---

---

Nigeria: Stakeholders Call for Use of Bonds and Specialized Institutions

Babajide Komolafe

27 October 2008

---

Stakeholders and experts in the finance sector have called for a paradigm shift in the involvement of financial institutions in infrastructural financing under the public private partnership (PPP) model, Babajide Komolafe writes

The seeming emphasis on direct investment by banks in infrastructural financing has been faulted by industry experts. Speaking at a two-day workshop on 'Financial Institutions and the challenge of infrastructural financing' by financial correspondents in Abeokuta, Ogun State, stakeholders stressed that bonds and not banks should be used for such purposes.

According to Dr. Ayo Teriba Managing Director/chief executive, Economic Associates, Infrastructural financing is not something that banks can make to happen. He explained that a critical factor needed to facilitate private sector financing of infrastructure is the risk rating of the government of the day and hence there is need to rate the risk of the various tiers of government in the country, adding that banks and private sector can do nothing if the government is not ready in this regard.

Projects, he stated needs to be initiated by the government entity and it is necessary to know the risk profile of the entity, and the best place to finance the project is the bond market. He noted that the Federal Government is yet to issue bonds for infrastructural financing and this means that bonds are still under issued and the government needs to be aggressive in this regard. Speaking further, he stated that the government should de-emphasize using the budget to finance capital expenditure and should rely on more bonds. Projects like the Nigeria Liquified Natural Gas (NLNG) and the railway, he noted adding that states are no longer issuing bonds. He stressed that states should not be going to banks to raise funds but should raise money through bonds.

Teriba averred that bonds should carry the weight of infrastructure in projects in the country adding that the interesting thing about bonds is that they are tradable and hence the risk inherent in the project can be financed. Summing up his presentation he reiterated that, "banks are the wrong place to look up to for infrastructure financing but we need to know the risk rating of the government entity.

This position was corroborated by the Managing Director/chief executive, Partnership Investment Company Limited, and Former President Finance Houses Association of Nigeria (FHAN) Mr. Victor Ogiemwonyin.

Speaking to Financial Vanguard last week, he stated, "The proper financing of long term projects that is why we have the capital market. But when the capital market is not deep that is why you have this idea that banks should finance infrastructure. But the problem is that banks don't have long term funds. Most of their funds are short term with maximum of one year and that is why they are not appropriate to finance infrastructure project which are long term in nature.

You also hear people saying banks are not financing the real sector, this is also wrong because most of the financing needs of the real sector is long term, banks can only finance short term needs like working capital for day to day running of the company.

The issue is that people don't seem to understand the role and importance of the capital market. For example when we call for government intervention in the market, it was dismissed on the basis that the capital market is a private sector arrangement. But what they have forgotten is that the market is where you have the pension fund, insurance premium and all the money of other critical sectors of the economy. That is why the ramification of the capital market is more that the private sector. And it is the best place to mobilise savings for long term investment.

Elaborating on the why banks are not suitable for infrastructure financing at the workshop, Mr. Charles Mordi, Director of Research, Central Bank of Nigeria (CBN), noted that "First, many infrastructure projects require long-term financing. When banks provide such funding, they are exposed to a maturity mismatch, as most of their funding is through short-term deposits. Second, large infrastructure projects may breach banks exposure limits for individual borrowers or industries. This problem arises when banks attempt to fill the gap created by the projects inability to tap other sources of finance.

Third, the regulatory issues involved in opening up the economy to external capital flows. Opening up the capital account to foreign debt is more dangerous than opening it up to foreign direct investment (FDI) or even to foreign portfolio investment. The East Asian crisis stood out as a classic example."

Speaking on Regulators Perspective to The Challenge of Financing Infrastructure in Nigeria, Mordi stated that generally there are some financial sector constraints to infrastructure financing in developing countries. By their nature, infrastructure projects are complex, capital intensive, long gestation projects and involve unique risks to financiers. They are characterized by non-recourse or limited recourse financing in which lenders can only be repaid from revenues generated by the project. This and the other characteristics make financing a serious challenge.

