Bridging the gap | White & Case LLP International Law Firm, Global Law Practice
Africa Focus 2017 Bridging the gap

Bridging the gap

Sources of funding for infrastructure financing in Africa

In October 2014, the Africa Development Bank noted that Africa's 'primary task' was to find ways to plug the annual infrastructure funding deficit. It is nearly a decade since they estimated the financing requirement to close the deficit amounts would be US$93 billion annually until 2020. Finding sources of funding to make up these estimated amounts is clearly key.

While investment in African infrastructure projects has been significant, it has been nowhere near the amounts detailed above. Sources of funding have evolved following the global financial crisis, and commodity price fluctuations have impacted the ability of many African nations to fund their infrastructure development out of national sources.

Private sector financing forms a large part of the answer in closing the funding gap in the form of private equity, debt and the relatively untapped resources of pension funds and capital markets. It now accounts for less than 50 per cent of external funding of African infrastructure products, and a wider range of instruments is being used than before. More sophisticated forms of finance that were previously restricted to developed economies are being deployed in many emerging markets, and Africa is no exception. In absolute and global terms, the amounts being invested may be relatively modest. In terms of the impacts that the investments are having on the target economies, though, they are anything but.

Within Africa, the number and type of projects vary by country, region and sector. South Africa and Nigeria are good examples of the more mature African countries when it comes to investment in and success of projects, and in 2016 South Africa had the highest number of projects in the continent. However, recent years have also seen the emergence of other developing economies in Africa (such as Rwanda) with previously low numbers of projects, which are expected to have much more increased activity and investment in the next five years. There are also, of course, variations by region. It was West Africa which had the highest number of projects (valued at US$120 billion) in total for 2016. Different regions also focus on different sectors, with 33.6 per cent of projects falling in the transport sector, followed by 22.4 per cent in real estate and 21 per cent in energy and power in 2016. All of these trends and variations play a part in deciding which sources of funding are the most suitable and where.

This paper explores the range of funding options available for African infrastructure, including trends, examples, advantages and challenges associated with each.

 

Sovereign debt

Sovereign debt remains a key source of infrastructure financing. A number of African countries have been seeking to find alternative financing measures and, after the global financial crisis in 2008, nearly half of all African countries issued sovereign bonds.

This was because bilateral loans and grants from Europe and the US had dwindled due to global debt problems. Demand for sovereign bonds, especially high-yielding African debt, is increasing with growing activity in debt capital markets across Africa. Sovereign guaranties have been used to protect investors but pose a challenge as many African governments continue to face issues over their creditworthiness and rating.

Examples and trends

  • Republic of Kenya's US$2 billion debut debt issue 2014 — one of the largest- ever debt issuances by an African sovereign issuer. The capital raising comprised two tranches of bonds: a US$500 million, five-year tranche paying an interest rate of 5.875 per cent, and a US$1.5 billion 10-year tranche with an interest rate of 6.875 per cent
  • Federal Democratic Republic of Ethiopia's US$1 billion debut sovereign bond offering (eurobond) 2014. The proceeds will be used to fund planned government capital expenditure in priority areas including industrial zone development and the development of the sugar and energy industries. The 10-year bonds were priced to yield 6.625 per cent
  • The majority of Africa's eurobonds will reach maturity between 2021 and 2025, and Africa holds approximately US$35 billion in eurobond debt1
  • Senegal's 2017 US$1.1 billion eurobond to fund infrastructure projects (including a regional commuter rail project and power projects) was more than eight times oversubscribed

Advantages

  • Ideal for government-funded and owned infrastructure developments, especially those not suited to private ownership or PPPs
  • Proceeds from debt issues can be used to refinance existing public debt. This has been done by Gabon, Ghana and Rwanda, where portions of the proceeds from their debt have been fed back to pay off public debt previously incurred

Disadvantages

  • Tied to the sovereign debt rating, which in most African markets is speculative-grade
  • Sovereign rating caps exist whereby if a country has a particular sovereign debt rating, sovereign bonds can never be rated higher than that, which can prove a real limitation for markets
  • African currencies have depreciated against the dollar and other mainstream currencies, and it has become harder to afford debt servicing costs of the bonds in local currency terms. Additionally Nigeria, Mozambique and Ethiopia are facing foreign currency shortages. So if sovereign bond investments have been made in non-income-generating projects, sustainability of the bonds becomes threatened
  • If the cost of debt rises too rapidly, many African countries could default on debts and therefore jeopardise future infrastructure spending

Current global public debt

    
    

Development finance institutions (DFIs) and International financing institutions (IFIs)

DFIs have long played an essential role in financing infrastructure in Africa with a combination of direct lender and soft and hard tools to attract private-sector investment. DFIs can lend directly to projects and also lend under A/B loan structures whereby they have been able to bring other DFIs and smaller commercial banks into the market, which otherwise may not have previously been able to sustain the associated project and jurisdictional risks.

