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Darryl MurphyManaging Director, Infrastructure @DarrylMurphy
While the shape of the UK’s future relationship with its European neighbours is still unclear, the question of how to finance infrastructure fit for the 21st century is equally pressing, argues Darryl Murphy.
3 minute read
The vast scale of investment needed to make the UK’s transport, energy, social and telecoms infrastructure fit for purpose is certainly focusing minds. An infrastructure development pipeline worth £600 billion over the next ten years was set out in broad terms in late 2018.1 From improving resilience to climate change and providing data and power infrastructure, major sums are going to be required, with around half expected to be from the private sector.
However, although the UK has a long and innovative history of mobilising private capital, there is clearly no appetite to use established public private partnership (PPP) models from either the left or the right of the political spectrum. So, there is an immediate need for new tools and ideas to get projects over the line.
Public or private? What happens now?
Delivering tomorrow’s infrastructure needs
The first and most important consideration is that tomorrow’s infrastructure needs are very different to those financed before. The risks that come from financing data infrastructure with obsolescence risk or mega-power projects at a time of energy transition are clearly unlike those from low-risk utilities, like water. Many of the projects on the drawing board are large, do not have proven financing or funding models, nor will they generate stable, predictable cashflows from the outset – features that appeal to institutional investors.
In the short term there is a need for short duration, high risk-bearing capital, which is typically not a comfortable fit for many European pension schemes and other institutional investors. With that in mind, there is clearly a need for be a new, independent body supporting government policy on infrastructure, providing early stage capital and ‘pump priming’ key technologies. With a public-service remit, and the intention of staying public, it could focus on the specific technologies that might bring positive socio-economic or environmental returns. Direct lending, using credit enhancements, or co-investing with a body like this might take some early-stage projects out of the starting blocks and to the point where institutional investors, and even the wider community, want to be involved.
As an institutional investor, we are particularly interested in the scope for credit enhancement, through flexible guarantees that could address specific risks like complex construction or counterparty credit risk. Institutional debt investors mainly have appetite for investment-grade projects, particularly those investing to fund pensioners’ annuities. We believe using credit enhancement where there might be material illiquidity premia - say in single-A to BBB rated credits - could mobilise significant capital.
The equity element is also worth touching on, as up until now successive governments have not really been able to capture equity gains under the ‘old’ PPP-type models. Instead, there have been cases where private sector operators have carried the bulk of the risk, but also been able to take gains when operating performance has fallen short.
Getting this part right this might mean some real ‘win-wins’: for the government in delivering on its commitments; for private sector stakeholders, who could make a genuine contribution to enhancing assets and services; and for the public, the users. But for that to materialise, there needs to be greater clarity around what ‘success’ is and communicating the findings to the public.
The reality is that the outcomes achieved by many privately financed projects have not been regularly assessed before now, but until this happens it will be a challenge to demonstrate value for money has been achieved. That is why providing hard evidence supported by data must become an immediate priority for the infrastructure finance community.
Evolution of future financing models
In terms of future model design, appetite for PPP is lacking but it appears the regulatory asset base (RAB) model - as used for financing the Thames Tideway Tunnel (TTT), London’s super-sewer - could play a more prominent role. There are important differences between the PPP and RAB models in terms of risk transfer and to date the RAB model has only been used for consumer funded investments.. Broadly, the RAB model can be used to define a broader risk allocation between a wide number of stakeholders which can reduce the overall cost of capital of the investment.
Ultimately, the model could be rolled out quite widely for large-scale projects where cost certainty is difficult. Developing automated signalling and train controls on live railways, carbon capture and storage, nuclear power and wider digital infrastructure are examples that come to mind.
The long-term challenge, of course, extends far beyond the current political malaise. Working through how the right institutional framework and a more appropriate alignment of incentives can draw the best-qualified stakeholders to the table should be a priority in one of the most advanced infrastructure markets in the world.
A version of this article originally appeared in IPE Real Assets.
References
- Projects worth £600 billion in the pipeline as government gets Britain building. UK Infrastructure & Projects Authority. 26 November 2018
