Issue is whether the Exchequer can continue pumping billions into large ticket infrastructure plans easily.
As the public debate around the standard gauge railway (SGR) funding and its attendant costs continues to elicit varied nuances, the broader debate we need to have is whether the exchequer can continue funding large infrastructure projects without exerting significant pressures on the fiscal space.
This week I spoke at the East Africa gathering of Bonds, Loans and Sukuk, an event that brings together debt market players (both sell and buy sides).
The thrust of the funding discussions gravitated around the role of pension industry in providing liquidity for infrastructure financing. The issued also descends into the ongoing debate around the National Housing Development Fund, which is meant to help the State realise its affordable housing agenda.
It will be funded through a defined contributory scheme in which an employee will contribute 50 basis points of their income with the employer expected to match it-up to a maximum of Sh5,000 (or just about $50).
But the scheme and concerns expressed around it from different quarters stem from the fact that on the face of it, it appears to lack sufficient ring-fencing mechanisms. But that notwithstanding, it can best be viewed as a stately response to a market failure; one that has been incubated by a misalignment in goals between project sponsors and holders of liquidity, such as pension funds.
Kenya’s pension fund industry has come of age, with total assets, for the first time crossing the Sh1 trillion (or $10 billion) mark in 2017.
Expectedly, three asset classes, namely government securities (Treasury bonds and bills), quoted equities (stocks) and property accounted for 77 per cent of the pension funds’ investments. Not such a great cocktail, right?
Pension funds are constantly faced with a trilemma—profitability, liquidity and security. Profitability is all about investing to achieve highest returns, liquidity rotates around the ability to meet liabilities as at and when they fall due and security is all about capital preservation.
Additionally, pension funds are overseen by a group of persons known as trustees, whose dexterity in matters investments may not be sound, yet they are expected to build and preserve pension wealth.
On the sell-side, sponsors are driven by a single objective—to secure funding, contemptuous of bankability of their projects. Resultantly, this misalignment designates the Sh1 trillion pension funds as liquidity so near, yet so far.
Broadly, it is clear that pension funds need to play a leading role in large infrastructure financing such as housing. It is still a matter of public debate on how to bridge this divide—and I have few ideas. From closed-door debates (such as the Bonds, Loans and Sukuk forum) project sponsorships must now entail a series of addressing the pension funds’ trilemma. In other words, projects must be significantly de-risked in order to enhance their bankability.
Part of the solution involves wrapping the projects with enhanced credit guarantees from Sovereigns or other AAA-rated corporate guarantee providers.
Such wraps provide second line defence in case first line defence, which are project cash flows and charges (fixed of floating) on project assets, are breached. It will go a long way in addressing the security component of the trilemma.
Further, while there is no doubt that project internal rates of return (IRR) are attractive, given their risky nature, projects must also address liquidity turnaround component of the trilemma as pensions always have liabilities falling due. For real estate projects, an investment trust (REIT) offers the turnaround.
However, it’s always a tough call for non-real estate projects and broadly points to a need for a public secondary loans market. Consequently, project sponsors must present the best structure, albeit on a private basis.
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Note: The results are not exact but very close to the actual.
