From ports to power generation and from roads to rail, improving Asia’s infrastructure is vital to the region’s growth. The challenge, however, is huge. The Asian Development Bank puts the bill at US$8 trillion over the next ten years.
While the global financial crisis did little to change Asia’s infrastructure needs, it did have a crucial impact on its ability to finance them. The size, complexity and long-term nature of projects meant that financing methods included some of the more exotic forms of structuring and securitisation. These were quick to disappear when the credit crisis hit.
Now, although Asia’s recovery has been rapid, credit is still constrained and the appetite for risk reduced. Bond markets remain tough and securitisation is still, to some extent, a dirty word. Banks are being understandably cautious about how they allocate their capital, and corporations are being more careful about everything from buyer and country risk to the wisdom of undertaking new ventures.
As a result, a gap between Asia’s infrastructure needs and the money available to fund them has opened up. Governments, which took the lead in rebuilding trust during the credit crisis, have continued to lead the way. Through their export credit agencies (ECAs), they are able to bridge the funding gap by giving exporters and banks the assurances they need to fund the capital goods that are vital to building first-class infrastructure.
From planes to power turbines, the traditional story has been of US and EU suppliers providing the high-value capital goods required to generate power and improve connectivity in Asia. Now, high-value manufacturing growth in countries such as China and Korea means that Asian ECAs have also played a crucial part in supporting infrastructure growth.
In fact, Asian state agencies have shown great ability to adapt to current trade needs. China’s Sinosure, for example, launched two innovative short-term insurance products recently which allow exporters to go direct to banks like J.P. Morgan to get the necessary guarantees, rather than having to apply first to Sinosure.
However, the real action in infrastructure financing is in longer tenors. Generally, infrastructure means big value projects that will take many years to repay their initial investment. This can create difficulties for Asian lenders, as few local bank markets have that depth of tenor. Western banks, although generally happier with longer tenors, may have other concerns – such as country, buyer and project risk – that need addressing before they are willing to sign-off finance. Into this gap step the ECAs, able to provide the comfort factor that local and global lenders need.
For banks that are more cautious than ever before about how they allocate capital, the terms of an ECA-backed loan are favourable. The risk-weighted assets (RWA) and capital requirements for deals are low, with banks generally at risk on the borrower for a maximum of 5% to 10% of the loan amount with, in some cases, a 100% guarantee by the ECA. Western banks will typically leverage their relationship with the supplier’s national ECA, while a local bank will have appetite for the buyer. This combination of local and global banks will pitch together for the deal with both, plus the ECA, conducting their own due diligence on the solidity of the underlying project.
The attractiveness of these ECA-backed loans has helped to keep pricing low, as have the cross-selling opportunities whereby lenders can offer keen rates in return for a share of a corporate’s FX, bond or cash management business. However, there is evidence that pricing is now firming up as the volume of recent transactions has impacted the demand/supply balance. The fact that many of these deals carry full government guarantees means that they are suitable to be repackaged for distribution to other investors. At present, secondary buyer appetite remains fairly limited though, partly due to historically low pricing. However, with pricing increasing and securitisation coming back on the horizon, we may see the climate changing.
Another factor on the horizon is Basel III. Although its proposals are currently no more than recommendations, they would raise the risk weighting of ECA-backed assets. Higher risk weighting would mean higher capital allocations and therefore far higher pricing for such loans, making them far less attractive. This treatment of guaranteed assets appears harsh, equating them in capital allocation terms with far less secure lending. This would severely impact the ability of governments to provide the vital infrastructure targets that play a central role in economic and social development.
While ECA-backed infrastructure financing covers a variety of sectors – including power generation, ports, telecoms, road and rail – let us focus briefly on the aviation sector. Here airlines face a financing challenge. High fuel costs and increased competition mean the industry is perhaps not at the ideal stage of the cycle to invest in major infrastructure projects. However, airlines cannot afford to get left behind. They must have planes that will meet the future demands of passengers, regulators and business. Here, by enabling ECA-backed, sovereign-guaranteed, long-tenor structured finance, government agencies can step into the financing gap. By helping their airlines to access low cost finance they are ensuring they have the transport necessary to meet future demand.
Our strong relationship with US EXIM and understanding of the business of leading American manufacturer, Boeing, has enabled J.P. Morgan to secure several aviation-related structured trade mandates across Asia this year alone. With major deals in other sectors such as petro-chemicals already mandated or in the pipeline, ECA backing has enabled J.P. Morgan to play an increasing role in Asian infrastructure projects across a variety of business areas.
The right partner
As a US bank with a strong presence in Asia, we are clearly in pole position when it comes to financing the export of US capital goods for Asian infrastructure projects. However,
J.P. Morgan’s global and local connections mean that it has also built a strong relationship with ECAs right across Asia and Europe. This is important because one of the barriers preventing buyers from seeking ECA involvement can be the complexity of the application for and legalities of a deal. Here J.P. Morgan’s advisory and legal support can make a real difference, whether the buyer is supported by K-Sure, COFAX, Hermes or indeed any other ECA. Deciding the best course of action and the right mix of funding is key, and this can only be built out from a strong understanding of individual client needs and aspirations. Appetite is also important. Having come out of the global financial crisis in good shape, J.P. Morgan is able to put its fortress balance sheet to work in Asia.
Will the ECA boom be maintained or will it fall away as credit markets continue their recovery? The answer, I suspect, is both. As liquidity improves and economic growth continues, the demand for ECA-backed finance may weaken. But with a range of economic problems in the West, that outcome is far from certain. And with demand and inflationary concerns also pegging back growth forecasts in Asia, it seems that the need for ECA funding is unlikely to disappear.
ECAs look set to remain the key to unlocking capital for long-term, risk-inherent projects. Only by continuing to provide ECA backing will Asia keep up the pace on building the infrastructure it needs to underpin its long-term growth.
Pravin Advani is global trade executive, Asia, at J.P. Morgan
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