Asian Infrastructure Project Bonds:
Attracting Foreign Investors
August 2016
I.

Introduction

This initiative started in October 2015. ASIFMA put together a working group to discuss with its members what could
be done in Asia to help facilitate private sector funding of infrastructure projects via capital markets and throughproject bonds or other adequate instruments. Infrastructure has emerged as a distinct, fast growing asset class overthe past years.
Project bonds need to be approached as a separate fixed income asset class – with itsown unique characteristics
although they should not be seen as “alternative investments” as this can set the return expectations unrealisticallyand can inhibit the growth of the project bond market. Project bonds might be less liquid, more suitable for private
placements etc. and therefore need to be approached differently to Government, Corporate Bonds, Bank Sub-debt,
Covered Bonds etc. by all parties - investors, promoters, stakeholders and regulators. As an instrument to match
conservative long term investors and well developed projects – there needs to be a conducive environment for bonds(a functioning bond market of sorts) as well as a conducive environment specific to the asset class. It also needs aneco-system of credible support institutions; bond arrangers, trustees, rating agencies, independent engineers,
consultants, agents. In order to develop project bonds as a “safe”asset class, each stakeholder will have to play a keyrole to develop the market, otherwise a single default – especially at the start - could have a huge impact on the wholeasset class for investors in the future. While this paper focuses on attracting foreign investors, “creating domestic
project bond investors” is also very important as there is a need to build large pools of indigenous long term savings
through domestic insurance and pension funds as well as to make bonds attractive for foreign investors in tandem.
A developed market for project bonds in Asia would offer some significant benefits for the financing of
infrastructure projects, including:Significant additional investor liquidity
The infrastructure investment need in Asia is estimated to be $8
trillion between 2010 and 2020, which is beyond the funding
capabilities of host-governments, multi-lateral institutions and thebanks whom presently operate as project finance lenders in theregion. Project bonds would help to provide an additional source ofliquidity for projects, either by funding greenfield projects or more
likely, by providing a refinancing option for projects after
construction, thereby enabling bank lenders and/or governments /multilateral institutions to recycle their capital into new projects.

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Diversity in the funding sources available
to projects in Asia

The possibility for greater stability in thecapital structure for infrastructure projects

To date, debt funding for infrastructure projects in Asia has tended to
be funded directly by governments or by a combination of loans
advanced by multi-lateral institutions and commercial bank debt
lenders. The regulatory capital burden on banks is increasing,particularly for illiquid assets like infrastructure projects and many of
the traditional project finance lenders are retreating from non-coremarkets. Project bonds represent a valuable, diverse source ofadditional liquidity.
Project bonds also offer longer tenors than many banks can generally
provide, including tenors that may match the length of the concession
period. By minimising or avoiding the refinancing risk inherent in‘mini-perm’ structures (where debt maturities are significantly
shorter than the concession period for the relevant asset), projectbonds provide significant stability to the capital structure for the
relevant project. If provided in local currencies and fixed rates as wellbesides long term – project bonds help “derisk” projects byeliminating the currency mismatch, refinancing and interest rate risks
although this may pose challenges if a large amount of domestic longterm savings is not available.

Project bonds may take various forms, ranging from private placements through to fully public bond issuances. Even
within these categories there are a wide variety of different structures (for example, private placements may be
documented as listed issuances or under the US model form documentation for US private placements). Defining thetypes of project bond that would work in Asia is difficult as it is mainly untested ground for many countries, with little
precedent or relevant examples to act as models, but some high level features can emerge. Set out below is a highlevel summary of the features foreign investors would be looking for while investing in infrastructure project bonds.
II.