Furthermore, infrastructure financing involves complex and a mix of contractual arrangements amongst many parties including banks, domestic and foreign financial institutions and government agencies. Other constraints include;

Difficulty in raising equity finance which covers the bulk of operational, financial and market risk. Even so the capital markets in developing countries are weak and corporate governance is poor as well. Moreover, mezzanine financing needed for infrastructure financing in developing countries is limited due to absence of sufficiently large pool of projects, thus, leaving funding institutions with only the choice of more straightforward loans than the hybrid types. In addition there is the risk of using foreign currency loans where there is no deep forwards market.

Underdeveloped debt market in developing countries is yet another constraint to infrastructure financing given that such projects take as long as 10 - 15 years in some cases to generate profit. Also, in many developing countries, regulatory uncertainties constrain infrastructure financing as it raises the risk profile of projects. Regulatory requirements in some cases restrain insurance and pension funds from participating in infrastructure financing."

Besides the above he noted that there are some arguments in the literature about regulatory dilemmas (vis-a-vis involvement of financial institutions in infrastructure financing). "One such argument is whether regulators should relax some financial regulations to assist private investors.

A common argument in favour of this is that regulators, for example, securities and exchange commission, central bank etc, should place national interest above their own regulatory objectives, since the country needs roads, bridges and other infrastructure.

The argument goes further that slight laxity in financial regulation is a small price to pay for economic development which is the ultimate objective in developing countries. The argument implies that regulators in developing countries should balance their regulatory and developmental roles. Although it is far from implying that regulators should compromise their basic objectives like investor protection in the pursuit of larger national interests."

Against this background Mordi recommended that instead of the current emphasis on conventional banks for infrastructure financing, "The government can float a well capitalized National Infrastructure Bank that would pool, package, and sell public infrastructure securities in the capital markets, while the private sector should be encouraged to establish specialized infrastructure financing institutions such as infrastructure leasing and financial services companies which would participate at the design stage of a project.

The backing of such institutions at an early stage would carry at least two advantages. First, it would make it easier for project developers to obtain finance from other sources. Second, it would provide the developer with opportunity to use the expertise of such institutions in project designing and financial structuring.

The financial regulators are expected to give the necessary supervisory and regulatory assistance that would help such institution achieve its set objective."

In agreement with Teriba's submission, Mordi also recommended increased funding of infrastructure through government bonds stressing, "A well developed government bond market is critical prerequisite for the development of the corporate bond market. Hence, there is an urgent need to increase the depth and the breath of the government bond market; improve the existing regulation that relates to institutional funds (insurance and pension funds) ; and introduction of an element of marketability and price discovery, which can only be brought in by making securities trading screen-based and more transparent."

Furthermore he called on, "Relevant regulatory authority to improve relevant policies to make it easier for investors to survive. In this regard, a key priority is for the regulator to introduce enabling regulations for the use of put options as an exit mechanism for investors in unlisted (private placements) companies. Greater comfort on exit would encourage financial investors to take equity in greenfield infrastructure projects by having some defined, low guaranteed returns, which is the practice in some emerging markets, especially in Latin America.

An additional and desirable outcome of this would be that with the entry of more financial investors in the equity market, it would broaden the investor base and with successful closing of projects it would increase investor confidence.

Investment policies and regulatory guidelines for insurance companies, pension funds, mutual funds, banks and other financial institutions need to be sufficiently flexible for these entities to choose an appropriate risk-return profile within fiduciary constraints. This will also help professionalize fund management. In addition, legislations relating to pension and insurance companies should be modified to allow them invest in infrastructure projects, which have a guarantee from the federal government or multinational agencies. The cost of such funding will be lower since these will not carry any currency risk."

Be the first to Write a Comment!

---