, and guarantees covering letters of credit. A Partial Credit Guarantee (PCG) is a credit enhancement mechanism for

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90 80

USD billions

70 60 50 40 30 20 10 0 2010

2011 EU

2012 Other MDBs

2013 Other

2014 UN

2015 Vertical funds

2016

2017

2018

WBG

Fig. 3.1 Outflows of MDBs from 2010 to 2018 (Source Authors’ calculations based on OECD Stat [2022a]) 250.00

200.00

150.00

100.00

50.00

57.32

55.64

68.32

76.95

81.67

76.27

2012

2013

78.31

86.42

89.72

82.85

2015

2016

103.04

97.97

93.70

91.17

2017

2018

0.00 2014 Concessional

Non-concessional

Fig. 3.2 Concessional and non-concessional finance (Source Authors’ calculations based on OECD Stat [2022a])

debt instruments (bonds and loans). The guarantee amount is usually expressed as a percentage of principal and amortizes in proportion to the bond or loan. Partial Risk Guarantees (PRGs) cover private lenders or investors through shareholder loans, against the risk of a government (or

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Table 3.2 Instruments offered by MDBs MDB

Loans

Grants

Line of credit

TAs

Guarantees

Equity

ADB AfDB AIIB EBRD EIB IADB IsDB NDB WB

Source Authors based on AIIB (2021), Engen and Prizzon (2018) Note ADB: Asian Development Bank; AfDB: African Development Bank; AIIB: Asia Infrastructure Investment Bank; EBRD: European Bank for Reconstruction and Development; EIB: European Investment Bank; IADB: Inter-American Development Bank; IsDB: Islamic Development Bank; NDB: New Development Bank; WB: the World Bank

government-owned entity) failing to perform its contractual obligations with respect to a private project. A few MDBs such as AIIB offer innovative products like stapled financing. Table 3.3 indicates the percentage of various instruments used by the MDBs. Table 3.4 presents the shares of various instruments used by the MDBs in the period 2015–2020. The loans (senior debt) account for nearly a third of the instruments used, followed by common equity. The credit enhancement products such as first-loss equity and debt account for about 5%. Table 3.5 captures the investments done by various MDBs using different types of instruments.

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Table 3.3 MDB investments by instruments MDB

Loans (%)

Guarantees

Equity (%)

Grants (%)

94 79 85 90 73

NA 4% 6% NA 19%

1 3 10 3 4

3 15 NA 7 4

ADB AfDB EBRD IADB WB

Source Authors based on Ahluwalia et al. (2016) NA—Not available

Table 3.4 Investment instruments used by MDBs for years 2015–2020

Instrument

Proportion of financial commitments in (%)

Senior debt Common equity Guarantee Technical assistance grant Subordinate debt First-loss equity Investment-stage grant Design-stage grant First-Loss Debt

32 22 15 11 10 3 3 2 2

Source Authors based on Convergence (2021)

Table 3.5 Investment instruments used by MDBs/DFIs (2015–2020) All numbers are in $ million and for year 2020 Syndicated Shares loans in CIV

ADB 445.3 AfDB 50.823 EBRD 137.608 WB 1959.561

61.1 NA 367.544 844.336

Guarantee

Direct Credit Simple investment lines co-financing in companies and SPV

All mechanisms total

81.878 152 62.636 4718.411

57.243 8,356.20 971.589 5919.667

645.521 9177.069 1539.377 13,441.975

NA NA NA 0

Source Authors based on OECD Stat (2022b) NA—Not available

NA 618.046 NA 0

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A large share of MDBs loans is concentrated in four to five countries. For example, of the 94% of ADB’s loan assistance, China and India are the primary borrowing countries, followed by Indonesia, Philippines, and Pakistan. Similarly, IBRD’s (the lending arm of the World Bank) top five borrowers are Indonesia, Brazil, Mexico, China, and India. The latter two countries and Brazil have gradually reduced their dependence on IBRD and have shifted more toward AIIB and NDB in the recent years for their financing needs. As far as private sector operations are concerned (non-sovereign), only three MDBs, namely IADB, IsDB, and the World Bank have separate entities through which they lend to the private sector. Some other banks, such as AfDB, ADB, BADEA (Arab Bank for Economic Development in Africa), CDB (Caribbean Development Bank), EBID (ECOWAS Bank for Investment and Development), and OFID (OPEC Fund for International Development), have a specialized unit under the main bank that carries out private sector lending. Most MDBs also finance projects that are implemented on public–private partnership (PPP) arrangements.

3.6

Infrastructure Focus

In 2015, the Millennium Development Goals (MDGs) gave way for the creation of 17 Sustainable Development Goals (SDGs) and 169 targets to be achieved by developing countries by 2030. Infrastructure remains a top priority in the SDGs. The gap in investment needed to achieve the SDGs, as estimated by the United Nations, is about $ 5–7 trillion per year (UN Global Compact, 2022). In addition to this, $ 1 trillion per year was estimated for low-carbon infrastructure projects to combat climate change impacts. The MDBs agreed to follow the Addis Ababa Action Agenda on Financing for Development and also the Paris Agreement and Sendai Framework to ensure countries reach their SDG targets and climate commitments (ADB, 2019a; Miyamoto & Chiofalo, 2016). The largest investments would be required in the energy, transport, and water and sanitation sectors. Figure 3.3 indicates the current annual investments and the projected annual investment gaps of various sectors. Besides China, which accounts for half of the investment needs, the remaining resources are required mostly in Asia and Latin America. Figure 3.4 indicates the investment needs across different regions. As we can see from Table 3.6, most of the resources toward infrastructure spending came from governments in developing countries, a third

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600 530

500

$ Billions

400 300

300

260

260

200

260

150

160

155

100 0 Energy Current investments

Transport

Water and Sanitation

Communications

Projected annual investment gaps (2015-2030)

Fig. 3.3 Current investment and projected gaps in infrastructure (Source Authors based on Miyamoto and Chiofalo [2016]; Note Developing nations only [2015–2030])

Fig. 3.4 Geographical distribution of infrastructure investment needs (Source Authors based on Miyamoto and Chiofalo (2016]; Note Developing nations only [2016–2030])

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from the private sector, and only about 6–7% of the financing came from MDBs. Transport and energy sectors attracted bulk of the financing. Figure 3.5 below shows the year-on-year investment commitments by sector. Energy, transport, and water and sanitation have consistently received more investments (non-concessional financing). In the last decade, infrastructure financing and particularly the share of MDBs have been steadily increasing. However, the funding was concentrated in the emerging economies, such as India, Vietnam, China, and Table 3.6 Developing country infrastructure by source of finance and by sector Water and sanitation (%) Developing countries Private Sector Development partners

Communication (%)

Energy (%)

Transport (%)

85

39

49

58

10 6

60 1

45 6

35 7

Source Authors based on Miyamoto and Chiofalo (2016)

12000 10000 8000 6000 4000 2000 0

2016

2017

2018

2019

2020

Fig. 3.5 Non-concessional lending from multilateral organizations (commitments) (Source Authors based on OECD QWIDS [2022])

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Brazil, most of which came from a few MDBs. Even in the broader infrastructure sector, energy and transport garnered bulk of the share of investments. Moreover, MDBs and private sector collaboration have been highest in the energy sector, perhaps, because the projects are commercially viable. About 50% of MDB funding with private sector came from IFC alone (Miyamoto & Chiofalo, 2016). The role of MDBs became very important, particularly for infrastructure projects that require high capital investments. For example, the Belt and Road Initiative (BRI) is a very large project initiated by the Chinese government and has a footprint across many countries. The total investment expected to be required over the life of the BRI is between $1.2 and $1.3 trillion by 2027 (Morgan Stanley, 2018), though the actual numbers may substantially be different. AIIB and NDB are expected to play a key role in financing this initiative. The projects that the MDBs are financing a spot of BRI are through concessional loans and not from grants to a large extent.

3.7

Evolution of Innovative Financing Mechanisms

The SDG goals and the Addis Ababa Agenda bolstered MDBs’ support of the development agenda. Post-COVID-19, there is an increased demand from MDBs to step up their funding to cope with the additional impacts on health and the environment. While most of the financing would be required in social sectors that are less amenable to the private sector, the evolving innovative finance landscape provides a glimmer of hope. Innovative financing or leveraging private finance, philanthropic capital, and other resources for sustainable development projects is becoming an important component of MDB financing. There are two important dimensions to innovative financing—mobilizing resources for funding development and improving the effectiveness and efficiency of these resources (Dalberg Global Development Advisors, 2014) to meet the desired social and environmental outcomes under the SDGs. There have been many other innovations, such as bonds and public–private partnership arrangements. The range of instruments that the MDBs have been offering is quite wide; however, the sophistication and the customization have increased substantially in response to the need of the DMCs. While the conventional term loans (senior loans) have been the norm, increasingly, the

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mezzanine and equity products are also finding an appreciable share in the financing mix. This also points to the shift in the risk mindset of the IFIs from being conservative sovereign-backed loan providers to those comfortable with a certain amount of calculated risks (Global Infrastructure Hub, 2019). The effectiveness of the MDB assistance to the poorer countries has been a point of debate. Moreover, given the number of MDBs that have been operating in different geographies, there is a risk of duplication and lack of coherence to support that is being extended. OECD analysis indicates that there are twenty different MDBs operating on an average in each developing member country. African countries (e.g., Uganda with 30 MDBs, Ethiopia, United Republic of Tanzania, and Kenya with 29 MDBs each) have garnered the attention of international development agencies (OECD, 2020b). The criticism of the MDBs is that the focus is not on actually augmenting the development but on pushing more funds to DMCs. This has triggered the need for innovative financial instruments that focus on assuming more risk and include disbursements based on results or outcomes. The landscape of innovative financing is gradually shifting from simple resource mobilization to results-based and outcome-based financing mechanisms. The largest traditional asset classes for financing are generalpurpose bonds and risk guarantees. In recent years, this class has been expanded to include thematic bonds (e.g., health, climate), impact investment funds, and microfinance funds. These funds provide dedicated resources to specific SDGs and have mobilized huge amounts of capital. A recent example of thematic funds is the world’s first global pandemic bond that was issued by the World Bank in 2021. The fund was designed to prevent Ebola outbreaks and minimize deaths and other negative impacts to the economy (World Bank, 2018). The Global Concessional Financing Facility (GCFF) is another example of an innovative financing mechanism. Jointly set up by the World Bank, the United Nations, and the Islamic Development Bank, the fund was designed with a purpose to manage the Syrian refugee crisis, by lowering the cost of funds for those countries that host refugees. Securities and derivatives accounted for about 80% of the funds mobilized in the last decade. Of these, guarantees, in the form of credit enhancements, form the largest share and are reflective of public sector’s ability to leverage capital. Together, bonds and guarantees accounted for over 50% of the capital mobilized through innovative financing mechanisms.

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Results-based financing is another category of innovative financing that uses incentive-linked payments as part of a contract (e.g., performancebased) between the funder and borrower of the project. This mechanism improves the performance of investments and balances the risk between the various parties to the contract. This class of investments has been steadily increasing at a rate of 80% per year on an average. An emerging innovation in this category has been development impact bonds (DIBs) that pool performance-based contracts to attract private capital. This is a relatively new mechanism which is yet to demonstrate success and scale but has surely picked up since the previous decade. Outcome-based financing is a category of innovative financing and largely includes social impact bonds. In this type of financing, donors or private investors provide upfront financing to an implementing agency which is repaid by the agency, usually with a financial return after the predefined outcomes have been achieved. Voluntary and compulsory contributions contribute to a small percentage of the innovative financing landscape. Examples in this category include carbon credit purchases to offset emissions or tying a percentage of company’s profits to address global challenges. The largest example in the compulsory contributions category is the “Solidarity levy on airline tickets,” where a small tax is levied on airline tickets in some countries to mobilize funds from the private sector. While this is an established practice to fund public sector initiatives, the solidarity levy is a working demonstration that such resources could also be used by international institutions in meeting their development goals. Philanthropic investment funds are another example of innovative financing that enable different types of investors and international foundations among others to pool their financial contributions in meeting the development goals. This type of financing has been used by the Global Fund to support its health programs. Debt Swaps are emerging as an opportunity to swap debt-fordevelopment by NGOs in creditor and debtor countries (Kaiser & Lambert, 1996). It is defined by IUCN (the World Conservation Union) as: “Debt for development” consists of a transaction in which the debt of a developing country is swapped into financing for development works. Using this instrument, a NGO can convert its foreign currency into local currency. Given the financial stress faced by many developing countries,

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the chances of default on their debt instruments are high, leading to their trading at a discount to the face value in secondary markets. The NGO can purchase the debt at a lower price and the developing country offers to redeem the instrument in local currency at a price more than what the NGO has paid, with an agreement that the NGO spends the same in approved local activities.

An example of debt swaps has been demonstrated by the Global Fund’s Debt2Health program, which converts debt repayments into investments in health. The debt swaps allow the borrowing country to offset its debt by investing in initiatives that augment its health infrastructure through the Global Fund. The agreements containing the terms and conditions of the debt swap need to be individually negotiated.

3.8 Private Sector Participation: Blended Finance, Co-Financing Blended Finance is the blending of development finance and philanthropic funds to mobilize additional private capital for emerging economies. Through this mechanism, limited resources available from philanthropic contributions or from other sources are used to raise capital from the private sector to drive social, environmental, and economic impacts. Blended finance is a theme that has attracted the attention of all the stakeholders involved—the government, MDBs, and the private sector. Figure 3.6 shows pictorial form of the blended finance mechanism. In a survey done by RDFI, there are at least 74 blended finance funds with a cumulative $25.4 billion in committed assets (RDFI, 2016). The growth of the blended finance or the period is depicted in the figure below. The innovation of structuring these funds and facilities is happening largely in the new generation infrastructure sectors such as clean energy, climate adaptation, and mitigation, and food and agriculture infrastructure. Figure 3.7 below shows the growth of blended finance over 14 years from 2007 to 2020. MDBs also are active in their private sector operations. International Finance Corporation (IFC), part of the World Bank Group, was established in 1956; the private sector operations department of the Asian Development Bank was established in 1966; ADB Ventures, an initiative to support early-stage technologies that help in ameliorating development

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Fig. 3.6 Blended finance structure (Source Authors based on Convergence [2021]) 160 136

$ billions, cumulative

140 113

120

145

149.5

122

94

100 79 80 60 32

40 20

16

36

42

50

58

20

0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Fig. 3.7 Cumulative growth of blended finance from 2007 to 2020 (Source Authors based on Convergence [2021], Mutambatsere and Schellekens [2020])

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challenges in Asia, is part of the ADB’s private sector operations department. These agencies are active in financing various private sector and non-sovereign projects in their developing member countries. EIB has been at the forefront of co-financing or providing credit enhancement products to the many deals that involve private sector developers and financial institutions. For example, the A11 motorway in Belgium is one of the first few projects that was supported using the EIB’s project bond credit enhancement instrument. It was also the first PPP transport project that was fully financed through project bonds. This PPP project also was structured to have a deferred drawdown structure on the project bonds (Dockreay, 2014). Co-financing is becoming quite common in various MDB-supported projects. For instance, the first loan given by AIIB for a highway in Pakistan was co-financed with ADB (Whiteaker, 2016). The funding for the Phase I of the Bangalore Metro Rail Corporation Limited (BMRCL), in India, is jointly undertaken by the Asian Development Bank, the Japanese International Cooperation Agency (JICA), the French Development Agency (AFD), in collaboration with the other national Indian financial institutions such as Housing and Urban Development Corporation (HUDCO) and India Infrastructure Finance Company Limited (IIFCL). EIB, AIIB, JICA, and ADB are supporting the Phase II of the project (AIIB, 2022; Deccan Herald, 2013). A consortium of IFC, AfDB, Export Development Canada (EDC), Emerging Africa Infrastructure Fund (EAIF), and DEG has provided a $750 million loan to an open-cast bauxite mine that has an associated transport infrastructure in Africa, one of the largest new mining financing initiatives (PFI, 2020). The larger projects of late have been witnessing a combination of financing sources that involve MDBs, international project finance institutions, export credit agencies, and commercial banks. For example, the financing of e3.7 billion project of the Trans Adriatic Pipeline involved a unique combination of downstream and midstream companies. The project involved transporting gas from Azerbaijan to Italy through 878 kilometers gas pipeline. The institutions involved in financing the project include the MDBs (EIB and EBRD), export credit agencies (Bpifrance, Euler Hermes, and Sace), and commercial banks (including Bank of China, BNP Paribas, Credit Agricole, ING, Korea Development Bank, MUFG, Natixis, Societe Generale, Standard Chartered, SMBC, UBI Banca, and UniCredit).

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The push for increased private sector activities in implementing public sector projects continues to be a priority for many MDBs. The private sector role in public infrastructure projects can be either through investment or through implementation modalities. Private sector participation through the investment route essentially involves having only financial stake and with limited role in the implementation. Private sector participation through the implementation route is through public–private partnership arrangements and can involve little or substantial investments. The initiatives to encourage private participation have yielded mixed results due to the challenge in configuring appropriate frameworks that encourage blended finance mechanisms. The World Bank had constituted a “Cascade approach” that attempts to explore utilizing private resources for implementing the public infrastructure projects. Under this approach, the entity which is proposing to implement the project is required to answer a series of questions. First, it is proposed to assess if a private sector solution is possible to be implemented that could result in limiting the public debt and contingent liabilities. Depending on the answer, reasons relating to policy or regulatory challenges are evaluated further. If needed, the World Bank can provide support for reforms relating to policy or regulation. The next step is to assess the risks involved in the project if a private sector option is chosen. If the risks could be reasonably managed, the World Bank would support mitigating the same. The last resort is to opt for public funding if that is the only route available. Essentially, this puts the onus on the project proponent to evaluate if a private sector option is feasible and only resort to public funding once all the other options are exhausted (World Bank, 2021). Similarly, the ADB is promoting a One ADB approach that involves their sovereign lending departments working with the private sector operations department to explore opportunities to promote private sector involvement in infrastructure projects. The objectives of maximizing private finance for development may not necessarily align with optimizing finance for development. The public sector authorities are expected to investigate in detail the various ecosystem changes and policy requirements that are needed to be implemented to encourage private sector participation. A substantial amount of time and effort is required to investigate the modalities in which private sector can contribute to the infrastructure projects. The participation of private sector is dependent on numerous other parameters, and the configurational paths toward a successful private sector involvement

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involve a much larger array of factors (Dharmapuri Tirumala et al., 2020). An approach that explicitly requires a series of sequential steps need to be followed to evaluate the financing and implementation modality not only requires considerable investigations but also consumes substantial amount of time. Requiring such a process to be adopted further aggravates the complaint against the MDBs regarding slow processing of loans. The choice of public or private funds needs to be based on relative efficiency, except when there is a shortage of public funds (making the Cascade’s “private if possible” rule realistic).

3.9

Observations

One of the key concerns of the developing member countries (DMCs) in relation to the MDBs is the long time that it takes to get a loan processed. The following table provides an overview of the time taken by different MDBs to process their loans. The newer MDBs such as AIIB and NDB are structuring their systems in such a manner to expedite their loan processing (Ahluwalia et al., 2016). The longer time frames that the MDBs take are due to the various project preparation activities, studies, and discussions that need to be held prior to loan negotiation and disbursement of the amounts. The skill sets require substantial technical knowledge of the sector, along with other functional skills including risk management, legal structuring, social, and environmental safeguards management. Table 3.7 shows the processing timelines of different MDBs. Innovation in the context of MDBs has been defined to address a knowledge transfer for identifying better solutions for the unmet expectations (Oswald & Ramon, 2019) or existing challenges (Cegarra-Navarro et al., 2016). The older MDBs have been styled on meeting all the project development activities, and consequently, their processes many times are thought to be time-consuming. The newer MDBs such as AIIB and NDB have pitched their uniqueness on the speed of processes compared to the older ones and from an innovation perspective for infrastructure financing (Oswald & Ramon, 2019). The MDBs play a strong role in ensuring that the infrastructure financing happens in a manner that is environmentally benign and in a sustainable manner. The social and environmental safeguard assessments and assessment of the economic returns form substantial input into the due diligence of the various MDBs. For example, AIIB has structured its due diligence philosophy on having reasonably high standards of social

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Table 3.7 Processing times of MDBs Indicator ADB

AfDB

EBRD EIBG

IDBG

WB IFC

Sovereign operations processing time (from concept paper approval to first disbursement) Non-sovereign operations processing time (from concept review form approval to first disbursement) Processing time—Time from concept note to first disbursement Processing time for all projects (Sovereign and Non-Sovereign) From Preliminary Information Note (PIN) to first disbursement Time elapsed from project profile to first disbursement (months) Concept Note to first disbursement Mandate to disbursement

In months for 2016

In months for 2017

32.0

32.9

15.2

14.8

20.2

18.9

9.8

9.1

18.7

19.4

15.4

11.7

27.7

25.4

10.3

9.3

Source Collation from (A group of multilateral development banks, 2022)

and environmental safeguards, but at the same time make use of flexible parameters or criteria based on the economic status of the recipient country. Most MDBs including WB, ADB, and AIIB are now encouraging that the countries rely on their own systems to ensure that the safeguards are adhered to. The concern that the time taken for the process is long as the need for integration of this safeguard assessment in to the appraisal process is yet to be fully addressed by the MDBs; however, EIB appears to be taking strides in that direction (Griffith-Jones et al., 2016). The role of the MDBs has started to transcend the provision of funds to play a catalytic role in multiple regions. Creating institutional mechanisms along with the regional DMCs is an approach that some of the MDBs are taking to accelerate infrastructure financing. For example, the member states of the Association of Southeast Asian Nations (ASEAN) along with ADB have established the ASEAN Infrastructure Fund (AIF), incorporated as a limited liability company in Malaysia. The objective of AIF is to promote the implementation of connectivity in the region and to

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help the member countries to achieve their infrastructure goals. The AIF was established with an initial capital base of $485 million, out of which $335 million was contributed by the countries, and the remaining $150 million was contributed by ADB. ADB is the secretariat for AIF. The uptake of the monies from the fund was high in the initial years but has tapered off over the period. AIF also wanted to tap the capital markets. However, the credit rating of the various countries and the group as a whole is a concern when attempting to do so. ADB has created a financing facility under AIF to support the green transformation of the ASEAN nations. This facility, known as ASEAN Catalytic Green Finance Facility (ACGF), is actively supporting the member countries in their transformation to green infrastructure by providing a combination of concessional finance along with the regular sovereign lending by ADB. ACGF’s success is largely due to the in a way to financial instruments that it has been configuring and the support of a number of multilateral and bilateral partners (ADB, 2012, 2019b; Green Investments, 2019). The innovative financing landscape continues to evolve. While there are some mechanisms that are tried and tested now, a few have had some success that could possibly be scaled, and some other instruments are in the pilot phase yet to demonstrate success.

3.10

Conclusions

The sheer volume of development financing generated by MDBs is growing with the plethora of innovative financing instruments that have taken shape. Though some critics may question the effectiveness of MDBs in delivering results and outcomes that are in line with the development agenda, it is an established fact that MDBs have been successful in providing financial assistance to developing countries, especially in sectors such as health, education, and environment over the past five decades. Global MDBs and their regional and sub-regional counterparts are playing a catalytic role in leveraging various sources of capital and are also playing an important part in creating an enabling environment for development financing. Their unique role in policy engagement and reform-driven approaches has improved the overall quality and impact of development funds. The ambitious targets of SDGs and climate action are backed by technical, financial, and knowledge support provided by MDBs, especially in emerging economies where this assistance is most useful. The response

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from the emerging markets to advance their development needs has been encouraging, with the Asian countries and BRICS alliance forging alternatives to global MDBs that are mostly dominated by Western countries. However, it remains to be seen if these regional development banks can balance development without diluting policy reforms or social and environmental safeguards that the global MDBs have strived to strengthen. As the deadline for meeting the SDGs is drawing closer, it is imperative to sustain the development action by increasing investments in climatefriendly infrastructure. The innovative financing landscape can provide much of the financing requirements through funds, facilities, and instruments to target a broader range of infrastructure, social and productive sectors. The rise in middle-income countries will pose new challenges. Rapid urbanization and a warming climate will entail enormous infrastructure investments.

References A Group of Multilateral Development Banks. (2022). Multilateral development banks’ final report on value for money. https://www.mof.go.jp/english/pol icy/international_policy/convention/g20/annex4-4.pdf ADB. (2012, May 3). Facts and data about ASEAN infrastructure|Asian development bank. Asian Development Bank. https://www.adb.org/features/fastfacts-asean-infrastructure-fund ADB. (2019a). Multilateral development banks and private sector engagement for sustainable development. In Asian Development Bank. https://www.adb.org/ publications/mdbs-private-sector-engagement-sustainable-development ADB. (2019b, September). ASEAN infrastructure fund. Asian Development Bank. https://www.adb.org/sites/default/files/publication/221281/aseaninfrastructure-fund.pdf Ahluwalia, M. S., Summers, L., Velasco, A., Birdsall, N., & Morris, S. (2016). Multilateral development banking for this century’s development challenges five recommendations to shareholders of the old and new multilateral development banks. AIIB. (2021). AIIB annual report. https://www.aiib.org/en/news-events/ann ual-report/2020/_common/pdf/2020-aiib-annual-report-and-financials.pdf AIIB. (2022). India: Bangalore metro rail project—Line R6—Projects. Asian Infrastructure Investment Bank. https://www.aiib.org/en/projects/details/ 2017/approved/India-Bangalore-Metro-Rail-Project-Line-R6.html

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Engen, L., & Prizzon, A. (2018). A guide to multilateral development banks. https://cdn.odi.org/media/documents/12274.pdf Federal Reserve History. (2013, November 22). Creation of the Bretton woods system|Federal Reserve History. Federal Reserve History. https://www.federa lreservehistory.org/essays/bretton-woods-created Fondad. (1995). The capital structure of the MDBs multilateral development banks: An assessment of their financial structures, policies and practices. www. fondad.org Gisela, G. (2021). Asian infrastructure investment bank: How lean, clean, and green is the AIIB? European Parliamentary Research Service. https://www.eur oparl.europa.eu/RegData/etudes/BRIE/2021/679086/EPRS_BRI (2021) 679086_EN.pdf Global Infrastructure Hub. (2019). Guidance note on national infrastructure banks and similar financing facilities. https://cdn.gihub.org/umbraco/ media/2621/gih-national_infrastructure_banks_-full_report-web.pdf Green Investments. (2019, August 2). Funding organization: ASEAN Infrastructure fund (AIF)—Green investments. Green Investments. https://climatefinan ceoptions.org/2019/08/funding-organization-asean-infrastructure-fund-aif/ Griffith-Jones, S., Xiaoyun, L., & Spratt, S. (2016). Rising powers in international development. https://opendocs.ids.ac.uk/opendocs/bitstream/han dle/20.500.12413/9701/ER179_TheAsianInfrastructureInvestmentBank WhatCanItLearnFromandPerhapsTeachTotheMultilateralDevelopmentBanks. pdf?sequence=1 Gurria, J. A., & Volcker, P. (2001). The role of the multilateral development banks in emerging market economies. https://carnegieendowment.org/2001/ 04/26/role-of-multilateral-development-banks-in-emerging-market-econom ies-pub-687 Güven, A. B. (2017). The world bank and emerging powers: Beyond the multipolarity–multilateralism conundrum. New Political Economy, 22(5), 496–520. https://doi.org/10.1080/13563467.2017.1257596 Investopedia. (2022, March 21). Bretton woods agreement and the institutions it created explained. investopedia. https://www.investopedia.com/terms/b/bre ttonwoodsagreement.asp Jasanoff, S. (1997). NGOs and the environment: From knowledge to action. Third World Quarterly, 18(3). https://library.fes.de/libalt/journals/swetsfull text/1160569.pdf Kaiser, J., & Lambert, A. (1996). Debt swaps for sustainable development : A practical guide for NGOs—Resource. IUCN Gland, Switzerland, and Cambridge, UK. https://www.iucn.org/km/node/27439 Lazard. (2022, June 1). Policy brief: How to make sovereign debt restructuring more effective. Lazard. https://www.lazard.com/perspective/policybrief-how-to-make-sovereign-debt-restructuring-more-effective/

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Mahmudova, M. (2009). Debt funding in infrastructure 2009. In Infrastructure Journal. Mendez, A., & Houghton, D. P. (2020). Sustainable banking: The role of multilateral development banks as norm entrepreneurs. Sustainability, 12(3), 972. https://doi.org/10.3390/SU12030972 Miyamoto, K., & Chiofalo, E. (2016). Official development finance for infrastructure: With a special focus on multilateral development banks. https://www.cbd. int/financial/doc/oecd-oda-infrastructure.pdf Morgan Stanley. (2018, March 14). China belt and road initiative: Silk road. Morgan Stanley. https://www.morganstanley.com/ideas/china-belt-and-road Mutambatsere, E., & Schellekens, P. (2020). Recommendations to strengthen the rationale for and efficient use of concessional resources in development finance institutions’ (DFI) operations the why and how of blended finance. https://www.ifc.org/wps/wcm/connect/768bcbe9-f8e9-4d61-a179-54e5cc 315424/202011-New-IFC-Discussion-Paper.pdf?MOD=AJPERES&CVID= no0db6M ODI. (2021, June 16). What do countries value about multilateral development banks? | ODI: Think change. ODI. https://odi.org/en/about/our-work/ what-do-countries-value-about-multilateral-development-banks/ OECD. (2018). Multilateral development finance: Towards a new pact on multilateralism to achieve the 2030 agenda together. https://doi.org/10.1787/978 9264308831-en OECD. (2020a). Financing from the multilateral development system. In Multilateral development finance 2020a. OECD. https://doi.org/10.1787/E61 FDF00-EN OECD. (2020b). Panorama of the multilateral development System. In Multilateral development finance 2020b. Organisation for economic co-operation and development. https://doi.org/10.1787/E61FDF00-EN OECD QWIDS. (2022). QWIDS—Query Wizard for International Development Statistics. OECD. https://stats.oecd.org/qwids/#?x=1&y=6&f=4:1,2:1,3: 51,5:3,7:1&q=4:1+2:1+3:51+5:3+7:1+1:2+6:2016,2017,2018,2019,202 0,2021 OECD Stat. (2022a). Creditor reporting system (CRS). OECD. https://doi.org/ 10.1787/888934177537 OECD Stat. (2022b). OECD mobilisation. OECD. https://stats.oecd.org/ Index.aspx?DataSetCode=crs1 Oswald, S., & Ramon, O. (2019). The new architects: Brazil, China, and innovation in multilateral development lending. Public Administration and Development, 39(4–5), 203–214. https://doi.org/10.1002/PAD.1837 Perry, G. (2009). Beyond lending how multilateral banks can help developing countries manage volatilit y. https://www.cgdev.org/sites/default/files/978 1933286327-Perry-Beyond-Lending.pdf

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PFI. (2020). PFI yearbook 2020. PFI. https://www.pfie.com/featured/pfi/yea rbooks/2019 RAY, R. (2019). Who controls multilateral development finance? GEGI working paper 026 ● 3/2019. Global Development Policy Center. https://www.bu. edu/gdp/files/2019/04/GEGI-WP-R-Ray-2019-Power-Weights.pdf RDFI. (2016). Insights from blended finance investment vehicles & facilities. In ReDesigning development finance initiative. Reisen, H. (2015). Will the AIIB and the NDB help reform multilateral development banking? Global Policy, 6(3), 297–304. https://doi.org/10.1111/ 1758-5899.12250 S & P. (2000). How preferred creditor support enhances ratings. Standard & Poor’s Structured Finance Securitization in Latin America. UN Global Compact. (2022). UN alliance for SDG finance. UN Global Compact. https://www.unglobalcompact.org/take-action/action/glo balallianceforsdgfinance UNCTAD. (2018). Scaling up finance for the sustainable development goals: Experimenting with models of multilateral development banking. https://unc tad.org/system/files/official-document/gdsecidc2017d4_en.pdf Whiteaker, J. (2016). AIIB’s push into Pakistan. IJGlobal. https://onedrive. live.com/?cid=7293DB041749CA1D&id=7293DB041749CA1D%216700& parId=7293DB041749CA1D%216121&o=OneUp Wihtol, R. (2014). Whither multilateral development finance? ADBI Working Paper 491. Tokyo: Asian Development Bank Institute. http://www.adbi.org/ workingpaper/2014/07/21/6359.whither.multilateral.dev.finance/ World Bank. (2018). Leveraging innovative finance for realizing the sustainable development goals. World Bank. https://www.worldbank.org/en/news/ speech/2018/05/15/leveraging-innovative-finance-for-realizing-the-sustai nable-development-goals World Bank. (2021). Maximizing finance for development. World Bank. https:// documents1.worldbank.org/curated/en/168331522826993264/pdf/124 888-REVISED-BRI-PUBLIC-Maximizing-Finance.pdf

CHAPTER 4

Exponential Growth of Sustainable Debt: Green Bonds Surge

To me, Sustainable Finance means that the days when asset managers, who have a fiduciary duty to their customers, worked within the “magic triangle” of yield, security and liquidity are over. —Johannes Behrens-Türk, Head of Sustainability Management, Deka Bank Green finance can only go upward and onward. With Asian policy makers doing their part, we can expect the subsequent capital flows to accelerate climate mitigation and adaptation across Asia. —Chaoni Huang, MD, Head of Sustainable Capital Markets, BNP Paribas

4.1

Rapid Growth

OECD estimates that $93 trillion is needed to achieve low-carbon scenario in 15 years. It is estimated that $6.9 trillion is needed till 2030 to meet the target set under the SDGs and in consonance with the Paris Climate agreement. The internal resources of an entity are not usually enough to meet the climate targets, and they need to approach external financiers for bridging the gap. This has acted as a trigger for the use of green bonds as a means of financing for many corporates (OECD, 2017). The proceeds from the green bonds are typically used to finance in either

© The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2023 R. D. Tirumala and P. Tiwari, Advances in Infrastructure Finance, https://doi.org/10.1007/978-981-99-0440-2_4

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full or partially the capital expenditure of the green projects and usually are not used for working capital management (OECD, 2016). Green bonds are one of the most remarkable innovative financial instruments (Maltais & Nykvist, 2021) that witnessed a very rapid growth in the last 10 years (Environmental Finance, 2022). The application of green bonds spread across the world rapidly, in diverse sectors, and helped a diverse set of issuers in accessing finance for their project needs. They helped spur the economy by directing capital market debt to sectors that promote climate change mitigation and sustainable development (Flaherty et al., 2017). The green bonds brought in the universal change that the investors’ contributions are ring-fenced and applied to the projects as envisaged. Defining the use of proceeds for the green investments makes green bonds a crucial financial innovation in the world of sustainable finance (Piñeiro-Chousa et al., 2022). In 2009, post the global financial crisis (GFC), at the Copenhagen Summit, there was an acknowledgment by the industry stakeholders (187 institutions with an AUM of $13 trillion) that threats posed by climate change need to be addressed. By 2011, many more institutions (287 institutions with an AUM of $20 trillion) were supporting the need to take concrete action in this direction which ultimately led to the development of a common framework that can help to identify the resources for the climate change-related issues (CBI, 2012). US Environment Protection Agency in 2014 mandated to cut carbon emissions by 30% from its 2005 level by 2030. This also added to the need for shifting to low-carbon-level emissions (Eckhouse, 2014). There has been growing awareness in the international corporate community about the environmental, social, and governance (ESG) issues. To incorporate these elements into the business decision-making and subsequently into the operations, it was crucial to linking the financial resources or investments that the companies raise with the projects being undertaken by them (CBI, 2014). Shifting to low-carbon energy is capital intensive, and among all the sources of financing, bonds can pool resources from a very diverse set of investors. Since the implementation of the Kyoto protocol, bond issuance in the green sectors has come into prominence, as bonds are considered to be an attractive option for capital investments. Almost a decade ago, Climate Bond Initiative, in their report, noted that approximately $6 trillion would be needed as a cumulative capital investment in terms of debt (primarily bonds and bank loans)

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for promoting low-carbon energy between 2010 and 2020 (CBI, 2012). The cumulative growth of green bonds is shown in Fig. 4.1. CBI started categorizing the bonds issued post-2005 based on the criteria such as use of proceeds, since then the journey of labeled and non-labeled green bonds started. CBI segregated the bonds issued based on their alignment with climate themes (Climate Bonds Initiative, 2012). At the end of the Q3—2021, different categories of bonds have been introduced, namely Green, Social, Sustainability, Transition, and Sustainability-linked bonds. The years 2013 and 2014 were the most important years for green bonds when many institutions apart from multilateral agencies had started to issue green bonds. Issuance of the green bonds had reached $11 billion in 2013, and in 2014, it was 36.6 billion (more than triple from the previous year) (CBI, 2015). Initially, development banks or multilateral agencies were among the players who issued green bonds. By 2015, volume of green bonds increased more than four times since its 2013 levels. Since then, there has been no turning back for green 2000 1800 1600

$ billion

1400 1200 1000 800 600 400 200 0

Fig. 4.1 Cumulative green bonds issuance from 2007 to September 2022 (in $billion) (Source Authors compilation from various annual reports of Climate Bond Initiative)

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Table 4.1 Top five country issuers for 2021 as per bond category

Green bonds in $million

Social bonds in $million

Sustainability bonds in $million

USA, 83,587 China, 58,825 Germany, 58,536 France, 52,730 UK, 36,308

France, 62,931 USA, 22,546 Chile, 12,784 Japan, 8,296 Korea, 4,858

USA, 37,223 France, 8,814 UK, 8,708 Japan, 8,532 Spain, 8,197

Source Authors based on Environmental Finance (2022)

bonds. In 2021, green bonds crossed the crucial milestone of $1 trillion worth bond issuance (CBI, 2013, 2015; Harrison & Muething, 2021). Cumulative green bond issuance stands at $1.956 trillion as of September 2022 (CBI, 2022a). Approximately $288.7 billion worth of green bonds were issued for the year September 2022, almost 90% of the bonds are labeled green bonds and aligned as per the Climate Bonds Initiative’s (CBI) “green” definition. There were also $69.5 billion worth of green bonds issued, which were not aligned with the “green” definition of CBI (CBI, 2022a). At the end of 2021, cumulative total labeled bond issuance reached at $2.8 trillion, and for green bonds, it was $1.6 trillion (Harrison et al., 2022). This really helps in understanding the diversion of the financial resources as per their goal and area they are working in. The growth of green bonds has been fueled by private sector, except in China and India where the government and the public sector entities took the lead. Vasakronan, the Swedish real estate company, was the first corporate to issue a green bond in 2013 (Vasakronan, 2022). This points to the strength of the markets to configure appropriate sustainable finance instruments for the challenges at hand (Maltais & Nykvist, 2021). Table 4.1 shows the top five country issuers for green, social, and sustainability bonds. Table 4.2 captures the top ten emerging markets as per the green bonds’ issuance. Table 4.3 highlights the sector wise use of proceeds for green bonds for years 2019 and 2021.

4.2

Multilaterals as Frontrunners

The multilateral development agencies were frontrunners in devising innovative ways of generating financial resources for addressing the climate, environment, and sustainability challenges. European Investment

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Table 4.2 Emerging economies’ green bond issuance for top ten countries—2020 and 2021

Country

2020 ($million)

China Chile Czech Republic Hungary Brazil Indonesia Saudi Arabia Mexico Romania Thailand India Poland Russian Federation Turkey Serbia

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2021 ($million)

18,076 3,811 2,508 2,192 1,913 1,860 1,300 1,239 1,041 955 – – – – –

59,300 5,700 4,000 1,200 2,000 – – – – – 5,900 2,700 1,600 1,200 1,200

Source Authors based on Amundi and IFC (2021, 2022)

Table 4.3 Sector wise use of proceed breakup of green bonds

Sector

% Use of proceed (2019)

% Use of proceed (2021)

Energy Buildings Transport Water Land Use Waste Unallocated adoption & Resilience Industry ITC

31 30 20 9 3 4 1

35 30 18 6 5 4 1

1 1

1 1

Source Authors based on Liam Jones (2022), Rangone and Ali (2021)

Bank, World Bank, and International Finance Corporation were among the leading agencies issuing green bonds. In 2017, at “One Planet Summit,” multilateral agencies including WB and EIB assumed a lead role as investors in the green bonds and climate-related projects for the transition to a low-carbon economy (Climate Bonds Initiative, 2018).

