6.1  SOURCES OF LONG-TERM, LOCAL CURRENCY FUNDING

This section discusses sources of long-term local capital and how to attract such resources to infrastructure.

Local commercial banks-Local banks (public and private) may provide a very convenient source of long-term financing. While often less sophisticated than their global brethren, local banks have more access to local currency. Local banks also tend to be less risk averse when assessing projects in their own country, taking a more pragmatic view of Government and political risk, and having the confidence that local bureaucratic and technocratic challenges can be resolved in a satisfactory manner.

Global commercial banks-Global commercial banks are often more sophisticated, with experience in construction risk, operation of infrastructure and structured finance that will give them a clear competitive edge (though this capacity may be located in other offices and not in the local office). Global banks may also have superior access to the global financial markets, with its deep pools of liquidity and long tenors, well suited to infrastructure finance. Global banks may have local activities, giving them access to local currency liquidity, but generally in limited volumes. There are exceptions where the global bank has a strong local subsidiary or branch, but the local offices of global banks may have competing interests and are unlikely to have serious capacity on infrastructure in the local office, as they will be staffed for local operations. For these reasons, global banks tend to focus on foreign currency finance for infrastructure and are less competitive in local currency finance for infrastructure.

Development financial institutions-External development financial institutions (DFIs), including multilateral institutions like the World Bank and the IFC, and bilateral institutions like Agence Francaise de Developpement (AFD) of France, are ideally placed to support infrastructure finance and are increasingly critical to PPP in developing countries. They tend to have relatively low interest rates, long tenors, and grace periods. In addition to debt, they can also provide guarantees and insurance that may address specific financing risks faced by the project. However, DFI financing tends to be in foreign currencies and can involve additional costs, related to the conditions imposed (such as procurement, safeguards, financial management), complying with DFI practices and the time it takes to access finance.

Institutional and retail investors-Long term liquidity may be available in local currency, in particular from institutional investors like pension and insurance funds. Institutional investors like pension funds would seem to offer an ideal opportunity for infrastructure finance. Pension funds hold large volumes of long-term capital; in most countries they have difficulty finding long-term placements outside of Government bonds and real estate. Long term liquidity may also be available from retail investors, such as high wealth individuals otherwise tempted to move capital off-shore, retirees looking for long term security, etc., in particular where other long-term investment opportunities are not available in local currency. Access to these investors is often facilitated through capital markets.

Debt capital markets-Capital markets often hold depth of liquidity in addition to, and often in excess of, that available from commercial banks. Debt capital markets (through the issuance of debt securities often called "bonds") may provide access to credit at lower interest rates and longer tenors than commercial banks by providing access to retail investors and to institutional investors. However, the financing available through capital markets is often less flexible than the financial instruments available from commercial banks. E.g. they are not designed to provide grace periods (where the lenders agree not to defer payment of debt service during an initial period and instead to capitalise these payments) nor to provide debt in tranches (where the borrower must pay a commitment fee from financial close, but only pays interest once it has drawn down the amount needed), instead under a bond issuance, the project company must borrow the full amount of debt needed at financial close, and pay interest on that full amount until repayment (the extra interest charged for funds not yet needed is called "carry cost"). Also, the most active purchasers of debt securities (i.e. pension funds, insurance and other institutional investors) do not generally have the expert staff and processes of commercial banks, designed to assess and manage risk, and respond to changes and requirements of dynamic investments like infrastructure; and must hire investment banks and other intermediaries to provide such expertise.

Global capital markets-The global capital markets have access to deep and long-term capital, from sophisticated investors likely to be more interested in infrastructure investments. However, these investors are likely to have limited appetite for local currency placements. Even in foreign currency, these investors will be subject to certain limitations on the credit rating of the securities they purchase, in particular the prominence of pension, insurance and other prudential funds in the global markets may limit appetite for anything less than investment grade, or even higher international credit ratings. Global capital markets are unlikely to be a significant source of local currency debt. There have been local currency bonds issued in the global markets (e.g. diaspora bonds), with some success, but usually not in large volumes. These efforts often focus on currencies from countries with large emigrant communities with close contact with their home country and desiring investments in local currency.

Domestic capital markets-Local capital markets have more appetite for local currency positions, and will be less sensitive to political and other country specific risk. However, for the purposes of financing PPP, local debt capital markets often elicit a number of challenges:

• liquidity-local capital markets, in particular in developing countries, often suffer from a lack of liquidity.

•  tenor-infrastructure is best financed with long term debt. Local capital markets will need a robust yield curve, covering the different tenors up through long tenors.

•  familiarity with infrastructure-local investors may not be familiar with the risk profile of infrastructure, and therefore may be particularly risk averse.

•  lack of a yield curve-in sum, there are no comparable financial instruments freely traded in the local market, so no way to set a price.