Understanding ‘bankability’ assessments in infrastructure needs a wide lens

But the fact that a risk was ‘banked’ in one factual scenario doesn’t mean it can always be banked - the growing complexity caused by energy transition technologies and regulations leaves potential infrastructure financiers facing new challenges in assessing bankability.

The bankability of an infrastructure or energy project is generally determined by the technology, operational revenue stream, contractors and the sponsors involved. The simple expression carries significant weight, as it attempts to reduce to one word the complex investment and interface analysis that underpins global capital injections into infrastructure. Being ‘bankable’ opens the doors to all manner of financing options.

In the UK, like many countries around the world, vast amounts of private capital are needed in infrastructure, partly to reach net zero, because government borrowing is constrained and corporate balance sheets are often committed to higher growth opportunities. Maintaining and upgrading the basic plumbing of any country – whether social or economic – is costly (and increasingly politically visible), but these lower-risk assets are not viewed as assets that should generate stellar returns. That premise is the basis of the regulatory systems that facilitate investment from lenders and investors across many asset classes within the infrastructure market, whilst seeking to control returns.

However, the infrastructure investment landscape can make lending decisions more complex. New energy transition technologies, such as carbon capture, hydrogen and energy storage, come with greater performance risk, whether technical or financial. In addition, regulators can intervene and upend the most careful assessments. There are also risks linked to the potential insolvency from the so-called ‘tier 1’ contractors, which are large companies managing large-scale projects from start to finish. The insolvency of a tier 1 contractor could leave clients and supply chains in huge difficulties. Global political risks are another area of great concern to lenders and finance providers. Meanwhile, they need to navigate carefully the increasing costs and risks associated with carbon emissions as countries implement measures like carbon borders to impose carbon tariffs on carbon intensive products such as steel and cement. There is also a growing need to keep pace with technological progress to avoid becoming obsolete. A stranded asset is undesirable to investors and financiers.

New financing models and changing allocation of risk

It is clear that not all investments can be done with low-cost, low-return senior debt. The financing market has continued to innovate to stay ahead and keep relevant. Increasingly infrastructure and energy investment will require a mix of debt products, with corporate finance, project finance, export credit, insurers, pension funds, development finance institutions and private debt funds all playing a role.

Each of these entities will bring different levels of appetite for risk, and price their cash accordingly, to blend the financing into an optimised debt stack that envisages full repayment and promises a financial return for the use of the risked money.

The identification and allocation of risk is critical to any financing. The traditional view is that the best way to manage a risk is to allocate it to the person who is best able to manage it. However, the application of that principle hasn’t always led to good outcomes. Increasingly, the expectation of a fixed price construction contract does not reflect the reality of a volatile market affected by inflation, raw material price surges and supply chain constraints. Low-margin contractors cannot absorb these risks, just as much as low-margin lenders avoid them. The result is that risks are moving towards taxpayers – either directly or indirectly – and consumers. This shift is pushing a demand for increased regulation and oversight to protect taxpayers and consumers from being exposed to these risks and ensure they are not left with the burden when the commercial parties have failed or avoided these risks.

At the same time, contractors and employers are using collaboration and two-stage contracting techniques to de-risk substantial elements of projects whilst retaining competitive tension.

Climate risks and energy transition elevate bankability hurdles

Lenders are increasingly looking for more information on carbon emissions, supply chains and ESG elements to provide a complete picture on risk and liabilities that can impact a project. The elevated risk of protestor action linked to climate risks might need some form of government guarantee to protect against the financial consequences.

Part of the challenge facing potential infrastructure financiers is that the significant amounts of capital at risk need protection from foreseeable but potentially catastrophic events. Insurers can play their part and fit into a wider matrix of risk mitigation and bankability analysis. For lenders, the losses associated with project finance vary between different types of projects and countries. For example, financial losses from risks crystallising in renewable energy projects appear to be higher than in traditional energy projects. This experience leads to caution among lenders. Investing in renewable energy projects could demand higher margins and cover ratios to mitigate these risks and counter the effects of higher regulatory capital requirements.

There is therefore the challenge that new technology could cost more to deliver and be at higher risk of financial loss, yet this is the path that will facilitate decarbonisation. As technology advances at a fast pace, it will require lenders to continually assess what is bankable – it will not be a static assessment that can roll from project to project.

Governments, including the UK government, will also face challenges, as value-for-money assessments will become more difficult. If managed solely based on financial criteria, the demands for decarbonisation and the rising energy costs could undermine the industrial core of many nations. The need for capital investment will require a balance between public underwriting and private risk-taking as the pressure to minimise taxpayer liability and preference for consumer-pay models increases.