Out of the Shadows

How private capital can accelerate Australia’s post-COVID recovery

by David G Rose

Over the coming months we are going to emerge from global lockdown into an economy over which the Covid-19 virus will cast its long shadow.  But does that have to be the end of the story?  For there is yet another shadow that could go a long way towards neutralising the worst effects of this malignant virus on the global economy.  A shadow cast by a colossal, multi-trillion dollar mountain of unused private capital that stands ready, willing and able to be deployed into construction, infrastructure, energy and other projects across Australia and the wider world.   

To find the first stirrings of the tectonic capital market upheavals that bought us to this point, we need to look back to the OECD Global Pensions Report 2006*.  In this unlikely setting we find the first mention of a ‘financial meltdown’ from a recognised IGO.  It analysed how family offices, hedge and private equity funds had become so awash with liquidity that it was proving impossible to generate any meaningful returns for the private capital they were trying to deploy into the market.  A trend that had been under way, according to that OECD Report, since 2005 and, since when, nothing has changed. 

CFO Australia readers will recall the fleeting appearance of the ‘shadow banking’ sector in the wake of that financial meltdown.  This was a term coined by the global banking establishment for a phenomenon they were struggling to get to grips with, the rapid and (to them) inexplicable ascendancy of the entire gamut of private capital institutions.  But look now at any ‘private capital’ data and you will find numbers running well into the multi-trillion dollars, conveying the sheer magnitude of the private wealth-powered ‘shadow banking’ sector. 

According to the Wealth-X The World Ultra-Wealth report 2019 there were 353,550 U/HNWI’s with a projected total wealth of $43 trillion by 2023.  The Economist reported that, at a conference for UHNWI’s and their family offices in Dubai in December 2018, there was over $2tn in the room.  Preqin, the font of all wisdom in the alternative capital sector has 100,000 subscribers across every conceivable type of private capital entity.  Numbers that simply cannot be ignored and prove that, after a decade of growth and consolidation, the so-called ‘shadow banking’ sector has come to clearly overshadow traditional banks.  Irony lives.

This is most certainly true of project finance, again a multi-trillion dollar market in its own right and now dominated by private capital institutions.  The RAISING PROJECT FINANCE Handbook (Amazon) suggests that there is $4.5tn available as private debt and equity for project finance but, due to its currently unstructured nature, it is a market in name only.  Whereas municipalities and major corporates can take their ‘A’ (or better) credit agency rated proposal to the institutional capital markets where their funding is guaranteed, the story is a whole lot different for those without that rating. 

These are the overwhelming majority, thousands of them ranging from local $20m care homes through $200m social housing or $500m renewable energy plants to $1bn+ transport and other infrastructure projects.  They are entering a fragmented and frustrating global market of yet more thousands of private capital sources ranging across hedge funds, private equity and debt funds, mandated lenders, asset managers, wealth managers, private banks, multi- and single-family offices and more besides.   Although fragmented, they comprise a vast and abundant resource of capital, known as ‘dry powder’, waiting to invest in viable projects. 

Few business leaders with projects seeking finance are aware of this fundamental shift in the capital markets, with many still in futile pursuit of finance from their own banks.  Even fewer appreciate that genuine project finance is ‘non-recourse’.  Meaning that, provided there is a contracted and credible buyer for whatever the built project is going to produce the project company and, its shareholders carry no financial liability whatsoever.  This could be in the form of a power purchase agreement (PPA) for a renewable energy plant, an operations and management agreement with a hotel or hospital operator or any one of dozens of other ‘off-take’ options.  Alternatively, an independent and credible feasibility study will sometimes be sufficient to secure finance for a transport, hospital, social housing or similar infrastructure project.  This directly reflects how the institutional capital markets work with credit agency-rated borrowers, where they lend against the rating and not the project sponsor or its principals. 

For private lenders, the off-taker and all those contractors involved in the project have to meet acceptable and underwrite-able standards of financial stability and track record.  Also all documentation including permits, permissions, site access, connectivity and many other statutory and other requirements all have to be clearly documented, organised and presented.  But after all that, and following all the necessary due diligence, financing can be directed into the project through its Special Purpose Vehicle (SPV). 

Navigating what is right now a market in its infancy, for both the buy and sell sides, remains a challenge.  The majority of private financiers like to keep a low profile, working through their trusted intermediaries.  Finance raisers are left to seek these people out whilst avoiding joker-brokers, advance fee scams and other hazards.  However, there are standards, protocols and the first hint of structure emerging.  Particularly as the more seasoned intermediaries start identifying each other and deploying the opportunities through their networks to reach more financiers.  Baby-steps towards overcoming the current market fragmentation and releasing as much as possible of that dry powder.

So, there is hope for the post-Covid economy yet.  Indeed, this abundant private capital resource could be unleashed to get many hundreds of currently frustrated renewable energy, agri, infrastructure and other projects throughout the UK and the world off the starting blocks.  Beyond any shadow of doubt we have to pick up this ball, and run with it.

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OECD 2006 Pensions report:

Full quote: “The blurring and overlap of the investment trains of PE, MFO’s and hedge funds is not only specifically due to the financial meltdown and changing regulatory environment.  The change began even before, where hedge funds and private equity firms were banding together and entering each other’s turf in an attempt to get to the best deals in an increasingly complex and global playing field where new markets are emerging both geographically as well as in new industries.

The blurring of the difference between hedge funds and private equity funds reflects increased competition among the growing number of funds and the huge injection of capital between 2005 and 2007, making it more difficult for funds managers to provide superior returns.