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The Infrastructure Finance Challenge

Ingo Walter

7. Infrastructure Finance

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1So far, this study has considered generic infrastructure development issues — ranging from greenfield projects in developing countries to the redevelopment and maintenance of aging and obsolete infrastructure in advanced countries — that have significantly hindered economic and social progress. Infrastructure also figures heavily in urbanization, a global phenomenon, and the development of grid-based “smart cities” intended to facilitate the accompanying shifts in both population and economic activity locations. As discussed, infrastructure development issues differ equally dramatically in areas such as eminent domain, reliance on market versus command mechanisms, bribery and corruption, and the state of civil society.

2We considered the nature of infrastructure projects; some of the uniqueness and challenges in the underlying dynamics, including scale and the role of externalities; and the legal dimensions and globalization of infrastructure activities including sustainability and governance issues. We now turn specifically to project and infrastructure finance — how to link sources and uses of investable funds worldwide to most efficiently finance infrastructure development and maintenance.

3Next, we shall examine two separate issues. First, how can global banking and capital markets provide a cost-effective financial “air supply” for financially viable infrastructure initiatives whilst denying capital to projects that are not viable? Second, how can the financial instruments created by infrastructure finance be placed with institutional investors that are trying to optimize portfolios and meet fiduciary obligations to their own clients?

4To address these questions, we consider the mechanics of project finance and the role of financial instruments and markets, and we explore their debt-like and equity-like characteristics as an asset class. We present some encouraging empirical results on infrastructure financing returns and risks from the perspective of global investors. We also conclude, however, that the techniques and markets needed to transform financing for large-scale infrastructure initiatives into financial instruments suffer from “clogs” that impede progress. New approaches are needed to combine the return, liquidity, and risk attributes that investors and fiduciaries seek in a way that allows infrastructure finance via the global capital markets to reach its full potential.

  • 1 See, for example, World Economic Forum (2014).

5We begin by building on the extensive infrastructure literature that already exists.1

6Infrastructure finance is one of the most complex and challenging dimensions of the global financial architecture. Equity and debt, bank lending and bond markets, foreign exchange and derivatives must all come together in an understandable way in order to unlock the underlying potential of infrastructure projects — and to deny funding for those projects incapable of demonstrating viability. Project returns to investors must account for an array of interrelated risks ranging from completion risk and market risk to sovereign risk and force majeure risk. In addition, the instruments emanating from project financing must fit the portfolio-efficiency objectives of major capital pools worldwide, including bank lending portfolios and the asset profiles of pension funds and other institutional investors.

  • 2 For example, an interesting new financing approach and asset class seems to be emerging in the for (...)

7We aim to combine the foregoing substantive discussion of the role of infrastructure development and its financing at one end of a spectrum with the requisites of investor portfolio optimization at the other. Shortcomings in the global financial architecture that forms key linkages across this spectrum are associated with both explicit costs and opportunity costs that affect economic efficiency as well as growth. Here we explore these shortcomings and attempt to address them through a set of policy-related conclusions. We also provide anecdotal evidence, however, that suggests the financing available today may outstrip the supply of financeable infrastructure projects.2

8Project and infrastructure finance has existed for hundreds of years, mainly in the form of production payment loans and, more broadly, limited-recourse lending. All of the 17th century European trading companies, such as the Dutch East India Company, financed their maritime expeditions by borrowing to underwrite the cost of a specific voyage and then repaying investors if, and only if, the fleet returned and selling the cargo proved profitable.

9Emergence of project financing approaches has differed widely around the world. In the US, for instance, project finance schemes first began to appear for the construction of railroads and other transportation infrastructure in the late 19th century, as well as in the financing of high-risk exploration wells by independent oil companies during the 1920s and 1930s. In the second half of the 20th century, this financing technique evolved and became more widely used in the private sector for many high-risk, capital-intensive projects such as independent power plants, commercial real estate complexes, large oil and gas development fields, and mining.

