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Malaysia’s infrastructure finance market: a template for all

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Malaysia’s infrastructure financing market is well ahead of many of its peers, proving time and again that it can support greenfield financing when many other countries are still focused on funding pure brownfield projects.

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  While there is plenty to learn from the country, there is also potential for huge growth, given the vast infrastructure funding requirements in Malaysia, and China’s Belt and Road pivot to southeast Asia. At this roundtable on infrastructure and sustainable financing in Kuala Lumpur in mid-August, hosted by Standard Chartered, leading bankers, analysts and issuers dissected the opportunities and challenges facing different stakeholders.

Participants in the roundtable were:

Lila Azmin, head of group corporate finance, UEM Group Berhad
Boo Hock Khoo, vice-president of operations, Credit Guarantee & Investment Facility 

Davinder Kaur Gill, co-head of infrastructure and utilities, RAM Ratings 

Aaron Gwak, managing director, head of capital markets, ASEAN, Standard Chartered 

Rana Karadsheh-Haddad, country manager for Singapore, International Finance Corporation

Edward Lee, head of ASEAN economic research, Standard Chartered

Noormah Mohd Noor, chief executive officer, Express Rail Link Sdn Bhd 

Rashmi Kumar, Moderator, GlobalCapital Asia


Global Capital: The starting point for the roundtable has to be the economic environment, because clearly that is going to affect both pricing and appetite for project and infrastructure related bonds — onshore and offshore. This is all the more critical given the uncertainty at the macroeconomic and geopolitical levels globally. What is the economic outlook for Malaysia? 

 Edward LeeSC160x186
 Edward Lee, 
Standard Chartered
Edward Lee, Standard Chartered: Uncertainty is very high, but volatility is quite low. This is a pretty interesting discrepancy, and it’s because a lot of the uncertainty is quite difficult to price. It’s mainly due to geopolitics. We see some volatility, but pricing at spot is going to be extremely difficult. So in many cases, investors hang on until something happens and then they see what to do about it. So there is a risk of complacency in terms of overweight positions in quite a few emerging markets. But a lot of the risks out there — a lot of the known unknowns such as North Korea and potential trade wars between US and China — are quite difficult to price. Meanwhile, it is quite a disinflationary environment. If you take a look at the real yield differential between EM and DM markets, it is still relatively wide. 


If you compare it to the time of the Federal Reserve tapering in 2013, when the real yield differential between EM and DM was almost zero, now it is about 1.5 to two percentage points different. This means that as long as the Fed hike communication is good, and is not as high as what they think they can get to at 3%, the buffer will help. We think the maximum they will do is 2%, and the market is only pricing in one hike after 2018. At some point, there will be some convergence between the Fed and the market.



This kind of movement still makes term premium extremely low. Term premium is still negative at this point. Even if we take into account balance sheet reduction, where term premium based on the Fed’s own calculation may increase by about 18bp, it’s barely positive. Throw in the lack of rate volatility and conditions remain very benign for EM assets in general. People are long carry, are moving down the credit curve and moving down the duration curve. 



Indeed, the global environment has been very favourable for Malaysia this year. This is important, because even though Malaysia is becoming more of a domestic economy, its trade to GDP is still 120%-130%. So comparatively, it is still an open economy, but less so.



Some tricky points include export risk, which is over 20% on a year-on-year basis. That is a commodity-based price effect, so you may still be selling the same one unit of product but at a much higher price on a year-on-year basis. Second, the electronic cycle has been very favourable for Malaysia. Malaysia is a country that sits very nicely in this external pick up — both electronics (mainly integrated circuits) and commodities. 



So this has benefitted a lot. But by the fourth quarter this year, both the base effect of DRAM [dynamic random-access memory] and commodity prices should taper off. But so far, at least, there’s volume improvement in Malaysia’s exports on the external side.



The first quarter data for Malaysia was amazing at 5.5% year-on-year, given the highest forecast on Bloomberg was 4.9%. Everyone was very surprised. That is honestly very impressive for Malaysia because global growth is not exactly strong.



The US is at around 2.2% and Europe at 2%, while China’s growth is expected to see some slowdown in the second half. So where did the growth in Malaysia come from? One is consumers. Consumption remains very strong, which is pretty interesting as labour market condition is only so-so. Consumption is strong also because of rural income. You have rubber prices improving and BR1M [1Malayslia People’s Aid] is higher each year.

The second thing I want to highlight is private investment, which has been amazing. But loan growth is very lacklustre. So where did the other financing come from? FDI and capital marketing financing are likely sources.In the first quarter, most of it was in equipment and machinery, but I wouldn’t be surprised if a lot of it was linked to infrastructure as well. 

Looking at all the projects still coming up, I think that space should continue to hold up for Malaysia. So it can be a pretty solid year, and well supported by the improvement in the global environment. We are expecting some slowdown in the second half but nothing sinister, while the global environment baseline scenario still looks quite benign for the EM world.

