Imagine a road where drivers need to negotiate new traffic rules every time they arrive at an intersection. Then imagine the traffic flow, or the number of accidents that would happen. Luckily, such a ludicrous situation doesn’t exist – traffic codes standardizing rules have been in place since 1903 in the US and elsewhere.
Yet, when it comes to financing and building that road, there are no standardized codes for most infrastructure projects – neither in the U.S. nor in emerging markets. Whether in Cairo or Casablanca, every project is considered unique, terms are negotiated individually, and the sheer number of projects is long. No wonder global infrastructure faces an annual financing gap of some $1 trillion annually (the global spend should be $3.7 trillion, while in actual fact it is $2.7 trillion). To bridge that gap, the number one priority should be to standardize the code for infrastructure projects.
Doing so is particularly important for emerging markets, where infrastructure needs are the highest. As the World Bank noted, the lack of infrastructure comes at an enormous economic and social cost. Over 1.3 billion people – almost 20% of the world’s population – still have no access to electricity. About 770 million people worldwide lack access to clean water; and 2.5 billion don’t have adequate sanitation; 2.8 billion people still cook their food with solid fuels (such as wood); and one billion people live more than a mile from an all-weather road. It’s not hard to imagine people in emerging markets suffering most from these shortcomings.
Yet the first step to a solution is straightforward: implementing a standardized code would simplify the long list of individually negotiated terms. For example, the current U.K. government pipeline lists no less than 564 investment programmes and projects. Many emerging markets don’t even have an official pipeline that would list all projects. The consequence is predictable: politicians complain that they can’t find investors to build the necessary infrastructure. Investors complain that they can’t find projects to suit their risk and return profiles. Users of the infrastructure, whether in developed or emerging markets, are left with archaic airports (such as LaGuardia), clogged metro services (think of London), or power cuts as experienced in Pakistan or India. Meanwhile long-term investing is important for economic growth, as a report by Swiss Re and the IIF explores.
Compare this with the situation for companies’ equity finance. Every company is unique, yet there is a standard set of listing and reporting requirements on stock exchanges (note, for example, those of the London Stock Exchange). Companies that comply with those requirements can raise capital by issuing new shares on the exchange. Investors know where to look for these, and can invest in companies that suit their risk and return appetite. The market is big and liquid. And hardly ever does a company complain about a lack of investors – or does an investor complain about a lack of investable companies. Corporate equity is known as an established asset class.
What would it take for infrastructure to get there?
As it turns out, international institutions in the developed world have already laid out the ground rules. A group of Europe’s biggest banks and insurers have looked into the issue under the umbrella of the European Financial Services Round Table (EFR), while The World Economic Forum has conducted in-depth proprietary research for a number of years. Their findings agree that more standardization in infrastructure finance is needed – both in developed markets such as Europe and in emerging markets.
An all-important first step will be to harmonize debt terms and documentation, as well as disclosure requirements. To appreciate the importance of this step, consider the impact of the ISDA Master Agreement when it was introduced to derivatives markets. It enabled the growth of interest rate swap volumes from some $200 billion in 1987 to $1.3 trillion five years later and $10 trillion in 1997 – a whopping fifty-fold increase in 10 years. Infrastructure debt instruments in particular need a similar Master Agreement – something that can be achieved if firms, industry associations and regulators work together.
Similarly, project monitoring and reporting should be standardized as far as possible, so that appropriate benchmarks and databases can be constructed. This will enable investors to construct risk-return profiles for infrastructure that fit into their asset allocation models. The efforts of certain industry associations, such as the Long-Term Infrastructure Investors Association (LTIIA), are a great step in the right direction. The G20 initiative in building a Global Infrastructure Hub will also be very helpful. Additionally, it would be helpful for investors to have a global “golden source” for project pipelines, similar to what the U.K. and some other countries have achieved on a national level. This will allow for better visibility and comparability of projects.
Should adverse events occur during the lifetime of an infrastructure asset, effective arbitration will be crucial to maintain investors’ trust. While by definition most of those events will be idiosyncratic, a standard framework and process can play a very important role – for example, around governing laws, arbitration bodies and compensation mechanisms.
Of course, those standards alone will not solve every logjam in the highly complex and diverse universe of infrastructure projects. Standards will not make every project economically viable, or magically unlock trillions of institutional investors’ money overnight.
Infrastructure will also need better technical risk mitigation instruments and credit enhancements (provided by governments, multilateral banks and specialist private sector firms). It will need a more synergistic approach between the public and private sector, with less of the adversity that can “crowd out” private funds. It will need more transparent up-front discussions among the various stakeholders about how to share project risks and returns.
Therefore, standardization is not a single silver bullet. But, like with road traffic or stock exchanges, it is a very necessary foundation. Given the state and importance of the world’s infrastructure, we need to get it started now – and we know where to start.
Authors: Michael Drexler, Head of Investors Industries, Member of Management Committee, World Economic Forum; Guido Fuerer, Group Chief Investment Officer and Member of the Executive Committee, Swiss Re; Jerome Jean Haegeli, Managing Director, Head of Investment Strategy, Swiss Re
Image: Steelworkers work on the roof structure inside the Arena Amazonia stadium as construction continues in preparation for the 2014 FIFA World Cup soccer championship in Manaus December 10, 2013. REUTERS/Gary Hershorn