HKMA eyes infrastructure investments in Belt and Road initiative

Hong Kong’s central bank plans to invest reserves to help meet Asia's $1.7 trillion annual infrastructure needs, focusing on countries engaged in China’s Belt and Road initiative
HKMA
The HKMA plans to invest in Belt and Road infrastructure

The Hong Kong Monetary Authority (HKMA) launched an infrastructure financing facilitation office (IFFO) in July 2016 with the goal of promoting Hong Kong as an infrastructure financing hub for the infrastructure projects in countries along China’s Belt and Road imitative.

To date, the IFFO has built a network of more than 77 partners, including multilateral financial agencies and development banks, public and private sector investors, asset managers, banks, infrastructure project sponsors and professional service firms in Hong Kong, mainland China and elsewhere.

But now, in additional to developing a capacity-building platform, the HKMA is also looking to invest its own money in bankable projects identified by the IFFO, hoping this will also attract other investors, including sovereign entities.

Promoting and investing in infrastructure

Unlike multilateral and development banks, which tend to have a clear developmental mandate – often combined with a mission to promote inclusive growth and environmental sustainability –  or private investors that are seeking commercial returns, the IFFO, as a government agency, has multiple, yet somewhat more ambiguous, roles in infrastructure financing.

According to the description on the HKMA website, the IFFO is a platform for information exchange and experience sharing, capacity building and promoting market and product development.

Since its launch last year, the IFFO has organised and participated in more than 10 events, including executive workshops, investor roundtables and seminars. Its latest effort was to host the Asia-Pacific session of a five-day senior executive training programme in August on public-private partnerships (PPPs) and project finance, which was organised by the International Finance Corporation (IFC) in partnership with the Harvard Kennedy School.

The IFFO has also developed a reference term sheet that sets out a common language for various factors that need to be considered for investment and risk mitigation measures.

After a year of establishment, the HKMA is incorporating more functions into the IFFO.

For example, the HKMA is seeking to establish a mechanism under the IFFO to identify “good projects” in the Belt and Road countries for the HKMA’s $450-billion-plus Exchange Fund, which backstops the Hong Kong dollar’s peg with the US dollar, to invest alongside other IFFO partners, according to Norman Chan, HKMA chief executive. More than 10 IFFO partners, including sovereign funds, pension funds and insurance companies, have expressed an interest, Chan told local media in Hong Kong.

Although Chan did not give further details, including how much money the HKMA has earmarked towards Belt and Road infrastructure investments, one possible outcome is the creation of an ‘equity club’ – a co-investment platform for reputable and like-minded investors seeking long-term returns.

“On a mutually beneficial basis, the investment platform could select projects for experience sharing or even co-investments among the investors that could help generate demonstration effect for the market and to draw in greater private capital participation in infrastructure investments,” said Vincent Lee, external executive director at the HKMA at a forum in July 2017.

An equity club would operate similarly to a stock exchange in terms of deal-matching, a source from the HKMA says. The IFFO would identify bankable projects and present them to the equity club. Partners of the IFFO, including the HKMA’s Exchange Fund, could then bid on a project from the project pool or form a consortium with other investors for co-investment.

Position of the IFFO

While there is growing competition as rival cities strive to emerge as the fundraising hubs for infrastructure investment in emerging Asia, some parties say Hong Kong enjoys a unique position due to its proximity to China combined with its access to international investors that want to allocate funds to infrastructure.

“Many of the mainland [China] project operators, mainly from the power and transportation space, have a very strong presence in Hong Kong. In fact they are listed on the Hong Kong stock market, they also tap into the Hong Kong debt market,” says Enoch Fung, general manager at the IFFO and the head of market development division of HKMA.

“What can draw private capital into these [infrastructure] projects is the capital market,” Fung says, adding that many private sector investors still “shy away” from the risks associated with direct infrastructure financing outright.

Focus on financing

“The IFFO is to focus on the financing part, bringing different stakeholders together to accelerate infrastructure investment.” adds JC Parrenas, co-ordinator of the Asia-Pacific Financial Forum (APFF).

