If you want a microcosm of the bad habits global capital got into as the credit crunch hit, go to Brisbane. The story of Brisconnections there has everything you need, and its conclusion – unresolved at the time of writing – will have major ramifications for the way infrastructure is funded in Australia and beyond.

BrisConnections was set up by Macquarie Capital Group and the construction firms Thiess and John Holland to design, build, operate and finance a A$4.9 billion airport toll road in Brisbane, under a 45-year concession awarded by the state of Queensland in May 2008. BrisConnections floated two months later at A$1 a share, lost 60% of its value in a day and by November had hit one tenth of an Australian cent, the lowest possible price on the Australian Securities Exchange. The A$1.2 billion float, underwritten by Macquarie and Deutsche, used an instalment model in which investors paid A$1 up front, with two more payments to come in subsequent years, meaning they remain on the hook for two instalments which will each cost 1,000 times more than the trading value of the stock today.

How did it get to this? There are many components to the BrisConnection story and they all speak to the way infrastructure has become commonly funded in western markets.

The wrong assets for listed markets. When infrastructure first started to make its way to stock market investors, it was typically when a government sold an operational power plant or road: a tangible asset, throwing off consistent cash, and something you could go and see if you felt so inclined. BrisConnections was typical of a trend to list projects that were not yet built. “Listed markets are a natural home for assets when they’re more mature and yielding,” says Lachlan Douglas, director of Principle Advisory Services, which structures private market investments for institutional investors. “They don’t tend to go a good job of being a home for assets going through significant transformation, and there’s no greater transformation than when the thing’s being built.”

Worse, retail investors who in Australia had come to see infrastructure as a safe haven failed to note the difference and thought they were buying a cautious yield play. Nor did they ask where dividends could be coming from when there was no asset yet to generate them: the answer was from borrowings. These things get away in the good times but as BrisConnections was launched at a time of quickly changing attitudes to debt, institutional investors (including Macquarie itself) quickly jumped ship, triggering the share price falls and putting most of the stock into retail hands.

Financial engineering. The source of the dividend was only one example of common financial engineering structures that have since backfired. The most obvious was the instalment method.

People buying into the float knew clearly that there would be three separate payments of A$1 each, a year apart, and while the method is unusual it is certainly not unheard of. The problem was that some small investors in the secondary market don’t appear to have realised this and inherited huge obligations when they bought in. One investor spent A$600 on the stock at 0.3 cents per share without realising that doing so committed him to A$400,000 of subsequent instalment payments. Others are up for millions. So it was that a housewife called Fang He found herself becoming the biggest individual shareholder in the company by mistake, followed more recently by a 26-year old Melbourne entrepreneur called Nick Bolton, a lank-haired bohemian figure in designer stubble and a beanie. (The sting in the tale was that Bolton used his shares to launch a series of motions to wind up the company in order to get out of paying the later instalments – then at the last moment sold his voting rights to the contracted builder, Leighton, for A$4.5 million and voted all his shares against the very resolutions he had proposed.)

At the time of writing it was still not clear if Macquarie and Deutsche were going to pursue small investors for the later instalments, suffering the crushing PR of putting people out of their homes by doing so, or wear the costs of the shortfall on the two scheduled A$390 million raisings themselves by taking the vehicle private.

October is going to be a big month for Papua New Guinea. It doesn’t sound much on paper: it’s the deadline for the final investment decision on a liquefied natural gas and pipeline project. But it’s a project that will change the country dramatically – economically and socially. In fact, it’s hard to think of another example anywhere in the world where so much, good and bad, might depend on a single investment decision.

The project in question is known as PNG LNG, and it is an attempt to commercialise undeveloped petroleum and gas resources in the highlands and western provinces of Papua New Guinea. The gas has to go through a 470 kilometre pipeline across rugged terrain to a liquefied natural gas facility 20 kilometres outside Port Moresby, the capital, for liquefaction; once there, about 6.3 million tonnes of LNG product a year will be loaded into tankers to be shipped to offshore gas markets worldwide. ExxonMobil, with its Esso Highlands subsidiary as operator, is the driver of the project with a 41.5% interest; also in there are Australia’s Oil Search (34%) and Santos (17.7%) and Japan’s Nippon Oil (5.4%) among others, with the PNG state expected to join as an equity participant at a later date.

The numbers attached to this project are extraordinary in any context, but particularly so in an economically small country where 85% of the population exists on subsistence agriculture. The development costs are put at between $11 billion and $14 billion, figures confirmed to Euromoney by the Investment Promotion Agency (IPA); once completed in 2013 or early 2014, it is expected to double Papua New Guinea’s approximately $12 billion GDP.

