Rise of Infrastructure Investing- Part 1

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Retail and Institutional Investors taking over project finance.

Basel III accord signals the transition to a post-crisis world, where banks are constrained by tighter liquidity requirements. These requirements have significantly reduced commercial banks’ willingness to continue financing long- term infrastructure projects at high percentages of the total capital structure. Hence the significant drop in the percentage of bank loans to total infrastructure debt issuance after 2010.

The accord gradually phases in tighter capital ratio restrictions from 2015–2019 for commercial lenders (banks).

Essentially, banks will need to decrease their credit risk adjusted assets
( including project finance loans) for the next years, and then maintain these assets at lower levels.

The graph below serves as a simplified example on how tighter capital restrictions affect the bank’s balance sheet.

Graph Explained: Total Capital Ratio= (Tier 1+ Tier 2 Capital)/ (Credit Risk Adjusted Assets.) Take a commercial bank that is subject to Basel III capital ratio requirements. For simplification, assume that shareholders equity, retained earnings and tier 2 capital remain unchanged for these five years. Under these assumptions the bank must decrease its maximum level of risky exposures (project finance lending, mortgages e.t.c) by almost 24% within 5 years.

Bank Syndicates used to provide loans of up to 80% of project value to infrastructure project owners. Consequently, the changes due to Basel III create a shortfall in investments for essential infrastructure projects, including energy generation projects. The increase of project bonds and capital market participation to project finance is a reaction to address this shortfall. However, further increase in market participation is required in the next years, to offset further reductions of bank lending as tighter requirements are phased in. Source: Michigan Business Review

Back in 2009, after the onset of global financial crisis, infrastructure debt issuance in Europe decreased -164% in a single year and the participation of non-bank capital providers was at 0%. Then, Basel III accord was published in late 2009.

Graph adapted from : European infrastructure finance: a stock-take , AFME, ICMA 2017

Non-bank investor participation in project finance has increased since then in Europe, as bonds have gained ground versus loans . Due to their long maturity, these assets are primarily held by institutional investors (e.g pension funds). Given banks constrained balance sheets, further-increasing capital markets participation to project finance seems the only way to support global infrastructure needs.

At Parity Platform, we believe that greater participation to infrastructure investing leads to competitive financial returns for individuals and better growth outcomes for the economy.

This is why we developed a crowd-investing platform to make Energy Infrastructure investing accessible to everyday retail investors.

Part 2 of this series will examine advantages and challenges of infrastructure investing. You can sign up receive article likes this and market reports from Parity Analysts here.