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European Investment Bank (EIB) launched the first green bond ever, “Climate Awareness Bond” in the year 2007 (Sonerud et al., 2015). World Bank launched its “Green Climate Fund” in 2008. According to World Bank Sustainable Development Bonds Impact 2020 report, World Bank has issued bonds worth $14.4 billion since 2008 (World Bank, 2020). IFC also contributed to the green bond development through its Green Bond Program launched in 2010. As of June 2021, approximately $10,553 million bonds have been issued by IFC (IFC, 2021). There is a requirement of a strong policy signal which in turn will lead to higher investment in the sustainable investment instruments. Also, multilateral agencies are well-placed to leverage their “trusted partners” reputation and help private partners in seizing opportunities in green bonds—sustainable finance as well (AIIB, 2020). The nature of the environment finance and the sustainable finance sectors gave rise to many innovative financial instruments that provide a pathway to achieving the targets set under the Paris Climate Agreement and the UN SDGs. The Clean Development Mechanism (CDM) which is formed under the UNFCCC Kyoto Protocol was one of the first prominent innovative mechanisms. The CDM propagated certified emission reduction credits (CERs). The system not only assisted financially but also increased the awareness about the impacts of human actions on climate and the consequent challenges. The technology transfer mechanism under the CDM has substantially influenced the climate change action plan (Ellis et al., 2007; Schneider et al., 2008). The formation of Green Climate Fund (GCF) under the UNFCCC in 2010 is another impactful innovative finance mechanism contributing to the achievement of climate change and sustainability targets (Tolliver et al., 2019a, 2019b). The platform created by the adoption of various sustainable finance instruments led to the growth of debt instruments loan (loans and bonds) in financing these projects. The nature of the bond instruments including the possibility of structuring different options for the coupon and principal payments, ability to offer different maturities, and ability to customize the credit enhancement allows for the adoption of these instruments at a wider scale globally. The green bonds, and the broader thematic bond market, extended the logic through tying the projects to predefined eligibility criteria. These instruments can complement the public sector in financing infrastructure projects that are capital intensive.

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4.3

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Bond Issuance Process

Green bonds fall under the category of fixed income instruments whose proceeds will be used to finance climate or environment friendly projects. The issuer’s type is sometimes added either as a suffix or as a prefix to indicate which type of agency has issued the same. For example, a green sovereign bond is used to identify the green bond issued by sovereign governments. A typical process of how green bonds are issued could be observed from the UK government’s case. In the months of September and October 2021, the UK government launched its first two green bonds (green gilt—government bond), the first a £10 billion pounds 12-year gilt and the second a £ 6 billion 32-year gilt. Prior to the launch of the bonds, the government has prepared a Green Financing Framework document that sets out the principles of issuance, project identification, monitoring, and reporting. The projects that the government wanted to finance are in accordance with the use of the proceeds framework in sectors including energy efficiency, flood mitigation, and clean transportation. The government has a time frame of four years to deploy the proceeds in the eligible projects. The framework document also provided the government with the flexibility to finance projects which have commenced up to a year earlier than the bond issuance. However, the framework states that at least half of the proceeds must finance new projects. The application of the bond proceeds would be monitored by a new institutional entity (InterGovernmental Green Bond Board) which is headed by the HM Treasury and is represented by all the beneficiary government departments. Before issuing the green gilt, the government had obtained independent reports from two agencies, Vigeo Eiris and Carbon Trust. The former provided a second-party opinion that confirmed that the use of proceeds framework is in accordance with the Green Bond Principles (GBP) of the International Capital Markets Association (ICMA). The adherence to the targets by the Committee on Climate Change is confirmed by the Carbon Trust in their pre-issuance impact assessment report. The reporting on how the proceeds is being used will be made in an annual Allocation Report. The government would also report on the progress of the environmental and social impact in a biennial Impact Report. The government has also structured another household fixed rate savings product (Retail Green Savings Bonds) and offered the same along with the green gilt. This product aims

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Fig. 4.2 Green bonds issuance process (Source Authors based on ADB [2021], ICMA [2021])

to channel domestic savings into green projects (HM Treasury and UK Debt Management Office, 2021). Figure 4.2 captures the basic green bond issuance process. The green bonds are a key component of the sustainable finance instruments diaspora and are assisting the various stakeholders in progressing toward their climate goals. The processes that go into the green bond offering are also streamlining the internal systems and processes of the respective organizations and help in building synergies between the internal and external stakeholders. The public sector policymakers and project proponents are using these issuances to communicate their intention of meeting their NDCs and channeling their investments into low-carbon projects (Shishlov et al., 2016). The green bond market has witnessed a bottomup growth and would need to strengthen the processes to ensure that the integrity is maintained in all environmental, legal, and reputational aspects.

4.4

Green Taxonomies

Infrastructure has always been considered as one of the key sectors which can contribute to combating climate change-related issues. There was a general consensus that various mechanisms, policies, and frameworks which can serve as catalysts for addressing climate change need

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to be developed. Kyoto protocol, which came into force in 2005, was instrumental in uniting the countries to commit to a reduction in their greenhouse gas emissions, which is one of the major factors worsening climate change (UNFCCC, 2022). Many countries have declared their intentions and pathways to combat climate change through their intended Nationally Determined Contributions (NDCs). It was considered useful to align the NDCs and the targets set under the SDGs, once the latter have been formulated (Climate Watch, 2022). The path to achieving the NDCs and the SDGs consists of creating investable project pipelines by the countries, which in turn needs to leverage the various sustainable financial mechanisms available including the green bonds (SDGs—UNFCCC) (Ntsama et al., 2021). Subsequent to the global financial crisis (GFC), regulators have placed increased restrictions on bank lending. The implementation of Basel III discouraged banks to lend for long-term loans, which in turn led to increased costs, reduction in loan tenures, and posed greater refinancing risks (CBI, 2012). However, pension funds and insurance funds have stepped up their participation in the markets, as their perspectives on asset liability matches were more in congruence with the capital investment and cash flows of infrastructure projects. Green bonds emerged as a viable instrument that could vet the appetite of institutional investors’ inclination toward the low-carbon technologies and projects (CBI, 2012). The key challenge that remained was how the objectives of the various investors in contributing to the mitigation of climate change are directly reflected in the instruments that they are considering investing. There was a need to develop robust mechanisms that address the concerns of the investors. One of the biggest challenges for the green bonds is there is no universally accepted definition for the green bonds (Tang & Zhang, 2020). This poses different kinds of challenges for the issuer and investors. The absence of common understanding makes it difficult for the issuers— in terms of attracting investors and following the standards. For the investors, it becomes difficult to identify the right kind of bonds to match their requirements. Also, there exists the menace of greenwash—there are bonds that do not follow the generally accepted green principles but still promote themselves as one, leading to the ambiguity. In a study carried out by Schroders, 57% of respondents said that “lack of information/ understanding” was a factor in stopping them from investing more in

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instruments focused on sustainable investments (AIIB, 2020; Schroders, 2018). An international platform such as the Financial Stability Board’s (FSB) Task Force on Climate-Related Financial Disclosures gives a basis for disclosing climate-related information (FSB TCFD, 2021). The thirdparty or independent certifications are sought after as they give better credence to the issuers of their intentions and to the investors that their funds have been rightly deployed. Many countries, regions, and institutions have developed their own taxonomies of the definition and process to be adopted for green bonds. International Capital Market Association (ICMA), with over 600 members who actively participate in 65 international destinations, has been promoting the development of capital and securities markets and has been contributing to the formulation of policies and guidance documents for sustainable finance (ICMA, 2021). ICMA developed its Green Bonds Principles (GBP) framework in 2014 (voluntary process guidelines), updated and available as on June 2022, in order to support various issuers in their initiatives to configure climate and environment friendly and sustainable projects (ICMA, 2021). The GBP has four key elements, namely the use of proceeds, process of project evaluation and selection, management of proceeds, and reporting. The Climate Bonds Initiative (CBI) is a global not-for-profit organization that maintains the information of green bonds issued over a period from 2009. While the bonds have been categorized under different labels including green, a mere presence of the labeled bond on the CBI’s database does not indicate its endorsement of the correctness of the labeling. CBI had provided its Climate Bond Standards (CBS) that set out the sector-specific eligibility and suitability for labeling as a green bond. The issuances that are in conformity with the CBS are eligible for Climate Bonds Certification after a second-party opinion that the issuance is complying with the standards and adequate monitoring and reporting mechanisms are in place. EU Green Bonds Standard (EU GBS) is a voluntary framework that can be used by issuers to demonstrate that the bonds issued are in alignment with prevalent best practices of the industry. This helps the issuers located in the EU and outside the EU. These standards can be applied to any kind of bonds both listed and unlisted and other debt instruments of the capital market. Standards can be used by both public and private sector participants (EU TEG, 2020). EU GBS aims to “Enhance

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effectiveness, transparency, comparability & credibility of green bond market & encourage market participants to issue & invest in EU green bonds” (European Commission, 2022). EU GBS has been developed keeping the GBPs by ICMA and includes all the four principles from GBPs (EU TEG, 2020). EU Taxonomy lays out the technical criteria for economic activities and investments which are sustainable, while the European Green Bonds Standard focuses on recommending a uniform process for the issuance and reporting of green bonds (Tolliver et al., 2019a, 2019b). China has been at the forefront of the green bond issuance and they had issued their Green Bond Endorsed Project Catalogue (PBC, 2021). ASEAN Green Bond Standards have been developed in association with ICMA, and based on GBP, providing specific guidance for developing green finance in the ASEAN region.

4.5

Exchanges and Indices

Exchanges help investors invest in green bonds and other climate solutions and can act as a platform for developing indices that can accelerate the market. These indices can further assist investors to identify better opportunities available to them. Exchanges work as matchmakers between the issuers and investors, ranging from institutional investors to small investors. The development of the exchanges also helps in improving liquidity in the market. Exchanges can help in attracting retail investors and tapping their liquidity, e.g., LSE’s Shanks green bond (ORB) and WB’s sustainable bonds are listed on Borsa Italiana. (CBI, 2017). The following table lists the exchanges that have dedicated windows for green bonds. Figure 4.3 shows the establishment of the different green bond windows on different exchanges. Many green bond indices have been configured with their own methodologies in order to label specific bond issuances as green, effectively providing an alternative certification method. The methodology of building the index is proprietary; however, most of them state that they are aligned with the GBP while specifying additional elements such as the end-use industry sectors, size, and liquidity. The criteria that are used for labeling green is not considered as rigorous as the ones for conventional bonds, as certain criteria such as the minimum levels of market liquidity and credit ratings are not included. The flexibility to add or delete bonds from the index acts as an indirect monitoring mechanism. The ability of

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2015

2016

2017

2018

2019

2020

•Oslo stock Exchange, Stockholm Stock Exchange, London Stock Exchange

•Mexico Stock Exchange, Luxembourg Stock Exchange

•Borsa Italiana, Taipei Exchange, Johannesbu rg Stock Exchange

•Japan Exchange Group, Vienna Exchange, Nasdaq (Multiple stock exchanges), Swiss Stock Exchange, The Internationa l Stock Exchange, Frankfurt Stock Exchange

•Santiago Stock Exchange, Euronext (Multiple stock exchanges), Bombay Stock Exchange, Argentina Stock Exchange, Brazil Stock Exchange, Nigerian Stock Exchange

•Hong Kong Stock Exchange, Korea Exchange, Toronto Stock Exchange

2021

•Malta Stock Exchange

Fig. 4.3 Exchanges with dedicated green bonds window (Source Authors based on CBI [2022b], Green Finance Platform [2021])

the indices to track and report the environmental criteria is yet to be demonstrated (Ehlers & Packer, 2017). A few notable green bond indices include: ● ● ● ● ● ● ● ● ● ● ● ● ● ●

Solactive Green Bond Index Series S&P Dow Jones Green Bond Index Barclays & MSCI Green Bond Index Bank of America Merrill Lynch Green Bond Index ChinaBond China Green Bond Index Series ChinaBond China Climate-aligned Bond Index CUFE-CNI Green Bond Index Series SSE Chinese domestic Green Bond Index Series SSE Green Corporate Bond Index FTSE Global Green Impact Bond Index FTSE WorldBIG Green Impact Bond Index FTSE EuroBIG Green Impact Bond Index FTSE USBIG Green Impact Bond Index ICE BofA Green Index

Sources: (CBI, 2017; Intercontinental Exchange, 2022; Luxembourg Stock Exchange, 2022; Saleeba et al., 2021).

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The GBP recommended in the 2015 edition that the issuers use external agencies to provide assurance of alignment with the principles of green bonds. The GBP from 2016 suggested the recommended external reviewers, which also included the rating agencies. For instance, Moody’s Green Bond Assessments and Standard and Poor’s Green Evaluations have their respective methods for the assessment of green bonds. The number of taxonomies used has proliferated in the world; investors expect better alignment so that the green finance ecosystem becomes more transparent and coherent. Despite the tremendous growth of the green bond market and the adoption of numerous frameworks and principles, the definition of “green” remains incomplete. The “greenwashing” refers to the risk that the proceeds of green bond are used for projects that are not compatible with the agreed purposes. In effect, the purpose of the particular issuance is not met in spirit and letter (Saleeba et al., 2021). This has implications across the board, from the issuers to the certifiers and investors. For example, the CBI did not certify the issuance by Repsol, the Spanish energy company, in 2017, stating that the company’s environmental strategy is not adequately green. In its report, CBI stated that while there will be reductions in carbon dioxide emissions, the activities that the company is proposing will extend the operating life of the plant (refineries) and indirectly contribute to increased emissions. The CBI assessment appears to be a whole-of-life opinion rather than commenting on the immediate objective of the project that the bond is attempting to finance (Flammer, 2020). Depending on the where the proceeds are utilized, the green bonds may or may not receive the green bond label. Repsol issued self-labeled green bonds for financing and refinancing the energy of its chemical and refinery facilities located in Spain and Portugal subsequently. However, major green indices exclude it from their green indices, which shows that market does not consider such kind of transaction where it increases the energy efficiency of the oil and gas (fossil fuel) plant as an act of low-carbon transition. On the other hand, NTPC India issued green masala bonds in August 2016, which was certified by CBI as the proceeds were deployed to generate clean energy (Weber & Saravade, 2019). Hence, certification and transparency are the two important features for green bonds which will make green bonds the catalyst for the transition to the carbon neutrality. The current frameworks are focusing on binary outcomes, that is, whether the issuance is certified or not. In reality, the greenness may be a continuum. There have been suggestions to structure the greenness

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ratings in a similar fashion to a credit rating mechanism that gives different tiers of greenness. The blue bond guidelines that are being developed by the IFC, ADB are contemplating different shades of blue to indicate the impact of finance. This could provide more granular information on the impact. CICERO, a climate research institute operating out of Oslo and a leading second-party opinion provider, gives its opinion in different shades of green at the time of issuance. The continuity of the impact of the proceeds on the project is commented upon only if there is a request from the issuer (Ehlers & Packer, 2017).

4.6

Greenium and Transaction Costs

The yield offered on green bonds is typically lower than that of conventional bonds issued by the same entity. This premium or the price difference is termed in the market as “greenium.” This is particularly noticed in sovereign green bonds. Credit risk for both the conventional bonds and the green bonds of the sovereign is usually the same, as these bonds are issued by the same entity, and principal and coupon payments are serviced from the same cash flows. Hence, the existence of a greenium in such a case is not fully understood (Aikman, 2022). The sovereign green bonds could have a greenium due to the regulatory pressures to include ESG considerations in the public pension and superannuation funds, the anticipated foster growth of the sovereign green bonds, and expectations that the investment in green assets will lead to longterm economic and social benefits. Some of these assumptions go against the fiduciary responsibilities of the public sector pension superannuation funds to aim for the best possible return within the permitted investing universe. The sovereign green bonds can be a vehicle for the countries to achieve their nationally determined contributions (NDCs) first as a signaling mechanism to the world about the country’s seriousness and second as providing an anchor for the private sector participation in the green markets. A usual concern that the issuers express is the additional costs involved in structuring a green bond and the post-issuance monitoring reporting requirements. The issuers are constrained by the use of proceeds framework for deploying the funds raised. The additional costs incurred over the conventional bonds include preparing a green bond framework, which sets out the types of projects that would be funded, the selection criteria

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for individual projects, how the proceeds would be managed, the monitoring reporting of the use of proceeds, and impact of outcomes due to the intervention. The issuer would need to set up systems and procedures to adhere to these requirements, maintain separate accounts for the proceeds, and train the internal personnel on the requirements. The transaction cost for these activities is estimated to be an additional 0.3 to 0.6 basis points for a $500 million issuance (Hachenberg & Schiereck, 2018), which is a constraint for many smaller entities (Forsbacka & Vulturius, 2019). In some instances, the greenium is expected to partially offset the additional costs incurred for the issue of green bonds. The estimation of greenium is dynamic as it is difficult to compare similar circumstances (same issuer, size, rating, maturity, currency, and bond type). Earlier studies have indicated that the premium due to the issuance of green bonds is between two basis points (Zerbib, 2019) and 18 basis points (Gianfrate & Peri, 2019). The reasons on why the investors are willing to accept lower yields could include expectation of lower risk and better management due to higher transparency (Sartzetakis, 2020), willingness to contribute to the environment and sustainability (Maltais & Nykvist, 2021; Zerbib, 2019), or internal and regulatory constraints on the portfolio investments (Shishlov et al., 2016). The literature till date also indicates that the issuances certified by external agencies have a better premium than those are self-certified (Baker et al., 2018; Fatica & Panzica, 2019). Also, the absence of certification by an external party was found to have resulted in higher borrowing costs for non-public sector issuers when compared to the cost of conventional bonds (Bachelet et al., 2019). The presence of a greenium and the expectation that the investor would need to (marginally) lower their financial expectation from the yields of the green bond issuances go against the conventional wisdom of companies needing to act in a manner that maximizes shareholder wealth. There are different arguments to see that the primary objective needs to change to “maximizing shareholder welfare” and not stock returns, as this would give a better platform to assess the incorporation of ESG elements into corporate strategies (Hart & Zingales, 2017). The academic research indicates that the launch of green bonds increases the enterprise value in the near term. A study by Dragun Yongjun Tag and Yupu Zheng concluded that the greenium is 6.94 basis points (i.e., the yields of green bonds are 6.94 basis points lower than that of the

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regular corporate bond issuances). However, there is no appreciable price advantage over the period indicating that the greenium is not due to the financing aspects alone but is derived from broader institutional changes. The green bond issuances have witnessed nearly 8% increase in institutional ownership when compared with the conventional bond issuances. The increase is mainly due to the participation of domestic advisors and pension funds. The research into the attention on green bond issuances indicates that institutional investors do take an interest in the issuer’s ESG activities and performance (Tang & Zhang, 2020). In this article (Tang & Zhang, 2020), authors conclude about stock price increase of the green bond issuers. Authors note that market reacts stronger to the first-time green bonds issuer as compared to the repeat issuer. Another important observation is that market reactions are stronger for corporate issuers as compared to the financial institution issuers. This price increase ultimately gives benefit to the existing shareholders of the issuer (Tang & Zhang, 2020).

4.7

Impact and Reporting

The uptake of green finance has been widely reported with regard to the issuance size, beneficiary sectors, and profile of the issuers. While this subject has been on the radar of various government, multilateral, and private sector organizations for a while, the relationship between the issuance and impact requires more research. The objective of the impact reporting is to evaluate changes in asset performance, project, or project portfolios with respect to relevant indicators. The studies to date indicate mixed results in terms of achieving the ambitious targets that are set. The climate targets mentioned in the green bond documents do not reflect the aggressive intentions to achieve the emission targets or the path toward the same (Dietz et al., 2019). The issuers, in general, have not yet mastered the uniformity and coherence required between the stated targets, their green bond frameworks, and the monitoring reporting systems. As the reporting approaches adopted by different issuers are not easily comparable, there is a chance of double counting and concerns about the additionality that green bonds are expected to bring in (Tuhkanen & Vulturius, 2020). The post-issuance reporting is not uniform and comparable across the world, leading to concerns of greenwashing and apprehensions about the

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further uptake of the green bonds. The necessary regulatory requirements, investor, and business pressures combined with the physical risk due to changing climatic conditions are forcing organizations to set aggressive climate targets (Batten, 2018). The organizations set their climate targets hoping for an optimistic trajectory that is neither too quick nor too delayed (Bolton et al., 2020). A higher-paced transition could leave the companies with assets that are stranded, while a slower pace could mean greater exposure to climate risks. The organizational climate targets signal to the broader business community their intention to adopt climate-friendly and sustainable management practices. The targets typically refer to the extent of greenhouse gas emissions at a particular future point of time. The companies have used both absolute figures (i.e., the level of emissions they would like to see in a particular year or the extent of reduction from the baseline level) or metrics in relation to their production or output processes as their climate targets (Dietz et al., 2018). There has been a push requiring the corporations to state their targets as “science-based”; that is, the targets need to be within scientifically determined emission budgets allowed to increase each at 2 degrees centigrade or 1.5 degrees centigrade warming scenario (Walenta, 2020). The sciencebased targets (SBTs) can be determined either based on a linear emission reduction (i.e., companies decrease their emissions at the same rate as others) or the sector-based allocation method (companies in the sector have emission targets considering the respective sectoral characteristics) (Faria & Labutong, 2020). The relationship between the adoption of green bonds with the carbon neutrality translation is not well established (Linnenluecke et al., 2016; Maltais & Nykvist, 2021). This relationship needs to be understood under two main threads. First, how the targets or the key performance indicators have been structured so that the issuers can minimize their financial and reputational risk and second, how the post-issuance reporting mechanism has functioned in correctly communicating the outcomes. The climate targets, in particular the science-based ones, are considered as key indicators embodying the spirit of the Paris agreement (Faria & Labutong, 2020). The research on how well the issuers match the climate targets to their economic translation is currently limited (Walenta, 2020). The advent of green bonds is helping to bring in a transformation a change in how the organizations function. The tenets of better disclosure of the use of proceeds, institutional processes for objective identification of projects, evaluation of the impacts and establishing the relationship

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with the climate targets and the funds raised, mean that the internal functioning of the organizations needs to be adjusted to have a better awareness. The process in itself is helping to better align the corporate finance and the operational and sustainability departments (KPMG, 2015). The disconnect of the criticality of climate awareness among the non-technical executives, particularly from the finance department, hamper the overall achievement of climate targets (Shishlov et al., 2016). The green bonds-related impacts are not clearly identified in the post-issuance reports. It becomes difficult to establish connections between SDGs and NDCs-related environmental impacts and green bonds (Tolliver et al., 2019a, 2019b). A clear and accurate information will help in reducing ambiguity and in turn will be beneficial to all the relevant stakeholders such as investors, financiers, and policymakers. Relevant measurements for assessing the impact achieved in relation to the SDGs in the sectors such as water, wastewater, sustainable forest management, and ecosystem preservation, apart from carbon emission, need to be outlined. This will lead to better identification of the green bond opportunities and in turn will increase the relevant investor base who have green investments inclination (Tolliver et al., 2019a, 2019b). Tuhkanen and Vulturius (2020) conclude that most of the green bond issuers do not link them with climate targets and fail to make it part of their carbon neutrality transition. Post-issuance reporting related issues and no clear linkage between green bonds frameworks and climate targets lead to the conclusion that there is an absence of pressure from different stakeholders such as investors, regulators, and society for provision of required information, reduction of information gap, and tackling the issue of greenwashing.

4.8

Additionality

The extent of additionality due to green investments needs to be understood better. The additionality of green finance refers to new investments that otherwise would not have happened. The proceeds from the sovereign green gilt of the government of the UK are not completely ring-fenced as the government retained the right to manage any unutilized funds. It is also not certain that the beneficiary departments, who access the green gilt, will face any offsetting decrease in their usual sources of financing. It is not clear how the taxonomy used by the HM Treasury compares with the European Union’s taxonomy, as increasingly investors

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are preferring standardization (HM Treasury and UK Debt Management Office, 2021). The additionality of the current green financing is not fully clear as the projects which the bonds support could be implemented with other sources of finance as well. However, the procedural requirements and the premium along with the focus on specified targets helped in their adoption (Dupre et al., 2018). The philosophy of how the green bond markets function and are regulated has far-reaching influence on the other thematic bonds as well as other innovative financial instruments in the sustainable finance space. For instance, the carbon offsets operate under a similar framework. The process of carbon offsetting includes paying for the carbon dioxide emissions through initiatives in the other parts of the economy. Airlines such as Emirates and British Airways offer a choice to the passengers to “offset” the emissions of the flight they are traveling through funding other carbon-friendly activities such as renewable energy projects and tree replanting in vulnerable areas (Anderson, 2012; Forbes, 2019). The primary concern in measuring the effectiveness of such initiatives is that the impact of such contributions is not easily verifiable. The lessons from the green bond market can be used to better structure, monitor, and verify such sustainable finance initiatives. Likewise, the green bond governance mechanisms can learn from the insights from the adoption of innovative financial instruments in the sustainable finance domain. For example, the concept of additionality in the green bonds market can be strengthened from the experiences elsewhere. If the project that is proposed to be financed by green bonds is being implemented irrespective of the availability of finances from the green bond issuances, then the additionality is minimal. However, if the green bonds help accelerate new investments, then there is substantial additionality. The guidelines provided by agencies such as the United Nations Clean Development Mechanism additionality tests can be a good starting point for customizing the requirements for green bond markets (UNFCCC, 2004).

4.9

Discussions

One of the challenges that the sovereigns (e.g., India and UK) face is their ability to use tax revenues as a guarantee to certain projects or investors, as their constitutions and/ or statutes impose limitations on how the tax collections could be used. As the proceeds from the green bond issuance need to be deployed in accordance with the pre-advertised manner, some

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countries will have challenges in identifying dedicated sources guarantee the bond payments. The benefits of the green bonds are also the generation of a large amount of information on how the various project investments are analyzed and their progress monitored. The information, as valuable to the issuers, is equally vital for the investors for basing their investment decisions. They are better attuned to the environmental benefits of targeted investments, and the lessons from their participation in green bond issuances feed into the future decision-making into a broader sustainable investing market. Capturing the additional information comes at a cost for the investors too, and they are attempting to mitigate the impact as much as possible through various strategies. A simple no-regret strategy would be to invest in the green offerings, certified by independent third parties, from the issuers from whom they have been purchasing the traditional bonds. The standardization across the various frameworks and disclosure requirements would mean that the transaction costs might come down in the future. This, however, might slow down the learning ability and expertise of the investors in the nuances of investing in green finance. The rating for the green bonds appears to be better than that of the conventional bonds, with 30% of the green bonds having a AAA rating while only 8.5% of the regular bonds are AAA rated in the period 2007– 2018 as reported by Bloomberg. There is no green bond that has been rated in the D range (Flammer, 2020). This could be due to the extensive preparation and the development of various process documents with the need for independent second-party opinions. The evidence to date points to a systemic improvement in the general conduct of the business due to the launch of green bonds. The current application of green bond proceeds is restricted to a few sectors such as the renewable energy, buildings, and transport. However, the potential applications have a very substantial range as mentioned in the categories stated in ICMA classification. Many of these applications come into the purview of public sector projects where the underlying projects do not have any substantial revenue streams. The participation by the private sector in such projects is limited. The public sector involvement and consequently the governance would become crucial for the long-term growth and sustenance of the green bond market. The governance of the system at this stage is market driven, which could have

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concerns relating to transparency and accuracy. A hybrid model of governance with the public sector and the private sector working together is expected to provide a level playing field for robust sectoral performance (Park, 2018). Even though the private governance has proven to be nimble and practical, it faces the risk of being less transparent, legitimate, and accountable. There is much work that needs to be done to have a more equitable governance framework. The absence of public governance does not bode well in the monitoring of the impact of sustainable finance on climate change initiatives. The absence of regulatory requirements to disclose the broader information set consisting the financial as well as nonfinancial aspects would mean that the burden of enforcing the same has been landed on the shareholder groups (WSJ, 2019). The investor group believes that the better disclosures from the portfolio companies would go a long way in addressing climate risks (Flammer et al., 2019). The influence of the investors on the issuer’s behavior needs to be viewed from the nature of the instrument itself. Usually, it is a shareholder who plays a major role in the corporate governance of the entities through their membership of the boards. The lenders have a senior interest and usually have covenants in their loan documents that enable them to intervene only in specified cases such as the default of debt servicing conditions. The growth of green bonds and the role that the investors are playing in corporate governance are a welcome change from the typical creditor behavior. The controls exerted by the green bond investors emanate from the covenants set up in the bond issuance process itself and due to this reason, their actions are not perceived to be burdensome. Typically, green bonds rank pari passu with any other similar conventional instrument and are serviced from similar revenue streams. Like any other bond, the green bondholders have a direct recourse to the issuer (Park, 2018). Dr. Aswath Damodaran—a well-known educator in the world of finance—has strong arguments against the tag of ESG and green bonds when it comes to comparing them with the other conventional instruments available in the market. When green bonds are getting constrained by parameters like the use of proceeds, he argues that the green bonds would perform either lower or as good as conventional bonds in terms of returns, but green bonds might not generate higher returns. He further adds that constraints will add to the costs in most of the cases; hence, there will be some level of impact on the bonds issued as green bonds (Damodaran, 2021).

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4.10

Conclusions

The growth in green bond issuances was described as a “green bond boom” by Morgan Stanley (Morgan Stanley, 2017) and “Green bonds are the answer to Africa’s investment needs” by the Financial Times (Financial Times, 2014). The extensive adoption of green bonds by various entities and the positive outlook point to a large potential yet to be fully tapped. The green market is expected to bring in more transparency and accountability to the issuers. The information on how the assets are being developed and operated is expected to provide inputs for more reasoned investments. Multilateral agencies have developed different kind of innovative mechanisms for risk mitigation. In case of sustainable finance / green bonds broadly, MLAs should assume dual responsibilities by helping private partners to move toward broad sustainable finance through different products offered and also maintaining the standards which MLAs are known for (AIIB, 2020). Green taxonomy will help in accelerating the existing levels of the investors’ inclination and understanding about how the green bonds work. This will also address the issue of greenwashing and increase the trust of the investors in the green bonds. Also, the taxonomy should be flexible enough to include various preferences of the different investors. Transparent reporting standards should be at the core of the green finance definition, to create a conducive environment for all the stakeholders concerned and accelerate the agenda for achieving the sustainable development goals (AIIB, 2020; CBI, 2019). It is important to note that including green bonds in their portfolio is crucial for the sustainably responsible investors as green bonds not only help them meet their climate-related targets but also help in reducing their exposure to specific climate-related financial risks.

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Fatica, S., & Panzica, R. (2019). The pricing of green bonds: Are financial institutions special? https://doi.org/10.2760/496913 Financial Times. (2014, December 24). Green bonds are the answer to Africa’s investment needs. Financial Times. https://www.ft.com/content/e549131a8a97-11e4-8e24-00144feabdc0 Flaherty, M., Gevorkyan, A., Radpour, S., & Semmler, W. (2017). Financing climate policies through climate bonds—A three stage model and empirics. Research in International Business and Finance, 42, 468–479. https://doi. org/10.1016/J.RIBAF.2016.06.001 Flammer, C. (2020). Green bonds: Effectiveness and implications for public policy. Environmental and Energy Policy and the Economy, 1, 95–128. https:// doi.org/10.1086/706794 Flammer, C., Toffel M. W., & VIswanathan, K. (2019). Shareholder activism and firms’ Voluntary disclosure of climate change risks. Global Development Policy Center. https://www.bu.edu/gdp/files/2019/12/FlammerWP-Climate-Risk-Disclosure.pdf Forbes. (2019). Does carbon offsetting really allow you to fly guilt free? Forbes. https://www.forbes.com/sites/jamesellsmoor/2019/03/05/ does-carbon-offsetting-really-allow-you-to-fly-guilt-free/?sh=15ca48175603 Forsbacka, K., & Vulturius, G. (2019). A legal analysis of terms and conditions for green bonds : Focus on the financial markets in the nordics. Europarättslig Tidskrift, 3, 397–442. https://www.stockholmsustainablefinance.com/public ation/a-legal-analysis-of-terms-and-conditions-for-green-bonds/ FSB TCFD. (2021). TCFD status report. Task Force on Climate-Related Financial Disclosures. https://www.fsb-tcfd.org/publications/ Gianfrate, G., & Peri, M. (2019). The green advantage: Exploring the convenience of issuing green bonds. Journal of Cleaner Production, 219, 127–135. https://doi.org/10.1016/J.JCLEPRO.2019.02.022 Green Finance Platform. (2021). Malta stock exchange green market. Green Finance Platform. https://www.greenfinanceplatform.org/policies-and-regula tions/malta-stock-exchange-green-market Hachenberg, B., & Schiereck, D. (2018). Are green bonds priced differently from conventional bonds? Journal of Asset Management, 19(6), 371–383. https://doi.org/10.1057/S41260-018-0088-5 Harrison C., MacGeoch M., & Michetti C. (2022). Sustainable debt global state of the market 2021. In Climate Bonds Initiative. https://www.climatebonds. net/files/reports/cbi_global_sotm_2021_02f.pdf Harrison C., & Muething L. (2021). Sustainable debt: Global state of the market 2020. https://www.climatebonds.net/resources/reports/sustainabledebt-global-state-market-2020

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Hart, O., & Zingales, L. (2017). Companies should maximize shareholder welfare not market value. Journal of Law, Finance, and Accounting, 2(2), 247–275. https://doi.org/10.1561/108.00000022 HM Treasury and UK Debt Management Office. (2021). Green gilts investor presentation. https://www.dmo.gov.uk/media/yy2jvs0b/pr141021.pdf ICMA. (2021). Green bond principles. https://www.icmagroup.org/assets/ documents/Sustainable-finance/2021-updates/Green-Bond-Principles-June2021-140621.pdf IFC. (2021). Green Bonds. International Finance Corporation. https://www. ifc.org/wps/wcm/connect/corp_ext_content/ifc_external_corporate_site/ about+ifc_new/investor+relations/ir-products/grnbond-overvw Intercontinental Exchange. (2022). Sustainability indices. ICE. Intercontinental Exchange. https://www.theice.com/market-data/indices/sustainab ility-indices KPMG. (2015). Gearing up for green bonds. https://home.kpmg/xx/en/ home/insights/2015/03/gearing-up-for-green-bonds.html Liam Jones. (2022, January 31). $500bn green issuance 2021: Social and sustainable acceleration: Annual green $1tn in sight: Market expansion forecasts for 2022 and 2025. Climate Bonds Initiative. https://www.climatebonds.net/ 2022/01/500bn-green-issuance-2021-social-and-sustainable-accelerationannual-green-1tn-sight-market Linnenluecke, M. K., Smith, T., & McKnight, B. (2016). Environmental finance: A research agenda for interdisciplinary finance research. Economic Modelling, 59, 124–130. https://doi.org/10.1016/J.ECONMOD.2016.07.010 Luxembourg Stock Exchange. (2022). SSE Chinese domestic green bond index series. Luxembourg Stock Exchange. https://www.bourse.lu/sse-green-bondindex Maltais, A., & Nykvist, B. (2021). Understanding the role of green bonds in advancing sustainability. Journal of Sustainable Finance and Investment, 11(3), 233–252. https://doi.org/10.1080/20430795.2020.1724864 Morgan Stanley. (2017). Behind the green bonds boom. Morgan Stanley. https:// www.morganstanley.com/ideas/green-bond-boom Ntsama, U. Y. O., Yan, C., Nasiri, A., & Mboungam, A. H. M. (2021). Green bonds issuance: insights in low- and middle-income countries. International Journal of Corporate Social Responsibility, 6(1). https://doi.org/10.1186/ S40991-020-00056-0 OECD. (2016). Green bonds: Country experiences, barriers and options. https:// unepinquiry.org/wp-content/uploads/2016/09/6_Green_Bonds_Country_ Experiences_Barriers_and_Options.pdf OECD. (2017). Investing in climate, investing in growth. OECD. https://doi. org/10.1787/9789264273528-EN

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Park, S. (2018). Investors as regulators: Green bonds and the governance challenges of the sustainable finance revolution. Stanford Journal of International Law, 54(1). https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3142887 PBC. (2021, April 23). PBC, NDRC and CSRC issue the green bond endorsed projects catalogue (2021 Edition). People’s Bank of China. http://www.pbc. gov.cn/en/3688110/3688178/4241150/index.html Piñeiro-Chousa, J., López-Cabarcos, M. Á., & Ševi´c, A. (2022). Green bond market and Sentiment: Is there a switching behaviour? Journal of Business Research, 141, 520–527. https://doi.org/10.1016/J.JBUSRES.2021.11.048 Rangone, A., & Ali, S. (2021). European green deal and sustainable development: The Green Bonds as an integrated intervention tool to support Agribusiness in Italy. Economia Aziendale Online, 12(3), 313–327. https:// doi.org/10.13132/2038-5498/12.3.313-327 Saleeba, J., Chung, L., & Dai, L. (2021). Index insights sustainable investment. Green Bonds. https://content.ftserussell.com/sites/default/files/benchmark ing_the_green_bond_market_final_0.pdf Sartzetakis, E. S. (2020). Green bonds as an instrument to finance low carbon transition. Economic Change and Restructuring, 54(3), 755–779. https://doi. org/10.1007/S10644-020-09266-9 Schneider, M., Holzer, A., Hoffmann, V. H., Schneider, M., Holzer, A., & Hoffmann, V. H. (2008). Understanding the CDM’s contribution to technology transfer. Energy Policy, 36(8), 2920–2928. https://EconPapers.repec. org/RePEc:eee:enepol:v:36:y:2008:i:8:p:2920-2928 Schroders. (2018). Global investor study 2018 Global investor study is information the key to increasing sustainable investments? Marketing material. https:// prod.schroders.com/en/sysglobalassets/digital/insights/2018/pdf/globalinvestor-study/sustainability/global_investor_study_2018_sustainable_inve stment_report_final.pdf Shishlov, I., Morel, R., & Cochran, I. (2016, June). Beyond transparency: Unlocking the full potential of green bonds. I4CE—Institute for Climate Economics. https://www.i4ce.org/download/unlocking-the-potent ial-of-green-bonds/ Sonerud, B., Kidney, S., & Tripathy, A. (2015). “Scaling up green bond markets for sustainable development” climate bonds initiative and UN inquiry into the design of sustainable financial markets. https://www.climatebonds.net/files/ files/GB-Public_Sector_Guide-Final-1A.pdf Tang, D. Y., & Zhang, Y. (2020). Do shareholders benefit from green bonds? Journal of Corporate Finance, 61,. https://doi.org/10.1016/J.JCORPFIN. 2018.12.001 Tolliver, C., Keeley, A. R., & Managi, S. (2019a). Green bonds for the Paris agreement and sustainable development goals. Environmental Research Letters, 14(6). https://doi.org/10.1088/1748-9326/AB1118

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CHAPTER 5

Diverse Applications: Thematic Bonds Catching Up

2021 will be characterized by three key trends or three “S” words: Simplicity, Social, and Stability. There will be a clearer focus on Social indicators as investors assess and amplify their influence on creating more sustainable and inclusive societies. —Elena Philipova, Global Head of ESG Proposition at Refinitiv

5.1

Introduction

The thematic bond market is growing at an exponential pace and is expected to dominate the financial market discourse in the coming years. As a group, the green, social, sustainability, and sustainability-linked (GSSS) bond issuance had a fabulous run in the last three years, which is expected to continue in the near term. The aggregate issuance has increased from $326 billion in 2019 to $1.03 trillion in 2021 and expected to touch $1.5 trillion in 2022 (Environmental Finance, 2021, 2022). Thematic bonds such as the social, sustainability, and sustainabilitylinked bonds have come to the fore in the last five years, even though there were sporadic efforts to launch various concept-specific issuances in the past. One of the earliest thematic issuances was the vaccine bond of $1 billion issued by the International Finance Facility for Immunization Company (IFFIm) in 2006 to support Gavi, the vaccine alliance, in its immunization efforts. The need to increase efforts to provide © The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2023 R. D. Tirumala and P. Tiwari, Advances in Infrastructure Finance, https://doi.org/10.1007/978-981-99-0440-2_5

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finances has been recognized post the two global landmarks: the Paris Agreement on Climate Change and the 2030 Agenda for Sustainable Development in 2015 (United Nations, 2021). The variety of thematic bonds expanded in recent years with the rapidly growing range of issuers, even though the initial market growth was led by the green bonds, one of the largest thematic bond categories. There has been substantial support for financial instruments with a positive impact in response to the onset of the COVID-19 pandemic. They are fast becoming the preferred instruments for mobilizing financial resources for different causes which need urgent attention, like climate change, sustainable development and the ongoing pandemic, pointing to an emerging trend of investor interest and assessment of a wider gamut of environmental and sustainability challenges. “Thematic bonds are traditional fixed income instruments that allow investors to finance specific investment themes such as climate change, health, food, education, access to financial services and social housing” (United Nations, 2021). The main objective of such bonds is to meet the environmental, social, and sustainability goals and provide commitments to different projects which are considered to be beneficial from the respective perspectives. According to the bonds’ objectives, they are categorized or labeled as social, sustainable, sustainability linked, etc. (Hussain, 2022). This distinction of being “green”, “sustainability” or “social” depends on the end use of the funds raised under these categories of bonds, making it easier for investors to identify bonds that comply with their investment criteria. The social and sustainability bonds consisted of nearly 47% of the total sustainable debt issuance with $233.3bn issued in the first half of 2021, bringing total social and sustainability bonds issued since the year 2006 to $867bn. In 2020 alone, sustainability bonds issued nearly tripled to $140 billion (Environmental Finance, 2021). The rapid growth of these types of bonds is to be noted in the context that during 2021 social and sustainability bonds have been 20% and 19% of the overall GSSS bond issuance. This is significant as they were mainstreamed relatively late in 2018, in comparison with green bonds. However, green bonds took longer than both these categories to reach this level of issuances. Table 5.1 shows the value and volume breakdown of the sustainable bond issuance for 2020 and 2021. BBVA took the lead in green bonds, with a e1 billion green bond issued in May under its newly developed SDG Bond Framework (CBI,

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Table 5.1 Sustainable bonds issuance in 2020 and 2021 Bond category

Green bond Social bond Sustainability bond Sustainability-linked bond Transition bond Green bond, Sustainability-linked bond Total

Value in $ million (2021)

Value in $ million (2020)

Volume (2021)

Volume (2020)

532,245 205,185 189,875 91,708 4,438 1,511

295,851 164,874 139,294 8,781 – –

1739 1002 288 143 9 3

1,382 159 187 16 – –

1,024,962

6,08,800

3184

1744

Source Authors based on (Environmental Finance, 2021, 2022)

2019). This category of bond market has been growing steadily and swiftly, with the issuance up by 18% year-on-year (H1 2020: $197bn). The social sector bonds witnessed the sharpest increase, as their volume increased from $36.8bn in H1 2020 to $146.6bn in H1 2021 (a fourfold jump). The yearly growth of sustainability bond issuance was 20%. The issuance of social bonds related specifically to funding COVID-19 mitigation and/or recovery amounted to $88bn in H1 2020 (though there no issuances in H1 2021) (CBI, 2021). Market for these type of bonds in future is likely to grow with greater emphasis on responses to the climate emergency. The pandemic has also drawn the attention of the stakeholders to focus more on protecting livelihoods and social inequalities in our communities. Stakeholders are showing greater empathy towards facing challenges that have been confronting them and are eager to make a difference by incorporating innovative means of structuring and issue of such type of bonds (CBI, 2019). According to a poll conducted by the Environmental Finance, further growth is expected in future. The Table 5.2 shows the current market size of the thematic bonds. It is estimated that the weighted average credit rating of the various thematic bond categories globally is comparable (social bonds at AA, green bonds at A+ , sustainability bonds at AA−). The average size of social bonds ($540 million) and sustainability bonds ($455 million) are higher than that of green bonds ($300 million) in 2020 (ADB, 2021b).

