metadata: authors: 0: author: Inderst,Georg
1: author: Stewart,Fiona Elizabeth
count: World
docna: 0: docna: Institutional investment in infrastructure
            in developing countries : introduction to potential models
docty: Policy Research Working Paper
subtopic: Social Funds and Pensions,Capital Markets and Capital Flows,Non Bank Financial Institutions,Capital Flows,Financial Sector Policy
teratopic: Finance and Financial Sector Development,Private Sector Development
abstracts: cdata!: The link between infrastructure and
            economic growth is widely acknowledged -- as is the
            infrastructure gap, which can act as a break on growth in
            emerging markets and developing economies (EMDEs). Since the
            global economic and financial crisis, the challenges of
            raising financing for infrastructure projects in EMDEs are
            also well known. The challenges come from stretched
            government finances and restrictions on global bank lending.
            Hence much attention has been focused on the potential for
            institutional investors as a growing potential source of
            financing. This paper argues that infrastructure projects
            can potentially deliver long-term returns, but investments,
            particularly in EMDEs need to be carefully structured to
            meet the needs of both sides. The paper first considers the
            existing types of institutional investors and their
            potential for filling the infrastructure financing gap. The
            challenges of adjusting asset allocations, particularly
            toward EMDE infrastructure, are discussed and examples of
            projects where institutional investors have been involved
            are given. Finally, the paper considers a range of models
            for the involvement of institutional investors in EMDEs and
            makes initial proposals for how to determine which model
            fits best in a particular country context.
repnme: repnme: Institutional investment in infrastructure
            in developing countries : introduction to potential models
display_title: Institutional investment in
            infrastructure in developing countries : introduction to
            potential models
listing_relative_url: /research/2014/02/18983758/institutional-investment-infrastructure-developing-countries-introduction-potential-models
topicv3: Pension Funds m1326066 611,Non-Bank Financial Institutions m1326281 336,Capital Markets m1326967 332,Infrastructure Funds m1327219 342,Financial Sector Development m1327681 1920
publishtoextweb_dt: 2012-02-01T00:00:00Z
historic_topic: Finance and Financial Sector Development,Private Sector Development
no_of_pages: 21
author_keys: 0: author_key: 1264158
1: author_key: 1237818
model_extractions: WPS6780 Policy Research Working Paper 6780 Institutional Investment in Infrastructure in Developing Countries Introduction to Potential Models _Georg Inderst Fiona Stewart_ The World Bank Financial and Private Sector Development Global Capital Markets and Non-Bank Financial Institutions February 2014
Policy Research Working Paper 6780

# **Abstract**

The link between infrastructure and economic growth is widely acknowledged—as is the infrastructure gap, which can act as a break on growth in emerging markets and developing economies (EMDEs). Since the global economic and financial crisis, the challenges of raising financing for infrastructure projects in EMDEs are also well known. The challenges come from stretched government finances and restrictions on global bank lending. Hence much attention has been focused on the potential for institutional investors as a growing potential source of financing. This paper argues that infrastructure projects can potentially deliver long-term returns, but investments, particularly in EMDEs need to be carefully structured to meet the needs of both sides. The paper first considers the existing types of institutional investors and their potential for filling the infrastructure financing gap. The challenges of adjusting asset allocations, particularly toward EMDE infrastructure, are discussed and examples of projects where institutional investors have been involved are given. Finally, the paper considers a range of models for the involvement of institutional investors in EMDEs and makes initial proposals for how to determine which model fits best in a particular country context.

This paper is a product of the Global Capital Markets and Non-Bank Financial Institutions, Financial and Private Sector Development. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http:// econ.worldbank.org. The author may be contacted at fstewart1@worldbank.org.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
# **Institutional Investment in Infrastructure in Developing Countries: Introduction to Potential Models**

# **Georg Inderst, Fiona Stewart***

### **<mark>JEL Classification:</mark>**

- <mark>G15: Financial Economics / General Financial Markets / International Financial Markets</mark>

- <mark>G18: Financial Economics / General Financial Markets / Government Policy and Regulation</mark>

- <mark>G23: Financial Economics / Financial Institutions and Services / Non-bank Financial Institutions; Financial Instruments; Institutional Investors</mark>

- <mark>G28: Financial Economics / Financial Institutions and Services / Government Policy and Regulation</mark>

