Use pension funds on roads, rails

Columnists

Use pension funds on roads, rails


Motorists at the Nairobi Expressway Mlolongo Toll Booth on Sunday June 26, 2022. PHOTO | DENNIS ONSONGO | NMG

As the debate around the funding of infrastructure projects in Kenya intensifies, the broader debate that needs to take place is whether the Treasury can continue to fund major projects without putting pressure on the tax authorities.

Much of the financing discussion revolves around the role of private capital in providing liquidity for infrastructure financing, and in particular national pension funds. For example, the [President William] The Ruto administration presented plans to build 250,000 affordable houses a year.

It is clear that such an ambitious plan cannot be entirely financed by taxpayers. The recently completed Nairobi Expressway was financed by Chinese private capital under a public-private partnership (PPP). Another privately financed project in the offing is the proposed 473 km Nairobi-Mombasa highway.

This importation of private capital is largely a majestic response to a domestic market failure that has been caused by a mismatch of objectives between infrastructure project developers and the liquidity of national pensions. Kenya’s pension fund industry has matured, with total assets of 1.55 trillion shillings in 2021, up from a meager 44 billion shillings in 2001.

As expected, investments are still dominated by traditional assets, namely government securities (bonds and bills), listed stocks (stocks) and real estate. The three traditional asset classes accounted for 79% of pension fund investments in 2021. Not such a powerful cocktail, right? But there is a narrative behind impotence.

Pension funds constantly face a trilemma of profitability, liquidity and security. Profitability is about investing to get the highest returns.

Liquidity revolves around the ability to meet liabilities as and when they come due; and safety is a matter of capital preservation. In short, pensions do not hold venture capital. Also, pension funds are overseen by a group of people called trustees, who are appointed by a pension plan to hold and invest plan assets for the benefit of plan members.

At the heart of it, the trustees make investment decisions, in collaboration with the fund managers. However, in many cases, the investment dexterity of trustees may not be as robust, but they are expected to build and preserve retirement wealth.

On the selling side, infrastructure project promoters are driven by the sole objective of securing financing, regardless of the bankability of their projects. Really, they often pay little attention. As a result, this misalignment points to the 1.55 trillion shilling national pension funds as liquidity so close, yet so far.

Generally speaking, while how to close this gap is still the subject of public debate, it is clear that pension funds must play a leading role in the financing of major infrastructures, such as the lodging.

There are a few ideas. From debates behind closed doors, project sponsorships must now go through a series of answers to the trilemma of pension funds. In other words, projects must be significantly de-risked in order to improve their bankability.

Part of the solution is to wrap projects with credit guarantees from sovereign states or other providers of AAA-rated corporate guarantees.

These envelopes provide a second line defense in case the first line defense, which are project cash flows and charges (fixed or floating) on ​​project assets, are breached and go a long way to solving the problem of capital preservation component of the trilemma.

As for returns, there is no doubt that the internal rates of return (IRR) of the projects are attractive, given their risky nature. However, according to the pension funds, projects must also consider the liquidity recovery component of their trilemma.

The nature of the pension is such that they must always meet the debts as they come due. For real estate projects, a real estate investment trust offers relief.

However, it remains a tough call for non-real estate projects – such as roads, airports or energy projects. Generally speaking, this lack of liquidity points to the need for a secondary public loan market.

Such a market can provide on-demand output for a wide variety of loans, such as project loans. Project leaders, whether sovereign or private, must crack this nut and present the best structure to pension funds.

Otherwise, it is quite evident that there is a mismatch in objectives between project sponsorship and pension funds, which will continue to make pension liquidity seem so near and yet so far away.