The transport challenge

Investing in transportation infrastructure in China is difficult. But the returns are also potentially compelling, provided you know what you’re getting into writes Chris Josselyn.

THE OPENING OF the Hangzhou Bay Bridge linking Shanghai and Ningbo in May 2008 was an important milestone for Chinese infrastructure. Not only is the 36-kilometre cable-supported structure the longest sea bridge in the world; it also benefited from one of the largest ever injections of private capital into a Chinese infrastructure project. Almost 30 percent of its RMB11.8 billion (€1.16bn; $1.72bn) total capital cost came from a private sector syndicate led by Hangzhou-based company Songcheng Group.

As the Chinese government moves to convert the fruits of the country’s export-led GDP growth of the past 25 years into improved infrastructure for its 1.3 billion inhabitants over the next few decades, the successful financing and delivery of these colossal projects are high on the agenda of the People’s Republic.

Last November China’s state council, the highest decision-making body in the country, unveiled its economic stimulus package, which will inject RMB4 trillion (€396 billion; $586 billion) into the Chinese economy over the next two years. Of the total package, a remarkable RMB1.52 trillion (€150 billion; $222 billion), or 38 percent of the stimulus, is being dedicated solely to investment in transport infrastructure. With the spectacular transformation of road, rail and airport facilities in capital Beijing and largest city Shanghai already executed, China has demonstrated it possesses the engineering skills to develop infrastructure on a massive scale, as it attempts to build networks to keep pace with its economic and demographic growth. The challenge now is to apply the lessons learnt across the entire country.

In addition to state participation, there are increasing opportunities for private investment in infrastructure projects and assets in the country. Transportation is a particularly fertile field, with a host of large- and medium-sized projects being spawned to link China’s towns and cities. And infrastructure investors are drawn to the opportunities these projects offer.

“The earnings performance of Chinese airport and toll road investments has continued to grow throughout the financial crisis, evidencing a correlation with the country’s GDP growth. Given China’s forecasted GDP and household disposable income growth, these sectors continue to present exciting investment opportunities,” says David Russell, head of private equity for Asia and Greater China at Macquarie Group, which recently launched two Chinese infrastructure-focused funds in partnership with Hong Kong-based China Everbright.

In the roads sector alone, China’s National Expressway Network Plan has pledged that the country will build 51,000 kilometres of expressway before 2030. According to a study by academics Wang and Lv in 2007, the government is only able to provide 40 percent of the required capital for this plan. The contribution of private capital seems pivotal therefore.

However, despite this opportunity, China can still be a tricky market for non-domestic investors to establish a footing: “China is tough. Unless you’re Chinese, or extremely well connected, it’s still very difficult to do business there,” according to one senior PPP specialist at a global infrastructure investment group.

Nonetheless some international investors – such as Macquarie – are ready to meet the challenge. The past year has seen the emergence of a number of new funds, several with a China-focused mandate, others with a broader Asian remit.

It is significant too that major domestic sources of institutional capital have started to declare allocations to infrastructure. In September, for example, Chinese insurance giant China Life announced it is expanding its investment portfolio to include the asset class.


Macquarie launched its two Greater China-focused funds in conjunction with Everbright in August of this year. The funds have a combined target size of $1.5 billion and both will have a significant exposure to transport, in the toll road, rail, port and airport sectors. They will also be targeting investments in water, wastewater and renewables. All these sectors have been classified as “encouraged” under The Catalogue of Industries for Guiding Foreign Investment published by the Ministry of Commerce and the National Development and Reform Commission (NDRC), the two key national regulators.

The first fund will be open to non-domestic, non-retail investors targeting Greater China core infrastructure opportunities whilst the second fund will be a domestic investment vehicle admitting Renminbi investors and is subject to PRC law and approvals. The plan is for the two funds to co-operate and invest alongside each other and have identical mandates.

The funds will be managed by Macquarie and Everbright through jointly owned asset management companies. The firms are jointly committing $100 million to the funds, which are expected to reach first close next year. Fundraising is thought to be slightly ahead of schedule.

Another example, albeit on a smaller scale, of a China-focused international manager is London-based PSource Capital, a subsidiary of financial services group Punter Southall. The firm is offering its PSource China Infrastructure fund, focusing on build-transfer (BT) projects in the Chinese road transport sector.

The $200 million fund will invest in 7-year Build-Transfer schemes, a kind of deferred-payment construction arrangement, which typically comprise a 3-year construction phase followed by a 4-year repayment period, with the government providing a cash exit at the end of each project’s life period. The fund will have a standard 2 and 20 fee structure and has a projected IRR in excess of 20 percent, according to marketing materials for the fund.