- <mark>H54: Public Economics / National Government Expenditures and Related Policies / Infrastructures; Other Public Investment and Capital Stock</mark>

- <mark>J26: Labor and Demographic Economics / Demand and Supply of Labor / Retirement; Retirement Policies</mark>

## **_Key words: institutional investors, pension funds, insurance companies, social security funds, infrastructure, emerging-markets and developing economies_**

## **_Sector Board: Financial Sector (FSE)_**

## ________________________

*This paper was written by Georg Inderst, Expert Consultant, and Fiona Stewart, Senior Financial Sector Specialist, Global Capital Markets and Non-Bank Financial Institutions Group, Financial and Private Sector Development Vice Presidency at the World Bank. This report was prepared for the G20 Investment and Infrastructure Working Group, January 2014, with the kind support of Public-Private Infrastructure Advisory Facility (PPIAF).
# **I. Background**

1. The link between infrastructure and economic growth is well acknowledged<sup>1</sup> – as is the infrastructure gap which can act as a break on growth in emerging markets and developing economies (EMDEs).<sup>2</sup>

2. Equally the challenges of raising financing for infrastructure projects in EMDEs are also well known. These have become particularly acute since the global financial and economic crisis as government finances have become more stretched and multilateral development banks (MDBs) are reaching their capacity to step in.<sup>3</sup> At the same time private sector financing via bank lending (historically the main source of private sector infrastructure financing) is being restricted by market weakness (particularly in syndicated lending in Europe) and tighter regulation.<sup>4</sup> Alongside, pervasive economic uncertainty has led to a shortening of available maturities. Furthermore, concerns have emerged that the flow of capital to emerging markets will slow or even reverse as interest rates begin to rise again in advanced economies in response to the tapering off of unconventional monetary policy.<sup>5</sup> 3. Sources, including international organizations, academic and industry research have argued that institutional investors – both international and EMDE domestic institutional investors – have the potential to become a significant source of long-term capital for infrastructure investment in developing economies. The match is – in theory at least – a good one; infrastructure can help institutional investors deal with the current low interest rate environment and provide them with a predictable (inflation adjusted) cash flow and a low correlation to existing investment returns.

4. This note argues that infrastructure projects can potentially deliver long-term returns, but investments, particularly in EMDEs need to be carefully structured to meet the needs of both sides. The note first considers the existing types of institutional investors and their potential for filling the infrastructure financing gap. The challenges of adjusting their asset allocations, particularly towards EMDE infrastructure, are discussed and examples of projects where institutional investors have been involved are given. The final section considers a range of models for institutional investor involvement in EMDEs, making initial proposals for how to determine which model fits best in a particular country context.

# **II. Types of Institutional Investors**

5. Actual financial allocations of advanced and emerging market economies’ institutional investors in infrastructure remain quite modest, with most such investments concentrated in advanced economies. Institutional investors in OECD-member countries (including pension funds, insurance companies, endowments and sovereign wealth funds, with over USD $79 trillion in assets under management (AUM)),<sup>6</sup> have only around 1 percent of their portfolio exposure in infrastructure. Most of this is

> 1 For example see (Battacharya et al 2012).

> 2 The figure of an USD $1 trillion a year is often quoted as the order of magnitude of EMDEs’ infrastructure needs.

> 3 The public sector has traditionally been central to the ownership, financing and delivery of infrastructure services in emerging markets.  Public funding of infrastructure – through budget allotments and retained earnings of state owned enterprises - in developing economies accounts for about 70% of total infrastructure.  Private financing accounts for approximately 20%, while the rest (10%) is financed by multilateral and bilateral development agencies (Delmon 2011). For a more extensive discussion of developments since the global financial crisis that have impacted the availability of long-term finance, see (G20 2013)

> 4 Including new Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) frameworks, which are part of the evolving Basel III regulations.

