Panelists:
Chong Van Nee, co-head, infrastructure and utilities ratings, RAM Rating Services
Boo Hock Khoo, vice president, operations, Credit Guarantee & Investment Facility
Alejandro Perez, senior investment officer, Indonesia, IFC
Iman Rachman, managing director, investment banking, PT Mandiri Sekuritas
Ezra Nazula, head of fixed income, Manulife Asset Management
Ari Soerono, chief financial officer, Indonesia Infrastructure Finance (IIF)
Valery Tubbax, head of power and infrastructure advisory, Sumitomo Mitsui Banking Corporation
Moderator: Matthew Thomas, contributing editor, Asiamoney
The participants (left to right): Ari Soerono, chief financial officer, Indonesia Infrastructure Finance (IIF); Ezra Nazula, head of fixed income, Manulife Asset Management; Iman Rachman, managing director, investment banking, PT Mandiri Sekuritas; Alejandro Perez, senior investment officer, Indonesia, IFC; Matthew Thomas, Asiamoney; Boo Hock Khoo, vice president, operations, Credit Guarantee & Investment Facility; Valery Tubbax, head of power and infrastructure advisory, Sumitomo Mitsui Banking Corporation; Chong Van Nee, co-head, infrastructure and utilities ratings, RAM Rating Services.
Asiamoney (AM): It makes sense, before even discussing the willingness of bond investors to take on infrastructure risk, to make sure there is enough appetite for duration in this market. After all, infrastructure financing cannot take place in the bond market in any meaningful way unless investors are willing to accept long tenors. What is the appetite for duration like among Indonesian investors at the moment?
Boo Hock Khoo, CGIF: Long-term savings in this country are usually captured in pension funds or life insurance companies. Savings kept within the banking sector are pretty short-dated. This is often the case throughout the region, but the size of the pension fund and life insurance sectors differs dramatically among ASEAN countries. In Indonesia and the Philippines, it is pretty small. In Malaysia, it is very large because everybody who works pays at least 23% of their monthly salary to a fund that can only be withdrawn from when they're 55. That shows it is not just a question of personal savings retirement plans; governments can also have a major impact on the creation of long-term savings in a country to build the much needed capacity to fund infrastructure projects.
This is an area that every government needs to look into. But if you're lacking some of those longer-term savings, you need to look at opening up investment channels to those in countries that do have surplus longer-dated savings and are looking for a home.
Alejandro Perez, IFC: It is important to make it attractive enough for long-tenor investors to buy bonds in this market. The volume of investment needed in Indonesia, and the tenor of these infrastructure projects, require a solution that local banks will not be able to address on their own. The bond market is going to be essential.
AM: How much funding could the bond market realistically provide? Could it take up a big percentage of the more than $400bn of infrastructure financing needed over the next five years?
Valery Tubbax, SMBC: I cannot give an exact answer to that, because it is hard to predict. But I would say that there is a little bit of a chicken-and-egg situation here. By its very nature, infrastructure is an asset class that should attract a lot of demand from institutional investors. And the money is out there. It is actually domestically available, as well as available from offshore investors. The more important factor seems to be how many bankable projects there are.
It is very important to create a strong pipeline of bankable projects. No investor is going to spend time, money and energy just to look at a single project unless there is a credible plan to roll out further projects. There is a question over demand, yes, but there is also a big question over supply. If Indonesia was to put the framework in place to allow those infrastructure programmes to be rolled over, you would create a critical mass of institutional investors that could be used in the future.
AM: That's an interesting point. This brings to mind something that came up in the earlier discussion: the idea that the very notion of 'bankable' projects really differ from lender to lender. Is that also true in the bond markets, or does the relative lack of power of individual bond investors help to equalise standards of what is bankable between different markets?
Tubbax, SMBC: Bankability is a very subjective parameter, but historically the infrastructure markets have been developed first by commercial banks and then institutional investors have followed. The commercial banks will be the first to really decide the standard of what is bankable.
In Indonesia, where some of the projects are supposed to be best-structured, it takes years to reach financial close with commercial banks. It is difficult to see how that will attract institutional investors. Lenders, by definition, have a large team of experts. We look at those projects and we spend a lot of time analysing them and structuring them. As long as we are comfortable with these projects, institutional investors should be willing to follow – but there really needs to be a large enough pool of projects that do not face multiple delays when coming to the market.
Ezra Nazula, Manulife Asset Management: We manage various mandates where there is a requirement to make long-term investments. There is certainly demand from our clients to do that. The duration of the liabilities is quite long, sometimes around 15 years. You really do not find those kind of products in the market. It is, at least, very rare. Even if you buy a 30 year bond, the duration will not meet that and, in any case, that is only an option with government bonds.
Long-term government bonds offer us a yield of around 9%, which is still alright for our investment needs. But Indonesia is improving from a rating point of view and these yields are likely to go down. We are going to need to start finding alternatives. Corporate bonds are a key area of investment for us, but they do not tend to have the duration and, as a result, they do not really meet our clients needs for liability management.
