(Jin Mikami, CC BY-NC-ND 2.0)
Turning infrastructure into a new asset class is expected to help. Activities undertaken by a number of international institutions, such as the G20 and OECD, as well as AIIB, are heading in that direction.
Global infrastructure needs
The development of the global economy requires creation, expansion or reconstruction of infrastructure in developing countries. This applies to both economic infrastructure, covering areas such as energy, transport, water and sewage systems, and social infrastructure, schools, hospitals, etc. The World Bank estimates that around 1 billion people worldwide still live more than 2 kilometers away from a road that is motorable all year round, while another billion have no access to electricity, and 4 billion lack access to the internet.
Due to the enormous needs in this regard, the scale of the required investments is huge. The United Nations Conference on Trade and Development (UNCTAD) estimates that infrastructure investments will make up 41 per cent of the overall costs of implementing the Sustainable Development Goals (SDGs), adopted in 2015 with a completion deadline set in 2030. According to estimates by UNCTAD and the International Monetary Fund (IMF), investments worth USD1.3 trillion annually are required in order to achieve these goals in the area of energy and transport alone. The latest analyses of the World Bank indicate that low-income and middle-income countries should be spending between 2 and 8 per cent of their GDP on infrastructure.
One indication of source of infrastructure financing is the assets held by institutional investors, in particular pension funds. The cumulative value of these assets is estimated at approximately USD80 trillion. Due to their long-term nature, investments in infrastructure may be attractive for pension funds, since they hold long-term liabilities and are thus able to make long-term investments. However, according to OECD data, only approximately 1 per cent of institutional investors’ is directly invested in infrastructure. At the same time, research conducted by Global Infrastructure Hub–EDHEC shows that a vast majority of such entities (90 per cent) plan to increase the value of their investment in infrastructure. The establishment of infrastructure as a fully-fledged, separate asset class is to ensure that investments in this sector are more easily available to potential investors.
What is an asset class?
An asset class is most often defined as a type of investment that has similar characteristics, as well as profit and risk profiles, and behaves in a similar manner but at the same time differently than other assets in similar market conditions. They are also often (but not always) subject to the same laws and regulations. The classification of assets helps investors to diversify their investment portfolios, which allows them to reduce risk and increase the likelihood of profits.
Asset classes traditionally include securities (stocks, bonds, derivatives, etc.) and cash, real estate, raw materials (e.g. precious metals). Some also classify works of art, cryptocurrencies, and even postage stamps as separate types of assets. Infrastructural investments are also increasingly often treated as an asset, new or alternative asset class, providing new sources of profits and greater risk diversification.
Debate on infrastructure as a new asset class
Infrastructural investments have some of the features of a separate asset class. Such authors as Georg Inderst or Krzysztof Marcinek have identified the distinctive features of infrastructural assets:
- high barriers to entry (large capital outlays, a tendency for natural monopolies to emerge) and barriers to exit in a timely manner and/or on favorable terms;
- large scale of the investment (in terms of capital employed), which also implies a longer period of time necessary for the disposal of these assets, and thus low liquidity;
- resistance to stages of the economic cycle (low flexibility of the demand for infrastructure services resulting from the fact that they are necessary even during an economic downturn);
- stable periodic cash flows (often ensured by contractual provisions or other legal regulations);
- relatively low correlation with other asset classes, as a result of which — at least for some investors — infrastructural assets enable a diversification of investment portfolios;
- long average lifespan of infrastructural assets (approximately 60 years on average, while concession periods can reach up to 99 years).
On the other hand, it is emphasized that infrastructural investments are characterized by great diversity, because infrastructural objects themselves are very diverse, even within the same type of infrastructure. To this day, there is no universally accepted definition of infrastructure. Additionally, we are dealing with a growing number of increasingly diverse instruments used to finance it. Moreover, the profit and risk profiles for various infrastructure investments are more varied than in the case of traditional asset classes. Finally, there is relatively little reliable data concerning the performance of infrastructure investments.
