Financing Instruments – Infrastructure Financing

There are two kinds of financial instruments, which are used for financing infrastructure projects. They are popular in US. They include Asset Backed Securitization (ABS) and Municipal Bonds.

Asset Backed Securitization (ABS):

This involves conversion of loans or receivables of companies into marketable securities. They are secured by the underlying assets and carry a variety of credit enhancements. The essence of the process is that assets of high quality are transferred from their originator to an insolvency remote vehicle, which raises the funds to purchase the assets on the strength of the quality of the assets. The concept of ABS originated in the USA in the early 1980s. It is becoming popular in other countries too as an innovative means of raising funds. In India, the first securitization deal was done in 1991 with the securitization of auto hire purchase receivables and since then, a number of institutions have evinced interest in ABS. The growing sophistication of financial markets is expected to lead to an increased demand for such instruments.

Under ABS, the originator securitizes a portfolio of assets by selling them to a SPV. The SPV in turn raises funds from the investors. The funds are then passed on to the originator in payment for the portfolio. Payments by SPV to investors are funded by cash flows from the underlying assets during the life of the transaction. The assets themselves will be the security for the investment, but will generally continue to be managed by the originator who would charge a management fee for the purpose.

Municipal Bonds:

These are the instruments that are issued by municipal bodies or local governments for financing core urban infrastructure facilities like drinking water, sanitary systems, roads, bridges, highways, airways, hospitals etc. They are eligible for bond insurance. The Municipal Bond Market was born in the US in the 1970s, when the burden of financing certain infrastructure projects was transferred from federal to local governments. This led to municipal bodies turning to the capital market to meet their financial requirements.

Municipal bonds are of two kinds:

General Obligation Bond which is secured by the full faith and credit of the issuer, which in turn is derived from the taxing powers and revenue generating capabilities of the issuing authority

Revenue Bond which is project specific and is secured by the revenue streams (user fees or service charges paid by users) of the urban infrastructure facility it finances for instance, the tolls collected from a highway.

In addition to the above methods, several other methods of external financing, viz., collateralized lending applicable when the investment concessionaire has external accounts. Investment insurance (from either private market or from official insurers) is also available.

Infrastructure Financing – issues in India:

Prospective infrastructure development in India would involve increased public private collaboration, which will be a decisive movement away from budgetary modes of financing, with a consequent emphasis on commercialization. The financing of physical infrastructure has several unique dimensions that merit specialized treatment. The major issues of infrastructure financing in India are as follows:

High levels of Lag:

Typical infrastructure projects have a period of 2-3 years of construction, a gestation period of between 5-7 years and a total pay back period varying anywhere between 15 to 30 years. Such high levels of lags in the fructification of projects calls for a commensurate financial facility.

Local Revenue:

Most of the infrastructure projects generate only local currency revenues. These are susceptible to regulatory and other influences.

Project Risk:

Infrastructure projects are subject to considerable project implementation risks (including environmental factors) quite distinct from the business risks (e.g. financial risks, operating risks, and risk etc). Thus any financing plan for infrastructure needs to attempt a separation of project implementation risks from business risks. Besides, for successful commercialization of infrastructure projects, there has to be an appropriate allocation of risks among various stakeholders in the project on the basis of ability and competence of each party to bear the risk. Innovative and diverse financing techniques should take care of such optimal risk allocation.