FROM LONDON to Moscow to New Delhi, governments are sending
forth suitors to woo sovereign wealth funds. Officials are
looking to the funds to help finance large-scale public and
private infrastructure projects that they believe will help
boost the ailing global economy.
When George Osborne, Britain’s chancellor of
the Exchequer, traveled to Beijing in January 2012 to talk with
then-chairman of China Investment Corp. Lou Jiwei about
CIC’s possible involvement in U.K. infrastructure
and energy projects, the massive sovereign wealth fund was
already looking at potential investments. Projects in the
spotlight included the High Speed Two (HS2) rail line, which
aims to provide a superfast train link between London and
Birmingham and eventually will expand to Manchester and Leeds.
Shortly after Osborne’s visit CIC bought an 8.68
percent stake in Kemble Water Holdings, the private company
that owns Reading, U.K.–based Thames Water
Similarly, the Indian government has recently begun courting
sovereign wealth funds by allowing them to buy tax-free bonds
issued by state infrastructure companies, including New
Delhi–based India Infrastructure Finance Co.
Meanwhile, Russia is attracting sovereign wealth funds from Abu
Dhabi, China and Qatar to invest in its infrastructure. In
October 2011, CIC agreed to set up a joint investment fund with
the Russian Direct Investment Fund (RDIF), a state-sponsored
private equity company established by Vladimir Putin. In June
of this year, Abu Dhabi’s Mubadala Development Co.
agreed to coinvest as much as $2 billion with RDIF; that
commitment was followed this month by a pledge from Abu
Dhabi’s Department of Finance to invest as much as
$5 billion alongside RDIF.
Opportunities for sovereign wealth funds to invest in
infrastructure abound. The European Investment Bank (EIB) is
supporting a host of projects across Europe, including a road
connection between Bruges and Knokke in Belgium that will
provide better access to the port of Zeebrugge. In Brazil,
which will host the FIFA World Cup in 2014 and the Summer
Olympic Games in 2016, the government is offering concessions
for a host of transportation deals, including airports in
Brasília, Campinas and São Paulo.
A January report by New York–based McKinsey Global
Institute, the business and economics research arm of
consulting giant McKinsey & Co., in conjunction with the
firm’s infrastructure practice, estimated that
through 2030, $57 trillion will be required to sustain
projected economic growth. Although sovereign wealth funds
collectively manage trillions of dollars, to date they have
mostly been equity players in existing infrastructure projects
and assets. The question is whether they will follow insurers,
pension funds and asset managers in moving to the debt side of
the infrastructure funding market. But if they do, will there
be enough new projects?
Sovereign wealth funds prefer existing infrastructure assets
to project finance, notes Colin Smith, a partner and
infrastructure specialist in transaction services for PwC
(formerly PricewaterhouseCoopers) in London. "The former [asset
group] is a ready market," Smith says, "and a lot of [sovereign
wealth] funds are keen to invest in infrastructure that already
exists because it provides a good long-term asset base
— in turn providing reliable long-term yield."
There’s a big difference between investing in
existing and high-performing infrastructure assets such as
airports and water companies and allocating to new, or
greenfield, projects, he explains. "To persuade sovereign
wealth and other funds to invest in new schemes," Smith says,
"there would need to be government support or a high degree of
confidence in the investment case."
The need for such investment has grown urgent since the
financial crisis. Not only are governments short of money, but
European banks — long a reliable source of funding for
large infrastructure projects — are unwilling to lend
as much for as long.
Five years ago there were at least 70 banks involved in
lending on a project finance basis to new infrastructure and
energy developments around the world, says Matthew Vickerstaff,
London-based global head of structured finance for Paris-based
Société Générale. Today, he says,
only half that number offer such debt.
There are several reasons for this retreat. After U.S. money
market funds — which once provided heavily relied-upon
short-term dollar loans — pulled out of the euro zone
in 2011 and 2012, some European banks found it harder to fund
dollar-denominated project finance deals. Meanwhile, those
lenders most affected by the European sovereign debt crisis,
such as German regional banks and Italian and Spanish banks,
stepped away from funding projects and have yet to return.