Global Capital: Aaron, how strong is the credit environment for companies operating in Malaysia? 

Aaron Gwak160x186 
 Aaron Gwak,
Standard Chartered
Aaron Gwak, Standard Chartered: In general, looking at it from a broader perspective in Asia, we’re seeing an unprecedented amount of issuance from Asia year-to-date, and we’re probably going to end the year with a stronger amount of issuance out of Asia. And that’s driven not only by the appetite to issue coming from the issuers, but also by the appetite for bonds to be taken in by investors. Obviously, both sides have to meet for issuances to happen. It is a virtuous cycle of more issuers coming and better deals coming out, and investors getting more confident. And building on that, more issuers come out and then you see how that virtuous cycle churns. The amount of interest in, and the comfort that investors have, on credit is very, very high. I don’t see that backing down anytime soon.



There has been a fundamental shift in how investors in general look at bonds and credit. Traditionally, it has been about putting your money in the bank and have the banks do the credit work for you and on-lending. But as Edward has mentioned, loan growth hasn’t been as robust because a lot of people are using their money to directly invest and participate, not just through direct investments via private bank accounts but also encouraging their money managers, asset managers and pension funds to have more bonds in their portfolios, therefore increasing the overall drive of money into the bond arena. This is something we’re seeing globally and more so in Asia. People are having a very strong amount of comfort in credit, and it is something we will continue to see. 



One thing that is also interesting is that rates have come up quite a bit with the Fed raising rates. That has driven lots of loans to be priced a little bit higher as Libor has come up as well during that time. Meanwhile, long-term dollar rates haven’t really gone anywhere. So the difference between three month dollar Libor and three year/five year fixed rates is very small. Three month dollar Libor is 1.3%, and 10 year US dollar Treasuries are only 2.1%-2.2%. 



So you can see the difference is becoming smaller, therefore incentivising more people to issue long-term fixed rate bonds. Also, from an investment perspective, they want that stability, which is creating that virtuous cycle.



From an uncertain world perspective, there is an element of people getting a little bit too comfortable. That’s something we all keep in the back of our heads in terms of potential risk factors. But it is certainly not reflected in bond prices. Everyone is trying to make hay while the sun shines. So as people get comfortable, the positivity drives and continues to foster stability. 


Lee, Standard Chartered: Let me add that besides flush global liquidity and low term premium, there is nothing wrong with the fundamentals of the credits people are looking at in this part of the world. It’s pretty solid. You have low inflation, a very stable currency environment, and we are past tapering. Also, importantly, reforms are taking place. Investors love reforms in the right direction. Are you improving your fiscal balance? Are you improving the long-term structure and inflation in your economy? Are you improving the long-term structural competitiveness of your economy? In this part of the world, all this has been pretty solid.



Davinder Kaur Gill160x186 
 Davinder Kaur Gill,
RAM Ratings
Davinder Kaur Gill, RAM Ratings: On the credit side, we monitor the ratings drift of our portfolio. What this does is it measures upgrades net of downgrades and defaults. That is still mildly negative at minus 0.96% now, but we expect that to start turning in the next few quarters to either neutral or mildly positive.



The two main anchors of the anticipated turnaround are that Bank Negara has been holding up the overnight policy rate at 3%, and we have strong growth momentum. Those two are going to auger well in terms of the debt servicing ability and credit outlook for a lot of corporates. We go one step further because our portfolio may not be entirely representative of the corporates in Malaysia as we are skewed to financial institutions and infrastructure issuers.



We also track the Bursa listed entities (covering 859 listed entities). In 2016, we saw revenue and Ebitda pick up on a broad basis, and credit matrixes in terms of coverage as well as capitalisation were still healthy. There were some pockets of vulnerabilities, which we saw in oil and gas, as well as the property segments. But broadly the credit outlook is still strong.


Global Capital: Infrastructure growth and financing is a hot topic, and Malaysia has some of the highest quality of infrastructure among ASEAN countries. Malaysia’s progress often comes up in conversations with peers in the rest of southeast Asia. How large are the infrastructure needs in the country at the moment — and what is the best way to address them?


Noormah Mohd Noor, Express Rail Link: I have some statistics here. The World Bank estimates and suggests that the annual global infrastructure needs are about $3.7tr. To meet the sustainable development goals, $2.5tr is required annually. Asia alone requires $1.7tr annually and for Malaysia, it is estimated that infrastructure projects awarded in 2016 were worth about MR40bn ($9.5bn) and another MR27bn will be awarded in 2017.And beyond 2017, the Kuala Lumpur-Singapore High Speed Rail (HSR) project, the East Coast Rail Link (ECRL) and all the other rail infrastructure projects will account for MR112bn in investment.

With annual public investment in global infrastructure at $1.5tr and PPPs [public-private partnerships] at about $120bn, it definitely requires improvement of public spending efficiency and ramping up commercial investments. It is important for all the commercial banks to look at this. Multilateral development banks can only provide about $80bn annually. Besides all this insufficient financing, there is also a lack of well-structured bankable projects. An infrastructure fund of at least $500m will be required in order to efficiently channel all the support for the infrastructure issues in Malaysia.

