The Centrality of Innovation to Project Financing
Infrastructure remains the fundamental facilities and systems required to sustainably support the physiological needs of the current 7.7 billion and the projected human population on earth.
Despite its challenges, the planning and preparation for the co-living of the projected 9 billion of us and over 1 billion pets by 2050 is arguably the most significant global opportunity for over the next 30 years. Not only does food production needs to increase by over 50 percent, but it is also estimated that, without a fundamental shift in production processes, a projected 55 percent more water and 40 percent more energy would be required to support future food demands (Grafton, 2016), and similar upward trajectory for essential inputs to the entire infrastructure that supports living on planet earth.
It is also exciting that these opportunities are not limited to activities within planet earth but far beyond its boundaries. It is estimated that the space industry will grow exponentially in the coming decades and reach a market value of $1.1 trillion by 2040 and $3 trillion by mid-century (Sheetz, 2017). How would we know that technological breakthroughs will not foster relationships between the peoples of the earth and other planets? What about a football or soccer match between the earth and another world? Imagine the levels of the joy of unity that we can experience when we all cheer for the same team - these global opportunities.
Infrastructure and physiological Needs
Infrastructures remain the fundamental facilities and systems required to sustainably support the physiological needs of the current 7.7 billion and the projected human population on earth. To paraphrase the American psychologist, Abraham Maslow, who in 1943 titled a paper "A Theory of Human Motivation,” if written today, he may have stated, “the most basic human survival needs to include nutritious food, clean water, clean energy, sanitation, affordable housing, affordable healthcare, quality education, environmental sustainability, inclusion, industry, and of course reproduction.” Abraham Maslow concluded in his writing that these basic physiological needs must be addressed before humans can move on to the next level of fulfillment. (Hopper, 2020)
"What about a football or soccer match between the earth and another world? Imagine the levels of the joy of unity that we can experience when we all cheer for the same team - these global opportunities."
Infrastructure Propels Economic Growth
Any investment deployed in housing roads, clean water, electricity, ports, airports, rail, and telecom networks, which are the conduits of trade and mobility, is an investment to meet physiological needs. While infrastructure underpins physiological conditions, it is estimated that one dollar investment in infrastructure can propel economic growth and raise GDP by 20 cents in the long run. These economic benefits arise from reduced travel cost and time-saving, access to reliable electricity, and broadband connectivity that allows individuals and businesses to plug into the digital global economy (Ben Lutkevich, 2020). In addition to the long-term productivity benefits, investments in infrastructure development and construction create jobs immediately.
The nexus of infrastructural development, economic growth, productive investment, job creation, and poverty reduction is well established. (The World Bank, 2019). Over the recent years, developing economies have seen dramatic improvements in transport, power generation capacity, housing, telecommunication, and water infrastructure. The same improved infrastructure has driven growth, reduced poverty, and improved lives.
Increased Demands for Infrastructure
The growing population and continuous demands for economic development are driving countries to channel more funding into infrastructure projects. On average, the world spends 14 percent of global GDP or $9.6 trillion on infrastructure to meet the needs of ageing and new infrastructure projects. Despite the rise in investment, these spending requirements would leave countries facing significant gaps in infrastructure development because they are not enough.
"Some breakthroughs could render some current types of infrastructure obsolete, and they may create entirely new needs."
Technology innovation is completely changing the estimates of infrastructure usage and investment needs (McKinsey & Company, 2017). Any long-term project will need to put this into consideration. Some breakthroughs could render some current types of infrastructure obsolete, and they may create entirely new needs. Consider the infrastructure requirement of drone deliveries, additive manufacturing technologies; advanced automation; advanced materials, renewable or unconventional energy, and digitization. These challenges and transitions will require considerable investments.
More than $5.5 trillion additional spending on infrastructure investment per year is required globally between now and 2035, with regional variations. (McKinsey & Company, 2017). Financing the huge investment gaps in Emerging Market Economies, estimated at $1.3 trillion per year, is paramount to meeting the physiological needs of its growing population.
Consider the two largest world economies; the United States of America’s $2 trillion “Build Back Better” infrastructure plan, which includes massive new infrastructure spending, meant to revolutionize the US’s ageing and neglected infrastructure systems. Even with this amount of investment, there remains $2.8 trillion to bridge the infrastructure investment gap within the USA.