Even the European banks that emerged relatively unscathed
from the crisis remain reluctant to provide funding beyond
about seven years, according to several bankers and analysts;
they’re often only willing to fund new projects
until the initial construction phase is completed. This
conservative stance reflects banks’ efforts to
meet tough new Basel III regulations that require them to hold
more capital as a buffer.
To satisfy demand for infrastructure investment from
sovereign wealth funds and other long-term investors,
governments will increasingly need to complement traditional
sources of funding, such as the banking market, with new
sources of financing, such as project bonds, says Donald Chan,
COO of Clifford Capital, a Singapore-based structured-finance
group that counts Singaporean sovereign wealth fund Temasek
Holdings among its backers.
In the U.S. investors have long tapped the capital markets
to fund domestic infrastructure projects, but deals in Asia,
Europe and the Middle East have largely relied on bank funding.
As the banks have withdrawn in those regions, the expectation
is that construction, technology and other companies involved
in developing and operating new infrastructure projects will
increasingly turn to the capital markets.
Spying an opportunity, other financial institutions are
already moving to offer debt as well as equity services. For
example, Allianz Global Investors in 2012 brought in a team
from a unit of MBIA, the Armonk, New York–based
financial services group, to identify and manage infrastructure
debt for Allianz’s Munich-based parent company and
other investors. New York–based BlackRock, the
world’s biggest money manager, recently
established a division in London to target the market for
The project finance market is moving away from a straight
bank funding model to something more diversified, says Jim
Barry, CIO of renewable power and infrastructure in
BlackRock’s London office. Infrastructure projects
are attracting a range of nonbank institutions, but investors
are not going to deal at any cost, he says. Export credit
agencies and quasigovernment institutions continue to play a
pivotal role in providing support for new projects —
as do organizations like the Asian Development Bank, the
European Bank for Reconstruction and Development and the
Even without the types of guarantees that monoline insurers
provided before the collapse of Lehman Brothers Holdings in
September 2008, investors have flocked to recent bond issues.
Pension funds, insurers and agencies piled in to buy the
€1.4 billion ($1.85 billion) bond supporting an
underground gas storage project in Spain for privately owned
Castor Gas Storage. The transaction was the first to secure
funding under the EIB’s Project Bond Credit
Enhancement (PBCE) scheme, which provides a line of credit that
improves a deal’s overall rating, making it more
palatable for investors.
Michael Wilkins, a London-based senior credit analyst for
infrastructure finance at rating agency Standard &
Poor’s, says the strong appetite for Castor and
other recent projects financed in the capital markets shows how
interested yield-hungry investors are in well-structured
For investors with long-term liabilities, like sovereign
wealth funds, pension funds and insurers, the rationale for
investing in long-term infrastructure projects is clear. Those
funds that invest their money safely are making virtually
nothing, and the risks quickly accumulate when investors target
higher-yielding assets. Government bonds such as U.S.
Treasuries, U.K. gilts and German Bunds all pay very little, so
fixed-income investors are searching for higher-yielding
assets. Sovereign wealth funds are no exception.
"Investing in infrastructure or real estate is therefore an
attractive alternative, as long as you get comfortable with the
risks," says Robert Ohrenstein, London-based global head of
private equity and sovereign wealth for financial services and
accounting firm KPMG, which is headquartered in the
Sovereign wealth funds certainly have the money to invest.
They managed an aggregate $4.1 trillion in assets at the
end of 2012, up from $2.4 trillion in 2007, according to
Institutional Investor’s Sovereign Wealth Center.
Although still relatively modest, the proportion of that total
invested in infrastructure is significant and growing.
"Sovereign wealth funds are clearly moving more capital into
the infrastructure financing space," Ohrenstein says, adding
that they are relatively cautious investors. "Capital
preservation ranks fairly high on their list of concerns, so
they will select how they deploy capital carefully."
That may be so, but since sovereign wealth
funds’ disappointment in the performance of their
external managers during the financial crisis, an increasing
number of the largest funds are expanding their internal asset
management capabilities and choosing to make direct
In June, at a dinner to celebrate the 60th anniversary of
the Kuwait Investment Office, the London outpost of the Kuwait
Investment Authority (KIA), Osama al-Ayoub, a former banker for
Goldman Sachs Group who heads the KIO, announced that the fund
planned to make direct investments totaling as much as
$5 billion in infrastructure, predominantly in the U.K.
