Analysing financing models for infrastructure projects

By Sharmil Bhushan and Jyoti Punjabi, HSA Advocates

The infrastructure sector is critical to India’s development. Financing in infrastructure is expected to grow exponentially over the next few years, particularly as India needs to spend about US$1.4 trillion on infrastructure if it is to achieve its goal of becoming a US$5 trillion economy by 2025. Infrastructure projects are long term and require full or bridging financing at each of the construction, commissioning and operating stages. Balanced financing models are therefore essential.

Sharmil Bhushan
HSA Advocates

Greenfield projects: Projects under construction are typically rated BB or below, signifying high risk in funding these projects. Large investors, such as pension funds and insurers, invest conservatively and limit investment in paper rated below AA. It is a challenge for greenfield projects to raise financing through the bond markets, or to raise equity or quasi-equity capital or structured capital, as they are not generating cash. Usually, financing for greenfield projects is limited to debt financing by the government, the banks or development financial institutions (DFI). However, once a project becomes operational and generates cash flow, the risk reduces considerably and other financing options then become available.

Jyoti Punjabi
HSA Advocates

Brownfield projects: The infrastructure sector has for a long time faced a shortage of capital. Traditional lenders such as banks and non-banking financial companies (NBFC) have high exposure to stressed assets in the infrastructure sector. These stressed assets have led to capital adequacy issues for several major lenders, restricting their ability to lend, thus they have become selective in providing capital to these projects, especially brownfield ones. The traditional risks associated with long-term lending such as asset-liability mismatch (ALM) issues, have also led to greater risk aversion.

To meet these challenges, the government has introduced initiatives such as the Insolvency and Bankruptcy Code, 2016 (IBC), the Prudential Framework for Resolution of Stressed Assets and amendments to capital raising norms. Opportunities now exist for investors and traditional lenders to acquire stressed assets at attractive valuations within and outside the IBC framework. Investors such as corporates, financial institutions, alternate investment funds (AIF), infrastructure investment trusts (InvIT) and infrastructure debt funds (IDF) use different structures depending on the nature of the financing.

Traditional and innovative financing: Traditional sources of financing include banks, DFIs, external financing from multilateral and bilateral agencies, and foreign investments. Innovative means of financing include capital markets, AIFs, IDFs, infra-NBFCs and InvITs. With 100% tax exemptions in respect of interest, dividends and capital gains, sovereign wealth funds (SWF) may increase their investment in infrastructure and in greenfield projects, sharing the risk with domestic SWFs and institutional investors.

Financing a project in both models is typically done by extending credit to a special purpose vehicle (SPV) into which the project is folded. It is characterized by non-recourse or limited-recourse lending, in which the primary security package consists of a first charge on project cash flows held in an escrow account, rights under the private-public partnership agreement and a first charge on project assets. Security may include a pledge of shares of the SPV and guarantees by the promoters. Depending on the structure, a shortfall undertaking may be given by group companies.

The prerequisite for project financing is margin funding, which needs to be provided upfront by the promoters or the sponsors either by the acquisition of land or the investment of initial capital in the SPV. In addition to the comforts provided by securities and the contract, financial covenants, such as security cover ratio, debt-equity ratio, loan to value ratio, change in control, material adverse effect and deviation from the business plan, may be written into the financing agreements.

It is ideal for project financing institutions to provide funding up to the pre-commissioning stage. After the project has been commissioned, the greenfield financing institutions should refinance the debt through bonds or long-term investors such as IDFs and InvITs. Such refinancing frees up considerable bank funds and enables their redeployment to new projects. This financing model allows banks to address their ALMs better, and other investors will get access to good quality, long-term assets with stable cash flows. There should be encouragement to use innovative mechanisms such as loan securitization, InvITs and increased participation of IDFs and DFIs. This will require a regulatory amendment to increase the participation of foreign portfolio investors and the flow of foreign direct investment into IDFs, DFIs and securitization markets to provide long-term capital for infrastructure.

Sharmil Bhushan is a partner and Jyoti Punjabi is an associate at HSA Advocates.


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