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Investors have high hopes for Canada’s PPP infrastructure market, but can it deliver the opportunities investors crave?
The Canadian infrastructure market has obvious attractions to international investors: a well-established model for public-private-partnerships (PPP), including over 250 active projects, of which those that have reached financial close are worth over C$120 billion1. This is complemented by a sound legal framework and a federal government that, on the face of it, has infrastructure at the heart of its policy agenda. The challenge now, however, is to ensure the government’s grand vision matches investors’ expectations.
The government in 2016 unveiled its Investing in Canada plan; a hugely ambitious programme that could see over C$180 billion invested across five priority areas: public transit, green, social, trade and transportation, and rural and northern communities’ infrastructure2. Central to the plan is the Canadian Infrastructure Bank (CIB), a C$35 billion entity that was officially launched in November 2017, which will “invest in projects in the public interest and generate revenue, by attracting private and institutional capital”.
In theory, the CIB and broader infrastructure plan could be transformational; but some caution is warranted given the recent history of planned investments being held up in political red tape. In its latest budget, announced in March, the government admitted that almost $4 billion from the first phase of its programme would be delayed by over three years, until at least 2021. It conceded further delays should be expected3.
So what does all of this mean for investors? In this Q&A, Aviva Investors’ head of Canadian infrastructure debt, Frank Vihant, takes a look at how Canada’s PPP market has evolved and the current state of play.
Can you give some background to Canada’s PPP market?
The Canadian PPP market has been active consistently for over 15 years with a strong track record in delivering projects across multiple provinces and sectors. The model was heavily based and influenced by the UK’s private finance initiative model, including the adaptation of the standard form contract used in the UK.
The federal government largely has jurisdiction on infrastructure projects involving national defence, international trade (ports, border crossings) and public works and government services (buildings occupied by federal ministries and agencies; not only in Ottawa, but across the country).
Provincial governments have jurisdiction over healthcare, transportation, education, justice (courts and correctional facilities) and energy. A number of provinces have established agencies or departments with direct responsibility for the procurement of PPP projects, the most prominent being Infrastructure Ontario and Partnerships BC.
Although some provinces have not created separate agencies for overseeing PPP projects, they typically have a ministry or governmental department responsible for infrastructure. Inter-agency cross-collaboration is widely practiced, resulting in a fairly consistent approach across the country.
Municipal governments have jurisdiction over public transportation/transit, roads and sidewalks, fire and police services, recreation facilities and water and wastewater treatment facilities. Municipalities are often advised by the applicable provincial agency. While much of the procurement of PPP projects has been at the provincial level, the increased focus on transport infrastructure - particularly urban transit - has resulted in more procurement at the municipal level.
Has the PPP model changed much?
It has, and not necessarily for the better from an investment perspective. The PPP model was first used widely for the procurement of new hospitals. This was easily adapted for schools procurement, but was not as easy to apply to transport projects. There has been a rethink on risk allocation and payment structures to reflect the complexity of transport projects.
This led to a move towards different types of completion payments for different sectors and greater use of the design-build (DB) or design-build-finance (DBF) models, which do not require long-term funding or equity. On larger design-build-finance-maintain (DBFM) and design-build-finance-operate-maintain (DBFOM) transportation projects, financial structures have featured milestone payments and substantial completion payments of up to 85 per cent of the project cost, reducing the amount of long-term funding needed.
Introduced after the global financial crisis to encourage banks back to the market and to stimulate the private sector to invest in infrastructure development, milestone and/or large substantial completion payments have led to smaller equity cheques in deals, which have made bidding for projects costly for sponsors and precluded the participation of large Canadian public sector pension plans. Project sponsors have also raised concerns with provinces as lower equity reduces the resiliency of a project during the operation and maintenance phase.
Has this led to a reduction in PPP deal activity?
The value of PPP transactions that reached financial close in 2017 was just C$2.7 billion, the lowest level since 2006. Of the thirteen deals to reach financial close, four were in healthcare, four in transport, three in water and waste water and one in power transmission. Of the thirteen, ten were located in Ontario, two in British Columbia and one in Alberta. The small capex size of these deals meant infrastructure loans were at the lowest level since 2012 and capital market financings since 2006. Furthermore, equity deployment was below C$50 million for the first time since 2006.
More positively, major PPP procurements, both for social infrastructure and transportation, should see 2018 capex top C$10 billion once again. According to IJGlobal, there are currently 100 PPP projects in various stages of procurement, worth an aggregate C$20.2 billion.
Infrastructure Ontario, the largest procurement agency in Canada, recently released its pipeline update on 32 projects with an estimated value of C$15.8 billion. These are almost evenly split by sector and model, with 17 civil and 15 social infrastructure projects and 17 being procured as a BF/DBF and 12 as a DBFM/DBFOM.
Where are the opportunities for international investors?
While the Canadian infrastructure market has historically been well served by domestic and international banks and the Canadian life companies, there are a couple of reasons it may now be a more compelling market for international investors.
First, recent adverse changes to the capital provisioning requirements for Canadian life insurers on unrated private placements may create opportunities for international investors not subject to the same regulations. This is particularly the case for smaller projects (i.e. with a long-term debt component less than C$250 million) where the cost savings from not requiring a rating could provide a bidding consortium with a competitive advantage.