> 5(G20 2013)

> 6 (OECD 2012)

2
concentrated in equity investments in advanced economies by a few leading institutions in a few countries (notably Australia and Canada). Relatively little of this is in ‘greenfield’ investments. However, some international institutional investors have started to seek out infrastructure investment opportunities in EMDEs, although largely in upper middle income economies.<sup>7</sup> 6. Another potentially important and growing source of long-term capital is the assets of EMDE institutional investors in their domestic economies. Arguments in favor of greater domestic investment in infrastructure by EMDE institutional investors include the contentions that such investment can reduce foreign exchange exposure and risks, are more stable and contribute to economic growth and development not only via infrastructure improvements, but by increasing savings and developing the local financial sector and capital markets. That said – the governance arrangements around such domestic investment needs to be carefully structured to ensure that it is made on a financial basis and that political interference and other conflicts of interest are avoided.<sup>8</sup> 7. These domestic institutional investors come in many forms and the importance of different groups varies by country. Many EMDEs are currently reforming and developing their pension systems to introduce funded pillars. Establishment of mandatory funded pension schemes can often enable rapid growth of assets under management to a large percentage of GDP. Experience of infrastructure investing by pension funds is most widespread in Latin America<sup>9</sup> but there are also some early examples in Asia and Africa. At present, the bulk of pension assets in EMDEs consist of social security (centrally run by government) and/or public sector pension funds.

8. The assets of insurance systems can also accumulate to a significant percentage of GDP in EMDEs. Examples of domestic insurer infrastructure investments can be found, for example, in investments by South African insurers in the Pan African Infrastructure Development Fund or the South African Infrastructure Fund (Chukun 2010). In their survey of Africa, Irving and Manroth (2009) also found national insurance assets invested in telecoms equity in Cape Verde and telecom bonds in Mozambique. There are other countries with similar investments in domestic infrastructure stocks and bonds.

9. Sovereign Wealth Funds (SWFs), based either in developed economies or EMDEs, are another potentially major source of infrastructure financing. New funds are being set up in natural resource rich countries such as Angola, Nigeria, Gabon, Mauritanian, Chad, Equatorial Guinea and Ghana – often with the specific intention of investing in infrastructure.<sup>10</sup> Chinese funds have also been involved in a large number of ‘infrastructure for resources’ deals brokered in Africa.<sup>11</sup> 10. Table 1 provides an overview of the current institutional investor assets under management (AUM) in EMDEs. Estimates of their current allocation to EMDE infrastructure are given and some idea of the potential size this could increase to. More work needs to be done in this area, but some sense of how

> 7 For further details see OECD’s annual survey of pension funds (OECD 2013).

> 8 These considerations are behind the on-going debates around sovereign wealth funds (SWFs). There are different views as to whether SWFs should invest domestically or abroad, and if they do invest domestically, whether this should be undertaken via the budget process. These are important issues but beyond the scope of this current paper.

> 9See (BBVA 2010 +2011) and World Bank (2012).

> 10 Infrastructure deals have so far been limited to the major funds. For example, the Libyan Investment Authority was previously active in African projects, including frontier markets such as Somalia or Sudan. Given the commercial risk of such investments, they would appear to have been largely politically motivated. Lin and Doemeland (2012) note that the Qatar Investment Authority plans to invest US$400 million in infrastructure in South Africa.  These funds differ from traditional SWFs that attempt to serve a domestic development mandate in addition to a financial mandate and therefore invest in domestic infrastructure. 11 Lin and Doemeland (2012) cite the examples of the China-Africa Development Fund, an equity fund that invests in Chinese enterprises with operations in Africa, which reportedly invested nearly US$540 million in 27 projects in Africa that were expected to lead to total investments of US$3.6 billion in 2010.  See also Orr and Kennedy, (2008).

3
much of the EMDE infrastructure gap institutional investors might realistically be able to fill can be gleaned. Expecting flows of around USD $1 trillion building over several years would not be unreasonable. Though not sufficient to solve the problem alone, this could certainly prove an important source of new capital to help fill in the EMDE infrastructure financing gap.

