Face to face: Karim Nassif, S&P Global Ratings
S&P Global Ratings’ Karim Nassif says that, although challenging, the 2019 implementation of Basel III banking regulations could motivate the GCC’s construction sector to seek out alternative avenues for project finance
Although not everybody agrees on the most appropriate course of action, few would deny that GCC member states need to change the way in which regional projects are financed. Spurred on by the post-2014 oil price decline, Gulf countries are looking for novel ways to maintain funding for long-term infrastructure developments, while reducing the historic tendency to dip into national coffers.
For the most part, project stakeholders are turning to the banking sector to bridge the gap. However, this situation is placing significant pressure on such institutions and, with fresh regulatory changes on the horizon, there is an ever-growing need for the GCC to identify alternative avenues for project finance.
Basel III is likely to act as a catalyst for this shift. Developed by the Basel Committee on Banking Supervision (BCBS) in a bid to improve regulation, supervision, and risk management within the banking sector, the implementation of this global framework is scheduled for Q1 2019.
Karim Nassif, associate director of infrastructure finance at S&P Global Ratings, says that Basel III is likely to result in numerous challenges for the GCC’s construction sector. Moreover, he tells Construction Week that, when it comes to project finance, the entire industry is already under significant pressure.
“The construction sector is feeling the strain in terms of its operational ability to deliver the GCC’s vast infrastructure pipeline,” he explains. “According to S&P Global Ratings’ estimates, the GCC has a funding gap of roughly $270bn. By this, we mean the gap between the [value of] contracts that we expect to be awarded between the end of 2016 and the end of 2019, and the capital expenditure to which governments have committed, which stands at approximately $330bn for the period.
“If the region is going to deliver this infrastructure pipeline in spite of the funding gap, stakeholders are going to need to secure project finance [from other areas] – and the financing environment is becoming increasingly strained.”
On the one hand, Nassif points out that banks – whether domestic, regional, or international – are finding it difficult to carry the burden of project finance. Factors such as reduced oil and gas revenues, a lack of dollar liquidity, low interest rates, and a saturated market have served to squeeze margins within the GCC’s banking sector. And this is before the introduction of Basel III.
On the other hand, construction firms are also feeling the pinch. In addition to difficulties surrounding project finance, the industry is having to deal with the myriad challenges associated with delayed payment.
“[Contractors] are not getting paid on time,” says Nassif. “This is no secret. You hear about firms like Arabtec, Drake & Scull International (DSI), Saudi Oger, and Saudi Binladin Group (SBG); there are some very notable entities – which sit at the core of [regional project delivery] – that are facing difficulties.”
In the short term, the implementation of Basel III could result in additional obstacles to project finance. Nassif explains: “Banks in the GCC are quite well capitalised compared to their international peers; their capital adequacy is strong. That said, this market will witness changes as a result of the implementation of Basel III. While each country will have some leeway to interpret the rules on a national level, the reality is that the regulation is going to make it difficult to provide long-term tenures for project finance.
“At a very basic level, banks will have to put up a capital charge as soon as Basel III comes into force. This charge is expected to increase by around 40%, according to our estimates. That is a significant amount; it will make it more difficult for banks to find the funds for long-term project finance and infrastructure.”
Nevertheless, Nassif points out that regulators have included several measures designed to offset some of the capital charges, and ensure that structured finance does not take too much of a hit. He continues: “For example, Solvency II, which is specifically targeted at project infrastructure, will reduce this capital charge by 30%. Furthermore, the new regulations will favour debt that is rated. So debt relating to long-term projects and infrastructure will involve a lower capital charge for banks, and encourage the rated- debt markets.”
Such measures have been put in place to support specialised and structured lending. Nassif says that there is a realisation that without this type of support, long-term project finance would take up a lot of the risk-rated capital of banks.
“Ultimately, the GCC must continue to encourage insurance and pension funds to support its long-term developments. Whether in Europe or the Middle East, policy-makers appreciate that there is a challenge when it comes to delivering on their infrastructure roll-out [commitments],” he explains.
Encouragingly, Nassif says that while the implementation of Basel III will create certain obstacles for the GCC’s constructions sector, it could serve to strengthen and reshape the region’s project financing landscape in the longer term.