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Table 5.2 Market size of various thematic markets for 2020 and 2021 Market type

Year

Market size ($ millions)

No of issuers

No of instruments

No of countries

No of currencies

Green

2020 2021 2020 2021 2020 2021 2020 2021 2020 2021

1,100,000 1,600,000 316,800 520,500 315,600 538,800 – 135,000 – 9600

1428 2045 178 425 601 861 – 225 – 15

7716 9886 885 2323 1230 3471 – 317 – 32

71 80 30 51 36 44 – 37 – 12

42 47 33 38 25 33 – 16 – 7

Sustainability Social SLB Transition

Source Authors based on (Harrison C. et al., 2022; Harrison C. & Muething L., 2021)

5.2

Diverse Applications

To highlight/demonstrate impacts related to a specific sector/segment, investors prefer to invest in the bonds which are specifically labeled for that particular sector/ segment. This also helps investors to incorporate the ESG aspect into their investment process and express their value rationale. Opting for such labeled bonds also helps to show the investors’ commitment to increased transparency and governance. Institutional investors have started considering bond alignment with social or environmental causes as one of the important criteria over and above financial returns. Stakeholders of the institutional investors are becoming aware, and they consider the issues like climate change and SDGs as one of the priority sectors for investments (United Nations, 2021). This also creates pressure on institutional investors to allocate their funds accordingly. Another important aspect that investors may like to leverage is the publicity and awareness that comes along with such bond issuance, which allows the investors like government agencies or non-profit organizations to convey their priorities clear to the different stakeholders, investors, and policymakers (ADB, 2021b). The bond issuers increasingly see these as an important aspect of focusing on the impact of environmental, social, and governance (ESG) risks of the projects that they undertake. It has become an effective and efficient tool to further their corporate social responsibility of meeting the needs of sustainability features (Ghosh et al., 2021).

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The purpose and main characteristics of a few categories are presented in Table 5.3. Table 5.3 Characteristics of different thematic bonds Green bonds Purpose

Issuer wise breakup for Year 2021

Investors

Social bonds

Invest in projects with positive environmental impacts

Affordable housing, Social inclusion, Financial inclusion, Gender equality, and Health and education Corporates Agency (43.3%), (37.6%), Financial Supranational Institution (32.9%), (18.5%), Financial Sovereign Institution (14.3%), (12.2%), Agency Sovereign (11.4%), (6.8%), Municipal Corporate (7.3%), (6.4%), Supranational Municipal (5.3%) (4.2%) Mainstream Mainstream investors investors with with envisocial sector ronmental as priority impacts as priority

Framework Green Bonds Social Bonds applicable Principals Principals (ICMA) (ICMA)

Sustainability bonds

SDG Bonds

Blue bonds

Environmental Focuses on Concentrates and social fulfillment of on ocean impacts Sustainable conservation Development Goals (SDGs)

Supranational (37.1%), Corporate (24.9%), Financial Institution (16.3%), Municipal (8.9%), Sovereign (7%), Agency (5.9%) Mainstream investors with ESG as priority

Agency, Governments, Financial banks, Institution, corporations Sovereign, Corporate, Supranational, Municipal

Guidance on Sustainability bonds (ICMA)

No global standards

Mainstream investors with SDGs as priority

Investors with CSR and generate benefit for the ocean and humankind Guidelines for Blue Finance (IFC)

Source Authors based on (ADB, 2021b; Environmental Finance, 2022; Flammer, 2020; IFC, 2022; United Nations, 2021)

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5.3

Social, Sustainability and SDG Bonds

The social bonds are attractive to investors as they not only generate the required social impact but also provide financial profitability (Pellizzari & Lecuyer, 2018). Social bonds allow investors to diversify their portfolios in terms of asset type and geographical location. Investors who want to generate social returns have preferred investing in Europe and subsequently expanded globally to build regionally diversified portfolios. In case of social bonds, there is a clearly defined social objective that gets fulfilled for the specific population. Social bonds cover categories such as affordable housing, access to basic infrastructure services such as water supply, sanitation, sewers, energy, and transportation, access to basic services such as healthcare, education and financial inclusion, food security, job creation, and socioeconomic advancement. In the Green Bonds Principles (GBP) 2016, to regulate the bonds that were focusing on projects with high social impact targets, Social Bonds Guidance was annexed. In the June 2017, separate guidance was provided for the issuance of social bonds—Social Bonds Principles (SBP) (Pellizzari & Lecuyer, 2018). Most of the social bonds issued between 2014 and 2019 focused on projects related to the provision of affordable accommodation. Dutch state-owned bank NWB issued $ 2200 million worth of social bonds for affordable housing. Another example is National Australia Bank’s $ 384 million gender equality bond. Social bonds have played an important role in helping different issuers deal with pandemic relief efforts. In 2020, the French unemployment agency “Unédic” issued social bonds worth EUR 8 billion in two tranches in a one-month gap. In 2020, the Ford foundation issued social bonds worth $ 1000 million (Takhtayeva, 2021). The European Union’s initiative to create a social taxonomy and the Sustainable Finance Disclosure Regulations (SFDR) aims to increase investor confidence in social bonds. One more category “Sustainability bond” was introduced, which was a combination of the environmental and social impacts, and this category is regulated by Sustainability Bond Guidance (SBG). Sustainability bonds do not have their dedicated principals as it is treated as an intermediate category and both the GBP and SBP can be used (Pellizzari & Lecuyer, 2018). Sustainability bonds are usually used for financing green and social projects. They are governed by International Capital Market Association (ICMA) through guidelines for project selection, use of proceeds, and

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reporting. The usage of sustainability related strategies is on the rise across the world. For example, more than a quarter of assets under management (AUM) incorporate sustainability-related strategies in the USA in 2018, an increase of nearly 38% from that of from the beginning of 2016 (Li, 2019). The thematic bonds investments aligns with the sustainability strategies as the use of proceeds is tied to a positive sustainability outcome which is meaningful to investors (CBI, 2022). Thailand government was the first issuer of a thematic bond which was also the first sovereign sustainability bond issued by any ASEAN country. Bond proceeds were allocated for refinancing capital expenditures for the Mass Rail Transit Orange Line (green project) and for public health-related expenditures post-COVID-19 (social project). Through this bond, Thai Baht 30,000 million for 15-year tenure was raised (Hussain, 2022). New South Wales Sustainability Bonds program was started in 2018 to issue the green and /or social bonds. This program is also aligned with the SDG targets of Australia as a nation. The first green bond was issued by TCorp in 2018 of AUD 1.8 billion of 10-year maturity. In 2019, the program issued its first sustainability bond of AUD 1.8 billion of 6year maturity. The program has allocated proceeds to various areas such as clean transport, sustainable water, and wastewater management, and access to essential services. These areas have green bonds proceed allocation of AUD 3100 million and sustainable bonds proceeds allocation of AUD 2100 million (NSW TCorp, 2021). The governments are likely to continue to deploy and utilize the proceeds from the issuance of sustainability bonds for climate mitigation and adaptation projects. It is believed that such issuances in future would combat the impact of climate change and facilitate governments to meet the commitments made in the Paris climate agreement, besides helping them to stagger the spending on projects spread over several years in a systematic manner. This will also allow the governments to achieve the program targets across categories such as clean water, restoration of biodiversity, green transportation, providing more employment opportunities, adaptation to climate change, and so on. The challenge, however, is to monitor the results during the utilization of such proceeds by setting out the right type of key performance indicators (KPIs) for the implementation agencies to comply with. The second challenge would be to determine if these KPIs could be made public and are achieved over the longer term. Presently in the sustainability-linked loan (SLL) market, the

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ESG rating is seen as the parameter for measuring the achievement of results in utilizing the proceeds. Its effectiveness may, however, need to be still ascertained (Environmental Finance, 2021). The issuers of these types of sustainability bonds are largely government and other agencies, who consider them useful in dealing with social and environmental risks on account of climate change and other problems confronting them. Given the success of the various issuances by governments in December 2016, along with the green bonds issued by Poland, Egypt, and Mexico, it is felt that the growth of green bonds from governments and agencies is likely to see a further increase post the pandemic period (Environmental Finance, 2021). These types of bonds have significantly contributed to fight COVID-19 19 and mitigate the negative impact on the social and economic conditions. The Bank of America had issued a $2 billion Equality Progress Sustainability bond that aims to support racial equality, opportunities for all and environment sustainability. Sustainability-linked bonds provided a further innovation in the thematic bond space. This category has witnessed rapid growth due to accepted market standards and the usage of proceeds for general purposes. The issuers had greater flexibility in using the monies raised for different purposes and were not tied as closely to the specific sectors or projects. Out of the 43 sustainable linked bonds studied, which were launched between June 2020 and April 2021, they addressed an average of 1.6 key performance indicators per issuance with an average sustainability performance target achievement time period of 4.7 years. Less than a quarter of the sustainable performance targets have science-based measurement criteria. The financial payouts of these sustainability-linked bonds change based on whether the key performance indicators meet the pre-agreed sustainability performance targets. So far, sustainability-linked bonds have structured variable coupon payments (either interim or at maturity of the bond), and additional payments (via coupon or lump sum) to the nonprofit organizations. The investors expect the issuers to meet their targets in general. However, if there is a continued suboptimal performance, the sustainability-linked bonds might have increased selling pressure and a risk that the non-performing issuer will find it difficult to raise more money in future. Over time, the financial characteristics of this product are expected to become more precise as the market correctly prices the risk of the sustainability performance targets not being met (Moody’s, 2021).

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In 2020, a new paradigm on the GSSS bond came into existence from Mexico. The first sovereign bond issue was made by the government and the proceeds of this bond were tied to UN SDGs. They were to be utilized for eligible green or social projects in the areas of sustainable infrastructure, rural development and agriculture, health care, education leading to employment generation. It was also meant to cater to areas where there have been larger social gaps (Giráldez & Fontana, 2021). A new type of sovereign bond known as the “Pandemic Bond” was issued by Indonesia in April 2020, the proceeds of which is to provide relief to people affected by COVID-19. This was followed by Israel with a USA$1 billion fund for 100 years to deal with the pandemic. ICMA encouraged the issue of social bonds for mitigating social issues to mitigate the impact of COVID-19 (Giráldez & Fontana, 2021). Even though, GSSS bonds have come in existence in recent times, its architecture has evolved continuously and latest addition to the bouquet is the sustainability-linked bonds’ issuance by private sector participants. These bonds are also known as “Key Performance Indicator” (KPI) bonds. As the name suggests, the bond’s interest rate is linked with sustainability-related target achievement by the issuer within pre-defined timelines. The proceeds of the bonds can be used at issuer’s discretion, and there are no defined criteria which enforces the use of proceeds for certain activities or manner. Though KPI bonds are new to the market, their presence is growing quickly. Multinational energy company from Italy—Enel was the first one to issue KPI bonds. Followed by many others—Suzano (paper and pulp producer), Novartis (multi-national pharmaceutical company), and Chanel (luxury fashion label) to name a few and many more issued KPI bonds in recent months. KPI bonds bring along innovative combination in terms of letting use of proceeds to be used at discretion and advantages of the GSSS bonds (Moody’s, 2021). KPI bonds were envisaged to ensure performance by the issuer in the utilization of the funds according to the pre-defined environmental, social, or sustainability linked targets. Failure to comply with this condition would entail “coupon step-up” interest rate on the bonds if the specified and time-bound targets are not met (A step-up bond is a bond that pays an initial interest rate but has a feature whereby set rate increases occur at periodic intervals.). The KPI bonds may not have an identified end use in terms of specific theme, but are pegged to the achievement of a predetermined green, environmental, social, or sustainability aspect. If the issuer fails to achieve the stated KPI target, the financial payments or

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the structure of the instrument changes to the benefit of the investors. Most of the KPI bonds issued to date include a condition of “coupon step up”, i.e., the coupon rate increases by a predetermined number if the issuer fails to achieve KPI target by a cut-off date. The structure of the bond is aimed to incentivize the issuer to meet the KPI targets rather than as a penalty for non-performance. The issuance usually does not have any covenants for non-fulfillment of the KPI targets rather the reputation and credibility of the issuer are at risk if the targets are not achieved (Giráldez & Fontana, 2021). SDG bonds are structured to support the issuer in targeting specific SDGs. The estimated investments required to meet the SDGs in the AsiaPacific developing nations is about $ 1.5 trillion per annum (UNESCAP, 2019) While green bonds have been distinctly popular over the years, however, sustainability and social bonds have been prominent in the recent past, from 2018, and followed by SDG bonds (Environmental Finance, 2021). The social, sustainability, and SDG bonds may become game changers in future for sustainable management of infrastructure assets. Two other categories of bonds that are becoming popular are social impact bonds and development impact bonds. These bonds’ structures are innovative as through such transactions, social causes are served by performance contracts. In this type of bonds, an intermediary raises capital from investors to make an impact. If the set outcomes are achieved, investors receive returns based on the outcome from the outcome payers. If the outcome payer is government, this bond is known as social impact bond and if the outcome payer is a philanthropic organization, such bond issuance is categorized as development impact bond. Collaboration between UNICEF and the Education Outcomes Fund (EOF) works towards fulfilling targets of SDG 4 by establishing a joint structure for delivering EOF’s numerous initiatives in different geographies. In Rajasthan (India), Utkrisht Bond works towards providing better maternal care to women to reduce the number of mother and baby deaths. This bond is expected make impact on 600,000 pregnant women and saving almost 10,000 lives over the period of five years. In the same state of India, another bond named “Educate Girls” impact bond intends to improve learning outcome of the children living in the remote areas of the state. This bond aims to cover approximately 20,000 children (Environmental Finance, 2021).

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5.4

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Biodiversity

The tackling of biodiversity loss is one of the important priorities currently dominating the conservation sector. The introduction of fiscal incentives to facilitate positive actions may play a key role in helping to reverse this loss. Biodiversity offsets are used in developed countries such as the USA, UK, and Australia. These, operating in a similar fashion to the carbon credits, are used to fund initiatives to mitigate the negative impact on biodiversity in some other places. Porras and Steele (2020) define “Biodiversity credits or ‘bio-credits’ are coherent units of measurement that track conservation actions and outcomes and can help improve tracking and transparency.” For example, government funding for coral reef conservation will always be essential but may never be sufficient. Donor funding may partly fill the conservation finance gap, yet it plays an important role in leveraging private capital, including philanthropic organizations. If these are well designed, they can make investments in biodiversity management more financially attractive, especially for the private sector. Governments can use them to monitor their actions and report on biodiversity commitments. Increasingly, new financing tools and sources are required to achieve financially sound conservation of coral reefs and protection of biodiversity (Porras & Steele, 2020).

5.5

Blue Bonds

In addressing the risks to the ocean on account of climate change and significant human activities, substantial investments are needed to sustain the ocean activities. Limited efforts are made to attract private capital to ensure sustainable growth in ocean activities (Mathew & Robertson, 2021). The Republic of Seychelles launched the world’s first blue bond in October 2018. Its $15 million issuance is envisaged to finance ocean protection projects and thus give an impetus to the country’s burgeoning fisheries sector (WB, 2018). It has a coupon rate of 6.5% to be redeemed in three equal installments of $5 million each during 2026, 2027, and 2028 (Tirumala & Tiwari, 2020). This was deemed to be a first of its kind financial instrument aimed to develop sustainable marine and fisheries projects in the country and in the waters comprising its exclusive economic zone (Silver & Campbell, 2018). As the country’s tax base is small, considering that such a big issue may suffer from liquidity issues

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due to significant interest payments, the issue was supported by a partial guarantee from the World Bank and a concessional loan from the Global Environment Fund (GEF) (SeyCCAT-WB-GEF, 2019). This transaction was expected to fast track the growth of a blue bond market similar to the first green bond issuance more than a decade ago which transformed the green-labeled debt market. The Fig. 5.1 below sets out the structure of the Seychelles initiative. While the idea of structuring a bond specifically to address the ocean and marine-based projects existed in theory for a while, Seychelles blue bond demonstrated that the debt instrument could actually be brought into practice. Seychelles intended to utilize the proceeds from their issuance for three specific purposes: (i) investments to support the expansion of the economic zone with appropriate restrictions on fishing; (ii) enhancing the capacity of the institutions and developing key management plans relating to fisheries; and (iii) developing its blue economy sustainably through investments in the related sectors (IFLR Correspondent, 2019). The Seychelles blue bond framework was developed in collaboration with the World Bank. In contrast, the subsequent blue bond issuance from the Nordic Investment Bank adopted a framework that more closely resembles that of a green bond. The existing

Fig. 5.1 SeyCCAT Blue Fund (Source Authors based on [Bolliger & John, 2020; Pouponneau, 2015; The Commonwealth Blue Charter, 2020; World Bank, 2017])

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green bond framework addresses the first two purposes of expanding the marine protected areas and better governance of fisheries. Seychelles’ blue bond framework has conceptually taken a step towards specific thematic bond frameworks by incorporating a third purpose of developing the blue economy sustainably. This demonstrates that the country has taken cognizance of the fact that while limiting the priority of fishing activities is vital for the long-term sustenance of the economy, the unintended consequences would be the impact on the livelihoods of people prevented from participating in such activities. The third item in the blue bond framework acknowledges that the affected people need to be compensated for their losses incurred due to the first two activities. The broader blue economy projects were intended to support the affected people in engaging in activities such as building port infrastructure, marine food, or industrial processing, some of which do not align very well with the green bond or sustainable bond frameworks. By deliberately including such components in its blue economy strategy, Seychelles has signaled its intention for a more holistic engagement with the stakeholders and the broader blue economy ecosystem (IFLR Correspondent, 2019). The World Bank has provided a partial guarantee to the blue bond, which needs to be structured to ensure that the same does not violate its policies. In a conventional guarantee issued by multilateral development banks such as the World Bank, there would be covenants or restrictions on the underlying loan to be transferred to other parties. It is typical that World Bank would require that the identity of the transferee of the loan amount be known and, in some instances, need its approval. The knowledge about the loan holders (“know your customer”) is required as the World Bank needs to adhere to sanctions that may be present in different jurisdictions. However, under the structure of the Seychelles bond issuance, the bonds can be traded freely through electronic clearing systems, making it difficult for the World Bank to be aware of the background of the bond purchasers. To overcome this issue, the World Bank devised a Good Actor Regime that stipulates that the commitment of guarantee will hold good only upon the transferee bondholder certifying that they meet all the required criteria of being a good actor. The failure to provide such authentication by the transferee would mean that they cannot access the guarantee mechanism. This innovation has helped in the World Bank retaining its regular safeguards against making guaranteed payments to transferees who do not qualify under the good actor regime (IFLR Correspondent, 2019).

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The electronic clearing system, however, do not generally block or allow a smaller pool of investors from its system. The Good Actor Regime mandated that the trade in the bonds be stopped while the eligibility was confirmed. As the guarantee provided by the World Bank is expected to be called upon only in extreme circumstances, i.e., when the Seychelles government fails to honor its obligations of debt service requirements, this system innovation was acceptable. This could very well become the norm regarding KYC requirements going forward to comply with sanctions imposed by different agencies (IFLR Correspondent, 2019). The blue bond issuance would also need to be considered from the perspective of the other innovative structure that the Seychelles government has undertaken in collaboration with The Nature Conservancy, the debt for nature swap. This instrument allowed the government to free up funds from its natural debt to invest in the marine conservation area with “no-take” and “Sustainable use” zones. Out of the $15 million raised in blue bonds, $3 million was combined with another $20.2 million raised from the debt-for-nature swap, and passed on to a natural trust fund termed as The Seychelles Conservation and Climate Adaptation Trust (SeyCCAT), which was managed jointly with the Development Bank of Seychelles (DBS). The fund is expected to play a pivotal role in developing the marine spatial planning zones through grants to eligible entities through its subsidiary, The Blue Grants Fund. The remaining $12 million was placed in a Blue Investment Fund, which deploys concessional loans to projects that meet the safeguards of the World Bank. SeyCCAT was responsible to provide grants to the private sector, and it would analyze the feasibility of the business proposals put forth by the developers. Welldeveloped business plan attracting an interest rate of about 4% would have an advantage. The condition put forth by DBS while approving the applications for loan largely from NGOs, local stakeholders, and smallscale fisher folk was that the project proposed should be sustainable. It was felt that the hybrid mechanism of the blue bond encouraged the local entrepreneurs by significantly mitigating their business risk (Shiiba et al., 2021). The initiative to have a broader blue economy growth has contradictions as the oil and gas industry players were also included in the deliberations. The fishing industry has raised concerns over the stricter regulations, with the intention of the government to include the oil and gas sector within the exclusive economic zone affecting the green image of the Seychelles government. There were concerns on the transparency

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of the marine spatial policy initiative as the details of how the various industries come together is not very transparent (Bolliger & John, 2020). The aim of the Seychelles government seemed to functionally align the themes of sustainable development, conservation, and climate change. There was a push from a few stakeholders to use the blue economy initiative to deliver results across all the SDGs. For instance, Seychelles has supported the installation of wind turbines on reclaimed land, thereby reducing the reliance on fossil fuels through renewable energy. There is a push to consider offshore wind turbines also, which could have a positive effect on the fishery sector (Moolna & Thompson, 2018). Similar to the carbon credits market, which has witnessed rapid growth, there are attempts to create similar products by different financial institutions. ADB has suggested the formulation of blue credits to convert the economic benefits into financial ones and encourage the participating stakeholders to take a share in the implementation of the blue economy projects. They have suggested that the blue credits can also be used to provide shadow revenues for projects that contributed to the achievement of the specified metrics (ADB, 2021a). ADB’s Blue SEA Finance Hub, based out of their Jakarta office, is set up with an objective to accelerate the development of blue economy projects in a manner consistent with achieving its Ocean Finance Initiative and, in turn, achievement of SDG 14 (ADB, 2022). Green Climate Fund’s (GCF) proposed Blue Co, a sustainable blue economy Co-investment facility, aims to bring flexible capital from different sources into an open investment platform, and is expected to collaborate with many development partners. This facility loosely follows ADB’s Blue SEA Finance Hub concept. This innovation to fund the blue economy sector demonstrates the complexities involved not only in developing appropriate instruments but also the challenges that are likely to be encountered while implementing the project. It is important to see the infrastructure ecosystem in a holistic manner while pursuing innovation.

5.6

Discussions

The size of the thematic bond market has been galloping in the last few years; however, it is still a fraction of the international fixed income markets (Wilson, 2018), the growing pace of green bond funds. The growth of the thematic bond market signals commitment to a particular premise by the issuer. Investors have considered criteria like bond issuer’s

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risk profile, credit rating, and financial returns. However, in the case of thematic bonds, investors’ primary evaluation criteria is that if the bond proceeds then it will be deployed for environmental or social causes, as the thematic bonds concentrate on the utilization of the bond proceeds for demonstrating environmental, social, and governance (ESG) principles. Due to this uniqueness, thematic bonds are considered to be innovative (United Nations, 2021). Initially, it was envisaged that with the advent of thematic bonds, the dependence on budgetary funding for infrastructure would gradually minimize over a period. However, this has not happened if one sees the recent experience in the global bond markets. A few countries, such as UK, have initially stated that thematic bonds affect conventional debt-raising efforts by reducing efficiency and liquidity through fragmentation of the market (Financial Times, 2020). The UK had subsequently launched their green gilt program in September 2021. Over the period of the time, continuously growing awareness and recognition to tackle the climate change and SDGs have motivated many investors incorporate the environmental and social concerns in their business strategies. This will be the reason for future market growth of the thematic bonds. As per Environmental Finance (2022), this trend is expected to continue. Another point highlighted by the same report is that both the issuers and investors have started to appreciate the importance of incorporating thematic bonds in their corporate objectives to achieve their defined environmental and social objectives. Also, investors’ increasing willingness to produce more positive social impacts will lead to further innovation in labeled bonds’ issuance starting from the project types, diversification of issuers, and bond structures (Environmental Finance, 2022). The question that the multilateral development institutions grapple with when structuring such issuances is whether the universe is large enough to attract institutional investors over a longer term. The issuers, public entities in most cases, are keen to attract cheaper and longer tenor sources of finances, but the underlying project pipelines barely meet the criteria required for the use of proceeds’ norms. Any adjustments to the framework or the definition of the project scope leads to the concerns of “green” or “blue” washing, as the case may be. Once the realm of the projects extends to those that have substantial economic benefits but not enough financial cash flows, which many of the conservationrelated or social sector projects tend to be, the need for guarantees

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increases manifold. Providing such guarantees either by the public sector (sovereign) or by multilateral, bilateral development agencies point to an indirect assumption that the project dynamics are not self-sustaining (Walsh, 2019) This, however, also needs to be seen in the context that guarantees have become a common component of infrastructure financing packages. The thematic bonds have brought in a better focus on delivering the final services rather than financing the upfront capital costs alone. For instance, a social impact bond can be issued to pay for the independently verified outcomes of the training of people who have been released from prison. This contrasts with the conventional mode of upfront payment for the training of that group. The structure of the thematic bond can enable the government, which are typical off-takers of social impact bonds, to measure the outcome and pay accordingly (say with a metric of the number of beneficiaries who gain employment or an educational qualification). This class of thematic bonds structured with payments for achieving particular outcomes (sustainable, social, and environmental good) has brought in a much-needed change from the earlier focus on inputs to the delivery of services (Iyer et al., 2018). The concept has been expanded to address different situations. In times of extreme weather events such as high temperature, floods, and heavy and continuous rainfall and storms, it is difficult to assess accurately the damages that the infrastructure asset (for example, a hydel power plant vs toll bridge) may sustain. Therefore, at the development stage of an infrastructure project, it is essential to consider and anticipate climatic conditions at its location and estimate the expenditure that may be needed to restore the asset to its original condition. This would require careful consideration of the impact on an asset over its life in terms of inundation, water stress, and location-specific extreme weather conditions, if any. Therefore, at the time of conceiving the bond issue on a resilience project, it is to be confirmed that these factors are taken into consideration so that it becomes easy for the issuer during the repayment period and lends comfort that all necessary steps were taken during construction of the asset keeping in view the likely extreme climatic conditions (Environmental Finance, 2021). Another type of thematic bond, “Resilience Bond”, is issued for adaptation and resilience projects meeting the requirements emerging out of climate resilience. This is proving to be an attractive investment for large

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institutional investors striving to integrate ESG factors into their portfolios. The first resilience bond was issued by the EBRD in 2019, which was oversubscribed by $700 million and was to be used to avoid impacts on a community or project on account of an extreme climatic event (Bennett, 2019). With the rise in issuances of resilience bonds, properly tracking and reporting are becoming vital for the market to quantify the value of resilience. Timely investments to prepare for extreme events pay off significantly, compared to repeated renovations and rehabilitation when a calamity strikes. This is becoming necessary with the increased frequency of climate change-driven events (Environmental Finance, 2021). In the case of resilience bonds, upfront commitment to programs that promote resilience would greatly help in mitigating the substantial expenses when faced with an event endangering the ecosystem. In the case of catastrophe bonds, the payments can be structured in a manner that reflects the need when a calamity strikes. If there is no disaster occurrence, the bondholders could be paid back both the principal and the interest. However, if a disaster occurs, the principal amount is used to mitigate the costs towards recovery and the bondholders receive only the interest component. More recently, institutional investors such as Blackrock, Vanguard, and others have expressed a greater interest in addressing climate change concerns through their investments, thereby pushing up the demand for sustainable instruments. KPI bonds go a step further than GSSS bonds by defining KPIs that are central to the issuer’s sustainability and business strategy. When the sustainability performance targets are missed, the bond interest rate increases (“step-up” clause). The variation in interest rates is a structural characteristic of the bond that offers a clear financial advantage to investors, should the step-up clause be triggered. Since these bonds reflect a strong commitment to social and environmental targets, there is a surge in demand for KPI issuances surpassing all previous expectations. Most of these issuances were not only oversubscribed two times but also saw a larger subscription by each investor when compared to regular bonds. Based on anecdotal evidence, KPI bond issuers have also enjoyed a pricing benefit of 50–75 points, when compared to bonds issued by the same issuer that are similar in nature (Giráldez & Fontana, 2021). These instruments incentivize investors to transition towards more climate friendly investments beyond just profits, and to take a long-term view of the consequences of their financial investments. Transition finance is also being looked at to support many organizations moving from their carbon intensity activities to those aligned with

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the net zero low-carbon ones. A substantial quantum of funds is required to finance this transition. A category of the thematic bonds “transition bonds” are being configured. The investors are finding it attracted to participate in the credible transition efforts of various organizations from their current carbon intensive activities to a decarbonized state in the alignment with the net zero system. This segment is just finding its foot in the broader thematic market. Snam, the Italian energy company, and Cadent, the UK major, are notable issuers in the segment. The banks are also supportive of such initiatives; the Bank of China (Hong Kong branch) is showing its first transition bond, the proceeds of which are proposed to be used for cement plants (in waste heat recovery and electricity generation) (CBI, 2021). The launch of the various thematic bonds needs to be seen as an important stage in the trajectory of developing financial instruments for securing long-term reliable funding to achieve the triple bottom line. The efforts for financing the sector have gone beyond the launch of debt instruments to much more nuanced structures. ADB’s Blue SEA Finance Hub and the GCF’s Blue Co are examples of institutional initiatives that aim to bring together the different stakeholders, both on the supply side and on the demand side, to the financing of the blue economy. There are broad-based efforts to develop the frameworks, including the taxonomies, institutional structures, and financial instruments. A practical guidance document was prepared by the UN Global Compact and the Sustainable Blue Economy Finance principles by UNEP FI.

5.7

Challenges

The breakneck pace at which the thematic bond market is growing did not allow for a critical assessment of how the various stakeholders benefited or faced unintended consequences. The limited research so far did not present engagement in a constructive debate on the broader position of the thematic bonds in the policymaking spectrum. The argument for having theme-specific innovative financing instruments emerges from various contemporary priorities that hold sway at the moment in time. The concern relating to unclear additionality is the potential risk that the thematic bond issuers face. The issuers of thematic bonds, similar to those of the green bonds, have activities that are not so benign to the environment or the society (Razzouk, 2018).

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The growth of the blue economy and its instruments are cases in point. Initially, the perspectives that oceans offer high growth potential and that they have an economic frontier of significance (OECD, 2016; Steinberg & Kristoffersen, 2018) were emphasized in the Abu Dhabi declaration, the view that was supported by high-income countries. This was followed by a substantial push in the institutional and economic literature on oceans being the drivers of innovation (Voyer et al., 2018). The perspective of the environment conservation stakeholders emphasizes the need to treat the natural capital as an important component of the overall economy that need not be financialized (Dempsey & Suarez, 2016). The taxonomies articulated by the World Wide Fund for Nature (WWF) in 2015 focus on giving credence to oceans as the natural capital. However, the need to find resources to support the blue economy meant that the protection articulated was never fully made available. There were unintended consequences. The UN’s perspective of oceans being considered as a source of livelihood, together with the initiatives by different governments, including Seychelles, China, and Norway, is providing a potential positioning of the blue economy within the broader economic realm. The frameworks are still evolving with no internationally accepted definition prevalent at this point in time. There are numerous initiatives for creating particular thematic frameworks, for instance, that of the blue framework. IFC, ADB, Climate Bonds Initiative, etc. have been drafting their own versions of the taxonomy, which hopefully, over a period of time, might converge in all respects. Currently, the sectoral definition of the blue economy is wide to include aquafarming, offshore wind, logistics, eco-tourism, and tidal power technologies. However, there is a debate about whether to include initiatives to improve fuel efficiency in commercial shipping in the definition of the blue sectors and, consequently, the blue finance. The evolution of thematic bonds allows for the stratification of the market with those who would like to embed the environment, social, and governance in their investment portfolio decisions. The concern for the growth of the thematic bond market is more philosophical. The conservation interest groups are hesitant to see the discourse becoming more financial that is assessing the investment decisions largely based on financial feasibility and cash flows (Credit Suisse, 2016). While the thematic bond market is being presented as a clearly identifiable functional market segment, it faces challenges for a wider scaling up and mainstreaming of the usage of various instruments. The underlying sectors

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that the thematic bonds attempt to finance continue to face the challenges relating to the absence of long-term project pipelines, yet to be developed, and accepted taxonomies, limited due diligence capability of the investors, the mismatch of the scale with the potential participation profile of the investment community, lack of suitable aggregation mechanism of the individual projects, the lack of uniformity in the underlying project profiles, implementation structures, the instability, and uncertainty of the cash flows (ADB SDG Accelerator Bonds, 2021). These challenges are substantial and can be addressed only when there is a broader development of the business models of individual projects or subsectors. Experience shows that typically KPI bonds have been issued and managed by the private sector, and if governments were to adopt this, they need to consider various aspects such as setting out the right kind of targets for performance, its measurement mechanism, and an acceptable method of verifying the performance of the fund preferably through a third-party agency. Appropriate regulations and guidelines need to be framed in this regard (Giráldez & Fontana, 2021). Investors are becoming more nuanced and are not afraid to take corrective actions if they find that the issuers are not adhering to the stated objectives. There are instances where the investors have expressed their concerns in public fora or threatened to sell their positions if the issuers do not take any remedial action. NN Investment Partners, a Netherlands based asset manager, had stated that Poland’s Green Bond does not meet their green bond portfolio requirements as the government does not have a sufficiently strong policy for transitioning from coal-based electricity generation (Allen & Shotter, 2018; NN Investment Partners, 2019). The Amundi Planet Emerging Green One fund, the first green bond fund focused on emerging markets, declared that it would exit the State Bank of India’s green bonds if the bank were to finance a coal mine in Australia (Retures, 2020). This bodes well for the influence of the market to ensure that the underlying environmental, social, and governance-related issues are taken seriously. There are many challenges that can lead to slower market growth even though it seems that both investors and issuers will continue to stay interested in social bonds post COIVID-19 too. Some of them are inadequate standardized metrics for impact measurement, which in turn leads to the probability of “social washing” (similar to green washing—overstating the social value of a bond), more market depth requirement from both volume and diversity perspectives, lack of adequate training of financial

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advisers, and inadequate social bond framework (ADB, 2021b). While the growth of ESG investing is very rapid, there are arguments against the same by a few researchers. For example, Dr. Aswath Damodaran, NYU Stern School of Business, has called ESG investing a “Goodness gravy train that is rolling on”. He states that the benefits of ESG continues to be subjective and difficult to measure accurately (in a manner that is universally accepted). Like any other investment modality, ESG investing is good for a few companies, has a negative impact for others, and remains unaffected for the third set of organizations (Damodaran, 2021). As the thematic bonds market has evolved, disclosures related to the use of proceeds have emerged as a crucial aspect. There are many instances when issue of greenwashing has been raised. Issuers try to gain the “green image” without incorporating strategic measures related to the bond issuance in the business operations. There are opponents of transition bonds who raise questions about genuineness of such instruments. On the other side, proponents of such bonds argue that economic transformation is difficult if everything is considered in terms of “black and white”—for example—full capital flow restriction on any specific sector is not possible considering the complexity of existing system. However, it needs to be acknowledged that provision of the separate transition label to the bonds helps investors in identifying relevant bonds for their strategy alignment and also provides transparency (Pratsch, 2022). It is necessary to highlight at this crucial juncture that to build a robust thematic bonds’ market, best practices in the form of regulations or voluntary guidelines need to be adopted. Also, it is important that what type of ESG narrative is company bringing to the market (Environmental Finance, 2022). The expectation from sustainable investing is not to compromise on the financial returns for gains on the environment, social, and governance benefits. For example, nearly 93% of the surveyed impact investors indicated that their investment performance is either on power or exceeded their hurdle rates (GIIN Research Team, 2018). Bank of America stated that the three-year returns of the sustainable investment stocks to be higher than that of the peers. Barclays mentioned that “sustainable investing has been beneficial to bond returns”. A Black Rock study indicates that in the emerging markets, ESG investments outperformed the conventional investments by 1.5% annualized returns (9.1% for ESG investing vis-a-vis 7.8% for conventional investing) (Li, 2019).

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Conclusions

The thematic bond market is gaining traction after the renewed international focus on ecological, environment conservation and achieving sustainable development goals. The individual sectors under the broad categorization of thematic bonds address a diverse range of applications. However, the contribution of these instruments in achieving the triple bottom line of economic growth, environmental sustainability, and social welfare needs to be better understood. Governments in future are likely to depend upon the issue of thematic bonds to fund climate mitigation and adaptation projects. These kinds of bonds not only meet the Paris agreement commitments but also help in combating the negative impact of climate change. The thematic bonds are widely diversified and can target to achieve several goals for a longer duration of time. They can be usefully deployed for climate adaptation, water management, restoration of biodiversity, green transportation, and to achieve the overarching objective of the State to reduce unemployment (Environmental Finance, 2021). The thematic bond issuances demonstrate the innovative use of blended finance across a variety of sectors. Unlike green financing, which is linked to the reduction of greenhouse gases, there is no universally accepted metric that measures the performance of the thematic bond sectors. The financing strategies of most stakeholders (sovereign, public sector, and private and financial institutions) are expected to include the environmental, social, and sustainability elements as the core factors going forward. Finance continues to have the potential to influence good behavior provided an appropriate policy and institutional and governance frameworks are set in place.