**Table 1: Current and Potential Allocation of EM Institutional Investors to EM Infrastructure**

|**Institutional**<br>**Investors**|**AUM USD $**|**Current**<br>**Investment in**<br>**EMDE**<br>**Infrastructure**|**Potential**<br>**Investment in**<br>**EMDE**<br>**Infrastructure**|**Comments**|
|---|---|---|---|---|
|**OECD**<br>**Institutional**<br>**Investors**|79 trillion +|<1% = total<br>leading investors<br>c10%<br>most in domestic<br>markets|1% assets = $750<br>billion|WEF (2011) breakdown of<br>institutional investors AUM to<br>truly long-term capital = $6.5<br>trillion<br>Around 1% of this implies c$50<br>billion target<sup>12</sup>|
|**Emerging**<br>**Market**<br>**Institutional**<br>**Investors**|4.5 trillion<br>NB growth<br>potential – e.g.<br>EM pension<br>funds currently<br>$2.5 trillion<br>AUM estimated<br>to rise to $17.4<br>trillion by2050|Even more limited<br>than leading<br>OECD investors<br>Chilean pension<br>funds 1.5%<br>|1% assets = c$50<br>billion|This target could be much higher<br>as many EM institutions can only<br>invest in domestic markets|
|**Sovereign**<br>**Wealth Funds**|4 trillion|0-5%<sup>~~13~~</sup>|c5% assets =<br>c%250 billion|Many of new EM SWF being set<br>up to specifically invest in<br>domestic infrastructure|
|**EM pension**<br>**reserve and**<br>**social security**<br>**funds**|1 trillion|Limited – ad hoc<br>examples (up to<br>10%)|10% assets =<br>c$100 billion|High target as these funds are<br>often the largest single source of<br>capital in a developing country|

Source: authors (from references)

> 12 (TUAC 2012) contains an interesting exercise in estimating the potential flows from institutional investors to finance climate change related investments – though the numbers could equally be applied to emerging market infrastructure.  The AUM of large OECD DB pension funds and pension reserve funds is estimated at $15 trillion. Total portfolio growth is estimated at 2.5% year nominal 2013-2050. AUM. An allocation to infrastructure funds is assumed at 0.2% year 2013-2025 and 0.1% 2025-2050 – giving a total exposure remains below 5% Allocation to infrastructure bonds is estimated at 0.75% initially, falling gradually to 0.1% year, to give a total exposure of around 10%. This gives flows in the order of $150bn tapering off in subsequent years. Total flows amount to around $2 trillion out to 2030 then add a further USD$3-4 trillion.

> 1356 percent of SWFs invest in infrastructure, according to Preqin (an infrastructure database) with investment volumes of about US$55bn between 2005-2012 implying asset allocations around 1 percent (TheCityUK 2013). Between 2007 and mid-2012, about US$ 26bn were invested by SWFs in foreign infrastructure assets, with Europe being by far the most popular destination (US$ 16bn). The picture is mixed in terms of sectors and preferred vehicles (Barbary 2013).

4
|Issueswith<br>governmentsupport|e<br>Lackofpoliticalcommitmentoverthelong-term<br>=e<br>Lackofinfrastructureproject pipeline|
|---|---|
|for infrastructure<br>projects|e<br>Fragmentationofthemarketamongdifferent<br>levelsofgovernment<br>e<br>Regulatoryinstability<br>e<br>Highbiddingcosts|
|Lack of investor<br>Capabillly|e Lack of expertise in the infrastructure<br>sector<br>e<br>Problemofscale<br>ofpensionTunds|
inflation-adjusted income streams. This means that they will be primarily interested in mature, operating assets with proven, predictable cash flow. While some of the larger, more sophisticated institutional investors are able and willing to invest at the riskier end of the spectrum (i.e. greenfield projects, untested technologies, etc.), it is unlikely that this will constitute more than a small percentage of their portfolios.

**Figure 1: Types of Infrastructure Investment**

<!-- Start of picture text --> Infrastructure Investment<br>Economic Infrastructure – e.g. transport, Social Infrastructure - e.g.. schools,<br>hospitals, defense buildings, prisons,<br>utilities, communication, renewable energy stadiums<br>Greenfield Brownfield Investments Secondary Stage<br>Investments • Typically medium risk Investments<br>• Construction - e.g. operating toll • Post construction<br>• Design, build, road with need for • Low risk, low return<br>significant capital<br>operating risk investment for • Similar to long term<br>• Typically higher risk improvement/ bond with coupon<br>expansion • Well established<br>cash flows – e.g.<br>operating toll roads<br><!-- End of picture text --> Source: World Bank 15. However, the main source of demand from EMDEs tends to be for greenfield investment, often largescale in nature. From an economic and social development perspective, mobilizing financing for greenfield investments holds the greatest potential. This is different from the operational phase investments in already up and running projects delivering steady cash flows which institutional investors have mostly been making to date.

16. From a growth and development standpoint, facilitating institutional investment in mature, low risk infrastructure is not a public-policy objective in and of itself, unless the resources freed up can be expected to be rolled over into new projects. Hence commercial banks will continue to play an important role in infrastructure financing, particularly for greenfield projects, which require strong credit underwriting and supervision skills that many international institutional investors do not have. With European banks continuing to adapt to fallout from the global financial crisis and the implementation of tighter regulatory standards, they have moved away from infrastructure finance in EMDEs. The challenge is therefore to explore the potential for local commercial banks in emerging markets to become more involved in such deals. How to encourage debt-to-bond rollovers between banks (and other sources such as private equity infrastructure funds) and institutional investors - which have so far been disappointing - is a topic worthy of further attention.

