Note 4 | April 2016 INFRASTRUCTURE FINANCE—COLOMBIA AND FDN Lessons on Infrastructure Lending from Colombia The World Bank Group is shifting from lending to mobilizing third-party money by leveraging its financial and advisory resources, with the goal of moving from billions to trillions of dollars in development financing. The promising start to Colombia’s 4G road project is evidence of the role that partnerships between governments and development banks can play in unlocking urgently needed infrastructure financing. The lessons learned from the 4G project will help similar partnerships replicate its success in other developing countries with adequate levels of domestic capital market development and similar challenges in infrastructure financing. Underinvestment in infrastructure limits economic growth in emerging restrained credit growth. And new banking regulations have adversely markets, and Colombia is no exception. The South American nation’s affected the ability of banks to provide long-term financing. economic potential and competitiveness are constrained by the poor Governments and government funded financial institutions suffer from quality of its national infrastructure. By some estimates it is more strained public finances and fiscal conditions and the distortions that expensive to transport a container from an inland city in Colombia to a government subsidized funding creates. The emerging long-term port than to send that same container from the port on to Asia. The financing gap is particularly acute in the emerging-market infrastructure World Economic Forum rates Colombia’s overall infrastructure 84th sector. out of 140 countries, and it is estimated that $40 billion in infrastructure investment is needed across the country over the next ten years. Meanwhile, over $5 trillion of emerging-market pension and insurance assets need investment (about $61 trillion when investors in developed Colombia’s narrative is typical of emerging markets, which collectively countries are included). Globally, less than one percent of pension suffer from an annual infrastructure financing gap of as much as $1.5 assets are invested in infrastructure. That is often for good reason, as trillion. Bridging this deficit is at the heart of the Sustainable infrastructure investments carry a higher risk and institutional investors Development Goals established in 2015. Yet public investment alone is usually lack the internal capacity to analyze and mitigate construction expected to be insufficient, raising the need for a public-private risk. Further, those investors are required to invest in rated instruments alignment to mobilize additional sources of finance. and to meet certain return benchmarks. Regulatory uncertainty, the lack of government support and political commitment, and meager project FINANCING FOR INFRASTRUCTURE pipelines dilute their attractiveness. And a shortage of data and Traditional sources of infrastructure financing—banks, governments, benchmarks on infrastructure project returns, as well as a general lack international financial institutions—cannot meet the financing needs of transparency in the infrastructure sector, further chill investor enumerated above. Since the global financial crisis of 2008, structural interest. weaknesses in the banking sector have led to deleveraging and But pension funds in particular, as a result of their long-dated liabilities FDN’s mandate is to be the principal catalyst in developing the in local currency, may be a good fit with the maturities and inflation infrastructure finance market in Colombia. It will offer products and indexation inherent in infrastructure assets that also typically require services that are critical to financing infrastructure—including long- funding in local currency. Infrastructure tends to have a low correlation tenor loans, subordinated debt, and credit enhancements—that currently with traditional asset classes, and unlisted infrastructure (despite being absent from the local market. Its operations are intended to supplement, illiquid) can be a beneficial source of diversification. Infrastructure rather than compete with, existing structures through such products and investments produce long-term, predictable, and stable cash flows services. And FDN’s active presence and participation in transactions matching the need of pension funds for certain and low-volatility facilitates greater participation by local banks, domestic institutional returns. The participation of pension funds in infrastructure investment investors, as well as foreign banks and international institutional also ushers in more transparency in the concession process and more investors. thought toward risk mitigation and innovative investment structures. FDN plays an important advisory role to market actors in addition to On the menu of structures, infrastructure debt funds are an interesting, establishing market and industry standards. It offers expertise in project intermediated product to channel institutional capital. Such funds are a structuring, financing, and advisory services to domestic financial useful means of pooling local currency capital for the financing of institutions as well as state and local governments. This not only projects that allow institutional investors to delegate construction and strengthens the domestic market but promotes international best- other commercial risks to professional managers while diversifying practice. At the sub-national level in particular there is a strong need for their investment in a portfolio of projects. Further, their existence, their advisory services around project structuring, design and execution of visibility, and the scrutiny of their investment activities provides a public-private partnerships, concession agreements, and project valuable demonstration effect which can mobilize future investors into management. In fact, FDN has partnered with IFC to create a jointly- the infrastructure asset class. funded public-private partnership advisory facility that will focus on building public sector capacity. THE CASE OF COLOMBIA As a result of its mountainous geography and recent history, As a nascent organization, FDN’s metrics have yet to fully crystalize. It Colombia’s infrastructure needs are concentrated in transportation. holds assets of $228 million but its current financials represent the Transport investment is needed to connect areas of concentrated vestiges of FEN, since much of its ongoing work is only beginning to population and production with the country’s key ports, a factor critical approach financial close. All products and services will be priced to Colombia’s sustainable growth. To address this need, Colombia’s competitively according to the market, with project finance and fee- government partnered with IFC and the Development Bank of Latin based advisory expected to meet current shortcomings in the Colombian America (CAF) to create La Financiera de Desarrollo Nacional (FDN), market. Overall, FDN’s activities are expected to not only transform the a financial institution that catalyzes investment in Colombian infrastructure finance sector but further develop and deepen Colombia’s infrastructure and addresses market failures that undercut optimal capital markets. infrastructure financing. COLOMBIA’S ROAD INFRASTRUCTURE FDN emerged out of the Financiera Energetica Nacional (FEN), an In