Dec 7,2012 / News / Legal Brief

Around the world, governments have embarked on major infrastructure investments following the global financial crisis and the resultant economic downturn. These initiatives are designed to cushion, if not reverse, the rapid slide into economic recession. Governments are also attempting to fill the gaps that have emerged as banks, other financiers and major equity investors turn off the funding tap for many infrastructure projects.
“Locally, the time is ripe for the injection of fresh life into South African infrastructure investment – but borrowers will have to start looking beyond the banks at alternative sources of funding,” says Richard Roothman, head of Banking and Finance at Werksmans Attorneys.

“Project bonds, an asset class that is still untapped in this country, could be a viable alternative means of financing infrastructure projects,” Roothman suggests. “These bonds allow access to large international pockets of non-bank money and could potentially fill some of the gaps being left by international banks scaling down their involvement in the project finance arena.”

Project bonds are typically debentures used to finance project and infrastructure transactions, and are issued with a long maturity, usually longer than 10 years. This is in contrast to the tenure of five to seven years for corporate bonds and bank loans, the more traditional means of financing projects.

Roothman says the tenure of project bonds would not appeal to all investors but specifically those with an appetite for long-term investments, notably pension funds and insurance firms.

PROJECT BONDS ADVANTAGEOUS FOR BORROWERS AND INVESTORS

At this particular juncture, project bonds could be advantageous for borrowers and investors alike as the capital markets are not contending with the same cost and regulatory constraints as the banking sector.
“Banks need to bear higher liquidity and capital holding costs as a result of Basel III, and this has pushed up the cost of lending,” says Roothman. “Additionally, faced with the Eurozone crisis, European banks’ credit committees have less appetite and are taking a much more conservative approach towards long-term lending.”

While the position of South African banks is more positive, local banks have a clear preference for shorter dated assets, typically of five to seven years, and so are unlikely to step into the funding gap left by international banks.

“Also, the funding available from local banks may be stretched because of demand for financing from bidders in the renewable energy programme for independent power producers,” he says.

“As an alternative source of funding for capital-intensive projects, project bonds are well worth looking at,” says Roothman. “They have been used successfully in markets such as Europe, Latin America and the Middle East. In South Africa, if transactions are properly structured to address the issue of construction risk, there should be significant potential and appetite for project bonds among investors.

Construction risk refers to the initial period when the project is built or constructed, usually the first three years, when the risk to investors is highest because no cash flows are being generated yet and construction could be delayed for whatever reason or ultimately fail.

Roothman says investor concerns about construction risk can be addressed through upfront credit enhancement in the form of subordinated debt, or through guarantees from third parties, whether government or development finance institutions.

“I think there is a place in South Africa for project bonds,” Roothman concludes. “The expertise is available, there must be appetite and there is certainly a need for alternative sources of project finance provided that the bonds are structured in such a way as to minimise investor concerns. Project bonds could supplement existing infrastructure funding and help deliver the growth boost for which politicians and economists are looking at infrastructure investment to deliver. The question is: who is going to be first to test the waters?”