“We are targeting relatively simple projects in roads, bridges and tunnels throughout China’s secondary cities,” says Soondra Appavoo, managing director at PSource and a non-executive director of the fund. “We are not going for the huge glamour projects in the biggest or richest cities that just get snapped up by state-owned companies” he added. These second-tier cities include Shenyang, Guilin and Chongqing, each one a regional industrial hub.

PSource, which also manages a listed structured debt fund, started marketing the fund earlier this year. At the time of going to press it was understood that first close of the fund is being targeted before the end of 09.

Other funds of note which invest in Asian infrastructure with a significant, though not exclusive, allocation to China include JP Morgan Asset Management’s $1.5 billion Asian Infrastructure & Related Resources Opportunity Fund, as well as AMP Capital Investors’ $750 million Asian Giants Infrastructure Fund.


It has become something of a cliché that non-domestic investors have to tread carefully when investing into China, and in relation to infrastructure, many believe the return premium required still needs to be compelling. Says one foreign fund manager: “A Chinese toll road should be paying the same as a US toll road, plus a premium for the sovereign credit risk, then a further premium for the regulatory risk.” The implication is very much that China remains an opaque market, where the ill prepared or ill advised can founder. 

Partnering with a local – and probably state-controlled – company that has the know-how to navigate the at times hard-to-chart waters of infrastructure development successfully in China can therefore be crucial when investing in the country.

Macquarie is a case in point. Few were surprised that the firm sought a local partner and the selection of state-owned fund manager Everbright looks an astute one.  Everbright is the Hong Kong-listed fund management business of financial conglomerate China Everbright Group. It is part-owner of mainland-based brokerage firm Everbright Securities and of commercial bank China Everbright Bank; it also has broad and deep connections across the country’s public and private sectors.

Similarly, PSource is working in collaboration with Nanjing-based unlisted Chinese construction group Pacific, a transport infrastructure specialist and the only non-state-owned firm with a national construction licence, according to Appavoo.

Investors in Chinese infrastructure through dollar-denominated funds face a specific set of challenges – “China risk” as Psource’s Appavoo collectively terms them.

One of these is currency risk – the danger that the renminbi will depreciate dramatically against the US dollar. While analysts generally agree that the Chinese currency is set to appreciate gradually over the next few years, exchange fluctuations remain a concern for those looking to bring in foreign funds to invest in RMB-denominated projects or assets.

Of course, currency risk is not unique to Chinese investments, but is inherent in any foreign project where the local currency is not dollar-pegged. Furthermore, investors can hedge against this according to their risk appetite.

Another risk is the ability to exit an investment fully and cleanly, something that has caused concern amongst foreign investors looking at China in the past. The NDRC has recently created new rules governing foreign investment in the country, taking what some fund managers see as a more free-market approach. In September this year, the NDRC submitted draft rules to the state council which proposed lower taxation and less-stringent licensing obligations, which, if approved, could make exiting investments and repatriating capital an easier process for non-domestic investors. It is notable too that the NDRC has instituted four categories of regulation for assets, ranging from “encouraged” all the way down to “prohibited”. Most core infrastructure lies in the “encouraged” category.

The levels of permitted foreign ownership for transport assets vary. With toll roads for example, foreigner investors are permitted to own 100 percent of the asset. Airports, on the other hand, are restricted to 49 percent being owned by a foreign entity. China’s Port Law of 2004 also provided legal and regulatory support and protection for foreign investors to take part ownership of ports. The broad message here is that foreign ownership of infrastructure assets is being recognised and formally incorporated into statute.

“At least at a local government level, China appears receptive to foreign fund managers – and some LP money – investing in its infrastructure,” says Fred Chang, a partner at law firm Lovells in Hong Kong who focuses on private equity and leveraged and acquisition finance. “One reason for this is the credibility some of these big-name foreign investors give the local authorities in their fund-gathering.”


Despite the challenges facing foreign investors in Chinese transport infrastructure, the outlook is encouraging. Given that the state is unable to finance all its road, rail, sea and air ambitions by itself, it will either have to downsize its plans (unlikely) or enable private investment to play a more significant role. 

The surfacing of a handful of China-focused infrastructure funds already is a positive sign, as are the Chinese authorities’ steps to, albeit slowly, alter regulatory frameworks in order to accommodate heightened foreign ownership of key transport infrastructure.

“The fast growing market and enhanced business and institutional environment provide great chances for foreign private transport infrastructure investors and developers to enter the Chinese market,” according to Dr. Chuan Chen, a lecturer in construction management at the University of Melbourne and an expert on Chinese infrastructure financing.

In the meantime all eyes will remain on the first movers. How they fare will show whether or not China is ripe for more foreign infrastructure investors to move in.