Speaker 1  00:01
So the Western world obviously saw this as quite a bit of a risk. I mean, there is a long history of successful PPPs, but at the same time, there are also cases where things haven't gone according to plan. The reality of it is that even in the developed jurisdictions, the moment you open up these markets and where there's a failure of regulation, or where regulators don't evolve as fast as the market, there can be abuse and undue practices. So infrastructure is very much needed here, and I think according to World Bank estimates, there is a gap of about 200 to 300 billion US dollars annually.

Speaker 2  00:37
Hasintha Uswatha is a structured finance specialist with experience in building multi-asset investment strategies, he has global investment experience spanning equities, debt, private equity, and infrastructure across Australia, Asia, and Europe. A CFA charter holder and NUS graduate, he brings expertise from previous roles at the Northern Australia Infrastructure Facility, KPMG Australia, HSBC Bank, and Amba Research. He is currently employed at Asia Securities as the head of principal investment strategies and alternatives, having recently returned from an eight-year stint in Sydney, Australia. He joins us on our latest episode of Advocata Conversations.

Murtaza Jafferjee  01:18
Hasant Ulswata, welcome to Advocata conversation.

Speaker 1  01:21
Thank you. Thanks, Muntusa. Thanks for having

Murtaza Jafferjee  01:24
me. My pleasure. Why don't we start by me first asking you what your personal story is?

Speaker 1  01:30
Pleased to be talking to Advocata. I'm Hasanto Swata. So I was I was educated in Sri Lanka. So I've had all my schooling in Sri Lanka. For my undergraduate studies, I went to the National University of Singapore, and there I completed a Bachelor of Business Administration with a minor in Political Science. That was way back in 2010.

Murtaza Jafferjee  01:52
And how did you get to NUS?

Speaker 1  01:55
Well, I always had an interest in going to NUS as well, and at the time when I when I graduated from high school, it was considered one of the best universities in this region. So it was always my choice.

Murtaza Jafferjee  02:11
So don't they get you to work two years in Singapore?

Speaker 1  02:14
Yes, they do. It's not explicitly in Singapore. It was for a Singapore registered employer,

Murtaza Jafferjee  02:21
right? And what what was your reflections of Singapore during your time at the university?

Speaker 1  02:26
Well, in US is, I mean, they are quite famous for their academic rigour. So it wasn't it sometimes wasn't the most pleasant, or definitely was not a party school by any means, so it was a lot of hard work. I quite enjoyed it. I was always studious in Sri Lanka. I think university was probably a time where I wasn't as studious. I enjoyed myself a little bit more, and in the process, sort of discovered certain things about myself which were important for my adult life, but I probably could have done better from a study perspective.

Murtaza Jafferjee  03:09
So you come back to Sri Lanka, and then what happens?

Speaker 1  03:13
So in 2010, when we graduated, it was at the height of the credit crisis in the U.S. So Singapore was very much affected by that. My first preference was to live in Singapore, and as you said, the part of my financial educational package included a three-year bond to the Ministry of Education in in Singapore. So I very much wanted to get a finance job in Singapore. That was the initial plan, but as circumstances would have it, at the time getting a finance, a core finance job as an undergrad in 2010, when Singapore GDP growth was minus, was was a very sort of unlikely thing. So when I was looking for jobs at the time, one of my previous colleagues who had who I had interned for in Sri Lanka, she referred me to Amber Research, and they they happened to be on the lookout for sort of global equity research analysts. So they made me an offer, and they also were able to accommodate my bond requirements as well. So as a result, I ended up coming back to Sri Lanka, and then I worked for them, covering global equities for bulge bracket investment banks for a period of about three years in Sri Lanka. So that that experience also I quite liked it, and I think the training you receive and the the technical skills that are sort of developed at Amber Research was a really like strong foundation for me. After three years, I wanted to move to a more sort of front office facing role, and I moved to HSBC Institutional Banking in. 2013, and I was there managing a corporate, a large corporate portfolio for about a period of about two and a half years. This

Murtaza Jafferjee  05:09
was in Colombo.

Speaker 1  05:10
Yeah, this was in Colombo, and during that time, so I, my wife and I got married. She happened to have studied at the University of Melbourne, and she was a permanent resident of resident of Australia, so that we had we had this sort of distant possibility that we could actually go to Australia, but at the time we were quite comfortable in Sri Lanka. 2015 was the first time I went to Australia, but that was for the World Cup, just to see how we would like it, see what the country is about, and what all the fuss is about. I quite liked it, and we felt that it was something that potentially would would be maybe a useful experience for us, because we were very comfortable in Sri Lanka, we both come from very large families, but we wanted to try to experience something different for a little while. And at the time, we were in our sort of mid to late 20s, so it felt like it was potentially a risk we could take. We didn't have kids as well, so soon after leaving HSBC, I actually worked. I had a stint in the local capital markets at Asia Securities for a period of about one and a half years, and then in 2017 March, we decided to make the move to Australia. So, so

Murtaza Jafferjee  06:39
you went as a legal migrant, as you know, quite literally. Some people from Sri Lanka try to swim there or go in rickety boats, and it was often said that Australia was the land of milk and honey. Was it so?

Speaker 1  06:54
I think the quality of life that you get in Australia is probably difficult to match in a lot of places, you get to sort of enjoy a good quality of life at a relatively manageable pace of life. My wife is a forensic account, and I was in finance. If you look at the kind of jobs we did, if we were to do that in, say, London or New York, the reality of it would have been that we would have been working far longer, and our quality of life perhaps would have been much lower. But in Australia, it was it was quite manageable. You could do meaningful work, you could earn a good living, and still have relatively sort of you know comfortable. I mean, doesn't mean that you don't work hard at all, but yeah, you you can still have a pretty good quality of life.

Murtaza Jafferjee  07:49
So you go as a new immigrant. The Australian psyche is that you came with a sack on a ship and you had it hard and you made it. But in your case, was it relatively easy for you to get a job?

Speaker 1  08:06
It it took a few months. I mean, I I had some referrals from Sri Lanka as well, and I think I had a very good idea of what the job search would entail. So within I got my permanent residency in August. I started working at KPMG, which was my first job in December.

