Asia's infrastructure opportunity
Both Japan and China have significantly increased their commitment to invest in Asian infrastructure, but steps must be taken in a number of other areas to unleash the region's full potential.
The Asian Development Bank (ADB) recently estimated that Asia's infrastructure gap could rise to a staggering US$8 trillion by 2020, far higher than current investment levels. The projected shortfall presents an opportunity for Japanese sponsors and lenders to significantly increase their involvement, deepening relationships throughout the region while boosting economic growth at home. Japan is already a major player in Asian infrastructure development through the Japan International Cooperation Agency, the Japan Bank for International Cooperation (JBIC) and the Japan-led ADB.
Japan intends to actively make use of such funds in order to spread high-quality and innovative infrastructure throughout Asia, taking a long-term view.
Prime Minister Shinzō Abe of Japan
Just as China was launching its Asian Infrastructure Investment Bank in 2015, Japan announced broader plans to provide US$110 billion in investment for Asian infrastructure projects over the next five years—a 30 percent increase over Tokyo's past infrastructure funding.
Unveiling the initiative, Japanese Prime Minister Shinzō Abe declared that Japan intends "to actively make use of such funds in order to spread high-quality and innovative infrastructure throughout Asia, taking a long-term view." New legislation is also being implemented to allow JBIC to play a greater role by investing in relatively high-risk infrastructure projects across Asia, and to set up a financing facility. The government's rising commitment is a significant step toward alleviating the Asian infrastructure crisis, says Paul Harrison, a partner at White & Case in Tokyo—especially when coupled with rising commitments from other nations. "However, Japan can do even more to narrow the gap—not just by providing financing but also by working with partners in the region to develop a pipeline of bankable projects," he says. Japan's megabanks have a long track record in financing regional infrastructure. Recent reports suggest that their appetite for cross-border lending remains strong, fueled by low rates on Japanese government bonds, a shortage of investment opportunities in Japan and—at least in the short term—a lack of projects to finance in the oil and gas and natural resources sectors.
But since the financial crisis, increased regulation on Japanese and other global lenders—including tougher capital adequacy requirements and restrictions on tenor, country risk and currency risk arising out of Basel III—may limit the level of investment that megabanks can commit, particularly in the relatively high-risk developing Asian economies most in need of infrastructure investment.
To continue investing within these constraints, the megabanks may need to work more with other Japanese banks that have substantial cash reserves available for increasing project capital, including regional banks and trust banks. This approach has already been put into practice in a number of regional projects, including the recent involvement by 14 regional Japanese banks in a syndicated loan of US$310 million to help build an 80 km stretch of highway in central Vietnam.
Tap the benefits of project bonds
Project bonds can be used to finance investments in a variety of areas, including transportation, communications and energy infrastructure. They also open opportunities to access alternative funding sources such as pension funds and insurance companies.
In 2015, the ADB signed a PPP co-advisory agreement with eight global commercial banks including the Bank of Tokyo-Mitsubishi UFJ, Mizuho Bank and Sumitomo Mitsui Banking Corporation.
Project bonds can be appealing to investors for many reasons. They enable investors to match long-term liabilities to long-term cash flows from projects (maturities may extend to 20 years or more), and project bonds typically offer stable returns at higher rates than similarly structured sovereign debt. Their performance is not correlated with that of other assets, and they offer flexible financing structures that can be adapted to include multiple assets and projects. "In the United States, 20 percent of project funding comes from the bond market," says Rajeev Kannan, general manager of Project & Export Finance with Sumitomo Mitsui Banking Corporation in Tokyo. "To replicate this in Asia, there is a need to educate insurance companies and other institutional investors to foster a better understanding of their benefits."
Instituting a robust, well-defined and fair public-private partnership (PPP) scheme—one that provides for an appropriate allocation of risk and addresses the basic expectations of the investment community—can help infrastructure projects demonstrate that they can generate attractive and secure returns. A well-conceived PPP regime empowers host governments to unlock funds that have been earmarked for Asian infrastructure and to attract financiers to their projects.
"Previously, the PPP model focused on government credit risk," says Hallam Chow, partner in Projects and Infrastructure with White & Case in Beijing. "Now, the focus is more on project fundamentals."
The Association of Southeast Asian Nations (ASEAN) has issued guidelines containing a common set of policy principles to help its member states implement effective PPP laws. "Risks need to be appropriately identified and allocated," says Kannan. "Otherwise, the project will suffer. Determining the risk allocation requires a country-by-country and sector-by-sector analysis." Governments in the Philippines, Indonesia, China, Mongolia and elsewhere have been taking steps to put improved PPP regimes in place. In addition, the Office of Public-Private Partnership (OPPP), established by the ADB in 2014, will prioritize PPP infrastructure projects that involve regional cooperation and sustainable development and address climate change.
In May 2015, the ADB signed a PPP co-advisory agreement with eight global commercial banks, including the Bank of Tokyo-Mitsubishi UFJ, Mizuho Bank and Sumitomo Mitsui Banking Corporation, to accelerate the flow of private funds to critical infrastructure projects in developing Asian countries. Under the agreement, the ADB will work with the banks to provide independent advice to governments on how best to structure PPPs to make them attractive to the private sector and to manage the subsequent PPP bidding process.
"It takes time to institute a proper legal framework," says Katsumi Miyamoto, general manager of Marubeni Corporation. "Marubeni can work with multilateral government agencies (MLAs) and export credit agencies (ECAs) to improve the PPP environment, and ECAs can also guide government officials."
Keys to increasing bankability
In addition to implementing such a PPP model, a number of other strategies can enhance the bankability of infrastructure projects in Asia.
Risks need to be appropriately identified and allocated.... Determining the risk allocation requires a country-by-country, sector-by-sector analysis.
Rajeev Kannan, Sumitomo Mitsui Banking Corporation in Tokyo
Projects can be made more attractive through the involvement of experienced sponsors with an established presence in the region. Many Japanese companies have been active in Asian markets for decades, forging strong local partnerships in the process. As those companies increasingly shift their focus overseas to seek returns that are not available in their domestic market, the opportunities for partnership between Japanese lenders and sponsors are likely to increase.
ECAs also have an important role to play in making projects more bankable. They support the involvement of less experienced players, such as smaller domestic and regional banks as well as lenders in the host country, and they can work alongside host countries on a government-to-government level. "An ability to lend in the local currency of the host county represents a big advantage in the context of infrastructure projects with local currency revenues," explains Hideo Naito, managing executive officer (global head of Infrastructure and Environment Finance Group) at JBIC. "The growing trend to include domestic banks in project financing, with the support of MDBs, ECAs and more experienced international commercial lenders, will facilitate such lending. Some global lenders are also taking steps to grow their local currency lending capacity across Asia."
The long-term success of these efforts will depend on the extent to which host countries can provide a satisfactory investment environment and generate a pipeline of bankable projects that satisfy the commercial requirements of interested investors.
By strengthening existing partnerships in the region and forging new ones with targeted organizations in the right places, Japan will be well placed to maintain its strong position in the Asian infrastructure sector. These strategies should enable Japanese companies and lenders to secure strong returns from their investments, while also helping to improve living conditions and increase economic and political stability across the continent.
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© 2016 White & Case LLP