The consortium signed a gas agreement with the Papua New Guinea government in May and has since moved to what is known as the front end engineering and development (FEED) part of the project – a sufficiently big step that many seem to think the project’s development is now a foregone conclusion. “They are spending $400 million on FEED, so it would be silly to spend that kind of money and not have the project go ahead,” says Ivan Pomaleu, who heads the IPA. One foreign banker says he senses “100% certainty among local people that it’s going to happen.” But in truth it won’t be until October that the deal is confirmed. “That’s basically the point where we say yes, no or defer,” says Pomaleu. “That’s the moment when we can say: yep, we have a project; no, we don’t have a project; or we will have a project but not immediately. It’s a big project and we want to be sure.”

So big that those involved tend to use great understatement in describing it. “The scale [financially] will depend on commodity prices but if it doubles our current GDP, that’s quite big,” says Simon Tosali, secretary for the department of treasury. “It will be the biggest project this country has ever undertaken in its 34 years of independence. So it’s going to be quite big.”

The knock-on effects will be varied, and not entirely to the good. An increase in wealth on this scale obviously has enormous potential for budget revenues and the ability to fund badly needed spending on schools, hospitals and roads, among other things. There’s also the demonstration effect to consider: if a project like this is shown to be not only possible but practical then a host of other possibilities come to the surface in this remarkably resource-rich country. But there are real questions about Papua New Guinea’s ability to cope with this sudden influx of money and development. “There is already a strain on all infrastructure: telecoms, security, power, skilled labour,” says one banker. “There are lots of business opportunities but the capability of the local market to provide that support is already sorely tested.” Foreign banks – there are three of note, the Australians Westpac and ANZ and the Malaysian Maybank (Malaysia is the most active foreign nation in Papua New Guinea, particularly in areas like forestry and palm oil) – should stand to do remarkably well out of the development of Papua New Guinea, using their own global or regional networks to help serve the multinational companies who are coming in. But it’s the on the ground presence, from the 7500 construction workers required for PNG LNG, to the hotels and schools they will need and the roads they will drive on and the power for their businesses, to the local accountancy and legal professions, that are really going to be under stress.

This time last year, Phil Green had plenty to smile about. The chief executive of Babcock & Brown, Australia’s newest and fastest-growing investment bank, was preparing to announce a 53% increase in interim group net profit year on year, with 44% growth in earnings per share. B&B’s landmark bid for the Alinta energy group, in partnership with Singapore Power, was on its way to completion; the share price was flying high at almost $35.

What a difference a year makes. On June 13 this year, the share price hit a low of $4.70 – a more than 80% drop since last July. Investors have fled over concerns about the bank’s debt load, and when their flight breached a threshold in market capitalisation, a covenant was triggered allowing a consortium of lending banks to review a $2.8 billion debt facility (which, in turn, set off further share price falls). Since then, the bank has suspended distributions in some of its listed infrastructure funds, spurring further alarm. These days Green is spending much of his time trying to reassure the market that the whole thing isn’t going to keel over.

Quite a shift for the bank that was welcomed to the Australian Securities Exchange with such fanfare in 2004. B&B seemed a curious arrival then: far from a start-up, it had been founded in San Francisco in 1977. But the banks’ management had spotted in Australia a local investor base hungry for a competitor to local incumbent Macquarie Bank, and carefully followed the Macquarie model: buy lots of assets, put them in funds, list those funds, and get a steady flow of fees from them to the parent.

It has certainly been busy: the bank says its pipeline of assets in greenfield development include 16,000MW of wind assets, 1400MW of solar, 3360MW of gas-fired power assets, and a host of PPP projects from Europe to North American and Australia. But along the way, it seems to have borrowed a bit too much for the market’s liking. At a group level its total gearing was 53% in December, the last publicly stated figure.

The troublesome A$2.8 billion loan (B&B calls it an “evergreen facility”) had been extended to 2011 only in April, but the problem was a caveat that if the company’s market cap dropped below A$2.5 billion, the banks could review their loan and potentially call it in earlier. The precise meaning of this caveat has been open to some dispute, with B&B itself seeking to clarify it in an announcement to the ASX on June 16. “The market capitalisation clause in its corporate debt facility does not constitute a default or breach of covenant,” it said. It “provides for the facility banks to have the right to call for a review of their position under the facility rather than any specified action.” Peter Hofbauer, global head of infrastructure at Babcock & Brown, tells Euromoney: “the banks haven’t as yet indicated whether they will or won’t take a review” but that “the discussions we’ve had have been very constructive.” Many in Sydney believe that hedge funds, aware of the threshold, helped to breach it by aggressive short selling.