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Flammer, C. (2020). Green bonds: Effectiveness and implications for public policy. Environmental and Energy Policy and the Economy, 1, 95–128. https:// doi.org/10.1086/706794 Ghosh, R., Nwanna, K., & Cliquet, B. (2021). Credible targets and structures key to long-term growth of sustainability-linked bonds. https://assets.web site-files.com/5df9172583d7eec04960799a/60a1da152e1185ea3f5f7566_ BX6396_MESG_SLBs_17May2021.pdf GIIN Research Team. (2018). Annual impact investor survey. https://thegiin. org/assets/2018_GIIN_Annual_Impact_Investor_Survey_webfile.pdf Giráldez, J., & Fontana, S. (2021). Sustainability-linked bonds: The next frontier in sovereign financing. SSRN Electronic Journal. https://doi.org/10.2139/ SSRN.3829946 Harrison C., MacGeoch M., & Michetti C. (2022). Sustainable debt global state of the market 2021. Climate Bonds Initiative. https://www.climatebonds. net/files/reports/cbi_global_sotm_2021_02f.pdf Harrison C., & Muething L. (2021). Sustainable debt: Global state of the market 2020. https://www.climatebonds.net/resources/reports/sustainabledebt-global-state-market-2020 Hussain, F. I. (2022). Thematic bonds to diversify fiscal sources. The Sustainability of Asia’s Debt: Problems, Policies, and Practices, 409–425. https://doi. org/10.4337/9781800883727.00027 IFC. (2022). Guidelines for Blue Finance. https://www.ifc.org/wps/wcm/con nect/cdbfb6c5-2726-47a6-9374-6a6f86032dd4/IFC-guidelines-for-blue-fin ance.pdf?MOD=AJPERES&CVID=nWxsyxN IFLR Correspondent. (2019). Behind the deal: Seychelles’ landmark blue bond. International Financial Law Review. https://www.proquest.com/docview/ 2193076275 Iyer, V., Mathias, K., Meyers, D., Victurine, R., & Walsh, M. (2018). Finance tools for coral reef conservation: A guide. https://www.conservationfinanceal liance.org/news/2019/2/28/cfa-publication-finance-tools-for-coral-reef-con servation-a-guide Li, H. H. (2019, May 26). 5 Questions about Sustainable Investing | ISEP. Initiative for Sustainable Energy Policy. https://sais-isep.org/5-questionsabout-sustainable-investing/ Mathew, J., & Robertson, C. (2021, January 12). Shades of blue in financing: Transforming the ocean economy with blue bonds. DLA Piper. https://www.dlapiper.com/en/us/insights/publications/2021/ 01/shades-of-blue-in-financing/ Moody’s. (2021). Credible targets and structures key to long-term growth of sustainability-linked bonds. https://assets.website-files.com/5df9172583d7 eec04960799a/60a1da152e1185ea3f5f7566_BX6396_MESG_SLBs_17M ay2021.pdf

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Moolna, A., & Thompson, B. S. (2018). The Blue Economy approach for sustainability in Seychelles & East Africa. Keele University Institute for Sustainable Futures Discussion Paper 1. https://doi.org/10.21252/b4wm3598 NN Investment Partners. (2019, December 5). Green Bond Bulletin: Market growth, green QE and beware of greenwashing. NN Investment Partners. https://www.nnip.com/en-INT/professional/insights/articles/ivgreen-bond-bulletin-market-growth-green-qe-and-beware-of-greenwashing NSW TCorp. (2021). NSW Sustainability Bond Programme. https://www. tcorp.nsw.gov.au/resource/NSW_Sustainability_Bond_Programme_Annual_ Report_2021.pdf OECD. (2016). The Ocean Economy in 2030. OECD. https://doi.org/10. 1787/9789264251724-EN Pellizzari, M., & Lecuyer, J.-M. (2018). The Social Bond market: towards a new asset class? https://www.icmagroup.org/assets/documents/Regula tory/Green-Bonds/Public-research-resources/II-LAB2019-02Social-Bonds130219.pdf Porras, I., & Steele, P. (2020). Making the market work for nature. How biocredits can protect biodiversity and reduce poverty Economics; Biodiversity Acknowledgements Produced by IIED’s Shaping Sustainable Markets Group. http://pubs.iied.org/16664IIED Pouponneau, A. (2015). Blue economy and finance in practice: An example from the Seychelles. Division for Oceans Affairs and the Law of the Sea. https:// www.un.org/Depts/los/nippon/SustainableOceanEconomies_final.pdf Pratsch, M. (2022, February 16). The sustainable bond market in 2022 and beyond - transition is key! Environmental Finance. https://www.environme ntal-finance.com/content/the-green-bond-hub/the-sustainable-bond-mar ket-in-2022-and-beyond-transition-is-key!.html Razzouk, A. (2018, March 6). Green bonds do more harm than good | Opinion | Eco-Business | Asia Pacific. Eco-Business. https://www.eco-business.com/ opinion/green-bonds-do-more-harm-than-good/ Retures. (2020, November 27). Amundi gives bond warning to State Bank of India over coal mine. Reuters. https://www.reuters.com/article/amundistate-bank-india-letter-idINKBN28725H SeyCCAT-WB-GEF. (2019). Innovative financing for healthy oceans. SeyCCAT. https://seyccat.org/wp-content/uploads/2019/03/The-Seychelles-ModelThe-Worlds-First-Sovereign-Blue-Bond.pdf Shiiba, N., Wu, H. H., Huang, M. C., & Tanaka, H. (2021). How blue financing can sustain ocean conservation and development: A proposed conceptual framework for blue financing mechanism. Marine Policy. https://doi.org/ 10.1016/J.MARPOL.2021.104575

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Silver, J., & Campbell, L. (2018). Conservation, development and the blue frontier: The Republic of Seychelles’ Debt Restructuring for Marine Conservation and Climate Adaptation Program. Article in International Social Science Journal. https://doi.org/10.1111/issj.12156 Steinberg, P., & Kristoffersen, B. (2018). Building a Blue Economy in the Arctic Ocean: Sustaining the sea or sustaining the state? The Politics of Sustainability in the Arctic, 136–148. https://doi.org/10.4324/9781351031981-9 Takhtayeva, M. (2021, November 23). Social bonds – A tool to effect positive social change. Viewpoint. https://www.bnpparibas-am.com/viewpoint/ social-bonds-a-tool-to-effect-positive-social-change/ The Commonwealth Blue Charter. (2020). Innovative Financing-Debt for Conservation Swap, Seychelles’ Conservation and Climate Adaptation Trust and the Blue Bonds Plan, Seychelles. https://production-new-commonwea lth-files.s3.eu-west-2.amazonaws.com/s3fs-public/2022-02/Case%20Study% 20-%20Innovative%20Financing%20%E2%80%93%20Debt%20for%20Conserv ation%20Swap,%20Seychelles%E2%80%99%20Conservation%20and%20Clim ate%20Adaptation%20Trust%20and%20the%20Blue%20Bonds%20Plan,%20S eychelles%20(on-going).pdf Tirumala, R. D., & Tiwari, P. (2020). Innovative financing mechanism for blue economy projects. Marine Policy. https://doi.org/10.1016/j.marpol.2020. 104194 UNESCAP. (2019). Economic and Social Survey of Asia and the Pacific 2019 Ambitions beyond growth. https://www.unescap.org/sites/default/d8files/ Executive%20Summary_Survey2019%20%28English%29.pdf United Nations. (2021). An introduction to issuing Thematic Bonds. https:// www.unescap.org/sites/default/d8files/knowledge-products/Draft%209_ An%20Introduction%20To%20Issuing%20Thematic%20Bonds_web.pdf Voyer, M., Quirk, G., McIlgorm, A., & Azmi, K. (2018). Shades of blue: What do competing interpretations of the Blue Economy mean for oceans governance?, 20(5), 595–616. https://doi.org/10.1080/1523908X.2018.1473153 Walsh, J. (2019, October 21). Investing in the oceans - Environmental Finance. Environmental Finance. https://www.environmental-finance.com/content/ analysis/investing-in-the-oceans.html WB. (2018, October 29). Seychelles launches World’s First Sovereign Blue Bond. World Bank. https://www.worldbank.org/en/news/press-release/ 2018/10/29/seychelles-launches-worlds-first-sovereign-blue-bond Wilson, M. (2018). The growing pains of green bond funds. https://www.env ironmental-finance.com/content/analysis/the-growing-pains-of-green-bondfunds.html World Bank. (2017). Project appraisal document. https://documents1.worldb ank.org/curated/en/394051505478217219/pdf/SEYCHELLES-PAD-091 22017.pdf

CHAPTER 6

The Appeal of Land-Based Financing Instruments

Each man shall pay taxes in exact proportion to the value of his property. —Abraham Lincoln Land value capture isn’t a silver bullet but rather an additional revenue stream resource for regional governments that is currently under-utilized. —Luis Quintanilla Tamez, Policy Analyst, Lincoln Institute of Land Policy

6.1

Introduction

The rapid pace of urbanization is placing undue stress on infrastructure and public service delivery in cities across the world. In developing countries, the situation is more dire, making cities practically unsustainable. It is, therefore, no surprise that the sustainable development goals (SDG 11 in particular) have been established to bring an urgent focus to “make cities and communities more inclusive, safe, resilient and sustainable”. A big part of the challenge for cities lies in financing their infrastructure and development needs. However, it is a well-established fact that revenues generated by city governments are insufficient to meet their growing investment needs. Increasingly, cities are looking for alternative sources to raise finances in addition to their existing tax revenue base. Land-based financing opportunities are becoming popular instruments embraced by city managers and policymakers at various tiers of government. © The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2023 R. D. Tirumala and P. Tiwari, Advances in Infrastructure Finance, https://doi.org/10.1007/978-981-99-0440-2_6

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Infrastructure and real estate, as two distinct asset classes, have many areas of confluence. They have a substantial share of international economic markets in terms of the physical stock, the extent of investments, and the number of people employed in the sector (Lambrev, 2019; Shatkin, 2016). The infrastructure assets are characterized by huge capital expenditures, which act as a natural barrier to entry of different private sector players (Yermo et al., 2011), and have very substantial operations and maintenance expenditures over the life of the assets, which can go upwards of 30 years in many cases. Infrastructure projects are financed traditionally through government budgets and borrowings from development financial institutions and large commercial banks. Over the last two decades, there has been a huge popularity in implementing projects through public–private partnerships (PPP) arrangements and also the exponential growth of project finance. The use of project finance techniques involves the usage of limited recourse or non-recourse mechanisms. The increased participation of the private sector through the PPP arrangements has also brought into focus how the whole of life costs are calculated and accounted for while bidding for the projects. These models have nudged the public sector project proponents to consider various options to make the infrastructure project business models robust. The project proponents considered alternatives to make the projects viable, i.e., ensure that the metrics (typically the debt service coverage ratio or the internal rate of return) are within the expectations of the lenders or the equity promoters. The schemes such as Viability Gap Funding of the Government of India (DEA, 2020) provide a financial mechanism to bridge the gap. However, for the proponents who do not have access to additional funds, a potential alternative is the additional land that could be provided, which the private sector can use to recoup its investments. Using land as a sweetener is observed in infrastructure projects in the transportation sector, particularly in airports and metro rail systems and in economically weaker sections’ housing development, shopping complexes, etc. The need for leveraging land as an important revenue resource and innovations in land-based financing adopted by cities to fund large public projects appear to be a few of the potential routes to broaden the infrastructure financing space. While these innovations can lead the way in urban transformation, their success is contingent upon an enabling policy and governance framework that supports the adoption of these instruments.

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Demand for Sustainable Infrastructure in a Rapidly Urbanizing World

According to United Nations’ estimates, more than half of the global population (4.3 billion) currently live in high-dense cities (Ritchie & Roser, 2019; United Nations, 2022). Though the numbers are often debated due to varying definitions of what constitutes an urban area, the phenomenon is itself important from a development and economic standpoint. As per different estimates, if current urbanization trends continue, it is likely that more than two thirds of the world’s population (United Nations Department of Economic & Social Affairs, 2022) or as high as 80% of the world’s population will reside in urban areas by 2050 (WEF, 2022a), underscoring the need for planning our cities and public services better. The increase in urban population is mostly expected to be concentrated in three countries—India, China, and Nigeria. The number of cities with more than 10 million inhabitants (called “megacities”) is also projected to increase. Similarly, the percentage of people living in million plus cities is expected to increase from 23% in 2016 to 27% by 2030. (Floater et al., 2017) Table 6.1 captures the population and settlements related data for year 2016 and projections for 2030. Figure 6.1 highlights percentage wise and population wise shift from the rural to urban. New Delhi, the capital of India, is expected to be the most populous city in the world by 2028, overtaking Tokyo and Shanghai. The second Table 6.1 Human settlements and population (2016 and 2030) Number of settlements

Urban 10 million or more 5 to 10 million 1 to 5 million 500 000 to 1 million Fewer than 500 000 Rural

Population (millions)

2016

2030

2016

2030

– 31 45 436 551 – –

– 41 63 558 731 – –

4034 500 308 861 380 1985 3371

5058 730 434 1128 509 2257 3367

Source Authors based on data from (United Nations Department of Economic and Social Affairs Population Division, 2016)

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A - 2016 10 million or more, 6.8% 5 to 10 million, 4.2% 1 to 5 million, 11.6% Rural, 45.5%

Urban, 54.5%

500 000 to 1 million,5.1% Fewer than 500 000, 26.8%

B – 2030

10 million or more, 8.7% 5 to 10 million, 5.2% Rural 40%

Urban 60%

1 to 5 million, 13.4% 500 000 to 1 million, 6%

Fewer than 500 000, 26.8%

Fig. 6.1 Percentage of world population (A) 2016 and (B) 2030 (Source Authors based on data from [United Nations Department of Economic and Social Affairs Population Division, 2016])

and third largest cities are projected to be Mexico City and Sao Paulo (United Nations Department of Economic and Social Affairs, 2022). The share of the population living in cities is also a result of the country’s

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economic status. More than 80% of the population in high-income countries, such as Europe, the USA, Australia, and Japan, live in cities and towns, whereas it is about 50–80% in upper-middle income countries (Ritchie & Roser, 2019). Growing cities, especially in developing countries, do not have the funds to provide basic infrastructure facilities and services to their citizens. It is estimated that 70% of the population in developing countries do not have access to or more basic services, such as water and sanitation, housing, energy, and transportation (Hart, 2020). In most cases, the existing infrastructure is also aging and puts further strain on its capacity to serve the growing population. Lack of adequate infrastructure also impacts further development and economic potential of cities, defeating the very purpose for which people migrate to urban areas (Fint, 2017; Hart, 2020). Bigger challenges seem to be haunting cities today. The need for effective regional and local planning for service delivery cannot be understated (Bahl et al., 2013). With increasing mobility and car ownership in developing countries, the need for better roads and transportation infrastructure will only exacerbate the challenge. Further, cities and metropolitan cities are vulnerable to risks from a globally warming world. About 56% of the cities today are prone to at least one type of natural disasters, be it floods, droughts, hurricanes, landslides, or earthquakes (United Nations Department of Economic and Social Affairs Population Division, 2016). Of this, at least 15% of cities that are situated on coastlines are at a greater threat from tropical storms, sea level rise, storm surge, and inland flooding. Cities are not only the biggest contributors to climate change but are also victims of its worst impacts (Duarte, 2020). For example, Tokyo, Osaka, and Manila face a heightened risk from multiple types of natural and climate disasters. An estimated 90% of urban areas in developing countries are either near disaster-prone areas or were developed haphazardly as unplanned settlements (World Bank, 2022). Not just climate disasters, but from the recent experience of the COVID-19 pandemic, it is obvious that cities also bear the brunt of pandemics and communicable diseases. The high density of population and the transit connections that cities provide to other parts of the region and world made the virus spread rapidly. Little wonder that more than 95% of COVID-19 cases reported were in urban areas (Duarte, 2020). The vulnerability of cities was exposed during the pandemic when they

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were at the forefront of battling public health crises along with social and economic crises. The risks from climate change and pandemics, coupled with infrastructure deficiencies in cities, have compounded the problem for city administrators to manage growth and development in a sustainable, equitable manner. The resiliency of cities to brace for such compounding challenges was exposed, and their lack of preparedness was on stark display. The United Nations Sustainable Development Goals (SDG), particularly Goal 11, highlight the need for developing cities in a sustainable, climate-resilient, and inclusive manner. The target areas outlined in SDG 11 include safe and affordable housing, affordable and sustainable transport systems, inclusive and sustainable urbanization, protecting the world’s cultural and natural heritage, reducing the adverse effects of natural disasters, reducing the environmental impact of cities, providing access to safe and inclusive green and public spaces, a strong national and regional development planning, implementing policies for inclusion, resource efficiency and disaster risk reduction, and developing sustainable and resilient buildings in the least developed countries (The Global Goals, 2022). The challenges of urbanization and its impacts on vulnerable populations and cities are well understood and articulated by the global community through the multilateral development banks, international financial institutions, development organizations, and large international foundations. The problem is acute, but the support available is also strong. The responsibility lies with the cities and governments to plan, and finance infrastructure and public services in a way that urbanization is sustainable and economic growth is not compromised.

6.3

Financing Sustainable Urbanization

The gap in infrastructure investments needed for achieving the SDGs is estimated at $38 trillion for 2020–2030 by the United Nations. Most of this is anticipated to occur at the city level through municipal administration and governance. Developing cities into sustainable economic centers require huge infrastructure investments. Going by current trends, most cities are not able to meet this demand (WEF, 2015). A recent study conducted by UN Habitat in four countries, namely Bolivia, India, Malaysia, and Columbia, gives useful insights on what it costs to build sustainable cities. The study shows that for achieving SDG 11, the average

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annual cost for small cities in Malaysia and Bolivia ranges from $18 million to $54 million, respectively. The same for medium-sized cities in India is $144 million and in Malaysia is $516 million. Thus, the quantum of investments depends on the size of cities and the economic status of the country. For larger developing cities, the costs are much higher, running sometimes into billions of $ per year (UN Habitat, 2020). That substantial investment is required for the successful implementation of SDG 11 is clear. The funding sources for cities are typically made of tax and non-tax sources, and their control is better on the latter, as the need for approvals is higher regarding the tax revenues (Peterson, 2008). Traditional mechanisms for raising revenues need to be re-evaluated along with exploring new and innovative approaches for increasing revenue and financing infrastructure (WEF, 2022b). The urban infrastructure financing landscape has evolved significantly in the last decade, with governments coming up with creative ways of financing their infrastructure and service delivery needs. The capacities of cities and governments at all levels is crucial to access diverse revenue sources and combine tax revenues with non-tax revenues, private sector investments, and other sources of financing (WEF, 2019). The private sector is keen to make investments in public infrastructure provided projects are well structured and viable from a business context. In addition to viability, a focus on environment and social gains is becoming increasingly important for private investors. The Green and Blue Bonds and other similar instruments bear testimony to this growing trend. It also satisfies the twin goals of development and investment in a responsible manner. Partnerships and collaborations with stakeholders across the landscape are crucial for creating the appropriate environment to enable these investments. While the need for infrastructure and investments in SDG 11 is huge, the combined volume of public and private funds available, surpasses this need (UN Habitat, 2020). Innovative efforts are required by city governments to tap into these funds to close the infrastructure investment gap.

6.4 Land as a Resource for Funding Infrastructure Land-based financing is an alternative mechanism used by local governments to finance their urban infrastructure and services needs in an

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effective manner (UN Habitat, 2015). If well designed, these instruments can leverage land as a resource to attract private investments. It also increases the value of underutilized land, and the development itself can boost economic growth and prosperity of the neighboring areas. Landbased tools are often across three different categories—(i) land-based taxes; (ii) land use, zoning, and development financing tools; and (iii) land value capture mechanisms (WEF, 2022b). Land-based taxation is an established municipal financing tool and includes property tax, stamp duty, betterment charges, impact fee, and sale of development rights. One of the aspects that governments have been resorting to raising revenues for infrastructure financing is to levy taxes on properties that are likely to benefit from the surrounding development. Large cities have the advantage of a larger tax base of properties and have a large volume of land within their control. Such lands are typically more than average commercialized and industrialized areas, and this facilitates the government to levy higher taxation. This also enables the local governments to levy increased goods and sales taxes. The generation of revenues from trade and commerce in the central areas of an urban agglomeration is also greater than the outlying areas. For example, in Sao Paulo the per capita revenue in the central area is about double that of the suburbs. Even the property tax and sales taxes are higher in terms of per capita in the central area of Sao Paulo in comparison to nearby smaller municipalities (Sá Porto & Rocha, 2018). This does not mean that large city governments willingly decide the increase of taxes but rather show a considerable restraint in doing so. One way of dealing with this issue is to consider an incremental tax on land value as was done in Columbia. Few of the public services like water supply and urban transport where user charges are levied can be provided with private sector participation. However, there are challenges in administering this kind of tax on account of problems faced in fixing a base value of capital appreciation due to the impending increased public investments and adjust the base value in line with the inflation vis-a-vis the improvements made to the existing infrastructure assets. There is also the challenge of implementing this program as the tax collection is required to be efficient to achieve the require financial targets to meet infrastructure expenditure (Mathur & Smith, 2012; Nunez & Acero, 2016). There are examples of levy of betterment fees in East Asia for value increase upon development of MRT systems. For example, in Hong Kong and Tokyo such levies are used for joint development of residential and

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commercial properties around the new transit stations to finance the MRT projects. Income derived from commercial properties are a source of sustainable revenue for economic development in the area (Cheung et al., 2012; Hwang et al., 2013). Betterment levies were used in Columbia; however, it was found that it is not a sustainable source of revenue. It was found in the 1980s and 1990s that the betterment fee levied were insignificant and contributed a low percentage of the overall municipal finances essentially since the estimation of the betterment fee was more than the actual levies. The other contributable reason was high administrative cost and many legal disputes raised by the property owners. Whereas in Bogota this has been parceled into a different perspective in the form of a tax on infrastructure improved and the resultant gains to the land values, this method was found to be more sustainable and sought to be replicated in Colombia and other Latin American countries (Peterson, 2008). England and Scotland through legislative action—The Local Government Act (2003) and the Scottish Executive Act (2003), respectively, enunciated the concept of encouraging establishment of Business Improvement Districts (BIDs) for the purpose of leveraging land as a financing instrument. Within a BID, all the property owners and businesses are required to pay an additional tax or fee to receive a particular level of service from the local authority. This has also been effectively utilized in some parts of the USA for the purpose of improving the transport services, for instance, the Portland Pioneer Square BID (Munoz-Gielen, 2011). Land use, zoning, and development financing tools —A few countries such as India and Brazil have introduced policies to allow residents in urban areas to purchase additional floor space in the form of higher Floor Area Ratio (FAR). In India, along the metro rail alignment, permission is granted to have a higher FAR, and in Brazil, building rights are sold on the securities’ exchange and the funds generated are utilized for developing infrastructure assets in the city. In Cordoba, land developers are required to pay additional amount if they need any changes to the building norms mandated under the law. In Maharashtra and Mumbai, India, selling of the unused Floor Space Index (FSI) (ratio of built-up area in comparison to the plot area available to a builder) is permitted to be sold/traded in accordance with the municipal regulations. The municipal fee received in such cases is utilized for infrastructure development.

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Another example is developers give a portion of built-up property to the municipality meant for economically weaker sections of society. This is provided in exchange of grant of rights to build and dispose of residential and commercial properties at market rates. This was done in Cambridge, Massachusetts, in 1998 by means of an Inclusionary Zoning Ordinance where 1000 housing units were developed on affordable rental and ownership basis throughout the city. Land pooling is another concept adopted in some places. For instance, in the development of Japan’s Greater Tokyo Railway Network, the landowners willingly surrendered their land to the government/developers and in turn received a smaller portion of developed land after the railway network was built. The objective was to make use of the increased value of their land on account of the surrounding infrastructure development and improvements made. In a similar manner, the government agency handovers the land development rights to a private developer for construction of mass transit railway as was done in the Hong Kong Mass Transit Railway (MTR) Corporation in which the Rail Plus Property Co-Development (R + P) model was chosen for this project. As a result of development of the transit railway, the shares and profits thereof are put back into the project as well as for other public improvements. The people living in the surrounding area get the benefit out of the improved infrastructure. In this case, the R + P model that was in use for nearly three decades had made significant contribution in the development of neighborhood infrastructure, protection of open space, and construction of railway system (221 kms) and this project helped more than 5 million people in Hong Kong (Germán & Bernstein, 2018). Restrictive zoning methods used by government authorities to drive up land prices or increase developer exactions can result in distortion of land prices, affecting the local economy and hindering development objectives. Land value capture mechanisms —A significant number of cities across the world carry out assessment of land based on the improvements made thereto. For instance, while cities across South Africa consider “market value” of the property, however, in Dar es Salaam land is considered separately from the building. The depreciated replacement cost is considered with respect to the buildings without the land being attached to it. Same is the case with Manila. The assessment of the cost of land is based on the transactions that has happened in the market, whereas the buildings and improvements thereto are depreciated. In Latin American cities too, this practice is adopted more so on account of lack of adequate number of

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valuers/assessors. But, in Bogota, the assessment is based on the market prices. However, the disadvantage in this method is that there may be political resistance to make changes to the replacement value as was seen in Buenos Aires where the replacement costs of buildings was not changed for more than 20 years. Any exercise in re-assessment requires significant efforts in data collection and analysis especially of number of properties, the sale transactions, and proper maintenance of the records. With strong legislative process of ensuring the recording of each sale transaction and discouraging informal sales, and by use of modern technological tools, this must not be a difficult task. Certain cities like Sydney, Brisbane, and Christchurch have attempted capturing of site value without carrying out any improvements therein. South Africa introduced a new legislation to tax properties provided that all cities should use the “capital improved value system”. In 1993, Estonia introduced a land value tax and its coverage proved to be excellent. Sao Paulo in Brazil is a good example of how the city generated over $1 billion in financing from the private sector leveraging land value capture mechanisms (WEF, 2022b). Land value capture for infrastructure investments in China is done a bit differently. Typically, they consider lease of land on long-term basis to mobilize financial resources which is about 40% of average revenues and is quickly reducing by the year. However, this has found not much favor in Indian States because it is deemed that land belonging to Government once sold to private sector will never come back and thus cannot be sustainable in the longer term. The various instruments that are being used for land-based financing is presented in Fig. 6.2.

6.5

Innovative Land-Based Instruments for Financing Infrastructure

Much of the innovation in land-based financing has happened in two sectors—transit and transportation and urban redevelopment. One of the unique ways of mobilizing finances was done by the Bloomberg administration for the development of the Hudson Yards Project in Manhattan between 30th and 42nd streets in 2005. The objective was to extend the 7-subway train from Times Square to 34th street and 11th avenue where a new subway station and an additional 15 acres of land was to be earmarked as public open space. Two separate value capture methods were conceived by the administration—the first one being PILOTs (Payments

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Fig. 6.2 Types of land-based financing instruments (Source Authors based on data from [Abiad et al., 2019; Blanco et al., 2016; Mehta, 2018])

in Lieu of Taxes) and the second was recovering of moneys from property developers and land owners along the alignment as “purchasable density bonuses”. The value recovered on account of the PILOTs and bonus purchase was used to pay the initial debt by the administration. While the city’s General Fund paid $369 million towards interest on the bonds during the early years of the project, the property owners were required to pay lesser amount of taxes than otherwise required. The concessional tax will be phased out in 2026. However, the entire property taxes that would become payable because of the project existence and will be receivable to the Hudson Yards Infrastructure Corporation till the year 2044. This method of mobilizing finances helped the respective institutions such as the Hudson Yards Infrastructure Corporation and Hudson’s Yards Development Corporation to manage the project on their without depending on the funds from the city (Wolf-Powers, 2019). Typically, worlds over cities have considered two models of urban development by incorporating an integrated transit model. Some cities have chosen the method of enabling higher density of continued traffic in land use that is mixed with both residential and commercial facilities. Other cities have considered adapting to methods of transit improvement

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by focusing on lower density patterns of urban and suburban development by allowing the market to decide rather than imposing upon the city’s choice. In the former case, the solutions suggested includes high-capacity transit services like the metro rail and bus rapid transit systems (BRTS). For instance, cities like Curitiba in Brazil and Ottawa in Canada have considered BRT systems. Cities like Copenhagen and Stockholm have attempted to maximize revenues for deployment in the building of infrastructure assets by area planning in a selective and judicious manner. Cities in the South Asian region like Tokyo and Hong Kong have successfully implemented transit-oriented development projects by capturing value from land and generating revenues from grant of property and air rights to the stakeholders. However, it is imperative that both public and private interests are kept in mind while visualizing and shaping of infrastructure investments that are sustainable in the longer term. In fact, it is possible to steer economic growth of a region if timely and adequate planning on the utilization of existing land resources is made. This was observed in the Copenhagen’s Finger Plan which envisaged a long-range planning particularly for railway asset development which helped in directing faster pace of economic growth in the region. A similar example can be found in the Singapore’s “Constellation Plan” in 1991 which focused on the development of new towns and commercial centers close to the Central Business District and alongside the MRT corridors with a view to decentralize the population that was increasing. Such an arrangement was also found attractive to the investors and lenders who saw it as an opportunity to improve business in the longer term as the projects closer to metro stations were seen to be more remunerative. Global experience with such examples shows that developmental planning with a combination of transit orientation and land use helps if integrated in a cohesive manner and will be financially beneficial to the stakeholders concerned (Suzuki et al., 2013). The metro project in Hyderabad, India, offers a good example of partial financing through surrounding property development on DesignBuild-Operate-Transfer (DBOT) framework with private sector participation. The DBOT concession was for 35 years and included partial financing, building, and operation of a 71-km and 66 stations subway network. The two main revenue sources were from the operation of the subway (passenger fares) and development of adjacent land (real estate developments, advertising, and parking). While 70—80% of the floor space in the adjacent lands were reserved for construction of

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depots/metro stations, the remaining floor space was allocated for real estate development (UCLG Committee on Local Finance & Development, 2016b). Under the project agreement, the real estate developments could not be sold but could be used to generate rental income. In addition to these revenue sources, Viability Gap Funding (VGF) was provided by the state and national governments to finance 30% of the total project cost (GI Hub, 2021). Another innovation that cities have successfully implemented is the issue of municipal bonds. Cities like Bogota in Columbia and several Indian municipalities have been issuing bonds for financing infrastructure. In 2001, Bogota issued international bonds with an interest rate of 9.5% for a five-year term after having done a global rating by Fitch and Standard & Poor’s (Schloeter, 2016). These bonds did not have a sovereign guarantee or guarantee from international funding agencies. Experience has shown that municipal bonds are a dependable source of financing infrastructure projects (Ghio et al., 2020; World Bank, 2017).

6.6

Public–Private Partnerships

Public sector has engaged gainfully with the private sector to attract investments in public infrastructure by grant of government-owned land on lease or license basis at nominal rates in return for investments in building assets like commercial properties, water supply, bus terminals, etc. There have also been instances of sale of public land and the proceeds thereof utilized by local governments for building infrastructure assets. For instance, for connecting Orestad, a new town near Copenhagen, a 22-kilometer automatic metro, was constructed in 2003 to serve nearly 60 million passengers each year. The supporting infrastructure for Orestad and the metro line were financed by the sale of public land. Similarly, the New Urban Communities Authority (NUCA), Egypt, had auctioned land along with its built infrastructure in May 2007 for USA$3.12 billion. The amount recovered from this sale was to be utilized to build a major highway between the new city to Cairo (El-Nagdy et al., 2018; UCLG Committee on Local Finance & Development, 2016a). However, it cannot be said that at all places sale of public land and utilization of the proceeds for additional infrastructure will be successful, as was found in the project related to connectivity to Bangalore airport which is concerned. In this case, the government felt that the excess land acquired for the Bangalore airport could be auctioned off and

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the proceeds utilized for building a road from the city to the airport. However, the government later decided to utilize the excess land for its offices and the development of industrial area. This decision delayed the implementation of road connectivity to the airport from the city. For capturing realistic values against land sales, it may be relevant for governments to frame detailed policy or guidelines for ensuring transparency and greater efficiency. Experience shows that the auction of public land has given significant value to the authority, as was shown in Ethiopia where the auction price discovered were 2 to 80 times higher than the value negotiated by the government as per administrative rules. Similarly, in Egypt, the land auction gave a return of more 10:1 from the prices determined by the administration. To make it sustainable, government may need to take several steps for streamlining land auctions, such as preparing of an inventory of public lands available with the authority, determining upfront the market value of the inventoried parcels of land, clear decisions taken beforehand whether to sell the parcel of land, jointly develop with the private sector under a PPP arrangement, or to develop and manage the infrastructure asset by the public authority itself. Egypt and South Africa have an excellent record for the development of public land through a systematized approach and management of their public assets efficiently. It can be replicated elsewhere (Peterson, 2008). There are examples of joint venture arrangements between the public and private sector where both the government agency and the private party have joint ownership of the land during the contract period and increased taxation to the users on account of land value appreciation in the area. The financial proceeds received by the government agency is utilized for developing other infrastructure assets. Innovative PPP contracts such as BOO (Build-Own-Operate), ROMT (Renovate-Operate-MaintainTransfer), BOOT (Build-Own-Operate-Transfer), BOT (Build-OperateTransfer), etc. are entered into that have been successfully implemented in not only creation of large-scale infrastructure assets like airports, ports, metro rail, etc., but have also helped in the financing of ancillary infrastructure to support these large projects (Peterson, 2008). Some infrastructure sectors like water supply, waste water, and solid waste management rely less on the use of land-based financing instruments in structuring projects as compared to transportation or urban renewal projects. The land for the latter set of projects is typically owned by the project agency or the municipal authority which can be leveraged for financing purposes. The same is different for the other sector projects

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as excess land is usually not held by the agencies implementing these projects. However, this is a lesser challenge in cases where the municipal authority is responsible for delivering the complete range of infrastructure projects and services to its citizens. In such a scenario, the authority can resort to land-based financing mechanisms for projects where feasible and utilize a portion of the revenues to meet the competing demand for basic services by managing its budgets effectively. The situation is complex when different institutions in the government have ownership rights on the land assets vested with it. Experience reveals that these institutions are often reluctant to share the land or the sale proceeds from the land with their peer institutions in the government. Establishing a consolidated capital budget through governance reform is perhaps a solution or entering into sharing arrangements where land financing proceeds are automatically allocated to agencies responsible for delivering basic services (Peterson, 2008). India has experimented with a large array of land-based financing instruments for a very long time. The learnings from these initiatives can feed into the strategies of many developing countries when they look to configure such instruments. The city development process in many parts of India has relied on the monetization of the urban land. The port city of Bombay (now Mumbai) was developed by selling the leasing rights by the then British administration. The peri urban areas across many of the larger cities in India (for example Delhi, Bengaluru, Hyderabad, Chennai, and Mumbai) were developed by their respective development authorities or parastatal agencies, unlocking the land value (Nallathiga, 2010). The growth of the infrastructure and the real estate sector was congruous through the early 2000s in India which led to the government bodies explore ways to finance the infrastructure projects using land as a resource (Tirumala & Tiwari, 2021). The rapid growth of the infrastructure sector, led by the highways and other transport related sector projects, percolated into other sectors. The Government of India had launched its major initiative of building the highway corridor through the Golden Quadrilateral, East West North South corridors, which propelled the adoption of PPPs in the country. This rapid growth led to many state government, subnational entities to launch their versions of PPPs in sectors as diverse as redevelopment of commercial complexes, building of car parks, rehabilitation of government managed hotels in tourist locations, minor and major airports, ports, etc. (RICS Research, 2020). In most of these projects, additional land was then required for the infrastructure project which was

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used as a sweetener. The aggressive participation by the private sector and the increased lending by the commercial banks led to a few unrealistic bits in the process (Kelkar, 2015). The Table 6.2 presents a sample list of projects that have been configured using land as a financing mechanism. The Government of India and its agencies did not find a uniform success in all the initiatives that they have implemented. However, the diversity of the sectors and the models that have been used provide an insight into the possibilities that can be explored for using land-based financing for various infrastructure projects. Though land-based financing is a powerful tool to finance infrastructure and development projects, the risks need to be carefully evaluated before leveraging its potential. The announcement of large infrastructure projects and offering land to developers to boost project viability can lead to over speculation and artificial inflation of land values. Moreover, urban land prices cannot steadily increase year on year and there is bound to be some volatility in the land markets. An example of this is the Mumbai Metropolitan Regional Development Authority which had held an auction of Bandra-Kurla commercial complex. Two of the five parcels auctioned did not receive bids that met the minimum price threshold set by the Authority. Another risk is the lack of transparency and accountability in land sale/lease transactions and the proper use of revenues. Effective legislation and guidelines for proper disclosure could mitigate the problem to a large extent.

6.7

Conclusion

The land value capture mechanism as has been adopted by many countries attracted mixed reactions. The proponents of the land value capture mechanism have argued that this enables better economic efficiency and has a substantial potential to objectively raise the revenues of the municipalities concerned. The land value capture process provides the flexibility to the citizens to exercise their choice went to undertake a transaction and accordingly monetize their positions. The city enters into a virtuous phase to augment its revenue generation potential. The mechanism is also seen as one of the tools to achieve social equity in the region this is being implemented (Abiad et al., 2019; Blanco et al., 2016; Mahendra et al., 2020; Smolka, 2012, 2013; Smolka & Amborski, 2000). The critics of the land value capture mechanism object to the increased participation by the private sector in urban planning activities as the same might

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Table 6.2 Sample Indian projects with land-based financing elements Project

Brief Description

Hyderabad Metro

Metro system for the southern city of Hyderabad. Estimated capital expenditure of INR 14,132 crores. The project was won by a consortium Maytas, who folded up. The project is now managed with the L&T group

Delhi Airport

Nandi Corridor (Bangalore—Mysore Infrastructure Corridor)

Amravati State Capital of Andhra Pradesh

Land based financing tools used

Additional land was given to construct shopping complexes along with various metro stations, the revenues from the same were expected to offset the project costs (Kulshreshtha et al., 2017) Brownfield development of Additional land was the airport in the capital of provided to develop an India aero city, hospitality, and Private developer: GMR group commercial facilities in addition to the rental Land: Approximately 5000 space in the terminals Acre (Chaudhuri, 2011) An expressway connecting two Additional land for the major cities in Karnataka, residential, commercial, conceptualized in 1980s. The and industrial highway, of 111 kms, is infrastructure was given. proposed to have residential, The highway was industrial, and commercial perceived to be very townships along the way small in relation to the other components Developer—Nandi (Balakrishnan, 2013) Infrastructure Corridor Enterprise Ltd The project was very controversial as the residential localities came up before the highway corridor A new state has been carved Land pooling scheme was out and the capital has been adopted to make the land identified—Amravati. The city owners part of the stake is being built with all the holders in the city amenities including the development process. The government buildings and participants got back a housing complexes smaller, but substantially increased in value, plot. They had to give up a larger piece for the city development (Ramachandraiah, 2016)

(continued)

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Table 6.2 (continued) Project

Brief Description

Land based financing tools used

Bus stand cum commercial complex, Haldia, West Bengal

The city intended to build a bus stand

The developer was given 7 acres for bus stand and is expected to build and operate the same for 20 years. To recover the cost incurred, the private developer was also given additional 4 acres of land for developing a commercial complex, to be managed for 50 years. (MoUD CII, 2022)

Source Authors based on information from websites and literature

dilute the public good purpose in favor of the profit motives of the private sector. They fear that increased adoption of such mechanisms to exploit the potential that land-based financing mechanism offers might lead to an increase in the prices of infrastructure services, thereby negatively affecting affordability. The process is in the case of most land-based financing models that involve front ending the investments, which are then recovered over a longer time frame and possibly paid by a different set of public or users. This creates both an equity as well as an affordability issue as the time value and inflation need to be considered during the time frame that the monies are recouped. The critics caution that an appropriate framework and enabling conditions need to be put in place to avoid such possible exploitation by the private sector (Smolka & Amborski, 2000). A strong and enabling legal environment that allows for land-based financing is key to minimizing disputes that can slow down the pace of development. Equally important is the administrative capacity, policy, and governance frameworks to design, implement, and monitor developments that use the land as a key revenue source. Establishing institutions and procedures to aid governments in designing and using land-based financing instruments can improve transparency and accountability in the overall process.

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CHAPTER 7

Growing of Age in Risk Mitigation: Funded and Unfunded Participation

If you don’t invest in risk management, it doesn’t matter which business you’re in, it’s a risky business. —Gary Cohn, Former COO of Goldman Sachs and director of the National Economic Council Indeed, better risk management may be the only truly necessary element of success in banking. —Alan Greenspan, Chairman of the Federal Reserve System, USA

7.1

Introduction

Infrastructure finance is all about risk management. World over, many countries and development financial institutions have been quite good at generating a long list of infrastructure projects. At every economic disturbance or event that threatens the growth of a country, infrastructure development is seen as a potential pathway to bring back the economy to the chosen path. This has been the situation in many countries, including the USA, UK, Australia, or India, either after the global financial crisis (GFC) or, more recently, configuring the recovery of the economy post the slowdown caused by the COVID-19 pandemic. The challenge, however, has always been how to fund the large infrastructure plans that the countries announced. The conventional sources of

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funding, consisting of government taxes, revenues, and loans from development financial institutions, go only a part of the way. The expectation has always been that the private sector chips in to bridge the massive infrastructure financing gap. It is very important to mobilize financial resources from the private sector to bridge the existing infrastructure gap. The private sector in turn looks towards the commercial banks and institutional investors to provide the finances for implementing the projects in a combination of debt and equity. A large number of financial institutions (banks, infrastructure funds, sovereign wealth funds, insurance, and pension companies) are actively exploring the market for direct or indirect investments in infrastructure. Implementation of infrastructure projects comes with many inherent features, and risk management is key among them. Risk needs to be addressed at all levels, and preparedness to handle that risk can play a vital role in the successful project implementation (APEC/OECD, 2019; Dailami et al., 1999; Tikhomirov & Plotnikov, 2018). The management of risk is a key component of modern finance theory and is based on the estimation of the probability of occurrence of events. The risk management techniques rely heavily on probability distribution functions developed based on the information about the past occurrence of events. Some of the basic products which provide for the risk mitigation for infrastructure projects are financial guarantees, credit enhancements, and insurance (WEF, 2016). Insurance has been the most preferred way to mitigate risk, second to loan sales (Group of MDBs, 2021).

