Context - attracting institutional investment in infrastructure
Alan Aisbett, Pinsent Masons
Tue 13th November 2012
The Government estimates that over £250bn of investment in infrastructure is planned to 2015 and beyond. The National Infrastructure Plan 2011 identified two challenges to financing infrastructure over the long term:
- Challenges for traditional commercial bank lending arising from changes in banking regulation and commercial banks’ desire in the current economic climate to conserve capital, and also the disappearance of monoline insurers has made bond finance less favourable;
- Constraints on the extent to which public finances will support specific projects (we have already addressed the "demand" side of this equation by looking at alternative funding sources in "Capital Investment Options": Pinsent Masons 2012).
Whilst a large proportion of the current National Infrastructure Plan will be financed either through traditional public finance or the balance sheets of utilities, both will be constrained in the short to medium term for the reasons outlined above (there will also be the constraints on the size of balance sheets of utilities and conflicting corporate priorities).
Whilst the National Infrastructure Plan covers projects of a national and strategic nature specifically in energy, water supply, transport, communications (particularly digital communications and broadband) and waste, those of a local and regional nature are barely mentioned and are left to the UK government's economic policies for growth. With the abolition of the Regional Development
Agencies, these projects, both economic and social infrastructure, have the additional challenges of local and regional delivery in addition to that of finance.
Whilst the constraints on traditional sources of finance are there for all to see, there is a significant potential pool of private finance in the hands of institutional investors (particularly pension funds).
Infrastructure is an ideal investment for infrastructure funds offering protection against inflation and long term stable income for matching long term liabilities. However, thus far institutional investors
have not played a major role as direct investors in infrastructure assets. The UK exposure to the asset class is less than 1 per cent compared to 8-15 per cent in Australia and Canada.
There are one or two exceptions, the recent upsurge of institutional investors funding social housing in the UK being one and the appearance of large Canadian and Australian pension funds investing in utilities (particularly airports) being another.
The reasons for the absence of institutional investors as direct investors in UK infrastructure are also well documented and include:
- Risks associated with the delivery and operation of infrastructure particularly construction and associated ("green field") risks;
- A dislike of leverage;
- A lack of the required resources to assess and undertake due diligence on individual infrastructure projects to understand the risks involved (and as a consequence choosing to dilute their exposure through infrastructure funds and purchasing bonds from utilities);
- Difficulties in benchmarking performance of infrastructure investments when compared to other markets.
The National Infrastructure Plan announced that HM Treasury had signed a Memorandum of Understanding with the National Association of Pension Funds (NAPF) and the Pension Protection Fund to establish a platform (now known as the Pensions Infrastructure Platform or PIP) to facilitate pension fund investment in infrastructure.
It was also announced that a separate group of UK pension funds were formulating detailed proposals for early stage institutional investment in green field infrastructure. These funds included Meridiam Infrastructure, The Greater Manchester Pension Fund, London Pensions Fund Authority and Hermes GPE.
The initial target for institutional investment in infrastructure was £20bn. The Prime Minister assumed in March 2012 that the Pensions Infrastructure Platform will make the first wave of £2bn of investment by 2013.
The Pensions Infrastructure Platform will be owned by the funds and will provide the necessary expertise and support to engage UK pension funds.
If the Pensions Infrastructure Platform proceeds as planned then how might institutional finance work and what sort of delivery models will it throw up?
How attractive will funds find infrastructure investment? What incentives may need to be offered to funds? Which type of risks are unacceptable or will need to be guaranteed?
There is probably no one simple answer to these questions as there will be substantial difference across sectors and geographical regions.
Certain infrastructure models are well developed whereas others including renewable energy are emerging, there is "green field" and "brown field" and transport and utilities are different to social infrastructure.
Different legal structures driven by different types of cash flows also yield different risks. We already know that the Pensions Infrastructure Platform are unlikely to take primary construction or "green field" risks.
All this makes it more likely that pension funds will invest through "funds of funds" or infrastructure funds to spread and dilute the risk.