6
**_The Role of the Public Sector in Attracting Private Sector Finance to Infrastructure_**

17. Overcoming many of the above challenges to private (including institutional) investment in EMDE projects may require the development of new and additional financing mechanisms, using public resources complemented by legislative and institutional provisions supportive of private financing of infrastructure. This role is becoming more important since the demise of the monoline insurance companies.<sup>16</sup> Multilateral development banks can play a particularly important role in mobilizing private sector sources of financing not only through their risk-sharing instruments, but also by bringing advisory and technical standards and well understood standards and safeguards to projects, thereby raising confidence and reducing the investment risk premium in EMDE infrastructure projects for private sector investors, including institutional investors—(See Box 1).

18. The structuring of infrastructure financing investment vehicles is particularly important. Institutional investors are not looking for risk-free investments but they are only willing to take on certain types of and amounts of risk. The key to the successful involvement of institutional investors in infrastructure projects in EMDEs is isolating and packaging risks so that the players which can best take them on are able to. Well-designed infrastructure financing vehicles can help achieve this goal.

# **Box 1: Role of MDBs in Supporting Infrastructure Investment in Developing Economies**

Multilateral Development Banks (MDBs) can attract additional financing from the private sector in a number of ways:

**_Financial additionality:_** MDBs contribute their own funding, building confidence in projects and markets and thereby attracting commercial funding. This can be done by bringing financing partners into specific deals (though syndications or cofinancing), sometimes improving partners’ creditor status. Investment project loans with longer maturities and grace periods than those commercially available, as well as equity investments and risk guarantees, can all be used. The latter are particularly important for attracting private capital into high-risk, inexperienced markets, and protecting financial viable projects from noncommercial risks. For example, the Multilateral Investment Guarantee Agency (MIGA), which is part of the World Bank Group, provides insurance against political risks such as expropriation or civil disturbance, whilst partial risk guarantees cover government non-payments.  Foreign exchange risk mitigation is another important tool. Partial credit guarantees, which can reduce the spread on project bonds or infrastructure finance funds, can also play an important role.

**_Design additionality:_** MDBs also play an important role in contributing technical expertise to projects by ensuring adherence to accepted standards in project design. For example, investments by the International Finance Corporation (IFC – part of the World Bank Group) adhere to environmental and social sustainability, governance, integrity, due diligence and funding terms consistent with best market practice

> 16 Monolines are insurance companies providing a particular type of insurance, usually bond insurance. Bonds insured by these companies are sometimes said to be ‘wrapped’ by the insurer as they gained credit enhancement from the strong credit ratings of the insurance company. In addition to providing such credit enhancement, the monolines also provided an important project analysis and screening role. These institutions were victims of the sub-prime fall out and the financial crisis. Indeed the World Bank is one of the last AAA providers of such products in the market – though does not provide coverage for construction phase risk which institutional investors often seek. Some interest has been expressed by MDBs and private sector players in the establishment of such EM-dedicated as well as sub-AAA monolines.

7
**_Policy additionality:_** MDBs can assist the host nation to improve the policy and regulatory environment for investment, which are often the biggest investment barriers in emerging markets, via advisory services and technical assistance provided to borrowers.

**_Demonstration additionality:_** MDBs can demonstrate feasibility by backing projects that show the possibilities for successful investment in untested frontier markets.

**_Selection additionality_** : MDBs can support government entities in better project selection and preparation, thereby helping to prioritize projects with greater development, growth or climate impact. –.

Other incidental roles MDBs can play include advice on policy frameworks, advisory programs on building domestic capital markets and cross-border investment promotion.