Gill, RAM Ratings: In terms of infrastructure needs, the government has been pursuing privatisations since the 1980s and 1990s. Very early on, the government established that infrastructure build-out is an important component to support long-term economic growth. If you look at the Global Competitiveness Report done by the World Economic Forum, Malaysia is already 19th out of 138 countries on quality of overall infrastructure. The way we have managed to achieve this positioning is mainly through the government’s commitment to the necessary infrastructure rollout, as detailed in our five year Malaysia Plans. We are currently at the 11th Malaysia plan (11MP). 

The main focus under 11MP is on an integrated transport system. We’ll also be focusing on trade facilitation and connectivity, which includes the ECRL and HSR. There will be some emphasis on rural and urban connectivity as well. We are looking at a development agenda that takes on a more inclusive approach. If you look at our guesstimates, in terms of the amount needed for infrastructure projects that are coming on board, the rail side itself will be in excess of MR200bn.

That will be taken up by ECRL and HSR, and there are also three MRT projects, the first of which is already fully delivered. There is also a double tracking project and the Rapid Transit System (RTS). If we add up the other announced projects like the Pan Borneo Highway and Central Spine Road, as well as another 7,000MW of new power generating capacity, among others, it will pick it up by another MR100bn to MR150bn.

As far as funding sources are concerned, the 11MP has dedicated MR260bn for development expenditure, of which half goes to the infrastructure space. That will be around MR26bn of public funding annually over the next five years. The rest will be mopped up by the private side, which is the loan market, the bond market, and now we are also seeing bilateral loans coming through, like the ECRL deal which has come directly from China Eximbank. 

So if you look at the bonds space itself, in the last 12 years, infrastructure issuances have been averaging about MR23bn a year. That pipeline has been very steady. 

 Rana Karadsheh-Haddad160x186
 Rana Karadsheh-Haddad,
IFC
Rana Karadsheh-Haddad, IFC: I come from a slightly different perspective. We don’t invest in Malaysia as Malaysia is already very well developed and our focus is on emerging markets where we have a role to play. Having said that, we do look at some unique elements that will make us open to investing in Malaysia, such as renewable energy and frontier regions.



There are a couple of things I would be very interested to see from the big picture perspective. One is productivity gains for every additional million or $100m of infrastructure that is spent. I’d be very interested to see where Malaysia falls in that spectrum. If you look at the likes of Indonesia, there would be relatively high productivity gain for every dollar that is put into infrastructure.



The other thing that will be useful to look at is the percentage of GDP that is attributed to infrastructure spending. What you find across many of the ASEAN countries is that the figure varies. If I turn to Malaysia, its infrastructure and lessons learned, it is about what we can take that has been done here and apply it elsewhere, and also what more can be done here.



With the lens of IFC and sustainable financing, which is what we focus on, the one area we could potentially look at is investing in renewables. That’s where we see potential growth in the infrastructure space. If you look at our portfolio globally in power, more than 50% is now in renewables. It’s just a testament that in any emerging market, renewable energy can play a very large role.



Secondly, the innovative finance schemes. Much was alluded to about all this dry powder globally that is waiting to be deployed but not able to do so due to a number of different reasons, such as a lack of quality projects and improper risk allocation.



Malaysia has made inroads in tapping funding for infrastructure through various sources. In terms of growth and infrastructure, one area that I believe will impact Malaysia’s infrastructure growth and spending and development is connectivity. I don’t think you can have this discussion without mentioning BRI, the Belt and Road Initiative. 

This global connectivity and infrastructure initiative is part of the discussion and is really going to impact everybody in Asia and ASEAN included. I see that as another element of potential infrastructure growth and where Malaysia can play a role. 

 Lila Azmin160x186
 Lila Azmin,
UEM Group

Lila Azmin, UEM Group: When you look at the numbers, infrastructure spending requirements are huge for Malaysia. But it also gives you a sense as to when that will be spent over time. The likes of HSR will not be just for the next year but the spending will be over time. We’ve heard that it will require around MR50bn-MR60bn, so it will be interesting to see how they will structure it, and who will fund the project.



Will it be the traditional government guaranteed bond funding or will there be a part for the private sector to play in this infrastructure spend? We do need the infrastructure but it will be good to see how it will be rolled out and which parties are going to play big roles. We’ve seen a lot of government guaranteed bonds over the past years. But the government has only certain capacity to guarantee bonds without affecting its own rating. So we will need to structure something that will not stress the government’s balance sheet. 


Global Capital: Infrastructure bond issuance in the international market has been very much brownfield focused, or typically backed by credit enhancements during the construction period. The Malaysian market, on the other hand, can accommodate greenfield financing. How can the appeal of greenfield financing in Malaysia be increased among international investors? 