Second, there may be opportunities for international investors comfortable with assuming revenue risk to invest in CIB-sponsored projects and experience in less-developed sectors of the Canadian renewable energy market, such as offshore wind.
What are your thoughts on the Canadian Infrastructure Bank: can it meet its lofty goals?
The federal government’s initial C$35 billion will support investments in public transit, trade and transportation and green infrastructure and is expected to attract private sector investment, particularly from large Canadian public sector pension plans, worth around four to five times that of the federal government’s contribution.
The objectives of the CIB are to improve the performance of infrastructure delivery in Canada by prioritizing projects with the highest net benefit to taxpayers. However, it’s fair to say there is some concern regarding the degree of independence the bank will have. While political involvement on how much to spend and where to spend it is required to ensure democratic accountability, once these decisions are made the CIB needs strong independence to implement those decisions in the most effective way without interference.
The bank has to operate in Canada’s federal system, where provinces and municipalities deliver the vast majority of infrastructure projects.
What kind of opportunities is the CIB likely to be involved on?
There are several major projects on which the CIB may play a role. These include Reseau Electrique Metropolitain (REM), a fully-automated light rail network linking downtown Montreal with the West Island, South Shore, North Shore and the airport. Once completed, the REM will be the fourth largest automated transport system in the world.
The Caisse de depot et placement du Quebec (CDPQ), the investment arm for Quebec’s largest public sector pension plans, the Province of Quebec and the Government of Canada have agreed to invest C$6.3 billion, establishing the first public-public-partnership in Canada.
The CDPQ will own 51 per cent with the federal government and province each owning 24.5 per cent. The CDPQ will be entitled to its target rate of return of eight per cent after which the federal government and the province will receive their target return of 3.7 per cent. Returns above these levels shared on a pro rata basis.
Separately, the plan to expand the rapid transit network in the Greater Toronto and Hamilton Area (GTHA) of southern Ontario is one of the largest transit investments in the world, valued at approximately C$13.5 billion. Ontario’s Regional Express Rail (RER), delivered in partnership with Metrolinx, which is responsible for coordinating transportation planning and transportation systems in the GTHA, consists of three packages.
The first is well under way, with ten projects in procurement and three to follow in the short term. These DBF projects include track work, redeveloping Metrolinx GO transit stations and improving rail crossings. The second package, also DBF projects, includes off-corridor works such as building new stations and the redevelopment of existing stations.
The third package, the largest by project cost and to be procured as a DFFM/DBFOM project, includes complex in-corridor work such as new signaling, electrification and train control systems, new and expanded track construction, vehicle procurement and maintenance and operation of the Metrolinx fleet. An RFQ is expected before the end of March for the second and third packages.
Concurrently, IO and Metrolinx are proceeding with a number of Light Rail Transit (LRT) projects. Eglinton Crosstown LRT is under construction, while the Finch West and Hurontario LRT projects are expected to be awarded in 2018. The RER and LRT and projects are part of the grand plan to transform Toronto’s Pearson International Airport and Union Station into transportation and transit hubs for southern Ontario.
A high speed rail project has also been touted. Could that also be in scope of the CIB?
Most infrastructure projects have some degree of controversy, but few have evoked as much as the Toronto-Windsor High Speed Rail (HSR) project. As the only G8 country without a high speed railway, the proposed C$21 billion project, which would provide a seven-stop line connecting Toronto’s Union Station with the City of Windsor, has been debated for decades. While a business case has been made, there are many skeptics who point to the looming election in Ontario and the potential for the project to be a key election issue in several prominent ridings in the province.
In addition to Ontario, HSR projects are being considered in Alberta and British Columbia.
The privatization of airports is another potential area of activity, particular those in the largest seven cities. These are currently managed by airport authorities (AA), not-for-profit entities without share capital, under long-term leases.
The main objective behind privatization is to transfer from the public sector to the private sector the economic burden of maintaining and operating these assets. The potential proceeds from selling them is estimated between C$ 7 billion and C$16 billion, which could be reinvested by the government in other infrastructure projects.
Whether the process involves change in the structure of or the transfer of assets by the AA, it would require the approval of existing bondholders. While the privatization of airports has been studied for some time, the creation of the CIB may be the impetus required to make it a reality.
Politics seems to be both the trigger for infrastructure activity in Canada and sometimes a barrier. How do you see the current situation?
Ontario is the real focal point. It is unsurprising we have seen a flurry of new projects recently announced by Infrastructure Ontario in an election year. A provincial election takes place on June 7 and the Liberal Party, which has ruled for the past 16 years, is behind in the polls. While the Liberal party has been very supportive of the PPP model, a change in government could have adverse consequences as a result of differing priorities.
This would be similar to the experience in Alberta, which placed a moratorium on PPPs, and British Columbia, which recently cancelled a tunnel replacement project well into the procurement process and eliminated tolls on two bridges.
The future direction and robustness of the Canadian PPP infrastructure market will depend to some degree not only on the outcome of the Ontario election, but also the ability of the CIB to work with its provincial and municipal counterparts to ensure inter-governmental support of its initiatives for the greater good of all Canadians. It should make for an interesting year.
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