Bridging the US$15 trillion infrastructure gap and finding ways to attract the so-called ’wall’ of private capital into infrastructure projects are not new subjects. A priority for years, this matter has now become crucial given the unprecedented drain on public finance caused by the economic impact of COVID-19. Yet, there are no great results to report.
The Global Infrastructure Hub’s (GI Hub) recently published Infrastructure Monitor 2020, indicates that private investments in greenfield infrastructure continuously declined in the last 10 years to reach just two-thirds of what they were in 2010. Paradoxically, the financial performance of infrastructure investments has exceeded expectations showing both yield stability and a default risk that is lower compared other asset classes. This is probably why private investment in proven brownfield assets has gone from strength to strength and reaching a level of around 1.2 trillion in 2019. Puzzling.
What went wrong?
In short, the right conditions for greenfield investments have not been assembled. A few insights:
- The cost of private capital is judged too high by public authorities despite the apparent efficiencies and savings attributable to private asset management.
- In many countries, the legal and regulatory framework required to support the procurement of public-private partnership (PPP) projects is not sufficiently developed. The same would apply to capital markets.
- Projects often lack preparedness whether in terms of public capacity building, governance on both sides or advancement of development activities.
- The PPP model is judged too rigid and risky by many private sponsors and contractors.
A way forward that tackles what investors are looking for
The recent global surge in renewable energy provides pointers to what is needed to attract more private sector investment into greenfield projects: clear national strategies and consistent regulation; digestible construction and implementation risk; and highly predictive offtake and revenue risk arrangements.
Taking key learnings from the renewable energy sector, let us look at the key subjects that would need to be considered by public authorities to maximize the injection of private capital, especially at this economic juncture.
Predictability is the key word in infrastructure investments. Infrastructure investors are interested in assets that generate long-term and predictable cash flows. These objectives predicate all their project reviews. Country rating, the financial projections and the contractual terms will be analysed but in addition, the governance of the welcoming jurisdiction will be probed. This includes the soundness of the legal and regulatory framework together with the strength and integrity of the procurement agency, all to ensure that the project agreements will be delivered on for 30 years, which is a typical infrastructure lifecycle.
Easier said than done for public authorities. The GI Hub tool InfraCompass may help analysing the status of several countries in that regard. One must remember that there is more to private capital than the initial equity provided by the project sponsors together with the loans available from local commercial and sometimes development banks. Institutional money and material support from private infrastructure funds will come, once capacity building and improved governance have materialised. Perhaps a long journey for some emerging public authorities but ultimately, a rewarding one. Again, the upsurge in renewable energy projects in emerging markets shows that this is a feasible notion that can be extended to other sectors.
Does the selection of projects matter?
An ever-increasing investor base are interested in quality infrastructure and regulatory requirements may soon favor such investments. This may provide public authorities with an opportunity to focus on private sector partnerships in technology driven and sustainable infrastructure sectors, which would include all environmental, social and governance (ESG) factors. Priority could also be given to green financing. The concept of sustainability-linked loans, derived from green bonds, is finding its way into project financing.
Would fixing the PPP model free up private capital inflow?
Fixing the current structural PPP shortcomings would certainly help greatly.
The contractual allocation of risks associated with lumpsum turnkey contracts no longer works for very large PPP projects. Over time, the size and complexity of PPP projects has grown and the transfer of construction risks to the private sector increased whilst margins have become unsustainably thin. Contractors in some markets have faced losses in half of their contracts. Required adjustments for changes or unforeseen events have often been delayed or refused due to lack of contractual flexibility and governance, leading to claims and endless litigations. As a result, several contractors withdrew from leading PPP markets such as the UK, USA, Canada and Australia, curtailing private project financing in these and other markets.
Some work is being done to explore new avenues related to early engagements and more collaborative mechanisms derived from alliance models. Construction risks have also been made more manageable, perhaps learning from renewables:
- larger projects have been broken down into smaller engineering, procurement, and construction packages;
- key equipment was procured separately from the civil works to avoid unnecessary joint liabilities; and
- the risks associated to third-party responsibilities were left with the public authority, when appropriate, among other things.
Further, the presence of a larger number of delivery packages forces collaboration among all stakeholders to manage the integration risk and calls for faster approvals of scope variation to keep the project going. Variations are funded through pre-arranged stand-by facilities and contingent equity, which were lacking in the past.
Activate banks to draw the private sector
Multilateral Development Banks (MDBs) and National Infrastructure Banks are supportive of infrastructure projects however more of their fire power is needed.