Boo Hock Khoo, Credit Guarantee & Investment Facility: Greenfield appetite is very particular to Malaysia. We’re trying to figure out why. Why are the investors here so gung-ho about construction? It is important to go back to when the respective countries started privately financing infrastructure. Often, greenfield projects are funded by bank loans from local banks. Loans are also often disbursed prematurely, before all the key project development risks have been addressed. They do so probably because of sponsor support and relationship banking.



But unfortunately, when something adverse happens, then the perception of construction risk becomes heightened. So it’s actually less ‘greenfield financing’ and more ‘barren land financing’ with a lot of faith on sponsors or project owners. With that, greenfield gets a bad rep.



But this is not really the case here in Malaysia because greenfield project bonds that predominantly come out in the ringgit bond market are very well structured. The risks are well assessed, and ratings agencies do a great job vetting the independent engineers’ reports and opinions. When construction risk is well structured, the risk can then be quite manageable. Very few well-structured projects are totally abandoned globally. 



To address this, we’ve created a new product called the Construction Period Guarantee. The belief is for a well-structured project with well-assessed risks and mitigants, we can frame construction risk to acceptable levels. We developed a good assessment framework, and we worked on boilerplate conditions precedents (CPs). When you’re assessing a greenfield opportunity, you need to ask for detailed technical studies. Towards this end, we have collaborated with Surbana Jurong from Singapore, a global engineering powerhouse, to provide engineering inputs to the construction risks we face, because these are not areas that bankers can sit on their desks and say ‘OK, three years is enough time to build the bridge’. You need the technical expertise to be built into the assessment. 



For risks that cannot be mitigated, you ask for them to be addressed as a CP to be met before all the cheques are written. For example, risks around land acquisition need to have passed before we can achieve financial close. Together with a strong assessment framework, the boilerplate CPs will facilitate construction risks to be well defined and framed to an acceptable level, for us to guarantee it. But what we hope to do after we find a pilot implementation, is to put it on our website and make it open source, so that not just CGIF, but anyone — investors or co-lenders — will be able to use the same to manage construction risks.

Azmin, UEM Group: In terms of allocation of risk, before it gets to ratings, before it gets to CGIF, the issuer itself must be comfortable that the risks involved are manageable. Not all of us are contractors. When we did our first IPP [independent power plant] in this country, we made sure the EPC contractors were renowned names, and used tried and tested technology. Then the construction risk is reduced. You go with the power house that knows how to do this. 

For concession agreements with the government, in the early stages, we did use lawyers and legal advice that have a proper template to manage the risk between the government and the developer. That’s quite important so everybody knows what kind of risk they are taking on. That helped with the success stories in Malaysia. And once there is a showcase, it will snowball into private developers wanting to come in and say, ‘maybe the risks are manageable and we can do it as well’.  

That encourages other investors, and also shows bondholders that the project can be completed on time. You just need a success story. UEM does projects in Indonesia now, for example — we have a toll road that is already operating — but it took us nine years to get to completion. 

Gwak, Standard Chartered: There’s a role to play for each of the parties, to give both issuers and investors more options. There’s definitely a role to play for bank lenders and there’s definitely a role for bond investors. I don’t think there’s going to be a wholesale change, where all the infrastructure projects are in the bond realm or, as they are now, in the loan world, or even that everything that is greenfield has to be done by the government, or anything that is bond related has to be guaranteed. It it will be an amalgamation of different options that will inherently build a bigger market.

One of the things we certainly want to see more of is the recycling of capital. In the early stages, how can we make the structure more robust and how can the regulators ensure that the sanctity of the contracts are upheld? In the construction period, how can we get comfortable on the abilities of construction companies to make good on their promise? And then when cashflows start coming in, or in the ramp-up period of a typical project, how can bond investors get comfortable that the cashflow would be meaningful? That’s where CGIF or the ADB can step in. 

One of the things that aided the success of the Malaysian project bond market is the ability of ratings agencies to provide clear ratings guidelines. It hasn’t been as prevalent in the international bond markets, where you’re looking at it from a country risk perspective and doing a bottom-up approach from the project level. It has not made it competitive enough to look at non-recourse project-level bond financing. All of these things need to come together for it to proliferate outside Malaysia. There’s definitely a role to play for everyone and little bits of it are moving in the right direction. 

Khoo, CGIF: Some of our contributing governments have come to us to decipher project bonds. Our advice has been really clear. Never tear up the contract of the old administration because you’re going to have to sign a new contract in this administration that will extend beyond its term. 

If you start tearing up contracts, the risk premiums get elevated and you’re not going to be able to finance any new infrastructure going forward. We renegotiate contracts in Malaysia so that the project bond asset class is well protected. Investors continue to have faith in it and premiums are not elevated because of regulatory uncertainties and risks that one can’t price in. 

Gill, RAM Ratings: On managing greenfield risk and making it more attractive for investors in general, we are taking it a step further. In the past when greenfield risk is present, the project bond issuance was issued at a AA3 domestic local currency rating. Now we have project bonds with greenfield risk being issued at AAA because of external third-party credit enhancements, as well as rolling guarantees from shareholders. The market is moving along the curve and getting more innovative, even in the greenfield space.

