The story of infrastructure financing revolves around varying infrastructure needs—from basic to complex, interconnected infrastructure. And as this narrative develops, it’s becoming clear that by 2030, the additional infrastructure financing required to keep up with projected global GDP growth is an estimated $57 trillion.
Because public finances are overstretched, governments must consider alternative financing models to leverage private capital into infrastructure, along with strategic use of International Financial Institutions (IFI) financing to crowd in private investments. At the same time, developments in global financial markets are fundamentally reshaping how capital is transmitted and invested around the world, including in infrastructure. A key element of attracting private sector debt and equity into infrastructure is to make the underlying transactions commercially viable through clear, transparent Financial Viability Support (FVS) mechanisms.
During the past few years, our Singapore-based team has spent significant time exploring the way that FVS mechanisms can make a difference in PPPs around the world. In the new issue of Partnerships IQ, we discuss in great detail how FVS is being implemented across the globe, and its potential for even greater impact. Here, we’d like to discuss FVS a little more broadly, introducing our ideas for how and where it might operate most efficiently.
What is Financial Viability Support?
There isn’t any one or universally accepted definition of the methods that government use to provide financial viability support to PPPs. Its interpretation and scope varies across countries, which adapt it to the socio-economic and political environment.
Most definitions of FVS describe the direct cash-based support provided by governments ensuring that their public-private partnership (PPP) programs are attractive for private sector financing and investments. Usually this support bridges the shortfall between a project’s revenues and whole-of-life-cycle costs, after providing for reasonable returns to private investors. Typically, FVS mechanisms enhance cash in-flows and project revenues accruing to private investors, or reduce the cash out-flows and project expenses paid by private investors in the project. FVS therefore makes infrastructure projects commercially viable to private investors while managing user affordability.
How to think about the role of FVS in a PPP transaction
Public sector financing support needs to integrate with private capital—equity and debt—in a timely, appropriately-sequenced, and reliable manner to make a deal bankable. At a practical level, this means having a clear understanding of whether and how much FVS is required while maintaining the balance required to classify a PPP as a privately-financed project. Other considerations include at what point in the project it should be injected, whether the government can credibly commit and honor payments, what the performance milestones might be vis-à-vis private equity and debt to trigger FVS flows, and how such support will be integrated into the bid processes.
A bankable deal results in a coherent package that is aligned with the requirements of the project. Such a package would include, inter alia, an appropriate financial structure given the project’s revenue and risk profile, availability, and terms of financing. To examine FVS further, we need to look at three key players in PPP project financing—equity investors, debt financiers, and governments—and how they interact with operational and institutional issues in the public and private sectors. These players are continually adjusting to global and domestic financial and economic conditions, with each of them correcting course in reaction to the market.
Yet, the critical bottleneck is not the availability of finance. Capital has and will continue to flow into appropriately structured deals, provided they are commercially viable. In some markets, it could be slow-moving pipelines or inappropriately structured projects, and not lack of financial market liquidity that has been the key constraint on private infrastructure financing. The important question – amid all of the other questions that are certainly valid -- is what needs to be done differently to ensure that more deals come into the market and achieve financial close.
Asking the right questions
The new Partnerships IQ aims to lay out the operational constraints on government decision-making
and project finance realities that influence private investment decisions. To do this, our team set out to answer three key questions:
- How do you choose an appropriate FVS instrument? What are the key strategic and financial considerations that can inform selection of appropriate models by governments considering PPPs for infrastructure financing?
- How does FVS impact the project finance landscape? How does provision of FVS influence the behavior of debt and equity providers, and their willingness to invest?
Why do commercially viable deals, even when supported by robust FVS financing solutions, not move ahead? What are the operational issues constraining FVS implementation?
To shed light on these issues, our team met with PPP practitioners around the world, recording their responses in a series of formal, structured consultations. Our analysis, grounded in these consultations, provides commentary on various FVS instruments against country snapshots detailing political economy and market conditions. Viewed either in parts or as a whole, these instrument-based summaries and country snapshots present findings that offer a deeper understanding of how infrastructure finance is evolving.
Next generation thinking on FVS and PPPs
The consultations on FVS with PPP practitioners around the world revealed that after a relatively successful run of PPPs, deals reaching financial closure seem to have slowed down in several countries. Key factors appear to have been the liquidity crunch in financial markets and government fiscal constraints in the aftermath of the global financial crisis of 2008, and a continuing lack of government capacity in deal preparation. Indeed, Countries visited appear to be engaged in a period of introspection as they consider the best next-generation version of PPPs and FVS mechanisms that can be integrated with sound project preparation.
Overall, the consultations highlighted the need for governments and private investors to engage in a constructive dialogue in order to identify how, through targeted interventions and support, governments can help improve the risk-reward calculus for private sector investments in infrastructure projects. Financial viability support is and will continue to be an important piece of the puzzle, and those interested in learning more can find Partnerships IQ at the PPP Knowledge Lab.