South Africa: Unlocking The Development Of Infrastructure Through Bonds Across The African Continent

Last Updated: 15 January 2014
Article by Jonathan Cawood and Lindiwe Magana

There is a growing need for large-scale infrastructure projects around the world. The OECD and the World Economic Forum (in a report prepared in collaboration with PwC) estimates that around 3.5 - 4% of global GDP, or around USD 53trn from 2010 to 2030 needs to be invested in electricity distribution, transportation, telecommunications, and water infrastructure annually. For Sub Saharan Africa, the World Bank estimates infrastructure funding requirements at USD93M per annum for the next 10 years, of which at least 50% must be financed from non-government sources.

Policymakers, governments and banks are refocusing their efforts on how infrastructure needs to be financed in the wake of the global financial crisis. Budgetary constraints have left many governments financially constrained and unable to pay for large infrastructure projects on their own.

"Although banks are continuing to lend, they are unlikely to meet the demands of a growing project pipeline. New banking regulations, such as Basel III, are also making long tenor project finance loans challenging. says Jonathan Cawood, Capital Projects Leader for PwC Africa. Based on our recent PwC research in this area, 'The rise of non-bank infrastructure project finance', we think there is an opportunity for the private sector to provide infrastructure financing by way of project bonds and non-bank lending, he says.

Project bonds are not a new phenomenon and have been used to fund large-scale infrastructure projects primarily in Europe and the US. Infrastructure bonds have the potential to expand beyond the jurisdictions where they are currently used.

Project bonds, which are still largely unexplored in South Africa and the African continent, are a debt instrument usually issued by the Government or private companies to raise funds from capital markets for infrastructure projects. Infrastructure bonds can also be issued by private companies without assistance from the Government.

To date no dominant project bond model has yet emerged. There are numerous financing solutions for investor and procurer attention, each with different benefits and challenges.

Discussions at the 14th IMF-OECD World Bank Global Bond Market Forum are expected to focus on how capital markets can help enhance infrastructure financing. Issues such as the role of banks, other financial intermediaries and local currency bond markets in financing infrastructure are on the agenda.

In South Africa, local currency infrastructure bonds have not been issued to date as the Government is of the view that such bonds are far removed from infrastructure projects. Instead, parastatal bonds have been issued and in some instances the Government has tended to provide guarantees for certain projects. The implementation of Basel III and a growing pipeline of projects are expected to spur greater demand for capital markets financing.

In Africa, many countries need to deepen sovereign and multilateral bond issuance as a precursor to corporate and project issuance. Across most of the continent, reforms to date have focused on getting sovereign bonds issued, often to finance infrastructure development. Many sovereigns are not rated, and those with natural resource revenues often need to setup a sinking fund committing future revenues to secure financing. Nonetheless, 2012 and the first half of 2013 saw significant Eurobond issuances, notably Ghana , Rwanda, Zambia, Tanzania, Angola, Nigeria and Kenya.

It is important that African issuers appeal to investors by focussing on the "basics" of increasing transparency in the financial markets and coordinating more effectively across borders. The specific needs of each country vary, but commonly needed reforms include deregulation, a lifting of capital controls and stronger governance and disclosure.

South Africa has a developed bond market in place, and sizable life insurance and pension markets. Some institutional investors have bought into projects post completion, but have not yet shown much appetite for construction risk. The infrastructure market in South Africa is dominated by state owned utilities such as Transnet and Eskom who finance infrastructure on balance sheet. The largest project finance programme to date is to support investment in the ambitious renewables PPP program which the domestic banks have so far financed comfortably to the surprise of some international investors. Nevertheless, the implementation of Basel III in general and a growing pipeline of projects could spur greater demand for capital markets financing. In particular, round 3 of the renewables program will drive cZAR30-40bn across 1,000MW of capex

Other emerging economies, such as Chile, are also using project finance bonds as a means to attract investor interest in large scale infrastructure projects "However, it is important to bear in mind and understand the different policy measures and governments regarding the creation and processes in place for these project bonds," adds John Gibbs, PwC Advisory Partner. "In addition, different markets have varying degrees of receptivity to institutional debt and different norms."

The PwC study identifies four preconditions that should exist for a project bond market to take root:

  1. Available capital outside of the banking system. In most cases, this implies a stable and well-structured private, public or third-sector insurance and savings industry with retirement savings and pension funds managed by investment professionals. Such a system creates a competitive pool of capital which generally seeks a wide range of debt investment opportunities.
  2. Sufficient governance and transparency in financial reporting. A functioning bond public market requires a significant amount of financial infrastructure, including adequate disclosure and reporting rules. The provision of additional information for investors needs to be balanced against public market information disclosure rules which require time dissemination to all participants.
  3. Balanced tax and commercial policies. The key needs here are clarity of policy and whether there is a level playing field between bank debt and bonds.
  4. Project-specific credit support. The degree of credit support for infrastructure projects varies substantially by market. Not all markets have certain a class of investors seeking highly rated infrastructure debt. For many markets, project credit enhancement is not relevant. In these markets, a significant amount of infrastructure is either built by government directly or funded by state owned banks. Where infrastructure is privately financed, it is usually done so through corporate guaranteed loans or bonds.

These four areas represent clear priorities for governments looking to establish a private infrastructure project bond market in order to get infrastructure ventures financed.

With these four perquisites in mind, the PwC study analyses the current conditions in markets around the world to determine the feasibility and attractiveness of financing infrastructure projects. The study shows that African countries need to look at alternative forms of financing infrastructure. Across most of the continent reforms have been focused on getting sovereign funds issued, usually to finance infrastructure development.

It is important that African issuers appeal to investors by focusing on the 'basics' of increasing transparency in the financial markets and coordinating more effectively across borders. The specific needs of each country vary, but commonly needed reforms include deregulation, a lifting of capital controls and stronger governance and disclosure.

"Given the regulatory pressure on banks it is difficult to see them continue financing at pre-global financial crisis volumes or terms should investment levels recover. This gap will need to be filled by capital market products – directly or indirectly – continuing the recent evolution of the project finance market.

"It is evident that infrastructure bonds hold clear appeal for institutional investors, project sponsors and governments seeking to get projects funded. However, some clarity regarding the preconditions that must be in place – and the relative attractiveness of this model in markets around the world – will help all interested stakeholders in industry identify and capitalise on the opportunities," concludes Gibbs.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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