7.2

Natural Hazards

The investments in infrastructure assets involve substantial long-term commitments and attract huge funds from many public and private proponents. The interest in the infrastructure assets needs to be protected against a wide array of risks. One of the most important risks that the assets need to be protected is against natural hazards and disasters. The hazard event, if it occurs, can cause catastrophic damage to the assets and also have a consequential impact on the region’s economy. Having adequate financial sources with the associated structures is only one part of the solution of financing infrastructure. It is vital to ensure that the assets remain productive throughout their active life. The first level of defense against unforeseen events is to have robust Business Contingency Plans (BCP) and Crisis Response Protocols (CRP)

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that are continuously reviewed and updated as needed. These plans and protocols are expected to be followed up through appropriate training and capacity building. The lack of such procedures can lead to liability issues in the unfortunate event of damage or loss to stakeholders, including third parties. Insurance plays a key role in bringing back the assets to their intended performance levels subsequent to a hazard event. The insurance sector has come a long way in assessing the probability of occurrence of natural hazards and the likely costs to bring the assets back to their peak performance condition. The associated premiums are estimated more scientifically, and the risk is spread across a broad range of insurers and reinsurers. It is vital to understand the implications of the language of the insurance policies to ensure that there is no difference of opinion on how the policies will be executed should the need arise (MarshMcLennan, 2019). The various risk covers that are available for infrastructure shareholders include Political Violence/ Political Risk (PV/PR), Property All Risk (PAR), Contractors All Risk (CAR), Public Liability (PL), and Employees Compensation (EC). Given the expansive list of coverages that are possible and given that there is no uniformity in the carrier approach, certain insurers insert exclusions or exceptions for specific events. For instance, strikes, riots, and civil commotion (SRCC) may or may not be included, or the provisions of these clauses might not be very clearly worded. It is imperative for the project stakeholders to check and confirm the adequacy of the coverage. The natural ecosystems benefit humankind in more diffused ways than can financially be calculated. The insurance system that is being configured for the nature-based conservation efforts is a substantial deviation from the traditional mode of indemnifying the actual damages or losses. The evolution of parametric insurance for nature provides a new way of protecting the agriculture value chains, marine ecosystems, coral reefs, and other nature-based infrastructure. This system of insurance involves paying a predetermined sum based on the type, occurrence, and intensity of the natural hazards. For example, the coral reef at Qunitana Roo, Mexico, was insured under a parametric insurance scheme, wherein the payouts are structured in two formats. A payment of 40% of the agreed total will be paid if the wind speeds are in the range of 100–110 knots in a particular area. If the wind speed crosses 160 knots, the insurance is paid in full. The insurance payments are irrespective of the actual damage

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by the devastating winds on the coral reefs (the assessment of the actual damage is subjective and could take a while, and under a parametric insurance policy is not of concern). The insurance payouts are subject to the use of proceeds conditions that stipulate that the funds should be used for the restoration and rehabilitation of the coral reef system and the coastal ecosystem equally. The first ever coral reef insurance was triggered in October 2020 with the resultant payment of $800,000 (TNC, 2020).

7.3

Risk Mitigation in Project Finance

Project finance transactions are heavily reliant on long-term contracts among different stakeholders such as project promoters, government, creditors, suppliers, operators, contractors, and service providers. The relationships between the different stakeholders is formalized through a series of agreements/contracts. Different types of contracts serve different purposes: property rights transfer from the government to the project company are stipulated in concession agreements, performance contracts are agreed upon between the project company and contractors and operators, and lenders, equity investors, and project company execute loan and share purchase agreements. All of these agreements are designed in such a way to provide clarity in terms of risk sharing and protection to any contracting party against opportunistic behaviors by others (APEC/OECD, 2019; Dailami et al., 1999). For risk mitigation purposes, public private partnerships (PPPs) themselves can be considered as one of the methods to address the probable risks arising during project implementation (WEF, 2016). PPPs continue to be considered as a preferred mode of implementing infrastructure projects across the world. The experience in the last three decades in implementing the PPPs have been a mixed bag (Dharmapuri Tirumala et al., 2020). The governments across the world have been exploring the creation of an attractive ecosystem that promotes greater participation of the private sector. The understanding of the roles and responsibilities of the public and private stakeholders has witnessed a paradigm shift. The role of the public sector has transformed from being a provider to being a catalyst in ensuring that the citizens get the appropriate quality and quantity of infrastructure services. This progressive reduction in the provision of physical services has resulted in an increasing transfer of responsibilities and risks to the private sector. Traditionally, PPPs had substantial participation from the financial institutions, pension, and insurance sectors

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(Gatti, 2014). Risk management framework under the PPP arrangements has been the point of debate for the private developers and institutions supporting them to ensure that the long-term sustainability of the arrangement remains intact (Vecchi et al., 2017). Many governments have formulated supportive policies and financial structures to support the development of PPPs and to provide assurance of the viability of the projects being implemented (Hellowell et al., 2015). The Government of India has launched its Viability Gap Fund that provides a gap funding of up to 40% of the project’s capital cost to support PPP projects (DEA, 2020). The European Union has been promoting PPPs through various financial mechanisms including the Juncker Plan that was launched in 2014. Infrastructure projects are usually large-scale, have long duration, and capital intensive. Apart from that, the involvement of many stakeholders, their management, and risk allocation make PPPs complex as compared to typical infrastructure project implementation method (Eshun & Chan, 2021; Jin et al., 2019). However, a provision in the contracts only may not be enough for mitigating the risks that might arise during the project life cycle. There might be specific scenarios in which it would be better if the third party assumes that particular risk (APEC/OECD, 2019). The long-term nature of the infrastructure assets, along with the associated features of reasonably predictable cash flows, was attractive to banks when structured with adequate risk protection. The project finance market was very active in the early 2000s, and many banks, particularly the European ones, were actively financing the greenfield assets at very competitive rates (in the range of LIBOR plus 100 basis points). Subsequent to the GFC, the interest rates have sharply increased to about LIBOR + 250 basis points range. The number of banks that were active in the infrastructure debt market has fallen dramatically after the GFC. The sudden withdrawal of the banks from providing long-term debt to the infrastructure projects is due to the capital adequacy norms stipulated by the regulators in various regions and the requirements to manage the associated stress tests. The banks started to roll over the loans in the period immediately after the GFC (Clifford Chance, 2020; MacroTrends, 2022; Regan, 2017). The appetite of the banks to participate in infrastructure debt has been high as they have been traditionally conservative in their outlook. The structure of the project finance market allows them to mitigate many of the inherent risks. The infrastructure assets are less cyclical, the

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project revenues are usually backed by entities with substantially high credit ratings (or with adequate credit enhancement structures), and the revenues are usually under long-term contracts with mechanisms built in for passing over the inflation and are backed by assets. Despite having all the desired characteristics, over-leveraging or having a wrong structure while participating in infrastructure finance leads to a sudden fall, as was discovered during the GFC. The financing for infrastructure works in a close relationship of the availability of debt and equity. The project financing structure needs to have an adequate quantum of debt (about 70–80% of the capital cost) for the equity investors, particularly the infrastructure funds, to be keen on participating in the project. Any reduction in the levels of debt (say to about 50–60% of the project cost) results in infrastructure funds losing interest and pulling out from the deals (Euromoney, 2012). The appetite for equity has substantially increased in the last two decades. The challenges of availability of adequate quantum of debt, at appropriate interest rates, tenors, and in this structure that the lenders want, have been a concern, particularly after the GFC. Infrastructure debt funds have not been investing in senior loans historically as the margins are relatively thin. The primary segment that the infrastructure debt funds have been interested in has been the mezzanine products. Nachtigal hydropower plant, with a capacity of 420 megawatts, is the largest hydro independent power producer (IPP) in Africa. The estimated project cost is $1.36 billion funded with $233 million of equity and $1.06 billion of debt. The project is being implemented on a 35-year build own operate transfer (BOOT) arrangement. The equity is contributed by different stakeholders e.g. the private sector developer (EDF (40%)), the public sector (Republic of Cameroon (15%)), international financial institutions (IFC (20%), AfDB (15%), STOA (an impact fund created by AFD France and Caisse des Depots) (10%)). The debt for the project is provided by six multilateral development banks (IFC, AfDB, EIB, OFID, PIDG, and AFC), four development financial institutions (AFD, DEG, CDC, FAO), and four commercial banks (BICEC, Standard Chartered Bank Cameroon, Société Générale Cameroon, SCB Cameroon). The project has a political risk guarantee cover by two agencies viz. the International Bank for Reconstruction and Development (IBRD) and the Multilateral Investment Guarantee Agency (MIGA). The IBRD has issued $100 million payment and a $200 million loan guarantee. MIGA has provided $187.9 million in breach of contract for 15 years guarantee.

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Swiss Re is the lead insurer with a $580 million cover that addresses Construction All Risks (CAR), Inherent Defects (from 2023), utilities (from 2023), general liability, marine cargo, contractors’ plant, and equipment (CPE) insurance. Clifford Chance provided the legal advice for the project as well as the documentation for the political risk guarantee, construction, and financing documentation. The transaction is complex with 15 lending institutions involved in the financing structure. The transaction was awarded the “Multilateral Deal of the Year” by Project Finance International magazine and the “Africa Power Deal of the Year” by IJ Global (Clifford Chance, 2018; IJGlobal, 2019; WB, 2018).

7.4

MDBs: Funded and Unfunded Participation

International Financing Institutions (IFIs) (including the multilateral development banks [MDBs]) play a crucial role in the financing of infrastructure projects as they have enough expertise in terms of both the provision of risk mitigation products and by actively monitoring the projects (APEC/OECD, 2019). IFIs have been actively making efforts to create ways for mobilizing resources through different platforms and structures for opening up a new set of investors in emerging-market debt. Through unfunded mobilization instruments, MLAs can utilize risk appetite from the private sector financial institutions. Such unfunded mobilization instruments are growing at a fast pace. Figure 7.1 shows the mechanism used for funded and unfunded risk mobilization products. In case of traditional lending activity, MDB loans would be accompanied by commercial debt–bank loans. In the innovative way of unfunded resource mobilization, MLAs provide for the entire loan from their own financial resources. However, the additional funding portion related to risk is allocated to insurance companies by paying a premium (ADB, 2019). Irrespective of the funded or unfunded resource mobilization as shown in the figure, borrower receives the same stipulated amount. This mechanism opens doors for the institutions like insurance companies to participate, which have a low-risk appetite and look to invest for the longer term. The institutional investors feel comfortable with the presence of MLAs as lending partners (Group of MDBs, 2021). The guarantees that MDBs provide are either towards risk coverage or credit guarantee. A risk coverage address is either in full or part of the financial obligations not being honored due to your specific event. The

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Fig. 7.1 Funded versus unfunded mobilization—a basic schematic (Source Authors based on Group of MDBs [2021])

credit guarantee is triggered when the debt service has not been made and is not dependent on any specific event. The guarantee can be either in full or partial depending on the mandate of the MDB, and the features of the specific projects being considered. An example of credit enhancement through the support of MDB guarantees can be seen in the case of Elazig hospital PPP transaction in 2016. The hospital is offered under a long-term concession agreement by the Government of Turkey, which had a sovereign rating of Ba1 (speculative grade) by Moody’s at that time. The Elazig hospital issued two bond tranches, the first e83 million bond maturing in 2034 and the second e125 million bond maturing in 2036. The bonds could have at best received the rating of Ba1 (speculative grade) at that point of time due to the cap of the Turkish government’s credit rating. The MIGA and EBRD stepped in to provide a credit guarantee to the PPP transaction. The MIGA political risk insurance (PRI) has been offered to cover any breach by the Turkish government (who is the off-taker of the services from the hospital), expropriation, and currency convertibility challenges. The EBRD provided a guarantee to support in the event of the Turkish government defaulting on its payments in the operations’ phase or if the proceedings of the arbitration are extended. The guarantee also covers the construction phase for delays and overruns. The guarantees provided by the two MDBs increase the credit rating to Baa2 (investment grade) thereby enabling the issuance and purchase of the bonds. A further increase in the rating was not possible due to the risks relating to the private developer, construction site conditions, etc. were still present.

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Most of the constitutional documents of MDBs provide for supporting the infrastructure sector through a combination of debt, equity, and guarantee products. However, the uptake of the guarantee products by the various users has become noticeable only in 1980s (Humphrey & Prizzon, 2014). The range of guarantee instruments that the MDB’s offer include those covering political and credit risks. There are multiple reasons for the low off-take of the guarantee products for a long period of time. The internal structure of how the MDBs is constituted restricts their ability to seek additional capital from their shareholders, forcing them to make the best use of their available resources. The restrictions placed on their processes and procedures by their respective managements mean that they are better off focusing on loan products than guarantees. The amount of capital deployed and the ability to liquidate the assets to honor other guarantees and the limited access as a lender of last resort also result in the guarantee products being considered as a secondary option to the lending instruments. The MDBs are expected to adopt prudent financial practices that limit the deployment of guarantees as part of their business models. The historical reason why the guarantee products did not become a mainstream option is due to the accounting treatment of guarantees. These products were considered on par with the traditional loan products with respect to the capital adequacy requirements and the provisions to be made for the can contingent liabilities created by the guarantees. The consequence of this accounting treatment is it restrictions on the lending limits and hence leads to lower preference of guarantees over loan products. On the demand side, the users of guarantees have been hesitant to take on these products due to the higher costs, and the perception that the instrument does not fully address the needs of the project at hand. It is also felt that the time and effort-intensive process for due diligence, approval, and claims for guarantees is as onerous as for the loan products (Pereira Dos Santos & Kearney, 2018). Unfunded resource mobilization instruments also help MLAs to address one of the biggest challenges of lending in local currency. The financing of infrastructure projects leads to risk relating to the foreign exchange and interest rate, which needs to be managed. Derivatives such as interest rate swaps (IRS) (An interest rate swap is an agreement between two parties to exchange one stream of interest payments for another for example fixed interest rate with floating interest rate, over a set period of time) and the cross-currency swap (CCS) (A crosscurrency basis swap agreement is a contract in which one party borrows

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one currency from another party and simultaneously lends the same value, at current spot rates, of a second currency to that party) are used extensively to manage these risks. Most of these are traded over the counter (OTC), and hence the overall statistics are not readily available for empirical analysis. The derivatives used have large notional values (to match the transaction sizes), are of long-term nature in line with the debt tenure, and are usually uncollateralized (Quintana et al., 2019). Many countries, particularly the developing nations, do not have mature capital markets that provide a platform for international financial institutions to provide long-term local currency lending. MLAs, who have access to the local capital markets, and hence with the help of insurance companies, can increase their lending potential in local currencies (Group of MDBs, 2021). The share of the guarantee products in the multilateral development banks’ offering of various products has been limited, accounting for only 5% of their operations, even though they form a substantial 45% of the finances mobilized by the private sector (Betru & Lee, 2017). The total outstanding guarantees by the MDBs’ is about $31.2 billion in 2016, out of which the World Bank Group accounted for nearly twothirds. The Multilateral Investment Guarantee Agency (MIGA) is the largest provider of guarantees as it specializes in risk mitigation products. MIGA accounted for nearly 46% of the total guarantees by MDBs in 2016 (Pereira Dos Santos & Kearney, 2018). This sum of guarantees extended includes all the trade and infrastructure guarantees issued by the MDBs. MIGA’s portfolio of guarantees consists of nearly 50% extended to the infrastructure sector. Many other MDB’s do not provide the sector specific information indicating their split of guarantees for various sectors or projects. However, the other MDBs have a substantial share of trade guarantees and the credit enhancement products provided to infrastructure are relatively smaller (Pereira Dos Santos & Kearney, 2018). MLAs have made considerable investments in different platforms to attract a fresh set of investors to the sector. MLAs have increased their insurance usage over the past couple of years (Group of MDBs, 2021). As a perspective, ADB has increased its usage of credit insurance from $740 million in 2017 to $921 million in 2019, out of which approximately 56% was in local currency. ADB has established insurance counterparty limits of $4300 million by 2019. Just like ADB, IFC has also grown its new credit insurance policies on long-term assets from $328 million in

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FY 2018 to $793 million in FY 2020 (Group of MDBs, 2021). PCGs and PRGs worth $1219 million were issued by ADB between the years 2015 and the first half of 2019 (ADB, 2019). ADB was able to raise $575 million worth of private finance by transferring credit exposure on guarantees and loans worth equal amounts to various independent counterparties in the first half of 2019 (ADB, 2019).

7.5 Managed Co-Lending Portfolio Program (IFC) IFC was the pioneer in utilizing credit insurance policies for financial resource mobilization from the insurance companies by launching the first facility in 2017 under Managed Co-Lending Portfolio Program (MCPP). In September 2017, IFC engaged Liberty Specialty Markets and Munich Re by signing master policies for providing coverage on 50% of risk taken by IFC for its fresh loans provided to emerging-market banks for the coming two years. Over the next 16 months, IFC was able to leverage $1000 million risk appetite from the two insurers for providing loans worth $2400 million to 30 banks spanning over 17 countries. These loans supported the implementation of SDGs (Group of MDBs, 2021). In this way, MCPP allows IFC to increase its lending ability, which it otherwise would not have if it were to lend from its own resources. This also helps in increasing the financial resources available for fulfilling the development goals (World Bank, 2020). Following the success of the MCPP facility, both the insurers were able to further engage with other multilateral agencies to set up a similar kind of structure—Liberty Specialty Markets engaged with the U.S. International Development Finance Corporation and Munich Re with Dutch Development Bank (FMO). This structure attracted participants from both sides—many other insurers started to engage with the MLAs to provide credit insurance (Group of MDBs, 2021). As per (World Bank, 2020) report, IFC operates two unfunded MCPP facilities worth $1500 million of capacity from three insurers. The third facility was launched in June, 2020 with a capacity worth $2000 million with six insurers. This facility will be able to provide lending support worth $5000 million to not only banks but also to nonbanking financial institutions (Group of MDBs, 2021).

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7.6

Government Credit Enhancement

The governments have configured various credit enhancement tools to ensure the participation of the private sectors with reasonable expectations. Typically, the guarantees/credit enhancement is under two categories, either as a minimum payment guarantee or as a support when faced with loan servicing defaults (debt guarantee). The first approach, the minimum payment guarantee, is the promise of ensuring that the revenues are as estimated prior to the implementation of the project. Usually, these are pegged to the debt service coverage ratio (DSCR) or an acceptable return on investment/internal rate of return (IRR). The minimum payment guarantee mechanism has been used extensively over the world, for instance, in Korea (Kim et al., 2011), Chile (Vassallo, 2006), Latin America (World Bank, 2012), and Columbia (Irwin, 2003). The initial merchant independent power producers in India were offered a guarantee of 14–16% project IRR (Ranganathan, 2003). The guarantee is usually provided to ensure that the financial close happens and the banks are comfortable lending to the project on more favorable terms. For example, the lenders were expecting a DSCR of 1.7x without any guarantee, but with the availability of a minimum payment guarantee, the DSCR expectation has come down to the 1.1x to 1.2x range (Estache et al., 2009). The second method of guarantee is the payment of debt service obligations if the private developers’ default (debt guarantee). This is also a widely used mechanism to address the refinancing risks across many countries. For example, the UK’s guarantee scheme of 2012, the USA’s Transportation Infrastructure Finance and Innovation Act, and Indonesia’s Infrastructure Guarantee Fund are some of the notable structures (OECD, 2012). The public intervention comes into play when the instruments are not available in the first place or available instruments do not provide enough risk coverage. This kind of intervention is required to enable the involvement of private sector participants, especially when institutional or other low-risk appetite investors are involved. Considering the limited availability of public financial resources, it is necessary to utilize them in a judicious way so that it can help to de-risk the projects and help in attracting private sector participants to invest in infrastructure projects. Subordinate debt or guarantees provided by the public sector as risk mitigation measures can help in improving the risk profile of projects

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and, in turn, help in attracting investments from multiple investor classes (APEC/OECD, 2019). The guarantees extended by the government need to be quantified and monitored periodically as the same can lead to a substantial burden going forward. For instance, the guarantees for minimum revenue need to be enough to sustain the project but not high so as to disincentivize the private sector from performing diligently and with disproportionate obligation to service borne by the government (Brandao & Saraiva, 2008; Wang & Liu, 2015). By committing to the minimum revenue guarantee, the government also takes on substantial future budgetary pressures which could have an impact on the rest of the system (Jiang, 2016). The assessment of the appropriate level of guarantees that need to be provided has been a topic of both academic and applied research (Carbonara & Pellegrino, 2018). The government which is providing a debt guarantee or a minimum pay guarantee, faces numerous challenges. The contingent liability of the guarantee could be very substantial and can affect the future budgets of the government for a long term. For example, the guarantee issued by the Mexican government for its 25 highway toll concessions in 1997 is estimated to be $7.7 billion (Ehrhardt & Irwin, 2004). The guarantee offered by a sovereign effectively means that the liability is assured by the taxpayers, who may not be the users, and hence is transferred to the stakeholders who may not benefit from the transaction. On a similar vein, the current taxpayers are benefiting from the deal in relation to the future generation of taxpayers, who might be paying for the guarantee should it be called upon (EPEC, 2012). The guarantee mechanism also acts as a disincentive for the private sector to not put in their best efforts to maximize the potential of the operating structure but rather depends on the guarantee mechanism to ensure that their hurdle expectations are met. The administrative costs of managing the guarantee also add to the overall burden of the transaction that the public budget system has not initially planned for. All this could lead to a potentially negative perception about the guarantees that are being issued, and any default or opposition can lead to other public sector project proponents to shy away from structuring such credit enhancement initiatives in future.

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7.7

Credit Enhancement---Capital Markets

The banks have been constrained by the stricter regulations that have come into place after the GFC, and their risk appetite for long-term loans has considerably declined (Dominguez et al., 2015). The institutional investors have stepped up their activities and have increased their participation in financing infrastructure projects around that time. Given the large infrastructure requirements in each country, there has been a recognition that the capital markets need to play a much larger role in the infrastructure deals and that they need to participate much earlier in the project lifecycle. Capital markets have been loath to take construction risk of the infrastructure projects and have preferred to participate when the substantial risks in the projects have been managed and when the cash flows become more steady. Prior to the GFC, the participation of the bond investors in the infrastructure finance deals was possible due to the presence of monoline guarantors. These entities wrapped up the project risks into very acceptable AAA rated bonds that the institutional investors were buying. The pension funds, insurance companies, and sovereign wealth funds typically invest through bonds in the projects. The share of bond financing in the European markets has increased from 3% in 2008 of the total project finance debt to about 27% in 2013 (ScottQuinn & Cano, 2015). The bonds are typically priced cheaper than the senior loans and they can be structured with longer maturities. The debt for infrastructure projects, particularly of PPP projects, comes from a combination of sources, including bank loans, bond issuances, and institutional investors or funds. For example, the Southern Cross station in Melbourne had three different types of bonds issued for its implementation. The first tranche of bonds is AUD $126 million for a period of 11.5 years, fixed rate and denominated in US dollars. The second tranche is AUD $200 million Australian dollar denominated 20-year floating rate bonds. The third tranche is a AUD $135 million US dollar denominated 30 year indexed bond (Regan et al., 2010). This method of financing was popular in the European and Canadian markets as well as the composite bond structure gives the advantage of factoring the currency, tenor, and the pricing aspects as needed. Many PPP projects in Europe in the early 2000s at a high debt component are going up to 85% (NAO, 2005). The availability of the extent of debt for larger projects and the pricing that is offered are dependent substantially on the credit ratings. There is an assessment undertaken of the credit for the privately sourced layers

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of finance. The processes and requirements vary with the consortium of financial institutions willing to support the project. The bond investors typically are very adept at analyzing the corporate risks (as the entities are treated as going concerns with permanent assets and an acceptable debt profile), but have not built the project appraisal skills that are required for infrastructure investments. The project financing poses a challenge in understanding the cash flow profile of a unique asset, the risks involved at various stages of the project lifecycle, particularly during the construction phase, the risks involved in realizing the contracted payments, and the aspects relating to refinancing. The bond investors have been very receptive to the financing deals in the infrastructure sector that are structured similar to the corporate bond market (Euromoney, 2012). The utilities in UK across sectors (water, transport) have been raising funds from bond investors, when they have multiple assets that are strung together into a corporate type profile. The solutions suggested for increasing the participation of bond investors into single assets and during the construction phase are either for the project proponents to completely mitigate the construction risk or create an entity (akin to a monoline or a supranational) to provide a wrapper for this risk (Euromoney, 2012). The primary requirement for bond investment is a credit rating of an adequate level. Typically, institutional investors are bound by their investment principles relating to safety. Most instruction investors would prefer at least a “A” credit rating but most PPP transactions are in the range of BB+ or BBB− (Dominguez et al., 2015; EPEC, 2012). The bond issuers look for credit enhancement instruments in order to improve the credit rating by at least a couple of notches. The most popular mechanism to provide great enhancement in the early 2000s was the monoline insurers. These entities have a single purpose of providing credit enhancement to bond issuers and usually do not have any other business. However, with the GFC, the monoline insurers have gone out of business. The public sector agencies have stepped into the role of monoline insurers in most of the infrastructure projects after the GFC (Ehlers, 2014). The public sector entities provide guarantees (typically a minimum pay guarantee or a debt guarantee) to bolster the credit rating of the project company. The provision of credit enhancement by a superior rated entity will increase the credit rating of the instrument to an acceptable level (of say “A” rating or above) and assist in attracting low-cost and long-term capital. The examples of government setting up structures to give debt guarantee

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include Europe’s 2020 Project Bond Initiative and the Transportation Infrastructure Finance and Innovation Act and the Railroad Rehabilitation and Improvement Financing Programme in the USA. The support of the governments by providing a guarantee is welcomed by the private sector and the financial institutions supporting the deal. But this comes at a cost of the performance or track record over the period, and hence the ability to sustainably configure similar initiatives in future. Infrastructure funds have also structured their offerings in an innovative manner that allows them to participate in senior debt as well as subordinated debt. For example, Hadrian Capital Fund, from Aviva Investors, has been funding both senior and subordinated debt to the projects. This has assisted the projects in enhancing their rating to investment grade, thereby allowing the participation of other institutional capital market investors. The Hadrian capital fund had created a structure that resembled a credit enhancer (Dominguez et al., 2015).

7.8

Residual Risks

The risks emanating from an infrastructure project are managed either under contractual arrangements or with insurance to the extent possible. The risks that are not addressed under either the contractual conditions or the insurance products are known as residual risks. These risks, which the private developer cannot handle on its own, include political, regulatory, counterparty, demand, expropriation, and exchange rate. Some of these risks depends on the project structure and geography and are partially addressed through insurance and derivative products such as swap agreements. The uncovered residual risks can be substantial and force the lenders to either increase their costs or worse, they will not lend to the project. The risk management products from the MDBs are also used to cover the residual risks. The guarantee and the insurance cover provided to Angola by a diverse group of stakeholders indicates the complexities involved in modern-day infrastructure financing and the need for innovation in risk mitigation. Similar to many other developing countries, the supply of timely, adequate quality and quantity of water has been a big challenge in Angola. To augment the portable water supply access to more than two million inhabitants in South Luanda, the capital city of Angola, the government of Angola configured a project titled “Luanda Bita water supply guarantee project”. The project involves the construction of a 260,000 cubic meter

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drinking water plant in Bita, laying of water mains for 82 kilometers, improving the distribution system, and disconnecting the drinking water supply from tankers in select localities. The estimated capital costs for the project is $1.1 billion. The transaction involved two loans, the first a $910 million loan supported by a World Bank guarantee. The second loan is a facility of $165 million. The Government of Angola had limited budget capacity and decided to implement the project through commercial borrowings. Given the limited fiscal space that the government has, it was imperative to provide credit enhancement to the initiative to make it attractive to commercial lenders. The Government of Angola’s initiative has been in the works since 2015; however, the project was not able to secure adequate create enhancement due to the prevailing economic conditions in the country. The project is being implemented by Luanda city’s water utility (Empreza Publica das Aquas de Luanda E.P. [EPAL]), who structured the construction works into seven contracts on a design-build arrangement. The Government of Angola had approached the World Bank to provide a partial credit guarantee for the senior loans. The first loan of $910 million is syndicated among five institutions led by the Standard Chartered Bank UK, who acted as a financial advisor, co-underwriter, co-bookrunner an Initial Mandated Lead Arranger. BNP Paribas France, Credit Agricole Corporate and Investment Bank France, Credit Suisse AG UK, and Société Générale France were part of the syndication. The loan is for a 15-year tenure provided to the Republic of Angola, acting through the Ministry of Finance. The World Bank gave a partial credit guarantee of $500 million to support the loan. As the project size is large, and accordingly, the size of loans from the participating institutions is large, there is still an uncovered risk after the World Bank has committed its partial credit guarantee. To bridge this gap, the African Trade Insurance Agency (ATIA) issued a $351 million guarantee as second loss insurance. This guarantee is for covering the principal and interest on the loan and to mitigate the risk of default by the Government of Angola to the designated lenders of the project. The deal also involved support from the private insurance market and was the largest World Bank partially guarantee financing till 2019. The projects also had a second facility of $165 million. This is a structured loan with the Standard Chartered bank UK as a sole mandated lead arranger with participation from Helaba and Santander. The French export credit agency, BpiFrance Assurance Export, also backed the deal. The payments to the French firms, Suez and Saint

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Gobain, were also supported by this loan facility (African Trade Insurance Agency, 2021; Takouleu, 2021; UN SDG, 2022). The project is a showcase example of collaboration between different infrastructure finance institutional stakeholders including the development financial institutions, export credit agencies, insurance market, and international commercial banks. This innovative blended finance solution has supported a much-needed essential service augmentation in a developing country.

7.9

Force Majeure---A Pandemic Context

The rapid spread of the coronavirus pandemic across the world in early 2020 triggered lockdowns in many parts of the world, leading to abrupt stoppage to the operations of many transport infrastructure facilities and suspension of numerous under-construction infrastructure projects across different sectors. The operational projects were impacted due to the very steep decline in the project revenues, particularly in the transportation sector, where the farebox revenues and toll charges declined suddenly due to the restrictions on travel imposed by the respective governments. This has a substantial bearing on the viability and sustainable functioning of infrastructure projects, particularly those which are operating under public–private partnership (PPP) arrangements. The construction activities have stopped for many infrastructure projects with the workforce required to stay at home and with disruptions in the movement of the materials. The economy as a whole, including the infrastructure sector, was under considerable stress, and the viability of many projects was jeopardized. It is assumed by many private sector stakeholders that they would be insulated from this calamity, and the public sector authorities would step in to make good the losses. However, the government system was also facing considerable challenges due to the need to rapidly upgrade the health infrastructure and, at the same time, ensure that the public is safe and provided with basic necessities. The government revenues also had a steep decline pushing them towards the default of their obligations under various contracts that they have executed (Casady & Baxter, 2020). The question that many contracts, particularly those under the PPP arrangements how faced is: Can the onset of the COVID-19 pandemic be treated as a Force Majeure event? (Outerbridge et al., 2020). In many contracts appear to be standardized but are couched in a not-so-clear legal language (EPEC, 2013). The definition used by many countries

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and multilateral banks such as the World Bank typically contains the definition of a force majeure event defined broadly and included as many events as possible. For instance, the World Bank’s 2017 Guidance on PPP Contractual Provisions (World Bank, 2017) defines a force majeure event as a. plague, epidemic and natural disaster, such as but not limited to, storm, cyclone, typhoon, hurricane, tornado, blizzard, earthquake, volcanic activity, landslide, tsunami, flood, lightning, and drought; b. fire, explosion, or nuclear, biological or chemical contamination (other than caused by the negligence of the Private Partner, its contractors, or any subcontractor, supplier or vendor); c. war (whether declared or not), armed conflict (including but not limited to hostile attack, blockade, military embargo), hostilities, invasion, act of a foreign enemy, act of terrorism, sabotage or piracy [, in each case occurring outside the Country]; d. civil war, riot rebellion and revolution, military or usurped power, insurrection, civil commotion or disorder, mob violence, act of civil disobedience [in each case occurring outside the Country]; e. radioactive contamination or ionizing radiation [occurring outside the Country]; or f. general labour disturbance such as boycotts, strikes and lock-out, go-slow, occupation of factories and premises, excluding similar events which are unique to the PPP Project and specific to the Private Partner or to its sub-contractors [and occurring outside the Country]. On a cursory reading, it appears as if the COVID-19 pandemic fits into multiple categories, such as a plague, epidemic, or a biological contamination or an Act of God. The actual enforcement of the clause would be contingent upon drafting of the final provisions, the type and characteristics of the contract, and the impact of COVID-19 on different stakeholders (Outerbridge et al., 2020). The courts have taken a narrower interpretation of the definition of force majeure in the past, while the definition as it appears in the PPP contractual documentation might need a broader interpretation of the term force majeure (Bloomberg Businessweek, 2020). The well-accepted adage in PPP contracts is that the “risk needs to be allocated to the party best able to manage the same”. This

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is much harder in practice and open to debate during the preparation of contractual documentation. The risk management and the allocation of responsibilities for the force majeure clauses are often the most unclear and are considered to be the crux for better performance (EPEC, 2013). The provisions of the force majeure clauses that are most discussed or elaborated on are the ones that are more predictable and not necessarily those that are completely unforeseen. When one looks at the ranking of factors critical for the success of PPP projects, the force majeure clauses score low, implying that they are not on the top of the mind (Wang et al., 2004). The incorporation of the pandemic related aspects in the force majeure clause in the Nova Scotia’s highway PPP tender augurs well for providing a much-needed clarity for dealing with such situations. The Ministry for Transportation and Infrastructure Renewal, Nova Scotia, Canada, issued a tender on May 6th, 2020, for a 38-kilometer highway development on a design, build, finance, operate, and maintain (DBFOM) basis. The project is estimated to cost CAD $717.9 million. The project agreements have incorporated specific clauses on how to handle the pandemic situation as part of the force majeure section. the coverage of the force majeure was widened to include “epidemic/pandemic” as a “communicable disease” or a “dangerous disease” under the Nova Scotia’s Health Protection Act (P3 Bulletin, 2020). The Minister for Health was mentioned as the authority to declare the commencement and the conclusion of the pandemic. This was done to address the uncertainty on the length of the pandemic, which can impact the construction phase and the operations phase. In case the construction is delayed due to the reasons attributable to the pandemic, the government will compensate the private developer (Dexter Nova Alliance) for the additional debt service requirements. These provisions in the contract differ from a typical PPP arrangement where either party has the right to terminate the agreement when the force majeure event extends beyond 180 days, and the termination payments include the lender getting paid their outstanding dues. In this contract, the project company is promised the debt service obligations that are additionally incurred due to the delays during the construction for reasons attributable to COVID-19 (P3 Bulletin, 2020). Usually, the impact of pandemic is not considered during the operations period as the infrastructure facility is treated as an essential service and is likely to continue to function. However, in the unlikely scenario of the operations

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being stopped due to the reasons attributable to COVID-19, the government has agreed to pay the due sums (which covers the debt service obligations, operations, and maintenance (O&M) expenditure and related costs) to the private developer. However, no compensation is payable (P3 Bulletin, 2020). This initiative to clarify the performance during a pandemic cancel is a good example for other PPP contracts. The onset of the pandemic has forced all the project proponents to carefully consider the provisions related to the treatment of the pandemic in the contractual documentation and the events or payments leading from the same. The sudden impacts of COVID-19, and any other unforeseen future event, cannot be handled by one stakeholder alone, but would need the collective efforts of all concerned. The principle of the “party best suited to handle the risk” might need to be broadened to provide for mechanisms that enable a collaborative way of resolving the challenge in the immediate term while also having a clear financial resolution mechanism in the longer term.

7.10

Political Unrest

It is increasingly becoming important to consider strikes, riot, civil commotion (SRCC), and insurance into the overall risk protection package of infrastructure financing. The events that caused the civil unrest in Minneapolis in 2020 and spread across other cities are estimated to have cost between $1 billion and $3 billion, making it one of the largest insured civil disorder losses in history. The previous major losses due to civil unrest were the riots in Los Angeles in 1965 ($357 million) and in 1992 ($1400 million). Similar situations have been encountered in many other countries. For instance, the estimated economic loss due to the protests that started due to the increase in taxes on fuel in Gilet Jaunes in France is $4.43 billion, and insured loss is estimated to be $220 million. The protests that have started when the passenger fares that were increased for public transport in Chile in 2019 were estimated to have resulted in $4 billion in economic losses, and the metro system incurred damages to the tune of $370 million. Most of these events are categorized as politically motivated risks, which manifest in multiple forms (for example, war, civil war, strike, malicious damage, mutiny, civil disturbances, civil unrest, terrorist act, sabotage, etc.). Many insurance companies offer variants of political risk insurance (PRI), or

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political violence insurance (PVI) though the actual coverage and description of events vary from the insurer and with the specific geography. Unlike the risks relating to natural events and other forms of traditional hazards, assessing the likelihood of politically motivated events and the consequences are more difficult. The adoption by the public and private sector project proponents of SRCC insurance cover is on the rise world over partly due to the coverage provided for terrorism related activities (Ronken et al., 2020).

7.11

Conclusions

The growth of the infrastructure sector and the matching appetite for infrastructure finance was due to the aggressive bank lending to the sector, and the participation of capital markets, wrapped with monoline guarantees, was the story of many countries still 2007. As the monoline insurers have exited the market, the stakeholders in the debt and bond markets have looked upon their respective governments and MDBs to support through the guarantees for addressing the residual risks. The fallout of the GFC was the loss of the AAA rating of the monolines and the increased risk aversiveness of the commercial banks (partly due to the higher regulatory requirements that have come into force) that resulted in the tenor of the loans being reduced and also substantially decrease in the commercial banks’ interest to invest in the infrastructure sector. The risks that exist in an infrastructure financing context are sought to be addressed by a combination of better design, procedures and processes, contractual provisions, insurance, and credit enhancements. The insurance sector has innovated substantially as they bring in various methodologies to assess the risks, the products that they have been offering in helping the governments, sub-sovereigns, private sector, and financial institutions to better understand the natural hazard risks and offer the required cover to the infrastructure assets. The assurance that the insurance sector provides to the equity and debt providers has been substantial and played an important role in the growth of the infrastructure sector. The loans given to infrastructure companies tend to be much longer tenor than the typical corporate finance transactions and are usually well designed. The credit enhancements, including the guarantees and insurance, help in providing a robust structure for various institutional investors to participate in the infrastructure financing transaction. This means that the credit risk of an infrastructure asset substantially declines

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overtime most of the risk in infrastructure projects is during the construction phase and the initial operations. A well-structured credit enhancement initiative can address the expectations of all the stakeholders; the borrowing company can have access to low-cost funds, the bond investors can have the comfort that their investments are backed up by a higher rated entity in case of any potential default, and the government can get a much-needed infrastructure project off the ground.

