London, 29 Feb 2016
With the OECD predicting that almost $US3 trillion is needed in global infrastructure investment over the next 15 years, leveraging private sector interest will become increasingly important.
In Europe alone, figures for infrastructure spend range from €470 billion to €800 billion a year. Exact amounts are hard to quantify, but the urgent need to upgrade existing assets and build new ones is undisputed.
Historically, the vast majority of infrastructure investment has been made by the public sector.
Governments remain the prime funders; however the private sector has made a notable and growing contribution to infrastructure investment. Airports, from London City to Toulouse Blagnac in France have significant private investment. HS1, the UK high-speed rail link, is privately owned.
Toll roads across Europe are managed by the private sector, and many schools, hospitals and prisons are privately owned and run, as are utilities, from water companies to electricity distributors.
There is a strong interest in infrastructure assets because they behave differently from other asset classes. They tend to be in a strong competitive position, and there is limited risk of technological obsolescence or digital disruption.
Private sector interest in infrastructure has evolved over several decades, but there has been a distinct shift in momentum since the financial crisis. On the supply side, governments are financially constrained and looking for ways to reduce expenditure.
At the same time, factors such as the low-interest rate environment and increasing longevity are driving institutional investors to seek out alternative assets with long-term, predictable returns to match their liabilities.
"There is a strong interest in infrastructure assets because they behave differently from other asset classes. They tend to be in a strong competitive position, and there is limited risk of technological obsolescence or digital disruption," says Arthur Rakowski, Executive Director, Macquarie Infrastructure and Real Assets.
However, infrastructure assets do not just behave differently from other assets but also differently from each other.
"If you own a water company, you know that the demand will always be there. No one is going to create a rival product, and no one is going to build another water company on your patch because it would be physically and financially prohibitive. Economic regulation ensures relative stability of the business."
"But assets such as unregulated airports can be more volatile because demand can change if economic conditions deteriorate or people choose to take high speed rail instead of flying," adds Rakowski.
Most investors want stability and predictability, and therefore tend to be more attracted to assets where demand is most assured. Often they also prefer to invest in assets which are already operating than those yet to be built.
Yet, this is where demand is greatest, particularly as urbanisation accelerates both in the developed and developing world.
"The key tension with infrastructure development is capital. Someone has to pay for it," says Daniel Wong, Head of Macquarie Capital, Europe.
"There are billions of pounds available to invest but only a tiny proportion of that is available for new infrastructure."
"The projects are really long term so it takes many years to recoup capital, let alone make a return on it, so investors can feel like there is a lot of risk," says Wong.
However, certain risks can be reduced. Institutional investors do not need to be directly involved in creating the consortia that will build projects; nor do they need to participate in the planning process, often the most arduous piece in the infrastructure jigsaw.
"Planning is a real challenge. There can be agreement that a project is value for money and that a city needs it but, in mature democracies, there are many levels of government, the approval process can take years and some projects just never get built," says Wong.
The other key issue is affordability. Even if it is widely acknowledged that a city requires certain infrastructure to be built, someone ultimately has to pay for it.
David Roseman, Macquarie Capital’s Global Head of Infrastructure, Utilities and Renewables says there are only three ways to pay for infrastructure projects.
"First, a government can sell assets it owns and use the proceeds to invest in new infrastructure," he explains.
"Second, the consumer pays for new projects, for example through tolls on roads, utility bills or fares for rail transport. And third, taxation, where the people pay but the cost is essentially hidden."
All methods present challenges to governments, largely because the benefits do not tend to manifest for many years, yet electoral cycles are relatively short term.
Some countries try to circumvent this by separating infrastructure decision-making, at least in part, from government. The UK’s recently created National Infrastructure Commission is a case in point.
The New South Wales (NSW) state government in Australia has also devised a novel way of channeling funds into infrastructure, by privatising the electricity grid but explicitly telling the electorate that the proceeds will be used for new infrastructure projects.
"People tend to mistrust privatisations but the approach in NSW is different. By telling local communities that the money raised will directly benefit them, the NSW government has shown voters how privatisation can work in their favour," says Roseman.
Recycling of funds can also work in the private sector, where privately owned greenfield projects are sold once they are built – or even once they are about to be built – and the money raised is used for new projects. This approach can help to assuage institutional appetite for brownfield assets.
"Finding assets with an attractive risk/return balance is the challenge facing institutional investors. With the demand for stable, predictable infrastructure assets currently outweighing supply there is a risk of prices becoming inflated as a result," says Rakowski.
Co-investment is another way of introducing private sector capital into public sector infrastructure.
"In many European countries, many attractive infrastructure assets remain in state or local government ownership. There is often reluctance to cede control completely. In such cases, a part privatisation is often a good solution – say 25 per cent. Private investors can drive performance and efficiency while the cash injection can be used to upgrade the asset or build new infrastructure," explains Rakowksi.
"Creating the right investment climate is fundamental. The greater the uncertainty, the higher the cost of private capital. Investors need to know that projects are well-planned, properly considered and have political and social consent. Then the money will come," says Rakowski.
Ultimately, governments and the private sector share the same objective: to create long-term, sustainable infrastructure assets that deliver an efficient, value-for-money service to customers and a worthwhile return to funders. Achieving that aim requires smart thinking, effective planning and a strategy that does not just focus on today but on the years to come.
Case Study: £645 million Mersey Gateway Project
The Mersey Gateway Project is a landmark £645 million infrastructure project comprising a 30-year scheme to build a new six-lane toll bridge. It is a top priority project within the UK Government’s National Infrastructure Plan, and was awarded Project Finance International’s European Infrastructure Deal of the Year and Infrastructure Journal’s European Roads Deal of the Year.
Macquarie Capital acted in many capacities on the project, including equity sponsor, adviser and debt arranger. As debt arranger, Macquarie Capital structured the first greenfield bond wrapped by Infrastructure UK, a unit within Her Majesty’s Treasury, and leveraged offshore offices to introduce a multilateral lender to the project. Additionally, Macquarie’s Commodities and Financial Markets team provided an interest rate swap and the Macquarie Asset Management team placed the project’s insurance.
Macquarie Capital committed £120 million of capital to the project across the capital structure, and leveraged other Macquarie business groups, to provide the sponsoring local council with value for money.