While commercial banks have been one of the largest supporters of project finance in the past, the introduction of new capital rules (Basel III) will make it more expensive for banks to participate in the market of long-term financing. Therefore capital markets, particularly via institutional investors, are likely to play a more relevant role in the financing of infrastructure in the future. Privately-administered defined-contribution pension funds (i.e., 401[k]-type individual savings accounts for retirement) have become an important type of institutional investor in many Latin American countries. A common error, however, is to assume that these funds offer a silver-bullet solution to PPP-based infrastructure long-term finance.
To be sure, defined-contribution pension funds can be part of the solution (and there is room to improve their role as long-term investors), but they are far from being the whole solution. The main limitation of these funds arises from the simple fact that they are pure asset managers (they do not have a formal liability and, hence, are not asset-liability managers). Although they manage savings for old age, they tend to behave like any mutual fund with shorter-term horizons (with an eye to the next quarterly or monthly report). All the risks are fully borne by the workers that put their savings into these pension funds, and not by the fund managers. Managers try not to deviate from the performance of their peers, which fosters a herding behavior. In all, under current regulations, defined-contribution pension funds do not have an inherent and consistent vocation to invest in truly long-term assets. They invest in long assets only if such assets command high secondary market liquidity (which tend to be, for instance, the case of government bonds). Infrastructure-related financial assets, however, are typically illiquid.
A fundamental solution to long-term infrastructure finance denominated in local currency can come only from well-regulated (prudent) institutional investors that have formal long-term liabilities and, hence, are systematically in need of long-term assets to match their liabilities. This is the case, for example, of life insurance companies that sell fixed annuities to retirees. These institutions are dedicated long-term investors because they have a contractual obligation to provide a fixed stream of payments to individuals for many years after retirement. Hence, infrastructure bonds can easily prosper in the context of a national financial system that has this type of dedicated long-term asset-liability managers. In most of the Latin American countries with defined contribution pension funds, annuity providers are incipient and face regulatory challenges that inhibit their development.
Engaging defined contribution pension funds in long-term bonds, including infrastructure bonds, is not impossible, but it would require regulatory changes that induce pension funds to operate with longer investment horizons. For example, regulations can be amended to measure the performance of a defined-contribution pension fund against long-term benchmarks commensurate with the long-term nature of savings for old age, rather than against short-term indicators (e.g., the average performance of the industry) as is typically mandated in many Latin American countries today.8
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8. See De la Torre, A. and H. Rudolph (2015). "Sistemas de Capitalización Eficientes: Fricciones de Mercado y Desafíos de Política." in Fortaleciendo los cimientos del sistema de capitalización individual para asegurar su sostenibilidad. FIAP.