Handbook On Urban Infrastructure Finance - NewCities

Executive Summaryin this space—and, increasingly, theirmost of the urbanization and growthactivities are at sub-sovereign, local levels.is projected to take place and whereinfrastructure financing challenges areThe issue at hand, hence, is not a lack ofmostmoney, but rather insufficient infrastructuregovernments in these cities have limitedprojects in the pipeline to keep up withfinancial savvy and knowledge in whatthe money supply. There is an importantis available in the market place. Ratherdistinction between financing and funding.than providing a running list of the state-Infrastructure financing, in essence, isof-the-art financing tools and instrumentsraising the high upfront costs to build theor detailed case studies of a select few,infrastructure when and where needed bythis handbook focuses on importantleveraging the future revenues that canconcepts underlying the myriad financingrepay the upfront costs. Financing is thevehicles available today so that theyraising of this upfront capital to expedite theare understood in proper context. In thisprocess. Funding is the revenue streams inregard, this handbook is intended to bethe future to repay the financing. The lackmore of a “how-to” rather than a majorof projects in the pipeline is due in realitypolicy document.daunting.Mostlikely,localto many projects that are not financeablebecause of the lack of clear revenueAn overview of various urban infrastructuresources.financing instruments available to citiestoday are provided as well as effectiveThis handbook is the culmination of theways of addressing the issues related toFinancing Urban Infrastructure Initiativesustainable funding sources describedlaunched by the New Cities Foundationabove. It also discusses new and innovative(NCF) in early 2015. The primary aimfinancing models that are emerging andof the Initiative is to address criticalcritical roles each stakeholders have to playinfrastructurein dealing with the global infrastructurefinancing(andfunding)issues and challenges facing cities todayastheyundergorapidurbanization.Through this handbook, we hope toprovide a set of practical guidelines thatcan help cities become smarter in theurban infrastructure finance space andrespond more effectively and timely to thebasic infrastructure service needs of theircitizens and businesses.This handbook is written primarily for midsize cities in the emerging world wherefinancing crisis.Urban Infrastructure FinancingInstrumentsAlthough many infrastructure assets (e.g.,energy utilities) are in private hands, sfinancingtodayarethose assets in the public domain (e.g.,public transit, roads, water/wastewatertreatment) where the public sector is4

Handbook on Urban Infrastructure Financeresponsible for owning and operating thefunding and more on financing instrumentsassets and where financing largely reliesthat help cities become more self-on grants, subsidies, taxes and othersustainable in the long run. Because manysources that are unsustainable in the longof these financing instruments are morerun. Currently, for these public assets,developed in the advanced economies,infrastructure can be financed completelythe case examples we present tend toby the public sector or can involve theweigh in their favor. In most countries, citiesprivate sector.commonly rely on bank loans to financePublic Sector Financing Instrumentstheir infrastructure projects, either throughcommercial banks or public banks—e.g.,Public sector financing is almost always 100landesbanks in Germany—that serve localpercent debt financing (i.e., fully leveragedneeds. However, one of the most robustwith no equity capital at risk). The cost offinancing instruments available for citiesthis debt financing is significantly lowertoday is municipal bond financing (andrelative to the private sector due largelymany variations thereof).to taxes and other public assets thateffectively serve as collateral on the debt.The U.S. has by far the largest and mostTaxpayers are thus de facto equity holdersmature municipal bond markets in theof government investments and any risksworld. For cities and local governmentsassociated with these investments arein the U.S., municipal bonds have playedultimately borne by the taxpayers. Thesea critical role in their ability to self-financerisks, however, are not reflected in themajordebt financing costs per se because theypartially or fully. Most municipal bonds areare considered relatively risk free, implyingtax-exempt bonds, where the yields bondtaxpayers are obligated to make the debtholders earn are not subject to incomeholders whole in one way or another.taxes. Tax credit bonds (e.g., BAB bondsinfrastructureprojects,eitherin the U.S.) have been emerging in recentFor fully publicly financed projects, first andyears as another viable municipal bondforemost, cities rely on their national andinstrument. They are taxable bonds that arestate governments for support, which areconsidered more cost effective becauseessentially inter-governmental transferstax subsidies are paid directly to issuers orin the form of direct grants, subsidies,bond buyers. They also appeal to a largelow-interest loans, and/or various formsgroup of investors with no in-country taxof credit enhancements. In conjunctionliabilities, e.g., institutional and foreignwith these transfers from higher tierinvestors, who have been largely excludedgovernments, cities can seek their ownfrom the tax-exempt bond market in thefinancing options. In this handbook, wepast.focus less on transfers and subsidy-like5

