In this paper, we develop a framework to measure the credit risk of unlisted infrastructure debt, including the first formulation of “distance to default” in infrastructure project finance. We propose to use the debt service cover ratio, which is routinely collected by project finance lenders, to measure and benchmark credit risk in infrastructure project finance. We have shown that full knowledge of the distribution of the DSCR in infrastructure project finance is sufficient to characterise the credit risk of infrastructure project debt. In this paper we also propose a template to support data collection initiatives and improve the future benchmarking and transparency of infrastructure investments.
In July 2013 the Central Bank of Ireland issued a discussion paper on loan origination by investment funds, in which it suggests that developing alternative sources of financing to bank loans may be beneficial to the real economy but requires the careful consideration of the potential development of “shadow banking” risks.
In this response to the discussion paper, we argue that the development of alternative sources of financing is most relevant with regards to long-term private debt, in particular the financing of SMEs and infrastructure projects. The demand for such financing has been identified as instrumental to long-term growth in Europe, which justifies regulatory changes.
We use standard results from agency theory to assess the ex ante and ex post efficiency of the fixed price risk transfer contracts used to procure public infrastructure under the Private Finance Initiative (PFI) in the United Kingdom. We argue that these contracts act as a revelation mechanism designed to improve ex ante contracting efficiency at the cost of ex post inefficiency: PFI contract are a case of solving the moral hazard problem (creating maximum incentives for cost reduction) at the expense of increasing the adverse selection problem and therefore the selected firm’s information rent. Hence, Risk transfer leads to ex post inefficient outcomes that are directly related to the distribution of firm type: the more this distribution is skewed in favour of a few efficient firms, the less competition there is for the risk transfer contract, the larger the rent of the efficient firm should be. Thus, the ex post inefficiency of PFI contracts may be heavily country dependent. Using a detailed database of individual construction contracts for standard and PFI school projects in the UK, we find that full risk transfer does indeed lead to self-selection by the efficient firm, and that the distribution of firm types is indeed skewed in this market. We also find evidence of lower unit construction costs for the firm under PFI contracts compared to traditional procurement, which supports the hypothesis of the self-selection of the efficient firm when the public sector creates a menu of contracts (PFI vs. TP).
This paper is the first of series discussing the opportunity for long-term institutional investors such as pension funds, insurance companies or sovereign wealth funds, to invest in large portfolios of infrastructure debt, both to manage their liabilities and to minimise their exposure to capital market volatility. Our analysis focuses on project finance debt since it represents the bulk of existing and, in all likelihood, future infrastructure debt.
In what follows, we review existing academic research on infrastructure project finance and propose a theoretical and empirical analysis of the role of credit risk in infrastructure debt from a portfolio standpoint, on a held-to-maturity basis.
In March 2013 the European Commission published a green paper on the long-term financing of the European economy in order to initiate a broad debate about how to foster the supply of long-term financing and how to improve and diversify the system of financial intermediation for long-term investment in Europe. The Commission requested responses to a series of questions in the Green Paper, in order to assess the barriers to long-term financing, with a view to identifying possible policy actions to overcome them. This paper presents the answers of EDHECinfra to the questions of the green paper.
In March 2013 the European Insurance and Occupational Pension Authority presented the preliminary findings of its analyses into the regulatory capital requirements for insurers’ long-term investments in certain asset classes under the Solvency II regime. Infrastructure financing and other long-term financing through project bonds and other types of debt and equity were included for consideration. EIOPA sought responses to the findings in order to help produce well informed recommendations on the design and calibration of the standard formula in relation to the asset classes considered. This paper presents the answers of EDHECinfra to the questions of the discussion paper.
The paper highlights a recent research quandary with respect to infrastructure equity investment which has also been a source of interrogation for final investors: while the economics of underlying infrastructure investment suggests a low and potentially attractive risk profile, the experience of investors and available research evidence have been different and rather mixed.
This paper attempts to explain why this has been the case and what new research and benchmarking efforts are necessary to create investment solutions that realign expectation and observed investment performance as well as to inform the regulatory debate in relation to institutional investing in long-term assets like infrastructure equity.
In February 2012, EDHECinfra responded to the UK Treasury’s Call for Evidence about the reform of the Private Finance Initiative (PFI) with a particular reference to the opportunity for pension funds to invest in infrastructure assets. In this publication, we extend our response to the issues relating to pension fund investment in social infrastructure. Social infrastructure investments have by design the characteristics that pension funds find attractive in a liability-driven investment context: long-term contracts with steady and predictable inflation- linked income, high operating margins and high risk-adjusted return. Social infrastructure also corresponds to the bulk of the assets procured under PFI.
Theoretical literature suggests higher asset construction costs in a public private partnership (PPP) than in traditional public procurement, due to the bundling of construction and operation and the transfer of construction risk, among other factors. Data on ex ante road construction prices in Europe suggest a PPP road to be 24% more expensive than a traditionally procured road, ceteris paribus. This estimate resembles reported ex post cost overruns in traditionally procured roads. Thus, the public sector seems to pay a premium on ex ante PPP construction contract prices mostly to cover construction risk transfer. Other reported sources of higher PPP road construction costs, including bundling, seem on average of lesser importance.
This paper offers an updated description of the macroeconomic and sectoral significance of PPPs in Europe, without assessing PPPs from a normative perspective. It shows that, over the past fifteen years, more than one thousand PPP contracts have been signed in the EU, representing a capital value of almost 200 billion euro. While PPPs have in recent years become increasingly popular in a growing number of European countries, they are of macroeconomic and systemic significance only in the UK, Portugal, and Spain. In all other European countries, the importance of investment through PPPs remains small in comparison to traditional public procurement of investment projects. However, PPP procurement is used extensively for major projects and this is spreading out from transport into other sectors.