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Clifford Chance. (2018, November 9). Clifford chance advises the lenders on the 1.2 billion euro Nachtigal 420MW hydro project in Cameroon, the largest hydro IPP in Africa. Clifford Chance. https://www.cliffordchance.com/ news/news/2018/11/clifford-chance-advises-the-lenders-on-the-1-2-billioneuro-nach.html Clifford Chance. (2020). Libor transition for the infrastructure sector. https:// www.cliffordchance.com/content/dam/cliffordchance/briefings/2020/02/ libor-transition-for-the-infrastructure-sector.pdf Dailami, M., Lipkovich, I., & van Dyck, J. (1999). INFRISK: A computer simulation approach to risk management in infrastructure project finance transactions. https://papers.ssrn.com/abstract=620542 DEA. (2020). Scheme and guidelines for forwarding proposals for financial support to public private partnership in infrastructure under viability gap funding scheme. Department of Economic Affairs, Ministry of Finance. https://dea.gov.in/sites/default/files/Notification%20of%20the%20Reva mped%20VGF%20Scheme%20-%20%20DEA%20OM%20dated%207%20Dece mber%202020%20regarding%20Scheme%20and%20Guidelines%20for%20f orwarding%20proposals%20for%20financial%20support%20to%20PPPs%20in% 20Infrastructure%20under%20VGF%20Scheme_0.pdf Dharmapuri Tirumala, V. R. R. S., Tiwari, P., Sawhney, A., & Kodumudi Pranatharthiharan, K. (2020). Analyzing configurational paths for successful PPPs in Indian urban drinking water sector. Journal of Infrastructure Systems, 26(3). https://doi.org/10.1061/(asce)is.1943-555x.0000557 Dominguez, C., David, O., Sangay, U., & Dorji, T. (2015). Green bonds in public-private partnerships. https://www.iisd.org/system/files/publications/ green-bonds-public-private-partnerships.pdf Ehlers, T. (2014, August). Understanding the challenges for infrastructure finance. https://www.bis.org/publ/work454.pdf Ehrhardt, D., & Irwin, T. (2004). Avoiding customer and taxpayer bailouts in private infrastructure projects: Policy toward leverage, risk allocation, and bankruptcy (Policy Research Working Paper No.3274). https://doi.org/10. 1596/1813-9450-3274 EPEC. (2012). Financing PPPs with project bonds—Issues for public procuring authorities. Journal of Addiction Disorder and Rehabilitation. European Investment Bank. EPEC. (2013). Termination and force majeure provisions in PPP contracts. Journal of Addiction Disorder and Rehabilitation. European Investment Bank. Eshun, B. T. B., & Chan, A. P. C. (2021). An evaluation of project risk dynamics in Sino-Africa public infrastructure delivery; A causal loop and interpretive structural modelling approach (ISM-CLD). Sustainability, 13(19), 10822. https://doi.org/10.3390/SU131910822

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Estache, A., Iimi, A., & Ruzzier, C. (2009). Procurement in infrastructure: What does theory tell us? World Bank. https://doi.org/10.1596/1813-9450-4994 Euromoney. (2012, April 3). Risk wrap key to Europe’s infrastructure ambitions. Euromoney. https://www.euromoney.com/article/b12kjmdwz904cv/ risk-wrap-key-to-europes-infrastructure-ambitions Gatti, S. (2014). Private financing and government support to promote Long Term Investments in infrastructure. https://www.oecd.org/daf/fin/privatepensions/Private-financing-and-government-support-to-promote-LTI-in-inf rastructure.pdf Group of MDBs. (2021). Mobilization of private finance 2019. https://www. aiib.org/en/about-aiib/who-we-are/partnership/_download/Mobilizationof-Private-Finance-MDB-Joint-Report-2019-Final.pdf Hellowell, M., Vecchi, V., & Caselli, S. (2015). Return of the state? An appraisal of policies to enhance access to credit for infrastructure-based PPPs. Public Money & Management, 35(1), 71–78. https://doi.org/10.1080/09540962. 2015.986896 Humphrey, C., & Prizzon, A. (2014). Guarantees for development: A review of multilateral development bank operations. ODI. https://odi.org/en/pub lications/guarantees-for-development-a-review-of-multilateral-developmentbank-operations/ IJGlobal. (2019, March 22). IJGlobal awards 2018—Europe & Africa | News. IJGlobal. https://www.ijglobal.com/articles/138849/ijglobal-awards-2018europe-and-africa Irwin, T. (2003). Public money for private infrastructure: Deciding when to offer guarantees, output-based subsidies, and other fiscal support. World Bank. https://doi.org/10.1596/0-8213-5556-2 Jiang, Y. (2016). Selection of PPP projects in China based on government guarantees and fiscal risk control. International Journal of Financial Research, 8(1), 99. https://doi.org/10.5430/IJFR.V8N1P99 Jin, H., Liu, S., Liu, C., & Udawatta, N. (2019). Optimizing the concession period of PPP projects for fair allocation of financial risk. Engineering, Construction and Architectural Management, 26(10), 2347–2363. https:// doi.org/10.1108/ECAM-05-2018-0201/FULL/XML Kim, J.-H., Kim, J., Shin, S., & Lee, S.-Y. (2011). Public-private partnership infrastructure projects: Case studies from the Republic of Korea (232 pp.) https://www.adb.org/publications/public-private-partnership-inf rastructure-projects-case-studies-republic-korea MacroTrends. (2022). 6 month LIBOR rate—30 year historical chart. https://www.macrotrends.net/2519/6-month-libor-rateMacroTrends. historical-chart

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MarshMcLennan. (2019). Hong Kong protests—Risk advice and policy coverage https://www.marsh.com/ph/migrated-articles/hong-kong-pro concerns. tests-risk-advice-and-policy-coverage-concerns.html NAO. (2005, March 15). Improving public services through better construction. National Audit Office (NAO). https://www.nao.org.uk/reports/improvingpublic-services-through-better-construction/ OECD. (2012). Indonesia public-private partnership governance: Policy, process and structure. OECD. www.oecd.org/regreform/backgroundreports. Outerbridge, D., Lumière, J. R., Slavens, S., & Wall, N. (2020, March 11). COVID-19 and force majeure clauses: Key considerations, implications, and practice tips | Insights | Torys LLP. Torys. https://www.torys.com/Our%20L atest%20Thinking/Publications//2020/03/covid-19-and-force-majeure-cla uses/ P3 Bulletin. (2020). P3 signed with pandemic agreement. P3 Bulletin. https:// www.p3bulletin.com Pereira Dos Santos, P., & Kearney, M. C. (2018). Multilateral development banks’ risk mitigation instruments for infrastructure investment. https://doi.org/10. 18235/0001008 Quintana, I., Konidaris, T., & Sands, P. (2019). The effects of derivatives regulation on infrastructure finance. https://doi.org/10.1596/33590 Ranganathan, V. (2003). Tanir Bavi: How not to sign PPAs on JSTOR. Economic and Political Weekly, 38(27), 2791–2794. https://www.jstor.org/stable/441 3743 Regan, M. (2017). Capital markets, infrastructure investment and growth in the Asia Pacific region. International Journal of Financial Studies, 5(1), 5. https://doi.org/10.3390/IJFS5010005 Regan, M., Smith, J., & Love, P. E. D. (2010). Impact of the capital market collapse on public-private partnership infrastructure projects. Journal of Construction Engineering and Management, 137 (1), 6–16. https://doi. org/10.1061/(ASCE)CO.1943-7862.0000245 Ronken, L., Eilers, H., & Re, G. (2020). Strike, riot and civil commotion: An increasingly significant form of cover. Scott-Quinn, B., & Cano, D. (2015). Guide to infrastructure financing: Bank loans, debt private placements and public bonds-smoothing the pathway for effective funding. International Capital Market Association. https://www.d20-ltic.org/wp-content/uploads/2022/07/AFME_G uide_to_Infrastructure_Financing_1_1.pdf Takouleu, J. M. (2021, September 8). ANGOLA: ACA issues $351m guarantee for Bita mega water project. Afrik 21. https://www.afrik21.africa/en/angolaaca-issues-351m-guarantee-for-bita-mega-water-project/ Tikhomirov, D., & Plotnikov, V. (2018). The minimisation of risks in project finance: Approaches to financial modelling and structuring. MATEC

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CHAPTER 8

Unlocking Value Through Asset Recycling

Effective asset monetization can help create substantial fiscal impact, worldclass infrastructure in India. —Amitabh Kant, CEO, NITI Aayog

8.1

Introduction

The idea of raising finance for new infrastructure projects through unlocking value from the existing assets has gained prominence in the last decade primarily due to the asset recycling (AR) initiative of the Australian government launched in 2014. Post the global financial crisis, it was important for governments to maximize the revenue generated from the available resources while ensuring the protection of the public interest during the delivery of infrastructure services (Fenn, 2014; Nowacki, 2019). AR is considered as an attractive policy tool to accelerate the upgrading/ improvement of infrastructure projects through monetizing the existing assets and using the proceeds to invest in new infrastructure (Niquette, 2017; Poole Jr., 2018; Varn & Kline, 2017). The AR mechanism is expected to benefit the public sector project owners through monetization by unlocking the substantial value embedded in infrastructure, which has been accumulated over a long period of time. The widespread media coverage for this innovation has attracted closer scrutiny from other countries, including the USA, Japan, Brazil, and © The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2023 R. D. Tirumala and P. Tiwari, Advances in Infrastructure Finance, https://doi.org/10.1007/978-981-99-0440-2_8

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China, over the period. India and Indonesia have gone ahead and configured their versions of AR, such as the Toll-Operate-Transfer (TOT) model and the Least Concession System, respectively (Somani et al., 2020). The increased attention has led to the countries committing to develop more robust project structures and channeled enthusiasm to develop larger pipelines. This tool has been popular in nations that spend very little on civic infrastructure (Fallows, 2015). The existing infrastructure in many countries such as the USA, Canada, and Australia is aging and needs to be replaced with new projects (Fenn, 2014). AR was perceived as an option worth exploring to augment the infrastructure in relation to the conventional routes of investing using own resources or relying entirely on BOT-styled PPP arrangements. AR is attractive to the countries that spend little on infrastructure, and their existing infrastructure gap is increasing day by day as it serves as a catch-up funding mechanism for infrastructure that is viable as well (Infrastructure Australia, 2016; Oxford Economics, 2017). AR provides incentives to project authorities for recycling their capital from existing projects for new projects which are more productive (Infrastructure Australia, 2016). For AR models to have sufficient traction, it is important to have enough private sector interest in participation (with the backing of their respective investors and lenders), and the different elements of the AR structure designed in a manner that meets the objectives of the participating stakeholders (governments, private sector, and the public). The Australian initiative was launched during a period when private participants’ increased appetite for the infrastructure sector was observed (Nowacki et al., 2016). The Indian models of Infrastructure Investment Trusts (InVITs) and TOT are taking off in the transport and energy sectors supported by international investors such as Macquarie (Somani et al., 2020). Similar to a few other innovations in the infrastructure financing sector, the adoption and effectiveness of AR need to be seen in balance with its real achievements and substantial international attention. Not all states in Australia adopted the AR initiative when it was launched; the program itself was terminated in a few years (The Australian Government the Treasury, 2019). The conceptualization of AR in Australia, its variants being developed across the globe, however, demonstrates the close integration of the different elements of infrastructure development, delivery, and operations. The financing of infrastructure remains a holistic venture that needs to be carefully stitched together in relation to the local ecosystems.

8

8.2

UNLOCKING VALUE THROUGH ASSET RECYCLING

189

Asset Recycling Initiative of Australia

A study was conducted in 2011 by the Financial Services Council of Australia (supported by the consultants Ernst & Young Australia) to ascertain the interest of Australian pension funds to invest in in public infrastructure projects. The aim was to seek the industry’s views on a broad spectrum of issues at different stages of the project life cycle and to seek inputs for framing the investment and divestment policies of the state and federal governments of the Australian Commonwealth. The biggest hindrance to attract investments in infrastructure was poor certainty over pipeline of the prospective projects. Even though participants could notice the growing commitments of the state governments for the new projects, there existed considerable uncertainty about some projects receiving required financing (EY, 2014). There was a consensus that the Australian government should devise a policy of recycling the public infrastructure. The idea was to identify existing projects held by the Australian government and assess their suitability for selling or leasing and reinvest the capital for developing greenfield projects. The intention was also to match the current appetite of investors to participate in government-sponsored projects. Pension funds were looking to invest in the assets where stable revenue streams exist while conforming to their metrics of the asset-liability match. AR was looked at as an opportunity to create a pipeline of long-term infrastructure assets across the nation, which would help in optimizing the government’s financial budgeting process and release financial resources to develop new infrastructure projects (Infrastructure Australia, 2013). Considering the previous successes of the PPPs and the limited scale recycling of assets by Queensland, Australian government (Abbott administration) possibly thought that asset recycling is an option that should be encouraged for implementation by all the Australian states. Subsequently, a general view emerged that Australia’s federal and state governments should adopt a formal public policy of “recycling” public assets. AR originated in Australia as part of the government’s 2014 Asset Recycling Initiative (ARI) (Poole Jr., 2018). Under the ARI, the federal government would review the proposals of the state governments concerned, which set out the operating assets that they would like to be monetized (sold or recycled), and develop “greenfield” assets using the proceeds from the monetization. This mechanism found general acceptance with the governments recycling a few capital

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assets and using the proceeds to build and finance infrastructure (Fenn, 2014). Government officials could foresee the benefits of the successful implementation of AR, and they were positive that unlocked capital would help in achieving the targeted national economic growth. The government was also aware that it could attract institutional investors who prefer a steady revenue generation stream with a relatively lower risk profile to the infrastructure sector. This gave the government confidence that AR would help in freeing up capital required for developing infrastructure projects. This initiative would simultaneously help them in the debt reduction and allow them to utilize their revenue streams for other financing other infrastructure assets (Poole Jr., 2018). ARI worth AUD 3.3 billion aimed to incentivize state governments of Australia for selling or leasing public assets which were underutilized to the private sector and reinvesting freed up capital or proceeds for development of new assets (Varn & Kline, 2017). For sell or lease of every asset concerned, state or territory was eligible to receive 15% of the original transaction value in federal dollars (see Fig. 8.1) (Casady & Geddes, 2020). Australia was able to generate AUD 15 billion from 2013 to 2016 by recycling assets available in the transportation and power sector (Bishop, 2018). New South Wales (NSW) received benefits worth AUD2.2 billion from ARI over the period from FY 2016–2017 to FY 2018–2019, which is the highest return in comparison to any other state during that period. Infrastructure funding in NSW and the percentage allocation for the infrastructure in the budget also increased post-ARI implementation. An average four-year NSW budget allocation share for the infrastructure sector increased from 9% in 2005–2006 to 17.65% in 2018–2019 (Infrastructure Partnerships Australia, 2019). The funds received by NSW are equivalent to funding needed for the construction of Sydney Metro’s first two parts. It is sufficient to fund Northconnex and next 4 years’ infrastructure expenditure for health and education. It would have been difficult to raise a similar quantum of financing through Increasing taxes or raising government debts (Infrastructure Partnerships Australia, 2019). The AR approach included attracting investments from different institutional investor communities including pension funds, sovereign wealth funds (SWFs), and private investment funds in core infrastructure projects. The focus, in line with the risk profile of the institutional investors, was on brownfield projects, which have an established track record of generating cash flows. John Brogden, the CEO of the Financial

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Fig. 8.1 Asset recycling program of Australia (Source Authors based on Varn and Kline [2017])

Services Council of Australia, stated that the growth in Australian pension (superannuation) funds under management was exponential from AUD 140 billion to AUD 1.3 trillion in 20 years, while the infrastructure gap has widened during that period. He argued that using pension funds to invest in infrastructure in Australia would help in bridging the gap. The case for increased participation in infrastructure by super funds needs to be evaluated (EY, 2014). It was felt that the Australian pension funds should increase their asset allocation to infrastructure projects which will not only generate good returns for the fund members but also support economic growth. However, there are cautioning views that pension funds’ allocation should not be considered as the cash cow for resolving

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Table 8.1 A few prominent asset recycling projects from Australia Project name

State

Year

Lease/sale

Proceeds (AUD million)

Port Botany and Port Kembla Territory Insurance Office (TIO) ACTTAB

New South Wales

2013

99-year lease

Northern Territory

2014

Sale

411

2014

Sale

106

Transgrid

Australian Capital Territory (ACT) New South Wales

2015

10,273

Port of Darwin Ausgrid

Northern Territory New South Wales

2015 2016

Port of Melbourne Endeavor Energy

Victoria

2016

100% lease for 99 years 99-year lease 50.4% lease for 99 years 50-year lease

New South Wales

2017

7,624

Titling and New South Wales registry business of Land and Property Information Land Titles Office South Australia

2017

50.4% lease for 99 years 35-year lease

2018

40-year lease

1,605

5,070

506 16,200 9,700

2,600

Sources Author’s compilation from different sources (Marsh & McLennan Companies, 2018; Menezes, 2013)

the economic challenges of Australia (Fenn, 2014). A few well-known Australian AR projects have been listed in Table 8.1.

8.3 Other International Asset Monetization Initiatives Chicago Skyway, Puerto Rico’s Toll Road and Airport, Maryland’s Seagirt Marine Terminal, and Ohio State University’s parking concessions are some of noteworthy examples that has put asset recycling concept in practice (Casady & Geddes, 2020; Poole Jr., 2018). Chicago Skyway toll project is one of the most prominent projects that consisted of an innovative financing structure that allowed the public sector authorities to monetize the future cash flow of the existing toll project. It was the first

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operational toll road in the USA to be privatized. The Skyway Concession Company obtained the 99-year concession lease from Chicago City in 2005 for $1.83 billion (US Department of Transportation, 2021). This transaction helped the authorities to improve the financial condition of the city by deploying the funds received from this transaction to address their existing liabilities. Authorities paid off their existing loan on Skyway ($463 million) and settled their short-term ($258 million) and long-term ($134 million) city debts. In addition, the authority was able to establish long-term reserve ($500 million) and allocate $100 million for the creation of “people, neighborhood, and business investment fund” (Bipartisan Policy Center, 2016; Dyble, 2013; US Department of Transportation, 2021). Chicago Skyway project is a prime example where government authorities benefitted from the privatization as it also generated resources for the other projects/infrastructure. The successful implementation of this transaction benefitted from the extant political will, a driving force for many PPP/privatization transactions all over the world, along with the other favorable ecosystem features. There are many other similar examples, such as Indiana Toll Road, Maryland’s Seagirt Marine Terminal, Puerto Rico’s Toll Road and Airport, and Ohio State University’s parking which comprised the project proponents successfully monetizing their operational assets. Many of such initiatives are for standalone projects (Bipartisan Policy Center, 2016; Casady & Geddes, 2020; Dyble, 2013; US Department of Transportation, 2021). The USA’s Infrastructure Plan contemplates the use of private activity bonds by the private sector to raise finances that could be used to make lease payments for assets offered under an AR scheme. Such bonds, also incorporating tax exempt status, are expected to boost new asset recycling (US Department of Transportation, 2021). The Indiana toll road was leased to the Indiana Toll road concession company in 2005 for which the state received $3.85 billion as a consideration. The private operator was expected to implement electronic tolling, invest in upgrading/widening sections of the toll road, and maintain specified levels of service in designated rural and urban areas for a period of 75 years, and recoup its investments from the road’s tolls. This transaction supported in raising finances for the Indiana state’s ten years surface transportation plan, “Major Moves”. The Indiana Department of Transportation (INDOT) has used the payments made by the Indiana Toll Road concession company to implement upgrades in its road network (500 miles of new highway, 6,400 miles of rehabilitated or

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replaced highway, and 60 new or reconstructed interchanges, and 1,400 rehabilitated or replaced bridges, approximately a quarter of the state’s total network). The cumulative payments received were of the order of $10.8 billion. In addition, Poole (2018) notes that this deal allowed the state to repay “$200 million in outstanding ITR debt and [invest] $500 million into a ‘Next Generation Trust Fund’, which was designed to provide stable, long-term maintenance funding for the new transportation infrastructure” (p. 23). According to Gilroy and Aloyts (2013), this fund generated approximately $755.5 million in interest income by April 2011, thereby turning “a [once] revenue-losing asset into an asset that is funding billions in transportation investment now and generating hundreds of millions of dollars for the state’s long-term transportation infrastructure needs” (Casady & Geddes, 2020). NSW government had also undertaken an asset monetization initiative by establishing Restart NSW fund, which was part of the Rebuild NSW program, with an objective to propel economic growth. This fund was established through the Restart NSW Fund Act, 2011 (Restart NSW Fund Act 2011 No. 32, 2011). This fund was used to capture and deploy the money received through different transactions, such as leasing the existing infrastructure assets, for the development of new infrastructure projects. As part of this initiative, the NSW government screened the new projects through a selection procedure, and only those which are justifiable both financially and economically have been supported. Identification of the eligible projects through a defined process has assisted in this initiative of becoming successful (Nowacki et al., 2016). As per 2022–2023 budget of New South Wales, inflows to Restart NSW stood at AUD 37.7 billion in June 2022, and government has already committed AUD 34.5 billion for the various infrastructure projects. More than 1000 projects from New South Wales have received AUD 26.5 billion since the fund’s inception out of a total commitment of AUD 34.5 billion (State of New South Wales [NSW Treasury], 2022). To ensure that the process of AR is managed efficiently, NSW had created Infrastructure NSW, an independent entity to provide oversight to the AR process. The projects funded by the Infrastructure NSW from the proceeds of the AR program include Newell Highway (AU$78.8 million, 28-kilometer road); the extension of Princes Highway (AU$52.5 million, 9.8 kilometer); and the New England Highway bypass route (AU$30.4 million, 12 kilometer) (Bishop, 2018).

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In Asia pacific region, most of the countries need to replace their existing infrastructure as they face challenges including rapid urbanization and increased levels of congestion. Due to limited government capacity and resources, bridging the infrastructure gap is increasingly becoming difficult, particularly for low-income countries. Many countries face issues such as limited global borrowing capability, constraints related to the current account deficits, and low credit rating putting constraints on the availability of fresh investments in the infrastructure sector (Bhattacharya, 2012). AR in such circumstances is appealing because it offers a viable, catch-up infrastructure funding mechanism (Infrastructure Australia, 2016). India is one of such countries in the region which has laid down the National Infrastructure Pipeline (NIP) (2020) and National Monetization Plan (NMP) to capture the benefits of the asset recycling process (Bhattacharya, 2012). NIP proposes to complete 6835 infrastructure projects by 2025. To undertake this, $14 trillion will be required till 2025. NIP proposes to develop projects in the energy, roads, railways, ports, airports, urban, digital, irrigation, rural, agriculture and food processing, industries, and social sectors (DEA MoF, 2020a, 2020b). The monetary value that the private sector perceives in such asset monetization transactions varies from region to region and is influenced by the prevailing conditions. The bid value paid by the private sector for the USA projects was 60 times the current cash flows. In contrast, for a similar type of toll road transaction in France in the 18-month period between early 2005 to mid-2006, the private sector paid only 12 times the cash flows (Bel & Foote, 2009; Enright, 2006). A straight comparison of the multipliers does not present a full picture of the deal structure. Bel and Foote (2009) and Enright (2006) acknowledged that such transactions have opened a door for a new type of financial structure based on the future cash flow, taking into consideration that revenue increase (toll) is permitted. The private sector’s exuberance in bidding for government-owned assets varies substantially from having no bids for many transactions to very keenly fought transactions. For instance, the Government of India’s attempts to privatize its national carrier, Air India, was not successful many times. Only recently have they managed to hive off the airline operations to a leading industrial conglomerate, Tata group. Rio de Janeiro’s international airport, Galeão, was offered to private operators in 2013, which attracted numerous competitive bids. The consortium of Odebrecht engineering group and

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Changi Airport Group submitted a successful bid of R$19 billion for the transaction, which is more than 30% higher than the second-best bidder and four times the government’s estimate. Similarly, the tender for Belo Horizonte’s Tancredo Neves International Airport was competitive. This management contract was won by a consortium of CCR, Zurich Airport and Munich Airport, who submitted a bid worth R$1.8 billion, which is nearly 2/3 more than the government estimate of R$1.1 billion. Successful bids create an impression that the private sector interest is unlimited, and they make offers that are much more than the minimum estimates of the project proponents, while still making an acceptable profit from the venture (Marsh & McLennan Companies, 2018). It would be interesting to explore the experience in future of such transactions in terms of who between the government sector and private sector should reap the benefits of the price increase over the period. If the government benefits, the additional amount received can be deployed in other public projects, which is advantageous to the users (Bel & Foote, 2009). The private sector is in for obtaining a fair return for the risks that they assume over the period. A transportation project that is developed by the government might have more economic value and taxes and minimize future costs to the government when not fully funded by the user fees, in relation to a project such a toll road that is fully funded with tariffs (Nowacki et al., 2016).

8.4 AR for Social Infrastructure: Permanent Funds The modalities of AR have been configured to create or capitalize permanent funds. In some instances, such structures have been used to address critical maintenance issues through a “fix-it-first” (FiF) models. A FiF structure typically uses the proceeds from the AR in two steps: (i) first, attend to any critical, urgent repairs and maintenance issues in the existing infrastructure; (ii) use the remaining monies from the AR proceeds to set up/build the corpus of a permanent fund. A permanent fund operates as a trust fund and is conventionally configured to conserve wealth from natural resources. The application of permanent funds can be seen in many countries, including Canada, the USA (Alaska, Texas), and Norway. An AR arrangement can constitute setting up a permanent fund as proceeds from the program can be parked in a public trust permanent fund which can invest in social infrastructure (Fenn, 2014). Ringfencing

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the permanent fund would also insulate the same from the region’s other budgeting and spending demands (Casady & Geddes, 2020). The Alaska Permanent Fund (APF) is a prominent example of the benefits of such structures. The APF was configured subsequent to the large public sector spending by the government after oil deposits were discovered on the North Slope in 1968. The boom in oil exploration began in Alaska when Atlantic Richfield extracted the same from Prudhoe Bay. The state government auctioned the oil leases next year which resulted in a massive inflow of $900 million in a single day. This amount was more than nine times the then state budget. A sudden inflow of a large amount of money prompted the state to increase capital spending, which some of the commentators commented was wasteful. In the two decades from 1961 to 1981, the Alaskan general fund expenditure increased at an average annual rate of more than 20%, from $45 million to over $3 billion (Casady & Geddes, 2020). The APF was configured and developed subsequent to this massive public spending with an objective to conserve Alaska’s natural resources for generations to come. The constitution of Alaska mandates that at least a quarter of the revenue from this sale of oil and gas or royalties thereon be channeled into the APF. The income generated from the investments by the APF is distributed as annual dividends to the taxpayers resident in the state of Alaska (Geddes & Nentchev, 2013). The APF had become quite large with an estimated market value of more than $79 billion as of August 2022; its dividend was $696 million as of 31 December 2021 (APFC, 2021). A permanent fund created under AR mechanism can operate in a similar manner as the APF. The proceeds from the AR permanent fund can be used to finance projects in the social infrastructure sectors in contrast to the APF’s distribution of its investment income as dividends to its taxpayers (Casady & Geddes, 2020). Social infrastructure sector typically consists of education (schools), health (hospitals), prisons, and other public purpose buildings. Typically, such infrastructure does not generate enough revenue to meet its capital and or maintenance expenditure (Casady & Geddes, 2020; Ciolek & Fahy, 1997). The construction and upkeep of this infrastructure require sustained public or government funds over the long term. Such need of long-term government funds to manage social infrastructure can be structured through the permanent fund configured as part of an AR program. The investment income generated from the proceeds of the AR can be deployed in such a manner to provide a steady stream of cash flows

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for defined social infrastructure projects. As this operative structure does not infringe hugely on the extant government’s budget, it is possible to garner enough political and bureaucratic support without increasing the taxes. An appropriately structured AR program aimed towards developing social infrastructure can assist in the funds staying in infrastructure asset creation space rather than being used for non-infrastructure or general expenditure purposes. While there are no current AR initiatives aimed at social infrastructure, infrastructure Ontario’s Capital Planning Program has some similarities (Casady & Geddes, 2020).

8.5

The Case for Mainstreaming AR

With the increasing demand for infrastructure services across the globe, and the constraints the governments have been facing, the “infrastructure gap” has been widening. The infrastructure gap typically refers to the gap between the needs, requirements and expectations of different stakeholders, and the nature of the existing information ecosystem (projects, regulations in place, and bidding process) (Enright, 2006; Nowacki, 2019). This gap acknowledges the noticeable paucity of investable/viable projects that governments and the private sector can work together to implement. Closing this infrastructure gap would entail matching the divergent expectations of various stakeholders and bridging the knowledge discrepancies between the public and private sector investors (Nowacki et al., 2016). The charm of the AR is that this modality is perceived to be a potential fast track mechanism to bridge the infrastructure gap. The proponents of the AR to be used as a mainstream option for financing new infrastructure assets have argued their case based on the benefits that are likely to accrue to the government, private sector, and the general public. The private sector is expected to pay the government authorities a discounted value of the future cash flows, while also maintaining the assets for an agreed period of time. This simultaneously provides immediate cash to the government stakeholders while also resulting in risk transfer. Moreover, if the asset is leased, it is expected to revert to the public sector proponent at the end of the lease in working condition. The release of cash and the (temporary) relief from the operations and maintenance of the asset is expected to reduce the burden of the local or state authorities for infrastructure development. The public sector project proponent is

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expected to use the resources generated through AR into other infrastructure activities as per the prevailing priorities. The diversion of funds from the existing assets can potentially be used to have balanced regional development (across developed and underdeveloped areas or urban and rural areas) or support infrastructure in sectors that are not readily generating requisite cash flows (Casady & Geddes, 2020; Niquette, 2017; Poole Jr., 2018; Regan, 2017; Varn & Kline, 2017). Formal capital recycling structures within each state/region are also expected to provide a reasonable sight of the future infrastructure pipelines. The advantage of AR system is the certainty of the budgets, available funds for investment of the respective state governments, and the upside of leveraging the asset sales of major projects (EY, 2014). AR is also expected to remove the conflict that exists for government to play the role of both an owner and a regulator for the infrastructure provision. As the private participant assumes the ownership of the projects, a conducive environment for a more efficient and regulated market is expected to be created (Infrastructure Australia, 2016). The benefits for the private sector arise as the existing/operational infrastructure projects come with predictable revenue streams, which makes the transaction less risky and more lucrative as compared to greenfield projects for the private sector participants (Bishop, 2018). The AR mode has received a fair share of attention at a concept level, with its detractors arguing that the path is not all rosy. The philosophy of income-generating assets being disposed off was opposed for the precise reason that the assets are revenue generators. The process of divesting the revenue-generating assets and deploying the proceeds on infrastructure assets that do not have adequate income or have limited cash flows was argued as not being justified when viewed from the perspective of regular cost–benefit analysis. The process of AR implied that the projects sought to be divested are chosen on the basis of their ability to attract private sector interest and hence financing, rather than the strategic reasons of ownership and value addition. This was considered as not adhering to the fundamental principles of public infrastructure investment, where projects need to be justified through an economic analysis. The rationale of picking specific projects with a stronger ability to attract private sector interest to support favored projects in non-revenue-generating sectors is considered to be ad hoc (Quiggin, 2022). In order to address these concerns, policymakers in the USA are exploring alternative approaches

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for strengthening operations and management of existing infrastructure and prioritizing value creation within these systems. Another aspect that comes up in the context of government’s management of its budgets and finances is its creditworthiness to raise finances, determined by a credit rating. In the case of the asset recycling strategy adopted by NSW government, it allows for proceeds from sale of assets to be used for financing transportation infrastructure. This approach could negatively impact the government’s credit rating over the medium and long-term based on how agencies like Standard & Poor issue credit ratings. A rating agency gives greater weightage to a government’s ability to keep its revenues above its expenditure as compared to the total debt maintained by it. This implies that if the sale of a valuable revenue stream can generate an alternate revenue stream that is bigger, then it would have a positive impact on the government’s long-term budget (Koukoulas & Devlin, 2014).

8.6

Criticism

One of the most important things for the success of any initiative is the support of the public, particularly in relation to privatization of public infrastructure. Countries all over the world be it the USA, Canada, UK, Australia, or India have witnessed opposition from the public when the infrastructure assets are either privatized or being developed under PPP arrangements (Quiggin, 2022). Some of the Australian infrastructure assets, particularly in the electricity sector, have been sold to corporations controlled by foreign governments (Singapore, France or China), which themselves do not allow any foreign ownership of certain defined or critical infrastructure (Quiggin, 2022). A key criticism of the AR mechanism is that governments privatize or dispose infrastructure assets that are generating steady cash flows. This results in both direct and indirect loss of revenue to the public sector project proponents. In the instances where these proceeds of the AR initiative are deployed in sectors that will need a higher amount of operations and maintenance expenditure, effectively, the government is developing new infrastructure with recurrent O&M attached to the projects. This was observed in the case of NSW government which aimed to redeploy the AR proceeds into various greenfield rail and road projects. The greenfield projects in the transport infrastructure sector are expected to have a higher share of O&M expenditure which cannot be met by

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their individual project revenues. Researchers who are not in favor of AR mechanism having implied that the governments end up privatizing infrastructure projects that have crossed the key risk phases, which have an established and steady cash flow streams to support projects in those infrastructure sectors which have substantial capital and O&M liabilities over a longer period of time. They suggest exploring alternative methods of financing the newer projects prior to embarking on the AR mechanism (Koukoulas & Devlin, 2014; McIlroy, 2017). The asset recycling initiative in Australia was perceived by the public as an effort to privatize infrastructure, just like in other emerging and developing economies such as India. The $5 billion fund, which was set aside by the Commonwealth Government for the various state governments, that did asset recycling for the projects, was considered as a bribe for the state governments to escalate the process of asset recycling (McIlroy, 2014). The private sector motivations for participating in AR initiatives remain the same as that is expected in a public–private partnership arrangement. The private sector’s concerns around the ecosystem that governs the taking over off an existing operational asset and managing the same in accordance with the performance metrics have been set out. Private sector expects that the risk allocation is equitable, as the project under an AR involves an asset that has been functioning at the desired performance level. Another key challenge which the private sector needs to address is the management of people and integration of the public and private sector culture. It is also important to fully understand the prevailing regulatory system and navigating any potential pitfalls in the process of taking over and managing brownfield infrastructure assets (Marsh & McLennan Companies, 2018).

8.7

Credit Rating

The implementation of AR programs might have an adverse impact on the credit rating of the public sector project proponent. In the short run, following an AR initiative, the project proponent might witness a situation of lowering of their debt in conjunction with unlocking value from the established infrastructure projects. This might affect the credit rating by either remaining neutral or witnessing a marginal increase; however, the result of the AR program might have a negative impact in the medium to

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long term as the government deploys the proceeds of the AR into greenfield assets. The project proponents might have to incur higher borrowing costs through larger debts, thereby limiting the flexibility to invest in essential but not revenue-yielding infrastructure (Koukoulas & Devlin, 2014). In order to protect NSW’s AAA rating, the Fiscal Responsibility Act (FRA) was enacted in 2012. This act sets out an umbrella framework for NSW’s fiscal responsibility, including ensuring that its revenue growth stays about that of the corresponding expenditure. The NSW government has been in compliance with the FRA requirements since the time of its enactment and has continued to invest in the infrastructure requirements through its AR initiative (Infrastructure Partnerships Australia, 2019). The tenor of the long-term contracts has attracted attention in different countries. Australia and India have experimented with longer tenure contracts ranging from 50 to 99 years. However, the long period of the concessions has also been criticized. The PPP projects in the USA, including the Chicago’s parking agreement, have received substantial negative press due to the longer contract periods (Varn & Kline, 2017). If private capital can only be attracted with long-term lease agreements than it will be necessary for the public agencies to have technical capacity and skills for incorporating relevant performance metrics and oversight mechanism provision in the agreement. Many instances like Chicago parking agreement and other P3s were criticized for giving away too much power to the private partners for tolls or fees charged by them (Hodge & Greve, 2010; Varn & Kline, 2017). Incorporating provisions related to frequency and size of any increases or revenue-sharing arrangements in AR agreement in very clear manner can help in avoiding a perception about private participant benefits from the asset transfer (Petersen et al., 2018; Varn & Kline, 2017). As always, precise and regular communication to the public about the benefits of such arrangement is the key for earning continuous support from the public (Varn & Kline, 2017). The AR initiatives need appropriate structuring supported by a conducive policy, regulatory, and institutional landscape. The life cycle of the AR comprises the configuration of the principles of the initiative, identification of assets that can be hived off, the process of monetization and procedures to hold and deploy the proceeds, and configuring the project structures to maximize private sector participation, along with their financiers need to be thought holistically to have successful outcomes. The

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softer aspects of communicating to all the stakeholders involved, consultations with those concerned, and managing the procurement process have equal roles in the entire process (Sundararajan, 2021).

8.8

Conclusions

Many countries, including Australia, Brazil, China, India, Indonesia, Japan, Mexico, Uruguay, the UK, and the USA, have configured their respective AR programs. The models that each of the countries have adopted vary substantially and are customized to their local needs. Some of the more prominent ones include Infrastructure Investment Trusts in India, Limited Concession Scheme in Indonesia, and Revenue Securitization in Mexico and Uruguay. The lessons learned from each of those initiatives indicate that the overall AR strategy needs to be holistic and address all the elements of the life cycle (Sundararajan, 2021). The experience of public–private partnership arrangements in these countries provides pointers to how the performance of AR initiatives would look like. Countries like Indonesia and India have well-established institutional and governance setups. The performance of infrastructure investment trusts (InVITs) and the toll operate transfer (TOT) bidding in the highway sector in India has been encouraging. However, it is important to establish appropriate legal and regulatory mechanisms that would address the risks in public infrastructure provision through private participation, as these are prone to political and other stakeholder opposition. A weak regulatory mechanism can introduce additional risk in the AR mechanism, which would be hard to price (Mukherjee, 2021). There is a need to define critical infrastructure as has been done in UK and Australia that provides a restriction on the assets which cannot be privatized or establish a set of rules which defines the nature of assets that can be privatized. Clear guidelines for identification of the projects of national importance or the projects on which government does not want to relinquish its rights will help private participants to understand the government’s perspectives and the level of trust and comfort with the process would increase (Marsh & McLennan Companies, 2018). Institutional investors (pension funds—or similar funds), due to their limited risk appetite, are hesitant to assume the construction risk. Hence, they prefer to focus on brownfield projects which already have stable revenue streams (Boghossian & Walter, 2017). Institutional investors are also inclined towards brownfield or less complex greenfield projects (Rey,

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2010). A key characteristic of a successful AR initiative is in attracting the right private sector partner into assets earmarked that can yield a fair market value (Mukherjee, 2021). There would be instances where projects need government support through various mechanisms such as grants, subsidies, debt, or equity financing. Such projects might not be financially viable or riskier for the private sector. It might be more prudent to finance the project through conventional sources such as own funds or borrowings from multilateral development partners rather than resorting to an innovative structure such as AR. The project development, financing, and implementation need to be driven by economic and social diligence (Déau & Touati, 2022; World Bank, 2022). AR results in the government giving up future cash flows from existing projects to fund the construction of new projects. The public sector project proponents would still need to provide for the O&M expenditure through conventional sources of finance such as taxes or user fees. Efforts would need to be made to recoup the capital and O&M expenditure through appropriate mechanisms where feasible (Lewis, 2021). The cycle of AR can repeat itself, with the assets developed through an earlier AR initiative become cash flow steady and are then ripe for being hived off in a subsequent AR scheme. It is essential to operate under appropriate fiscal discipline to secure future cash flows. AR provides an innovative option for securing cash flows for a project that does not involve a direct levy of taxes to the immediate beneficiaries. This option hence appears to have the potential to be adopted more widely going forward (Nowacki et al., 2016).