Executive SummaryAlthough the municipal bond marketmanaged infrastructure equity funds haveis not yet well developed outside thebeen the critical source of this equity capital.U.S.,worldBy some measure, these funds have beenare beginning to explore it as a viableable to raise about USD 300 billion overfinancing option. Cities like Ahmedabadthe last decade, which, based on typicaland Bangalore in India and Johannesburgleveraging that occurs in the industry,and Kigali in Africa already have issuedcould potentially mean as much as 1-1.5bonds for their infrastructure. Others thattrillion of financing available to supportare new to the municipal bond market,infrastructure projects. In large part, thishowever, must ensure basic buildingequity capital is sourced from institutionalblocks are in place. Especially for citiesinvestors who collectively oversee overin the developing world, these building 100 trillion in investment assets globally.blocks should include, in addition toAlthough their investment in infrastructurecredible institutions, support from onehas been slow in growing, their role inor more IFIs, establishment of their ownhelping to close the global infrastructurecredit rating where possible, and full buy-financing gap—perhaps as much as 20in from their national government, whichpercent—is now generally recognized.may ultimately be held responsible if theyMoredefault.have also been taking up the slack inmanycitiesaroundthePrivate Sector Financing and y,institutionalinvestorsthe long-term infrastructure debt spaceleftbehindbycommercialbankingand insurance industries as a result ofmore stringent liquidity and leveragingattractive when the public sector is fiscallyrequirementsconstrained and facing serious debtenvironment. Sourced from institutionalcapacity issues. Private sector financing isinvestors, major infrastructure debt fundsgenerally perceived to be more expensivehave also been emerging, offering a widebecause it almost always involves at-range of products from bond-oriented torisk equity capital. Also, unlike publicsubordinated debt and with varying termssector financing, the risks underlying theand risk-return profiles.inthepost-2008crisisinvestments are fully manifested as riskpremiums in the financing costs of bothWhenthe equity and debt capital.involved, it is also generally combinedprivatesectorfinancingiswith the delivery of infrastructure projects.Unlike public sector financing, equityHistorically, relative to the public sector,capital plays an important role in privateit has been shown that the private sectorsector financing. It is used as a leverage tocan be much more cost effective in theraise the needed debt capital. Third-partydelivery, but their financing can be more6

Handbook on Urban Infrastructure Financeexpensive. Private sector participationsize, P3 is generally preferred for large-thus is better accepted politically when (a)scale,overall cost of providing infrastructure ishave long-term strategic importance. Innon-recourse in nature, i.e., the privateaddition to financing, P3 offers a number ofsector takes on most of the risks by notadvantages over the traditional approachadding any significant new debt to thetopublicandimportantly, P3 provides an opportunity(b) financing costs can be minimized,for the public sector to transfer some orespecially to the extent that the costall of the risks inherent in infrastructuresavings from efficiency gains in theprojects to the private sector. Otherdelivery surpass the higher financing costsadvantagesassociated with private financing.innovations, lifecycle approach to tiesforand operational efficiencies, acceleratedTwoprimarydeliveryimplementation of critical infrastructureapproaches under private sector financingprojects, and bundling of multiple projectsare: (1) public-private partnerships (P3)across multiple jurisdictions for economieswhereof scale.theinfrastructuregovernmentcontinuestoown its infrastructure assets and play anactive oversight role but, through a long-Privatization is essentially a brownfieldterm concession agreement, delegatestransactionits service delivery responsibilities to thereceives capital from the sales proceedsprivate sector over the lifecycle of theof existing facilities. These proceedsassets and (2) divestment or privatization,are unencumbered in that the publicwhereitssector has no repayment obligations.infrastructure assets to the private sectorPrivatization transactions thus have thein whole or in part through a one-timedual benefit of the private sector takingtransaction relinquishing its responsibilitiesover all the upkeep associated with thecommensurate with the shares sold.existing infrastructure and also itional capital for the public sector’sP3 has been evolving continuously sincedisposal. Privatization often involves thethe 1990s. The key consideration is whetherdecoupling of vertically integrated sectorsthe private sector takes on the brunt of the(e.g., railroads, water utility) to separateoverall financial risks (revenue-risk model)out those operations/assets that are moreor the public sector has the ultimateamenable to competition and thus benefitfinancial liability in the long run (availabilityfrom privatization (e.g., train operations,payment model). Because preplanning andwater reservoirs) from those that are moreprocurement processes can be long,monopolistic in nature, better left in publiccomplex, and costly regardless of projecthands (e.g., railroad tracks, water pipeline7