Colombia, infrastructure finance needs are met mainly by inactive state owned enterprise established to finance energy sector commercial banks and corporaciones financieras, which are nonbank development. As such, FDN was essentially a start-up financial finance companies. Both the increase in sector-concentration risk in the institution with an entirely new structure, operations, and corporate banking system and emerging regulatory constraints will restrict banks’ governance. In 2014 IFC and CAF acquired equity stakes, reducing the ability to finance these programs. Therefore, the success of the transport government’s stake to around 65%, and FDN became a private sector infrastructure programs hinges on mobilizing institutional investors, entity no longer governed by the regulations and procedures applicable mainly local pension funds, which not only have the capacity to invest to state firms. FDN’s board was expanded and the government’s in local currency but also benefit from the long tenors and inflation representation reduced—with even fewer seats in the future—as FEN- indexation inherent in toll-road assets. era corporate structures were rebuilt to give the government a passive voice. FDN is aligned with Colombian government efforts to upgrade the deepen Colombia’s markets and begin to provide financial products that country’s road network. Known as the Fourth Generation, or 4G, road were previously scarce. program, the government’s toll road development program relies on a public-private partnership structure to improve and build over 7,000 LESSONS LEARNED kilometers of roads with an estimated capital expenditure investment of 1: Governance is key. $24.4 billion. As of February 2016, eight projects under the 4G road It is important to bear in mind the challenges to FDN’s launch when program had reached or were near preliminary financial close with an considering replication. First and most important, such institutions must estimated FDN financing of approximately $331 million. More maintain operational autonomy and the ability to operate commercially important, FDN is expected to mobilize more than ten times as many even as government retains a large shareholder presence. In FDN’s case resources for a total of $3.7 billion. this was achieved through an expansion of the board and a reduction of government representation on it, while initiating a competitive hiring Colombian pension funds, FDN, and IFC recently invested in the process for upper management. Colombia Infrastructure Collective Debt Vehicle (Infra CDV), the first infrastructure debt vehicle in Colombia, which will provide senior debt 2: Public sector support is critical for successful implementation of financing to greenfield and brownfield infrastructure toll-road projects public-private partnerships and capital markets solutions. in Colombia. The investment represents a milestone in the aggregation The government of Colombia has introduced a number of institutional of efforts by the World Bank Group to deliver comprehensive solutions and regulatory changes to promote the development of the infrastructure for infrastructure financing, leveraging investment, advisory, and sector with private sector participation, improving the public-private treasury resources. partnership framework and providing government guarantees and project support. The impact of Infra CDV and FDN is best exemplified in the Pacifico 3 road project. Achieving financial close in February 2016, Pacifico 3 is Further, the government has implemented regulatory changes to allow an ambitious component of the 4G program: a 146 kilometer initiative pension funds to invest in this asset class through infrastructure-debt with 26 bridges and six tunnels. FDN has committed $66 million in funds, making these the only vehicles through which pension funds can credit enhancements through its liquidity facility, while mobilizing invest in infrastructure debt. While infrastructure funds have existed for $663 million. Critically, some 59 percent of mobilized funds will come a long time, usually in the form of equity-sector funds or specialist from international capital markets and 28 percent from local financing. private equity funds (such as energy), infrastructure-debt funds were specifically allowed as an asset class for pension funds. These results highlight FDN’s critical role in attracting international investors while also mobilizing more domestic resources. The first part And the 4G Program benefits from availability payments from the of these funds will be issued as long-term debt financing of 19 years— government, top-up payments in the event of lower-than-projected toll shifting market tenors from medium to long-term, which will be the first revenue, and termination payments for early termination of concession debt financing in an international market tied to the 4G road program. It contracts, all of which reduce investor risk. The concession framework will also be the first 4G issuance with an investment grade rating, with a was designed by IFC’s infrastructure advisory group and provides a local rating of AA+ and international rating of BBB-. While the 4G clear allocation of risks to both the public and the private sectors, with road program is still in its early stages, FDN’s presence is already performance incentives for the private sector. beginning to reap dividends through the mobilization of diverse financing. 3: Successful mobilization requires close collaboration with institutional investors in structuring a new asset class. Over a longer time horizon FDN is expected to expand its scope to all IFC played an important role in bringing core institutional markets to segments of the infrastructure sector. These efforts will play a key role the table and negotiating a deal that imparts sound risk management in promoting inclusive growth and enhancing competitiveness in with structuring expertise, project finance, and sustainability standards Colombia. While domestic capital market development is complex and in an innovative way. IFC worked with the pension funds, visiting their interrelated, the efforts of FDN to crowd-in local investment will help offices and explaining IFC’s recommendations on structure and commercial terms. In particular, IFC spent time explaining the environmental and social provisions and how they served as a risk mitigation mechanism, especially in infrastructure investing. IFC is the only investor of global scale with substantial infrastructure expertise, and pension funds derived comfort from this. Via this project, IFC successfully contributed to creating an active financing market for public-private partnerships to deliver key infrastructure. IFC’s valued role resulted in a mobilization fee for its efforts. 4: Collaboration is critical when pushing the envelope. Colombia was one of the first countries selected for a capital markets deep dive in 2013 by the World Bank Group, combining all relevant Bank Group entities focused on capital-markets development. WBG’s unique strengths and abilities in working and collaborating across sectors and disciplines can bring the best global development experts together to solve particular development challenges.  Meera Narayanaswamy, Senior Investment Officer, Financial Institutions (MNarayanaswamy@ifc.org); Jordan Townswick Pace, Research Assistant, Office of the Chief Economist – Thought Leadership, (jpace1@ifc.org).