Enhancing secondary market liquidity to increase infrastructure funding

The well-documented^[1] infrastructure funding gap in emerging and frontier markets in Africa and Asia necessitates innovative funding solutions, particularly in effectively utilising existing market liquidity. Tapping into and further developing secondary markets to mobilise capital towards infrastructure financing is one of the thematic areas in the PIDG 2023-2030 strategy.

The inefficient allocation between liquidity supply and demand throughout the infrastructure project lifecycle is a barrier to effective infrastructure financing. One of the tools at our disposal to address this capital mismatch is through capital markets which provide a means of accessing prospective investors for secondary opportunities. By tapping into exchanges and listed instruments, both issuers and investors benefit from a deeper pool of market participants vis-à-vis direct lending or private placements.

Given the nascency of capital markets in lower income countries, compounded by vanilla structures and lower trading volumes, bond instruments are often ‘buy and hold’ investments. By providing investors exit mechanisms within documentation – as developed in GuarantCo’s Pran II transaction^[2] – investors are provided certainty of exit, reducing the illiquidity premium for these investments.

A further market mechanism available is securitisations, specifically the securitisation of infrastructure loans through infrastructure asset backed securities (IABS). IABS provide a multi-pronged solution to addressing the infrastructure funding gap by:

1. Allowing banks which are facing tighter Net Stable Funding Ratio and other restrictions through Basel regulations (which constrain banks’ lending capacity) additional exit channels, allowing for effective recycling of capital into new projects.
2. Providing institutional investors^[3] (who may be restricted by investment policies) instruments matching their minimum rating criteria. Given the limited investment grade opportunities in the emerging markets infrastructure financing space, this a novel way to facilitate indirect exposure. IABS facilitate the effective capital transfer from developed to lower-income countries whilst also providing local institutional investors diversification opportunities away from government securities.
3. Using guarantees to credit enhance junior tranches of securitisation vehicles, thus further expanding the pool of eligible investors in IABS.

Points (ii) and (iii) also help build capacity for institutional investors less familiar with infrastructure debt as an asset class, in order to enable further participation in direct project exposures. The profile of infrastructure debt also aligns naturally with the long-dated liabilities of institutional investors such as insurance companies and pension funds.

Bayfront and IABS

Bayfront is a specialist financial institution with the mandate to acquire, structure, and distribute infrastructure debt on a regular cycle to create sustained volume for IABS to become a mainstream investment asset class.  Bayfront was set up following a commissioned market study by the Monetary Authority of Singapore to increase institutional participation in infrastructure financing across Asia-Pacific. Established in 2019 with ‘Bayfront Infrastructure Capital (BIC) I’ as the inaugural pilot issuance of USD 458 million, Bayfront has since continued to issue BICs II, III, and IV. Bayfront focusses on acquiring brownfield project finance and infrastructure loans from banks, whilst building a ‘warehouse’ of loans with sufficient scale and diversity to later be securitised for distribution.

Since BIC II, each issuance has also featured a dedicated sustainability tranche and BIC IV – issued in September 2023 – saw GuarantCo’s participation for the first time, via the guaranteeing of the mezzanine (Class D) tranche. This was the first time an IABS featured a guarantee and further demonstrated Bayfront’s and GuarantCo’s capacity to continue innovating the IABS model. BIC IV was also Apollo’s first investment in an IABS issuance from Bayfront thus supporting the thesis that guarantees expand the investor universe for IABS issuers.

The regulated nature of IABS, reinforced by the rating of senior notes and listing through exchanges, provides investors an instrument which is more liquid compared to investing in the underlying loans. Typically, the bulk of secondary market trading in infrastructure loans is through bank-to-bank syndications. Investors further benefit from participating through IABS by leveraging the credit risk/underwriting capabilities of the Sponsor coupled with ongoing portfolio management support over the life of the notes. Lastly, the customisable nature of IABS allow for tailor-made solutions for investors with different risk appetites and investment horizons, thus facilitating the ‘right placing’ of capital between parties.

Conclusion

Private sector participation is critical to closing the infrastructure funding gap. The private sector continues to be constrained by limited secondary liquidity in infrastructure loan markets. This illiquidity translates to an illiquidity premium, further increasing the cost of funding for borrowers. This can be addressed through increasing the tradeability of bond instruments and/or securitisation structures, which GuarantCo, part of the Private Infrastructure Development Group, has been able to support through its Pran and Bayfront partnerships, and aims to continue developing in the future.

Secondary market liquidity is an indicator of the development and sophistication of a market; given the long-term (10-25+ years) of infrastructure loans, providing a suitable exit point for all investors will advance said market development. Notwithstanding the predictable nature of repayments under infrastructure loans (and particularly structured notes backed by these loans), improving the route to exit and their tradability frees up capital for new investment opportunities. This capital recycling can occur at two levels: (i) in the portfolio construction for IABS, whereby banks can recycle capital into new loans or (ii) through investors holding secondary loans (directly or under an IABS) who can on-sell the loans or notes, receiving cash for new IABS issuances or loan participations. These capital flows can in turn be directed into the most in-need markets through credit enhancement solutions as offered by GuarantCo, part of the Private Infrastructure Development Group.

^[1] Bridging the trillion-dollar infrastructure gap in Asia Pacific, PwC, 2022 and Institutional reforms: The critical factor to attracting infrastructure investment in Sub-Saharan Africa, World Bank Blogs, 2023

^[2] This transaction also demonstrates the power of replicability, further discussed by Mohamed Massoud in GuarantCo Blended Knowledge.

^[3] Institutional investors essential to closing the infrastructure funding gap, GuarantCo Blended Knowledge, 2023