There needs to be a way for us to structure these infrastructure bonds appropriately. It does need to have a very long tenor, but they could have a bullet payment, for instance; they could be zero-coupon bonds. They would enable us to add long duration assets to our portfolio without forcing issuers to sell very long tenor deals.
Iman Rachman, Mandiri Sekuritas: The demand for infrastructure bonds is there already. The issue is about the supply of these bonds and the appropriate structuring. When we start to structure these deals, we have to educate institutional investors on why the structure makes sense. In project finance loans, for example, there is a grace period where no interest is paid. Bond investors expect coupons from pretty much the very start. It is actually not easy to do a zero-coupon bond, as Ezra mentioned, because for very long-dated deals, the company really only receives a small amount of the principal.
These are just some of the issues with regard to the structure that we need to consider. But another issue is the rating these structures will get. Issuers prefer selling stand-alone deals over project bonds at the moment, because they can usually get a higher rating that way. Why bother issuing a project finance bond if the cost is higher because of the lower rating? This is something we are working on with the rating agencies. If a deal has a rating below single-A in this market, it is hard to sell.
There is a lot of education that needs to happen in this market. It makes sense to start with brownfield projects, meaning the construction risk is not there. Investors can concentrate only on the financing risk, not on that initial construction risk. That is going to help the process a lot.
Ari Soerono, IIF: There is demand for long-term assets and there should be a role for the debt capital market to contribute to infrastructure financing in Indonesia. But at the moment, the structural education that needs to be done means there is still someway to go, so I fully agree with the idea mentioned earlier that there should be a hybrid solution.
Rather than financing project bonds, the bond market could instead support intermediary institutions, like SMI and ourselves, which already have the ability to analyse infrastructure projects. Another option is securitisation of our assets, or of a bank's assets. There is also the option that the bond markets can provide take-out financing to mature projects.
AM: Those 'intermediary institutions' that help develop the market could, of course, include guarantors such as CGIF. Is it a viable option right now for CGIF to guarantee the construction period of a project, allowing sponsors to finance their projects on a stand-alone basis later down the line?
Khoo, CGIF: When we guarantee a greenfield project, we take all the risk, so for our risk to fall off after the construction period is fine. The key is that we are able to fully understand the construction risk. Not many projects actually fail due to the fact that they can't be completed. Most contracts are given to respectable parties and there are enough buffers and safeguards put in for delays that make the risks acceptable. If you do everything well, construction risk is not that large a risk compared to demand risk, regulatory risk and other forms of risk.
This is something we're definitely willing to look into. If we're willing to guarantee a greenfield project, then why can we not just guarantee the construction period of a project? If investors want that, and that is going to help develop the infrastructure bond market, it is definitely something we would want to do in the future.
AM: Could IFC do something similar in the rupiah market?
Perez, IFC: We are looking at a similar structure [to CGIF] in Latin American countries, for instance. It is a risk that we have to take anyway when we provide loan financing to greenfield projects, so in theory it should work to guarantee just the construction phase of a project. The catch is that the bond market really needs to be developed before more innovative structures are put in place. IFC is looking at some ways to help achieving just that.
The usual way we attempt to help develop bond markets in many of the countries that we operate in is to issue an IFC bond. We raise our own funds from the bond market, which not only helps the bond market develop, but also allows us to raise long-term funding to use for infrastructure financing. We can turn to the swap market for local currency financing using the funds we raise internationally, of course, but swaps are expensive and you can often only go out to 10 years before you have to reset. We are getting close to getting all the approvals in place to issue a rupiah bond in Indonesia.
We also use partial credit guarantees to help bond markets develop. That is something we have already done in Indonesia with Ciputra Residence. They issued a Rp500bn bond and we were able to guarantee 20% of the risk. We do not tend to guarantee a majority of a bond; we try to provide the minimum required to enhance the credit rating or increase the investor base. In this deal, our guarantee helped them appeal to a lot of new institutional investors.
AM: How important are rating agencies to bridge the knowledge gap for investors?
Chong Van Nee, RAM: Rating agencies have played an instrumental role in building Malaysia's project finance market and, of course, that includes project bonds. We have rated a lot of project bonds in Malaysia and there are a few key success factors that we can identify. The first factor is that there is a wide pool of institutional investors. The second factor is that projects are fundamentally strong, with strong sponsors that have the capacity to pull through that initial risk phase. The project bonds rated by RAM are all highly-rated, because although the risks are there, the sponsors are able to mitigate those risks.
Rating agencies can certainly play a big role in bridging the information gap between investors and issuers. It is natural that when a market is in its early phrases, investors are not familiar with some of the key risks. We play the middle-man role by trying to simplify the process and break down some of the credit linkages to help investors understand project risk better. That is an important element for the development of a project bond market.
Nazula, Manulife Asset Management: When we review a company for us to invest in, the data is usually more readily available and it is more simple than analysing a project. We can look at financial strength, the management, the operating history, and other factors that can help us decide whether an investment is worthwhile. But when we look at a project, it is something we are not used to. The credit rating agencies are definitely important. We have our own analysts that give companies internal ratings, but we certainly use the analysis of rating agencies as a starting point.
