Towards a digital future: Risk transfer enabling change

Countries around the world are upgrading their digital infrastructure following increased demand and changes to the way we live and work accelerated by the COVID-19 pandemic. Johannes Schmidt, Senior Risk Analyst Global Political Risk, Credit & Bond Insurance at AXA XL, discusses the role that political risk credit and bond (PRCB) coverage can play in enabling this evolution

The digital transformation has been under way for some time, but this trend has been accelerated by the COVID-19 pandemic. Today, more than ever, digital infrastructure has underpinned the way we work, learn, shop and relax.

As a result of the lockdown restrictions imposed in many countries because of the pandemic, more people have been working remotely than ever have before. And even as people across the world begin to return to offices and other workplaces, the trend towards agile working appears set to stay.

Consultancy firm McKinsey recently surveyed more than 800 corporate executives from around the world and found that – across all sectors – 38% expected those colleagues who are able to work remotely to work away from the office two or more days per week once the pandemic is over.

To ensure that they are able to operate efficiently with large numbers of colleagues working remotely, businesses need fast and reliable internet coverage. And organisations of all types are heavily reliant on the processing and transportation of digital data. This need, which was highlighted during the global pandemic, is pushing forward a worldwide movement to upgrade digital infrastructure, such as fibre networks and data centres.

It is not just remote working that is driving the digital transformation. Consumer habits and expectations are also fuelling demand for fast, secure internet services. Consumers increasingly want to stream music, television and movie services, to be able to buy things ranging from groceries to cars online, and to be able to control household appliances like their fridge or their doorbell using reliable, high-speed internet.

As well as this expansion in the ways people are using the internet, the sheer numbers of those with access to it are on the rise too. It is predicted that global internet traffic will increase to 4.2 zettabytes a year by 2022 (one zettabyte is equal to a trillion gigabytes). And according to estimates, by 2023, two-thirds of the global population – about 5.3 billion people – will have internet access.

Fibre infrastructure

Improving digital infrastructure is of critical strategic importance for many economies and to meet the increased demand from businesses and individuals, many countries are upgrading their digital infrastructure to enable businesses and customers to access gigabit broadband –a hyperfast broadband connection with speed of one gigabit per second or more.

Hyperfast broadband mainly requires fibreoptic lines in place of the legacy copper or cable lines that often run into telephone services in homes and work premises. Fibre networks increasingly are considered by many to be ‘the fourth utility’, alongside electricity, gas and water supply.

The pace of migration to fibre optic line networks varies across the world. There are now more than 20 countries that have at least 50% fibre coverage, and some eight markets where fibre coverage is greater than 90%.

Other countries are lagging far behind in fibre coverage, with some in Western and Central Europe currently only reaching fibre coverage in the single digits.

Efforts are underway in those markets to upgrade digital infrastructure. In the UK, for example, the telecommunications regulator, Ofcom, in March laid out its plans to help achieve a “full fibre future for the whole of the UK.” Ofcom said it recognised the need for the UK to upgrade its current infrastructure, which is still heavily reliant on 100-year-old copper wire networks, and said it would regulate in such a way that would drive commercial investment in an upgrade over the next five years.

And certain markets, including Hong Kong, Portugal, Singapore, Spain and Sweden, have seen intense competition between telecommunications and cable operators for higher-speed broadband, serving to hasten and enable digital upgrades.

Investment opportunity: The role of political risk credit and bond (PRCB)

This global drive to upgrade digital infrastructures provides a huge opportunity for investors. Analysts at KPMG suggest that the digital infrastructure investment opportunity in the UK alone could be as large as £100 billion. And the investment is considered to be largely uncorrelated with equity markets and somewhat ‘future-proof.’

The need for investment is not limited to fibre optic networks. Data centres are a critical link in the chain to ensure that companies’ data is stored, processed and disseminated securely and with uninterrupted power and cooling sources to guard against even temporary disruption. There are other infrastructure investments that are also needed to upgrade digital networks, such as the installation of mobile telecom towers.

The financing of data infrastructure can be complex. Often, as with project financing, there is no recourse to the investors. Banks financing those projects lend against revenue from these projects alone, meaning they must be economically viable on a standalone basis. This requires careful due diligence of business plans.

Many data infrastructure financings are structured to have bullet repayments after five to seven years, requiring careful consideration of refinancing risks at maturity of the financing. It is therefore crucial to understand the long term prospects of such a project, both from an economical and technological point of view.

This new kind of infrastructure is considered a safe haven for investors and therefore attracts significant volumes of capital. That leads to more competition, which can compromise a project’s economics. In fibre in particular, a first-mover advantage is key because laying a fibre cable where there is already fibre coverage is often uneconomical. But being the first mover can also come with challenges. Financings need to be carefully structured to avoid the speculative construction of a fibre network without any customers lined up to pay for such a service.

While data centres appear to be relatively simple buildings, they require complex infrastructure such as reliable power supply and cooling. The importance of this became clear during the 2018 heatwave in the UK when some data centres struggled with cooling. Since data centres are critical for their users, any interruption of availability might give them the right to terminate their contracts with the owner.

Credit insurance coverage can help clients to manage and transfer some of the potential risks associated with lending to in digital infrastructure projects.

This type of coverage, often bought by banking clients involved in project and technology, media and telecom (TMT) finance, offers protection if borrowers fail to pay back loans.

In addition to helping mitigate against possible loan defaults, credit insurance can enable lenders to manage in-country risks, achieve a better rate of return and gain competitive advantage by supporting higher lending limits.

The digital infrastructure sector is largely uncorrelated with other areas of PRCB, making this an exciting area to expand into.

Digital future

Experts have been predicting for some time that the future will be digital. The pandemic and the enforced isolation that has come with it for many millions of people has moved this a step closer to reality. From buying groceries to watching movies to video-conferencing, huge numbers of us have become even more used to conducting areas of our lives online. And these habits are likely here to stay.

As countries around the world gear up for a digital upgrade to meet this demand, and investors eye opportunities to play a part, PRCB insurance coverage is available to support this digital transition.