Infrastructure investors willing to allocate more capital to Emerging Markets (EM) are faced with a dearth of identified investable projects. You managed to fully load your first Africa fund in just 4 years where others are still struggling to find the right opportunities : How did you do it?
Emerging markets, Africa in particular, have tremendous needs. The question is not to identify projects but to bring them to a stage where they are investable. One of the key drivers to solve the infrastructure gap in Africa lies in project development expertise. Let me share with you our approach in that respect.
(1) Which market to enter? We developed a methodology to assess the countries’ resilience, not only in term of macroeconomic fundamentals but also in terms of Governance: public services institutions and capability to channel and engage with private capital. Through a tier-down approach, we could prioritize countries with a clear agenda and a political will to procure projects through a clear-country SDG plan.
(2) Which partners and type of projects? It is not only critical to set strategic partnerships with governments and local Sovereign Wealth Funds (SWFs) to co-develop projects but, also, to rely on some of our industrial partners with strong footprints in Africa. As for projects, they should always be essential to the local economies and create a sustainable impact. All of this will help to further de-risk projects and make them investable.
(3) Having the right risk assessment and impact framework. Our natural expertise of developer led us to take the leadership on Environmental & Social (E&S) assessment, engaging with the communities and local stakeholders while applying IFC E&S standards. We also specifically developed a UN SDG impact measurement methodology. This contributed to change the perception on private/foreign investor. We also apply the highest standards for integrity checks. And, finally, developing projects in Africa is resource-intensive, especially when you have a pan-African strategy, so, it is key to identify, hire and train local talents to build up the team.
(4) Invest in people. We developed a strong local presence in all emerging markets where we operate ranging from Eurasia – covered from Istanbul and Amman – to Africa where we have put together a significant team with 2 offices (Dakar and Addis Ababa) where our African leadership is located. This has been a significant investment for Meridiam and it paid off.
There is still a perception that investing in EM is, by nature, significantly riskier and should then command higher returns (“risk premium”) than for comparable projects in advanced OECD economies. What is your view, based on your track record? Why the gap between risk perception and the reality?
Actually, the reality of project finance default in Africa, as per Moody’s report, demonstrates that Africa still has one of the lowest default rate observed over the past few decades across all regions of the world (including. OECD markets). An explanation could be that projects in Africa are usually over-structured with a lot of de-risking mechanisms (e.g., political risk insurance by some DFI, DFI lenders, stringent risk assessment framework mentioned above, etc.). The willingness of public authorities, their capability to procure or work to procure projects, the essentiality of the projects and the de-risking mechanisms in place available, provided by the DFIS, are not necessarily reflected in that “expected” country risk premium. Our conclusion is that the additional equity premium compared to OECD similar projects does not exceed 500bp in the countries that we currently operate in.
What is in your view the main issue limiting supply of investable projects in EM: lack of capacity on public side, Governance, political risk, lack of local financing actors…?
We often witness limited public sector capacity (financial and human resources), governance/policy uncertainty including a weak regulatory environment, narrow financial markets/local financing actors with fragile underlying currencies, even if the role played by the Development Financial Institutions enables to bridge part of the gap.
How do you manage shortage of LT local currency financing/ForEx risk?
This remains one of the key impediments even if solutions can be found. We can take, for instance, the African example. Though there is structural market imperfection (very few local players being able to lend over the long term), we can leverage the presence of DFIs providing LT financing (in EUR or USD) at attractive terms matching a significant share of the project hard currency revenues. This enables to limit the risk in part. In general, we benefit in the contract with the authorities from a strong FX risk protection reinforced by a political risk insurance coverage in case the government does not meet its commitment. Eventually, this provides a very robust protection. However, governments in EM will continue to face the arbitrage between underwriting part or all of the FX risk as a contingent long-term liability or relying on short-term local, often expensive, financing pool with limited depth to the market. It is also a clear incentive for them to develop their own capital markets and provide a regulatory framework for local institutions in order for them to invest locally
What are, in your views, the main regulatory/fiduciary obstacles to a greater investment by the OECD-based institutional Investors in EM Infra?
Most regulated financial institutions from the OECD bear heavy capital charges when investing EM or non-investment grade due to the regulation. Over the past years this issue has clearly been identified by the multilateral agencies and the OECD resulting in many initiatives to de-risk projects and investment for institutional capital. The blended Finance Handbook produced by the OECD lists a number of these initiatives. However, despite the awareness, the necessary scale to attract sufficient capital to the EM has not yet been reached. De-risking will remain fundamental whether at project or portfolio level. Nevertheless, regulators and rating agencies will need to make some progress on recognizing the benefits of the de-risking instruments provided by the DFIs, but also the materiality of the resilience-driven processes delivering investment in EM based on ESG and SDGs.
LTIIA & Meridiam launched an initiative last fall to improve the deal flow of bankable projects in emerging markets & developing economies (EMDEs) by furthering momentum of on-going dialogue between the private sector, MDBs and DFIs. A key takeaway was that, by themselves, market players won’t be able to successfully address all obstacles: far more proactive engagement by MDB/DFI is needed. How do you see this agenda moving forward?
Part of the answer is pursuing the capacity building initiatives and strategic partnerships between public and private sectors to help public counterparties in those countries to procure projects more efficiently. Meridiam has signed strategic Partnership with local SWFs in Africa, as well as local/regional Development Banks, to pursue those objectives. Those Partnerships have been effective as we put to good use our expertise of developer to co-develop projects with them and co-invest together and, therefore, by certain extent facilitate knowledge transfer. We can quote examples of Senergy Solar PV and Treichville Hospital. Furthermore, Meridiam has been supporting the Africa Infrastructure Fellowship Program (AIFP) whose objective is to bring governments and the private sector together to provide practical training and support that helps facilitate better infrastructure procurement across Africa. Unless our industry mobilizes more human capital, we will continue to see a large constraint on financial capital deployment. Addressing contemporary challenges such as climate change and, more widely, meeting the UN SDGs will be possible only if we keep in mind that, as the French proverb puts it, “little streams make mighty rivers”.