Creatively financing future cities

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By Ayesha Khanna September 21, 2012 | The Straits Times

As the world enters the urban century, continents such as Asia and Africa are truly gal- loping into it. In China alone, 350 million hopeful villagers, or about the United States’ entire population, will move into cities by 2030. Asia’s infrastructure needs – in areas like power, transportation, housing, sanitation and water – will require US$8 trillion (S$9.83 trillion) of investment within the next decade, says the Asian Development Bank.

Yet Asia has lagged behind not only in quantity but also quality of infrastructure. The 2009 Global Competitiveness report calcu- lated that 15 of the 24 Asian economies surveyed had below-average infrastructure.

Poor and overburdened infra- structure plunged half of India’s population – 600 million people – into darkness when its north-eastern power grids failed.

The urbanisation phenomenon is matched by an equally pro- found technological change with the potential to make infrastructure efficient, sustainable and integrated. “Soft” infrastructure like water sensors, intelligent traffic management systems and solar panels combined with traditional “hard” infrastructure like dams, roads and buildings enable emerging countries to leapfrog to better managed urban environments.

According to Cisco, US$400 billion of global infrastructure allocations will be spent on this “soft” or smart layer of infrastructure. Smart systems offer reduced capital costs with better maintenance and management, and in- creased efficiency in coordination and synchronisation of governance.

Rio de Janeiro, for instance, spent US$14 million on IBM’s crisis operations centre, which integrated information from weather forecasting systems, police, hospitals and sensors to predict and plan for floods in the shanty are- as. Even as cities recognise the need for both technology and built infrastructure investments, they find themselves fiscally con- strained in financing it.

Traditional infrastructure funding from taxes, grants, leases and user charges is now grossly insufficient. Most countries cannot afford upgrading or building new infrastructure projects, unlike China and its recent US$150 billion infrastructure package, and the Middle East’s petro-monarchies and their possible over-capacity in infrastructure.

Governments also have to face the wholesale withdrawal of banks from the project financing market, particularly the European banks that have provided loans to project finance deals all over the world. With recent Basel III regulations, which require banks to hold higher capital reserves for long-term debt, banks are shying away from project loans. Many, like Royal Bank of Scot- land, have sold bundles of project finance debt.

This financing gap is driving cities to reach out to new kinds of investors and to structure more pub- lic-private partnerships (PPPs) in an attempt to channel liquidity and risk-sharing into infrastructure projects.

New players, including institutional investors and state-backed agencies, are showing interest in infrastructure projects. Asset management firms like BlackRock and infrastructure funds like Aviva are seriously looking into different projects and funding options. Funds like Canada Pension Plan are removing their middle managers and managing their infrastructure investments themselves.

Export credit agencies such as South Korea’s Kexim are providing substantial funding to support national companies and infrastruc- ture projects. Mega-corporations like General Electric have their own financing arms which help fund the acquisition of their smart urban technologies.

As a result, corporate and multilateral development banks like the World Bank are left with the critical role of facilitation and ex- pert advisory. For example, Standard Chartered is coordinating the financing for Abu Dhabi’s US$20 billion nuclear reactor project with funding primarily provided by Kexim.

The desperate need for infra- structure funding has led San Francisco to seriously consider a US$1.7 billion investment by China Development Bank in two long-stalled, real estate development projects, a far cry from the national security uproar over Dubai Port World’s attempted purchase of management rights at six US ports in 2006.

But in order to attract such investors, governments must create the policies and financing mechanisms that reassure a project’s feasibility over the long term.

Infrastructure financing holds several risks for investors: It is a capital-intensive process with high upfront costs, the payback depends on the cash flows generated over several decades from the investment and political uncertainty is embedded in the dependence on the public sector for regulatory support and administration.

Governments are debating several ways to attract the private sector to both invest in infrastructure and to participate in it. In the US, there has been talk of a National Infrastructure Fund, modelled partially along the lines of the European Investment Bank (EIB).

This would supply low-interest loans by raising funds in international capital markets along with concessions from the govern-ment. While that idea has remained mired in political stale- mate, Chicago’s mayor recently set up a municipal level infrastruc-ture trust worth US$7 billion, with strong interest from private investors like JP Morgan and Citigroup.

Using private investment in combination with smart technologies, user fees and efficiency improvements in governance, the trust could prove a model for other cities to follow.

Infrastructure bonds, or securities that are created from pooling a number of projects, have also been discussed in the US and Australia. PPPs have been used widely in Europe but most of them have been bank-funded, and those that were bond-funded made use of monoline (bond insurers’) guarantees.

The European Union’s pro- posed Europe 2020 project bond initiative is also targeted towards providing an alternative to guaran- tees previously given by monoline insurers by instead having the EIB credit-enhance the loans, thus raising their rating and making them attractive to private investors.

Another way to assuage the riskiness of infrastructure bonds is to make them “covered” by the pool of infrastructure assets. In other words, covered bond investors, common in Europe, unlike those in the mortgage-backed securities during the financial crisis, have a recourse to recover their loans should the originator be- come insolvent.

Smart systems, depending on the extent of their maturity, should, in future, be able to offer better control over data, leading to the possibility of offering securities with both increased certainty and increased weighted return for investors, while also reducing overall cost of capital for the projects being financed.

Water sensors deployed by Singaporean company Tritech in India have been shown to help the city monitor water quality and lev- els. LED street lights have saved millions of dollars in energy bills in cities like Boston. Intelligent traffic and fare management systems similarly offer measurable benefits like passenger traffic and revenue increases, and reduction in carbon footprints.

Cities sometimes find systems like waste-to-energy technologies, integrated government agencies and electric vehicle infrastruc- tures riskier because the technologies are still untested and it is difficult to capture the return on in- vestment. The EIB has launched Jessica (Joint European Support for Sustainable Investment in City Areas) to reduce risks through providing funding for smart city initiatives.

In the US, energy performance contracts provide a way for energy service providers to cover the upfront costs of energy retrofit in- vestments, recouping the costs over time through the technology’s energy savings. In a more innovative twist, New York City has become a business partner with Microsoft in the deployment and development of urban surveillance systems.

The Domain Awareness System centralises data and video feeds from thousands of CCTVs around the city. Mayor Michael Bloomberg announced that New York City would co-develop the system with Microsoft and take a 30 per cent cut of any deals with other cities that ensue from this collaboration.

The private sector’s participation is critical if the world is to meet the needs of its burgeoning urban populations. But institution- al investors have significantly reduced their appetite for risk after the financial crisis.

In both the built and smart components of infrastructure, efforts to find creative ways of channelling private capital in a way that minimises risk must be debated and tested.

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