Structured finance is a specialized financial approach mainly suited for large corporations with specific financial needs that traditional loans cannot address. It involves complex and sometimes risky transactions and is often used to fund significant infrastructure projects. These financial instruments help manage risks, attract investors, and allocate resources efficiently, typically requiring substantial capital from investors. Unlike standard loans, structured financial products are non-transferable.
Securitization is at the core of structured finance, allowing the creation of tailored asset pools and intricate instruments, such as collateralized debt obligations (CDOs), collateralized bond obligations (CBOs), collateralized mortgage obligations (CMOs), and hybrid securities. These instruments are frequently utilized to meet the unique needs of corporations and specialized investors.
Key Purposes of Structured Finance
- Risk Mitigation: Bundling assets spreads risk across multiple investors, mitigating the impact of defaults or market fluctuations
- Tailored Financial Solutions: Structured finance permits the creation of customized cash flow structures, risk profiles, and payment priorities, enabling borrowers to secure financing tailored to their specific needs while aligning with investors’ risk and return expectations
- Optimizing Cash Flows: Structured finance can repackage and restructure cash flows from underlying assets to align with different investment strategies and preferences, optimizing cash flows for various investor or issuer requirements
- Enhanced Funding Access: Structured finance and securitization encompass diverse assets like mortgages, auto loans, and corporate debt, facilitating broader access to funding for various industries
Common Use Cases of Structured Finance
- Project Finance: Typically applied to long-term infrastructure and industrial projects, often involving government participation
- Export Credit Agency (ECA) Finance: ECAs act as intermediaries between governments and exporters, offering credit insurance and financial guarantees to promote domestic company exports
- Structured Trade Finance: Specialized financing based on commodity trade flows structured around the supply chain, often used for high-value or large-quantity commodity trading
- Real Estate Finance: Uses income and property values as collateral to secure loans for property purchase through special-purpose companies, aiding property owners in optimizing balance sheets and facilitating real estate investment trusts (REITs)
Structured Finance for African Infrastructure Projects
Africa’s robust economic growth demands creative financing solutions, with structured finance taking on an increasingly vital role across the continent in areas such as project, acquisition, asset, and investment financing. Africa requires approximately $93 billion each year for its infrastructure, equivalent to 15% of the continent’s GDP. However, only $45 billion is currently invested in infrastructure annually, with over 50% of this funding coming from the public sector.
In 2020, total infrastructure commitments decreased from $85 billion in 2019 to $81 billion. This decline was influenced by some organizations redirecting their focus from infrastructure to addressing COVID-19’s impact, mainly in health and macroeconomics. The IMF played a crucial role by providing $25.5 billion in emergency assistance to 39 African countries in 2020. Without this aid, infrastructure investments might have experienced a more significant decrease.
Currently, the private sector’s involvement in structured financing and executing infrastructure projects in Africa is notably lower compared to other regions, mainly due to the decline in commodity prices. Approximately 95% of infrastructure initiatives are undertaken by public entities like national governments and state-owned enterprises. When viewed on a global scale, Africa receives only 2% of foreign direct investment, and the majority of these investments are directed towards natural resources and extractive industries rather than essential sectors like healthcare, transportation, or water.
Infrastructure projects typically involve substantial initial expenses with returns realized over extended durations, posing challenges for private investors in terms of evaluation. Additionally, private sector expansion relies on existing networks and value chains, which may be absent in emerging markets like Africa. In cases of pronounced difficulties, governments might need to offer additional incentives to render infrastructure projects appealing to private investors.
Structured finance plays a critical role in meeting the unique financial needs of large corporations and infrastructure projects, particularly in regions like Africa where there is a substantial demand for creative financing solutions. However, in Africa, private sector involvement in structured financing for infrastructure projects remains relatively low compared to other regions, primarily due to challenges related to risk assessment, returns on investment, and the absence of established value chains. To bridge this gap and promote private sector participation, governments may need to offer incentives and create a conducive environment for private investors. As Africa continues to experience robust economic growth, the potential for structured finance to drive essential infrastructure development on the continent remains significant.