"Financing the huge investment gaps in Emerging Market Economies, estimated at $1.3 trillion per year, is paramount to meeting the physiological needs of its growing population."- (McKinsey & Company, 2017)
By international standards, China is seen to have been investing much more in the infrastructure sector starting in 2006 than most of its developing-economy peers. China's public capital expenditure was estimated to be an average of 13.4 % of GDP ($2 trillion), compared with the average investments in the other BRICS countries of just 3.2% (China, 2018). Yet, China still has an infrastructure investment gap of $1.9 trillion. Again, on the two largest economies, China’s overall national debt was at 270.1 percent of its GDP at the end of 2020; and the Office of Management and Budget in the United States of America recorded a Government Debt to GDP of 128.10 percent of the country's GDP in 2020.
The Infrastructure Challenge
It is abundantly clear that “everyone around the world is having the same nightmare” because the infrastructure needs exceed traditional funding sources. The conventional sources of financing may even contract further due to reduced fiscal resources, mismanagement, and tighter government regulations. The international development communities have acknowledged the increasing need for enhanced private sector participation, especially as a long-term financier in infrastructure projects (The World Bank, 2019).
Traditional Financing Models
The major challenge for any capital project financing is securing the capital required to develop and complete the project. Typically, four significant sources of financing are available to explore: public funding, private funding, partnerships, and project financing. Irrespective of the sources, the funding or financing source would evaluate the project based on corporate or project financing approach.
Corporate financing requires the project sponsor to demonstrate to investors that it has sufficient cash flows to meet the debt obligation and assets on its balance sheets for use as collateral in the case of loan default. The lender can foreclose on the sponsoring company’s assets and use the proceeds to recover its investment in the project in case of financial default. It is not so for project finance.
Structured finance, for which project finance is a subset, deal with simple transactions that lower corporations’ funding costs to more complicated financial engineering involving unique purpose entities (SPEs); leveraged products such as constant proportion debt obligations (CDOs); collateralized debt obligations of collateralized debt obligations (CDO).
A Special Purpose Vehicles (SPVs) project that requires financing has no operating history at the initial equity and debt financing. Therefore, the project’s creditworthiness depends on the project’s anticipated cash flow, collateral value, and other collateral support provided by third parties through various contractual arrangements. The availability of funds to a project will depend on the sponsor’s ability to convince investors that the project has raw materials, capable management, is technically feasible, and is economically viable.
Some advantages of project finance techniques are the possibility to enable projects to be built and refinanced using private capital to achieve private ownership of even public services such as energy, transportation, and other infrastructure development initiatives. It alleviates investment risk and relatively low cost to the benefit of sponsor and investor alike. (Ahmed, 1999) Build Operate and Transfer (BOT), Public-Private Partnership (PPP), and Asset-backed Securitization (ABS) are the three most popular project financing models, which are being used for development and construction in the infrastructure sector.
"Some advantages of project finance techniques are the possibility to enable projects to be built and refinanced using private capital to achieve private ownership of even public services such as energy, transportation, and other infrastructure development initiatives."
Challenges of Investing in Infrastructure
Institutional investors globally, excluding hedge funds, hold over $120 trillion in total assets under management, with banks at the forefront with $40 trillion in assets; investment companies, including investment banks, asset managers, wealth managers, family, and multifamily offices, investment trusts, and investment companies hold $29 trillion; insurance companies and private pensions holding $26 trillion; public pensions and superannuation plans holding $11 trillion; sovereign wealth funds at $6 trillion; infrastructure operators, developers and private equity funds holding $6 trillion, while endowments and foundations bring up the rear at $1 trillion.
The scarcity of financing is not the cause of the unavailability of more significant infrastructure investments, considering the abundance of funds in the world markets at meagre long-term interest rates. The challenge is matching the supply of available finance from the private sector with bankable projects. The potential pool of long-term financing is sufficient to meet infrastructure financing needs. Pension funds, insurance companies, and other long-term institutional investors have large and growing long-term liabilities, but little of their financial resources are allocated to infrastructure. Creating a pipeline of bankable projects requires a coherent legal, regulatory, and governance (project and ESG) framework for infrastructure projects. These frameworks do not exist in some countries. Political risk is among the most significant concerns of private investors (OECD 2014).
"Institutional investors globally, excluding hedge funds, hold over $120 trillion in total assets under management."
The Nature of Infrastructure Business
The nature and characteristics of the infrastructure markets make it more challenging to match investment demand and financing supply.
