Infrastructure accounts for only a small slice of an Asian insurer’s portfolio, but in a stubbornly low interest rate environment, that is expected to change as firms search for higher yields while addressing urgent challenges. Lynn Strongin Dodds reports.
The attractions of diversification and stable income are universal, but the challenge lies in finding the right opportunities in a region as heterogeneous as Asia.
“The Asian infrastructure market is not as mature as Europe and the US, nor is it as transparent,” says So Yeun Lim, global head of infrastructure research at Willis Towers Watson. “Like Europe, the region consists of different countries and requires local specialist skills. The questions that any investor – whether insurers or pension funds – have to ask is what is the opportunity set and the implementation available?
“There are only a handful of Asian managers who have been in the market for a long time and not all have raised strictly Asian funds but are part of an emerging market.”
The potential opportunities are underscored by a report from the Asian Development Bank (ADB), which shows that throughout developing Asia, except for China, there is a longstanding and significant underinvestment in infrastructure. The research shows that while around US$900 billion a year is spent on infrastructure in the Asia-Pacific region, the figure falls substantially short of the $1.7 trillion the ADB estimates the region needs annually from 2016 until 2030 to keep pace with climate change and the economy. This translates into 4.2% of GDP and a total of $35 trillion.
Commenting on the report, ADB president Takehiko Nakao said: “The demand for infrastructure across Asia and the Pacific far outstrips current supply. Asia needs new and upgraded infrastructure that will set the standard for quality, encourage economic growth and respond to the pressing global challenge that is climate change.”
The Asian landscape
Even in China, with its ambitious Belt and Road Initiative and other significant infrastructure projects over the past two decades, a need for further investment still exists, albeit to a lesser extent than in most developing countries in the region. China is spending around $1.2 trillion, or 4.5% of GDP, each year, which is around 35% of global investment and 54% of all emerging market investment.
The Belt and Road Initiative, which is often described as a 21st century Silk Road, was started in 2013, with projects ranging from $1 trillion to $8 trillion, to build new road and shipping lane trade corridors between China and other countries in Asia, Europe and Africa.
Outside of China, the gap is prominent in southeast Asia, which requires basic infrastructure such as roads, bridges, hospitals and power plants. In the past, these assets were typically funded by governments or multilateral organisations such as the ADB but today, important sources of income though they are, they are no longer sufficient to meet the region’s demands.
As in the US and Europe, Asian governments across the region are looking at the insurance industry to step into the breach and help close the funding gap, according to Andries Hoekema, global head of the insurance sector at HSBC Global Asset Management. “Infrastructure debt has the potential to add another string to the bow, but it needs to be a good-quality project with underlying long-dated contractual flows and that can generate strong future returns,” says Hoekema.
An allocation to infrastructure is also seen as helping insurers mitigate the uncertainty and volatility of the current environment. The pandemic is forcing them to recalibrate their risk management models and review their asset allocation as low interest rates have eroded yields while bond spreads have widened. They have no choice but to broaden their investment mix and add alternative investment solutions to generate higher risk-adjusted returns.
For example, numbers crunched by data provider Preqin show that global unlisted infrastructure funds have not only generally held their value but also turned out 10.6% annualised returns over the ten years to December 2019 and 11.7% per year between 2014 and 2019.
In a year defined by Covid-19, the pandemic is not the only driver. There are also regulatory forces at play.
International Financial Reporting Standard (IFRS) 9 and IFRS 17, which has been delayed until 2023, will, among other things, require insurers to better match their assets with liabilities. In addition, by 2023, new or revised risk-based capital (RBC) adequacy regulations will be in force in China, Hong Kong, Singapore, South Korea and Thailand.
Two years later, global insurance groups worldwide must also report their capital position under the global risk-based Insurance Capital Standard (ICS), according to a new report from JP Morgan – ‘Capital-Efficient Alternatives for Asian Insurers’.
“The result is that risk-based capital regimes will put further pressure on insurers’ solvency, raising the bar for capital efficiency of new and existing investments,” says Rick Wei, head of Asia insurance ex Japan at JP Morgan Asset Management.
“The Asian RBC reforms along with the new accounting standards will lead to a paradigm shift where real assets will play an increasingly important role,” he says. “It is expected that over the next five years, they will account for about 10% to 15% of an insurance company’s portfolio in many Asian markets, compared to the current low single digits. Infrastructure as a separate asset class will become an important building block of alternative solutions. Not all infrastructure is the same, though, and we divide it into core, opportunistic and debt versus equity.”
Wei notes that the core and core-plus bucket includes either equity or debt investments tied to contractual and regulated projects that generate long-term and more predictable cashflows. It offers stable income, diversification and asset and liability-matching attributes. Opportunistic strategies are higher-risk but also associated with higher returns and are more akin to private equity.
A clean, green machine?
Although each market has its own unique characteristics, features, regulations, legal frameworks, opportunities and challenges, there are some common threads. For example, renewable energy is top of the agenda for many countries, particularly given the Association of Southeast Asian Nations’ (ASEAN) target of securing 23% of its primary energy from renewable sources by 2025, as energy demand in the region is expected to grow by 50%. Research from the International Renewable Energy Agency (IRENA), shows that this objective entails a “two-and-a-half-fold increase in the modern renewable energy share compared to 2014”.
China has also stepped up its programme, with President Xi Jinping’s recent surprise pledge at the United Nations general assembly to reach “peak carbon” before 2030 and drive down emissions to virtually zero by 2060.
While this will create greater interest in wind, solar and hydro-electricity plants, Shantini Nair, a senior product specialist for infrastructure debt investments at HSBC Global Asset Management, is also seeing increased demand for broader energy projects involving liquid natural gas and renewable forms of alternative energy production (i.e. wind or solar photovoltaic farms) as well as projects that address communities’ needs. That includes water, hospitals, schools and telecommunications such as 5G and e-commerce.
To date, the largest and most attractive projects are in countries such as Vietnam, Indonesia, the Philippines, Thailand, India, Malaysia and South Korea. The biggest competitors for insurers are typically local banks that also want to capitalise on the opportunities, according to Nair. The most popular funding mechanisms are public-private partnership (PPP) structures, which are also used in the UK and other developed markets. The attraction is having government-backed funding, with the most common model being a build-operate-transfer contract in which a private company finances and operates an infrastructure project before transferring back to the public sector after a set period.
Market participants expect the trend to accelerate in the post-pandemic period because PPP-backed infrastructure projects are not only producing strong and predictable cashflows, but also offer downside protection against unexpected events.
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