Good quality and available infrastructure is a key component of economic growth. Indeed, the government is currently looking at increasing its spend on infrastructure as a key component of its strategy for UK growth.
However, what is the future of long term project financing for UK infrastructure projects, especially given the global financial crisis and the limited ability of banks to provide long term financing going forwards, through upcoming regulatory changes? Could the lack of long-term project finance debt have come at a worse time for the government?
Infrastructure Journal webinar
The government has recognised that it needs to reconsider its approach to infrastructure funding and financing, and secure new sources of capital to invest in UK infrastructure. It has a stated policy to attract £20 billion of institutional investment into UK infrastructure. So I was delighted to be able to chair an Infrastructure Journal webinar on 25 May 2012, looking at the role of pension funds in funding UK Infrastructure.
We were fortunate to have an expert panel comprising Joanne Segars (CEO – National Association of Pension Funds (NAPF)), Phillip Hall (Head of Infrastructure and Transportation – Bank of Tokyo Mitsubishi UFJ Ltd), Julia Prescot (Chief Strategy Officer – Meridiam Infrastructure) and Duncan Hale (Head of Infrastructure Research – Towers Watson).
The issues that attracted most discussion were:
- What will motivate a pension fund to invest in infrastructure? This is the critical issue and one which the government has been working hard to facilitate. Pension funds are driven by their trustees (and their fiduciary duties) – they are cautious by nature and have plenty of investment options. They are also reluctant to take construction or development risk, especially if they are seeking a yield investment.
- Why are the NAPF and Pension Protection Fund (PPF) creating a new body, Pension Infrastructure Platform (PIP)? They are seeking to raise between £1-2 billion from pension fund members and then issue additional debt to take the total available investment size to £4 billion, with investments focused on brownfield (operational) infrastructure looking for returns at between RPI+2% and RPI+5%.
- How are Meridiam and other pension funds encouraging pension funds to consider greenfield/development risk? In particular, they are seeking investment by pension funds through collective investment vehicles/infrastructure funds to create diversity of asset type, geographical location and construction risk. They are also seeking to differentiate from traditional private equity style closed ended 2/20 infrastructure funds, with a long-term open ended platform.
- The state of the long-term project finance bank market and impact of Basel III, in particular the likely impact on pricing and tenor.
- The role of “project bonds” and capital markets solutions. There was much discussion about the recently approved EU project bonds initiative and further debate on the need to actively encourage bond financing as part of the procurement process. The aim being that every privately funded public procurement over a particular deal size will be required to fully price both bank funding and a bond funding package.
- The likely sorts of capital structures that will be attractive to pension funds, including leverage levels and balancing weighted average cost of capital (WACC) with return/risks. Discussion also focused on the proposed PIP model of a maximum leverage of 50:50 for each investment and the requirements for return levels of between RPI+2% and RPI+5%.
- The role of government in encouraging pension fund long-term infrastructure investment. The government is encouraging long-term institutional investors, so it is not about “demand” – the panel thought it was more about “supply” – so the need for greater visibility on project pipeline and greater certainty in the politics surrounding infrastructure (for example, the outcome of the PFI/PPP call for evidence).
Messages for the government
It was an interesting and wide ranging debate and I suspect, like many viewers of the webinar, there have been limited dealings with pension funds in the infrastructure market. It was particularly interesting to hear what pension funds are looking for (and what they are not looking for) and much depends on whether they are liability/asset matching or looking for growth, their own internal risk models/policies, currency, inflation linkage requirements and their geographical preferences.
While pension fund investment in infrastructure is challenging, it is by no means impossible. However, in my view, it is likely require some help from the UK government, whether that is by way of tax incentives, some kind of credit enhancement or simply encouraging bond and long-term finance through the procurement process.
So the key messages emerging from the webinar were:
- Listen to what pensions fund want to invest in, adapt your investment opportunities to gain most traction.
- The UK government needs to develop a greater pipeline of deals and encourage both bank and bond solutions, as described above.
Since broadcasting the webinar, there have been some interesting developments in this area:
- The CBI has commented on the need for further infrastructure investment, possibly through government backed credit enhancement/guarantees to increase the underlying credit rating of projects and allow for the issuance of investment grade debt (Financial Times, 28 May 2012) .
- There are suggestions in the infrastructure industry that the government is considering some form of guarantee or wrap to assist newly formed pension fund platforms (such as PIP) and encourage pension plan investors to provide capital during the construction phase.
No doubt more will emerge on this over the coming weeks, but these developments appear consistent with the Deputy Prime Minister’s remarks in a recent interview, suggesting that HM Treasury consider using the government’s balance sheet to assist and encourage pension fund and long-term institutional investor/sovereign wealth fund (SWF) investment (Financial Times, 22 May 2012). Will this mark a new policy for the government in infrastructure? Will we see new projects being announced and a greater visibility of project pipeline?
Room for optimism?
So, after all this, am I hopeful that we will see involvement by long-term pension fund investors in UK infrastructure? On balance, I am positive. A number of conditions necessary for this change are starting to align themselves, in no particular order:
- Pensions needing long-term stable cashflows in order to asset match their liabilities.
- The government’s recognised need for infrastructure investment.
- Infrastructure UK’s desire to encourage pension fund investment through a series of memoranda of understanding with pension funds.
- Lack of depth for affordable long-term debt financing.
Nevertheless, we have to be realistic, so rather than a case of the Field of Dreams… “Build it and they will come”, the UK government through its National Infrastructure Plan 2011 has adopted a more cautious, “Come along and then we will build it” approach: encouraging long-term pension fund investors to engage on infrastructure and prepare for investment in the asset class, and then creating a pipeline to ensure investments can be made.
But to achieve growth in the UK, maybe we should fully embrace the Field of Dreams ethos?