Murtaza Jafferjee  08:31
And what did you do?

Speaker 1  08:32
So my objective when I went there was to get into corporate finance in Australia. My experience here was more broad-based than perhaps an Australian sort of university student because I had worked in global equities, institutional banking, and then capital markets as well. So I had a technical skill set and also sort of client-facing skills and the ability to manage a portfolio and all that, and it so happened that at the time, their strongest suite, close to sort of 50% of their revenue, came from periodic equity valuations of brownfield infrastructure portfolios for local and global infrastructure funds.

Murtaza Jafferjee  09:20
Why were they valuing brownfield assets?

Speaker 1  09:23
So, in order to provide your investors, if they want a redemption or these

Murtaza Jafferjee  09:31
are not publicly listed in the private space. Yeah,

Speaker 1  09:34
I mean there were a minority of publicly listed investments as well, but the majority of them were private investments. Yeah, so for the private investments, so on a periodic basis, for assurance purposes, you needed to conduct equity valuations, and then they were used if there were redemptions or deal events, basically.

Murtaza Jafferjee  09:53
Just to give our audience historical context, you know the general. The basis of private ownership of infrastructure assets actually came with the the reform that Margaret Thatcher did in the early 80 s or late 70 s in the UK. So she basically famously said the problem is government, and the UK started a process of kind of divesting certain of these public assets that were owned by government because it was felt that you know a better owner, differently incentivized owner, Could best get the efficiency out of those assets, and since Australia is a Commonwealth country and ideologically very aligned with the UK, in line with the reform, I believe that was done in the late 80s, first on the macro side and on the micro side in the 1990, s, including the superannuation market, all these assets came into play. And before we dive deeper into your experience, let me do a small primer to give some terminology because we will be using some terminology, it's misunderstood here. So, what is this PPP public-private partnership?

Speaker 3  11:28
Defining public-private partnership according to the International Monetary Fund, PPPs cover agreements between a government and one or more private partners for the private partner to deliver an agreed-upon quantity and quality of service in return for a unitary charge paid by the government or a user charge, a toll levied on the direct recipients of the service, with an emphasis on a whole-of-life approach, the private partner is usually responsible for both the construction and operating phases. Some degree of risk sharing between the public and private sector determined on the basis of which party is best able to manage each risk? Projects where public-private partnerships are of value, according to the Victoria Department of Treasury and Finance, a project of appropriate size over $100 million, with the ability to bundle operation and maintenance services, the opportunity for appropriate risk transfer, the ability to specify outputs, the opportunity to encourage innovation, asset utilisation, and third-party revenues, a competitive market to bid for the project, and underpinned by the disciplines from using private financing, public-private partnerships-the ingredients, the first prerequisite of good public-private partnerships, project that has net positive impact on welfare in aggregate, including externalities across all relevant stakeholders. That can be physically, economically, and legally segregated from its surroundings. That has scope for innovation and real efficiency gains in construction and operation, with observable performance-based indicators that can be contracted upon and rectified. The second prerequisite of good public-private partnerships, partners, numerous private entities that possess the technical expertise to bring about real efficiency gains and have the ability to bear risks due to their experience, reputation, and size, and access to private finance that can bear some of the risks in lieu of rewards competing on a level playing field. The third prerequisite of good public-private partnerships. Process: a transparent and competitive procurement process that transfers only those risks that shape incentives, that ensures life cycle perspective and costing that promotes credible revenue expectations within a robust regulatory framework for performance monitoring under normal conditions, and for renegotiation under abnormal conditions, and minimises moral hazard due to contingent liability or restrained flexibility. Public-private partnerships schemes and modalities. Schemes number one: Build own operate B O O, build develop operate B D O, design construct manage finance D C M F. Schemes number two: Buy build operate B B O, lease develop operate L D O. Wraparound edition W A A. Schemes number three: build, operate, transfer (BOT) Build, own, operate, transfer (BOOT) Build, rent, own, transfer (BROT) Build, lease, operate, transfer (BLOT) Build, transfer, operate (BTO)

Murtaza Jafferjee  14:35
So let's now go to your journey back again. Now you're at KPMG, and what happens thereafter?

Speaker 1  14:45
Yeah, so obviously KPMG was where I I got my orientation into this world of infrastructure, and it piqued my interest because I've always enjoyed this intersection. Between government and finance, right? So even for my bachelor's, as I said, I did a minor in political science along with my business degree. So that's always been something that's been at the forefront of my mind.

Murtaza Jafferjee  15:14
And where was that interest in political science?

Speaker 1  15:17
I think, to a large extent, I think I need to credit my father. So from a very early stage at home, we used to have discussions on political and economic matters. So I used. What did

Murtaza Jafferjee  15:30
your father do?

Speaker 1  15:31
He was also actually in public equities. So he he was a equity broker, and yeah, so he had a very clear appreciation of how capital markets worked, and then also an interest in how government worked and how sort of public utility could be increased or maximised with private capital. So that was an area. I mean, obviously, when you're an undergrad, you can't put that whole sort of equation together. So I just had disparate interests in in finance and in government and in political science, but this was an opportunity to put those two streams together, right? So so I wanted to get into direct infrastructure financing. I mean, KPMG was more sort of advisory. I wanted to get directly into the financing side, and I made a decision that I want to go also to the greenfield side from brownfield because that's where a lot of the sort of risks need to be taken, and that's where a lot of the structuring happens at a very early stage. And it so happened that the Northern Australian Infrastructure Facility, which is one of the government-sponsored investment vehicles which invests in Australian infrastructure, was hiring for their investment team at the time. So, so I started working with them and directly got into sort of infrastructure financing, and it was that was a very different kind of place. So perhaps we, I think this is getting a little bit ahead of ourselves. But one of the ways that Australia has de-risked their infrastructure finance market. I mean, it's a country That's barely just slightly higher in population than Sri Lanka, but almost landmass is quite close to the United States, right? So it's a continent. So you don't have the economies of scale to really make infrastructure work in all parts of the country. In the the main sort of tier one cities, Sydney, Melbourne, Brisbane. Yes, it works, but in large parts of the country, and this northern the the the vehicle I worked for invested in the northern part of Australia, so it covered about 40% of the land mass, but only about 8% of the population. So you just didn't have the economies of scale to make these kind of public infrastructure projects worked. Work, so this was the government's way of sort of sharing in the risk that the private capital needed to take. So it came in the form of largely Concessional debt structures effectively, so NAEF would take a cornerstone holding in some of the large infrastructure transactions, and then structure in a way that it would incentivize commercial participation alongside us. So as a result of that, for every dollar that the government was putting in, in the form of and this was debt, it was not grant funding, you would crowd in a few dollars of public private funding as well. So that was the model that NIF operated on, and by definition, NIF was also on the very high part of the risk curve, so we would look at projects which were at the periphery of commerciality. That's how I would put it. So some of them would work, but some of them would not. And we would ultimately, after doing the due diligence, we would sort of back away if we don't feel that they can make it stack up. But our job is really to look at that sort of the the borderline of what was commercial and try to get commercial financing to to go into the journey alongside us.

