Can the ADB pull private sector into infrastructure?

IFR Asia, ADB report, May 2010

For many years now, the Asian Development Bank has being trying to coax the private sector to take a leading role in its projects and initiatives. The logic is straightforward: the ADB’s own assets as a lender are finite and inadequate for the social and infrastructure challenges the region faces, but if the bank can be a catalyst for private sector investment, then impossible funding targets become potentially achievable.

Last year the ADB put out a book, Infrastructure for a Seamless Asia, which argued that between 2010 and 2020 Asia needs to invest approximately US$8 trillion in national infrastructure, as well as $290 billion on specific regional infrastructure projects in transport and energy. On the flip side, it argued that if this happened, “developing Asia’s real income during that period and beyond could reach $13 trillion.” This contention – that if you spend money, you will make money – is the message the ADB must get across to the private sector.

How’s it done so far? “As a bank I think we’ve made tremendous progress both from the perspective of real investment, and catalysing additional investment in the region,” says Philip Erquiaga, director general of the Private Sector Operations Department of the ADB. Firstly, the bank has “ramped up our operations rather dramatically” in pure dollars and cents commitments, Erquiaga says. “Back in 2001 we were doing less than $100 million a year [private sector operations] in terms of approvals; last year we were close to $1.7 billion, with $1.8 billion anticipated this year.” By 2020, the bank hopes that engagements in private sector development will account for 50% of approvals.

Alongside that, the ADB has put heavy resources into what Erquiaga calls “upstream work” – creating the right environment for private investment, from company law and land registration to adjudication. Another challenge has been capacity. “If there is one lesson we have learned in dealing with the private sector in our operations, it’s that they don’t want the rules of the game to be changing on them midway through their investment. To ensure that does not occur you need to establish the right environment and to ensure that a PPP is staffed with the right people with the right competence.”

Since the ADB can only ever take a 25% role in the financing of a project, it has necessarily moved from being a banker to a broker. “It’s in our nature to act as a broker to make sure the deal gets done,” Erquiaga says. This, though, has changed as a consequence of the financial crisis: these days the ADB finds itself putting a lot of deals together with other international agencies, rather than with commercial co-financing. When the New Bong Escape hydro plant in Pakistan, the country’s first run-of-river hydro development, was financed last year, the ADB was alongside the Islamic Development Bank, IFC and Proparco, the French development finance institution. “Otherwise the financing would not have been available,” Erquiaga says.

Hopefully, though, that retreat of the private sector is temporary, and in the meantime the ADB continues to try to provide the facilities to keep them interested, such as political risk cover, partial credit cover – a guarantee can cover as much as 99% of credit on an individual transaction – and simply the ADB’s own participation. “A lot of people look to us for the halo effect,” says Erquiaga. “The fact that the ADB is involved in a transaction, with our close relationships with governments and so forth, means there are fewer instances of the rules of the game changing midway through.”

For many years the ADB has used a funds model to try to attract investment. The bank has been active in private equity since 1983, and today has 40 current funds, covering about 400 individual portfolio companies, with around $720 million of total current commitments.

Again, the ADB is held to a 25% limit on fund participation, but funds are one area where the catalytic effect of the ADB is easily measured. “If we look across the entire portfolio since 1983, we see that for every one dollar we have put into a fund, approximately eight is raised elsewhere,” explains Robert van Zwieten, director of the private sector capital markets division at the ADB. “That’s a huge effect and amplifies the impact we could have with our own resources.

“It’s far beyond what we ourselves could muster. The multiplier effect continues as funds then take minority equity stakes in portfolio companies.”

For much of the decade the focus was exposure to the SME and infrastructure sectors. “Those are widely seen to be a huge source of employment, and jobs are a conduit for poverty reduction,” says van Zwieten. From 2007 the department’s view broadened, with more activity in areas such as microfinance, clean energy and water, and socially responsible investing, as well as an increasing focus on frontier markets “where private equity is nascent or non-existent.”

The change of focus brought a shift in approach too: in clean energy the bank struggled to find suitable investable funds in late 2007, so stepped up to incubate some itself. That process entailed an RFP process that attracted 19 bids, five of which were accepted, and today they are “only just coming to the starting line, due to the harsh fundraising climate for such novel funds in 2008 and 2009.”

Hopefully these funds will, in time, be free-standing. One fund manager the ADB has long backed approached van Zwieten recently saying they hoped to start a fourth fund, and raise $700 million through it. “These follow on funds are getting a lot of mainstream institutional investors coming to the fore, which is exactly how it should be – but if they can do that, there’s no role for us,” van Zwieten says. The ADB’s own capital is better deployed in those that have yet to develop such traction.