Whether or not the banks’ do opt for review, B&B has set about putting some of its assets up for sale – Green calls this “asset recycling” – in order to de-leverage the balance sheet. First on the block is a portfolio of European wind energy assets, which the bank says are likely to be sold in the third quarter of this year. These assets, believed to be worth about A$2.5 billion, are owned by B&B and one of its listed satellites, Babcock & Brown Wind Partners. Deutsche and JP Morgan are advising on a sale.

Asked whether such a sale would fix the debt problem, Hofbauer is quick to retort: “I don’t think we have a problem. Our underlying business is no different. The only thing is our share price has moved. We continue to have an extremely good franchise. There’s no problem to solve.”

As if to illustrate the point, Babcock & Brown has been continuing its acquisition strategy as if nothing has happened. Remarkably, straight after the share price crash, it closed a deal to buy Angel Trains, the British train leasing business, from Royal Bank of Scotland for $3.6 billion. Babcock & Brown was also the arranger to the transaction and its long term financing – which comes to another $2.8 billion (although it is a separate entity, Babcock & Brown European Infrastructure Fund, leading the consortium, which also includes Deutsche Bank and AMP Capital Investors).

Be that as it may, the group does expect gearing to come down. Hofbauer says the bank uses its own balance sheet for three purposes: to co-invest in funds, for development of assets, and to aggregate assets for the introduction of third party capital. The business is shifting more towards the first two and is putting less cash in the third, so “our leverage will progressively reduce over time,” he says. He adds that gearing ought to be seen in a different light for infrastructure. “Our infrastructure funds are involved in activities that generally have high barriers to entry. They have very stable cash flows, are largely immune to economic cycles, and are involved in the provision of essential services. That needs to be taken into account when you look at the capital structure of those businesses.”

Most expect Babcock & Brown to survive this blip, although possibly not as an independent entity – a A$600 million fund-raising by Macquarie in June, coming when it already had A$3.6 billion in surplus capital in the parent stock alone, has been rumoured to be for a tilt at its rival bank. Nevertheless, the model is under increasing scrutiny in a tight credit market with falling asset values. Macquarie, which pioneered the approach, has by and large come out of it unscathed so far (notwithstanding a near halving of its share price in the last year) but its satellite funds have been under stress. It will privatise one of its listed vehicles, Macquarie Capital Alliance Group; this may prove to be a common approach and B&B has appointed advisors to look at the group’s own Australian-listed funds.

Still, Hofbauer does not think the model is the problem. “The financial world is based on managers managing third party capital,” he says. “I don’t believe there’s any material difference between our business, and the cornerstone of third party capital in the financial markets globally.”

In one corner: Asia’s vast savings pools. In the other: Asia’s equally vast infrastructure spending needs. Getting these two to meet in the middle is of vital importance to Asia’s future, and has become a keystone of Asian Development Bank policy.

Rajat Nag, managing director of the ADB, estimates the demand for infrastructure in Asia is around US$300 billion a year, and growing – and that doesn’t include investment in agricultural infrastructure. “Official assistance can provide just a tiny fraction of that,” says Nag. The ADB lent just over US$10 billion last year, roughly half of it for infrastructure; governments can provide a similarly small chunk. “So most of that $300 billion has to come from the private sector, and from public-private partnerships.”

There’s no shortage of money. Around 34% of GDP is saved in the Asian region. But mobilising that capital, and getting the private sector involved, has been impeded by two things in particular. One concerns dispute resolution mechanisms. “Even if you have the right legal framework, we find the private sector is very keen to know what is the dispute resolution mechanism, what will be the procedures for arbitration, where will the courts be where these things are settled.” This relates to a broader query about the governance structure for infrastructure investments – “who will be our counterparty? Will we be working the ministry of public works or will there be a project authority set up for this particular project?”

The second impediment is perhaps more surprising: lack of projects. It’s not that there’s a shortage of infrastructure that needs to be built. But there’s a big difference between identifying that, say, Bangladesh needs more power, and coming up with a carefully considered project in which to invite private sector involvement.

“I must confess we had not thought this was much of an issue, but it is increasingly becoming one,” says Nag. “Many times private sector sponsors will come in and say: we are willing to work with the ADB and the government, but where are the bankable projects? That means you’ve got to have projects that are prepared technically, socially and environmentally, so that you are not talking just in abstract terms about ‘coming in to infrastructure’.”

How to move that forward? “We now recognise that somebody has to invest money up front,” Nag says. “We would be willing to do that with the governments, and we are starting to do it, by creating what we call the project preparation facility. We go into countries and say: let’s look at this particular water project, and let’s spend $25 million up front – at our risk – so when the private sector comes in we can say: here are the details.”

