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RMB Dario Musso

Essential ingredients for private sector investment, by Dario Musso

At Rand Merchant Bank (RMB), we recognise the significant impact that high quality, affordable infrastructure has on stimulating Africa’s economic growth.We have dedicated many years to delivering tailor-made financing solutions for the sector.  This deep understanding and experience allows us to identify some of the key ingredients required to attract private funding for the infrastructure sector in sub-Saharan Africa.  

Investor-friendly and consistent government policy

Infrastructure projects can take years to develop and build, and the financing for these projects needs to be repayable over as long a period as possible to make them affordable.  This means that project developers, shareholders and lenders need to be confident that government policy is well thought through and can withstand political and administration changes over the long term.  A good example of an environment with a clear and reliable policy is Ghana.  The Cenpower IPP project was conceived over 10 years ago by its sponsors.  The project finally reached financial close in 2014 and is scheduled to reach completion later this year.  It was funded by commercial debt (led by RMB), development finance and institutional equity.  Since it was conceived, the country has seen several changes in administrations.  Throughout this period, government policy on IPPs and their role in the Ghanaian generation landscape has not changed materially – and the sector has remained free of political interference.  This obviously helps to encourage investors and lenders to invest for long periods of time. 

Stable and predictable regulation

It is perhaps stating the obvious that a country’s regulation is an important gateway for private sector investment.  To create a fertile environment for investment, lawmakers need to ensure that regulatory regimes cater for free and fair access to monopolistic assets, like electricity grids, generation licences, and rail networks. A country that attempts to protect its state-owned utilities by making it difficult or impossible for private sector competitors to enter the market ends up locking in inefficiencies, stifling competition and ultimately forces its population and businesses to pay more for inadequate infrastructure.  In the electricity sector, several African countries (like Ghana, Nigeria and Kenya) have taken steps to create a level playing field, like disaggregating their state-owned utilities into separately operated generation, transmission and distribution entities, coupled with investor-friendly regulation that encourages long-term private sector participation.  

A creditworthy cash flow stream

This is generally a challenge across Africa.  Many African offtakers for large infrastructure projects are not particularly creditworthy.  For example, state-owned power and water utilities are often heavily subsidised by government because their consumer pricing is typically not cost-reflective and their operations can be inefficient.  Offtakers and their government parents should therefore be open to credit enhancements like government guarantees and/or multilateral agency credit support.  A good example of this structure is the Nigerian power sector.  The Azura-Edo IPP financed by RMB reached financial close in late 2015 and is currently under construction.  The state utility, NBET, is the offtaker and its obligations are supported by a liquidity facility provided by the World Bank, called a partial risk guarantee (or PRG).  The PRG gives NBET access to short-term liquidity to help meet its payment obligations in the event of a cash flow squeeze, thereby avoiding a default under its power purchase agreement.  In addition, the project enjoys Nigerian government support through a Put Call Option Agreement, which protects investors and lenders from termination of the power purchase agreement pursuant to NBET default.

Efficient risk allocation

Any project finance text book will tell you that to get maximum efficiency, project risks need to be contractually allocated to the parties that are best able to manage them at the lowest price.  For example, a construction contractor is best placed to manage on-time and on-budget completion, an operator is best placed to manage the risk of plant performance, and government is best placed to manage the risk of future changes in law. An inefficient risk allocation leads to an inefficient project and has a direct impact on affordability and bankability.  An example of this is Namibia’s renewable energy programme which has struggled to attract long-term commercial bank funding because it offers no protection for future changes in law.

Access to local currency funding

As already mentioned, infrastructure requires very long investment timeframes to make it affordable over its useful life.  If it is to be affordable and accessible to all, it should ideally be priced in local currency.  The challenge in Africa is that local capital markets are generally underdeveloped, making long-term debt and equity simply not available.  This has generally been resolved by funding projects using hard currency such as US$, which then requires repayment also in hard currency. This means that a project’s revenue needs to be in the same currency as, or at least index-linked to the same hard currency.  This leads to the use of that infrastructure being priced in hard currency and exposes its users to long-term currency risk (a user is forced to pay in hard currency or the local currency equivalent).  Linked to this is the fact that the availability of hard currency in local markets can be constrained at times, particularly in countries that have traditionally relied on high oil prices to earn a large part of their hard currency export income.  This puts a project offtaker at risk of default if it simply cannot find hard currency to meet its payment obligations.  This risk is transferred to lenders and investors if offtakes are linked to hard currency but payable in local currency, as they would need to immediately convert their local currency receipts to hard currency, which may not be available at the time.  The only sustainable solution is to promote the development of deep, long and liquid local currency capital markets.  A good example of this is South Africa, where abundant long-term local currency financing for infrastructure is available from local banks and institutions. 

Conclusion

While the above covers a few ingredients for success, there are of course many other pitfalls and challenges to getting an infrastructure project developed, financed, constructed and operated.  The use of experienced and competent advisors, lenders and investors often makes the difference between success and failure.  

At RMB we remain excited about playing a meaningful role in driving Africa’s success through the responsible and efficient financing of the continent’s infrastructure. 

Dario Musso is the head of Infrastructure Finance at Rand Merchant Bank (RMB), a division of FirstRand Bank Limited.

RMB’s Infrastructure Finance unit specialises in funding infrastructure across sub-Saharan Africa. RMB’s expertise spans advisory, structuring, arranging and underwriting of long-term funding for projects covering power, renewables, ports, road, rail, PPPs, telecoms, water and healthcare.  Find out more at: www.rmb.co.za/weFinance_infrastructureFinance.asp

This article is sourced from fDi Magazine
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