Challenges in Infrastructure Financing, Belt and Road Opportunities, and The HKMA Infrastructure Financing Facilitation Office
(English version only)
by Vincent Lee, Executive Director (External), HKMA and
Deputy Director, Infrastructure Financing Facilitation Office
- Good afternoon Professor Dr Surakiart (Sathirathai), Mr (Gerard) Sanders, Mr (Dieter) Yih, distinguished guests, ladies and gentlemen.
- It is indeed a pleasure to be here today to take part in this panel discussion which examines a subject that is crucial to the development of our region. And, I would like to sincerely thank Professor Teresa Cheng for inviting me to the Colloquium. The very title of the panel discussion, “Investment Collaboration – Opportunities and Challenges in Asia”, embraces the subject that we have been exploring for a while – the challenges in infrastructure financing, the opportunities in the Belt and Road Initiative, and the recent establishment of the HKMA Infrastructure Financing Facilitation Office, or IFFO as we like to call it, which helps to facilitate investment collaboration in this region.
Challenges in infrastructure financing
As you may be aware, the Asian Development Bank (ADB) recently raised the infrastructure funding needs in this region from the previous estimate of US$800 billion a year to a new estimate of US$1.7 trillion a year from 2016 to 2030. To appreciate how enormous this number is, Hong Kong’s entire GDP in 2015 was worth US$309 billion, which is less than 2% of the yearly infrastructure funding needs in this region. The power sector alone represents more than half of this infrastructure funding need, followed by the transportation sector. These are basic yet important infrastructures for the development of any economy.
- Among many sophisticated investors, there is a growing desire to invest their money in infrastructure projects because they have the potential to offer more stable and higher returns over a longer term - think of power plants as just one example. But while there are substantial funding needs for infrastructure projects and a growing interest in the infrastructure asset class, there is a lack of “bankable” projects, particularly in emerging markets, including many parts of Asia.
- This is not hard to understand. At the country level, political, legal and regulatory risks often undermine the feasibility of a project. At the project level, construction risk, cost overrun, demand risk, currency risk, and refinancing risk all add uncertainty to the project’s profitability. Funding of cross-border or regional projects becomes even more challenging as these risk factors are magnified. Because of these risk factors, according to the International Finance Corporation, only around 20% of the total annual infrastructure spending in emerging economies is financed by private funding.
- Indeed, 80% of the infrastructure spending in emerging economies has come from the public sector, such as governments and multilateral development agencies. Historically, these bodies are well equipped to invest in infrastructure projects partly because they can better mobilize long-term funding to invest in these projects. In fact, multilateral development agencies, such as the World Bank, have also acquired the expertise to deal with the country and project risks that I just mentioned. National governments and multilateral development agencies are also seen as having more tools, political or otherwise, at their disposal to deal with situations like non-performing loans.
- Nevertheless, public sector financing has its limits as well. The balance sheets of the multilateral development agencies alone are simply too small relative to the needs of infrastructure financing. And, many national governments which traditionally sponsor overseas economic developments are now faced with increasing fiscal constraints. The trend that has clearly emerged in recent years is to encourage more private sector involvement in infrastructure financing. However, this is easier said than done. A recent report jointly published by the OECD and the World Bank Group1 notes that the costs and risks faced by private investors in infrastructure remain high. The report suggests that some of the issues facing these investors could be addressed by establishing national infrastructure plans, providing risk mitigation tools, promoting investor education and the pooling of funds. Hence, the key challenge here is how to make these infrastructure projects more "bankable" from the private sector point of view. I will come back to this point later.
Belt and Road opportunities
- China's Belt and Road Initiative (BRI) probably needs no introduction here. So, I will go straight to three areas where I think the implementation of BRI will provide opportunities for Hong Kong.
- Firstly, as I am sure you are aware, more and more Chinese corporates are already investing overseas. This process will be given further impetus by the BRI implementation. In 2015, China’s overseas direct investment, or ODI, reached US$146 billion; with Hong Kong the largest recipient of over 60% of the total. Indeed, Chinese corporates are already using many of Hong Kong's intermediary services, such as legal and banking to support their overseas acquisitions and other investments. Despite some recent concerns about capital outflows, I am confident that this going-out trend by Chinese corporates will resume, and this will bring more business opportunities to Hong Kong.
- Secondly, BRI is about building connectivity. As China continues to build closer economic ties with Belt and Road countries, the case for transactions in renminbi (RMB) will be even stronger, which will further strengthen internationalization of the currency. In particular, it will boost the RMB as a reserve currency; that is, I expect more Belt and Road countries' central banks will be willing to hold more RMB. And, I also expect the RMB to be used more often as a trade currency and investment currency between China and these Belt and Road countries. As you are no doubt aware, Hong Kong is the largest and most developed offshore RMB business centre. We have the largest pool of RMB deposits anywhere outside Mainland China, and also more than 200 banks in Hong Kong are already capable of conducting RMB business. Therefore, Hong Kong is well-positioned to capture RMB business opportunities arising from the BRI.
