Special Guest Address by Mr Ng Nam Sin, Executive Director of the Monetary Authority of Singapore at Investing in Infrastructure Assets Asia 2007
5 June 2007
"Financing Asia’s Infrastructure
Through the Capital Markets"
1 Good morning and a very warm welcome to Singapore. It gives me great pleasure to be here at this inaugural Investing in Infrastructure Assets Asia 2007 conference.
INFRASTRUCTURE AS AN ASSET CLASS
2 The landscape for infrastructure investments is rapidly changing. Until about 10 years ago, investments in Asian infrastructure assets were limited to a handful of infrastructure development companies. In the US, investment in the sector was primarily in government municipal bonds. In Australia, where the sector had a head start, investment opportunities were more diverse. Infrastructure investments then were commonly viewed as a subset of investment in the property sector.
3 Today, it is not uncommon to see fund managers allocating 5-10% of their investment portfolio to infrastructure, and this proportion is expected to grow. In the course of this 2-day conference, we will hear more about the exciting growth story of infrastructure and why it has emerged as a distinct asset class.
THE FUNDING GAP IN ASIA FOR INFRASTRUCTURE
4 We have all heard time and again that Asia has huge infrastructure needs. The Asian Development Bank (ADB) estimates that Asia requires US$300 billion worth of investments a year. However, investor interest and infrastructure investment demand in Asia are often mismatched, resulting in a funding gap. There are several reasons for this.
5 First, political risk. Infrastructure projects often require tremendous amounts of capital and time commitment before potential returns can be fully realised. During this long gestation period, the political and economic climate can change. Changes in public policies pose additional risks to investor interest and acquiring the necessary political risk insurance may undermine the profitability of the investment.
6 Second, regulatory and legal risks. The regulatory and legal environment in most Asian countries has improved greatly on the back of post-financial crisis policy reforms. However, reforms are still ongoing and implementation is still untested.
7 Third, cash flow profiles. Much of the infrastructure demand in Asia is for greenfield projects, which come with higher risks with no immediate cash flow during the construction period. Most investors prefer to put their money on completed projects, which come with stable and predictable cash flows. The cash flow profile is sometimes further complicated when cash flows are in local currency and investors are unable to sufficiently hedge their foreign exchange risks.
8 Fourth, limitations of traditional infrastructure financing. Traditionally, equity is usually financed by sponsors, but this is limited by the size of their balance sheet, risk appetite and commitments to other projects. Most infrastructure projects in Asia are debt financed through bank loans, but this is limited in tenor and exposes the project to refinancing risks.
CAPITAL MARKETS AS A NATURAL SOLUTION
9 These problems are increasingly being recognised by Asian governments, who are exploring solutions to plug the funding gap in Asia. One of the more pressing issues is the inadequacies of the traditional mode of infrastructure financing. To this end, the capital markets can help bridge this funding gap. In the US, Europe and Australia, the financial markets have been used for over twenty years as an alternative means to raise funds for infrastructure projects. The US has a far longer history in financing government infrastructure projects via capital market instruments. For example, bonds were issued in the 19th century in North America to finance the building of railways. Asia is only just beginning to realise the benefits of this mode of financing.
10 Capital markets financing for infrastructure exists both for equity and debt. Equity financing for infrastructure is raised through specialised listed infrastructure funds. And debt financing is raised though project bonds that are backed by the cash flows of an infrastructure project. Infrastructure financing through the capital markets can address some of the problems that traditional financing faces.
11 First, it is able to separate the investor of an infrastructure project from the operator. This will address problems associated with the operator such as limitations on operator risk appetite and balance sheet size. This then allows infrastructure companies to take on projects that are larger than the current capacity of the company.
12 Second, tapping the capital markets disintermediates bank lending and enlarges the pool of lenders beyond banks to include pension funds, insurance companies, and even retail investors. This helps increase the funding sources available to beyond what bank debt can offer.
13 Third, longer-term financing is possible. Infrastructure projects often have a long lifespan and require long-term debt financing. The debt capital markets are able to offer tenors extending beyond that offered by bank debt, reducing refinancing risks and hedging costs. This can be vital for capital intensive projects with costs that cannot be recovered in the near-term without increasing costs of the project’s end services or products.
ASIA’S UNDEVELOPED CAPITAL MARKETS
14 Enticing as the capital markets solution may be, therein exists another problem that makes such a financing solution difficult in much of Asia: underdeveloped and fragmented capital markets.
15 In the past, capital markets in Asia were almost non-existent save for a few pockets of equity market activity. Since the Asian financial crisis, many governments have recognised the pitfalls of having undeveloped capital markets and have taken steps to amend this. Governments are also working together with their regional counterparts to improve cross-border capital market activity. The Asian Bond Market Initiative is one such example.
16 The size of the Asian bond and equity markets might have grown but the liquidity in these markets is still far below that in developed countries. For example, a BIS report in 2007 showed that the size of Asian debt capital markets in 2006 generally fell short of developed countries by a factor of more than 10. Bond issuance is also dominated by governments and corporate bond markets have yet to take off in a big way. Lack of standardised documentation and market infrastructure, such as currency hedging tools, also impede cross-border activity and market access.
THE SINGAPORE STORY
17 Singapore recognizes the value and the benefits of developing deep and liquid capital markets for infrastructure financing. We have used our experience in the Singapore real estate investment trust or REIT market to help develop our infrastructure capital markets.
18 We started developing the REIT market in 2002, by giving tax and regulatory clarity to the REIT structures. At first, the underlying assets were mainly retail malls in Singapore, but this was expanded to warehouses and hotels. Over time, as investors and developers became more comfortable with the asset class, it was expanded to overseas assets. Investors who want an exposure to a diverse range of Asian commercial properties invest in the REIT market. On the other hand, Asian property developers who need to raise funds efficiently issue a REIT in Singapore because there is a ready pool of investors.
19 The development of the REIT market achieved a few things. First, sector players have a means to monetise completed projects and take on new projects, thereby re-cycling their capital. Second, widening the investor pool and spreading the risks reduced the cost of funding. Third, the benefits spilt over to the debt market as the commercial mortgage-backed security or CMBS market also developed. Fourth, the REIT market paved the way for cross-border activity, serving as a diversified conduit for funneling global investments to the Asian property market.
20 The success of the REIT model is useful and can be replicated for the infrastructure sector. We have taken steps to do this. We have put in place the necessary framework to facilitate growth of the infrastructure fund and project bond markets. We also issued the first 20-year Singapore Government Securities earlier this year to facilitate the pricing of long-term infrastructure debt financing.
21 Singapore is home to the first listed infrastructure fund in Asia-ex Japan, the Macquarie International Infrastructure Fund, and the first infrastructure trust in Asia, CitySpring Infrastructure Trust. It is encouraging to note that several specialist fund managers in infrastructure finance have or are in the process of setting up their offices in Singapore. This will complement the pool of project financiers already in Singapore. We expect that the next wave of development will be in project bonds.
22 The immense yet unmet need for infrastructure investments in Asia and the desire of Asian governments to develop their capital markets form an ideal environment for infrastructure capital markets to take off. It is our belief that this transformation will play a key role in opening the Asian infrastructure finance market to regional and global investors alike.
23 With that, I conclude this address and bid all delegates a fruitful conference ahead. Thank you.