Murtaza Jafferjee  19:31
So Hazanta, let's take a step back.

Speaker 1  19:34
Yeah,

Murtaza Jafferjee  19:34
can you explain what exactly is infrastructure financing and the cast of actors that are involved.

Speaker 1  19:42
Yeah. So, infrastructure transactions, by their very definition, I think the the the biggest difference with them and any sort of other conventional asset class is the contract interface that underlies any. Infrastructure transaction. Usually, as you said, for PPPs there is a project entity, and that project entity is is we're talking about greenfield projects. Usually, a single single project entity which has no operating history, right? So that's the entity that undertakes a project, and the the whole purpose of setting up that entity is to run that infrastructure asset for a period of time, and then it will be dissolved effectively at the end of it. So you have a project entity, and if you start from a financier perspective, you have obviously your conventional equity and debt financiers. For debt, you might have various tranches. So you might have your senior debt financiers and your subordinated debt after that. And sometimes in infrastructure projects, you do get hybrid financing as well. So some sort of mezzanine financing, and then you you move on to usually there is some form of a concession and a concession granter, effectively for the project, that is more similar to a PPP structure, but I'll talk about that as well because it's encountered in these type of transactions. So, a lot of the time, particularly in PPPs, you get this concession which runs on runs for say a period of 20 or 30 years, after which the asset is transferred back to the government. Then you get offtake. So usually off take itself is a government party as well, and that's why these cash flows are so considered so high quality because there's virtually sort of no risk unless you consider sovereign risk. There is virtually no risk in these cash flows, and then after the offtake, then you you usually get supplier agreements or various key supplies that go into the project. Usually, you would have a contract underlying that supply agreement, and then you usually get an operations and maintenance agreement. In certain other projects, you can get other agreements as well. But this is broadly the contract interface that we are talking about. So now, the the whole purpose of this contract contract interface is to make sure that risk sits with each of the parties who is best placed to manage that risk, right? So these are public assets. Usually, when you're talking about infrastructure, so in places like Sri Lanka, these are designed, developed, financed, and then operated by government, right? So instead of doing that, the model here is to make sure that that sort of design, build, finance, operate that entire bundle ideally happens through the private sector. So that ultimately the intention is by bundling it that way, the private sector will design something that is more commercial to operate eventually, and which will involve sort of lower maintenance capex, and that will lead to lower prices to the public. Effectively, that's the that's the underlying purpose. So, as a financier, what we are focused on is once all these risks are passed on to these various different parties, what are the residual risks that remain with the with the project entity, and there will always be some risk that remains with the project entity, and those determine the commerciality and the bankability of

Murtaza Jafferjee  23:30
the project. So, this is project financing, yeah, as opposed to balance sheet financing, yeah, where the whole viability is determined by the project's cash flows, and if you look at the liability stack, there is no one type of investors. Typically, what is the capital structure of such projects?

Speaker 1  23:58
So there is a fairly wide variance in in markets like Australia because you get you get the classic sort of core infrastructure projects, which are your sort of tour roads, ports, so the the more conventional infrastructure assets that you are looking at, and then you get these sort of sub commercial infrastructure type projects as well. So, if you are looking for looking at the the core infrastructure type of capital stack, then you are talking probably at least around 80 to 85% gearing. I've even seen 90% gearing. So predominantly debt financing, and I'm talking about this is assets once they're operational, right? This is not obviously at the greenfield end. At greenfield level, when the asset is getting developed, typically you're talking about maybe 7030 split, maximum maybe a 7525. Split between debt and equity, and the debt, as I said, can be in the form of various different tranches. So you you do get infrastructure bonds, which I which I issued for these transactions. Then you get sort of subordinated lenders who come in, and you sometimes get mezzanine lenders as well. Then, for even on the equity side, you get the classic sort of you know ordinary equity, but you can also get convertibles and hybrids as well.

Murtaza Jafferjee  25:33
So, the nature of these projects are they all economic investments, or you have social Investments also

Speaker 1  25:41
in Australia. If you typically look at classic sort of project financing, most of them are, I would say, economic assets. But it's not limited to just economic infrastructure. Particularly for PPPs, you get both economic infrastructure and social infrastructure. Now, the difference between the two is economic infrastructure is typically a user-paying model, say something like your tools, where you can very easily where there's a very discernible service, and for that service you levy a charge, right, and that is ultimately borne by the public for social infrastructure, the private sector player is rewarded for making that asset available and for providing a service. And that these assets are not sort of you know of the same economic standing as economic infrastructure, but need to be provided by the government. They can be things like schools, prisons, accommodation facilities. So basically, essentially, public goods which would have otherwise been completely provided by the government. But here, you're getting the private sector to effectively utilise their expertise and also getting them to realise some economic efficiencies by getting them to design, build it, but the the payment mechanism is different.

Murtaza Jafferjee  27:09
So, what has Australia's experience been in private partnerships, public-private partnerships? Has there been any studies about the productivity benefits of these arrangements?