_Source: (Chelsky, Morel, Kabir 2013) and authors_

# **IV. Examples of Institutional Investing in EMDE Infrastructure**

19. Private finance for infrastructure in advanced economies can come in different forms and vehicles. Figure 2 gives an overview of the main financing instruments (equity and debt), investment vehicles (publicly listed and private/unlisted), as well as of the various direct investment routes such as infrastructure stocks or private participation, corporate bonds or project bonds, direct loans, etc. It also gives examples of the indirect route via fund structures.<sup>17</sup> 20. Infrastructure ‘investment’ is a very broad term. In this paper, the main focus is on unlisted investments (i.e. investments in infrastructure debt or directly in project equity). Raising this form of capital (rather than by investing through the shares of listed construction, utility, and telecom companies) is the key to plugging the infrastructure financing gap.<sup>18</sup> In addition, unlisted investments can offer low correlations to other asset classes and illiquidity premiums with long-term pay-offs, which make them attractive to institutional investors.

> 17 It should be noted that this is a stylized representation. Capital substitutes that some investors are increasing willing to provide (such as insurance products, guarantees, credit enhancement etc.) are an important part of the picture, which need to be considered in addition to and combined with these basic instruments.

> 18 Investments in _listed equities_ of infrastructure companies are quite common not only in advanced but also in EMDEs. They include shares of large quoted utility and telecom companies that may have been (partly or fully) privatized, e.g. in Chile. Such stocks are typically a typical part of the mainstream equities allocation rather than a specific ‘infrastructure asset class’ (Inderst 2010, OECD 2013). They often also constitute a large part of pension funds’ investments in infrastructure overall, e.g. in Latin America (BBVA 2010, 2011). Similarly to listed equities, _corporate bond_ investments are often popular with local investors in many EMDEs. They include bonds of large quoted utility and telecom companies that may have been (partly or fully) privatized. They can be rated and traded, and are normally allowed in institutional investor portfolios. Such bonds are typically a part of the mainstream bond allocation. They often also constitute a large part of pension funds’ investments in infrastructure overall, e.g. in Latin America or Asian countries with relatively well-developed capital markets, e.g. Malaysia, Thailand and Korea. They are used by pension funds in Kenya and other African countries.

8
<!-- Start of picture text --> =<br>a io<br>—<br>J (=) ten<br><!-- End of picture text -->
25. Other funds are in some form sponsored by _governments or national agencies_ (such as in India), foreign countries (e.g. the EAIF) or _multilateral development banks_ such as the IFC, ADB (e.g. ASEAN fund, ALAC fund). Often, there is a combined public and private involvement in such funds.

26. There are other interesting examples of co-investments. One of them is a _fund jointly owned_ by multiple pension funds, i.e. the South African PAIDF. Mexico and Peru found their own way of engaging pension funds in infrastructure through dedicated _trust funds_ and _structured products_ .

27. Many emerging markets are too small to develop markets for infrastructure assets and products of any substantial size. Therefore, investing in a range of _regional infrastructure funds_ holds promise, as undertaken for example by Ghana’s social security fund.

28. Current experience seems to show that some financing structures are more suited to institutional investors and to EMDE conditions than others due to the higher and greater range of risks often inherent in these projects, low levels of capital market development, and the lack of experienced local institutional investors. Lower risk instruments are generally preferred, with bonds being used more often than equity, and with risks mitigated by exposure to a range of projects through a diversified infrastructure fund.

- **V. Models for Infrastructure Investing in EMDEs**

29. An interesting question arising from this survey is whether one particular mode of investing is better suited to the particular circumstances in an EMDE context than others. Some countries have a strong institutional investor base at home while others perhaps wish to attract regional or international investors. Other countries may have a relatively well-developed capital market while others have not. Some states are willing to privatize infrastructure assets while others prefer alternative ways of raising finance, e.g. in PPPs. Of course, the specific situation of every country and region depends on a whole range of economic, financial, political, social, and other factors.

30. The stylized table below shows how country context, level of market development and nature of the institutional investor base determine what sort of investment vehicle is best suited to a particular country. For example, in a country or region with relatively developed capital markets, and a number of institutional investors, such as pension funds, it may be possible to issue project bonds or to structure other securitized instruments which can meet these institutions’ needs (i.e. for investment grade instruments). This has proven to be the case in Latin American countries. However, in a situation where the sovereign has lower credit ratings, where it is more difficult to use credit enhancement to create investment grade products, and with a smaller number of more centralized investors, a fund structure may be more appropriate. This more centralized route has been popular in Asia, where the large social security funds are partnering with governments and MDBs to establish infrastructure funds or facilities, rather than opting for capital market solutions. In regions with very limited capital markets and investors, governments and MDB’s have had to be the issuers or backers of instruments to provide the necessary investment quality both in terms of credit levels and providing other investors with the confidence to join them.