Since DFIs have a long track record in funding projects that both encourage sustainable development and allow for economic returns on investment, they are persuasive and compelling partners for traditional lenders and are able to take significant political risk. They can offer tools that play a crucial role in risk mitigation in an area where political and economic instability are viewed as investment-hindering factors. DFI backing is still critical in many projects in order to provide confidence to other organisations to invest or for lenders to loan. Traditional DFIs such as the World Bank, the African Development Bank and the European Investment Bank remain important funders of Africa's infrastructure, and this trend is set to continue.

Examples and trends

  • In 2016, IFIs and DFIs funded 13.1% of projects in Africa2
  • The New Development Bank, formed in 2014 by the BRICS nations (Brazil, Russia, India, China and South Africa), will likely also be an important source of funding in Africa infrastructure projects in the future
  • IFIs funded 10.6 per cent of projects throughout Southern Africa in 2016 with African DFIs funding 4.7 per cent3
  • Coal-fired power plant in Senegal July 2013 — Euro debt from African Development Bank and FMO; and XOF debt from CBAO and BOAD. Total debt: US$206 million
  • Gas-fired power plant expansion in Cote d'Ivoire August 2013 – 15-year loans from African Development Bank and Proparco. Total debt: €250 million
  • Power project in Cameroon August 2013 — 14-year loans from AfDB, EIB, FMO, BDEAC and Proparco; 7/14-year CFA franc loans from commercial banks. Total debt €263 million
  • DFIs have introduced a variety of products into the funding market over the last 10 years, e.g., AfDB — single-currency loans, guarantees, risk management products and the introduction of the enhanced variable spread loan product for sovereign guaranteed borrowers. This allows DFIs to relieve pressure on their balance sheets whilst also using their ratings and ability to sustain political risk to tap into other liquidity sources

Advantages

  • Focus on economic inclusion and promoting development through private debt financing of projects. Traditionally more willing to take risk than commercial banks so able to enter markets where others cannot
  • DFIs can operate on a 'first loss' approach. This means that they take the initial risk on loan tranches which helps to encourage other (potentially smaller and less mature) DFIs and banks to join the investments
  • Variety of products— e.g., AfDB introduced single-currency loans to give borrowers the option to choose from a number of currencies, including the South African rand, along with three interest rate bases. Borrowers were also given the flexibility to customize their debt repayment profile with access to annuities, step-up or step-down amortization of principal or bullet repayment. These features enable sophisticated borrowers to profile their loans to fit their specific needs
  • DFIs facilitate the use of interest rate and currency swaps, caps, collars, commodity hedges and indexed loans to enable borrowers to manage risks occurring during the life of a given loan, as borrowers can manage the financial risks and access market-based hedging tools using the DFI as an intermediary

Disadvantages

  • Loans are essentially foreign direct investment for national DFIs and may require reciprocity
  • DFIs may not approve debt financing because of issues, such as dispute resolution provisions, foreign exchange risk and other issues that in their view create unacceptable risk. Many African projects fall into this category
  • The level of cover provided by each DFI varies for each DFI and for each type of risk
  • Often have very strict criteria with regard to issues, such as environmental and social standards that importers must adhere to, as well as an intense focus on anti-bribery and corruption. In developing markets, these standards can often hamper availability of DFI financing
  • Each institution has its own particular requirements, which need to be managed and which may lengthen a financing process

 

Commercial bank debt

Commercial bank lending plays an important role in funding African infrastructure. It can take the form of local and international commercial bank loans. Since the global financial crisis, the European banks have become far less active, and South African as well as Chinese banks especially have been quick to fill the vacuum that they left. Difficulties with commercial bank debt include managing the liquidity requirements of Basel III and other market reforms which have made non-recourse lending, typical for infrastructure finance, very difficult. Lending in Africa is generally coupled with high levels of political risk and thus often prove 'unbankable' for commercial banks alone, therefore leaving commercial banks (and developers) to have to consider ECA or DFI/IFI support to manage the risk.

