Financing The Revolution

The financial world has changed out of all recognition since the crisis back in 2008. In July, a Partnerships Bulletin conference considerd the innovations being developed to revive infrastucture investment

The world is currently going through a change the like of which we have not seen since the Industrial Revolution.” That was the opening gambit from KPMG’s Tim Stone, as he chaired the Innovations in Financing European Infrastructure conference at Haberdashers Hall in London on 14 July.

A fairly bold statement to start proceedings, Stone was referring not only to the major upheavals caused by the financial crisis of 2007 and its continuing impact on economies around the world, but also the rise of new economic powerhouses such as China and India.

If the UK is to remain competitive in the emerging landscape, it will need world class infrastructure. At a time when the public purse is empty, private investment will be critical to that ambition.

None of this is new. But the problem remains that, after 12 months of a coalition government that has remained largely sceptical of PFI, finding new ways of bringing private investment into public infrastructure is as difficult as ever.

One of the prime criticisms from the private sector has been the government’s lack of apparent commitment to seeking private investors. The prime minister launched the first National Infrastructure Plan in October last year, saying over £200bn of public and private sector investment is needed to deliver Britain’s infrastructure.

But since then, there has been little sign of government engagement with the private sector in attempting to develop this theme. However, the conference offered the first sign of things beginning to change.

Keynote speaker Lord Sassoon, the commercial secretary to the Treasury, reiterated the importance of private sector involvement. “The starting point is that private finance will continue to play an important role in underpinning our country’s future infrastructure needs.”

Specifically, he was complimentary about PFI, demonstrating the first conciliatory note by government on the procurement model.

“It’s impossible to deny that PFI projects have a better track record of delivering on time and to budget, compared to conventionally procured public sector projects.

“More than that, they allow us to achieve a real transfer of appropriate risks away from the public to the private sector.”

Since then, the government has gone on to announce a new school building PFI programme, push forward more housing PFI schemes and give support to the deed of safeguard in health PFIs.

One of the biggest criticisms levelled at the government over the past year, however, is the lack of pipeline in the UK today – and few see the recent announcements as replacing that. In education, for example, a £3bn scheme to deliver 300 new schools pales in comparison to the £50bn Building Schools for the Future programme to rebuild or refurbish every secondary school in the country.

However, Lord Sassoon admitted the government needs to do more on the pipeline. “We owe you, and you deserve, more detail,” he said, promising that detail from individual departments as they explain how their capital budgets will be spent.

“But the pipeline cannot be developed in the ivory towers of Whitehall,” he continued. “We want to know from the industry, in granular detail, where the key stress points are in the UK’s infrastructure.”

Having made this plea to the private sector, Lord Sassoon left the event after his speech, leaving a wealth of industry talent to discuss between themselves what the barriers to growth are in the UK – and how problems can be successfully tackled.

Lacking progress Few in the audience were impressed by Lord Sassoon’s comments. Critics doubted whether the government had made sufficient progress to maintain interest in the UK market, or stimulate growth in the range of funders coming into the market.

West LB’s Chris Heathcote was scathing about the lack of progress, referring to Lord Sassoon’s promise that National Policy Statements for ports and waste will be forthcoming in 2012. “If it takes two years to come up with a policy on ports and waste, we are in serious trouble in the UK,” he said.

His concern was felt across the debate, as critics warned that the government’s entrenchment in failing to either fully support the PFI model or develop alternatives will make it increasingly difficult to get the investment it desires.

Meanwhile, fears were also raised that the government’s review into operational PFI contracts will discourage institutional investors. One delegate pointed out the pathfinders may be considered as retrospectively changing the contracts, thereby infusing PFI investments with a high level of political risk that investors simply won’t want to take.

David Cooper, of Barclays, agreed, arguing that trying to bring investors in has proved difficult for the banking industry because investors “don’t know what will happen” on the operational PFIs review.

“It shows what the impact of delays such as this have on the market,” he added. "However, Lord Sassoon insisted that he and others at the Treasury are aware of the potential risk here. “Those who are holding onto the financing paper now are not those who made the [massive] gains,” he said. “We’ve got to work with the world as it is now.

“Financing gains on the early projects have flown out of the door and are gone.” But with the Efficiency Reform Group at the Cabinet Office now tasked with trimming £1.5bn from all PFI contracts, it may prove difficult to convince long-term investors of the stability of the deals.

These frustrations with central government being aired by delegates – many of whom were left underwhelmed by Lord Sassoon’s promises – were played out at the conference alongside concerns over the regulation being brought in across the globe in the wake of the financial crisis.

In particular, the Basel III regulations are expected to be a significant barrier to future
investment by banks in long-term debt. Glenn Fox, of Hadrian’s Wall, spoke of his organisation’s efforts to step into this breach by providing the mezzanine debt for projects, before bringing in institutional investors to support the long-term debt.