It is going to take a shift of resources and perspectives to move from analysing corporate risk to analysing project risk. There needs to be some internal education in terms of how we can best analyse projects on an individual basis, and how we can gauge the best way to price a deal. But we are definitely open to those kind of arrangements.
Rachman, Mandiri Sekuritas: Indonesian investors, especially pension funds, are really dependent on the ratings. Educating them about how ratings work for project finance deals is very important because, as we know, it is not always just a question of the cash flows; it is also dependent on the structure as well. Pension funds are going to represent 30-40% of local investors in project finance deals, so this education is very important.
Soerono, IIF: Rating agencies play a critical role. There needs to be a good dialogue between rating agencies and guarantors in order to get to that level that is needed, whether it is a one-notch or two-notch improvement in ratings. That has to take into account how the guarantee works.
In our case, we disburse the guarantee if there are not sufficient funds to make a payment. That way, we help investors avoid the risk of default. But we also help investors reduce their loss in the scenario of default. Both of these factors need to be taken into account by rating agencies when considering the impact of our guarantee on credit ratings.
Tubbax, SMBC: There is a long history of attempts to get institutional investors to start investing in project finance bonds, because of course many other countries have been through it. I used to work in the UK, where project bonds were an obvious source of financing for PPPs – so obvious that project bonds existed for most of the life-cycle of many projects there. But all this disappeared in 2008. The UK project bond market has completely dried up. This is largely because of the disappearance of the monolines, which were instrumental for the development of the market.
Monolines acted first as guarantors. That was very important because, if we take an Indonesia IPP for an example: the counterparty is PLN, at most PLN is BBB-, you add construction risk, operational risk and financial risk and you easily drop two notches below that. You need this credit enhancement. Monolines used to provide that role in the UK market, and I guess CGIF and IFC are trying to plug the gap here in that regard.
The second way that monolines helped was in allowing institutional investors to implement decisions. They acted as controlling creditors, taking decisions on behalf of investors. That ensured somebody was in control of the monitoring of the project, and upfront about the structuring of the project. That helped create a standard project. Investors did not need to analyse the structure of a bond time and time again. It was like a covered bond – once you have put the work in to understand the structure, it is much easier to understand the next deals. We need to see this gap be plugged in the Indonesian market.
Khoo, CGIF: The role of rating agencies is crucial because it sets the stage for investors to appreciate how much incremental risk they're getting from that of the sovereign risk-free benchmark bond. The first project bond was rated in Malaysia in 1993, and it would not be an exaggeration to say that the success of the project bond market in Malaysia has been largely due to the role rating agencies have played in that market.
Rating agencies need to be part of the development of project bond markets because these markets can be very fragile. It needs to offer sound methodologies and standards. In this space, it is not three strikes and you are out; it is one strike. The agencies really are critical to making sure the bonds that are coming out to the market are of high-quality and acceptable to the risk adverse nature of pension funds and insurance companies.
Chong, RAM: Of course, I absolutely agree with the importance of rating agencies. But one of the things we see that can be done here is that first step that can make it easier for the market to develop. The standardisation of agreements, as Valery mentioned earlier, is really important for the development of investors. For example, when we started rating power project bonds in Malaysia, there were five power purchase agreements. That was a hurdle, but a lot of standardisation was put in place that made investors much more comfortable. That needs to happen here.
AM: How strong is foreign demand for Indonesian infrastructure?
Soerono, IIF: Before the yuan devaluation happened, the interest of foreign investors in Indonesia was strong. There are foreign funds looking into infrastructure opportunities in Indonesia and just waiting for the right projects to come along for them to invest in. But after recent volatility in the currency market, which led to our currency weakening significantly, there is an element of currency risk that needs to be included in the equation much more than it did before. The swap market itself is quite thin in Indonesia, and not very long-term. This is a bit of an issue for those investors trying to mitigate currency risk, and that could reduce foreign demand.
Perez, IFC: On one hand, international investors may be more familiar with project bonds, so that is a factor that would help them lend long-term to infrastructure projects. But on the other hand, the bond market here can fill a gap left by local banks that have limited capacity to lend in the long-term and it can help institutional investors, such as insurance companies or pension funds, diversify their portfolios. It seems to me that the target should be local bond investors for now, allowing foreign investors to help fill the gap when that is needed.
Chong, RAM: Encouraging the growth of sukuk issues would help attract a wider pool of global investors. In Malaysia, there is holistic system to promote Islamic finance, not just sukuk issuances.
Tax incentives have also made it conducive for sukuk. These include tax deductions for issuance costs and stamp duty exemptions, as well as income tax exemptions for sukuk profits earned by investors.
Sukuk transactions are generally perceived to be more complicated compared to conventional bonds. But going back to the earlier discussion, rating agencies can play a role by explaining and providing clarity with regards to sukuk transaction structures and how the credit linkage works.