Speaker 1  27:28
I think there there have been a number of studies in it. Australia, I mean, just to trace back a little bit, Australia was one of the one of the more pioneer markets where where these type of structures were first used, and that is mainly due to this investment bank called Macquarie, which really commercialised infrastructure as a as an asset class. So just

Murtaza Jafferjee  27:55
as a side, the current CEO of Macquarie is of Sri Lanka origin, right?

Speaker 1  27:59
Yeah, yes, Shamara Vikramaika. Yeah. So in Australia, also, I mean, there is a long history of successful PPPs, but at the same time, there are also, you know, cases where things haven't gone according to plan. Right. These are, as I said, contractually heavy structures where risk is passed on to to certain sort of commercial parties, or it sits with the project entity. Some risk might even sit with the government, and there are obvious scenarios where things don't go according to plan. So one of the assets we looked at at KPMG was Gold Coast Light Rail, which was a which was a light rail project that covered 18 stations in Queensland. The first two stages of that were executed on plan. They had got a the the consortium. This

Murtaza Jafferjee  28:56
was a greenfield project.

Speaker 1  28:58
It was a greenfield project initially, so three years of construction, 15 years of operation, 18 years concession overall. So first two stages commercialised, everything went according to plan. But then the stage three and four, which started during COVID, obviously ran into a lot of issues. Then there were there was a public lot of public opposition against them, and then, then there were some utilities which had to be relocated from the the pathway of the, you know, the the that the light rail would cover, and that led to huge cost blowouts. So

Murtaza Jafferjee  29:37
why did the public oppose it? I would have thought a public transport.

Speaker 1  29:41
So I mean, in all of these projects, Mother Sa, at the end of the day, there are winners and losers, right? There, there's always maybe I mean, in Australia, there is this body called Infrastructure Australia that assesses the cost and benefit of any of the infrastructure projects. Government puts money into. While we were there, actually Sydney had a light rail project, which ran into huge sort of cost blowouts and time blowouts, simply because of this reason. There were there was a lot of public outcry again in terms of you know it changes the character of Sydney. It's not required. It's it's you know cost that's not required to be incurred, all of these things, and then so many public utilities that had to be relocated, and that were previously not scoped because it was going through major highways. So, and there was a visible real fallout between the government and it got it

Murtaza Jafferjee  30:39
got built. It got

Speaker 1  30:40
built in the end. So this is the

Murtaza Jafferjee  30:42
PPP.

Speaker 1  30:42
Yeah, there was that was a PPP as well. Yeah. So, so I mean, you can have even in the most developed jurisdictions. This this is quite normal when the public sector and the private sector work together on these kind of contractually heavy complex projects. There are disagreements. You just need sort of, you know, rational approach to resolve them. And at the end of the day, the the the penalty or the the financial damage will need to be shared, right? It won't be borne by one party. So I think one of the one of the core things that I see here is that there is this view that if the private sector is building that, then all risks should be passed on to the private sector. It doesn't work like that. So you have to ensure commerciality. There is nothing called a free lunch at the end, right? So private sector also does it for a particular reward.

Murtaza Jafferjee  31:35
Incidentally, Hasanta, about the Sydney East Light rail. I heard about it in 1989 because I studied at the University of New South Wales, and I believe that that light rail goes to the University of New South Wales would have been a huge benefit to the students. And another infrastructure project that I also heard so many years ago was this Badgeries Creek Airport out in the west. I believe finally it has been built.

Speaker 1  32:07
Yeah, it's not completed. I think yet. But is

Murtaza Jafferjee  32:10
that also a PPP?

Speaker 1  32:12
No, I don't. I don't think so. Yeah, yeah. The

Murtaza Jafferjee  32:14
state government has invested. Yeah. So if we can pivot back to the cast of actors in one of these infrastructure projects. So the residual interest is equity, and you have typically one of these projects is over what period time? It's it's a concession, right?

Speaker 1  32:35
Not always a concession. Sometimes it can be. I mean, the classic model for these assets ideally is what is called DBFO: design, build, finance, and operate. Right, and you operate over a very long period of time. But I mean, even in the PPP, I think the different categories that you were talking about, transferring back to the government is only one class of PPPs. Not every asset is transferred back to the government, and not everything is based on a separate and

Murtaza Jafferjee  33:06
transfer. Yeah,

Speaker 1  33:07
yeah, yeah. Not everything is a concession either. Yeah.

Murtaza Jafferjee  33:11
So how I mean, so how does competition operate? Then is there competition for the market and competition in the market, because if they are indefinite concessions, then you know, then it becomes a private monopoly unless you have very strong regulatory control.

Speaker 1  33:30
Yeah, so yeah, regulation there is the key word. So I mean, one of the assets that I encountered when I was at KPMG was OsGrid. So it's effectively the the distribution electricity distribution monopoly for New South Wales. So they they get their revenue, they earn their revenue. So that

Murtaza Jafferjee  33:51
that's not the transmission network. No, not the distribution. This is distribution.

Speaker 1  33:55
Yeah, and

Murtaza Jafferjee  33:56
Australia has a completely unbundled electricity system. Yes, right. Yeah, yeah. So there there are energy retailers who use all this infrastructure and buy the power and then sell it at the retail level. Yes,

Speaker 1  34:08
yeah. So, so Osgrid would typically sell to energy retailers like AGL. Yeah, the other the other yeah Retailers there, and they would pay a fee back to to Osgrid, and typically these sort of user chargers, which was what it was called, made about 25 to 40% of the ultimate electricity bill from the consumers' end. Right, that asset that was originally built by the government, the state government, and in 2016, under a programme called asset recycling, effectively where the federal government incentivized the state governments to to recycle their capital that they had already invested by providing them effectively a 15% rebate. On any of the leased assets, leased or sold assets, so during that time, Osgrid was effectively privatised under a 99 year lease. So effectively, it was you can say ownership was transferred to the private sector, and it was acquired by a consortium of investors, which included IFM, which is a very large infrastructure fund there, and Australia Super. So, for that one, if you talk about that, so you have a 99-year concession, obviously. So the way that competition was created was through this price determination framework. So every five years there would be a new price determination, and that price determination was broken into effectively four large components. The first one was a regulated return, and that was calculated on the basis of a regulated asset base and the weighted average cost of capital. Then the second one was depreciation, so that was return of capital for all the capex that they had incurred. Then you have opex and then maintenance capex. Right. So those were the four pillars on which the pricing determination was was decided.

