Private Enterprise and Financial Markets > Infrastructure and Financial Markets > Infrastructure
Pension Funds in Infrastructure Project Finance: Regulations and Instrument Design
By Antonio Vives (05/99, IFM-110, En, Es)
In the nineties, two major reforms were undertaken with intensity by Latin American countries; namely, private participation in pension fund management and in infrastructure investment. Many countries in other parts of the world have undertaken one or another of these reforms, but not both at the same time (with the exception of the United Kingdom, which closely resembles the case of many countries in Latin America and pioneered private participation in infrastructure). These dual reforms have created a sizable, mostly domestic source of long-term funds, while at the same creating a sizable need for domestic investment funds. Nevertheless, in spite of the potential benefits of a happy marriage, a relationship has not yet been developed.
The liberalization of many emerging market economies and the attendant realization of the many benefits of private participation in infrastructure, have resulted in a considerable need for private capital. This liberalization, occurring in the context of relatively underdeveloped financial markets, has meant reliance on foreign capital to finance growing needs, with the concomitant risk for the economies of unexpected devaluations and/or sudden reversals of those flows. Even though foreign capital flows into infrastructure projects are more resilient than portfolio investment, recent crises have reduced the willingness of investors to provide capital for emerging markets. As a result, projects have been subjected to severe foreign exchange risks.
This situation underscores the importance of developing domestic sources of long-term capital. The major, and sometimes only sources of domestic long-term capital are local pension fund resources, which, in addition, can contribute to the development of local financial markets. It is imperative that these resources be tapped by infrastructure projects. If they are to tap their resources successfully, project developers and the international project finance industry must be aware of the special needs of local pension funds. Even though the discussion is concentrated on Latin America it has implications for most countries with privately managed pension funds and private infrastructure.
The purpose of this paper is to promote this symbiotic relationship, outlining the conditions under which sources and uses of long-term resources can meet and focusing the attention of both parties to the benefits of a properly structured relationship. There are benefits for both parties that can be exploited through a better mutual understanding of the needs of the other party. We do not propose that special subsidies, guarantees or tax benefits be granted to infrastructure works to make them attractive to private pension fund managers. Nor do we propose that public pension fund resources be directed or forced into infrastructure investments on account of their positive externalities or social benefits. Private infrastructure investment instruments must be structured so that they fit into the investment strategies of private pension funds, while appropriate changes in the pension fund regulatory framework should be encouraged. We propose a strictly voluntary private to private relationship, albeit with the participation of the public sector as grantor and regulator of private activities. The public sector has the important role of facilitator; it controls most of the rules of the game and its actions in either sector can make or break the relationship.
Before embarking on the purpose of this paper, the discussion of the structure of infrastructure financial instruments needed to capture pension fund investments and the consequent policy and regulatory reforms needed in most developing countries, we briefly review the potential sources and needs for investment, the characteristics of the funds and of the projects, the current limitations to the relationship and the benefits for both parties. The article concludes with a discussion of the implications this can have for developed countries, like the United States and most of Europe, that lag in private participation in both areas, mandatory pensions and infrastructure.
Last updated: 01/29/07