Examples and trends

  • Standard Bank, based in South Africa, provides financing for energy deals and is currently involved in projects in Ethiopia, Ghana, Namibia, Nigeria, Mozambique, Zambia and Zimbabwe
  • Bank of America announced US$10 billion "Catalytic Finance Initiative" aimed at addressing the lack of available renewable energy investments in 20164
  • London-based Standard Chartered Bank recently agreed to double its funding in 2016 to US$5 billion for USAID's Power Africa initiative, whose aim is to increase access to electricity
  • Rand Merchant Bank, a holding company of FirstRand Bank Ltd. in South Africa, has facilitated US$11.31 billion in African infrastructure projects over the past two decades

Advantages

  • Commercial banks have much greater ability and capacity to raise debt on international markets than government bonds or sovereign debt, and using commercial bank debt can liberate developing countries' balance sheets
  • The syndicated loans market more easily allows for refinancing since syndicates do not impose penalties for early redemption
  • Local market commercial bank debt allows projects to offset certain FX risk. The 'first loss' approach already discussed in terms of DFIs can encourage commercial banks to invest in certain projects, and this, together with offsetting FX risk, can be an ancillary advantage for local procurers

Disadvantages

  • Political risk is a key concern for many commercial banks. International commercial banks have a very low appetite for political risk, and this means that uncovered commercial debt remains difficult. Large-scale projects, therefore, still rely very much on DFIs and IFIs being involved
  • International commercial banks generally only lend in dollars or major currency, meaning that currency risk in African countries is a big issue. Small devaluations of local currency may also need to be guaranteed against
  • Local commercial banks can provide local currency but are constrained by size, certain ratio fulfilments and liquidity costs

 

Export credit agencies (ECAs)

ECAs can provide direct untied financing or can provide guarantees/insurance policies to commercial banks with respect to political and commercial risks. ECAs focus mostly on extractive industries and sovereign deals. ECAs have always played an important role in Africa, which is characterised by extractive industries.

Examples and trends

  • The Chinese have been volume users of ECA-covered financing where Chinese contractors have brought with them huge liquidity with the likes of Sinosure and China EXIM and a raft of Chinese commercial banks behind them

Advantages

  • Designed in order to provide guarantees and mitigate risk in countries where conventional project financing is not feasible in order to allow projects and development. As such, Africa is one of the intended markets for ECA use
  • ECAs are seasoned participants in emerging markets and are less sensitive to political turmoil than commercial banks
  • When lending directly, ECAs can provide longer-term debt than commercial banks. This can increase the viability of a project or increase an importer's debt capacity
  • With ECA cover, commercial bank debt is more price-competitive

Disadvantages

  • Largely depends on the nature of the project. ECA debt has to be used in conjunction with other forms of financing, and is more suitable to certain projects than others
  • Often have very strict criteria with regard to issues, such as environmental and social standards that importers must adhere to, as well as an intense focus on anti-bribery and corruption. These standards can be problematic in developing countries
  • Like DFIs, the level of cover provided by each ECA varies for each ECA and for each type of risk. Level of cover will depend on whether political and/or commercial risk is covered
  • Often developers push ahead with procurement strategies without considering possible ECA involvement in later financing

 

Debt capital markets

Banks are reducing their lending to meet new liquidity standards. The balance sheets of the World Bank and the African Development Bank do not have enough funding available to bridge Africa's infrastructure gap. Against that backdrop, capital markets are an obvious alternative. Except for South Africa, though, to date these have generally not been widely used as sources of project finance in Africa. Most African countries still do not even have their debt formally rated. Yet capital market funding can be ideal for infrastructure development in frontier markets. This is nothing new. For instance, the railways of 19thcentury America were funded largely by bonds. Markets do not impose funding conditionalities in the same way as multilateral development institutions. Properly designed to reduce risk to acceptable levels, the cost of financing through bonds is frequently less than through conventional bank lending.

Examples and trends

  • Nigeria and Kenya have successfully issued infrastructure bonds, thanks in part to the conditions of their markets (corporate bonds are tax-free in Nigeria, for example)
  • Dollar bond offering for Zambia that was upsized from the initial target size of US$500 million to US$750 million and was hugely oversubscribed. International capital markets represent the largest pool of funding

Advantages

  • Large-scale finances can be raised on capital markets compared to the liquidity available from commercial banks, ECAs or DFIs, all of which are limited by how much capital they have
  • Bond investors offer long maturity and attractive pricing along with accessing a large pool of money
  • There is a strong appetite for sovereign risk in the global capital markets. Developed market bond yields are low and subject to significant risk, and African countries' credit profiles have improved significantly on the back of high GDP growth rates
  • Covered bonds which are securities backed by a pool of loans could be used. These stay on the credit issuer's balance sheet and ensure there is still 'skin in the game'. They offer double-recourse to the issuer and a diversified pool of loans can mitigate losses in the case of project defaults. North African countries are beginning to take steps to create a regulatory environment more conducive to such bonds, but such an environment was rejected by South Africa