The ADB’s long term strategic vision aims to put 50% of bank lending into private sector development (both in terms of creating an environment for the private sector and putting money into private sector projects directly) by 2020.

Getting there is going to have to involve greater development of domestic debt capital markets in Asia. “One reason we have not been able to get investment in infrastructure to the extent that we should is the lack of a suitable financial architecture in Asia,” Nag says. “We’ve got huge savings but we don’t have the mechanisms to mobilise those savings, excepting the banks,” which by necessity are short term funding options. “One of our priorities is to get a regional financial capital market.” The ADB backs this as an issuer in its own right; “I think that is of equal importance to having the right legal framework and dispute resolution.”

But how does it work in practice? Take the technical assistance recently offered to the Indian state of Bihar, granted approval on April 4. The words ‘private sector’ don’t appear once in the 14-page technical assistance report, which can be found on the ADB site, but everything else about it – long term demand forecasts, the development of capacity expansion scenarios, assessments of generation and transmission investments, a loss reduction program, software, a capital works program – implicitly increases the appeal of investment in the state to the private sector. “Ultimately that’s the objective but you’ve got to do quite a few things before you get there,” Nag says. “The private sector is not looking for goodies and handouts: don’t give them a tax incentive for five years, give them a level playing field, the right dispute resolution mechanisms, the right institutional support. That’s what the private sector wants, not financial incentives.”

India’s an interesting market, because one couldn’t really claim that there is a shortage of legislation or judicial establishments – its legal code goes back more than a century and a common complaint of local lawyers is that there is too much law and regulation, not too little. Nag points to the development of the public private partnership scheme in India, which the ADB has backed, as a way of getting past this. “Often it is not that the people at the top are not willing to move ahead – they are,” he says. “And the right legislative framework is in place. But the details, the implementation, that’s an issue and a constraint. We are working with the government both at the central and the state level to strengthen public-private partnerships, where you have a team of lawyers, engineers, economists and financial analysts in place to look at these projects.” Nag also believes the long-moaned battles between federal and state governments in India, long seen as a headache for infrastructure development which commonly involves both, are in the past and “there’s more of a common purpose. The central government certainly recognises that many of these projects have to be done at a state level. There’s a greater convergence of interests.”

It will take time, he says, “but I think we recognise that the issue is no longer whether there is a political will. That took some time, but I think we are over that. It is now a question of how we get the private sector in.”

Sticking with South Asia, a look at recent private sector-type lending from the ADB shows a lot of activity. On April 17 the ADB board approved a US$113 million private sector loan to help Gujarat Paguthan Energy Corporation set up wind energy facilities in Gujarat and Karnataka with an installed capacity of 183.2 MW. The objectives and scope include “demonstration of the successful implementation of large-scale wind power projects by the private sector.” The same day, a US$450 million private sector loan was approved for the Mundra Ultra Mega Power Project, to build and maintain a 4000MW coal-fired power plant in Gujarat. Among its aims is to “promote private sector participation in the Indian power sector.” In May a private sector credit committee meeting will discuss the Phulbari coal project in Bangladesh, involving a US$100 million private sector loan and $200 million political risk guarantee, with project sponsor Asia Energy. And in July the board is scheduled to consider approving two projects in Sri Lanka involving modest private sector loans, one for a biomass power project, the other a hydro plant.

The theory of putting the bank’s money where its mouth is – giving comfort to the private sector not just through guarantees but through active participation – will be tested in the years ahead. For example, the bank has gone quite heavily into significant power projects in markets like Vietnam, “and the precondition for doing that is to give comfort to private sector investors that there is a legal framework.” But Nag himself point out: “The test will really be if the dispute resolution mechanism works. We’ve got it in there, which has been enough for the private sector partners in these countries to come in, but the test will be, when you have a dispute, how it is resolved – how equitably and quickly.”

Today, Nag reckons private sector funding covers 20 to 25% of what’s needed: perhaps $60 billion a year. The hope is that as the private sector becomes more familiar with participation in these projects, the figure will grow quickly. “For example, as some of the infrastructure projects India is doing through public private partnership come to fruition, there will be a demonstration effect and others will come through,” he says. “There is a huge unfunded gap but we are quite hopeful the rate of uptake will increase.”

And even if the commitment of capital is slow, it is clear that the debate has moved on from a few years ago, when the broader question was whether the private sector should be involved at all.

“It is no longer an ideological debate about whether the private sector is good or not,” says Nag. “I think everyone recognises that without them we won’t go anywhere near $300 billion. It’s a question of how we implement it.”