Alternative Asset Classes for Pension Funds Transforming Need into Opportunities: Financing Infrastructure Trough Capital Markets –The Inca Model National.

Alternative Asset Alternative Asset Classes for Pension Classes for Pension Funds Funds Transforming Need into Transforming Need into Opportunities: Financing Opportunities: Financing Infrastructure Trough Capital Infrastructure Trough Capital Markets –The Inca Model Markets –The Inca Model

National Pension Commission of Nigeria and The IFC Abuja March 2008

Johan Kruger

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TopicsTopics

The Democratisation of South Africa The Democratisation of South Africa The Rationale for an Intermediary The Rationale for an Intermediary The INCA ModelThe INCA Model Prerequisites for Pension Fund Prerequisites for Pension Fund

Investments In InfrastructureInvestments In Infrastructure The Advantages of Infrastructure The Advantages of Infrastructure

Investments Investments Possible IntermediariesPossible Intermediaries Conclusion Conclusion

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The Democratisation of The Democratisation of South AfricaSouth Africa

Pre Democratisation Pre Democratisation Local Authorities White, Black, Indian, Local Authorities White, Black, Indian,

ColouredColoured White -economic base –strong cash flow-White -economic base –strong cash flow-

institutional capacity-good infrastructure-institutional capacity-good infrastructure-Government support – no problem Government support – no problem accessing capital markets accessing capital markets

Black etc - no economic base-grant Black etc - no economic base-grant dependant=weak institutional structure-dependant=weak institutional structure-inadequate infrastructure-no private inadequate infrastructure-no private funding funding

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The Democratisation of The Democratisation of South AfricaSouth Africa

Post Democratisation Post Democratisation Priority amalgamation of local Priority amalgamation of local

authorities authorities Investor withdrawalInvestor withdrawal

Service BoycottsService Boycotts Tremendous BacklogsTremendous Backlogs Lack of policy framework Lack of policy framework

Fruits of the new South Africa has to be Fruits of the new South Africa has to be delivered delivered

Market gap in private sector Market gap in private sector infrastructure fundinginfrastructure funding

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Rationale For Inca Rationale For Inca

Local authority portion minute in Local authority portion minute in comparison with total contractual comparison with total contractual savings institution’s portfolio (0.2%)savings institution’s portfolio (0.2%)

Lack of understanding of local Lack of understanding of local governmentgovernment

Uncertain policy environment Uncertain policy environment

But But Private sector know they must invest Private sector know they must invest

or jeopardise stability of Country or jeopardise stability of Country 5

IncaInca Started in 1996 with $10 mStarted in 1996 with $10 m Peaked in 2004 at of $1000 m PortfolioPeaked in 2004 at of $1000 m Portfolio Started in response to government appeal Started in response to government appeal

to private sectorto private sector Structured as intermediary between Structured as intermediary between

infrastructure providers and capital infrastructure providers and capital marketsmarkets

Listed and rated bonds on marketListed and rated bonds on market Created two subsidiaries:non profit Created two subsidiaries:non profit

capacity building fund and distressed capacity building fund and distressed bond company bond company

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Basic Business Basic Business casecase

Classic aggregation/disaggregation Classic aggregation/disaggregation intermediary intermediary

Issue bonds in domestic market and Issue bonds in domestic market and conclude international loans to raise conclude international loans to raise moneymoney

Pre approved credit limitsPre approved credit limits Provide funds to borrowersProvide funds to borrowers

Amortizing or bullet/couponAmortizing or bullet/coupon Bulk is on balance sheet lendingBulk is on balance sheet lending

Provide assistance trough an non profit Provide assistance trough an non profit companycompany

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The Inca Model The Inca Model

Offers investors Offers investors Understandable financials of single Understandable financials of single

entityentity Opportunity for social investmentOpportunity for social investment Market related return - listed and AA-Market related return - listed and AA-

rated bond rated bond Liquidity by market makersLiquidity by market makers Diversified risk and equity/reserve buffer Diversified risk and equity/reserve buffer Dedicated expertise & risk assessmentDedicated expertise & risk assessment Second corporate bond in South AfricaSecond corporate bond in South Africa

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The INCA Model (2)The INCA Model (2)

Offers Local AuthoritiesOffers Local Authorities Access to private sector financeAccess to private sector finance Reasonable rates given risk profiles Reasonable rates given risk profiles Transparency Transparency Assistance Assistance

Offers ShareholdersOffers Shareholders Opportunity to invest at market related Opportunity to invest at market related

rates rates Benefit of participation Benefit of participation

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Structure of Inca Structure of Inca