“For a long time in the Gulf, funding has been offered by banks at very cheap rates, and the pricing of these rates did not always accurately reflect the risk involved,” he notes. “As such, I think that by putting more of an onus on alternative forms of project finance – those outside of the traditional field of banking – these changes could help to secure the support of capital markets.”
Nassif points to a deal struck by Dubai Electricity and Water Authority (DEWA) as an example of how GCC banks are struggling to provide long-term finance for infrastructure projects. A consortium of lenders, including First Gulf Bank (FGB), Islamic Development Bank (IDB), National Bank of Abu Dhabi (NBAD), and Natixis, provided $924m (AED3.4bn) for Mohammed bin Rashid Al Maktoum Solar Park’s 800MW Phase 3.
“That deal had to be structured as a mini-perm loan, which is interesting,” he notes. “Mini-perm structures incentivise refinancing after three, five, or seven years. Now ask yourself why [the stakeholders opted for] this particular funding structure, [bearing in mind] that, ultimately, DEWA needs more than [10 years’ worth of money]. It links to my earlier point: that banks are facing a squeeze on long-term funding, and are therefore looking to structure deals in ways that limit the amount of exposure that such loans represent on their balance sheets.”
Nassif predicts that the implementation of Basel III, and the resultant shift towards alternative sources of funding, could facilitate a more flexible and realistic project financing landscape in the GCC. Moreover, he says that the transition may help to alleviate the lowest-bid mentality that has taken hold within the region’s contracting market.
“[This shift is] a very important part of the equation; it should help to introduce a sense of realism among stakeholders responsible for sponsoring and tendering out work on projects,” he says. “It can no longer be the case that the company that submits the lowest bid wins the tender. Competition is fierce within the GCC’s contracting market. Contractors working on large-scale infrastructure projects have told me there’s no way they’d have been able to survive without bidding low. The problem is that, sometimes, these bids have been unrealistic, [resulting in] the need for variations or amendments to contracts. I think this trend is also connected to financing; there has been an expectation that finance can be secured very cheaply.”
With this in mind, Nassif predicts that contracting standards will evolve to include more market-based measures that focus on overall value as well as price. He also foresees greater involvement from capital markets, and points out that evidence of this trend can already be seen in the GCC.
“S&P Global Ratings provided a preliminary rating for ACWA Power Management and Investments One (APMI 1),” he explains. “It’s not a final rating, but this preliminary rating came out at BBB-. This is a very interesting deal in the sense that it involves the monetisation ACWA Power’s minority interests in nine power and water projects in Saudi Arabia. Essentially, the company is raising money against its future dividend streams.
“If APMI 1 closes, it will go to the capital markets, bonds and, potentially, sukuk. And it’s a long-term deal; we’re talking 20 to 22 years. So it’s a classic example of infrastructure-related [activities,] which require long-term funding, going outside of the banking sector into the capital market.”
Nassif cites Ruwais Power Company’s (RPC) Shuweihat S2 IWPP in Abu Dhabi, which was funded through an $800m (AED2.9bn) bond that will mature after a period of 16 to 18 years, and the Dolphin Gas Project, which links Qatar, the UAE, and Oman, as other examples of large-scale infrastructure developments that have come to market through capital funding. He also notes that capital markets have a significant role to play in situations where many deals must be funded simultaneously, or within a short timeframe.
“Saudi Arabia’s National Transformation Programme (NTP) has been designed to be delivered by 2020. Meanwhile, the kingdom’s Minister of Energy, Khalid A Al-Falih, has [outlined the development of] 9.3GW of renewables by 2023; the first tender for a 700MW renewable plant has already been floated. In addition, there are regional diversification plans involving the downstream sector, metals and mining, and large-scale events such as Expo 2020 Dubai and the 2022 FIFA World Cup in Qatar. [Within this context,] the environment will [have to become] more conducive to alternative financing models and capital market investment.”
Nassif concludes: “Basel III, and the regional shift towards alternative project financing models, will pave the way for greater private sector involvement. Everybody acknowledges that this is a good thing, in terms of broadening the markets and the participation of local and international investors. Ultimately, it should serve to increase liquidity within GCC economies. I think what we are witnessing is, perhaps, the jolt that the Gulf needs in order to [set this transition in motion].”