Murtaza Jafferjee  36:13
And did they have an X factor to force you to keep improving productivity?

Speaker 1  36:18
In other assets, I have seen, but in this particular one there wasn't. But usually, yes, productivity improvements are also built into the the pricing determination as well. So this

Murtaza Jafferjee  36:33
concession was for five years, and it would be retendered out.

Speaker 1  36:37
No, the pricing determination was for five years, so it was in the concession. So the concession was for it was a 99-year lease to operate the asset. The pricing pricing would effectively be reset every five years, and there would be a revenue cap. So it's not a price cap; it's a revenue cap for those five years based on what you've done in the previous five years. So basically, the way that they had created competition was by making the private sector players effectively compete against themselves every five years to improve the these metrics, so that they'd be able to earn an alpha over the

Murtaza Jafferjee  37:19
operate of the asset could change.

Speaker 1  37:22
Yeah, you can you can sell the asset in the public market. Yeah,

Murtaza Jafferjee  37:26
but if if the price was for five years, yeah, then after five years, is there a price discovery process through competition?

Speaker 1  37:36
No, not a price discovery process. It's effectively they look at what was the the metrics that were used. I mean, what was the level of gearing that they employed in the last five years? It was the

Murtaza Jafferjee  37:49
same concessioner who was renegotiating the price. Yes.

Speaker 1  37:53
Yeah. Yeah.

Murtaza Jafferjee  37:54
Now you know, I don't know whether you're aware that Advocata came out with a strong view on the recent changes to the electricity law in Sri Lanka, where we put out a position paper, and we cited some other jurisdictions where periodically there was competition for the market, as opposed to competition in the market, because typically these natural monopolies you can't have more than one operator. Yeah, and how competition operated is that these concessions were recycled periodically, so that you'd have new players who could contest. But in Australia, they have taken a slightly different trajectory. So, coming back to the revenue, so the demand risk, for example, for some reason, if the electricity demand does not pan out, it's not based on how much of electrons that were carried on the grid, but it's a capacity charge, right?

Speaker 1  39:00
Yes, yes. So, so these were basically, I mean, for Osgrid and all, it was it was quite

Murtaza Jafferjee  39:08
guaranteed revenue, irrespective of the volume that is carried on the grid.

Speaker 1  39:14
Yes. Yeah. So these are effectively. I mean, I think there is a lot of demand forecasting that happens in the background, but their their revenue is not directly linked to the amount. So then

Murtaza Jafferjee  39:27
that's calculated into a unit rate at the retail level. Yes, something like that. Yeah, right. And how has that arrangement been? Has that worked well?

Speaker 1  39:39
Yes, I mean it. It has obviously enabled the state government to to recycle some of their capital. So during 2016, when the when the federal government announced this asset recycling programme, New South Wales was one of the leaders in adopting that, and at the time. There was a lot of criticism about it as well, but they were able. So the

Murtaza Jafferjee  40:03
criticism was of what nature? I mean,

Speaker 1  40:05
that this this is indirectly privatisation in in disguise, calling it asset recycling. That these were intrinsically sort of public goods, which were

Murtaza Jafferjee  40:15
public assets. Public

Speaker 1  40:17
assets, which were which ultimately were constructed by the public sector as well, which were being sold to the private sector effectively, but they were able to recycle that capital into things like Sydney Metro, which today is operational, and I I think that that process has really sort of paid dividends. And over a period of time, I think there are studies that show that that even the level of investment that was borne by by the private sector players was more was more efficient than what what might have been if if this were purely run as a government monopoly. It's interesting that

Murtaza Jafferjee  41:00
you talk about asset recycling because in the recent concluded legislative change, the view of government was that we will open the market for new assets to private investors, but Australia took a diametrically opposite view, saying that brownfield assets, we will divest it or recycle it, and use those proceeds for new assets. So, what do you think the thinking was that the government is taking the risk for new bills, and you know the more established assets, they are hiving it out to private owners.

Speaker 1  41:46
Yeah, yeah. So I think the I mean, as an infrastructure financier, the way we typically looked at these assets was obviously if an asset was already operational, brownfield by definition, then your your financeability was much higher. You could easily go out and and obtain bank financing. You could get equity investors who wanted to buy your asset at a premium. So so financing was never a problem for a brownfield asset. The the real sort of risk premium was incurred at the stage of it being greenfield, so I think that was one of the ways that Australia thought about it. That government funds are better utilised in in greenfield financing than in brownfield because there is a established commercial market for brownfield assets. In Australia's case. Obviously, there is also the I think we haven't discussed it yet, but there is this element of superannuation funds. So Australia's superannuation sector is one of the largest in the. So we'll come

Murtaza Jafferjee  42:52
come to that. Yeah. But I was just whilst you were talking, I was thinking through at a very first principles on corporate finance. What's happening here is that you know the risk premium goes down significantly for the recycled assets, so you realise much higher value, and the government is in a better position to finance greenfield assets because it's borrowing at the risk-free rate, and it's taking the risk on its balance sheet, but it's not paying for that risk because it is internalising the risk, and you know some of those are known unknowns, and some of those are unknown unknowns, and they are the best entity to carry that risk because I think when we started this conversation, you mentioned that risks are transferred to those who are best able to

Speaker 1  43:50
bear it. Bear it.

Murtaza Jafferjee  43:52
So in this particular case, for these greenfield assets, it happens to be on the financing side. The government is best positioned to to carry that risk. Yes, because there are so many uncertainties that a private operator is not going to be in a better position to navigate that. Because a lot of it is regulatory risk, social risk, political risk. So let's now examine who funds the liability stack?

Speaker 1  44:23
Yeah.

Murtaza Jafferjee  44:24
So who are the most senior creditors typically?

Speaker 1  44:27
Usually banks or bondholders.