The project reviews conducted by these institutions provides comfort to all private stakeholders and the concessional financing extended brings oxygen to the project financing structures and paves the way to commercial financing. Blended financing is clearly a catalyst to attract private capital and multilateral and nation development bank support should be used more often in emerging markets.
An interesting model of blended financing may be found in the Managed Co-Lending Portfolio Platform of the International Finance Corporation (IFC) which through securitisation allows for private institutions to participate in IFC-originated loans. This concept could be scaled up by other MDBs.
Further, as new delivery models move away from large turnkey lumpsum contracts, managing the integration risk discussed earlier requires guarantees and back stops to complement the security instruments posted by the supply chain, and to make the project bankable. Export Credit Agencies and MDBs should therefore help with their various credit enhancement products.
The facilities and instruments, including local currency loans, developed by the MDBs should be part of the infrastructure finance equation since each intervention carries a high leverage factor for private capital and may often become a prerequisite to closing the deal.
What about existing assets?
The retrofitting of public assets presents great potential in the context of the current public recovery plans and this avenue might have been neglected. New equipment and materials, Leadership in Energy and Environmental Design certifications and related energy savings should be considered to drive modernisation of government buildings, hospitals, airports, water treatment or power plants through PPPs. The sharing of energy savings would contribute to the return offered to the private investors. Long-term lifecycle management contracts would ensure the sustainability of the assets.
Precedents are showing up in the market. The Canada Infrastructure Bank is developing a program along these lines. A group of public universities in the US are implementing what are known as Energy PPPs. The Ohio State University pioneered the model, now being followed by Iowa, Idaho, California and Washington State Universities.
It should be noted that a material transfer price may be charged by the public entity upon assignment of the existing asset to the private party. One may look at it as an asset recycling feature built into a PPP concept. Further, these public assets are known and in use which can only accelerate the engineering, procurement and other preparatory activities. These two factors are highly desirable in circumstances were public finance availability is low and modernisation needs urgent.
Getting conditions right
In summary, we suggest the following five actions by public agencies to attract additional private capital, including from players that are already engaged in brownfield activities:
- Improve governance first and create a predictable pipeline. A thorough request for proposal issued by a solid procurement agency may do more to attract private capital than any public announcement.
- Do not hesitate to go green regarding the nature of the project, its ESG components and its financing. Learn from the success of renewables. Investors will embark.
- Participate in the effort to fix the shortcomings of the current PPP model for competent promotors and contractors to engage.
- Call in the MDBs for their ability to deliver risk mitigation structures and local currency financing acting as a catalyst for the private sector.
- Consider retrofitting public assets as they will likely deliver environmental improvements, energy savings, upfront cash and bring forward investments.
About the authors
Denis is a Strategic Advisor to the Global Infrastructure Hub. He has over 30 years experience in project financing, investment, commercial structuring, and portfolio management of multi-sector infrastructure assets. Denis is also Strategic Advisor to Plan A Capital, a Canadian development and project finance advisory firm active in the infrastructure and power industries.
Prior, from November 2011 to September 2019, Denis careered with SNC-Lavalin Capital. Over that period, he headed the investment and project finance team responsible for sponsoring infrastructure projects primarily procured through Public Private Partnerships.
Denis also led the structuring and management of an infrastructure fund dedicated to monetizing and managing 10 Canadian PPP Infrastructure assets, including light rail transportation systems, power generation facilities, hospitals, and motorways. He developed new financing strategies for the acquisition of renewable or decarbonized energy platforms in Canada, USA, and Australia as well as the project financing of nuclear reactors in Canada and the UK.
Denis also acted for two years as CEO of the project company responsible for the PPP implementation of a large PPP healthcare complex located in Montreal, Canada.
Denis holds a Master of Laws in International Business Transactions from Harvard Law School. He is a member of the Bar of the Province of Quebec.
Thomas is a Strategic Advisor to the Global Infrastructure Hub, with over thirty years of experience in infrastructure delivery and finance. He is also in the advisory board of Meridiam Infrastructure and an independent non-executive director in Global Ports Holding, a London Stock Exchange quoted company. He is working with International Financial Institutions on the implementation of innovative financing approaches for infrastructure delivery, including financing solutions for local public utility enterprises in emerging markets.
Prior, Thomas was Managing Director for Infrastructure at the European Bank for Reconstruction and Development, overseeing a successful private sector focused infrastructure programme with a number of ground-breaking PPP and corporate finance solutions in both commercial and social infrastructure delivery. The programme also pioneered local currency solutions and the systematic mobilisation of capital markets funding infrastructure.
Thomas has chaired the Global Infrastructure Council of the World Economic Forum and has been involved in infrastructure related workstreams of G20 since 2013.