Executive Summarynetworks). Decoupling also helps to defrayManyIFIshavethe conflict of interest situation oftensub-sovereignfacing vertically integrated sectors, wherespecifically address urban infrastructurethe government plays both the owner andinvestment challenges. Though limited,regulator roles.some can also supply capital to municipalleveldevelopedinstrumentsnewtogovernments directly without a stateOften, private sector financing and deliveryguarantee. They have also developed othercan be mired in political controversy.mechanisms such as municipal funds,There is sufficient evidence to prove,risk-sharinghowever, that wider public acceptancefinancial instruments that support urbanis possible if there is a clear mandate ondevelopmentsthe use of the proceeds to reinvest intypically earmark 10 to 15 percent of theirinfrastructure, credible institutions suchtotal portfolio for urban programs. Muchas public pensions are involved on themore is also earmarked for infrastructurebuyer side, and a clear regulatory regimeprojects that ultimately impact cities. Byis established to protect social objectives.some estimates, as much as 60 percent offinancing, IFIs provide critical financialtheglobalspecializedspecifically. Today,IFIsand urban areas around the world.In addition to public and private sectorinortotal IFIs lending has some impact on citiesIFI Financing Supportsupportfacilities,Credit Enhancements and LeveragingToolsinfrastructurefinancing space. IFIs are public sectorWhether public or private sector financing,development banks and developmentit can be said that the basic goal offinance institutions that are owned byinfrastructure financing is to get as muchonegovernments.money as possible as cheaply as possible.Operating at international, regional, andThere are many credit enhancementnational levels, IFIs provide a criticaland other financial leveraging tools thatnexus between the public policy goals ofhelp to achieve this goal, especially ongovernments and the international capitalthe debt financing side. Most of thesemarkets that allocate financial resourcestools are intended to decrease the riskon a global scale. Collectively, IFIs provideand increase the liquidity on the overallboth mobilization of significant capital and,investments. Low-interest subordinatedperhaps as importantly, knowledge onloans and standby contingent credits areinstitution-building, policy development,often provided by national governmentsand the blending of financial instrumentsor by IFIs to help reduce risks to investorsfor investing in urban infrastructure.and allow cities to borrow at lower interestormorenationalrates. In recent years, these subordinated8

Handbook on Urban Infrastructure Financedebt instruments have been used to targetof reducing the infrastructure fundinglargeprojectsgap. To effectively reduce the fundingto leverage significant private sectorgap, we need to address the revenue issuefinancing, especially in the form of seniorand make more transparent where thedebt (e.g., U.S. TIFIA program and EU-buck really stops ultimately.strategicinfrastructureEIB Project Bond Credit EnhancementFacility). Financing costs can also beHistorically, many cities around the worldreducedincentiveshave generally relied on direct grants and(e.g., tax-exemption in municipal bonds)subsidies from IFIs and/or their nationalor various forms of insurance productsand state governments as the primaryor guarantees (e.g., MIGA political riskfunding sources. These funds in turn comeinsurance, HM Treasury Guarantee in thefrom taxes that are levied at national andU.K.).state levels and, where available, frombyprovidingtaxsovereign wealth reserves tied directlySecondaryrefinancingmarketsalsotopublicly ownedcommoditiesandprovide additional liquidity for early-assets. Although limited, direct grants andphase investors to further leverage theirsubsidies from philanthropic sources caninvestments into new project opportunities,also be an important funding source forthus improving the overall infrastructurecities. These direct grants and subsidiesfunding picture. Recapitalizations throughhave no repayment obligations and cansecondary markets involve replacing shortbe further leveraged to secure additionalterm, high risk, expensive capital withinfrastructure financing.longer term, lower risk, lower cost capital.Sometimes this is accomplished throughOutside direct grants and subsidies, thepooling and securitization of multipletwo prevalent revenue funding rrentlyforinfrast

is indeed a "handbook" and is more a "how-to" guide than a policy paper. This handbook is intended for the public sector. Infrastructure, after all, embodies public goods and services. Preamble. 1. Mid-size or the so-called ''middle-weight city'' is defined as cities with populations between 200,000 to 10 million.