Private Participation in Infrastructure Investments

Written by: Cash101 Staff

One of the major discussions at the moment concerns the gradual entry of private capital into the infrastructure segment. This entry of capital is now seen as a “business” with great profitability opportunities. This article will raise the specificities of infrastructure investments, which make the private sector participation complex. This article will also highlight the fact that these investments necessarily involve financing outside the firm imposing great risks to both lenders and borrowers. In this perspective, the objective is to raise the financial innovations that make it possible today to leverage resources to this type of investment for private capital.

 

The complexity of infrastructure financing and State participation

The investment in infrastructure, implies the purchase of goods of long durability and large size. Because of their characteristics, they offer higher price, have great indivisibilities and are very illiquid. These projects involve scales higher than that of most industrial projects. As a rule, the average period of construction of infrastructure works is longer. In case if the construction is not completed, what has been set up will not be likely to have an alternative use. In this case, the costs incurred in the construction phase are sunk-cost. It should be noted that the risks incurred in the implementation phase of the investment are greater in the case of investments in infrastructure.

 

On the other hand, in the operation phase, infrastructure projects, which generally have a monopoly business profile, incur low risk. They have more stable cash flow than those linked to industrial projects. Thus, considering the operation phase of the enterprise, the construction of future profitability expectations is more complex and unstable in the case of industrial investments. This positive fact, however, should be analyzed in relative terms. This is because there is a slower return in infrastructure projects, besides the ongoing need to maintain the assets.

 

The private participation in the investments of infrastructure

In the nineteenth century infrastructure projects were financed privately in almost all countries of Europe when they were in the process of development. Given the size of these ventures, it is not possible to invest in this business with only its own capital, as external financing is required. On the other hand, individual capital usually does not go alone in these types of ventures. One of the important aspects that allowed the access of these investments to the private sector was the introduction of partnerships. Such an institutional arrangement has the basic characteristic of allowing the applicants the reduction of risks and the flexibization of the illiquid nature of the investment.

 

Considering the distribution of risks among the participants, the companies allow the impacts to be diluted between the participants from the assembly of legal nature of society. The fundamental question is that the shareholder can dispose of its bond in secondary markets, and be in a more flexible position. In addition, the introduction of Corporations is important as a mechanism of capital cohesion. Thus, the introduction of these funds is a fundamental funding instrument, since the IPO can be seen as a form of definitive financing (shares are a debt security). In the case that interests us closely we can remember that the first railroads could become private enterprises precisely because of this institutional arrangement.

 

New scenarios for infrastructure financing – project finance

In the 1980s, the potential abrupt disruption in interest rates and exchange rates exposed the fragility of financing structure and financial markets started to present new operations. Innovations were developed towards the practice of hedging finance, with intense integration of the International Financial System. The rapid development of a derivatives market (such as options, futures and swaps) is a sign of this growing integration. This has also led to the formation of a network of closely linked players. This movement can be detected when these instruments facilitate the integration of markets with different maturities and risk characteristics, creating a rapid restructuring of the portfolios.

 

Given the innumerable financial possibilities of raising cash, the operations of payment of debts constituted to finance the investment can also be carried out in multiple forms. These may involve diverse financial positions too. The financial arrangement responsible for financing the investment may cover the credit and equity market exclusively or simultaneously. This may also involve debt instruments with varieties of maturities.

Though the mixed financing and debt re-pricing strategies combined with hedge operations are not enough to make investments of this size. Simultaneously, it is necessary to consider that the financial innovations of 1980s opened the prospect of specific financial arrangement, of private investment in infrastructure. This allows these investments to be carried out through the public / private partnership. It is an innovation that considers the possibility of working with risk dilution schemes. This also allows to consider the different objectives of financiers, project builders, service providers and operators.

 

As can be seen, the setting up of project finance also makes it possible for the different interests of the financiers to be considered. What stands out in terms of this financial arrangement is that it makes possible a new approach that effectively takes into account the project. This entails a possibility of dilution and qualification of the risks from a complex set of contracts. These risks and contracts involve a large set of investors, being open the possibility of recycling the contracts themselves.


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