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Fenn, M. (2014). Recycling Ontario’s assets: A new framework for managing public finances. https://strategycorp.com/wp-content/uploads/2017/03/ Recycling-Ontarios-Assets.pdf Geddes, R. R., & Nentchev, D. N. (2013). Road pricing and asset publicization. https://www.aei.org/wp-content/uploads/2013/12/-road-pricing-andasset-publicization_12592596596.pdf Hodge, G., & Greve, C. (2010). Public-private partnerships: Governance scheme or language game? Australian Journal of Public Administration, 69(Suppl. 1), S8–S22. https://doi.org/10.1111/J.1467-8500.2009.00659.X Infrastructure Australia. (2013). National infrastructure plan. www.infrastructu reaustralia.gov.au Infrastructure Australia. (2016). Australian infrastructure plan priorities and reforms for our nation’s future report. https://apo.org.au/sites/default/files/ resource-files/2016-02/apo-nid61640.pdf Infrastructure Partnerships Australia. (2019). Submission to the 2019–20 federal budget. Infrastructure Partnerships Australia. https://treasury.gov.au/sites/ default/files/2019-03/360985-Infrastructure-Partnerships-Australia.pdf Koukoulas, S., & Devlin, T. (2014). Nothing to gain, plenty to lose: Why the government, households and businesses could end up paying a high price for electricity privatisation. www.mckellinstitute.org.au Lewis, M. K. (2021). Rethinking public private partnerships (160 pp.). Edward Elgar. Marsh & McLennan Companies, Inc. (2018). Infrastructure asset recycling. https://www.marsh.com/kr/en/industries/infrastructure/insights/inf rastructure-asset-recycling-insights-for-governments-and-investors.html McIlroy, J. (2014, August 1). “Asset recycling” bill held up in the Senate. Green Left Weekly. https://search.informit.org/doi/epdf/10.3316/informit. 490914077374403 McIlroy, J. (2017). Asset recycling: Another giant privatisation scam. Green Left Weekly, 1152(3). https://search.informit.org/doi/abs/10.3316/INF ORMIT.099082899186570 Menezes, S. (2013, April 12). NSW ports privatised in $5 billion deal. The Sydney Morning Herald. https://www.smh.com.au/national/nsw-ports-pri vatised-in-5-billion-deal-20130412-2hq0z.html Mukherjee, A. (2021, August 25). Some lessons from Australia for India’s asset recycling plan. Mint. https://www.livemint.com/opinion/columns/some-les sons-from-australia-for-india-s-asset-recycling-plan-11629909983701.html Niquette, M. (2017, August 16). Australia pitches Trump on a plan to fix America’s roads and bridges. Bloomberg. https://www.bloomberg.com/ news/articles/2017-08-10/australia-pitches-trump-on-a-plan-to-fix-americas-roads-and-bridges#xj4y7vzkg

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Nowacki, C. (2019). The financier state: Infrastructure planning and asset recycling in New South Wales, Australia. In Public–private partnerships for infrastructure development: Finance, stakeholder alignment, governance (pp. 246–264). Edward Elgar. https://doi.org/10.4337/9781788973182. 00023 Nowacki, C., Levitt, R. E., & Monk, A. (2016). The financier state as an alternative to the developmental state: A case study of infrastructure asset recycling in New South Wales, Australia. SSRN Electronic Journal. https://doi.org/ 10.2139/SSRN.2860264 Oxford Economics. (2017). Global infrastructure outlook. https://cdn.gihub. org/outlook/live/methodology/Global+Infrastructure+Outlook+-+July+ 2017.pdf Petersen, O. H., Hjelmar, U., & Vrangbæk, K. (2018). Is contracting out of public services still the great panacea? A systematic review of studies on economic and quality effects from 2000 to 2014. Social Policy & Administration, 52(1), 130–157. https://doi.org/10.1111/SPOL.12297 Poole, R. W., Jr. (2018). Asset recycling to rebuild America’s infrastructure. https://trid.trb.org/view/1577719 Restart NSW Fund Act 2011 No. 32, NSW Legislation. (2011). https://legisl ation.nsw.gov.au/view/whole/html/inforce/current/act-2011-032 Quiggin, J. (2022). The spurious case for privatising land titles. https://www. parliament.vic.gov.au/images/stories/committees/SCEP/Land_Titles/Sub missions/S50-John_Quiggin_Redacted.pdf Regan, M. (2017). Capital markets, infrastructure investment and growth in the Asia Pacific region. International Journal of Financial Studies, 5(1), 5. https://doi.org/10.3390/IJFS5010005 Rey, Y. (2010, April 19). Equity investments in infrastructure 2010. IJGlobal. Somani, S., Yan, N. J., & KPMG. (2020). Global infrastructure: Asset recycling and infra capital. https://assets.kpmg/content/dam/kpmg/sg/pdf/2020/ 07/Global-infrastructure-asset-recycling-and-infra-capital.pdf State of New South Wales (NSW Treasury). (2022). NSW budget 2022–23 (No. 03 Infrastructure Statement Budget Paper). https://www.parliament.nsw.gov. au/tp/files/82311/Budget%20Paper%20No.%203%20-%20Infrastructure% 20Statement%20-%20Budget%202022-23.pdf Sundararajan, S. (2021, August 4). Asset recycling in EMDE infrastructure development can be a win-win-win. World Bank Blogs. https://blogs.worldb ank.org/ppps/asset-recycling-emde-infrastructure-development-can-be-winwin-win The Australian Government the Treasury. (2019). Review of the national partnership agreement on asset recycling. https://federalfinancialrelations.gov.au

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US Department of Transportation. (2021). FHWA—Center for Innovative Finance Support—Project profiles. US Department of Transportation. https:// www.fhwa.dot.gov/ipd/project_profiles/il_chicago_skyway.aspx Varn, J., & Kline, S. (2017, June 8). How could “asset recycling” work in the United States? Bipartisan Policy Center. https://bipartisanpolicy.org/blog/ how-could-asset-recycling-work-in-the-united-states/ World Bank. (2022, January 28). Government support in financing PPPs. World Bank. https://ppp.worldbank.org/public-private-partnership/govern ment-support-financing-ppps

CHAPTER 9

Private Market Infrastructure Funds

It’s clear to me when you do private equity well, you’re making companies more efficient and helping them grow and become more profitable. That success means our investors—such as public pension funds—benefit, which contributes to the economic wealth of society. —David Rubenstein, Co-Founder of the Carlyle Group

9.1

Introduction

Private equity infrastructure investments have played a substantial role in the international infrastructure finance market, contributing to nearly 10% of all the finance since the global financial crisis (GFC). The infrastructure market has witnessed greater participation from institutional investors, with over 100 million per annum and more than 100 funds close all over the world (Mercer, 2021). The institutional investors participate in the sector through infrastructure funds, which are investment vehicles used to invest in a combination of infrastructure projects (Lara-Galera et al., 2017). The private markets infrastructure equity investing has garnered a place on its own as the investors look for reliable returns (cash yield and total return) across different market conditions. A rapidly growing opportunity for institutional investors and high networth individuals is the alternative asset classes such as private equity, venture capital, real estate, hedge funds, and a few other instruments that

© The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2023 R. D. Tirumala and P. Tiwari, Advances in Infrastructure Finance, https://doi.org/10.1007/978-981-99-0440-2_9

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deal with futures and options in interest rates, currencies, and commodities. They are considered alternative asset classes due to specific features such as not commonly traded in the public markets, relatively illiquid, not so common in the investment portfolio, their performance characteristics are different from the traditional assets, and their limited investment history (Leitner et al., 2007; Swärd, 2008). The infrastructure funds have started to occupy a distinct and substantial share in the portfolio of all assets as this sector is generally not closely correlated to other public equity or debt markets. For instance, the correlation coefficient of private markets infrastructure to international equity and bond markets is -0.1 (J.P. Morgan Asset Management, 2022). Infrastructure funds give liberty to institutional investors to invest directly in a variety of infrastructure projects from numerous sectors across the world (OECD, 2015). The infrastructure sector has always been considered a growth engine for any country’s economic health. Subsequent to the global financial crisis, many governments had to push their infrastructure commitments to get their economies back on track through commitments to spend. This infrastructure push initiative was in addition to providing policy and regulatory interventions to improve the health of the financial markets. The regulations such as Dodd-Frank and Basel III have been formulated and set out the performance boundaries for many financial institutions. However, as the public debt was very high, governments alone were unable to finance infrastructure projects. Simultaneously, regulations such as the Basel III norms restricted bank lending with the promulgation of sectoral ceilings. These systemic changes have made it difficult to source financing for infrastructure projects through the traditional route during these times (Lara-Galera et al., 2017). The infrastructure financing sector had once again looked to the multilateral, bilateral development financial institutions to step in and accelerate the infrastructure investments along with the public sector entities. However, the same reasons which made development finance institutions step in to help the governments to fund infrastructure projects also opened doors for a different class of institutional investors, such as pension funds, insurance funds, sovereign wealth funds, family offices, foundations, asset managers, and wealth managers to enter and then actively invest in the infrastructure sector (Shindo & Stewart, 2021).

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Growth of the Infrastructure Funds

Traditionally, infrastructure projects were managed by construction and engineering firms that were publicly listed. A diversified pool of investors like infrastructure funds and pension funds started becoming equity stakeholders and played an important role along with the traditional partners (who were experiencing a shortage of capital) in the infrastructure projects taking off (Mahmudova & Sourbes, 2010). Infrastructure funds have been in the existence since the 1990s. Infrastructure funds gained popularity mainly because of the debt availability at a lower cost in the early 2000s and post the GFC crisis (Lara-Galera et al., 2017). The year 2004 can be seen as a turning point for the infrastructure funds as the volume of the unlisted infrastructure funds rose from $ 1,100 million in 2003 to more than triple to $ 3,800 million in 2004 (OECD, 2014). In the mid-2000s, large institutional investors such as pension funds and private equity groups have begun to allocate a larger share of their portfolio investments to infrastructure. The motivations for a greater interest in the sector include perceiving infrastructure as an asset class that offers predictable and stable income with an appropriate assetliability match, allows hedging against inflation, and provides growth of capital (Kaminker & Stewart, 2012; Mahmudova & Sourbes, 2010). The participation of institutional investors in infrastructure is a result of many dynamic influences, starting with the burgeoning assets under management (AUM) of the pension, insurance, and sovereign wealth funds and the need for deploying the same effectively in favorable asset classes over a longer time frame. Institutional investor groups have been looking to increase their allocation to infrastructure as an asset class since 2004. Their investments increased to about $ 34.3 billion in 2007. However, as a consequence of the GFC and the economic activities slowing down all over the world, the investments were reduced to $ 21,580 million in 2009. The equity investments from institutional investors have begun to dry up as the investors started to move away from the perceived riskier asset classes (Lara-Galera et al., 2017). The valuation of the unlisted infrastructure sector had witnessed a substantial increase post the GFC. The number of funds and quantum that they have raised have witnessed rapid growth from 2010 onwards. These funds have started focusing more on the

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Table 9.1 Unlisted capital raised by value and volume

Year

No of funds

$ million

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

30 54 54 84 95 95 86 78 73 73 54

21,580 34,726 24,757 41,291 60,769 73,798 97,226 80,569 74,466 119,888 95,671

Source Authors compilation from (IJInvestor IJGlobal Service, 2020)

core infrastructure sectors that were able to generate stable returns (LaraGalera et al., 2017). The Table 9.1 presents the unlisted capital that was raised internationally between 2009 and 2019. The assets under the management of private equity infrastructure investors are estimated to be about $582 billion in 2019 (Preqin, 2020). These funds raised $388 billion between 2015 and 2019, out of which nearly 56% was for new funds (EY, 2019). The growth of institutional investors has spread wide and across many developing countries. The growth was stark in countries like India. The institutional infrastructure funds focused on India raised an amount of $ 208 million in 2004 to $ 23,415.9 million in 2014 (Harikumar & Susha, 2017). However, the quantum of the infrastructure allocations is relatively small in comparison to the overall funds managed by the pension and insurance companies. For example, the quantum of funds raised by the insurance companies is vast in relation to the needs of the infrastructure sector. Assuming that the insurance companies make a 5% allocation of the annual global gross written premium over to the infrastructure sector, this quantum is adequate to meet almost 50% of world’s annual investment gap (Shindo & Stewart, 2021). McKinsey has estimated that the private institutional investment in infrastructure can increase from the current range of $300 million to $400 million to about $1 trillion to $1.5 trillion, provided the right ecosystem is developed. The current investment is estimated to be

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an average allocation of 5.2% of the assets under management (Bielenberg et al., 2016). The median share of infrastructure allocation of various types of institutional investors in their total portfolios, and the average commitment size of different types of institutional investors to the infrastructure sector in 2015 and 2019 is presented in the Table 9.2. The superannuation schemes have the highest allocation to the infrastructure sector in their portfolios. The relative shares have not substantially changed between 2015 and 2019. The sovereign wealth funds typically have an exposure of more than $ 150 million, while the median corporate investor has only $ 6 million exposure to infrastructure. The size of an average infrastructure fund is generally similar to that of a buyout fund, twice the size of a real estate fund and four times the size of a venture capital fund (Andonov et al., 2021). Table 9.2 Median current allocation to infrastructure (As a % of Assets under Management (AUM)) and infrastructure investors’ mean commitment size by investor type Investor Type

Sovereign Wealth Fund Asset Manager Public Pension Fund Insurance Company Superannuation Scheme Government Agency Private Sector Pension Fund Wealth Manager Endowment Plan Foundation Family Office Corporate Investor Source (Preqin, 2020)

Median Current Allocation to Infrastructure (% of AUM in 2015

Median Current Allocation to Infrastructure (% of AUM in 2019)

Average mean commitment in $ million (2019)

6.0%

4.9%

153

3.3% 2.1%

3.6% 2.3%

79 60

1.0%

1.5%

43

6.3%

6%

38

–

–

33

1.9%

2.0%

31

5.0% 4.0% 1.6% 2.0% 4.5%

4.8% 2.7% 1.3% 3.0% 5.0%

24 16 11 8 6

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The following Table 9.3 lists the details of some of the largest institutional investors along with their portfolio allocation share in the infrastructure sector for the year 2019 and 2021. Most of the leading international investment banks, such as Goldman Sachs, Credit Suisse, Citi, Macquarie, and conventional private equity investors such as Carlyle, 3i, EQT, etc. have dedicated infrastructure funds. The following Table 9.4 lists the details of the largest infrastructure funds. The table presents their assets under management (AUM) and their allocation to the infrastructure sector as a percentage of the total portfolio. Table 9.3 Largest institutional investors infrastructure sector for 2019 and 2021 Institution

CPP Investment Board Canada Abu Dhabi Investment Authority National Pension Service of Korea Allianz Capital Partners GmbH Caisse de dépôt et placement du Québec China Investment Corporation APG Asset Management Ontario Teachers’ Pension Plan OMERS PSP Investments BCI Pensioenfonds Zorg en Welzijn

Infrastructure AUM in 2019 ($ million)

Estimated allocation in infrastructure in 2019 (%)

Infrastructure AUM in 2021 ($ million)

Estimated allocation in infrastructure in 2021 (%)

34,928.10

11.89

36,616

9.8

24,840.00

3.00

28,981

5.0

20,452.30

3.57

23,889

3.1

16,718.90

51.38

24,197

3.4

16,666.90

7.35

25,219

8.8

15,000.00

1.60

15,000

1.4

14,371.10

2.56

19,862

2.9

13,305.50

9.50

13,945

8.2

12,938.70 12,592.10 11,917.50 10,199.00

18.20 10.00 10.37 4.84

16,465 14,378 15,885 11,987

20.0 10.8 10.1 3.9

Source Authors based on (Botelho et al., 2021; Infrastructure Investor, 2021; PEI, 2019)

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Table 9.4 Largest infrastructure funds based on their AUM in Euro millions

Macquarie Infrastructure and Real Assets Brookfield Asset Management Global Infrastructure Partners

2019

2020

2021

2022

107,691 99,234 50,285

209,377 117,211 66,072

195,330 122,110 60,703

230,217 157,896 76,647

Source Authors based on (IPE Real Assets, 2019, 2021, 2022; Phillips & O’Dea, 2020)

The strained public balance sheets and the need to push the infrastructure sector, which was in need of an upgrade, were the contributing factors to the pension funds becoming active investors post the GFC. Infrastructure funds and private equity are, respectively, the second and third most preferred instruments after debt securities for pension funds to 2021). make investments in the infrastructure sector (Paklina & Stanko, ´ Many pension funds have infrastructure sector allocation well below 1% to 5%, even though the allocation of some of the pension funds was as high as 10 to 15% of the total portfolio. Australia and Canada are exceptions in this context who had a higher share of infrastructure in their portfolios. Many of the Australian and Canadian pension funds have steadily increased their investment allocation in infrastructure between 2004 and 2014 (OECD, 2014). Australia does not have any restrictions on pension funds in terms of asset allocation to infrastructure. Australian pension funds need to follow “prudent person rules”. For pension funds based in Canada, limitations regarding the extent of investments in the infrastructure sector are imposed based on their respective jurisdictions. For example, in Alberta there is a 10% cap on the general investment and concentration limits. In other jurisdictions, there are no defined quantitative limits, but the pension funds are expected to be prudent in making 2021). investments in infrastructure assets (Paklina & Stanko, ´ Traditionally, pension funds were dependent on infrastructure funds for allocating their investment in the sector. The pension funds appear to have become more active in evaluating their mode of participation in the infrastructure sector around 2009 and 2010. The pension funds had also commenced building their in-house teams for conducting due diligence on the infrastructure investment opportunities, which allowed them to invest directly in the infrastructure projects without going through the fund managers (OECD, 2014). This strategy was initially adopted by the Canadian and Australian pension funds, which were later on adopted

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by other pension funds the world over (Mahmudova & Sourbes, 2010; Malinowski, 2007). There has been a policy push and regulatory nudging to consider increased investments in the infrastructure sector. EU Solvency II Delegated Regulation on insurance firms mandated that the risk calibration of unlisted infrastructure equity investments is 30%, while the similar requirement for other unlisted equities is 49% (European Commission, 2017). Swiss pension fund regulations provide for an allocation of up to 10% for infrastructure assets, have a total cap of 15% for all alternative assets (Serenelli, 2020). The UK Treasury had stated that the insurance firms could provide long-term growth through infrastructure investments as one of their objectives of the regulations review (HM Treasury, 2020). This has also contributed to the growing interest of institutional investors in the infrastructure investment. The share of the infrastructure companies in the global stock markets is around 5 to 6 (Inderst, 2010; OECD, 2015). The major international index providers have created a separate infrastructure index in their overall portfolio, given the growth that has been witnessed in the infrastructure investment domain. The annualized returns on the private equity infrastructure indices (9.1%) were among the best when compared to the returns of public equity (8.1%), municipal bonds (4.6%), private debt (5%), global fixed income (3.2%), global equity (7.1%), and private real estate (8.7%) during the period 2005 to 2017(Davis et al., 2018). A few of the notable infrastructure indices are listed in the Table 9.5 given below. Infrastructure debt funds have become popular after the global financial crisis as the participation of banks in financing infrastructure projects had tapered off, and long-term funding was scarce. The participation in the debt funds is usually reflected as a fixed income or alternative asset in the institutional investors’ portfolio. The market opened up new partnerships between the traditional banks and long-term institutional investors. For example, Natixis, the French bank, had entered into an agreement with Ageas, the Belgian insurance company, to develop an infrastructure debt fund portfolio of e 2 billion in 2012 (Infrastructure Investor, 2012). Governments and development financial institutions are also active in establishing infrastructure funds. Philippine Investment Alliance for Infrastructure Fund, Pan African Infrastructure Development Fund, and the Marguerite Fund (Europe) are a few examples of public sector and

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Table 9.5 Infrastructure indices Name of Index

What does index represent?

Geographical presence

EDHEC Global Unlisted Infrastructure Equity Index (’EDHECinfra’) Dow Jones Brookfield Global Infrastructure Index (‘DJ Brookfield’)

Market value-weighted indicator of set of unlisted private infrastructure funds Reflects performance of almost 100 companies worldwide that own and operate infrastructure assets and receives 70% cash flow from infrastructure-related business line Group of listed companies that owns or operates infrastructure assets Keeps track of performance of stocks of infrastructure companies globally Keeps track of 75 publicly listed infrastructure firms in 3 sectors: transportation, energy and utilities

25 countries (most of them are OECD members and emerging economies) Global

MSCI Europe Infrastructure Index (‘MSCI’) RARE Global Infrastructure Index (‘RARE’) S&P Global Infrastructure Total Return Index (‘S&P’)

15 developed markets of Europe Global

NA

Source Authors based on (Lambrev, 2019)

development financial institutions supporting the establishment of infrastructure funds. These funds have been set up to attract other institutional investors to make investments in two crucial areas: emerging economies and greenfield projects. (Della Croce & Gatti, 2014). There are many infrastructure funds which have been supported by development financial institutions, for example, the ASEAN Infrastructure fund, Tropical Landscapes Finance Facility (TLFF), Leading Asia’s Private Sector Infrastructure Fund (LEAP), and Shandong Green Development Fund. Some of the specific features/characteristics of these funds have been listed in the following Table 9.6.

9.3

Infrastructure Investment Trusts (InVITs)

There has been a longstanding demand In India for creating vehicles that will allow institutional investors to invest in infrastructure in a tax-efficient manner. The discussion about real estate investment trusts (REIT) has been going on for a while between the real estate developers and other

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Table 9.6 A few funds established by development financial institutions Fund

Objectives and other relevant information

Fund Size & other details

ASEAN Infrastructure fund

This fund was established in 2011 with an aim to promote financing for regional infrastructure—ASEAN countries and ADB are stakeholders of this fund. Largest infrastructure financing fund with funding contributions from member countries To introduce an innovative leveraging mechanism to enable different types of capita such as private, institutional, and commercial capital for development of climate friendly infrastructure and business in Shandong Province of PRC This fund was established in 2016 with the aim of push good quality and sustainable private investments in infrastructure across developing countries in Asia-Pacific region This initiative’s main objective is to coordinate with various stakeholders to bring large-scale positive impact in the countries by long-term financing the projects and companies which can stimulate green growth and improve the level of rural livelihoods, deal with climate change, forest conservation, emissions reductions, and inclusive growth-related issues

Paid equity $ 485.3 million

Shandong green development fund

Leading Asia’s Private Infrastructure (LEAP)

Tropical landscapes finance facility (TLFF)

ADB—$ 100 million IFIs—$ 400 million Public sources—$ 360 million Private investors—$ 740 million $ 1,500 million committed by JICA

First corporate sustainability bond $ 215 million

Sources Authors compilation based on (ADB, 2019, 2022; Jenny et al., 2020; TLFF, 2022)

stakeholders with the Indian market regulator Securities and Exchange Board of India. A Ministry of Finance, Government of India’s initiative, brought together the infrastructure and the real estate stakeholders to a common forum to structure an alternative investment vehicle that can provide certain tax benefits to the participating organizations. The dividend distribution tax, pegged at about 18% in 2013–14, was seen as a restrictive taxation item for greater participation of the newer class of investors. REITs and Infrastructure Investment Trust (InVITs) were

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structured similar to mutual funds to leverage on the tax-efficient nature (Shah & Jain, 2021). InVIT is an innovative financial structure that provides opportunities for investors to finance infrastructure using more liquid and stable instruments. It is a pooled investment vehicle (or like a managed investment scheme) similar to mutual funds. InVITs are similar to REITs, a blend of equity and debt instrument with an expectation of stable and low-risk cash flows (similar to a debt instrument) and substantial appreciation due to the growth (akin to equity). InVITs allow the infrastructure developers to free up their investments from the completed assets and use the proceeds to develop new assets. It allows investors to invest in infrastructure assets with predictable cash flows and dividends (NITI Aayog, 2021). InVITs have been considered as a way to reduce leverage from the balance sheet of a company and thus freeing up funds for other projects (Agrawal, 2020). Money raised through establishment of such trusts is further invested in the development of the new infrastructure projects. (NITI Aayog, 2021). The operations of InVITs involve establishing a structure, populating with operational assets and managing and operating to generate cash flows, servicing the investors, and subsequent divesture of the assets when appropriate. A trust is established with one or more revenue-generating infrastructure projects (for example, toll road projects). (World Bank, 2017). The trust typically holds the infrastructure assets (either through purchase or transfer), operates, and maintains the same. Typically, the assets have crossed the risky phase i.e., they have been constructed and are revenue-generating operational assets. It is usual for a InVIT to procure assets that have long-term contracts with a clearly identifiable revenue stream. The InVITs issue securities/ units to its investors and then deploy the proceeds into real infrastructure assets such as highways, power plants, ports, etc. Investors are entitled to receive payouts at intervals commensurate to the number of units they hold. (NITI Aayog, 2021). InVITs portfolios are traded publicly on exchange, and an investor can own a stake/part in it. (Agrawal, 2020). The structure of InVIT allows procuring additional assets, thereby enhancing the returns of the investors over the long term. The InVIT benefits the lenders by allowing them to diversify their loans to higher rated infrastructure assets (Shah & Jain, 2021). In India, InVITs are regulated by Securities and Exchange Board of India (SEBI) through Infrastructure Investment Trusts Regulations since

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2014. In order to minimize the exposure to development and construction risks in the infrastructure sector, it is required that at least 80% of InVIT’s funds be invested in completed and operational projects. They cannot deploy more than 10% in assets that are under construction. Similar to the REITs in many parts of the world, it is expected that more than 90% of the net distributable profits are passed on to the investors. InVITs allow wide range of investors to invest in infrastructure starting from qualified institutional buyers, family trust, NBFCs registered with RBI and which are systematically important, and intermediaries registered with SEBI. All of these entities need to have net worth of more than five hundred crore rupees, as per the last audited financial statements. (SEBI, 2022a). SEBI has also stipulated the limits on leverage, which mitigates the risk of unwarranted debt. SEBI has also reduced the minimum market trading volume to one unit, which is expected to improve the liquidity and promote better price discovery. This structure of InVIT requires the presence of independent investment managers and trustees, biannual valuation of the assets by independent valuers, strong disclosure policies, and provisions to protect minority investor rights, which promotes good corporate governance practices (NITI Aayog, 2021; Shah & Jain, 2021). In line with the equities and equity-oriented mutual funds, the InVITs are eligible for concessional long-term capital gains tax rate in India if the units are held for more than three years. The first InVIT—IRB InVIT was launched in 2016 by IRB. (Naidu Boddu, 2020) As per (SEBI, 2022b), so far 19 InVIT trusts have received registration from as of September, 2022 in India. During financial year 2021–22, $ 2.93 billion was invested through InvITs route. (Outlook, 2022). The Table 9.7 lists some of the notable InVIT transactions in India. The total AUM for all these funds is more than $ 17.34 billion.1 While it is still early to assess the performance of InVITs in India, this has been considered as one of the most innovative financial products that have been launched in recent times. Like any other financial security, InVITs are also prone to the risks of the underlying assets in line with the nature of the infrastructure sector. Infrastructure assets have substantial natural and operational risks that can negatively affect the cash flows over the tenure of the contract. Giving the long-term nature of the debt,

1 USD-INR currency conversion rate of 31st March 2022 has been considered.

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Table 9.7 InVITs transactions in India InVIT

Year

AUM in Rs crores

IRB InvIT Fund—IRB Infrastructure Developers India Grid Trust of Sterlite IndInfravit Trust—L&T IDPL India Infrastructure Trust—Brookfield Oriental Infra Trust—Oriental Structural Engineering Pvt. Ltd. IRB Infrastructure Trust Tower infrastructure Trust—Reliance & Brookfield Digital Fibre Infrastructure Trust Powergrid InvIT Shrem InvIT Virescent Renewable Energy Trust

2017 2017 2018 2019 2019

6,500 15,000 10,500 14,500 11,000

2020 2020 2020 2021 2021 2021

22,500 42,000 1,500 7,800 6,700 3,850

Source Authors based on (NITI Aayog, 2021; SEBI, 2022b; The Economic Times, 2022; The Financial Express, 2022)

the refinancing risk might be substantial. The regulation is yet to mature which could lead to a few uncertainties in the short term.

9.4

Sustainable Investing by Private Equity Funds

Traditionally, private equity as an asset class has been considered in portfolios for receiving comparatively higher returns by assuming relatively low risk and has low correlation with other asset classes (IPE, 2004). At the same time, private equity funding is the one which has been supporting the start-ups and growing SMEs which usually do not get required financial resources from the other sources of financing such as debts or loans or bonds due to unavailability of the historical performance and presence of strong balance sheet history. (IFC, 2018). The private equity sector has been facing many challenges, such as its exposure to companies from the not-so-environmentally benign industry sectors such as oil and gas. The private equity industry is also seen as one of the causes for lowering the equity in the economy; causing job losses across different investee companies, and being one of the reasons for significantly high-pay inequality (difference in the pay scale of the senior management when compared with that of the lower levels at a time when the social equality is one of the challenges that world is facing). The public opinion against such issues, coupled with the increased push towards

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meeting the climate and sustainability-related challenges, is nudging the private equity sector towards incorporating sustainability related standards in their initiatives (Eccles et al., 2022). Sustainable Financial Disclosure Regulations (SFDR) has come into effect in Europe in March 2021. This regulation has made ESG disclosure mandatory for the asset managers and other financial market participants both at entity and at product levels (EUROSIF, 2021). Private equity funds are trying to address these challenges by incorporating sustainability in their business models by adopting relevant practices such as environmental, social, and governance (ESG) integration throughout the investment lifecycle starting from due diligence to exit strategies, transparency in disclosing sustainability performance, and transforming portfolio companies by helping them to increase their ESG capabilities (Eccles et al., 2022). Investors are configuring innovative financial instruments which can leave better impact on the world and private equity funds are also catching up on this trend. In the recent past, AUMs of private equity funds that have focus-sustainable impacts have increased by 19% annually as per Global Impact Investment Network (GIIN) analysis (IFC, 2018). As per US SIF Foundation, almost $ 16.6 trillion worth assets are managed using ESG criteria specifically. Out of this, $ 716 billion is managed by private equity and venture capital funds, property funds, and hedge funds (Conservice ESG, 2021). Asset of the funds with ESG focus put together reached to $ 3.9 trillion mark in September, 2021(Reuters, 2021). Europe has highest concentration with total asset size of approximately $ 3431.6 billion. The USA is the second highest with $ 330.7 billion assets. Asia excluding Japan has $ 50 billion sustainable funds’ assets. Japan and Canada have $ 31.6 billion and 22.2 billion worth sustainable funds, respectively. Australia/ New Zealand is not far behind with $ 27.2 billion assets in sustainable funds (Statista, 2022). Different funds incorporate sustainability at different levels by taking an innovative approach to investment allocation using positive screening/focusing on performance levels, specific sectors’ exclusion lists/negative screening, thematic investments (renewable energy), and impact investments (visible positive environmental or social impacts) (IFC, 2018). There are three reasons which are making private equity funds to integrate sustainability aspects into their process. One of them is the increased co-investing trend in the private equity funds with limited partners (LPs)

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who are more inclined towards ESG practices and also have access to the portfolio companies’ ESG performance data. These LPs are developing their own models for the general partner (GP) evaluation. Some of the LPs provide help in improving GP’s ESG capabilities. The second reason is that many studies indicate that ESG integration helps in delivering better performance in public markets. Hence, there are LPs and GPs who believe that same can be the case for private equity as well, as this asset class has a history of delivering high returns. The third reason is that portfolio companies also have started to recognize the importance of ESG issues, as they are also aware of consumer and stakeholder preferences, social expectations, climate change-related issues, increasing regulations, and opportunities to improve their value in terms of sustainability. Also, these companies are aware of the kind of public disclosure requirements of the publicly listed entities and increased pressure from the large customers to whom these companies are suppliers of goods and services (Eccles et al., 2022). The private equity and infrastructure funds, who target equity investments, are attempting to provide the direction for uptake of sustainable infrastructure. For example, Actis, a UK-based fund, is active in developing a platform play in the renewable energy sector in Africa that is focusing on wind and solar projects. This involves working with multiple developers and or projects across the continent, where they can establish the standards, thereby reducing the learning curve and increasing the chance of replicability.

9.5

Crowdfunding

Crowdfunding has emerged another innovative way (platform/approach) that brings together like-minded individuals, investors, and firms to support the infrastructure projects. (Maehle et al., 2020) There are wellestablished platforms such as Indiegogo and Kickstarter, which support green entrepreneurs specifically. There are platforms which concentrate only on green ventures, and renewable energy is one of the most preferred sectors. Abundance Investment is one such platform that allows investors to support the companies or projects which are working in area of energy, energy efficiency, and affordable housing (Abundance, 2022). SunFunder operates as financial intermediary which provides financing to solar energy assets in emerging nations. They help investors to connect with vetted solar businesses from Africa, Asia, Latin America, and the Caribbean

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(SunFunder, 2022). Mosaic from California is another crowdfunding platform example which aims to work towards achieving 100% cleaner energy for all by providing sustainable home improvements. (Mosaic, 2022).

9.6

Institutional Investor Participation Modalities in Infrastructure

Infrastructure investments cover a wide range of infrastructure projects, those in economic or social sectors, greenfield or brownfield assets, and based on the stage of the life cycle they are at (early stage at development, before construction, constructed and in early operations phase, stable operations, etc.). The nature of the project, its risk profile, investments needed, and expected returns vary substantially depending on the sector, nature of development, or the life cycle stage. For example, the investments required and the returns expected from the setting up of a greenfield hospital in a developed country will be very different from a privatization of a toll road in an underdeveloped country (OECD, 2014). The infrastructure assets are usually categorized under four groups namely core, core plus, value add, and opportunistic. The core infrastructure asset category typically compresses the conventional sectors (utilities and transport), and those which are implemented under the public–private partnership arrangements. This category of assets is considered less risky (brownfield development). The return expectations from this category of assets are at the lower end of the infrastructure sector spectrum. The core plus category of infrastructure assets usually consists of brownfield development, but with more variability in the cash flows. The projects from this category are more dependent on the economic growth and have higher risk and return profile than the core assets. The value add category of infrastructure assets typically consists of early stage projects in newer sectors or those that depend on substantial discoveries of natural capital and hence have much higher risks and returns as compared to the core and core plus categories. The opportunistic category of infrastructure assets typically refers to high-risk, high-return sectors. The projects involve greenfield development and could substantially be exposed to volume and price changes. The differentiating features of each of the categories is presented in the Table 9.8. The advent of institutional investors into infrastructure investing coincided with the new sectors such as digital infrastructure (supporting

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Table 9.8 Infrastructure categories Core

Core Plus

Value Add

Opportunistic

Essential sectors, Rate regulation/ availability agreements; High creditworthy counterparties Traditional infrastructure (Utilities, transport), PPPs

More variability in cash flows, less monopolistic than core infrastructure, include growth/ GDP component

Less monopolistic assets which have expansion or repositioning

High risk; high return, Exposed to volumetric or commodity price, Significant repositioning

Contracted power, oil and gas, toll roads, ports

Early stage projects in oil, gas, and newer infra sectors

Type

Brownfield

Brownfield

Tenure (Years) Returns Expectation (%) IRR targets Yield Capital gain

More than 7

More than 6

Brownfield/ Greenfield 5–7

Developing markets, Merchant power, oil and gas, Special situations Greenfield

6–9 5–7 1–2

9–12 4–6 5–6

12–15 2–3 10–12

Characteristics

Sectors

3–5

15+ NIl 15+

Source Authors based on (Mercer, 2021)

the telecommunications industry such as the optical fiber networks, data centers and storage, telecom towers), logistics (cold chains, food supply, and storage infrastructure, railheads and rollingstock, heavy vehicle trailers, etc.), health and retirement living, and energy transition (storage, energy efficiency and renewable) becoming mainstream choices for investment. The typical routes for institutional investors to enter the infrastructure space include unlisted funds, listed funds, direct investments, co-investments, listed securities, and project financing. Unlisted funds are the most popular choice, followed by direct investments and coinvestments (Preqin, 2012). Many insurance investors prefer to invest in unlisted infrastructure funds as they look for higher returns as the assets are illiquid in the short term but can yield substantial expected returns

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over the period. Also, investment in the unlisted market helps them stay away from the listed market’s inherent volatility. The unlisted funds typically operate as a limited liability partnership, wherein the institutional investors participate as “limited Partners”. The “general partners” of the funds, who provide the management expertise, solicit investments from the limited partners, and deploy the same in a variety of infrastructure assets. The general partners, much like the payment terms of a private equity firm, charge a fixed fee as a percentage of the investments (assets under management) and then have a variable payment based on the performance. To start with, the payment structure was similar to other private equity entities (for example, 2/20 i.e., 2% fixed fee and 20% on carried interest—on the profits that the fund generates. The structuring of the performance fee is negotiated between the limited partners and the general partners). However, given the greater certainty of the infrastructure business models in relation to other markets, there has been a push back from the institutional investors to have a lower management fee for the general partners (Deponte & Partners, 2014). In the early 2000s, the unlisted funds largely focused on developed markets, particularly in OECD countries and Europe. Their participation in the USA market was relatively lower due to the prevalence of municipal bonds for infrastructure financing and the low capacity to launch multiple PPP transactions. The direct investment route requires the presence of in-house due diligence capability and hence is not very common across the institutional investor landscape. Only a few investor categories who have the appetite and the skill sets venture into direct investing. A few pension funds have built their in-house expertise and are preferring a direct investment route (Shindo & Stewart, 2021). The infrastructure funds typically operate either as an open-ended fund, close-ended fund, or fund of funds. While the open-ended fund is used for core, core plus categories of infrastructure sectors, the closeended fund, and fund of funds are present across all infrastructure types. The open-ended funds are limited in number (i.e., not the predominant format), depend mainly on income returns, and have substantial inflation protection ability. The open-ended funds are usually more liquid (however, some funds might have restrictions on redemption in special circumstances). The other two types of funds (close-ended funds and fund of funds) are more similar; they generally have a four- to six-year holding period of assets and ten to twelve years term on individual funds and aim to generate total returns (Mercer, 2021). The institutional investors

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consisting of the pension and insurance companies, sovereign wealth funds, typically invest through closed private funds, listed funds, openended funds, and direct deals. The close-ended private funds have assets under management of $486 billion in 2019, a sharp increase from the $59 billion in 2008 (Andonov et al., 2021). The closed-end infrastructure funds have substantial fees attached to them. The data from CEM benchmarking indicate that the management fees of the median infrastructure closed end fund is 167 basis points, that of a private real estate fund is 95 basis points and private equity of 239 basis points (Andonov et al., 2021). The infrastructure funds deploy the capital as direct investments in various greenfield and brownfield projects, or increasingly bid for various PPP projects. For example, the Macquarie group was actively looking to invest in infrastructure assets across the world. Macquarie’s model of partnering with government and developing assets has become popular and spread across the world. Macquarie were the highest bidder for the Chicago Skyway Toll Bridge System in 2005, with an all-cash-in bid for $ 1800 million with their Spanish JV partner Cintra. The bid of the Macquarie was almost double the cover bid on the Chicago Skyway concession (Boghossian & Walter, 2017). Many institutional investors have started making co-investments with other funds both general private equity and infrastructure funds. This required them to have internal expertise to identify and evaluate the opportunities available (Della Croce & Gatti, 2014).

9.7

Discussions

The reasons why the infrastructure is considered separately in the global asset class portfolios include its intrinsic value, less volatile business drivers, not strongly correlated to the rest of the asset portfolios, substantial income returns (with potential for capital returns), and inflation protection. The classical understanding of why institutional investors prefer infrastructure investing is derived from their expectations of risk and return and the characteristics of the infrastructure sector. The generally accepted view is that the financing needs of infrastructure far outstrip the available government resources when invested in a fiscally irresponsible manner (Schwartz et al., 2020). The underlying sectors of infrastructure, when operating in a favorable ecosystem, provide a long-term reasonably certain cash flows that can offer a hedge against inflation, with

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low correlation to the other equity and debt markets. The sectors are also well regulated and, in most instances, operate in a monopolistic environment providing better comfort to both the public and private institutional investors regarding alignment with their objectives. The regulators have been treating infrastructure as a separate asset class, allowing for separate allocations to the sector. Typically, infrastructure assets and the revenues that are generated from them are given as a security to the investors. The cash flows are relatively certain, giving the investors better predictability of their returns on investment. The growth of institutional investors in infrastructure broadens the definition of the sector. The growth of the private equity investments coincided with the emergence of new generation sectors such as digital infrastructure and clean energy. The confluence of real estate and infrastructure has come to the fore as the private institutional investors have substantial skills in both sectors and were transferring the learnings from one to another. The institutional investors have been innovative with the underlying assets by bundling real estate with the traditional infrastructure projects, creating a newer alternative investment category and stretching the definition of infrastructure. Sentry Select and Lazard launched a “preferred infrastructure” fund that would invest in the shares of companies that are characterized by features such as revenue confidence, their ability to translate this confidence to profitability, and long-term sustainable performance (IJGlobal Equity Capital, 2007; Mahmudova & Sourbes, 2010). Infrastructure assets are expected to offer inflation and recessionary protection as most of the service providers can pass on the inflation rise to the users as part of their service charges. Studies done by First State Investments indicate that the service charges can be increased taking the inflation into account in at least 70% of the public sector assets. (Colonial First State Group Limited, 2018). JP Morgan indicated that the infrastructure sector growth was more than that of the inflation in a 27-year time period (J.P. Morgan Asset Management, 2015). In another study, JP Morgan estimated that the average yield over a 10-year time frame would reduce from 9 to 8% in a global recessionary scenario, indicating that infrastructure is one of the sectors to invest in for defense against recession (Leh, 2018). The participation by institutional investors in the infrastructure financing market is related to the general robustness of the ecosystem with a strong regulatory environment and legal system. The regulations on the product markets and the ownership restrictions are

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limitations to developing a stronger pipeline of projects, accordingly to the increased participation by institutional investors. In general, having a strong business model is important for the success of infrastructure projects being implemented under PPP arrangements (Dharmapuri Tirumala et al., 2020). Public sector support in terms of making good the shortfalls in revenues or providing a particular user fee is considered vital to attract private sector participation through the development route. However, the availability of public financial support, though important for the project’s success, is not considered as the most important decisionmaking criteria for infrastructure institutional investors (OECD, 2015). The infrastructure debt has also a substantially lower level of default and loss rates (0.7% & 0.3% respectively) compared to 9.8% and 6.2% for nonfinancial corporate issuances (Davis et al., 2018). This provides an added incentive to look for good quality assets in the sector. There appears to be a disconnect between the expectations of longterm stable returns from infrastructure investing and the choice to participate mainly in defined period closed private funds. The gains that the institutional investors achieve are dependent on the exits from the transactions, as the infrastructure funds appear to be similar to other private equity funds in terms of volatility and cyclicality (Andonov et al., 2021). As the risk profile of the close-ended infrastructure funds is on par with that of the other private equity funds, there are inbuilt incentives to exit the deal early, and reap higher returns. The underperformance of the closed-end funds, being the most preferred structure of institutional investors, might have long-term ramifications. There is a possibility that the investment flows into the more competitive private markets and that the institutional investors are not willing to support the initiative to bridge the infrastructure investment gaps. In theory, the open-ended funds appear to be in tune with the longer-term liabilities of the institutional investors, particularly the pension and insurance funds. However, the patronage of the same has been limited compared to the closed ended funds. The interest of the public sector investors was more than that of their private sector compatriots in allocating some portion of their asset portfolio to the close-ended infrastructure funds despite their weaker performance. These investors are guided by the mandates to invest in environmentally benign projects due to they being signatories to the entities such as UN Principles for Responsible Investment (UN PRI). The ability of the investor to assess the deals that they invest in becomes

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important while looking at the returns that they generate. It appears that the public sector entity investments have gone to the marginal deals in the developing economies or to the sectors such as the renewable energy, for which the private sector funding was not readily forthcoming (Andonov et al., 2021). The private sector institutional investors appear to be nimbler in limiting their exposure to such regions or sectors. Unlike other sectors, the infrastructure institutional investors have witnessed relatively higher investments driven by non-financial objectives such as the commitments needed environmental, social, and governance aspects or the compliance to regulations such as the UNPRI (Bauer et al., 2021; Krueger et al., 2020). The public sector institutional investors have also been hampered by the choices made to invest in projects in the sectors that have substantial social externalities such as prisons, education, and health. While these investments do have significant economic benefits, the financial returns are not commensurate with other infrastructure sectors (Eaton et al., 2020; Gupta et al., 2021; Mukherjee, 2021). The institutional investors usually enter a project after its preparatory/ development activities have been completed and hence do not generally influence the shape of the project, or the incorporation of various environmental, social, and governance elements. The trend in recent times is changing as some institutional investors, such as pension funds, are choosing to adopt a direct investment route and have become equity shareholders much earlier in the process. The institutional investors increasingly require that their portfolio companies meet green and sustainability-related targets. This is nudging the stakeholders involved, including the general partners, at the project development stage to be more proactive in structuring their projects in a sustainable manner. One of the research strands that the academicians pursued is to see if the infrastructure investing portfolio can be replicated through other means. Gupta and Nieuwerburgh estimated that the risk and return profile could be replicated using a combination of treasury bonds, listed infrastructure assets portfolio, and the stock market (Gupta & van Nieuwerburgh, 2021). The potential for private market infrastructure investors to increase their participation in this sector is substantial. Unlike the banks, which have higher restrictions on the sector and project investments and higher collateral requirements for the debt they issue, the private market infrastructure funds do not have such limitations. The infrastructure funds have substantial access to dry powder (funds kept in reserve that can be

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deployed quickly) that would enable quicker decision-making. They also have relatively lesser regulatory oversight when compared to banks. The private market infrastructure funds can structure themselves into various tax-efficient entities such as REITs (real estate investment trusts) and InVITS (infrastructure investment trusts), which could result in higher return to their investors (EY, 2019). On the other hand, the amount of dry powder the institutional investors hold can be substantially high, indicating either an absence of good quality projects to invest in or there is too much supply of money in relation to the projects available. For instance, the dry powder in 2015 was $108 billion, which increased to $137 billion in 2016 (Deloitte, 2017). This availability of funds tends to push up prices leading to a drop in the returns on investment. Macquarie and Cintra, the owners of Indiana toll road, sold the concession to IFM; the price was perceived to be very high, rumored to be around 30 × EBIDTA. The same consortium has also sold the Chicago skyway toll road to three pension funds from Canada, who invested directly at a similar valuation. The reasons the buyer found value at this particular price could be due to the environment of high liquidity, low interest rate, and the confidence that the underlying assets would generate revenues over the long term (IJGlobal, 2017). Increasing attention and competition to participate in private infrastructure deals mean that the returns have a declining trend. The private market equity investments are expected to take a more active role in revitalizing their portfolio companies and cannot expect similar performance in passive investments (BCG, 2018). The private equity infrastructure funds can also bring in the management expertise that can advise the investee companies on how to improve their performance and to inculcate best practices. Some of the private equity infrastructure funds are developing expertise in niche sectors, deepening their knowledge, and transferring the same to the management of the entities that they invest in. For example, the infrastructure private equity firm, EQT, improves the operations of its investee company, Tampnet, multifold during its holding period. Tampnet, a Norwegian company, is the high-capacity communication infrastructure provider for oil and gas sector. EQT acquired Tampnet in 2012, and adopting a buy-and-build modality converted the latter into a global organization with substantial increase in its operations and revenues. The company substantially added to its fiber cable network, provided 4G/LTE stations across the world. The EBITDA increased three times and the workforce increased 20 times from 2012 to 2018.