Murtaza Jafferjee  44:30
Right. And do the banks have the balance sheet to be able to fund these very very long? Because typically they are funded through short duration liabilities like deposits etc. Are they the natural lenders of you know 10 year 20 year debt instruments?

Speaker 1  44:49
No. So a lot of the time, what the banks do is effectively no on a lot of the brownfield assets, there is effectively very little Advocata. So, so the the term of the financing is usually capped at say five years, and you are servicing largely interest. And at the end of the five years, you go back to the market, and then you refinance the asset. That's typically how it is done. And

Murtaza Jafferjee  45:17
is this financed as a loan or is it a security?

Speaker 1  45:22
It can be both. It can be a loan and it can be a security. So I have seen bonds and you know security type structures as well. But the common one is senior bank financing. Okay. Yeah.

Murtaza Jafferjee  45:35
So that's the senior most part of the liability stack. Yeah. So who comes next?

Speaker 1  45:41
So you'd usually get a subordinated lender as well. Right. So those are typically, say, depending on the transaction, you'd get credit funds, private creditors, even some of the superannuation funds have started doing some private debt instruments. So you would, they would fit in at that level,

Murtaza Jafferjee  46:03
and they also have a duration of about five years. So these are more longer duration.

Speaker 1  46:08
Usually, I mean, I have seen durations running up to 10 years. Commonly, maybe five to seven years. Yeah, it's because it's there's very little amortisation. So effectively, you go back to the market at the end of that five to seven years. So even even

Murtaza Jafferjee  46:24
for the subordinated debt, it is of that nature. Yeah,

Speaker 1  46:27
yeah. It's is

Murtaza Jafferjee  46:29
there a convertibility feature in there?

Speaker 1  46:31
It's subordinated. Yes, a lot of the time there is some sort of convertibility feature. Yeah, that's how they get their equity kicker effectively. Yeah,

Murtaza Jafferjee  46:40
and then right at the bottom, the equity interest. Yeah. So, who typically is that?

Speaker 1  46:45
So, a lot of the time, equity interest is various sort of infrastructure funds. It can be so superannuation funds previously went through various infrastructure intermediaries, but they have started directly investing into projects now. So, so a lot of the time now, the the equity syndicate will be made up of infrastructure investors and some institutional investors like super funds. But you do get global investment houses who invest in Australian projects as well.

Murtaza Jafferjee  47:19
So during my time in Australia, was I think the early days of the superannuation system reform.

Speaker 1  47:26
Yeah,

Murtaza Jafferjee  47:28
where Paul Keating, the then finance minister, if I recollect, they had pay-as-you-go pension system, which they reckoned was not not viable because as the population ages, you know you have intergenerational wealth transfer, and they introduced the superannuation system, which I believe initially was eight or 9% contribution.

Speaker 1  47:53
So tell us a little bit about how the Australian superannuation system works. So it's a little bit different from here. So the the superannuation effectively is looked at as a component of your remuneration. So there isn't a sharing of of the burden between the employee and the employer. It's effectively a portion of your remuneration that's cut off to to be contributed to the superannuation funds, I think the government there has a target to build it up to 15% I think at this moment it's somewhere around 12 or 12 and a half percent. But because you're talking a you know relatively rich country with very high per capita incomes. So the superannuation industry by itself is now, in terms of assets under management, about 4 trillion Australian dollars, and it's forecast to grow eight to 10 to eight to 10 trillion Australian dollars by the 2040s, early 2040s. So it's a very large pool of institutional capital that's effectively, so far, been largely invested in Australia simply because of you know currency risks and global volatility and all that. So

Murtaza Jafferjee  49:14
at the individual level, it's it's a portable account, right? Yeah, you can. It's not a okay like in some countries, you have, you know, certain vocations, miners, teachers. Yeah. You know the famous Canadian pension funds. You have the Ontario teachers pension fund, etc. But Australia does not operate that way, right? Or the public sector has their own funds.

Speaker 1  49:39
Public sector has some of their own funds, but I think there are in certain public employers. I think there are restrictions on where you can take your super. But within the private sector, you can effectively take your super to to any provider. So

Murtaza Jafferjee  49:55
you have a competitive market. Yeah, like you decide who will have your. Bank account.

Speaker 1  50:00
Yeah,

Murtaza Jafferjee  50:01
you decide who your super provider is going to be, and you can switch.

Speaker 1  50:06
Yeah, you can switch.

Murtaza Jafferjee  50:07
You can switch X number of times a year. Yeah.

Speaker 1  50:09
I mean, I don't think there is a cap on how much you can switch. Okay. Effectively, you can take your. Obviously, there is every time you exit and you know enter. There are there are transaction fees. There's no usually there is no penalty or anything, but there's obviously transaction fees. So you don't want to be switching too much. But yes, people it's very common there to switch super funds from time to time.

Murtaza Jafferjee  50:35
And is it one size fit all kind of investment product or there are different options for different. No, so you

Speaker 1  50:43
you get everything from sort of fully active investing across various different asset classes, including debt, equities, alternatives, and the full stack of alternatives as well, and that's on one extreme, and then so that's a sort of so you can move across various different asset classes. You don't, you can't opt for you know the the percentage that you will put into these. So you can't

Murtaza Jafferjee  51:15
determine the asset allocation.

Speaker 1  51:16
Yeah. So so a lot of the time for for those very high, you know, the the more extensive asset class options, you can determine the asset classes. But on the other end, you can't determine the various different asset classes, and it's largely passive, but it's very low fee. So you largely invest through exchange traded funds, and predominantly in public markets, and you can't determine the the asset class split. But if you are okay to pay higher fees, then you can determine your percentage. You

Murtaza Jafferjee  51:52
can't withdraw until you reach 60.

Speaker 1  51:57
Yeah, yeah.

Murtaza Jafferjee  51:58
So unlike some jurisdictions, like in Singapore or even in Sri Lanka, you can't use your super balance to borrow for your house.

Speaker 1  52:07
No, I think that the this current Labour government they they are looking at some legislation in in that regard. But to date, yes, you you can't you can't use it.

