Building Africa

The Civil Engineering Contractor shares insight from the industry around the challenges faced by infrastructure funding within South Africa and sub-Saharan Africa.

Richard Roothman is the head of the Banking and Finance practice group at Werksmans Attorneys, specialising in project and limited-recourse finance transactions, debt capital market and structured finance transactions, and syndicated and bilateral funding transactions.

He shares his views on the challenges of infra funding.

The decline in direct foreign investment into South Africa over the past few years can be attributed to low business confidence as well as regulatory and political uncertainty. One initiative that can drive renewed direct capital investments, a decrease in unemployment, and economic growth, is the launching of new infrastructure projects by national and provincial government and by municipalities, as emphasised by President Cyril Ramaphosa on 16 April 2018.

Historically, government has used government funding in the form of taxes to finance government infrastructure projects, and state-owned entities (SOEs) have used cash collected from users and consumers to finance their projects.

Funding challenges

However, as a result of the budget deficit — which may exist for a number of years to come — and the dire financial situation in which SOEs find themselves, government and SOEs will have to rely more on private funding by banks, financial institutions, and foreign development investments (FDIs). Further borrowing by government and those entities may, however, cause further strain on government’s budget and that of SOEs. Because of ‘state capture’, the increase in corruption and fraud in several SOEs, as well as political risk, local and foreign funders may seek government guarantees to mitigate risk.

Another factor that may deter funders, especially foreign funders and FDIs, from financing local infrastructure projects, is the credit rating assigned by rating agencies to government and SOEs. Recently, the credit ratings of government and SOEs such as ESKOM have been downgraded. If those credit ratings are further downgraded, foreign investors, funders, and local banks may not be all that eager to fund local infrastructure projects without a government guarantee. Further, the lower the credit rating, the higher the funding costs may be to mitigate risk.

Cost overruns could also play a role in funding government and provincial infrastructure projects. This could result from political factors, changes in the scope of the project, and contractual issues. Almost all government infrastructure projects in the past five to eight years have experienced cost overruns. Such projects include the soccer stadia for the 2010 World Cup and the Medupi Power Station. Cost overruns put further strain on government funding as it will have to cover those cost overruns from sources it has not budgeted for. Private funders would become reluctant to fund such major infrastructure projects in the absence of sufficient risk mitigation. Cost overrun risk could be mitigated by government guarantees, contractual provisions that could impose a limit on cost overruns, and fixed price contracts, where cost overrun risk lies with the contractor.

Are PPPs the solution?

A PPP can be described as a contract between a public sector institution/municipality and a private party, in which the private party assumes substantial financial, technical, and operational risk in the design, financing, building, and operation of a project. PPPs have been used to build, operate, and maintain government buildings and accommodation as well as for government’s Renewable Energy Independent Power Purchaser Procurement programme (REIPPP). Under PPPs, the private party is required to raise long-term funding in the form of equity and debt. An important factor for the private sector to participate in a PPP is the revenue that the project will generate during its operation by the private party. The revenue derived from the project will have to cover operating expenses, payments to contractors, and the repayment of dividends, principal and interest to the equity funders and banks.

An important factor for the private sector to participate in a PPP is the revenue that the project will generate during its operation by the private party. Richard Roothman, Werksmans Attorneys

Advantages of PPPs include limiting dependence on government’s balance sheet; providing better infrastructure solutions and management than a project that is wholly publicly, or wholly privately driven; risks are appraised early in the process to determine project feasibility and faster project completions; and reduced delays by including time-to-completion provisions as a measure of performance.

Disadvantages of PPPs comprise high transaction costs that may discourage small service providers from participating in the bidding process; profits of the project can vary depending on the assumed risk; complexity and the size of the project; and political risk, among others.

Political risk would include the long negotiating process with government or a municipality on the PPP Agreement, which could take one-and-a-half to two years and which would delay financial close. The longer it takes to financial close, the higher the initial project costs would be. With respect to municipalities, if there is a change in the political party governing the municipality, the new municipal council could repudiate the PPP Agreement negotiated by the previous regime, which would have massive financial risks for both the private party and its funders. Another disadvantage could be the time delay from when the project is awarded to a tenderer to the date of financial close. An example is the last round of tenders awarded in government’s REIPPP programme: After the tenders were awarded, it took two to three years for those projects to reach financial close. The delay was caused by political interference and the lack of commitment on the part of Eskom. Such delays could certainly affect the appetite for private parties to tender for future projects.

Project bond option

An important source of funding infrastructure projects by both the private and public sectors, is the issuance of project bonds. Project bonds as an alternative source of funding infrastructure projects is well developed in Europe, Latin America, and the Middle East. Many SOEs have used bonds to finance projects. The difficulty that SOEs might experience with this method of funding, is that those bonds are usually unsecured, and with the current financial position in which many SOEs find themselves, investors may not have much appetite. Further, the credit ratings of SOEs will also play a role. A decrease in the credit rating will influence investors’ appetites to fund. A decrease in credit rating may also lead to a higher cost of funding to an SOE.

Municipalities such as City of Cape Town, Ekurhuleni Metropolitan Municipality, and City of Johannesburg have successfully used bonds to fund their capital requirements. Their success in raising financing through the issuance of bonds can be attributed to their sound financial position, good corporate governance, and credit ratings assigned to them.

Project bonds could supplement existing infrastructure funding, but the project bond market has not really developed in South Africa. I am of the view that one causal factor for a lack of project bonds in the South African market is construction risk (that is, the initial period where the project is built or constructed, which could be three years or more, and which risk to investors is highest because no cashflows are generated). Construction can be delayed for several reasons. Another factor could be that banks are content to keep the loans on their balance sheets as an asset for a long time, as opposed to relinquishing those assets to capital market investors.

If the challenges in securing funding for projects set out above is properly and expeditiously addressed, the appetite of banks and other financial institutions to provide funding to infrastructure projects will certainly increase. President Ramaphosa’s statement is a welcome indication that government is committed to drastically improve legislation, governance frameworks within SOEs and municipalities, and to restore confidence in SOEs.


Image credit: Werksmans Attorneys

 About the author

Richard Roothman obtained a BCom LLB (Law) degree from the University of Pretoria, a master’s degree in commercial law from Cornell University in the USA, and a master’s degree in tax from the University of the Witwatersrand. He is the head of the Banking and Finance practice group at Werksmans Attorneys and has been a director at Werksmans Attorneys for 11 years.


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