Reliance on Externalities
The reliance on indirect externalities of the project as the main payoff of the project, such as services the project provides to a wide range of other sectors that benefit directly or indirectly from the deployed infrastructure investment. Such benefits are fundamentally challenging to measure.
Infrastructure projects are often complex and involve many parties. Infrastructure usually comprises natural monopolies such as highways, electricity, or water supply, and hence governments want to retain the ultimate control to prevent abuse of monopoly power. Such infrastructure transactions would require complex legal arrangements to ensure proper distribution of payments and risk-sharing to align all parties’ incentives.
"Project Finance Experts, Financial Engineers, governments, industry captains, entrepreneurs, and digital innovators are encouraged to work closely to develop innovative and sustainable funding models for the enormous capital required to meet the global infrastructure goal."
Risk and Illiquidity
Cash flow and profit generation from infrastructure investments are only after many years, and the initial phase of an infrastructure project is subject to high risks. These character of infrastructure projects, the time profile of cash flows, high initial risks, and illiquidity make purely private investment difficult and costly.
In most emerging economies, long-term investment entities such as banks, pensions funds, and insurance companies are still at the early stages of development. They do not have the financial capacity to supply the funds required for infrastructure projects. Also, Infrastructure projects typically have several distinct phases. Each phase exhibits different risk and return characteristics, faces various incentive problems, requires other financial instruments to cover additional risk and return profiles, and targets distinct types of investors. Additional currency risks also exist for international investors because infrastructure project cash flows are primarily in lo currency. The resulting currency mismatches represent significant risks, both for the viability of a project and potentially for the financial system.
Poor Product Delivery
Another challenge is the prevalence of poor-quality infrastructure projects, especially in emerging economies. This is primarily because of the complicated political economy of infrastructure investment, flawed design and process decisions, difficulties in managing private sector participation, fragmented regulatory frameworks and standards, weak accountability mechanisms, and shortage of capable local workforce. In addition to the problem of poor-quality infrastructure, there may be a risk that infrastructure will not be built at all even when the funds are provided (United Nations, 2018).
"Project finance companies and other stakeholders must work in teams on policies, regulations, and financial market reforms supporting infrastructure financing to attract these investors."
More Efficient Models
More efficient and effective innovative financing structures are critical for closing these infrastructure gaps. Considering the magnitude of this global opportunity to deliver infrastructure projects to our global population, increased mobilization of innovative financing models is required to reduce the reliance on public funds for project financing or loan repayment. To leverage international infrastructure opportunities and overcome these challenges, Project Finance Experts, Financial Engineers, governments, industry captains, entrepreneurs, and digital innovators are encouraged to work closely to develop innovative and sustainable funding models for the enormous capital required to meet the global infrastructure goal.
Work in Teams
Project finance companies and other stakeholders must work in teams on policies, regulations, and financial market reforms supporting infrastructure financing to attract these investors. Implement methods for bankable project pipelines; creating partnerships with development banks and infrastructure agencies to strengthen institutional capacity, develop innovative financing models, investment in local construction expertise and raw materials; investment in regional development trades, credit enhancement instruments; and mobilization of both advisory and financing services across different infrastructure sectors to build more robust markets for infrastructure assets, is essential to taking advantage of this infrastructure challenge.
"Project finance practitioners and financial engineers can collaborate with digital entrepreneurs to drum up Infrafintech solutions for financing innovation to address infrastructure demands globally."
The role for Innovation in Infrafintech
Innovation in Project Financing will be the most critical enabler for meeting the funding requirements for our infrastructure projects. By harnessing emerging digital technologies in artificial intelligence, machine learning language, blockchain, crowdfunding, and tokenization technologies integrated with existing financing models to deliver innovative project funding, risk management models, project monitoring, and execution, from ideation to cash flow guarantee. Project finance practitioners and financial engineers can collaborate with digital entrepreneurs to drum up Infrafintech solutions for financing innovation to address infrastructure demands globally.
Project financing is key to achieving the global sustainable development goal. It will continue redesigning project landscapes by enabling new projects, products, business processes, operations, speed, and delivery efficiency. As the world faces these enormous financing challenges because of our progress technology and population growth, the centrality of project financing technologies and technology entrepreneurs cannot be overstated. They are the central piece for government, commerce, and industry, to overcome the challenges faced by the project finance ecosystem that involves project sponsors, investors, project delivery professionals, and all stakeholders.
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