10Over time, governments also adopted project finance techniques to fund public infrastructure, including toll roads, bridges, tunnels, stadiums, and airports. Many such projects were financed with general obligation (GO) bonds or their equivalent, backed by the full faith and credit of the government sponsor. Increasingly, however, such on-balance-sheet obligations have been replaced by industrial development bonds (IDBs) and industrial revenue bonds (IRBs), specifically backed by cash flows from the underlying project.

11More recently, government budgetary pressures have given rise to various innovative financing structures allowing for a greater private-sector role in constructing and operating large-scale public service projects. Such public-private partnerships (PPPs), pioneered by European governments, took the form of build-operate-transfer (BOT), build-own-operate (BOO), and design-build-finance-operate (DBFO) arrangements.

12In the last 20 years, project and infrastructure finance accelerated and spread from the industrialized world to emerging markets. Both the globalization of the world’s financial markets and the adoption of growth-oriented, market-based economic policies in many developing countries fed this infrastructure finance boom. Foreign-direct and portfolio investors sought out higher-return projects and cross-border exposure diversification in emerging markets, particularly in the energy, power, and telecommunications sectors.

13Meanwhile, deregulation and stepped-up privatizations in host countries broadened the opportunity set for project and infrastructure finance. OECD estimates suggest that more than $400 billion of state-owned assets were privatized in developing countries between 1990 and the onset of the global financial crisis in 2007.

14The infrastructure finance arena has faced some headwinds, such as the 1997–1998 Asian financial crisis, the 2001–2002 global recession, the Argentine sovereign debt default in December 2001, and a general rise in nationalism, punctuated by several high-profile Venezuelan and Russian energy project expropriations. Nonetheless, infrastructure project finance activity has remained robust for decades.

  • 3 Finnerty (2013).

15Project finance is narrowly defined as “the raising of funds on a limited-recourse or non-recourse basis to finance an economically-separable capital investment project, in which the providers of the funds look primarily to the cash flow from the project as the source of funds to service their loans and provide an acceptable return on equity invested in the project”.3

  • 4 For more detail, see Tice and Walter (2013).

16Given the large capital requirements involved, financing such deals typically involves multiple funding sources, usually consisting mainly of debt. Most private-sector infrastructure projects are financed with an average 70/30 mix of debt and equity, compared with a typical 50/50 mix in the corporate arena.4 The debt component of public-sector infrastructure projects is typically substantially higher than for private-sector infrastructure projects, although in some cases (e.g., the Eurotunnel), equity in the project’s special-purpose vehicle (SPV) may be sold directly to public investors with shares listed on stock exchanges. Figure 3 profiles the key contractual and financial components of infrastructure projects.

Figure 3. Prototype Project Finance Structure (Source: Tice and Walter [2014] based on Smith, Walter and De Long [2012])

17Based on this definition, three important aspects of project and infrastructure finance distinguish it from other financing approaches:

  1. The asset being financed is a long-lived capital asset.
  2. The project’s sponsors establish and become principal shareholders in an SPV, thereby de-consolidating the project from their respective public- or private-sector balance sheets.
  3. As a standalone legal entity, the SPV’s debt is structured without recourse to the sponsors, thus preserving their credit quality.


1 See, for example, World Economic Forum (2014).

2 For example, an interesting new financing approach and asset class seems to be emerging in the form of green bonds and other financing mechanisms aimed at tackling green infrastructure, such as watershed protection and storm-water capture, renewable energy microgrids and storage, and sustainable transportation grids in cities. Some of this need will require aggregating smaller units (such as residences) and distributing finance through historically less creditworthy entities.

3 Finnerty (2013).

4 For more detail, see Tice and Walter (2013).

Table des illustrations

Légende Figure 3. Prototype Project Finance Structure (Source: Tice and Walter [2014] based on Smith, Walter and De Long [2012])
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