In the pipeline

The infrastructure debt fund market has grown significantly since the Crisis, but where are players finding opportunity? Vicky Meek investigates

With around $50 billion of infrastructure finance required by OECD (Organisation for Economic Co-operation and Development) countries over the next 20 years, and a funding gap of around $1.5 billion a year, it would seem that infrastructure debt funds have plenty of opportunity coming their way. This is particularly the case when the retrenchment of more traditional forms of finance – historically provided by the banks – is taken into account.

This form of private debt capital has flourished during the post-crisis years, as institutional investors have sought yield in a low-interest-rate environment. This trend has been buoyed by the actions of European policymakers, which have sought to encourage infrastructure allocations among insurance companies through a lower risk weighting for infrastructure investments under Solvency II. There are also signs that some Asian markets are travelling in a similar regulatory direction, with an emphasis on asset-liability matching.

Investor confidence

Many in the market suggest investors have become comfortable with the risk-return profile of infrastructure debt relatively quickly.

“Infrastructure debt has become an accepted part of many institutional investor portfolios, with investment-grade opportunities increasingly seen as an alternative to corporate bonds,” says Tim Humphrey, managing director at Macquarie Infrastructure Debt Investment Solutions (MIDIS). “In addition, with a number of leading managers having built up a track record over the past five or so years, investors are now allowing them more discretion to capture opportunities – previously, there was very much a domestic bias and a heavier focus on financing investment-grade companies.”

For their part, equity funds have also embraced infrastructure debt as a flexible source of capital for their deals. “Infrastructure debt has become an established part of the financing landscape among sponsors, who were previously more used to dealing with the banks,” says Kit Hamilton, head of the MIDIS investment team. “The increased familiarity with the asset class among funds means that they are now building investment cases around what infrastructure debt providers can offer.”

European focus

Europe leads the way in this market, accounting for nearly €85 billion of the global €230 billion invested in 2017, according to the Thomson Reuters Project Finance International league tables, which include bank financing. Here, infrastructure debt fund activity has focused largely on the renewables space, with offshore wind, waste-to-energy and solar projects in the UK, France, the Netherlands, Spain and Italy among the more active markets.

Higher pricing, driven by liquidity in the market, has led to increased M&A, with European deal values rising 75 percent between 2010 and 2016 and volume by 196 percent over the same period, according to White & Case, while refinancing activity has also kept the debt funds busy.

Nevertheless, some are concerned about the lack of greenfield projects in the pipeline in Europe. “Much of the infrastructure debt investment activity was driven by refinancing and M&A in 2017, and I expect that to continue this year,” says Emeka Onukwugha, head of Barings’ private debt group. “There hasn’t been a lot of greenfield in Europe since the financial crisis and the environment isn’t right at this moment – you need bipartisan support to move forward and with many coalitions in Continental Europe and the UK focused on Brexit, it’s hard to get greenfield projects across the line.”

While there are plans for new projects, including road and canal improvement and development PPP projects in the Netherlands and roads, prisons and primary healthcare in the UK, few of these are immediate, with some set to close as far out as 2022. This could well lead to lower deal flow in Europe over the coming years.

“There may well be supply issues in Europe in the future,” says Onukwugha. “Many of the brownfield infra assets in M&A deals are being bought by pension funds and insurance companies today and these investors have much longer investment horizons than the prior private equity investors. Given the lack of greenfield projects at the moment – and it takes a very long time to fill that gap – there will be fewer opportunities to finance in the future. This scarcity is likely to push up prices still more, even in a rising-interest-rate environment.”

US shift?

So, with the Trump administration announcing a $200 billion infrastructure plan, which will cap federal funding at 20 percent, could the US market offer more opportunity? The market is less developed than that of Europe, says Ariel Jankelson, senior vice-president and head of US operations at MIDIS, so there is scope for growth. “The direction of travel in the US is the same as in Europe,” he says, “but it’s not as far down the line. Infrastructure debt as an asset class is growing, but we’re still at the stage where we often need to educate sponsors and investors about its characteristics – that’s largely a function of the product being less prominent and resulting investment volumes not being as high as in Europe.”

To date, most private infrastructure investment in the country has focused on the energy sector, so any plan that widens the scope for private investment is largely welcomed by players, including Jankelson. “Anything that raises the profile of infrastructure is positive and so the Trump administration’s infrastructure plan is to be welcomed,” he says. “We continue to be hopeful that the plan will offer an opportunity to diversify the types of infrastructure asset available for private investment.”

Yet few are pinning their hopes on the market opening up soon. While the Trump plan contains some reforms of the current approval process, including a relaxation of current environmental permitting rules, there remain a number of hurdles to private involvement in many infrastructure projects.

“The need for infrastructure investments in the US is there – everyone agrees on that point,” says Onukwugha. “To move forward, you need a more streamlined approvals process to attract private capital and the political will to make it happen. There are still misconceptions around the benefits of private involvement/ownership of infrastructure assets and so there needs to be education around how private investment works and benefits to the public that has to take place. Florida and California have had some successes here with P3 projects, which can serve as examples.” In Florida and California, P3 projects have centred on road building and improvement.

Federal vs state

It’s also worth noting that President Trump’s predecessor, Barak Obama, also attempted to shake up US infrastructure – to little avail. And there is a distinct feeling among investors that what gets discussed at federal level is often stymied at state level. “The US market has a lot of potential, but it’s such a devolved market,” says Darryl Murphy, head of infrastructure debt at Aviva.

“Infrastructure is driven not only on a state-by-state basis, but also at municipal level in many instances, making it highly fragmented. The US has also yet to answer the question of how taxpayers can pay for any infrastructure investment – what’s the right mechanism? Those looking outside Europe tend to be more comfortable in Canada and Australia, where the infrastructure financing market is more developed and more similar to that of Europe.”