Infrastructure Project Bonds in Context

Defining a single type of infrastructure project bond that would work in Asia is difficult. One of the key starting points,
for countries, would be to make sure the government and credit capital markets are as developed as possible (seebelow ANNEX A: 7 basic requirements of fixed income markets) as deep liquid markets attract foreign investors. “Riskfree” assets such as government bonds should be open to foreign investors. Once foreign investors are comfortablewith investing into “plain vanilla” products, they would feel more comfortable to go up the risk curve and invest into
more sophisticated products such as project bonds. One cannot therefore see the development of infrastructurebonds as being removed from the development of government and corporate bond markets including a deep liquidyield curve, repo markets and futures contracts. They are inevitably linked. And therefore, should be treatedsimilarly. Making project bonds have the same withholding tax waivers as government bonds is equally important.
Today, corporate/project bonds are frequently disadvantaged against the respective risk free benchmarks for both
domestic and foreign investors – a gap that needs to be narrowed.
To attract investors, the project bond’ structure would need to fulfill expectations in terms of risk, guarantee,
framework, market, bond structure, credit enhancement and type of financing amongst other requirements. For
investors, in order to invest and understand the country, the less risky the products the more attractive it will be, atleast initially. The closer the project bond is to plain vanilla products, the more likely it will be funded. This could bebonds in USD, with a clear concession agreement, investment grade, without political or construction risk and with the2Asian Infrastructure Project Bonds Factsheet
bond taking out (at least in part) the bank/government/multi-lateral funding. Alternatively, it is also important for
countries looking to build infrastructure, to consider developing a local currency Project Bond market rather thanissuing USD bonds which can be pitched as an asset class just below the respective local currencyGovernment Bonds
to match the currency of the project cash flow. Investors need appropriate return benchmarks for infrastructure given
the distinct nature of the asset class (e.g. lower volatility of returns, higher recoveries etc.). Project bonds should not
be benchmarked against corporate bonds indexes. This currently happens due to lack of alternatives or lack ofexperience/knowledge.
An additional point from investors’ stand point (and in addition to tax that is mentioned earlier) is that investors needappropriate return benchmarks for infrastructure given the distinct nature of the asset class (e.g. lower volatility of
returns, higher recoveries etc.). Project bonds should not be benchmarked against corporate bonds indexes. This
currently happens due to lack of alternatives or lack of experience/knowledge.
It seems that in Asia, some countries are more prepared than others to develop a strong project bond market. It isquite possible that we will see some infrastructure project bonds in Indonesia or China in the coming years. However,
it is also possible that investors prefer other forms of financing such as infrastructure project loans or hybrid bonds
which might better fit that investors’ needs. Of course, not all investors are like commercial banks or sovereign wealthfunds which have that flexibility, and many such as pension funds or insurers would favour capital market instruments
such as project bonds. Therefore, project bonds have the capacity to bring whole series of new investors into themarket who could not otherwise access it. This being said, certain institutional investors such as pension funds andinsurance companies have a comparative advantage (over traditional project finance lenders) in providing longer tenor
financing as they are more perfectly matching their liabilities with their assets.
An initial way to kick start the project bond market could be to package existing loans to a project that banks are
already financing into a bond that could be issued in order to refinance those deals and take them off the bank’s ormultilateral institution’s balance sheet. This could start with an existing strong and mature project with stable revenue
stream and proper features. The capital freed up from the balance sheet could then be reinvested in other projects
and the cycle of banks/institutions taking the initial political/construction risk could restart with the capital markets
coming in later as take out financing to allow long term investors to enter such as insurance, pension funds, SWFs after
the project is stable, mature and less risky. However, this might be challenging as banks may be reluctant to give up
good projects if refinancing clauses are not embedded in the initial financing arrangements and might not want tooffer good project to the capital markets, unless forced by exposure or credit limits. For strong projects, anotherdifficulty might be the tendency for the sponsor to want to raise more funds –“2nd generation funding” from futuresurplus free cash flows. Even if some lenders are not open to this concept, this is a very important capability as it
helps sponsors recycle their capital to build more. Long term project bonds are also the only method to deliver thiscapability cost efficiently as an equity listing route is too expensive for sponsors. As emerging countries need more andmore infrastructure, this efficient bridge to future cashflows could be pivotal.
Finally, regulators should revisit the level of capital requirements around investment in infrastructure through projectbonds if they are to grow the asset class. Infrastructure is a public good and as government bonds have special
treatments, there should be consideration given to provide capital relief for well-structured project bonds that have
low risks in order to stimulate the funding of infrastructure otherwise the much of the projected $8 trillion in projects
needed may go unbuilt.

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Asian Infrastructure Project Bonds Factsheet
III.