Global Capital: But how can the market move away from guaranteed structures? 

Gill, RAM Ratings: The way we look at it is that the Malaysian government has a self-imposed debt to GDP limit of 55%. We are near that limit. So they have been more careful about adding direct liabilities, and so are using quasi-government bond issuers that issue via guarantees and non-guaranteed transactions.

At the moment, we feel the contingent liability is still manageable. It accounts for an additional 15% of debt to GDP. The comfort we take from that is that a lot of these assets are cash generating to begin with. They have their own cashflow. In terms of the debt repayment of the government itself, they are spacing it out well with different tenors. 

If you look at the government’s payment obligations of contingent liabilities in the next five years, it stands at about MR5bn per annum. We feel that’s a manageable amount. As far as projects are concerned, it all boils down to viability and bankability. Some projects are going to continue to be publicly funded. 

The consideration for the private sector will continue to be standalone viability, project economics, the contractual framework, if performance risk can be well handled, and, if it’s a user pay model, how much market risk and volatility there is. That will continue to be part of the equation. 

Mohd Noor, Express Rail Link: I have had the opportunity to finance a power project before, among the first five IPPs [independent power producers] here. At the time, it was a combination of traditional financing and bond — among the first bonds at the time. It was still in the infancy stage and now it has grown by leaps and bounds. But the difference is now we have a lot of infrastructure bonds with government guarantees. I’m not sure how much more the government can trust in these.

When you talk about how to move away from government guarantees, in the 1990s the government privatised four rail projects and I was involved in the financing of two of those projects, including Express Rail Link. Three rail projects have gone back to the government because the project was not viable. Government had to take it back and restructure it. But the good thing about Malaysia is that we don’t just kill the project. The government will step in or the bank will help to restructure when necessary, when they find that the issuer or borrower cannot sustain the loan. Then we come back to the table and renegotiate, either with the government or with banks for the bond. That helps the overall environment. 

But over and above that, everyone learns. The government learned that they made some mistakes in some previous concessions and they tightened it up, which is not very good for us as companies. But what it does to the economy is that it helps the project and the company survive further.

Gwak, Standard Chartered: It goes back to the role. There will always be a role for the government to play in infrastructure because of the enormity and the social impact that good infrastructure has on developing a country. I don’t think everything is ever going to be privatised, where there won’t be any more government guarantees and everything will be hunky-dory. But at a certain stage, some structures with government guarantees can fall away, and be replaced with something that is more private led. 

Other jurisdictions have led and been successful with PPP projects, where there is a role the government plays but the private sector is still involved. We have to think a little bit more innovatively around different viable structures, but there is definitely an involvement of the government that will consistently be there. Infrastructure, by definition, is something that has big social impact and a boost to the overall economy, in line with the government’s vision of a country.

Karadsheh-Haddad, IFC: We obviously invest in infrastructure globally, so we see how that plays out, but invariably, there is always a role for the government. In some sectors which are less economically viable on a standalone basis or are socially charged, such as the water sector, you will see more government involvement. In these sectors, the World Bank and IFC try to play a greater role — assessing the needs and challenges and deploying tools to fill those gaps. 

We are introducing more risk-absorbing tools to the market, one of which is the IDA Private Sector Window. The idea is that if there is an infrastructure project on the cusp of viability, but parties are still hesitant to take the initial risk, we have tools whereby we come in to assume some of that risk. 

This will be deployed through different areas: 

(i) risk mitigation facility — to support infrastructure and PPP projects;

(ii) local currency facility — to provide local currency solutions where none is available; 

(iii) blended finance facility — to provide blended funds to support pioneering projects

(iv) MIGA guarantee facility — to extend political risk insurance products.

Once you set one or two good precedents, then you can see more money moving into those markets — it is a constant challenge, and we’ll see a continual role for the government. 

If you take a step back, there is much more dialogue happening around infrastructure investing. There’s all this money out there that needs to be invested. Infrastructure is a natural partner because it’s longer dated, yielding but not low risk. Yet, it’s not being deployed. 

Then the question is, when we don’t have sufficient bankable deals and risk aversion, how do you bridge that gap? I don’t think anyone has that silver bullet just yet. But the more dialogue we have, the more we understand what happens at the macro and micro levels, the more you may start finding either precedent-setting projects or innovative solutions.

Khoo, CGIF: Guarantees are the easiest of solutions to all issues. Perhaps for bond investors the risks go away, but from a macro perspective, guarantees do not extinguish the risks of a project — they are simply passed on to the guarantor. Given this, there is really a finite amount of guarantee capacity available. So this capacity needs to be properly managed — be it for the government, guarantee institutions and so forth — and in doing so we need to be able to assess, measure and manage the risks absorbed by guarantors within the system and not do so blindly. Whether you are guaranteeing a freshly laid duck egg or a salted egg is something you can probably tell from the onset Sadly, with respect to direct government guarantees around the world, this is rarely done well.

