Greenfield diet difficult for investors to digest


Louise Bowman
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Getting institutional investors to accept construction risk is one of the hardest nuts that the infrastructure market has yet to crack. The early stages of a project are clearly fraught with uncertainty. Even if you have a high-quality contractor and a well-structured project, cost overruns is still a concern. Funding construction has traditionally been the preserve of the banks, with many financings taking the form of a three-year to five-year bridge loan to cover construction leading to a refinancing either in the loan market or via bonds with irrevocable triple-A monoline guarantees.

Institutional investors are eager to match their long-term liabilities with long-term assets and if they can be made comfortable with construction risk the need for post-construction refinancing in greenfield projects could be eliminated. But getting them comfortable will be a sizeable task. Most don’t want to touch it. "A solid operating history is a big factor for us, we avoid greenfield and construction risk to the extent possible," says Klaus Weber, managing director and head of external investment mandates at Swiss Re in Zurich. "We are also careful about pricing and demographic risks as well. We are not trying to maximize total returns," he emphasizes. "We want to get a constant income out of safe assets."

James Wilson, chief executive of infrastructure debt investment solutions at Macquarie in London (Midis), believes that this might eventually change. "As this is a relatively new asset class for institutional investors, their focus is predominantly on operating assets," he says. "But over time, we think they will start to look at PFI-style deals or true project finance where there is an element of construction risk." Standard & Poor's launched a consultation exercise in January on proposed changes to its assessment of project finance construction risk, observing that as world demand for new projects increases daily the need for financing them grows apace.

The PFI market is looking to reinvent itself as bank finance evaporates and the transfer of construction risk will be at the heart of this. The UK might look to examples from other well-established infrastructure markets such as Australia and Canada where projects have a very similar risk profile during construction and operational phases. Canadian states tend to assume some interest rate risk on the projects while construction companies in Canada are often highly rated, which makes the risks more palatable. The UK is looking to move away from the traditional PFI model – which relied on monoline guarantees – towards an alternative that is able to provide long-term financing. This might involve banks, insurance companies or Infrastructure UK (a unit within the UK Treasury) wrapping construction risk.

"A wrap is not the answer," says Jim Barry, chief investment officer of renewable power and infrastructure at BlackRock. "You need to allocate different risks to different parties and not think too statically about the market. Some clients will be happy to take greenfield risk."

The Construction conundrum

There is certainly a strong argument to be made that institutional buyers need to make themselves more comfortable with infrastructure risk at the front end of the curve. "The risk of construction is sometimes overstated," says Deborah Zurkow, managing director and head of infrastructure debt at AllianzGI. "There are construction mitigants out there and people often do not focus enough on operational risks. Investors need to understand that the way in which construction risk is mitigated will impact the long-term performance of the transaction. The more you understand about infrastructure the more you realize that you can’t just buy into the operational phase without any exposure to the construction phase. That is akin to fitting a new kitchen in your house without knowing where any of the plumbing is. Construction impacts the operation of the project."

Experts argue that much of the concern around construction risk is the result of the private nature of the loan market. "Because infrastructure debt was privately owned by the banks there was no information available for new investors," says Benjamin Sirgue, global head of aircraft, export and infrastructure finance at Natixis. In October last year the bank launched a three-year research programme into construction risk together with the EDHEC Risk Institute. The first results of the study were published in January. "We decided to open our books to Edhec Risk Institute so that they can provide independent research on the characteristics of infrastructure debt compared with other asset classes, incorporating a real assessment of construction risk. More and more often people now understand that construction risk in project finance is very different from construction risk in public procurement," he says. "If you build a good and efficient infrastructure debt portfolio you need to have an element of construction risk in there." Ageas will be buying construction loans as part of its partnership with Natixis. "We went deeply through our lending policy and criteria with Ageas and designed a detailed criteria with them that they have appetite for. They have no problem with construction risk," says Sirgue.

Although it will not be for everyone, if more light can be shed on the risks that construction truly entails then an institutional appetite for it might develop.

"When exogenous construction risk is high and hard to quantify in the case of very large projects (think the Messina Strait) or if its contractual management is too difficult (think London Underground) then public sector guarantees will help," says Frederic Blanc-Brude, research director at EDHEC Risk Institute. But he says that "Hundreds of schools, hospitals and transport and energy projects are both what the economy needs and what investors should require in order to have access to the infrastructure investment narrative. If this kind of pipeline can be developed, construction risk will be a welcome diversifier in debt portfolios and financing infrastructure construction risk with institutional money should become standard practice."