10
**Table 3: Environment for Institutional Infrastructure Investment**

||**INFRA**<br>**BONDS?**|**LEAD**<br>**INVESTOR?**|**MDB?**|
|---|---|---|---|
||**_Country A_**|**_Country B_**|**_Country C_**|
|**_Sovereign credit rating_**|**_At / close to_**<br>**_investment grade_**|**_Below investment_**<br>**_grade_**|**_No rating_**|
|**_Size pension fund AUM (%GDP)_**|**_> 10%_**|**_1-5%_**|**_Minimal_**|
|**_No. pension funds_**|**_10s or 100s_**|**_A few main funds_**|**_Dominant social_**<br>**_security fund_**|
|**_Quality of pension system_**<br>**_e.g. Mercer Global Pensions Index_**|**_D_**|**_C_**|**_E_**|
|**_Insurance penetration % GDP_**|**_High_**|**_Medium_**|**_Minimal_**|
|**_SWF_**|**_Yes_**|**_Yes_**|**_No_**|
|**_Development Fund or Bank_**|**_Yes_**|**_No_**|**_Yes_**|
|**_Level financial sector_**<br>**_- bank assets % GDP_**<br>**_- private credit % GDP_**|**_Medium_**|**_Low_**|**_Fledgling_**|
|**_Level capital market_**<br>**_-Stock market cap % GDP_**|**_High_**|**_Medium_**|**_Low_**|
|**_Business conditions_**<br>**_e.g. IFC Doing Business ranking_**|**_Good_**|**_Average_**|**_Difficult_**|
|**_Infrastructure investment conditions_**<br>**_e.g. EC Harris Global Infrastructure_**<br>**_Investment Index_**<br>**_e.g. Nabarro Infrastructure Index_**|**_Good_**|**_Average_**|**_Poor_**|

31. Figure 3 and Table 4 illustrate some of the factors (e.g., legal/ regulatory reform, capacity building, project preparation and credit enhancement / structuring of investment vehicles) that support different financing models. Such a framework can help countries assess their situation and identify the best combination of policies to help mobilize institutional investment.

11
<!-- Start of picture text --> Are there Are there Are there Are there Is the bank Is there a<br>institutional substantial infrastructure working capital intermediation favourable<br>investors with investment assets to invest markets? working ? macro-<br>investment limits / in? (equities / eYes environment<br>funds? (Pension constraints? *Yes: private / bonds/ *No: reform banks (political, law,<br>/ social security BNO privatized derivatives) *No: development institutions)<br>funds, insurers, eYes: Review *Yes: public- private oy banks oi<br>SWFs) Quantitative limits JERE «No: Develop / eNo-muttilateral «No: reform /<br>*Yes asset cl. / eNo: Develop / reform cal ital CRE DUET im| prove<br> (type, size) CGS review P agencies prs a:<br>No: Create or Unseen infrastructure policy Pe political stability<br>reform funded vehicles erule of law<br>pension / social eliquidity eregulatory certainty<br>security system einvestor regulation einstitutions<br>efunding & solvency<br>Foreign<br>investments<br><!-- End of picture text -->
**Table 4: Financial Sector Factors Influencing Choice of Infrastructure Investment**

||**CAPITAL MARKETS**|
|---|---|
|**Quoted Stock**|In a country with well-developed capital markets, the issuance and investment<br>in quoted stocks and corporate bonds of infrastructure companies is relatively<br>straightforward. This is the case in South Africa and several Asian countries.<br>Local investors can invest in s accordance with their prudent investment<br>policies|
|**Infrastructure Project**<br>**Finance**|Countries with longer experience in infrastructure project finance may be able<br>to offer longer-term investment opportunities to institutional investors instead<br>of relying heavily on bank finance. Private equity infrastructure funds can play<br>an important role (passing on to institutional investors via their IPO exits).<br>Development of a working project bond market is an option over a longer<br>period of time.|
|**Debt Finance**|Some debt structures may be more feasible in countries with better credit<br>ratings. Such as was the case in Chile where monoline insurance was able to<br>move infrastructure bond ratings up to investment grade|
|**Trust Structure**|In order to use trust structures and products, financial companies and capital<br>markets must already be operational in some form, as was the case in Mexico|
||**FRONTIER MARKETS**|
|**Government Bonds**|In a situation with many smaller institutions (such as small pension funds) in<br>the market, government issued infrastructure bonds may be the most<br>appropriate investment vehicle for them.|
|**MDB**|In frontier markets, where both local and international investors lack<br>experience, the involvement of governments and /or multilateral development<br>banks may be necessary|
|**Lead Investor**|Local investors can profit from co-investing alongside international pension<br>funds and asset managers (including private equity infrastructure funds) by<br>learning international best practices in infrastructure investing. Exposure to<br>international competition can also have a positive disciplinary function for<br>national governance systems<br>If there is a large social security fund, then this institution could possibly act as<br>a lead investor, setting up an infrastructure fund for others to join|
|**Regional Funds**|Investors in small countries may be particularly interested in regional funds<br>but may be prohibited or discouraged from doing so due to investment<br>regulations confining them to domestic investments|

