Part 2: A conversation with Chris Olobo, Investment advisor, PPP transaction advisory, IFC
We spoke recently with Chris Olobo, the investment officer responsible for road project development with the IFC and a speaker at this year’s African Road Infrastructure and Investment Congress.
In part two of this two part series, we talk risk mitigation and pension funds.
What can developers and stakeholders do to enhance their ability to secure funding?
Governments need to understand why the private sector is investing. They want to come in to help – that's true – but they are not a charity.
As government therefore, they need to make sure the regulatory and legal frameworks are unquestionable. They must prove that as government, they can stick to the rule of law and that they respect contracts.
It is really important for government to show that it is ready for business.
Being ready for business is more than just having the required legal and regulatory expectations in place. It also requires government to be fair in how risk is apportioned. Risk needs to be commensurate with the reward that will be given out – that has to be very clear.
Increasingly, if you want to bring the private sector into government projects, you cannot run away from the fact that the environmental and social issues need to be dealt with in accordance with internationally recognised standards. If you aren't following international standards, it is unlikely that serious investors are going to show real interest.
Capital markets are also an area that need to be examined. Stakeholders, such as development partners like the World Bank and the African Development Bank have a big role to play in trying to develop the capital markets. They need to find ways as to how to unlock capital markets.
For instance, is it a situation where the AFDB needs to be providing credit enhancement to pension funds, ensuring that if they invest in a government bond for a road, the bank will stand behind the bond proceeds?
Pension funds are averse to things like construction risk, so the question that needs to be answered is "how can the development partners come in and try and mitigate construction risk?"
In Africa there is an opportunity for people like MIGA, AfDB and the World Bank to put credit enhancement in place that talk to the capital markets.
There is a lot of money lying underutilised in the capital markets. I recently spoke with someone from a government treasury and he was saying that their total pension fund pot is about $10 billion. 20% of that is invested in real estate and almost 70% is invested in treasury bills, government stock – that's a pot of money that could be invested elsewhere.
Unfortunately, the pension funds don't see anywhere else to invest because either they don't understand the risk in infrastructure investment, or they do not have a supporting regulatory environment to support that investment.
In Uganda we are working with MIGA and the AfDB to structure a bond-offering for a toll road. MIGA will come in with their PRI, but they also offer other breach of contract cover which they can deploy. Because MIGA is unable not support local currency, they cannot support a bond which will be offered in the local currency. MIGA can try and attract international or even regional institutional investors, as institutional investors will provide much better terms for money than commercial banks.
The AfDB is trying to support a bond offering in local currency and pension funds in Uganda are very excited because this is an opportunity for them to diversify their assets. However, it needs someone like the AfDB to provide PCGs and work to mitigate the risk away from the capital markets.
A large part of that risk, to be fair, occurs during construction. That's where the biggest uncertainty is and that is where pension funds are very cautious. Construction risk has so many unknowns - you could have escalating costs due to delays or FX fluctuations, there is the potential for the EPC costs to increase between the start date of the project and the end date – and pension funds just don't want to take that kind of risk.
Guarantco is considering supporting a project in Uganda to take on the construction and the refinancing risk on the understanding that as soon as the construction is completed and the project is operational, the pension funds will come in and buy over the debt that was incurred with the commercial banks.
The good thing about that is that commercial banks are very good at assessing short term commercial risk. So, a commercial bank will be able to appraise the construction risk of a project far more objectively than a pension fund. That's their business - short term, high stakes.
It makes sense to involve commercial banks for the risk phase and then bring the pension funds in for the longer term investment of 20-30 years, with no FX or construction risk.
What is the one key message you would like attendees at the Congress to take away with them?
There are many projects which are working toward financial close but how can we collectively put our heads together and pool our resources to make sure that one of these projects actually goes across the line?
It is only when we can have a demonstrated effect that we will see things being unlocked. If we don’t have a precedent set by the next congress, our story becomes weak, and all we are doing is saying the same thing in a different location. We hear about the same projects over and over - we have got to be practical and set that precedent now!