All too often, guarantees are used to plug the economic feasibility gaps when more measured support, such as viability gap payments, grants, soft loans or off-take assurances, should be deployed. To avoid abuse, these need to be well studied and structured to ensure that support can be justified and, if needed, fiscally accommodated in the budget. The contingent liability book must be treated with similar care as the budget.

Malaysia is blessed because it can build anything it needs. But it cannot build everything it wants. There has to be a prioritisation of what projects the private sector can participate in and the extent of support needed. Private sector participation is key. We should not let the government do everything. 

Also, for Malaysia to move forward downside support needs to be balanced with upside sharing mechanisms to justify the support provided by the government to private sector projects. This way we avoid “privatising profits and nationalising losses”.

Karadsheh-Haddad, IFC: That’s a great point and is something you see in the commodities space. In the commodities sector, it is not uncommon to have government upside participation in some form or other, whether it was through revenue sharing, or through a shareholding of some sort. Because of the cyclical nature of the commodity business, you will see upside sharing structures and downside protection through things such as minimum price formula. 

It’s different in infrastructure, but I say why not look at it? Well-structured deals need less government support, and poorly structured deals need more. All of this risk will be priced in one way or another. The likelihood of having to call in the government guarantee is higher if it’s poorly structured, and is lower if it’s well structured.

Gwak, Standard Chartered: Cross-jurisdictional comfort has been one of the key elements for boosting international bonds across the region in Asia. If I’m buying a dollar bond from Indonesia or I’m buying a dollar bond from Vietnam, I know exactly what law it’s under. I know there’s commonality; I know there’s liquidity, trading, etc. But if you’re an investor sitting in Korea and investing in something somewhere in ASEAN, do you really get the comfort that the government there is going to uphold your rights? 

They’d rather just buy government bonds and be happy with that, rather than invest in an infrastructure project, which may yield better and may be safer because it has assets behind it, but they don’t want to take the extra step, because of the added risks behind it. 

Global Capital: Since Malaysia established the public private partnerships concept, it has really taken off, and had positive spillover effects on the bond market. What is the potential of PPPs in further driving the bond market?

Gwak, Standard Chartered: It’s not easy. Someone mentioned silver bullets before, and I don’t think a silver bullet exists. It has to be a collective effort. It’s more of a journey than just finding a one-stop solution. Using the public and private sectors to work together for common good is something that, theoretically, works well. But without delving too deeply into the structure and viability of every particular project, it becomes a ‘you take the risk, or I take the risk’ kind of situation. 

When the public sector is involved, it also sometimes takes on a political agenda. So governments may start thinking, “from my administration’s perspective, how important is this politically to get through?” And when those things are put into consideration, rather than the viability of the structure, focus can shift. That’s one of the biggest difficulties PPPs have faced. 

But going back to the fundamentals — by having a supportive regulatory environment, a deep dive into the viability of the project itself, investors and lenders having the bandwidth to drill deep into the structure and to understand it, and banks facilitating it to make it easier — these are all the little ingredients that will actually make the soup as tasty as they come. 

I try to ask myself what is the magic formula that Malaysia has that the international community, broadly looking at Asia, doesn’t have, that allows for infrastructure financing to be so prolific? MR23bn is a big number year-on-year. Sometimes, it hits me that it may be because the funds that are prevalent in Malaysia continue to have and continue to get inflows for buy and hold financing? 

In the international bond markets, it is not really about buy and hold. The recent financial crisis taught us that if you sit on buy-and-hold assets, and you can’t value them properly, you will become like Lehman Brothers. So there’s a constant need to revalue, to be able to have liquidity, to be able to trade and change hands. But Malaysia is blessed with the fact that new money is forthcoming year-on-year into pension funds and needs to be invested. It is invested with the view that even if it is a 15-year solar powered asset, with a government guarantee, then I’m fine holding it for 15 years.

Azmin, UEM Group: You hit the nail on the head because our financial infrastructure was established a while ago. We have high percentage of savings through EPF [Employees Provident Fund] and KWAP [Kumpulan Wang Persaraan]. These institutions alone cover a lot of infrastructure bonds and it matches their long-term portfolio. Without the funds involved from early stages, it wouldn’t have been so successful. We may not have cases where EPF can take bonds for up to 30 years. That was one of the right formulae: that the government had thought of setting up the financial infrastructure to help the physical infrastructure. They go hand-in-hand.

Gill, RAM Ratings: If you look at the investor base, the two main ones are commercial banks and life insurers. There is also a steady flow of demand from pension funds such as EPF, but the market is a buy and hold market. They hold to maturity and there is not much secondary trading going on. 

That’s one of the feedbacks we get from foreign investors. If they want to rationalise their holdings, is there sufficient liquidity and is there a ready market to offload?

