1. Alternative Asset Classes for Pension Funds Transforming Need into Opportunities: Financing Infrastructure Trough Capital Markets –The Inca Model National Pension Commission of Nigeria and The IFC Abuja March 2008 Johan Kruger 1

2. Topics The Democratisation of South Africa The Democratisation of South Africa The Rationale for an Intermediary The Rationale for an Intermediary The INCA Model The INCA Model Prerequisites for Pension Fund Investments In Infrastructure Prerequisites for Pension Fund Investments In Infrastructure The Advantages of Infrastructure Investments The Advantages of Infrastructure Investments Possible Intermediaries Possible Intermediaries Conclusion Conclusion 2

3. The Democratisation of South Africa Pre Democratisation Pre Democratisation Local Authorities White, Black, Indian, Coloured Local Authorities White, Black, Indian, Coloured White -economic base –strong cash flow- institutional capacity-good infrastructure- Government support – no problem accessing capital markets White -economic base –strong cash flow- institutional capacity-good infrastructure- Government support – no problem accessing capital markets Black etc - no economic base-grant dependant=weak institutional structure- inadequate infrastructure-no private funding Black etc - no economic base-grant dependant=weak institutional structure- inadequate infrastructure-no private funding 3

4. The Democratisation of South Africa Post Democratisation Post Democratisation Priority amalgamation of local authorities Priority amalgamation of local authorities Investor withdrawal Investor withdrawal Service Boycotts Service Boycotts Tremendous Backlogs Tremendous Backlogs Lack of policy framework Lack of policy framework Fruits of the new South Africa has to be delivered Fruits of the new South Africa has to be delivered Market gap in private sector infrastructure funding Market gap in private sector infrastructure funding 4

5. Rationale For Inca Local authority portion minute in comparison with total contractual savings institution’s portfolio (0.2%) Local authority portion minute in comparison with total contractual savings institution’s portfolio (0.2%) Lack of understanding of local government Lack of understanding of local government Uncertain policy environment Uncertain policy environmentBut Private sector know they must invest or jeopardise stability of Country Private sector know they must invest or jeopardise stability of Country 5

6. Inca Started in 1996 with $10 m Started in 1996 with $10 m Peaked in 2004 at of $1000 m Portfolio Peaked in 2004 at of $1000 m Portfolio Started in response to government appeal to private sector Started in response to government appeal to private sector Structured as intermediary between infrastructure providers and capital markets Structured as intermediary between infrastructure providers and capital markets Listed and rated bonds on market Listed and rated bonds on market Created two subsidiaries:non profit capacity building fund and distressed bond company Created two subsidiaries:non profit capacity building fund and distressed bond company 6

7. Basic Business case Classic aggregation/disaggregation intermediary Classic aggregation/disaggregation intermediary Issue bonds in domestic market and conclude international loans to raise money Issue bonds in domestic market and conclude international loans to raise money Pre approved credit limits Pre approved credit limits Provide funds to borrowers Provide funds to borrowers Amortizing or bullet/coupon Amortizing or bullet/coupon Bulk is on balance sheet lending Bulk is on balance sheet lending Provide assistance trough an non profit company Provide assistance trough an non profit company 7

8. The Inca Model Offers investors Offers investors Understandable financials of single entity Understandable financials of single entity Opportunity for social investment Opportunity for social investment Market related return - listed and AA-rated bond Market related return - listed and AA-rated bond Liquidity by market makers Liquidity by market makers Diversified risk and equity/reserve buffer Diversified risk and equity/reserve buffer Dedicated expertise & risk assessment Dedicated expertise & risk assessment Second corporate bond in South Africa Second corporate bond in South Africa 8

9. The INCA Model (2) Offers Local Authorities Offers Local Authorities Access to private sector finance Access to private sector finance Reasonable rates given risk profiles Reasonable rates given risk profiles Transparency Transparency Assistance Assistance Offers Shareholders Offers Shareholders Opportunity to invest at market related rates Opportunity to invest at market related rates Benefit of participation Benefit of participation 9