Characteristics of bond investors and impact on project bonds in Asia

Characteristic of project bonds/ bondinvestors and bond markets
1. Bond investors have substantially thesame ‘bankability’ requirements forinfrastructure projects as bank debt
lenders

2. Bond investors may have difficultywith unmitigated construction risk

Consequence for potential project bond structures in Asia
Projects will need to meet basic standards of bankability for project
finance transactions, including:• an appropriate allocation of risks between the private and public
sector that is consistent with international best practice;• an adequate investment, legal and regulatory framework, including
strong and respected contractual and property rights, minimal
appropriation risk, predictable government policy and regulation;and• a revenue stream that can be forecasted with some degree of
accuracy and, to the extent comprised of government payments, isbacked by credit-worthy entities.
There are several factors that may make it difficult for bond investors
to offer a competitive funding option for projects with (unmitigated)
construction risk, including:• Bond investors generally prefer to invest by way of a single up-front
payment (although with private investors, it may be possible toobtain deferred drawings). Greenfield infrastructure projects may
have long construction periods. A single, upfront advance of debt
funding may result in significant negative carry for the issuer during
this construction phase. Although, for example in Malaysia,
greenfield projects, fully funded at financial close help to “derisk”
the project further. The negative carry is a trade-off for fixing thefunding cost for the life of the project – these are typicallyconsidered as part of interest during construction anyway. Whilehigher if funding is fully available upfront – interest during
construction can be pared down somewhat with well designed“permitted investments” for the disbursement account. Deferreddrawings - unless provided on fixed rates agreed upon upfront brings with it risks of significantly higher interest rates – affecting
the project’s economics and risk profile. This is particularly
pronounced for high interest rate countries like Indonesia andVietnam.
Also, if deferred drawings are contingent in some form or another –projects can get stuck during the construction phase if funds are notfully available to address construction risks. Frequently, things do not
go to plan and it is the availability of funds that actually help resolve
issues during the construction phase to reach completion.
• It is relatively common during the construction phase of major
projects for the project company to approach its financiers toconsent to various matters, for example, variations to the proposed
design of the project. Bond investors may not be suited toresponding to these requests in a timely manner.

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3. Possible mitigation of construction
risk for bond investors

4. Bonds investors need to take into
account the FX risk

• As noted below, most bond investors may only have a mandate toinvest in debt instruments with an international ‘investment grade’rating. Due to the relatively high risks facing a project during theconstruction phase, it is rare that a project in the construction phasecan support an investment grade rating (although over the life of
the project, it may in fact be investment grade). There may be
exceptions to this general rule, for example if the construction
period is very short (e.g. solar farms) and the builder is a large andreputable company, well rated, reliable and with good credit
support.
Many of the practical issues associated with the use of bonds in theconstruction phase of projects can be managed. Various possible
approaches have been adopted in Europe and other markets including:• public sector credit enhancement models, such as the PBCE which
involves the EIB providing subordinated debt or letters of credit toassist liquidity in the construction phase. Procuring authorities ormulti-laterals may be able to provide similar support for Asian
infrastructure projects;• private sector credit enhancement models, such as the PEBBLE
structure, which involves bank debt lenders providing asubordinated debt facility but taking the primary role in responding
to consent and waiver requests during the construction phase; and• the use of a project agent which is an independent entity taking the
primary role in facilitating responses from the creditors to consent
and waiver requests, particularly during the construction phase.
• as a practical Asian example, MDBs (e.g. CGIF and IFC) can
guarantee construction phase risks in project bonds. For example,
CGIF is developing a Construction Period Guarantee Facility whichallows the guarantors to be the “controlling creditor” to manage thevarious matters of the construction phase of the project. It is likely
to be a full wrap as it appears that a partial credit enhancement
product can only work within a consistent rating framework, where
investors are already familiar with project bonds and their ratings.
Many investors have not yet seen a project bond and will not beable to appreciate how how much partial credit enhancements will
be required to improve the rating.
• these practical issues do not apply to the same extent during theoperating phase of an infrastructure asset and accordingly it may bethat initially project bonds will be best suited to refinancing
brownfield assets in Asia (that is, assets where there is no remaining
political or construction risk).
• Construction risk can also be mitigated by Performance Bonds that
the EPC contractor engages
FX risk can have a big impact on those investments. The investor would
either have to be comfortable with the currency risk or hedge that
exposure through an FX product like a forward or option but the cost of5