Murtaza Jafferjee  52:20
So these long-term funds that have been accumulating, this is what has powered this whole infrastructure investing market, right? Yes, yeah. It is these funds, and these funds are investing in traded instruments in infrastructure space, or they are directly investing in projects, or they are investing into managers who are then reinvesting. How is it done?

Speaker 1  52:47
So they predominantly used to invest through managers, and a lot of these investments are not listed. So there were some like Sydney Airport which were listed, but a lot of the infrastructure space, even the core infrastructure projects, are not listed, so these are relatively, I think, by and large, unlisted investments. But they invested through intermediaries, which were effectively these infrastructure funds who had particular strategies for approaching the infrastructure market. But now the larger funds have got so large that they have in-house teams which sort of look at these assets and study them, and they they model them out. So they invest. If you look at very large superannuation funds like Australia Super, not only they do they invest in Australia, they invest globally in infrastructure assets as well. So this has, as you said, it's quite correct. This is the the sort of secret sauce that has really underpinned the the development of the Australian infrastructure market. Because if you look at the kind of returns that you know normal employee would want from the time they are in their early 20s till 60, you're talking about long duration inflation-indexed steady returns with very low risk, right? That's exactly the kind of profile that infrastructure provides. So there was a very good match between the requirement versus the the type of return that this asset provides.

Murtaza Jafferjee  54:17
So in the early 1990s, prior to your time, there was this reform process in Australia to hive off some of these assets into private owners, and the supply of funds came through the superannuation system, and this ecosystem was the genesis of Macquarie, who became the stellar player globally, the so-called Macquarie model?

Speaker 1  54:46
Yeah.

Murtaza Jafferjee  54:46
What exactly is the Macquarie model?

Speaker 1  54:49
So I think Macquarie were the first ones to look at infrastructure as a commercial asset class. So they powered the the commercialization. Of this asset class, and effectively married the the requirements of you know investors like pension houses, insurers, sophisticated institutional investors who wanted these type of annuity style investment vehicles. They married the need with the with the you know requirement of governments to raise financing because of the financing gap that they encountered in developing infrastructure. So

Murtaza Jafferjee  55:27
they did a lot of financial engineering,

Speaker 1  55:30
yes,

Murtaza Jafferjee  55:30
tranching and creating different instruments. Yeah,

Speaker 1  55:33
and funds, listed funds, unlisted funds. So yeah, a lot of that engineering was done by them, and then they also were some of the pioneers in in developing the PPP models in Australia, which were ultimately the know-how was exported to other jurisdictions like U.S. and Europe as well.

Murtaza Jafferjee  55:54
So, before you returned back to Sri Lanka, you were working in this infrastructure fund that was investing in the Northern Territory,

Speaker 1  56:04
not Northern Territory, Northern part of Australia. Yeah.

Murtaza Jafferjee  56:07
So Northern part of Australia is what Northern Queensland, Northern Territories, and Northern Western Australia. Northern

Speaker 1  56:13
part of yeah, yeah. Northern part of Western Australia. So if you were to draw a line across the sort of upper 40% of Australia that that's what constitutes Northern Australia. Okay,

Murtaza Jafferjee  56:23
and do you want to speak about one or two transactions you did in that fund?

Speaker 1  56:31
Yeah, so there, as I was saying, we were exclusively looking at greenfield infrastructure financing, so and very high risk transactions as well. So I think one of the more interesting ones that I looked at initially was this transmission line from northern part of Queensland up until Townsville, which was where the Australian national electricity market ended. That was the northernmost point of the national electricity market. So this was effectively extending that that point from there north by 1100 kilometres. So that was the length of the transmission line. So this was an area where there was a lot of rich minerals, according to studies that were undertaken, but they were just not commercial simply because

Murtaza Jafferjee  57:24
of the whereabouts exactly. See Northern Queensland.

Speaker 1  57:26
Yeah, this is this is a this is a part called Mount Isa. Yes, I have been there. Yeah, where it's a very remote mining area where there's a number of mining projects at the moment, but there isn't anything much more. So it

Murtaza Jafferjee  57:41
was not connected to the grid.

Speaker 1  57:43
No, yeah, it was not connected

Murtaza Jafferjee  57:45
to national grid. No,

Speaker 1  57:46
I mean to date it's not. It's it's just local transmission through through coal and some other sort of few generation players who are sort of active there. But electricity there is at a huge premium. If you look at the national electricity market, it's can be anything up to 40% higher than the national electricity market. So the idea was that through this transmission line, you'd commercialise a lot of these mining projects, which would then add to the you know the the tax revenues of the government and then increase the overall size of the pie. The other part of it was that there were a lot of Class A renewable energy projects in these remote areas, which could then be powered up and connected to the grid through the transmission line as well. On the other hand, there there was this issue of marginal loss factors, given that it was such a long distance to extend a copper line, so that was what we were contending with. One of the key issues there was that that project required was underpinned effectively by a few institutional players who who contributed a majority of the revenue for that project, and if any one of them were to leave, then that would be a major risk for that project because you don't get a lot of sort of population in that area. The idea was that by extending the the line, you'd be able to bring in population there, but they were not already there. And the second issue was that they that project also required a lot of concessional debt, both in terms of quantum and in terms of rate. So eventually, the Queensland government acquired that project because they felt that rather than provide a extremely generous PPA and underwrite some of those risks. They are in a better position to construct this transmission line and provide the this requirement rather than the private sector. So that was ultimately acquired by the Queensland government. I think the other major project that that I found quite interesting was. This railroads processing facility. So, I mean, with these Trump tariffs, rails are in the news again. So, rails are an essential part of the electric vehicle supply chain, and 80% of that market is currently controlled by China. So, so the Western world obviously saw this as quite a bit of a risk, and they wanted to try to find an ex-China supply chain. So Australia was stepping into that void. So this rails facility would do right up until the oxides, so until a fairly advanced stage of processing. But the risks underlying the project were that rails themselves are not a they are not a commodity they are not a traded facility. There is no sort of visible public market for it, so it's very much opaque. And the Chinese government actually sort of makes sure that price is controlled to some level. So that was one of the major issues. The second part of it was that it was very difficult to get offtakes for this project. So getting off takes, they they were able to overcome through going directly to automotive suppliers, and finally through a mix of government lenders, export financiers, and commercial banks, it looks like the project is the the debt part of the project was funded. So it's currently in the process of financing the equity side of it. So these are, as I said, very difficult projects to get off the ground, but potentially transformative projects for the various regions we were working in.

