Municipal Finance Series by Professor Jeremy Gorelick – Part 4 of 4: Strategies for Mega Finance

Are there advantages to going after financing for larger agglomeration infrastructure like hydropower versus smaller or medium-sized financing in one sector such as water?

It depends on what instruments you’re looking for. For longer-term infrastructure finance, two types of financing are going to be most appropriate: either DFI or commercial financing.

DFIs sometimes prefer a siloed approach. For example, just one sector such as water. This is because that’s how they’re structured, and they find it easier to bid on one thing. If you’re bringing something to the World Bank, you might ask them to look at a combination such as water and sanitation rather than a water project that also includes power elements. The reason for this approach is that one side of the organization (e.g., that addresses power) would agree and the other side might not. I could see a strong argument, if from a municipal level, to splitting the financing into two different sectors – if you’re looking for DFI finance.

If you’re interested in the other side of finance, which I would recommend, consider capital markets. Look at institutional investors. They have financing for a longer period of time. And don’t necessarily call this a “revenue-generating” bond. Instead call it a “general obligation” bond. If it’s a general obligation transaction, it’s largely up to the municipality how it wants to use its money.

Investors are always looking at your perspectives, and how you think the money will be used. But they make their decisions based on seeing the return that they’re expecting. And they will be looking at what the regulator wants. That is, if there’s not a clear expectation from the regulator that the general obligation bond would be only for this specific set of projects. If you’re trying to cross multiple sectors and suspect that the DFI’s won’t be able to reach a reasonable decision, then go through a capital markets transaction.

There’s also a case for a hybrid approach. When an intermediary is used, someone pulling together different discrete transactions or different discrete requests coming from different municipalities, the intermediary then goes to the capital markets. This can be to issue the debt or to guarantee the debt, relying on DFI’s to either capitalize the guarantee or capitalize the facility itself. But those instances are few and far between, and probably not replicable in most of the countries of the global South.

Can a municipality, hiring a Program Manager, embedded in government offices, offer more confidence to investors?

I’ve seen it happening more and more. I’ll respond in two ways. First, I’ll point to the European Bank for Reconstruction and Development (EBRD). The EBRD has a platform framework agreement with some large engineering firms. These firms have the ability to serve in a consulting or program manager role. The EBRD is betting on the projects. At the same time, it is investigating the financial viability of these projects, it is trying to ensure effective project preparation.

The EBRD has its own project preparation facility. Most importantly it ensures that project execution is as conceived and that quality standards are being met. But this approach is only starting to take off. There needs to be a clear demonstration that this is the way to move forward for decision makers to be comfortable. The EBRD would be a DFI to look at, and to meet with those at EBRD who are trying to figure out how this works. They’re finding that the opportunities are a bit easier to come across once they put that entire framework in place.

I was at a roundtable a few months ago where your exact question came up. How do we make sure the project execution happens according to plan? Not only is the EBRD interesting but also are other structuring intermediaries, like PIDG (the Private Infrastructure Development Group) is looking to see how it can benefit by creating a system where they know that projects will get completed. In real estate, development lenders often need some sort of assurance that the project will be completed, regardless of how many projects the developer completed and its historical success. Assurance is the number one criterion. If the developer has some equity in the deal, the lenders know that this is not something from which the developer will walk away.

 

But the second thing is lenders also want to see that you have some sort of completion bond in place. US real estate is not equivalent, because here there is less risk of government interference and the project not moving forward. But, some sort of a completion bond (a percentage of the transaction) to make sure that this goes forward could also be helpful. Putting some sort of completion bond guarantee in place strengthens investor confidence especially combined with some sort of political risk guarantee (e.g., from the World Bank Group).

The final thing, and something that I recommended in a few cases, is using two types of money. The first is short-term money. This comes from the commercial banks who will lend for three years, 18 months, or whatever the period for the project’s construction. The banks will find a way to be competitive on this. They want to see the project completed and then get paid out with long-term off-take financing. Hypothetically, construction finance comes in every few months until project completion.

The second in long-term money like a 30-year capital market play, where institutional investors accept say a five percent return for 30 years. They need to bring in relatively safe money at around that price point for the next 30 years, to make sure they can pay pensions, or meet needs such as pay-outs on insurance, or whatever else the case might be that motivates these institutional investors.