Disadvantages

  • There are key challenges, including identifying sufficient liquidity at the requisite tenor, structuring a cash profile to best match investments and achieving a strong rating from a recognised agency, with sovereign ratings often acting as an effective cap of what the market can offer or sustain
  • International investors typically lend in US$ or €, which creates significant currency risk for the issuing country
  • Bond investors find it very hard to take construction and project completion risk, and a single-issuance bond can offer challenges for developers as well in terms of negative cash carry. In developed markets, innovations are taking hold to provide for greater scope for collateral management and deferred drawdown, but ultimately the rating of the underlying project remains key unless a creditworthy corporate/sovereign can be seen as the key credit

 

New sources of debt: Islamic finance institutions

Islamic banking is a form of financial intermediation based on profit and loss sharing and the avoidance of interest rate-based commitments and contracts that entail excessive risks and finance activities prohibited under Islamic principles. Both Kenya and South Africa, for instance, have introduced measures to encourage Islamic finance. Lessons on its application to infrastructure projects may be learned from projects in the Middle East or even further afield (e.g., Malaysia.)

Examples and trends

  • Islamic finance in sub-Saharan Africa remains small but has the potential to grow given the region's demographic structure and potential for financial deepening By the end of 2012, many Islamic finance institutions —comprising commercial banks, investment banks and takaful (insurance) operators —were operating in Africa
  • Sukuk bonds, which accounted for nearly US$120 billion in 2013, have increasingly become a popular vehicle for infrastructure financing, including by sovereign wealth funds5

 

New sources of debt: Private equity and pension funds

Most major private equity firms include infrastructure funds in their portfolios, but very few infrastructure-focused funds exist in Africa. They could serve to bring much-needed regional expertise. Infrastructure-focused funds could also provide longer-term capital, helping to facilitate an exit for the initial project sponsor. In providing an alternative platform for liquidity, the funds could function as a synthetic capital market. Additionally, pension funds and other institutional investors find that long-term infrastructure investments tend to be a good fit.

Examples and trends

  • Between 1989 and 2014, the US government's development finance institution invested more than US$1.2 billion in private equity funds across sub-Saharan Africa6
  • By 2015, pension funds in 10 African countries already had US$379 billion in assets under management — 85 per cent of that based in South Africa7

 

New sources of debt: Sovereign wealth funds (SWFs)

SWFs are investment funds that:
• Are owned or managed by a government
• Are managed with long term perspective and
• Follow investment policies driven by national objectives such as economic stabilisation, diversification or investment for future generations

Examples and trends

  • According to the Sovereign Wealth Fund Institute, there are currently 80 active SWFs in the world with more than US$7 trillion of assets under management. Africa is home to nine of those with a total of US$89.03 billion in assets under management. The first African SWF was the Pula Fund, which was founded by Botswana in 1994 and has US$5.7 billion in assets under management today. The largest is the Libyan Investment Authority, with US$66 billion in assets under management7

Country

Name

AUM (US$ billion)

Established

Origin

Libya

Libya Investment Authority

66

2006

Oil

Algeria

Revenue Regulation Fund

7.6

2000

Oil & gas

Botswana

Pula Fund

5.7

1994

Diamonds & minerals

Angola

Fundo Soberano de Angola

4.6

2012

Oil

Nigeria – Bayelsa

Bayelsa Development and Investment Corporation

1.5

2012

Non-commodity

Nigeria

Nigerian Sovereign Investment Authority

1.4

2012

Oil

Gabon

Gabon Sovereign Wealth Fund

0.4

1998

Oil

Mauritana

National Fund for Hydrocarbon Reserves

0.3

2006

Oil & gas

Equatorial Guinea

Fund for Future Generations

0.08

2002

Oil

AUM = Assets under management. Source: Sovereign Wealth Fund Institute

    
    

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1, 2 & 3. Source: Deloitte (Africa's changing infrastructure landscape, 2016)
4. newsroom.bankofamerica.com/press-releases/corporate-and-investment-banking-sales-and-trading-treasury-services/bank-america-ann
5 Source: World Bank. pubdocs.worldbank.org/en/199731442253296403/FS-Gemloc-PGD-Minutes-June-3-2014-fin.pdf
6. Brookings Institute
7. Ashiagbor, D., Satyamurthy, N., Casey, M. and Asare, J., 2014. Pension funds and private equity: unlocking Africa's potential. Making Finance Work for Africa, Emerging Markets Private Equity Association. London.
8. Sovereign Wealth Fund Institute. swfinstitute.org/sovereign-wealth-fund-rankings accessed on 1 August 2017

 

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