Activities within the G20, OECD and AIIB
Several international institutions have recently launched efforts to develop infrastructure as a separate asset class. The report entitled „Breaking silos. Actions to develop infrastructure as an asset class and address the information gap. An agenda for G20”, published in December 2017 by OECD, contained specific suggestions for activities in this area, including on the international arena, especially within the framework of the G20. These suggestions primarily related to:
- mapping the channels/instruments for infrastructure financing and the risks related to infrastructure investments;
- increasing the availability of reliable data and information at project and company level, and the transparency in the valuation of infrastructure assets;
- mobilizing private sector investment in developing countries, among other things, through more accurate tracking of financial flows and the creation of new financial instruments.
At the beginning of 2018, the OECD in cooperation with the World Bank and the G20 also carried out a review of existing initiatives (tools, instruments, standards) conducive to the development of infrastructure as a separate asset class. These initiatives relate to political and macroeconomic issues (policy frameworks, finance, management, environmental protection), project management (planning and prioritization of infrastructure investments, project preparation), as well as data collection and analysis. Some of these initiatives relate solely to infrastructure, while others relate to more broadly defined investment or business conditions, indirectly affecting the chance of success in infrastructure investments. Particularly noteworthy examples include, among others, the principles pursuant to which private sector entities operate in the area of infrastructure, the good practices in the strategic planning of infrastructure development, or the principles of long-term financial investment of the institutional investors.
During the meeting of G20 finance ministers and central banks’ governors, held in Shanghai in February 2016, the leaders concluded that it was necessary to promote the development of infrastructure investments as an asset class. A road map was developed during Argentina’s presidency in G20 (in 2018). It was approved by the Group’s finance ministers and central banks’ governors in March 2018. The road map is intended to help in reducing barriers in this area, which include the heterogeneous nature of infrastructure assets, the lack of a critical mass of bankable projects, and the insufficient access to data enabling investors to track the performance of these assets. The activities planned within the road map are oriented towards greater standardization and encompass two areas:
- Improvement of the project development process. This involves greater standardization of contracts and tender documentation, unification of financial clauses, as well as the methodology of project preparation and the related technical assistance.
- Improvement of the investment environment aimed to make it more conducive to development of infrastructure. Actions in this area primarily involve creating appropriate and effective legal, regulatory, tax and accounting frameworks, as well as taking steps to ensure that domestic capital markets are deep and liquid.
The Asian Infrastructure Investment Bank (AIIB), whose mandate directly covers infrastructure financing, has approached this issue from a purely practical angle. In December 2018, the AIIB’s Board of Directors approved a project entitled „AIIB Asia ESG Enhanced Credit Managed Portfolio”. The objective of this project is to establish infrastructure as a separate asset class, to create a debt market in Asia and to mobilize financial resources for the development of Asian infrastructure. As part of the project the AIIB will assign USD500m for the purchase of bonds (ordinary or green ones) issued by enterprises carrying out infrastructural investments in the region of Asia, while simultaneously promoting Environmental, Social and Governance standards (ESG). The financial involvement of AIIB will lead to the creation of an investment portfolio which would include companies adhering to the above mentioned standards. This, in turn, would allow for attracting additional investors and, consequently, the mobilization of the funds available in the private sector. This would ultimately lead to the creation of a market and an index of companies involved in the development of infrastructure and adhering to the ESG standards in Asia.
For many years, loans for the development of infrastructure were the exclusive domain of a small group of the largest, international commercial banks. This changed after the financial crisis and the introduction of new regulations (the so-called Basel III). Many investors with long-term assets are now looking for opportunities to invest in infrastructure projects.
Even if infrastructure is treated as a separate asset class, it still remains a very heterogeneous one, for example, when it comes to the risk-return relationship, which is of a fundamental importance to investors. This is one of the reasons why the stakeholders — e.g. the OECD — are pushing for further harmonization of standards and the creation of benchmarks in areas such as project documentation, ESG, cash flow, application of new technologies, etc. There are also recommendations for the development of guidelines concerning anti-corruption measures, risk mitigation, technical assistance, blended financing, etc. It would also be advisable to agree on common definitions and indicators for quality and resilient infrastructure.
The optimal outcome would be the formation of a competitive infrastructural investment market, where prices and risks associated with investments are transparent, allowing investors to assess the risk-return tradeoff. In such a case, each investment would no longer be treated as a separate product, where contractual, institutional, social, and environmental frameworks have to be developed from scratch. Infrastructure investments could then become easier to scale up and to replicate.
The views expressed in this article are the private views of the author and are not an expression of the official position of the NBP.