13
# **VI. Conclusions**

33. The issue of how to encourage further private sector investment into infrastructure is currently at the top of many policy makers’ agendas. The potential to tap institutional investors has been recognized, and the barriers to doing so have been much discussed. However, the debate has so far focused mainly on developing countries in terms of both potential investments and investors.

34. A number of key points have already been made by academics, industry and international organizations, including the World Bank. These remain salient and include the following:

- The problem with infrastructure projects is often not a lack of financing but a lack of investable/ credible projects;

- Getting the broader enabling environment right is key;

- Traditional investment limits or other regulatory constraints may work against longer-term investment in less liquid assets such as infrastructure;

- Institutional investors should not be forced into these investments - they have to be made on a risk return basis and be mindful of investors’ liquidity needs, otherwise capital may be misused and directed towards uneconomic projects;

- Institutional investors should not be expected to fund all types of infrastructure projects – they will be more involved at the operational / cash flow generating stage. An important role for commercial banks (and other partners such as private equity infrastructure funds) remains and facilitating partnering between these institutions will be important;

- A capital market development strategy – including a strategy for developing infrastructure financing vehicles – needs to worked out at the same time as pension fund and other institutional investors’ assets under management grow;

- Getting the financing vehicles right is key - working out what the risks are at the start of the project, which parties are best placed to take on these risks and structure the financing vehicles accordingly is needed for success.

35. This paper attempts to move this discussion into the arena of EMDEs where the greatest infrastructure and development needs are found. The potential for growing domestic pools of capital has been laid out, and the additional challenges to doing so – not least in terms of investment governance - recognized.

36. Experience so far has found that there are not many examples of direct infrastructure investing (equity, bonds or loans) in the form of the ‘Canadian model’. In addition, if a privatization route was/is taken, local institutional investors are often happy takers of those stocks, as are international investors.

37. Infrastructure bonds – in the widest use of the term - are popular in EMDEs. When the project finance or PPP route is taken, there are a number of interesting experiences with project bonds or similar debt structures. Some examples of government and subnational bonds can also be found.

14
38. There is a broad range of possibilities on the indirect or fund route in developing countries. Many commercial funds exist, mainly in the form of private equity funds, mutual funds or listed investment trusts. Other types of funds are often in some form sponsored by governments, national agencies or multilateral development banks, frequently combining public and private involvement. Some other interesting examples of co-investments exist, e.g. funds jointly owned by pension funds, or dedicated trust funds and structured products. Some Asian countries have developed infrastructure “facilities” (a fund, a bank, an ‘assisting’ agency, or legal mechanism) to assist in institutional infrastructure investing.

39. In practice, one can find combinations of the above investment approaches, e.g. funds with both private and government or public bank involvement. There are several infrastructure development banks and financing institutions active in the field. They can act as facilitators or investors, but they also can issue their own bonds. They are often keen to co-operate with institutional investors, and more outreach to facilitate such cooperation may be useful.

40. Mapping these different types of instruments to different EMDE contexts needs further work – with the approach outlined in this paper requiring further development and testing in the EMDE context. When seeking to mobilize institutional investment for infrastructure, each country will clearly influence the mechanisms adopted. The approach will include some combination of:

- Legal/ regulatory reform;

- Capacity building;

- Project preparation;

- Credit enhancement/ packaging/ intermediaries.

An analytical framework should be developed to help countries assess their context and identify the best combination of instruments to help mobilize institutional finance. The framework should then be applied to a limited number of countries to test the thesis and help those countries make the first steps in reformed focused on institutional investors. This implementation phase will be used to verify and inform the analytical framework.

15