Khoo, CGIF: This is what we have been telling the contributing governments of CGIF. If you want to build infrastructure, build up local savings, relying on foreign savings lent on foreigners’ terms is not going to get you much.

Malaysia is blessed with a lot of indigenous long-term savings, but unfortunately this is not the case for the other countries. If fact, our problem is the lack of enough safe long-term investments in ringgit, and this is where PPPs come in.

Global Capital: Moving to the theme of the Belt and Road Initiative. Chinese investments into Malaysia have grown over the past two years on the back of the initiative. What have been the advantages/disadvantages of these investments in terms of giving a fillip to Malaysia’s infrastructure financing?

Karadsheh-Haddad, IFC: A couple of years ago, there were two big local trade and investment initiatives — the TPP and the BRI. But now TPP seems unlikely to move forward. Belt and Road is in active discussions, particularly around Asia.  

When you have that kind of savings to deploy, it will be important, you will see it around ASEAN and you will see it around southeast Asia, and Malaysia will be included in that. We will see infrastructure investments associated with that.

Mohd Noor, Express Rail Link: The impact of BRI is inevitable. The money and investment is important for Malaysia. It’s very good, but we have China coming to invest in Malaysia. If you look at the ECRL project, the funding provided is very, very reasonable at 3%; nobody in the market can provide that. I don’t know the terms beyond that, but are we exposed to the forex? That is very important to know. The government has to hedge that properly over 20 years. 

But if you ask me, for infrastructure projects, 20 year lending is too short, especially so for rail projects. In general, rail projects have very long gestation periods and would require long-term financing of 30-40 years. The only drawback from Chinese investment is that China comes not just with money and investment, but also with full force. When they do a project, they bring in everything from there — equipment and manpower. 

There is big hue and cry from local suppliers and local talents on whether we are giving up too much opportunity to China and not using enough local suppliers and talents or expertise in Malaysia. Therefore, the government needs to emphasise on local content of at least 50%. This is the big concern.

Gwak, Standard Chartered: From our perspective, BRI is a significant step and something we certainly embrace. We believe it is going to have meaningful impact in terms of developing countries, not only from a social or infrastructure perspective, but also generally in terms of the growth trajectory and relationship in the international community. 

The question we’re curious about is less around what this means, but more about how it is implemented, in what stage, and how quickly it is rolled out. We’re waiting to see how that pans out. As an initiative, as a general idea and theme, it’s something that we’re obviously very supportive of, and we want to see it done in the right way, where many different parties can contribute together. 

Gill, RAM Ratings: From a trade angle, as China is our largest trading partner, we need to stay in the global supply chain and remain accessible. That’s why the Malaysian government recognises that connectivity — building the ECRL and investments such as those in the Malaysia and China Kuantan Industrial Park (MCKIP) are key. The scale of investment by China in Malaysia is, however, unprecedented. 

Partnership with China in their Belt and Road Initiative offers Malaysia an enhanced position in terms of movement of goods and market reach, and it’s where Malaysia will want to continue to position itself.

There’s also discussion around the multiplier benefits to the economy from the large transport and connectivity infrastructure investments undertaken by the Chinese parties, such as bringing in additional employment, or the spillover to developing localities surrounding those areas.

Khoo, CGIF: The key distinction for me is the nature of the investments — is it equity, non-recourse, loans or loans with recourse? Ultimately, the structure of the investments will determine the impact, not only to Malaysia but also other receiving countries. I’d like as much money to come into Malaysia and the region as equity or loans, without any recourse to the governments. Perhaps aspirational, but that will be excellent.

Global Capital:What more needs to be done to build Malaysia’s sustainable and responsible investment market? How can green financing be used to boost infrastructure financing?

Khoo, CGIF: Green financing has typically been in the energy space. It’s easily defined and a lot of work has been put into this area. But green financing in Malaysia, and this part of the world, is just starting. Our mandate is to develop the bond markets, and green bonds are part of the agenda. 

However, if I had to adopt what we do in developing markets for countries without any bonds today, the principles are quite similar. You need key pillars and you need a regulatory framework. You need issuers or people undertaking green activities, and you need market intermediaries where people can rate green bonds or where people can establish standards for the greenness of the bonds. The last pillar is investors. We have yet to see investors having special funds where they can’t invest in anything else but a green bond. 

The second point is the approach a country wants to take. You can typically have an exclusive approach, where you really want to make sure only true green projects come to the bond market and are defined as green bonds, or you can have a slightly more inclusive approach, where people are able to respond to climate change in their respective activities and take steps to improve their environmental impact.

They may not be green necessarily based on international standards, but if they can prove that they are making rubber gloves better than they did before with the proceeds of these bonds, why can’t we include them in some sub-category of green bonds?In many economies that are small, you have to look at activities within the economy, and see whether you should adopt an inclusive or an exclusive approach. My fear is that if a country adopts the exclusive approach, and the economy is not fully engaged in it, you may end up with just a few showcase green bonds. It is difficult to be proud of a green bond market with just a few green bonds swimming in a brown or black bond market. 