His comments came just weeks after the U.K.’s
Severn Trent rejected a third bid, of £5.3 billion
($8.3 billion), for the water group by KIA, British pension
fund Universities Superannuation Scheme and
Canada’s Borealis Infrastructure, which is part of
pension fund OMERS. Coventry-based Severn Trent’s
board said the consortium’s offers failed to
reflect the company’s "long-term value and future
Other sovereign wealth funds are seeking to follow
KIA’s lead by expanding their infrastructure
investment capabilities. In May the Abu Dhabi Investment
Authority (ADIA) hired John McCarthy, former head of
infrastructure at Deutsche Bank, as its global head of
infrastructure. In a press release ADIA said McCarthy would
play an important role in developing the fund’s
ADIA bought a 9.9 percent holding in Kemble Water, the
holding company for the U.K.’s Thames Water, two
months before CIC purchased its stake in the British utility.
The Abu Dhabi fund also owns part of Australia’s
Sydney Airport Holdings and has a stake in the
country’s Port of Brisbane. Last year an ADIA
subsidiary was part of the consortium that acquired 24.1
percent of Gassled, which owns the integrated gas
transportation grid and processing facilities on the Norwegian
CIC, which in 2012 bought a stake in the company that owns
and operates London’s Heathrow Airport, told
China’s official Xinhua news agency earlier this
year that it was eyeing further infrastructure investment in
Europe and the U.S.
So far, sovereign wealth funds have largely chased equity
stakes in existing infrastructure assets, for which governments
offer a high degree of certainty and security. British
utilities, for example, are attractive to investors hunting for
safe assets with good returns because the regulatory regime in
the U.K. has been so stable.
"Funds want to deploy capital and get a decent return," says
PwC’s Smith, commenting on the rush into U.K.
infrastructure assets. "For a core infrastructure water
project, that could mean an 8 to 10 percent internal rate of
Still, it remains to be seen whether sovereign wealth funds
will seek to become key players in funding new infrastructure
projects. For good reason, they may be reluctant to shoulder
the complexities and risks involved in developing a highway,
airport or rail line. Analysts point out that like many asset
managers, sovereign wealth funds don’t like to
assume construction risk, preferring to take over a
project’s debt from banks once a facility has been
Given that sovereign wealth funds in general are unwilling
to accept the key risk at the start of an infrastructure
project and that some of them lack expertise in putting
together highly complex infrastructure transactions, banks will
still play a crucial role in getting deals funded.
Right now on the debt side, the expectation is that pension
funds and insurers are more likely than sovereign wealth funds
to plug the gap in project finance. "But as this market becomes
more established, sovereign money may well come into play,"
says BlackRock’s Barry.
However, inefficient pricing could thwart all
investors’ push into infrastructure. On the
high-quality, established core infrastructure side,
there’s no shortage of capital, but the
fundamental issue is a lack of assets, which is driving prices
up and returns down. And although the so-called project finance
funding gap has received plenty of attention in recent years,
bankers like Société
Générale’s Vickerstaff complain that
the real problem now is not enough new projects to satisfy
Although the grumbling about a lack of projects is a common
one, it may be overplayed. Initiatives such as the
EIB’s PBCE program are designed to help deals
attract funding. At the same time, credit agencies are stepping
up to get new projects moving.
What the infrastructure market lacks isn’t
necessarily a pipeline of projects but a wealth of creditworthy
financing proposals, points out S&P’s Wilkins.
That means sponsors and their advisers must come up with
innovative solutions to bring deals to market. "Since 2008
there has been a certain amount of inertia by financial
intermediaries," Wilkins says. "They haven’t been
prepared to go out and proactively put deals together; rather,
they have waited for municipalities and governments to come to
Sovereign wealth funds are clearly interested in
infrastructure, but not all projects will offer the prudent
risk-return profile they seek. "When you look at the
funds’ approach to investing, it’s
about capital preservation," says KPMG’s
Ohrenstein. "I don’t see a wall of money being
deployed globally and certainly not without careful thought and