Hon Cheung, a senior managing director at State Street Global Advisors, believes other government agencies will also have ‘an important role to play” in developing and helping to create “efficient intermediary vehicles and structures” that will be “critical to increase private sector participation in infrastructure financing”.

Cheung says creating a common platform and getting investors together is an important part of financial intermediation between projects and suitable investors. “It is about facilitating investment through collaboration. It is not only about scale but also diversification. Most institutional investors do like the idea of sharing the risk as well as the rewards of investment with other institutional investors,” says Cheung. “It is certainly within the government agencies’ remit to develop platforms. In any regulated market, they have a basic obligation to make sure that structures are available for efficient trading and access.”

Infrastructure financing needs in Asia

Infrastructure financing is not a new topic in Asia. Back in 1996, the Asia-Pacific Economic Cooperation (APEC) started discussions about mobilising resources for infrastructure development. Yet it was only in 2013 that APEC endorsed a multi-year plan on infrastructure development and investment.

The Asian Development Bank (ADB) estimates that developing Asian economies need $1.7 trillion of infrastructure project per year from 2016 to 2030 to maintain the region’s growth momentum. But there is still difficulty attracting investment from natural holders of longer-dated assets, such as pension funds.

“I also believe that we need to start thinking about the capital market ecosystem for infrastructure if we are serious about getting private-sector investment,” says Cheung. The central concerns of investors is linked to political, currency, liquidity, construction and regulation risks.

Given these investment constraints, Cheung says the mainstream owners of a $200 trillion investment pool cannot invest in PPPs. “But they can and will want to invest in high-quality debt instruments focusing on sustainable infrastructure development,” he says. But he cautions: “Looking at today’s liquidity of debt market generally as well as the state of development of infrastructure bonds, it is going to take at least two to three years before we can get into any sort of liquidity or size to make it viable for wide-scale financial intermediation.”

How much HKMA money is involved?

With its record-breaking fiscal reserve of HK$936 billion ($120 billion), Hong Kong is eyeing opportunities to capture infrastructure financing needs in emerging Asia, in particular to support the Chinese authorities’ centerpiece Belt and Road Initiative.

Any HKMA infrastructure investments look set to be handled by the Exchange Fund’s long-term growth portfolio (LTGP), with the IFFO responsible for project selection, deal matching and co-investment. A multilateral agency might also be brought in to manage the investments, given the HKMA’s lack of investment expertise in infrastructure.

The HKMA already started diversifying its Exchange Fund back in 2009 by investing in more asset classes. In particular, the LTGP invests in alternative assets, such as private equity and real estate projects.

At the end of 2016, LTGP assets were about HK$181.8 billion ($23.3 billion) and outstanding investment commitments amounted to about HK$133.8 billion. The annualised internal rate of return has stood at about 12% since the LTGP’s inception in 2009.

The HKMA is not required to detail specific LTGP holdings, as is the practice of its other Exchange Fund investments. The only obvious limitation on the LTGP is that the market value of any investment under cannot exceed one-third of the accumulated surplus of the Exchange Fund. At the end of 2016, the accumulated surplus of the Exchange Fund was about HK$607.5 billion, so one-third is about HK$200 billion.

The HKMA typically has been very wary of making large asset investments in China, with some officials being concerned about ‘wrong-way’ risk – the high likelihood that a shock requiring Hong Kong to draw down on reserves could occur when there are systemic stresses on the mainland that could hit both asset values and liquidity when resources are most needed.

Even the LTGP predominantly invests in traditional and mature markets, including North America and western Europe, with only a small exposure to certain emerging markets, Eddie Yue, the HKMA deputy chief executive, wrote in December 2015.

Other than its original assets, the LTGP also has further capacity arising from the allocation of a part of the Future Fund.

The Future Fund was established by the Hong Kong government in 2016 “with a view to securing higher investment returns for the fiscal reserve”. With an initial endowment of HK$219.7 billion, 50% of the Future Fund will be injected into Exchange Fund’s LTGP over a period of around three years.

Placements by the Future Fund, together with the interest, shall only be repaid at the end 2025. From now until 2025, the HKMA only needs to consult Hong Kong’s financial secretary and the secretary for financial services and the treasury once a year on the asset allocation for the Future Fund.

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