The 1980s and Project Finance
Photo credit: Julian Hochgesang on Unsplash

New Right thinking from the early 1980s shaped infrastructure in ways that have led to a pot pourri of models. Private sector involvement in infrastructure the world over today has been heavily influenced by the post-privatisation era in Britain from the 1980s.

 A major new step occurred in the 1980s as Britain started privatising lots of things. This activity helped accelerate the financial services industry, especially in corporate finance. Yet there was another area of banking that was developing alongside all this and it had to do with the way we finance some of our infrastructure.

Someone worked out that it was possible to do more than just sell “public service” assets to the private sector. It was also quite possible to get the private sector to build, finance and operate them in the first place. Commercial investors could see that infrastructure services could deliver stable long-term revenues that can carry a relatively high proportion of debt. As debt is “cheaper” than equity, this introduced the possibility of higher returns to shareholders and lower prices to end-users. It looked like a win-win.

Infrastructure projects are usually so capital intensive that the debt financing them is just too large for most investors to cover if things go wrong. To address this problem and to enable large projects to be developed privately, investors employed a form of financing that had been used since the times of ancient Greece and Rome, referred to as “limited recourse financing”. This form of financing sees lenders sharing in the risk of the project’s failure and, if so, having only some access to the project’s developers if it fails. In modern times, limited recourse financing techniques were used to finance the capital intensive projects needed to develop the North Sea oil fields, especially in Britain.

Limited recourse financing evolved to become known as “project finance”. The centre of the project finance world during the 1980s became London, helped by most U.S investment banks having located there after the Great Depression and, more especially, in response to the Glass-Steagall Act of 1933. As others learned of the technique, such as in Australia for the financing of the Woodside North-West Shelf oil and gas project (which was the world’s largest engineering project at the time) expertise had to be flown in from London.

Project financing documentation acted as something a stopgap for weak legislation and this helped much of the world’s project finance capabilities to become focused on developing countries from the late 1980s. Banks in London had by then established project finance units in Singapore, Hong Kong, New York, Sydney and other major financial centres.

In Asia, a wave of project financing occurred between 1990 and 1997. This led to substantial new infrastructure investment, which faltered from 1997 when the Asian Crisis started. In part, the Crisis occurred because of the very large volumes of external debt being taken on by private borrowers in Asian countries, much of which was applied to project financed infrastructure. This was compounded by certain countries (such as the Philippines, Indonesia and Thailand) pegging their currencies against the US Dollar, which proved to be unsustainable.

By the time the Asian Crisis took hold, project finance as a means of financing infrastructure in developing countries was very well established. However, project financing had also fallen short in a number of areas, not least being that they are highly customised and require large teams of skilled professionals to pull them together. Even then there are no guarantees that the project in question will reach fruition and projects that have gone wrong have been highly visible. Several high profile cases include the M1/M15 Toll Motorway Project in Hungary, the Cochabamba Water System in Bolivia and the Don Muang Tollway in Thailand. To some extent, these failures resulted from shortcomings in the business cases put together by the project developers. However, more often than not the failings had their beginnings in the public sector as a result of poor project selection, procurement failings, inadequate legislation and institutional problems. The project finance concept was sound, but the application was not.

There was general recognition, particularly in the United Kingdom, that the public sector had a major role to play in setting the framework to ensure good project outcomes. There was a desire to improve public sector capacity to deal with private sector developers, develop standardised procedures and documentation to minimise development costs and increase the chances that the public sector would negotiate consistent terms with the private sector. The aim was to address a trap that governments had fallen into, thinking project financing means they can unduly transfer project risks to the private sector while still procuring a new public service. A frequent consequence of this were delays in the development of project agreements, difficulties in raising finance for projects and a number of cancelled or failed projects along the way.

These are the issues that the British government sought to address from the early 1990s. The government created a public sector hub of expertise, standard documents and processes, and a transparent procurement process. These efforts formed part of the Private Finance Initiative (PFI), which aimed to develop a systematic programme for infrastructure development rather than developing infrastructure on a piecemeal basis, as had been the trend to that point. In parallel with those developments the Asian Crisis had come and gone, leaving many developing countries in a difficult position as the supply of capital dried up.