However, Cooper questioned whether the approach would have much impact. He claimed Barclays’ own discussions with investors suggested there is little appetite for this kind of approach among pension funds and other long-term investors.

Since the event, Barclays itself has launched the UK’s first bank-led infrastructure debt fund. Cooper hopes this model will prove more amenable to long-term investors. The fund will target infrastructure projects across the board, including PFI and PPP deals, and has access to Barclays Corporate’s existing portfolio of projects.

Meanwhile, Georg Grodzki, at Legal and General Investment Management, raised the potential for the European Union’s Solvency II initiative to negatively affect appetite. Solvency II is essentially the European insurance industry’s version of the Basel III regime. It aims to deliver a revised set of EU-wide capital requirements and risk management standards for insurance firms.

“The threat here is that long-term investors are penalised for anything that is not triple-A rated or government backed,” he said.

Searching for answers
Given these various barriers, where will the opportunities come from?

One likely solution that already appears to be gaining some traction is the bond market. Bonds largely disappeared from the PPP sector in the wake of the financial meltdown in 2008, as the monoline insurers that had provided the guarantees to get investors comfortable on infrastructure projects all but disappeared.

However, there is a growing belief that public sector bonds might be able to help. In the UK, the London Assembly has issued a bond to help finance its east-west rail link, Crossrail. It’s England’s first local authority bond for over 17 years and mayor Boris Johnson believes it will save £65m compared to the previous plan of borrowing from the Public Works Loan Board.

Jukka Luukkanen, from the European Investment Bank (EIB), gave conference delegates an update on the multilateral’s Euro2020 Bond Initiative.

Although the scheme will not see the EIB issuing bonds, it aims to provide “credit enhancement” to make investors more willing to put their money into schemes. “It is not offering the same as the old monoline wrap,” said Luukkanen. “We are proposing something where we apply the traditional EIB standards to it. We hope we have a very positive reputation in the market that will help to encourage investors.”

Whether this reassurance will be enough for the market remains to be seen. “The role of the EIB is always an issue in the bond market,” said Fox. “There are always tensions in the role it plays in the market. The EIB…needs to assess its often too dominant role in the infrastructure market.”

Deutsche Bank’s Mike Redican disagreed, however. “We are not pessimistic on project finance as long as the EIB bonds come in. I’m a big fan of EU project bonds and bank bonds.”

During the later session, talk began to turn to one of the current political favourites to replace PFI: the regulated asset base (RAB). Erwan Fournis, from InfraRed Capital Partners, argued that from a funding perspective there may be little difference between the two models. “We see all that is in a RAB is in a PPP deal,” he said.

Most agreed that RAB fails to deal with some of the underlying problems seen in the PPP market, so may offer little in the way of a solution to the current difficulties. “PPP achieves more in that it transfers the lifecycle risk for the whole of a contract’s life,” said Fournis. “I’m confused as to why people think RAB would offer something better than PFI.”

Lacking projects.

All delegates appeared to agree that while there may be more new ideas emerging from the private sector, the challenge remains putting these into practice.

“We would like to greatly increase our investments [into the UK infrastructure market],” said Grodzki. “But the flow of projects at the moment is disappointing.”

Others agreed that the lack of new projects coming to market is making it increasingly difficult for new forms of finance to be developed. New players considering whether to enter the market will want to see a strong pipeline of deals that will sustain their initial outlay in setting up in a new area.

But without the certainty of that pipeline, investors will remain reluctant, making it difficult to get the theory out of the conference rooms and into deals.

Since the publication of the report into operational PFI contracts, projects have begun to trickle through. Most notable is the plan for up to £3bn-worth of schools projects, but there has also been a revival of 11 housing schemes and Health Secretary Andrew Lansley’s confirmation that he will continue to act as guarantor on hospital PFIs.

But this remains far short of the previous pipeline and the perception remains that the UK is, at best, a stagnant market – and at worst a shrinking one. That view does not sit well with the growing PPP markets in other parts of the world, and means investors are more likely to put their money into growing markets.

Julia Prescot, of funder Meridiam, said her organisation is focusing on the European market, where activity is growing. “I’m particularly heartened by some of the recent comments by [European Commission President] Jose Manuel Barroso.

“We’re seeing fantastic projects coming through in France, and a whole pipeline coming through in the Netherlands and Germany.”

Andrew Percival, at contractor Vinci, agreed that continental Europe is looking attractive in the current climate. “We see a strong pipeline in France and other continental European countries,” he said.

Whether the UK can recapture its former lustre among investors remains to be seen. “There are a lot of countries with a desperate appetite to use PPP,” concluded Stone as he summed up the event. The danger remains that the pull of overseas markets will be too strong for most investors – particularly the new ones so desperately needed to breathe life into the UK infrastructure industry