10. Structure of Inca Choice of shareholders Choice of shareholders Financial institutions Financial institutions Empowerment and gender partners Empowerment and gender partners DFI’s ( political insurance and credibility) DFI’s ( political insurance and credibility) Rated (AA-) Rated (AA-) Back to back bonds in inception phase Back to back bonds in inception phase no interest rate risk no interest rate risk No expensive treasury No expensive treasury Government stock hedging Government stock hedging 10

11. Structure of Inca (2) General obligations General obligations Computerised credit model Computerised credit model Pre assessment Pre assessment Shadow rating Shadow rating Turn around time 3 weeks Turn around time 3 weeks Determines capital requirements Determines capital requirements Determines pricing Determines pricing Caveats Caveats Limited but incentivised staff Limited but incentivised staff Non banking entity Non banking entity International Funding International Funding 11

12. Capital Structure Of Inca Equity Mezzanine debt Senior debt 6% Return Govt plus 12-14% 23.5% Return Govt plus 2- 3.5% 70.5% Return Govt plus 0.8- 2.0% 12

13. Credit Model Solvency Liquidity Turnover Standardization Income Cash flow Diversity of tax Growth indicators Physical factors Management Competence Dispute resolutions Backlogs Payment levels Financial position Economic environment Institutional capacity Socio-economic analysis Environmental Policies Practices Score Peer Deviation Potential problem areas Shadow rating 13 Capital,pricing, caveats

14. Typical Projects Funding of: Municipal and regional infrastructure Municipal and regional infrastructure Roads Roads Sewerage Sewerage Water Water Electricity Electricity other other Parastatal infrastructure Parastatal infrastructure 14

15. Performance Portfolio peaked in 2004 at more than $ 1 Billion Portfolio peaked in 2004 at more than $ 1 Billion Defaults never exceeded 0.2% Defaults never exceeded 0.2% Return to shareholders always in excess of 20% Return to shareholders always in excess of 20% Capacity building fund had a major Impact Capacity building fund had a major Impact 15

16. Prerequisites for Successful Intermediaries Rule of law –fair and timely Rule of law –fair and timely Decentralised authority and autonomy Decentralised authority and autonomy Creditworthy or credit enhanced borrowers Creditworthy or credit enhanced borrowers Acceptance of cost recovery principles and/or appropriate subsidy where required Acceptance of cost recovery principles and/or appropriate subsidy where required Developed capital market – access - yield curves to price risk- tradability Developed capital market – access - yield curves to price risk- tradability Risk/reward in balance Risk/reward in balance Clear policy framework Clear policy framework Capacity to deal with defaults Capacity to deal with defaults Trust from investment sector in management Trust from investment sector in management Credible shareholders Credible shareholders 16

17. Prerequisites for Pension fund Investment in Infrastructure Pension fund’s first responsibility is to their members Pension fund’s first responsibility is to their members Risk must be acceptable Risk must be acceptable Reward must be market related and competitive Reward must be market related and competitive Appropriate listed and rated tradable instruments must be available Appropriate listed and rated tradable instruments must be available Long term yield curves Long term yield curves Must be socially acceptable projects Must be socially acceptable projects 17

18. The Advantages of Investment in Infrastructure Natural match between long term fixed rate requirement of infrastructure funding and the long term needs of the contractual savings sector Natural match between long term fixed rate requirement of infrastructure funding and the long term needs of the contractual savings sector Diversification opportunity Diversification opportunity Higher yields possible Higher yields possible Stimulates economic growth Stimulates economic growth Benefits members Benefits members 18

19. Risks for Pension Funds Failure of infrastructure providers Failure of infrastructure providers Failure of intermediary Failure of intermediary Market risks Market risks Reputational risks Reputational risks In Nigeria administration problems with intercepts In Nigeria administration problems with intercepts 19

20. Possible Borrowers and Intermediaries State governments State governments Local authorities Local authorities Utility Companies Utility Companies Private sector intermediaries Private sector intermediaries UDBN UDBN Banks Banks Spv’s Spv’s 20

21. Conclusion Infrastructure is a natural area for the pension fund industry and Inca in South Africa has proved the viability of investment in development Infrastructure is a natural area for the pension fund industry and Inca in South Africa has proved the viability of investment in development 21