To the question on how green financing can boost infrastructure financing, on the contrary, in Malaysia where infrastructure financing is abundant, it will be infrastructure projects that will boost green financing.

Azmin, UEM Group: Getting ‘green’ defined, and making sure everyone understands that, is the way forward. Khazanah issued an SRI bond for social impact for trust schools a few years ago. The response was not as good as PPP or power projects — it took a bit of time for investors to warm up — because more understanding and education is needed. Investors need to be more exposed to this so they can set a part of their portfolio to this.

Gill, RAM Ratings: The government has come up with a lot of incentives, including tax reduction for sukuk SRI issuance costs. You also get investment tax allowances for investments in green assets, and income tax exemptions for the use of green technology services and systems. They also have a green technology financing scheme that has been established. But in the bond market, there is no pricing difference to incentivise an issuer. There is also an added compliance cost. So the government is trying to think of grants or provisions to take care of the added cost to the issuer as an enticement. 

Gwak, Standard Chartered: The groundwork around all this awareness is probably the first step. Once the awareness is there, that we are living on a finite earth, and if we take this track to endeavour, in whichever industry we are in, to make things a little bit greener, a little bit friendlier, and every CFO has that in the back of his head, that’s where the first step and the changes will happen. 

It will be difficult to switch off and then switch on and say everything needs to be sustainable — that’s probably a step too far. 

The various incentives the governments have been putting out to incentivise both issuers and investors are definitely welcome, but until everyone changes their mindsets, it’s just going to be dollars and cents. The first steps are in place, so hopefully that catches on. 

Global Capital: How can sukuk play a bigger role in infrastructure financing, given the asset-backed nature of Islamic finance should, in theory, make it an ideal product for project fundraising?

Gill, RAM Ratings: Interestingly in Malaysia, if you look at year-to-date issuances (as at the first half of 2017), 60% of all issuance is sukuk. If you narrow it down to the infrastructure space, the number increases to 86%. That push has generally come from the government. It was a concerted effort through government’s public policy commitments to position Malaysia as a vibrant space for Islamic finance. 

For the sukuk market to flourish, the government looked at legislation concerning sukuk issuances, regulatory oversight, Sharia governance frameworks (they set up a Sharia advisory committee), and provided the relevant incentives to issuers. 

Now, we have moved to sustainable and infrastructure green financing and finding a bridge, to see if we can use the commonalities between Islamic financing and sustainable and responsible investing, to further boost the sukuk market.

Azmin, UEM Group: We’ve always used sukuk for our infrastructure financing. We haven’t gone green yet but we are open to the idea. There are enough incentives out there. 

Gwak, Standard Chartered: Sukuk price better here in Malaysia than conventional bonds. It’s because funds will prefer sukuk as an investment vehicle, and there are structural things that have been introduced, that have survived the test of time and have further evolved. 

Just pushing everyone to do a green bond is not going to work. But once the awareness is there, and changes take place one by one, then naturally funds will form around sustainability and then hopefully that will kick start it.

But I don’t see green financing becoming dominant as a separate tributary as sukuk has been. It will form a separate asset class that would be interesting to explore, that would definitely build on its own, but it won’t cut the next branch of financing.

Global Capital: As issuers, do you see the potential for using cross-border local currency bonds to fund infrastructure projects? 

Azmin, UEM Group: It will be a challenge because of currency mismatch and the availability of hedging in the market. Our projects are usually very long, and markets are not going to go that far out. Also, our local market is deep enough so we tend to go to local currency, either the loan or bond market, to match our needs. As developers, we are focused on operations and trying to make the project a success. We don’t want another headache of managing the currency risk on a daily basis. That’s one risk we try to mitigate. 

Khoo, CGIF: How would it work if you have projects outside the country?

Azmin, UEM Group: We tend to go to the local market over there. The market is limited because there is no bond market as deep as Malaysia for infrastructure, but we try to make use of the local currency market as much as possible. We closed an Indonesian deal with 22 banks for a term loan of 15 years recently. 

Gwak, Standard Chartered: There are lots of forums within the ASEAN community that are looking to develop further ties to make it more integrated from a capital markets perspective. In an ideal situation, you have a very prolific infrastructure bond market in Malaysia, so somebody doing a project in the Philippines should be able to use it to finance themselves. 

From a currency perspective, swap markets do help to mitigate some FX risk but you have to realise all swap markets culminate in dollars, meaning that to go from rupiah to Malaysian ringgits, you have to cross US dollars. There’s probably not enough of a market for direct Malaysian ringgits to rupiah swap market to start making those markets, especially for the 15-20 year requirements that infrastructure has. I can’t see that changing overnight.

Khoo, CGIF: Developing different bond markets in these countries is a more realistic step that we can aspire to. The Malaysian project bond and infrastructure market is more than 25 years old now. So there are lessons to be learned by the others and hopefully they can catch on, and in the future we can have local currency markets that support infrastructure projects as the ringgit market does here. 




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