As the debate around the funding of infrastructure projects in Kenya heats up, the broader debate that needs to take place is whether the exchequer can continue funding large projects without exerting pressures on the fiscus.
The thrust of the funding discussions gravitates around the role of private capital in providing liquidity for infrastructure financing, and specifically domestic pension funds. For instance, the [President William] Ruto administration has outlined plans to build 250,000 affordable houses annually.
It is quite clear that such an ambitious plan cannot be fully taxpayer-funded. The recently completed Nairobi Expressway was funded by private capital from China through public-private partnership (PPP). Another privately funded project in the offing is the proposed 473km Nairobi-Mombasa Expressway.
This importation of private capital is largely a Stately response to a domestic market failure that has been occasioned by a misalignment in goals between infrastructure project sponsors and domestic pension liquidity. Kenya’s pension fund industry has come of age, with total assets of Sh1.55 trillion in 2021, from a measly Sh44 billion in 2001.
Expectedly, investments are still dominated by traditional assets, namely Government securities (bonds and bills), quoted equities (stocks) and property. The three traditional asset classes accounted for 79 percent of the pension funds investments in 2021. Not such a potent cocktail, right? But there is a narrative behind the impotency.
Pension funds are constantly faced with a trilemma, that is profitability, liquidity and security. Profitability is all about investing to achieve highest returns.
Liquidity rotates around the ability to answer to liabilities as at and when they fall due; and security is all about capital preservation. In short, pensions don’t hold risk capital. Further, pension funds are overseen by a group of persons known as trustees, who are appointed by a pension scheme to hold and invest scheme’s assets for the benefit of scheme members.
At the core of it, trustees make investment decisions, in conjunction with fund managers. However, in a lot of cases, the trustees’ dexterity in matters investments may not be robustly as sound, yet they are expected to build and preserve pension wealth.
On the sell-side, infrastructure project sponsors are driven by the single objective of securing the funding, contemptuous of bankability of their projects. Really they often pay little attention. As a result, this misalignment designates the Sh1.55 trillion domestic pension funds as liquidity so near, yet so far.
Broadly, while it is still a matter of public debate on how to bridge this divide, it is clear that pension funds need to play a leading role in large infrastructure financing-such as housing.
There are a few ideas. From closed-door debates, 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 credit guarantees from Sovereigns or other AAA-rated corporate guarantee providers.
Such wraps provide second line defence incase first line defence, which are project cashflows and charges (fixed of floating) on project assets, are breached and go a long way in addressing the capital preservation component of the trilemma.
When it comes to returns, there is no doubt that project internal rates of return (IRR) are attractive, given their risky nature. However, according to pension funds, projects must also address liquidity turnaround component of their trilemma.
The nature of pension is such that they always have to answer to liabilities as they fall due. For real estate projects, a real estate investment trust offers the turnaround.
However, it remains a tough call for non-real estate projects — such as roads, airports or power projects. Quite broadly, this lack of liquidity points to a need for a public secondary loans market.
Such a market can offer an on-demand exit for a wide variety of loans, such as project loans. Project sponsors, whether Sovereign or private, must crack this nut and present the best structure to pension funds.
Otherwise it is quite evident that there exists a misalignment in goals between project sponsorship and pension funds that will continue to make pension liquidity appear so near yet so far.
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