Asian Infrastructure Project Bonds Factsheet

5. Bond investors may only have amandate to invest in debt securities
with an investment grade rating

hedging would be very prohibitive as such markets are very illiquid inmost countries in Asia. Alternatively, the issuer can issue in USD andswap the proceeds back into the local currency but the expensive
hedging costs would then have to be borne by the issuer and would besignificant. It is possible that the government could take the first loss
on that exposure or guarantee an FX rate through the concessionagreement or provide availability style payments partly in hardcurrencies to allow for foreign currency financing for local revenue
projects when that is needed. Mark to Market adjustments should also
be included in the concession agreement.
Obviously, the ultimate solution for FX risk is developing a a large
domestic investor base and domestic debt capital markets.
Infrastructure assets are among the most difficult to hedge even whenswap markets function well due to cash-flow based project financelending and common need for waivers during the construction phase.
In addition to the comments above, the following structural aspects
may also be important:• from a credit perspective, it will be important to ensure that projectcompanies have recourse to the full faith and credit of the sovereign
for any amounts payable under the concession agreement,
particularly on termination and without the risk of significant delays
associated with appropriations; and• ratings for project bonds are likely to correlate to the credit rating
for the relevant sovereign, with a higher yield to reflect the
expected difference in credit rating between the sovereign and therelevant project. A high sovereign credit rating may assist to
stimulate the project bond market for a particular country.
• the international rating framework does not work well for Asia’s
project bonds. When we consider the region’s low sovereign ratings(both foreign and local currency ratings), projects with or without
construction risks will struggle to be investment grade. Also one of
the main reasons for private sector participation in building
infrastructure is to provide relief to a government’s fiscal capacity soguaranteeing bonds or FX risks related thereunder push in the
opposite direction although project bonds still would provide
significant relief.
As there is a negative correlation with the need for infrastructure andthe sovereign ratings (higher rated countries would have sufficient
infrastructure or fiscal ability to build them vs lower rated countries),
developing an international scale project bond framework for Asia now
may be futile. Consider Indonesia and Vietnam as examples – howlikely are the projects there going to be investment grade rated,notwithstanding for example, Indonesia’s ample fiscal capacity)• also, the default rates for project finance are lower than corporate
bonds. Sovereign default rates are also lower despite the notionthat “all ratings are equal”.

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6. Project bonds may be subject toregulations relating to disclosure /the offer of securities

7. Bond investors favour long term,
stable cash-flows. Bond tenor may bevery long-term by comparison tobank debt.

• This dilemma is core to the issue of how best to meaningfullymeasure the risk of a project bond. The rating agencies (bothdomestic and international) have a role to try to offer a moreworkable solution.
• developing this “safe” asset class and drawing interest fromdomestic investors (for some countries – there is a need to create
investors) and foreign investors are the main challenges ahead.
• the competitiveness of the capital is also very important forinvestors and will greatly depend on the rating of the bond.
Securities laws in the jurisdiction in which the project is located should
not unduly prevent the transmission of important financial information
to potential investors (eg the provision of financial models to potential
investors). Project bonds, however, cannot be pitched like a normal
corporate bond with a standard offering circular and the normal
subscription period – it needs a different approach – investors need to
do their own due diligence.
In many nascent project bonds markets, sponsors face actual or
perceived execution risk in raising their project financing throughcapital markets. Mitigants to this are firm underwriting by thearrangers, back-stop loan facilities etc.
Long tenor debt offers significant benefits in terms of the stability of
the capital structure for the project. Long term investors may have agreater focus on:• Revenue risk: For projects where the private sector is bearing
demand / patronage risk (eg toll road projects), investors may
require government guarantees of a proportion of the revenue
stream during the operating phase. It may be preferable tostructure such projects (at least in part) on an ‘availability payment’model, whereby regular payment are made by procuring authorities
to the project company for performance (assessed against KPIs
specified in the concession agreement), irrespective of demand forthe project;• Inflation risk: Over the life of a 30 year concession, inflation in
operating costs is a significant risk. Procuring authorities can assist
by indexing a portion of any availability payments payable to theproject company (or permitting increases in user-charges tocompensate for inflation);• Hedging exposure: The potential mark to market exposure on abasis or currency swap over the term of a project bond can besignificant – as noted above, it will be important that either thetermination payments payable under concession agreements
provide appropriate compensation for the costs of breaking thesearrangements and that the relevant procuring authority has
sufficient creditworthiness (or credit support) to make thesepayment obligations enforceable and bankable; or the investors areable to bear the risk or pay to hedge it appropriately. Hedging a7