- Thirdly, at the Belt and Road Forum on International Co-operation in May, President Xi Jinping announced that China will provide a total of RMB780 billion to support implementation of the BRI. For example, the Silk Road Fund will be increased by RMB100 billion, and about RMB300 billion has been earmarked to encourage Chinese financial institutions to conduct overseas RMB business. In addition, support will be given to the China Development Bank worth RMB250 billion and to the Export and Import Bank of China worth RMB130 billion to set up special lending schemes to support Belt and Road co-operation, including infrastructure2. So, it goes without saying, the HKMA will be doing all it can to encourage these institutions to make more use of Hong Kong when conducting their Belt and Road businesses.
- Despite this state support, I believe the Chinese authorities would also like encourage the private sector to play a bigger role in financing the BRI implementation because the state, on its own, cannot address all the financing needs arising from this massive initiative. Indeed, Hong Kong has some of the best privately run companies in the world; and here again opportunities are in abundance for us.
IFFO and how it helps to facilitate investment collaboration in Asia
- IFFO was established in July last year with a mission to expedite infrastructure investments by working with key stakeholders in infrastructure financing. To date, IFFO has built a network of over 60 entities which come from Hong Kong, the Mainland and overseas, covering multilateral financial agencies and development banks, public and private sector investors, asset managers, banks, infrastructure project sponsors, professional service firms, etc.
- IFFO is uniquely positioned to facilitate investment collaboration in the following ways. Firstly, we have built strong relationships with our Chinese friends like the Silk Road Fund, the China Development Bank and project developers. In talking to some of them, they often mention they'd like to network with their overseas counterparts and share views on the best practices in corporate governance and risk governance when making investments. IFFO is a useful meeting place for our partners from the East and the West. Indeed, since our launch last year, IFFO has organized and participated in more than 10 prominent international and local events on infrastructure financing, including our first executive workshop last October, and the inaugural Debt Financing and Investors’ Roundtables in March this year. Looking ahead, IFFO will continue to collaborate with our partners to build capacity and make Hong Kong a more attractive place to conduct infrastructure investment and financing.
- Secondly, IFFO consists of many private sector representatives and can uniquely offer private sector views on infrastructure financing. The Roundtables held in March gathered together capital owners, including sovereign wealth funds and pension investors from around the world, as well as project developers and operators, to discuss infrastructure investment and financing opportunities in emerging markets; and how infrastructure projects could be made more bankable through different risk mitigation measures. A reference term sheet for infrastructure investment was developed at the Roundtables, which sought to devise a set of common language terms that can be understood and accepted by investors, financiers and sponsors, thereby narrowing the gap in their expectations and bringing them closer to doing deals. The term sheet set out various major factors to be considered for infrastructure investments. For example, as investors tend to be more interested in less-risky brownfield projects, the attractiveness of greenfield projects can be increased by securing land and approval documentation, or by bundling with brownfield projects. Another example is that since institutional investors also attach great importance to governance procedures, infrastructure project operators should put in place such essentials as proper procurement systems and effective anti-corruption policies. Roundtable discussions and the reference term sheet can help make projects more bankable, and strengthen the confidence of investors looking for long term sustainable returns when investing in emerging markets. In fact, these should promote smoother, more effective communication and co-operation between both sides.
- Last but not least, IFFO will consider forming an Equity Club with our Partners to allow some reputable and like-minded investors who are looking for long term returns, to formulate an investment platform. On a mutually beneficial basis, the investment platform could select projects for experience sharing or even co-investments amongst the investors, that could help generate demonstration effect for the market and to draw in greater private capital participation in infrastructure investments.
- Ladies and gentlemen, I realize I have been on my feet for some little while – some may think for too long! But, I hope you’ll indulge me by at least taking away a couple of key points-
Thank you, and I will definitely end here!
- There is a huge infrastructure gap in Asia that requires not just public but also private sector participation to bridge the gap; and
- Despite the challenges to “crowding in” private sector capital, IFFO has made a promising start and through its work, we believe the Office will play a key role in facilitating investment collaboration in this region.
1“Risk and Return Characteristics of Infrastructure Investment in Low Income Countries” https://www.oecd.org/g20/topics/development/Report-on-Risk-and-Return-Characteristics-of-Infrastructure-Investment-in-Low-Income-Countries.pdf