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Project Bonds

An alternative source of financing infrastructure projects

The global financial crisis has resulted in stricter regulations on banks and their lending requirements which mean that infrastructure projects can no longer be funded by traditional debt alone. Other more innovative ways of funding need to be considered and implemented such as project bonds.

Project Bonds vs. Traditional Debt

Recent surveys suggest that infrastructure is beginning to be viewed as an asset class of its own and the allocation to this investment class is expected to increase significantly. However, the global financial crisis has resulted in stricter regulations on banks and their lending requirements which mean that infrastructure projects can no longer be funded by traditional debt alone and other more innovative ways of funding need to be considered and implemented.

Advantages of Project Bonds

Project bonds open up an alternative debt funding avenue to source financing for infrastructure related projects. Traditionally, deals have been financed through banks, however the implementation of Basel III regulations requires stricter monitoring and disclosures, ultimately leading to higher costs and higher capital requirements. These higher costs will be passed through to the project developers translating to diminished project IRR’s (internal rates of return). By accessing the institutional bond market, companies are potentially able to reduce the project funding cost.
Project bonds offer an opportunity for institutional investors to participate in infrastructure projects through listed, tradable securities that can offer superior risk-adjusted returns.

Challenges of using project bonds as a source of funding

The use of project bonds as a funding mechanism may be unattractive to investors with a lower appetite for risk which is inherently higher in the construction industry. Before the financial crisis, capital markets were seen to be less stable than debt markets, which have now changed given the reduction in global liquidity. Local institutional bond investors, while happy to take on performance risk, generally are not prepared to take on any form of construction risk.
Not all debt portions of these deals will be able to take advantage of this source of funding, but this mechanism will certainly provide benefits to the project developers in the form of potentially enhanced returns due to the lower cost of capital.

Project bonds issued by corporates in the rest of the world

Thus far, project bonds have been successfully utilised in Europe and America to fund infrastructure projects. In Europe, corporate bond markets continue to grow in spite of the increase in market volatility and it is anticipated that the use of corporate bonds to fund infrastructure projects in Europe will play a significant role in boosting the Economy.
In Africa, both Kenya and Nigeria are examples of where project bonds have successfully been implemented. Both countries have a growing institutional investor base. In Nigeria, corporate bonds are tax exempt while Kenya has specific exemptions for infrastructure bonds which encourage the use thereof as an alternative funding mechanism.
The rest of Africa is still in the early stage of development of project bonds, and while the need for infrastructure development is clear, it will require investors to collect more funds, borrowers to gain a higher confidence in the bond market and governments to create an environment which will encourage the issuance of project bonds.