ADI: Regulatory Framework Must Adapt To Changing Circumstances

Dr. Bongo Adi is a senior lecturer at the Lagos Business School, where he leads infrastructure analytics and megacity competitiveness project. In this interview with DAVID OGAH, he harps on the imperative of investing pension fund on the nation’s infrastructure, saying it is a mismatch for Pension Fund Administrators to invest the fund in government bonds.
How do you think government can borrow from pension fund to fund social infrastructure?
ONE way that governments traditionally borrow or ‘raise’ money is by issuing bonds. Such government bonds are among the safest instruments, and therefore, attract the risk-averse investors, who are interested in earning a fair and predictable return on their investment.

Basically, this has been the practice with the nation’s pension fund administrators, who cautiously avoid risk and mainly patronise government bonds. So, we can say that government has been borrowing from pension funds as a standard practice. Perhaps, we should be asking more critical questions regarding the role of pension funds in infrastructure provision in a cash-strapped economy. Rather than taking the easy way out by lending to government in the form of investing in bonds, pension funds should be more creative and innovative in diversifying their portfolio. Infrastructure offers such opportunity.

Should pension fund finance infrastructure?
As someone recently put it, pension fund administration in Nigeria appears to be no more than “putting your money under the pillow.” It seems too that pension fund administrators have little else to do with the funds under their management, other than ensuring that they don’t lose them. Granted that the regulation on investment of pension fund assets does not give much room for innovation and discretionary investing on the part of the administrators, it still seems they do even less than required, just to be on the safer side or maybe for lack of better ideas regarding how the funds could be better optimised. This inertia, however, is not peculiar to Nigeria’s PFAs.

Pension funds globally have displayed a general lack of appetite for risk, as they tend to invest largely in core assets — government bonds, money market instruments with short-term maturities and large-cap equity. Their exposure in alternative assets like real estate, private equity and hedge funds have been very limited. Infrastructure on the other hand, represents just about a percent of their total managed assets. However, as governments all over the world, prompted by the 2008 – 2012 recession, are now forced to walk away from cost intensive, long-term financial commitments such as required by large infrastructure projects, some pension funds are beginning to experiment with longer tenured investments in infrastructure.

One could say that the infrastructure asset class perfectly matches the long term maturities of the liabilities assumed by Pension Funds. In Nigeria, for example, we have a demographic distribution having a significant number of pension fund contributors below 40 years and given the demographic structure we currently have, this number is expected to more than double in the future.

Under 40 means that there is at least a 25-year maturity for the liabilities of Pension Funds. It is, therefore, a clear mis-match when pension funds are invested in short term securities when their obligations or liabilities are very long term.

Infrastructure presents a veritable asset class for pension funds, yielding combined benefits of cash-flow matching with their long-term liabilities, protection against inflation and statistical diversification given that there is low correlation between this asset class and traditional assets such as equity and fixed income securities. In fact, this is the new development in pension economics pioneered by Canadian and European experts and the World Pensions Council (WPC).

Do you think that the funds should risk depositors’ money in funding infrastructure?
This is the standard line you get to hear from Pension Fund managers and regulators. The fact is that the risk imposed by having 5.5 trillion naira funds lying idle in a capital-poor economy like ours is far greater than the risk of investing in infrastructure. By the way, infrastructure investments are not all risky.

One of the core objectives of using project financing techniques in infrastructure projects is to de-risk projects to an appreciable level.Different infrastructure projects have different risk profiles and investors usually assess their capacity to shoulder different kinds of risks before embarking on any project. New developments in project finance are also been deployed by investors to mitigate various risks in projects. If risks were a major hindrance, we probably wouldn’t have seen South African Pension Funds investing in several Nigerian projects to the tune of almost a billion dollars over the past few years.

Are there sufficient bankable projects in Nigeria to attract pension funds?
Some people have the opinion that infrastructure is risky. As I argued above, this is argument is totally without merit if not completely flawed. We are witnessing a gradual upscaling of investment diversification by some PFAs owing chiefly to changing attitudes towards risks and a bit more proactive opportunity exploration.

There is clearly greater refinement in the process, the diversity of assets, the competence of the personnel and the risk appetite. There has been the emergence of real estate investments from Pension Funds, and a naira-denominated private equity funds raised from PFAs.

These are nonetheless, excellent initiatives in the direction we are proposing but however, the efforts really need to be intensified. Bankable projects don’t come ready made. If we need a pipeline of bankable projects, then someone should be interested in early-stage project development. This is what is critically missing in the Nigerian infrastructure market. Infrastructure Concession and Regulatory Commission is supposed to play some role in project origination and development, but we haven’t really felt their impact in the market.

The problem of lack of bankable projects manifests not only in the pension funds, but even among banks who often claim they can’t find enough firms that meet their lending criteria. So, the solution to not having sufficient bankable projects is simply to invest in project origination. Some have suggested that Pension Funds allocate about five per cent of their funds to origination. They should also incentivise product innovation as well as invest in infrastructure developers. In other words, the attitude needs to change to accommodate enlarged risk tolerance. Investing in people and institutions that originate and de-risk projects at an early stage should ensure that there is a pipeline of investable assets to generate the expected returns to make the pension reforms worth the while.

Do you think the regulatory framework supports the type of experimentation you have advocated here for pension funds?
Clearly, the regulatory framework must adapt to changing circumstances if our pension funds are not to be anything more than a piggy bank. Not just in Nigeria, all over Africa, institutional investors face specific barriers to long-term investment, such as the lack of appropriate financial vehicles, as well as, a dearth of data on this sector and related opportunities in low income countries.  This situation is particularly stark in Africa, where equity market capitalisation is low, and stock markets – which exist in only a third of Sub-Saharan African countries – are often shallow and illiquid.

I think rather than stick with rigid policies, we should adopt the approach of problem-driven iterative adaptation to ensure that policies respond to contexts and felt needs. In the case of pension funds, it is important to evolve policies to drive a more proactive, innovative and creative pension fund that adds value to the economy.

There is nothing new here as well. The G20/OECD High-Level Principles on Long Term Investment Financing by Institutional Investors set out policy recommendation aiming to mobilise institutional investors assets for long-term investment without diluting prudential safeguards.

Since the Pension Funds reforms championed by Fola Adeola we seem to have emerged from an era of theft to one where we are now seeing the largest pool of investable capital this country has ever seen.

Beside pension funds, which other sources do you recommend to fund infrastructure?
Institutional investors like pension funds mainly serve as suppliers of investible funds in infrastructure projects. However, given the situation we are in at moment, we propose an expanded portfolio of activities to include origination and financial innovation. The ideal scenario to bring in institutional investors in infrastructure funding is PPP.

Although, PPPs come at a higher cost over time, the theory suggests that it presents a way out for government facing severe budgetary constraints. We have heard so much talk about PPPs over the past decade, however not much has happened. I think that the present situation calls for a more concerted effort towards using PPPs to address our large infrastructure deficit.