Introduction

BACKGROUND AND OBJECTIVES

The quality and volume of infrastructure has a positive effect on the attractiveness, competitiveness, sustainability and economic growth of countries, cities and municipalities. Infrastructure opens up new business opportunities and promotes trade as well as the expansion of existing economic activity. It also improves the standard of living of the public by giving people access to essential resources, such as water and electricity, schools, hospitals and markets. This is even more true if the development of infrastructure is done in a sustainable way.

Notwithstanding, around the world - in highly developed industrialised nations, high-growth emerging economies and developing countries alike - there is a growing gap between the acute need for new or modernised infrastructure, maintenance and overhaul measures and the actual level of investment and current expenditure, as evidenced by crumbling bridges, broken highways and leaking water pipelines. The public sector, which is traditionally responsible for infrastructure, frequently claims to have a number of other priorities that prevent it from investing the necessary funds in closing this gap, which is so vital for societies in terms of furthering development and prosperity.

Institutional financial investors with a long-term perspective, such as insurance companies, pension funds, sovereign wealth funds, endowments and foundations, are increasingly investing in infrastructure assets, therewith joining strategic investors such as construction, energy and utility companies who have done so for decades. This is because (conservatively structured) infrastructure investments provide attractive returns in a low-interest-rate environment and, additionally, serve to diversify and thus improve the risk-return profile of an investor's overall investment portfolio on account of their low correlation with traditional asset classes.

The volume of private capital in infrastructure is expected to increase significantly in the future and to a certain extent will be essential to help close the aforementioned funding gap for the public sector and ensure further economic growth. This holds in particular for emerging economies.

Going forward, investors in (new) infrastructure assets need to consider rigorously and factor in sustainability and ESG aspects such as environmental risks (e.g. climate change and natural resource scarcity), as well as social and governance risks (mainly) in emerging economies in their investment decisions.

The market for infrastructure is vast and, contrary to popular belief, the range of potential infrastructure investments is extremely broad, which presents challenges and opportunities for most investors. While they appreciate the enormous market potential and the possibly excellent fit of the asset class with their own investment goals and their existing portfolio, they may lack a sufficient overview of the infrastructure market and/or insight into suitable investment opportunities and their related risks. Furthermore, institutional investors with a sustainable investing mandate may miss clear information and tools for assessing and integrating sustainability considerations in their investment process as well as related risks in their overall risk analysis of infrastructure projects. All of the above make it challenging for investors to take the right investment decisions for their individual strategies and existing portfolios.

This book offers a way out of the dilemma, providing investors with the necessary theoretical knowledge and background information as well as practical examples to help further their understanding of the key aspects of infrastructure investments with a particular focus on appropriate organisational structures, finance, benchmarking and sustainability.

As a minimum, professional investors should have a sufficient understanding of the infrastructure sectors and the corresponding markets and industries along with the relevant legal, contractual, institutional and commercial conditions - which can vary significantly from region to region and sector to sector - to allow them to identify inherent project-specific risks and to determine their prospective risk-return profiles. This is particularly important if the sectors in question have been dominated by the special rules and restrictions of the public sector in the past and are being opened up to the investment conditions required by private investors only on a gradual basis.

This brings us to a basic, yet vital, question: what exactly is infrastructure? We discuss the applicability and validity of various definitions of this term in detail in Section 1.3, but for now it is sufficient to note we use the following common and practical definition throughout this book:

Infrastructure generally describes all physical assets, equipment and facilities of interrelated systems and the necessary service providers, together with its underlying structures, organisations, business models and rules and regulations, offering related sector-specific commodities and services to individual economic entities or the wider public with the aim to enable, sustain or enhance social living conditions.

Typical examples of infrastructure include roads, airports, ports, oil and gas networks, energy generation, including renewable energy (e.g. wind, solar, hydro, biomass), water supply, waste water and waste disposal as well as social infrastructure, which includes public facilities such as schools, hospitals, administrative buildings and social housing.

Many investors are interested in the comparatively stable and predictable current income with moderate volatility and risk relatively independent of macroeconomic conditions, which is generated by a certain subset of infrastructure assets - return features shared by real estate or long-term, fixed-income investments. The long-term nature of infrastructure investments allows pension funds and insurance companies to use them to match the maturity structure of their liabilities. Infrastructure assets with this return profile are the driving force behind infrastructure's reputation as an attractive asset class - a hybrid with characteristics of debt, equity and real estate.

Although infrastructure investments certainly can have this comparatively low-risk profile, it is not necessarily so, and unless structured accordingly such investments can entail significant risks similar to those of investments in traditional companies. For any potential investment, these risks must be identified and assessed carefully.

To this end, we provide a fundamental understanding of infrastructure in general, the differences - in some cases significant - between infrastructure measures and key performance indicators (KPIs) within a sector and the various infrastructure sectors themselves.

A new section on benchmarking allows readers to assess the performance of infrastructure investments against a suitable benchmark. The suitability of a benchmark is determined primarily by the desired risk-return profiles and characteristics.

The systematic procedures and analytical tools we propose, enable readers to understand and evaluate both direct investments in infrastructure assets and indirect (fund) products along with their complex underlying project finance structures. Taken together, they allow the assessment of the risk-return profiles of the respective infrastructure investments.

Given that risk-return analysis, assessment and structuring are at the core of infrastructure investing, the main risks of infrastructure assets are discussed comprehensively in an individual chapter in this new edition. The risk analysis and assessment flows right into, and is among the most important input factors for, structuring the project financing, which itself is a crucial part of the financing of infrastructure assets involving the private sector.

Project finance has a number of benefits compared with traditional forms of financing; however, it also requires a deep understanding of financing structures and complex analytical approaches. All in all, a successful project finance fundamentally depends on the ability to develop the appropriate contractual structure for the respective sector in terms of optimal allocation of risk among the parties involved, financing and value added, competition/regulation and the possibility of private-sector involvement. It is the contractual structure that predominantly determines the risk-return profile of each individual infrastructure asset. To this end, the book guides readers step by step through the various phases of project analysis, using practical examples, and provides an introduction to concrete financing instruments and techniques.

This book is aimed at the following groups in particular:

• Financial investors, e.g. insurance companies, pension funds, fund managers and banks;
• Strategic investors, e.g. construction, operation and supply groups, technology suppliers and facility managers;
• Public authorities responsible for infrastructure in the various sectors, in particular ministries of construction and regional building authorities, including their budget departments, as well as ministries of finance and legal supervisory institutions such as audit courts;
• Public and private infrastructure companies, e.g. power suppliers, water supply and disposal companies, airports and railroad companies;
• International organisations, e.g. The World Bank, EIB, OECD, which seek to support and incentivise infrastructure...