Choice of shareholders Choice of shareholders Financial institutions Financial institutions Empowerment and gender partnersEmpowerment and gender partners DFI’s ( political insurance and credibility)DFI’s ( political insurance and credibility)

Rated (AA-)Rated (AA-) Back to back bonds in inception phaseBack to back bonds in inception phase

no interest rate riskno interest rate risk No expensive treasuryNo expensive treasury Government stock hedging Government stock hedging

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Structure of Inca (2)Structure of Inca (2) General obligationsGeneral obligations Computerised credit model Computerised credit model

Pre assessment Pre assessment Shadow rating Shadow rating Turn around time 3 weeks Turn around time 3 weeks Determines capital requirementsDetermines capital requirements Determines pricingDetermines pricing CaveatsCaveats

Limited but incentivised staffLimited but incentivised staff Non banking entity Non banking entity International Funding International Funding

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Capital Structure Of Inca Capital Structure Of Inca

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Credit ModelCredit Model

Solvency

Liquidity

Turnover

Standardization

Income

Cash flow

Diversity of tax

Growth indicators

Physical factors

Management

Competence

Dispute resolutions

Backlogs

Payment levels

Financial position

Economic environment

Institutional capacity

Socio-economic analysis

Environmental Policies

Practices

Score

Peer Deviation

Potential problem areas

Shadow

ratin

g

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Capital,pricing,caveats

Typical ProjectsTypical Projects

Funding of:Funding of: Municipal and regional Municipal and regional

infrastructureinfrastructure RoadsRoads SewerageSewerage WaterWater ElectricityElectricity otherother

Parastatal infrastructureParastatal infrastructure

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Performance Performance

Portfolio peaked in 2004 at more Portfolio peaked in 2004 at more than $ 1 Billionthan $ 1 Billion

Defaults never exceeded 0.2%Defaults never exceeded 0.2% Return to shareholders always in Return to shareholders always in

excess of 20%excess of 20% Capacity building fund had a major Capacity building fund had a major

Impact Impact

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Prerequisites for Successful Prerequisites for Successful Intermediaries Intermediaries

Rule of law –fair and timelyRule of law –fair and timely Decentralised authority and autonomyDecentralised authority and autonomy Creditworthy or credit enhanced borrowersCreditworthy or credit enhanced borrowers Acceptance of cost recovery principles and/or Acceptance of cost recovery principles and/or

appropriate subsidy where requiredappropriate subsidy where required Developed capital market – access - yield Developed capital market – access - yield

curves to price risk- tradabilitycurves to price risk- tradability Risk/reward in balanceRisk/reward in balance Clear policy framework Clear policy framework Capacity to deal with defaultsCapacity to deal with defaults Trust from investment sector in management Trust from investment sector in management Credible shareholdersCredible shareholders

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Prerequisites for Pension Prerequisites for Pension fund Investment in fund Investment in

Infrastructure Infrastructure Pension fund’s first responsibility is to Pension fund’s first responsibility is to their members their members

Risk must be acceptableRisk must be acceptable Reward must be market related and Reward must be market related and

competitivecompetitive Appropriate listed and rated tradable Appropriate listed and rated tradable

instruments must be availableinstruments must be available Long term yield curvesLong term yield curves Must be socially acceptable projects Must be socially acceptable projects

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The Advantages of The Advantages of Investment in Investment in Infrastructure Infrastructure

Natural match between long term Natural match between long term fixed rate requirement of fixed rate requirement of infrastructure funding and the long infrastructure funding and the long term needs of the contractual term needs of the contractual savings sector savings sector

Diversification opportunityDiversification opportunity Higher yields possible Higher yields possible Stimulates economic growth Stimulates economic growth Benefits members Benefits members

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Risks for Pension Funds Risks for Pension Funds

Failure of infrastructure providersFailure of infrastructure providers Failure of intermediaryFailure of intermediary Market risks Market risks Reputational risksReputational risks In Nigeria administration problems In Nigeria administration problems

with intercepts with intercepts

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Possible Borrowers and Possible Borrowers and Intermediaries Intermediaries

State governments State governments Local authoritiesLocal authorities Utility Companies Utility Companies Private sector intermediariesPrivate sector intermediaries

UDBN UDBN Banks Banks Spv’s Spv’s

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Conclusion Conclusion

Infrastructure is a natural area for Infrastructure is a natural area for the pension fund industry and Inca the pension fund industry and Inca

in South Africa has proved the in South Africa has proved the viability of investment in viability of investment in

development development

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