Asian Infrastructure Project Bonds Factsheet

8. The most liquid bond markets are in
the US, UK and Europe while mostbankable infrastructure projects arein Asia.

9. Project bonds should be‘securitizable’

10.Project bonds should be issued in theadequate currency

mismatch is the “elephant in the room”. If there is a mismatch – itneeds to be considered if it is the project companies that hedge orthe investors that hedge. Developing hedging capacities both ways
are needed but achieving the long term hedging capacity required isa huge challenge.
Bond investors in these markets are likely to look to invest primarily in
USD, but also sterling or Euros, whereas the revenues for Asian
infrastructure projects are likely to be denominated in the local
currency for the relevant project. Local currency investors would notneed hedging, but offshore investors would require currency hedging
as they will be swapping the proceeds from the bond issuance backinto the local currency. Hedging may be expensive, particularly inmarkets with low liquidity.
Procuring authorities may assist by:• denominating payments under concession agreements inalternative currencies (eg where the procuring authority is paying
availability payments, a proportion of them could be paid in thecurrency of the bond issuance);• offering direct or indirect support to the private sector in
implementing hedging, eg by entering into hedge transactions prior
to financial close on behalf of the project company, to enable that
hedging to be implemented over a period of time rather than all atonce;• accepting some or all of the currency risk in a project, by increasing
payments under the concession agreement to compensate theproject company for currency movements or permitting an increasein user-charges to offset significant changes in currency; and• ensuring that any costs of breaking hedging prematurely areincluded in termination payments payable by the procuringauthority under concession agreements.
• passing the FX risks to poor and weak countries may just make thempoorer and weaker. Would the users/government be able to afford
say a road built on LCY costs but to be repaid in USD? This would be
the consequence of a USD/EUR project bond market in Asia.
Infrastructure project bonds should be designed in order to bepotentially securitized in the future. This would give investors more
confidence in investing and allow them, in the future, to combine
project bonds with other instruments through securitization, to adapt
their investment strategy and give investors more flexibility.
Finally, this is the major question mark as hedging costs are expensive
in Asia. For markets where there is a sufficient or at least a significant
domestic class of investor willing to fund infrastructure projects, theproject bonds could and likely should be issued in local currency.
Foreign investors will then have to take on the FX risk to invest in local
currency market and/or would likely be willing to take part of theequity tranche of the project in the local currency. However, for8

Asian Infrastructure Project Bonds Factsheet
markets where there is not sufficient local demand to invest in bonds,
it would make sense to issue the bond in foreign currency (such as
USD) otherwise its unlikely to attract the foreign capital needed. Having
different tranches, in local currency and USD to attract both local
domestic investors and foreign investors doesn’t seem to be a viable
solution as it will spread the risk for investors.
Ultimately, the best long term solution is to develop the domestic
institutional investor base to sufficient size and the domestic capital
markets in order to support project bonds

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Asian Infrastructure Project Bonds Factsheet

ANNEX A: Seven Basic Requirements for Liquid Government Bond Secondary markets
Liquid Government Bond Secondary Markets:
Seven Basic Requirements
1. Disciplined issuance and reissuance programs to support large benchmark issues
2. Liquid “classic” term repo markets that allow easy short selling of government bonds
3. Active, liquid government bond futures markets
4. A broad range of liquid OTC derivatives contracts and exchange-traded derivatives contracts
5. High-quality, efficient and cost-effective electronic price discovery, trading, clearing and settlement
platforms
6. A broad, active domestic and foreign investor base (e.g., pension funds)
7. Market friendly and sound regulatory, legal, accounting and tax regimes (ex: no withholding taxes and notransaction taxes)

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