Murtaza Jafferjee  1:01:45
So, what happened to the project?

Speaker 1  1:01:48
So, it's it's still in the process of being the the equity side of the equation being funded. So, it's going through that. It's in a relatively advanced stage, from what I heard last.

Murtaza Jafferjee  1:01:59
So, Australia is known as the wonder from down under.

Speaker 1  1:02:03
Yeah,

Murtaza Jafferjee  1:02:03
I believe from what you said, from 1993 to 2020, didn't have a research at 27 years, and then you decide to come back to Sri Lanka. So what transpired?

Speaker 1  1:02:16
Well, we had some. I mean, obviously there was a. These decisions are never just, you know, just based on logic, right? So there was a, I would say it was both a head and heart decision. So we wanted to raise our kids here, so that was one of the primary motivators. From a professional perspective, I do feel that Sri Lanka and broadly South Asia. If you look at it from a global capital allocator's perspective, I think this is one of the most imminently exciting regions of the world for capital allocation. You have a 1.9 billion population, effectively made up of India, Pakistan, Bangladesh, Sri Lanka, a rising middle class and an area that's urbanising at a rate, right? So, so infrastructure is very much needed here, and I think according to World Bank estimates, there is a gap of about 200 to 300 billion U.S. dollars annually to finance the infrastructure in this region in South Asia. So, at the same time, there is a wall of private capital-you know, pension funds, insurers, institutional investors-who find that valuations in in jurisdictions like Australia, U.S. Europe, and even East Asia are very stretched, and who are looking for new places to find to originate these type of assets and to allocate capital, for them the issue is you know finding projects that are bankable and that that have a appropriate structure for them to invest into, and also to find people who they can work with who effectively act as a bridge between the world that they are conversant with, which is Australia or developed jurisdictions, and then the you know on the ground due diligence in terms of what's going on with these projects and what are the risks that they are facing. So I thought that I could play a role there in helping bring some of this capital into Sri Lanka specifically, and more broadly South Asia as well. So that's what I'm working on currently.

Murtaza Jafferjee  1:04:29
And now you're back here.

Speaker 1  1:04:31
Yeah,

Murtaza Jafferjee  1:04:33
we are at the moment enjoying a spot in the sun. We have achieved macroeconomic stability, but the question is growth, because for the past seven eight years, investment has come down significantly. The government's ability to invest in capital is constrained. Although they budget something like 4% of GDP, they only end up. Investing two and a half percent, not necessarily because they don't have the funds, but even the capacity to do that, and you are bringing a lot of expertise in how it can be done. But ideologically, the government does not seem to have the same thinking, because there is a perception in this country that you know in Singala what they say, jatika sampat, national assets, national treasures, but Australia basically has taken a very different view. I mean, nobody is taking these assets and going anywhere, are they? They're very much in the country, and the benefit finally has actually flowed to the people of Australia, right? Not in terms in terms of both as consumers, the consumer surplus, but also the investment returns are really flowing back to the people, right?

Speaker 1  1:05:55
This this is yeah. I mean, as you said, like if you take Australia of the early 90s to Australia of the 2020s, it's it's a vastly different country, right? So I think in those 30 years that transpired, the their ability to finance these infrastructure markets and deliver this public utility is one of the key things that has led to the quality of life that you see in Australia and why it attracts so many Sri Lankans and nationals of all various nationalities across the world to to that place. So yes, I would say the benefits have directly accrued to the people there.

Murtaza Jafferjee  1:06:35
Now, one one problem Sri Lanka has is the perception about the private sector and the market system is pretty bad because we have had crony capitalism. And what invariably happens is when you bring market mechanisms to work in these kind of assets, you need to have very strong regulatory setup, and there are three elements that a good regulator has: that it should have legitimacy; that they they will not be captured by the players in the market; they should be credible; that they will do what they say they are going to do, and they have to be predictable. That over a period of time that they stick to what they say or the philosophy of the regulation. So, any comments about the quality of regulation in Australia, and also about dispute resolution because you need a robust commercial dispute resolution mechanism because invariably you will get into problems. Now even if we are able to convince the powers that be in Sri Lanka to try some of this, this essential soft power is necessary. Basically, you want to reflect on your experience about regulation and arbitration and commercial dispute resolution in Australia. Yeah.

Speaker 1  1:08:09
So I think stepping back a little bit, we spoke about the Macquarie model, and Macquarie has been extensively criticised for some of the practices that they adopted at a very early stage of the 1990s, overleveraging some of these assets, then you know effectively flipping the assets from one fund to another, then having exorbitantly high pricing structure. So the reality of it is that even in the developed jurisdictions, the the moment you you open up these markets, and where there's a failure of regulation, or where regulators don't evolve as fast as the market, there can be abuse and undue practices. Right. So I think that that we always need to guard against, and there always needs to be very strong regulators who who have public utility at heart, but also understand the principles of how sort of commercial entities operate. In Sri Lanka, I think there is a there is this there is this view that government ownership is always the best outcome to deliver utility to the public. I disagree with that view. I think robust regulation, if it's operated well, works far better than government ownership. Simply because government is capital constrained, the opportunity cost of government doing this completely by themselves is that a vast majority of these assets would never get built if it were just government who were financing them, and it would have been the reality in Australia as well if it were only government who were commissioning and building these assets. Right? It is the ability to get private capital in. That has enabled this, you know, the broad pipeline of infrastructure assets to be commercialised within these last 30 years. So that that is essentially the, you know, the trade-off that you are facing. Are you okay to let go of some government ownership in return for a much faster rollout of infrastructure requirements, which would then underpin your economic progress, or are you going to be stuck in, you know, this? I think this, this fear mongering. Yeah.


Transcribed by https://otter.ai