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EQT subsequently exited the business in 2019, selling it straight to 3i Infrastructure Plc. (EQT, 2018). There are many challenges that pension funds face—starting from finding suitable and viable infrastructure projects for the investments, risk management, and responding to the LPs about the investment allocations. When investing directly in the infrastructure assets, it is difficult for the funds to manage the complex processes both at the state and federal levels. The experiences of funds from Canada and Australia, where direct investments are common, can provide good pointers for the international institutional investors (Wahba, 2021). Insurance funds also face similar challenges that are faced by pension funds, for example, having a steady pipeline of viable infrastructure projects to invest in over time. Also, the insurance funds have been offering guaranteed returns to their beneficiaries for which they need to ensure a steady revenue stream is available to them (Shindo & Stewart, 2021). Some of the other challenges they face include credit rating availability for the infrastructure assets, currency risk and hedging, and political risk. This is particularly important in case of developing countries that do not allow direct investments in the infrastructure sector, for example, China, Viet Nam, and Thailand (Shindo & Stewart, 2021). According to Paklina and Stanko ´ (2021), as many as 12 out of 33 IOPS member countries prohibit direct investments in infrastructure by pension funds. These 12 member countries include (Bulgaria, Czech Republic, China, Ghana, Kazakhstan, Hong Kong (China), Kenya, Mexico, Republic of North Macedonia, Nigeria, Uganda, and Turkey).

9.8

Conclusions

The recent trends indicate that the demand for the infrastructure asset class has continued to grow, with approximately $ 60 billion raising the first half of 2021 (Ali Miraj, 2021). As this fundraising has happened during the COVID-19 pandemic time, the modality that has been popular is through investment funds. The larger funds such as I Squared, KKT, Brookfield, and EQT continue to dominate the market in 2021. This exponential growth of the sector has resulted in the faster utilization (the average time between fundraising and deployment is about four months), while on the other side there is a growing concern that the valuations are overheated. A substantial shift is happening in the definition of infrastructure due to the participation of institutional investors. The lines between

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the conventional private equity asset classes and that of the infrastructure asset classes are continuously being blurred (Ali Miraj, 2021). The institutional infrastructure investors operating through either the dedicated infrastructure funds or investing directly in the projects are a new addition to the conventional project sponsors, which included mainly the public sector proponents and engineering and construction companies. The advent of the infrastructure private markets is expanding the diversified investor pool to include pension funds, insurance companies, high net-worth individuals, sovereign wealth funds, and the like. The expectation of returns from these investors is typically high, and the funds charge management as well as performance fees. While this accelerated the investments available for the infrastructure sector, it also has brought about the need for sustainable investing. There has been steady support from regulators across the world allowing insurance and pension companies to invest in secure infrastructure debt. The Indian government had a proposal to allow companies to invest in BBB-rated infrastructure investment instruments (Mahmudova & Sourbes, 2010). The advantages and the limitations due by the increased participation of infrastructure funds are still being debated. The performance of the infrastructure allocation in the institutional investors such as the pension and insurance funds’ portfolio is still not conclusively answered. There is academic research that mentions that infrastructure funds are not as attractive as they have been projected to be (Andonov et al., 2021). On the other hand, there are arguments for increasing current asset allocation limits coupled with a flexible but strong framework such as prudent person principles that need to be implemented for the sector to grow (Shindo & Stewart, 2021). Either way, the infrastructure funds have created a tectonic shift in how infrastructure is financed, and the approach is here to stay.

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Index

A A11 Motorway, 7, 69 AAA credit rating, 39, 53, 98, 172, 180, 202 ABP, 27 Abu Dhabi Investment Authority, 214 Abundance Investment, 223 ACTTAB, 192 Addis Ababa Action Agenda on Financing for Development, 5, 61, 64 Affordable housing, 112, 140, 223 Africa, 3, 18, 27, 51–53, 61, 69, 100, 144, 145, 149, 164, 223 Africa Finance Corporation (AFC), 164 African Development Bank (AfDB), 51, 57, 59–61, 69, 72, 164 African Trade Insurance Agency (ATIA), 175 Ageas, 216 2030 Agenda for Sustainable Development in 2015, 108 agriculture value chains, 161

airports, 2, 18, 34, 136, 149, 150, 195 Alaska Permanent Fund (APF), 197 Alberta, 215 Allianz Capital Partners GmbH, 214 Alternative asset class(es), 209 Alternative Reference Rates Committee (ARRC), 36 Amravati State Capital of Andhra Pradesh, 152 Amundi Planet Emerging Green One (AP EGO), 127 Andean Development Corporation, 52 Angola, 174, 175 APG Asset Management, 214 Arab Bank for Economic Development in Africa (BADEA), 61 ASEAN Catalytic Green Finance Facility, 73 ASEAN Infrastructure Fund (AIF), 69, 72 Asia, 3, 7, 37, 51, 53, 59, 61, 69, 116, 195, 218, 222, 223

© The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2023 R. D. Tirumala and P. Tiwari, Advances in Infrastructure Finance, https://doi.org/10.1007/978-981-99-0440-2

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242

INDEX

Asian Development Bank, 3, 23, 51, 57, 59–61, 67, 69, 70, 72, 86, 92, 109–111, 121, 125–128, 165, 168, 218 Asian financial crisis, 6 Asian Infrastructure Investment Bank (AIIB), 53, 59, 61, 64, 69, 71, 84, 88, 100 Asia Pacific, 7, 37 Asset Manager, 213 Asset Recycling (AR), 9, 12, 143, 161, 187–192, 194–204 Assets Under Management (AUM), 32, 33, 80, 211, 213–215, 220, 221, 226, 227 Association of Southeast Asian Nations, 72, 89, 113, 217, 218 Atlantic Richfield, 197 Ausgrid, 192 Australia, 3, 12, 27, 113, 117, 127, 139, 159, 188–192, 195, 199–203, 215, 222, 232 Australian Capital Territory (ACT), 192 Aviva Investors, 174 B Bandra-Kurla commercial complex, 151 Bangalore Metro Rail Corporation Limited (BMRCL), 69 Bank of America, 90, 114, 128 Bank of America Merrill Lynch Green Bond Index, 90 Bank of China, 69, 125 Barclays, 90, 128 Barclays & MSCI Green Bond Index, 90 baseline level, 95 BB+credit rating, 173 BBB-credit rating, 173, 233 BBVA, 108

BCI, 214 Beijing, 53 Belgium, 7, 69 Belo Horizonte, 196 Belt and Road Initiative (BRI), 53, 64 Bengaluru, 69, 148, 150 Bilateral development agencies, 47, 48, 55, 123 Bill and Melinda Gates Foundation (BMGF), 52 Biodiversity credit(s), 117 Bita, 175 Blackrock, 33 Blackstone, 27 blended, 10, 52, 57, 67, 68, 70, 129, 176 Bloomberg, 98, 145, 177 Blue bond(s), 11, 92, 111, 117–120, 141 Blue Co, 121, 125 Blue SEA Finance Hub, 121, 125 BNP Paribas, 69, 175 BNP Paribas France, 175 Bogota, 143, 145, 148 Bolivia, 140 bondholders, 99, 124 Borsa Italiana, 89 BpiFrance Assurance Export, 175 Brazil, 53, 61, 64, 83, 143, 145, 147, 187, 203 Bretton Woods Agreement, 48, 49 BRICS, 53, 74 Brisbane, 145 British administration, 150 Brookfield, 215, 217, 232 Brookfield Asset Management, 215 brownfield development, 224 building of car parks, 150 Build-Operate-Transfer (BOT), 149, 188 Build-Own-Operate (BOO), 149

INDEX

Build-Own-Operate-Transfer (BOOT), 149, 164 built-up property, 144 Bulgaria, 232 Business Contingency Plans (BCP), 160 Business Improvement Districts (BIDs), 143 Bus Rapid Transit Systems (BRTS), 147

C Cadent, 125 Cairo, 148 Caisse de dépôt et placement du Québec, 214 California, 224 Callable capital, 55, 56 Cambridge, 32, 144 Canada, 3, 147, 178, 188, 196, 200, 215, 222, 231, 232 capacity building, 9, 57, 161 capital cost, 21, 123, 163, 164, 175 capital structure, 54 carbon-friendly activities, 97 carbon neutrality, 91, 95, 96 carbon offsetting, 97 Carbon Trust, 85 Caribbean Development Bank (CDB), 51, 61 Cascade approach, 70 Cash Flow Available for Debt Service (CFADS), 37 Cayman Islands, 34 CCR, Zurich Airport and Munich Airport, 196 Certified Emission Reduction credits, 84 Chanel, 115 Changi Airport Group, 196 Chennai, 150

243

Chicago Skyway, 7, 192, 227 Chile, 82, 83, 170, 179 ChinaBond China Climate-aligned Bond Index, 90 ChinaBond China Green Bond Index Series, 90 China Investment Corporation, 214 Christchurch, 145 CICERO, 92 Cintra, 227, 231 Clean Development Mechanism, 84, 97 Climate Awareness Bond, 84 Climate Bonds Certification, 88 Climate Bonds Initiative, 81–83, 88, 126 climate change, 3, 5, 51, 52, 61, 80, 84, 86, 87, 99, 108, 110, 113, 114, 117, 121, 122, 124, 129, 139, 140, 218, 223 climate risks, 95, 99 climate targets, 79, 94–96 close-ended fund, 226 co-financing, 10, 53, 60, 69 co-investments, 225 cold chains, 225 Cold War, 51 Columbia, 140, 142, 143, 148, 170 commercial complexes, 8, 150 concessional, 9, 10, 49, 52, 56, 57, 63, 64, 73, 118, 120, 146, 220 concessional finance, 49, 56, 57, 73 constellation plan, 147 Construction All Risks (CAR), 165 construction risk, 172, 173, 203, 220 Contractors All Risk (CAR), 161, 165 Contractors’ plant and equipment (CPE), 165 conventional source, 159, 204 Copenhagen, 80, 147, 148 Copenhagen Summit, 80 coral reefs, 117, 161

244

INDEX

Cordoba, 143 Corporate Investor, 213 Costera, 33 coupon step-up, 115 covenants, 10, 32, 37, 40, 99, 119 COVID-19, 6, 22, 108, 109, 113, 115, 159, 177–179, 232 CPP Investment Board Canada, 214 Credit Agricole, 69, 175 Credit Agricole Corporate, 175 credit enhancement(s), 7, 8, 12, 20–22, 26, 37, 38, 59, 65, 69, 84, 160, 164, 166, 168, 170, 171, 173, 175, 180, 181 credit guarantees, 12 credit insurance, 25, 168, 169 credit lines, 57 credit rating, 7, 26, 39, 53, 56, 73, 89, 92, 109, 122, 164, 166, 172, 173, 195, 201, 232 Credit Suisse AG, 175 creditworthiness, 19, 56 Crisis Response Protocols (CRP), 160 Cross-Currency Swap (CCS), 167 CUFE-CNI Green Bond Index Series, 90 Curitiba, 147 Czech Republic, 83, 232

D Damodaran, Aswath, 99, 128 Dar es Salaam, 144 data centres and storage, 225 debt guarantee, 22, 170, 171, 173 Debt Service Coverage Ratio (DSCR), 20, 21, 136, 170 debt service obligations, 170, 178 Debt Swaps, 66 default, 21, 26, 27, 29, 37, 39, 55, 99, 170, 171, 175, 176, 181, 229

definition, 2, 3, 13, 19, 82, 87, 88, 91, 100, 122, 126, 176, 177, 228, 232 Delhi Aerocity, 8 Delhi Aerotropolis Private Limited, 8 Delhi Airport, 152 Delhi International Airport Limited (DIAL), 7 de-risk, 21, 170 Derivatives, 65, 167 Design-Build-Finance-Operate, and Maintain (DBFOM), 178 Design-Build-Operate-Transfer (DBOT), 147 Developing member countries (DMCs), 10, 64, 65, 69, 71, 72 Development Bank of Seychelles (DBS), 120 Development Finance Institutions, 19, 47, 48, 56, 60, 210 development financing, 51, 53, 73 Development impact bond (DIB), 66, 116 Development Policy Financing (DPF), 50 Development Policy Loans (DPLs), 49, 50 Dexter Nova Alliance, 178 Digital Fibre Infrastructure Trust, 221 digital infrastructure, 224, 228 direct investments, 8, 225, 227, 232 Discounted cash flows (DCF), 37 Dodd-Frank Act, 39 Dodd-Frank and Basel III, 210 dot com bubble, 6 Dow Jones Brookfield Global Infrastructure Index (‘DJ Brookfield’), 217 Dutch Development Bank (FMO), 169

INDEX

E Earnings before interest, tax, depreciation and amortization (EBITDA), 37, 231 East Asia, 142 East West North South corridors, 150 ecosystem preservation, 96 ECOWAS Bank for Investment and Development (EBID), 61 EDHEC Global Unlisted Infrastructure Equity Index (‘EDHECinfra’), 217 Educate Girls impact bond, 116 education, 18, 54, 73, 108, 111, 112, 115, 190, 197, 230 Education Outcomes Fund (EOF), 116 Egypt, 114, 148, 149 Elazig hospital, 166 Emerging Africa Infrastructure Fund (EAIF), 69 Employees Compensation (EC), 7, 161 Endeavor Energy, 192 Endowment Plan, 213 Enel, 115 energy, 2, 4, 10, 17, 24, 27, 31, 37, 53, 61, 63, 64, 67, 80, 85, 91, 98, 112, 115, 121, 125, 139, 188, 195, 217, 222, 223, 225, 228, 230 energy efficiency, 85, 91, 223, 225 energy transition, 225 Enhanced Structural Adjustment Facility (ESAF), 49 environmental impact, 96, 111, 140 Environmental, Social and Governance, 11, 80, 92, 93, 99, 110, 111, 114, 122, 124, 128, 222, 223 epidemic, 177, 178 EQT, 214, 231, 232

245

Equity, 25, 30, 59, 60, 228 Estonia, 145 Ethiopia, 65, 149 EU Green Bonds Standard (EU GBS), 88 European Bank for Reconstruction and Development (EBRD), 2, 4, 5, 51, 52, 59, 60, 69, 72, 124, 166 European Investment Bank (EIB), 7, 38, 51, 59, 69, 72, 83, 84, 164 EU Solvency II Delegated Regulation, 216 Export Development Canada (EDC), 69 F Family Office, 213 Federal Reserve Board, 36 financial guarantees, 160 financial institutions, 1, 6, 8, 9, 12, 13, 27, 29, 34, 38, 55, 69, 121, 129, 136, 140, 159, 162, 164, 165, 168, 169, 173, 174, 176, 180, 210, 216 Financial instrument(s), 11, 29, 30, 49, 56, 59, 60, 69, 87, 99, 117, 118, 120, 143, 167, 173, 219 financial model, 21, 36, 37, 56 financial returns, 54, 110, 122, 128, 230 financial risk, 100 Financial Services Council, 189, 191 Financial Stability Board, 88 financial statements, 21, 220 Financial Times, 100, 122 Finger Plan, 147 Fiscal Responsibility Act (FRA), 202 Fitch, 148 Fixed income instrument(s), 85, 108 Fix-it-first (FiF), 196 Floor Area Ratio (FAR), 143

246

INDEX

Floor Space Index (FSI), 143 food supply and storage infrastructure, 225 Force Majeure, 176–178 Foundation, 213 France, 82, 164, 179, 195, 200 Free Funds, 56 FTSE EuroBIG Green Impact Bond Index, 90 FTSE Global Green Impact Bond Index, 90 FTSE USBIG Green Impact Bond Index, 90 FTSE WorldBIG Green Impact Bond Index, 90 Funding, 4, 8, 10, 13, 19, 22, 33, 38, 47, 49, 52, 55–57, 63, 64, 69, 70, 97, 109, 117, 122, 125, 141, 148, 160, 163, 165, 174, 188, 190, 194, 195, 216, 218, 221, 230 fund of funds, 226 G Galeão, 195 Gatwick Airport, 27 Gavi, 107 General Fund, 146 General partner(s) (GPs), 223, 226, 230 German Development Finance Institution (DEG), 69, 164 Germany, 82 Ghana, 232 Gilet Jaunes, 179 Global Concessional Financing Facility (GCFF), 65 Global Environment Fund (GEF), 52, 118 global equity, 216 Global Financial Crisis (GFC), 4, 6, 10, 22, 25–27, 32, 38, 51, 52,

55, 80, 87, 159, 163, 164, 172, 173, 180, 187, 209–211, 215, 216 global fixed income, 216 Global Fund, 52, 66, 67 Global Infrastructure Partners, 33, 215 Golden Quadrilateral, 150 Good Actor Regime, 119, 120 governance, 4, 11, 21, 53, 55, 80, 97, 98, 110, 119, 122, 126–129, 136, 140, 153, 203, 220, 222, 230 Government Agency, 213 Grant(s), 10, 19, 21, 30, 49, 52, 56, 57, 59, 60, 64, 120, 144, 147, 148, 204 Greater Tokyo Railway Network, 144 Green Bond Endorsed Project Catalogue, 89 Green bonds, 10, 29, 30, 79–100, 108, 109, 113, 114, 116, 118, 121, 125, 127 Green Bonds Principles, 85, 88, 89, 91, 112 Green Climate Fund (GCF), 84, 121, 125 greenfield development, 224 Green finance, 89, 91, 94, 96, 98 Green Financing Framework, 85 Greenhouse Gas Emission, 87, 95 Greenium, 11, 92, 93 Green, social, sustainability, and sustainability-linked bond(s), 81 Greenwashing, 91, 94, 96, 100, 127, 128 Gross domestic products (GDP), 4, 18, 31, 50, 225 GSSS bond(s), 115 Gulf Cooperation Council (GCC), 34

INDEX

H Hadrian Capital Fund, 174 Haldia, 153 health, 2, 18, 37, 54, 64–67, 73, 108, 113, 115, 140, 176, 190, 197, 210, 225, 230 health and retirement living, 225 heavy vehicle trailers, 225 hedge funds, 209, 222 Helaba and Santander, 175 HM Treasury, 85, 96, 216 Hong Kong Mass Transit Railway, 144 hotels, 3, 8, 150 Housing, 2, 4, 25, 69, 108, 111, 136, 139, 144, 152 Hudson Yards Infrastructure Corporation, 146 Hudson Yards Project, 145 Hungary, 83 hybrid model, 99 Hyderabad, 147, 150, 152 Hyderabad Metro, 152 I ICE BofA Green Index, 90 Impact reporting, 94 India, 3, 7, 12, 13, 22, 26, 27, 33, 53, 61, 63, 69, 82, 83, 91, 97, 116, 127, 136, 137, 140, 143, 147, 150–152, 159, 163, 170, 188, 195, 200, 201, 203, 212, 217, 219–221 India Grid Trust of Sterlite, 221 India Infrastructure Finance Company Limited (IIFCL), 69 India Infrastructure Trust—Brookfield, 221 Indiegogo, 223 IndInfravit Trust—L&T IDPL, 221 Indira Gandhi International Airport (IGI Airport), 7

247

Indonesia, 35, 61, 83, 115, 170, 188, 203 Infrastructure Investment Trusts (InVITs), 13, 188, 203, 217–221 Infrastructure Ontario’s Capital Planning Program, 198 ING, 69 innovation, 1, 2, 8–10, 12, 13, 48, 51, 53, 54, 59, 64–67, 71, 73, 74, 80, 82, 84, 97, 100, 109, 114–116, 119–122, 125, 126, 129, 141, 145, 148, 165, 174, 176, 187, 192, 204, 218–220, 222, 223, 228 institutional investors, 6, 8–10, 13, 23–25, 32, 87, 89, 94, 110, 122, 124, 160, 165, 172, 173, 180, 190, 203, 209–214, 216, 217, 224–233 institutional owners, 94 insurance, 8, 23, 25, 26, 40, 87, 160–162, 165, 168, 169, 172, 174, 175, 179, 180, 210–212, 216, 225, 227, 229, 232, 233 Insurance Company, 213 Inter-American Development Bank (IADB), 51, 57, 59–61 Interest Rate Swaps (IRS), 12, 20, 167 Inter-Governmental Green Bond Board, 85 Internal Rate of Return (IRR), 20, 32, 136, 170, 225 International Capital Markets Association, 85, 86, 88, 89, 98, 111, 112, 115 International Finance Corporation, 24, 49, 64, 69, 72, 83, 84, 92, 111, 126, 164, 168, 169, 221, 222

248

INDEX

International Finance Facility for Immunization Company (IFFIm), 107 International Fund for Agricultural Development (IFAD), 52 International Union for Conservation of Nature (IUCN), 66 Investment Bank France, 175 IRB Infrastructure Trust, 221 IRB InvIT Fund–IRB Infrastructure Developers, 221 Ireland, 34 Islamic Development Bank (IDB), 52, 59, 65 Islamic Finance, 10, 34 I Squared, 232

J Jakarta, 121 Japan, 82, 139, 144, 187, 203, 222 Japanese International Cooperation Agency (JICA), 69, 218 Jersey, 34 Juncker Plan, 163

K Kazakhstan, 232 Kenya, 65, 232 Kickstarter, 223 KKR, 27 KKT, 232 Know your customer (KYC), 120 Korea, 69, 82, 170 Korea Development Bank, 69 KPI bonds, 115, 127 Kyoto Protocol, 80, 84, 87

L Labeled bonds, 81, 82, 88, 89, 91, 108, 122

Land-based financing, 7, 11, 135, 136, 141, 145, 146, 150–153 Land Titles Office, 192 Land use, zoning, and development financing tools, 142, 143 Land value capture (LVC), 7, 9, 11, 142, 144, 145, 151 Latin America, 26, 52, 61, 143, 144, 170, 223 Leading Asia’s Private Sector Infrastructure Fund (LEAP), 217, 218 Least Concession System, 188 letters of credit, 24, 57 leverage, 5, 6, 12, 34, 40, 53, 64, 65, 73, 84, 87, 110, 117, 136, 142, 143, 145, 151, 164, 169, 218–220 Liberty Specialty Markets, 169 Limited partner(s) (LPs), 222, 226, 232 listed funds, 225, 227 listed securities, 225 loan documents, 99 loan(s), 7, 10, 19, 20, 27, 29, 30, 34, 35, 49, 50, 53, 55–57, 59–61, 64, 69, 71, 80, 84, 87, 99, 118–120, 160, 162–165, 167, 169, 170, 172, 175, 180, 193, 219, 221 logistics, 3, 126, 225 London Interbank Offered Rate (LIBOR), 10, 35, 36, 163 Los Angeles, 179 low-carbon economy, 83 LSE’s Shanks green bond (ORB), 89 Luanda, 174, 175 Luanda Bita water supply guarantee project, 174 Luanda city’s water utility (Empreza Publica das Aquas de Luanda E.P. (EPAL)), 175

INDEX

Luxembourg, 34, 90 Luxembourg Stock Exchange, 90

M Macquarie, 33, 188, 214, 215, 227, 231 Macquarie Infrastructure & Real Assets, 215 Maharashtra, 143 Malaysia, 72, 140 Managed Co-Lending Portfolio Program (MCPP), 169 Mandated Lead Arranger (MLA), 23, 175 Manhattan, 145 Manila, 139, 144 Marguerite Fund, 216 marine ecosystems, 161 market value, 144, 149, 197, 204 Massachusetts, 144 Mass Rail Transit Orange Line, 113 Mass Rapid Transit (MRT), 142, 147 Megacities, 3, 137 Mexican government, 171 Mexico, 61, 83, 114, 115, 138, 161, 203, 232 mezzanine products, 65, 164 Millennium Development Goals (MDGs), 61 minimum payment guarantee, 170 minimum revenue guarantee, 171 mini-perms, 20 Minneapolis, 179 modern finance theory, 160 Monolines, 10, 26, 38, 39, 180 Monte Carlo simulations, 37 Morgan Stanley, 64, 100 Mosaic, 224 MSCI Europe Infrastructure Index (‘MSCI’), 217 MUFG, 69

249

Multilateral agencies, 34, 36, 38, 81, 83, 84, 100, 169 Multilateral Development Banks, 6, 10, 12, 40, 47–57, 59–61, 63–65, 67, 69–73, 119, 140, 160, 164–169, 174, 180 Multilateral Investment Guarantee Agency (MIGA), 164, 166, 168 Mumbai, 143, 150, 151 Mumbai Metropolitan Regional Development Authority (MMRDA), 151 Munich Re, 169 municipal bonds, 40, 148, 216, 226 N Nachtigal hydropower plant, 164 Nandi Corridor (Bangalore—Mysore Infrastructure Corridor), 152 National Australia Bank, 112 Nationally Determined Contributions, 86, 87, 92, 96 National Monetization Plan (NMP), 195 National Pension Service of Korea, 214 Natixis, 69, 216 nature-based conservation, 161 nature-based infrastructure, 161 NBFCs, 220 Netherlands, 127 New Delhi, 7, 137, 150, 152 New Development Bank (NDB), 53, 59, 61, 64, 71 Newell Highway, 194 New South Wales (NSW), 113, 190, 192, 194, 200, 202 New South Wales Sustainability Bonds program, 113 New Urban Communities Authority (NUCA), 148 New Zealand, 222

250

INDEX

Nigeria, 35, 137, 232 non-concessional, 56, 57, 63 Non-governmental organizations, 50, 66, 120 non-PLS contracts, 34 non-recourse, 20, 136 non-sovereign guaranteed, 49 Nordic Investment Bank, 118 Northconnex, 190 Northern Territory, 192 North Slope, 197 Norway, 27, 126, 196 Novartis, 115 Nova Scotia, 178 Nova Scotia’s Health Protection Act, 178 NSW Government, 194, 200, 202 NTPC, 91 NWB, 112 NYU Stern School of Business, 128

O Odebrecht, 195 off-take agreements, 20 Ohio State University, 192 OMERS, 214 One Planet Summit, 83 Ontario Teachers’ Pension Plan, 214 OPEC Fund for International Development (OFID), 61, 164 open-ended fund, 226, 229 Operations and maintenance (O&M), 8, 21, 22, 136, 179, 198, 200, 204 optical fibre networks, 225 Orestad, 148 Oriental Infra Trust—Oriental Structural Engineering Pvt. Ltd., 221 Orkdalsvegen, 27 Osaka, 139

Ottawa, 147 Outcome-based financing, 66 P Pacifico Tres, 33 paid-in capital, 55 Pan African Infrastructure Development Fund, 216 Pandemic Bond(s), 115 parametric insurance, 161 Paris Agreement on Climate Change, 95, 108, 113, 129 Paris Climate Agreement, 84, 95, 129 Partial Credit Guarantees (PCGs), 57, 169, 175 Partial Risk Guarantees (PRGs), 57, 169 payment guarantees, 57 Payments in Lieu of Taxes (PILOTs), 145 Pensioenfonds Zorg en Welzijn, 214 pension funds(s), 6, 8, 12, 13, 25, 27, 33, 50, 87, 94, 172, 190, 191, 203, 210, 211, 215, 216, 226, 230–233 People’s Republic of China, 3, 4, 52, 53, 61, 63, 64, 82, 83, 89, 126, 137, 145, 188, 200, 203, 214, 218, 232 Philanthropic capital, 64 Philanthropic investment funds, 66 Philippine Investment Alliance for Infrastructure Fund, 216 Philippines, 61 physical risk, 95 Poland, 83, 114, 127 policy-based guarantees, 57 political risk guarantee, 164 Political risk insurance (PRI), 166, 179, 229 Political Risk (PR), 161 Political violence insurance (PVI), 180

INDEX

Political Violence (PV), 161 Port Botany, 192 Port Kembla, 192 Portland Pioneer Square BID, 143 Port of Darwin, 192 Port of Melbourne, 192 ports, 2, 34, 149, 150, 195, 219, 225 Poverty Reduction and Growth Facility (PRGF), 49 Powergrid InvIT, 221 Preferred creditor status (PCS), 55, 56 preferred infrastructure, 228 Princes Highway, 194 private debt, 32, 216 Private equity, 8, 27, 33, 209, 211, 212, 214–216, 221–223, 226–229, 231, 233 Private finance, 6, 29, 47, 64, 70, 169 Private Finance Initiative (PFI), 18, 24, 27, 69 private if possible, 71 Private Infrastructure Development Group (PIDG), 164 private real estate, 216, 227 private sector development, 52 Private Sector Pension Fund, 213 Profit-and-loss sharing (PLS), 34 project appraisal, 38, 173 2020 Project Bond Initiative, 174 project bonds, 7, 25, 38, 69 Project finance, 8, 9, 12, 17–20, 23–27, 31, 32, 34, 37, 38, 40, 48, 52, 69, 136, 162–164, 172, 173, 225 project guarantees, 57 project risk(s), 22, 24, 38, 48, 172 Property All Risk (PAR), 161 property rights transfer, 162 prudent person rules, 215 Prudhoe Bay, 197 PSP Investments, 214

251

public equity, 210, 216 Public Liability (PL), 161 Public Pension Fund, 213 Public-Private Partnership (PPPs), 7, 18, 64, 70, 136, 148, 162, 176, 178, 201–203, 224 Puerto Rico’s Toll Road, 192 purchasable density bonuses, 146 Q Queensland, 189 Qunitana Roo, 161 R railheads and rollingstock, 225 Rail Plus Property Co-Development (R+P model), 144 Railroad Rehabilitation and Improvement Financing Programme, 174 RARE Global Infrastructure Index (‘RARE’), 217 Rating AAA, 39, 53, 98, 172, 180, 202 Ba1, 166 Baa2, 166 BBB-, 173, 233 RDFI, 67 real estate, 11, 25, 31, 82, 136, 147, 150, 209, 213, 217, 228, 231 Real Estate Investment Trusts (REITs), 217, 219, 220, 231 recourse, 18, 20, 22, 32, 99, 136 Regional Development Banks (RDBs), 51, 54–57, 74 regulators, 9, 26, 34, 40, 87, 96, 163, 228, 233 renewable energy projects, 97 renewables, 27, 225 Renovate-Operate-Maintain-Transfer (ROMT), 149

252

INDEX

Repsol, 91 Republic of North Macedonia, 232 Republic of Seychelles, 117, 120, 121 reputational risk, 95 Resilience bonds, 123 Restrictive zoning, 144 Results-based financing, 66 Retail Green Savings Bonds, 85 revenue streams, 6, 98, 189, 190, 199, 203 Rio de Janeiro, 195 risk appetite, 165, 169, 170, 172, 203 risk coverage, 165, 170 risk management, 18, 20, 22, 32, 38, 40, 71, 159, 160, 163, 174, 178, 232 risk management techniques, 160 risk mitigation, 9, 12, 32, 100, 160, 162, 165, 168, 170, 174 risk profile, 122, 170, 190, 224, 229 risk protection, 163, 179 Romania, 83 Russian Federation, 53, 83

S S&P Dow Jones Green Bond Index, 90 S&P Global Infrastructure Total Return Index (‘S&P’), 39, 90, 217 Safeguards, 50, 53, 54, 71, 72, 74, 119, 120 Saint Gobain, 175–176 sanitation, 2–4, 61, 63, 112, 139 Sao Paulo, 138, 142, 145 Saudi Arabia, 83 Scottish Executive Act (2003), 143 SDG Bond Framework, 108 SDG bond(s), 108, 111 Secured Overnight Financing Rate (SOFR), 10, 35, 36

Securities and Exchange Board of India (SEBI), 218–221 Sendai Framework, 61 Senegal, 35 sensitivity analysis, 21 Seychelles blue bond framework, 118 Shandong Green Development Fund, 217 Shanghai, 53, 137 shareholding structure, 55 Shrem InvIT, 221 SMBC, 69 Snam, 125 Social bond(s), 82, 109, 111–113, 115, 116, 127 Social Bonds Principles, 112 Social impact bond (SIB), 66, 116, 123 Social washing, 127 Societe Generale, 69 Société Générale France, 175 Solactive Green Bond Index Series, 90 South Korean National Pension Service, 27 Sovereign Wealth Funds (SWFs), 160, 172, 190, 210, 211, 213, 227, 233 Spain, 52, 82, 91 SSE Chinese domestic Green Bond Index Series, 90 SSE Green Corporate Bond Index, 90 Standard & Poor’s (S&P), 39, 90, 148, 217 Standard and Poor’s Green Evaluations, 91 Standard Chartered, 69, 164, 175 Standard Chartered Bank, 164, 175 stapled financing, 59 Stockholm, 147 storage, 225 Strikes, riots and civil commotion (SRCC), 161, 179

INDEX

Structural Adjustment Facility (SAF), 49 Sub-regional development banks (SRDBs), 51 Suez, 175 Sukuk(S), 34 SunFunder, 223 Superannuation Scheme, 213 support agreement, 22 sustainability, 11, 82, 84, 93, 96, 107–110, 113–116, 129, 163, 218, 222, 230 Sustainability Bond Guidance, 112 Sustainability bond(s), 82, 108, 109, 111–114, 218 Sustainability-linked bond(s), 107, 114 Sustainability-linked loan, 113 Sustainable Blue Economy Finance principles, 125 Sustainable Development Goals (SDGs), 3, 5, 51, 61, 64, 65, 73, 74, 79, 84, 87, 96, 108, 110–113, 115, 116, 121, 122, 127, 135, 140, 141, 169, 176 sustainable finance, 80, 82, 84, 86, 88, 97, 99, 100 Sustainable Finance Disclosure Regulations, 112, 222 sustainable forest management, 96 Suzano, 115 Sydney, 145 Sydney Metro, 190 Syrian refugee crisis, 65 T Tampnet, 231 Tancredo Neves International Airport, 196 Task Force on Climate-Related Financial Disclosures, 88 Tata group, 195

253

Taxonomy, 89, 96, 100, 112, 126 TCorp, 113 Technical Assistance (TA), 51, 57, 60 telecommunications, 225 telecom towers, 225 Territory Insurance Office (TIO), 192 Texas, 196 Thailand, 83, 113, 232 The French Development Agency (AFD), 69, 164 The French export credit agency, 175 The Local Government Act (2003), 143 Thematic bond(s), 9, 11, 65, 84, 97, 107–109, 111, 113, 114, 119, 121–123, 125, 126, 128, 129 The Seychelles Conservation and Climate Adaptation Trust (SeyCCAT), 118, 120 Times Square, 145 Titling and registry business of Land and Property Information, 192 Toll-Operate-Transfer (TOT), 188, 203 Tower infrastructure Trust—Reliance & Brookfield, 221 traded over the counter (OTC), 168 Trade liberalization, 51 Trans Adriatic Pipeline, 69 Transgrid, 192 transit, 139, 143, 144, 146 transition, 4, 36, 50, 83, 91, 95, 96, 125, 128 Transition bonds, 125, 128 Transition finance, 124 Transit-Oriented Development (TOD), 147 transport, 3, 4, 7, 17, 39, 53, 54, 61, 64, 69, 98, 113, 140, 142, 143, 150, 173, 176, 179, 188, 200, 224, 225

254

INDEX

Transportation Infrastructure Finance and Innovation Act, 170, 174 Tropical Landscapes Finance Facility (TLFF), 217, 218 Turkey, 83, 166, 232 Turkish government, 166 U UBI Banca, 69 UBS, 27 Uganda, 65, 232 Unédic, 112 unfunded, 9, 12, 165, 169 UniCredit, 69 United Kingdom (UK), 3, 18, 27, 34, 35, 38, 82, 85, 96, 97, 117, 122, 125, 159, 170, 173, 175, 200, 203, 216, 223 United Nations Framework Convention on Climate Change, 52, 84, 87, 97 United Nations (UN), 3, 5, 50–52, 61, 65, 84, 97, 108, 110, 111, 115, 122, 125, 126, 137–142, 176, 229 United Republic of Tanzania, 65 United States of America (USA), 3, 4, 7, 24, 27, 32, 36, 37, 48, 49, 80, 82, 115, 117, 148, 159, 170, 174, 187, 193, 195, 196, 200, 222, 226 unlisted funds, 225, 226 unplanned settlements, 139 UN Principles for Responsible Investment (UNPRI), 229

Urban, 3, 5, 54, 136, 137, 139, 141–143, 145, 146, 150, 151, 193, 195, 199 Urban area, 3, 5, 137, 139, 143, 150, 193 Urbanization, 3, 74, 135, 137, 140, 195 Uruguay, 203 US SIF Foundation, 222 Utkrisht Bond, 116 V venture capital, 209, 213, 222 Vertical Funds, 52 Viability Gap Funding (VGF), 22, 136, 148, 163 Vigeo Eiris, 85 Virescent Renewable Energy Trust, 221 Voluntary and compulsory contributions, 66 W wastewater, 96, 113 water, 2–4, 17, 31, 53, 61, 63, 83, 96, 112, 113, 123, 129, 139, 142, 148, 173, 174 Wealth Manager, 213 West Bengal, 153 World Bank, 29, 48, 49, 51, 52, 56, 57, 59–61, 65, 67, 70, 72, 83, 84, 89, 117–120, 139, 148, 165, 168–170, 175, 177, 204, 219 World War II, 47, 48