Much of the UK’s infrastructure is in desperate need of renewal. The country needs new energy generation, utilities, transport, communications and other infrastructure assets to strengthen its social and economic fabric and help reverse the decline in productivity. In late 2019, unpredictable political events notwithstanding, we should see the publication of a new National Infrastructure Strategy, following completion of the Infrastructure Finance Review, currently being led by the Treasury and the Infrastructure and Projects Authority (IPA).
The IPA has projected a £600bn investment pipeline for infrastructure over the next decade, with half that cost to be met by the private sector. There is, in theory, plenty of capital available, but a new model for Public Private Partnerships (PPPs) is required, to replace the Private Finance Initiative (PFI) model. PFI was used in the 1980s, 1990s and noughties to take infrastructure investment ‘off balance sheet’, but is now associated with poor value outcomes for taxpayers; and its replacement Private Finance 2 (PF2), was launched in 2012, but rarely used and abandoned by the government in 2018. Political and regulatory factors present additional problems. Brexit is the obvious concern: it will certainly disrupt the flow of investment from EU Member States, including finance provided by the European Investment Bank (EIB).
Some investors are worried about the possibility of a Labour victory in a forthcoming General Election, as party policy includes nationalising some transport and utilities assets and companies. Political indecision has additionally created uncertainty over energy and transport infrastructure projects. Infrastructure investment was also damaged in the aftermath of the financial crisis. Nick Prior, who leads Deloitte’s global infrastructure and capital projects team, says austerity policies had a significant impact. “Government departments and agencies, at central and local level, have not been allocated the capital or revenue budgets to fund infrastructure investment,” he says.
“Private sector investors might be ready with capital, but government needs to fund financing repayment over 25 years and government agencies haven’t had the long-term budgeting available. There is a lack of a pipeline of greenfield infrastructure projects. There are not enough opportunities for infrastructure finance markets.” Charlotte Chase, policy director at think tank The Infrastructure Forum (TIF), says her organisation has seen some potential investors considering turning away from infrastructure to invest in other asset classes “because of concerns about the prospect of a Labour government, about Brexit, about regulatory change altering the risk/reward balance and about the end of PFI and PF2”.
A new strategy
The Infrastructure Finance Review consultation ran between March and June 2019. ICAEW’s Corporate Finance Faculty submitted a response, listing policy recommendations related to enabling innovative approaches to finance; to use of public investment as an enabler; and to the need to unlock the supply of capital that could be used for infrastructure investment. It suggests that a new standard PPP framework must be based in part on learning from PFI and PF2, but must offer more flexibility, meaning it can be adapted to meet the requirements of individual projects.
It suggests the new model should use the design, build, finance and operate (DBFO) approach to infrastructure construction. ICAEW also suggests the government establishes an Infrastructure Growth Fund to act as a dedicated investment partner for infrastructure businesses, including those developing smaller and medium-scale projects. Post-Brexit government policy will need to address the loss of, or at least a reduction in, finance provided by the European Investment Bank (EIB), the lending arm of the EU.
During the past 46 years the EIB has provided finance, credibility and practical support to many projects that made private sector investors nervous, including during periods of maximum market contraction and volatility. It has played an important role in financing renewable energy generation, some transport and housing-related projects and many smaller projects. EIB lending to UK projects reached an annual peak of €8bn in 2015, but has fallen dramatically since 2016. Former chancellor Philip Hammond has said the UK government would seek a new relationship with the EIB after the UK leaves the EU, but the nature of that is uncertain. ICAEW advocates creating a new UK Investment Bank to play an anchor investor role in the absence of the EIB.
Partowned by devolved administrations, regional groups of local authorities, and central government, the UK Investment Bank would work with the Green Finance Institute to finance green infrastructure; and would complement support provided by the British Business Bank to businesses delivering infrastructure projects. “There is some value in having a UK version [of the EIB],” says Jeremy Barker, director of the infrastructure advisory group at KPMG. “I’m not sure I would support having all the paraphernalia that goes with a bank, but there is a benefit in a government-backed institution which supports infrastructure.”
He suggests this support might be expertise, or administrative support for government-backed funding mechanisms. But the EIB has been criticised for crowding out private investors unable to match its lending terms. Private sector investors could fill the gap created if the EIB ceased to invest in UK infrastructure, although this would have to be at a higher cost to borrowers – and so to the taxpayer.
Research from TIF suggests a loss of access to EIB lending would be problematic for smaller businesses, or for projects using new technologies. TIF suggests the UK pursues a Third Country Agreement with the EIB, which could enable UK-based borrowers to access loan finance worth up to €2bn per year. ICAEW also suggests enabling peer-to-peer investments for community-based schemes, allowing citizens to invest directly in local infrastructure, while government could support a marketplace for this lending with due diligence capabilities and stoploss guarantees. Other models that could be used more widely to support infrastructure investment include the Regulatory Asset Base (RAB) model.
“We have supported a wider exploration of the [RAB] model, which is used extensively in the utilities sector, where you have a monopoly supplier,” says Barker. “You can pass the cost of building infrastructure on to consumers, but in a regulated way. “In a PFI world the revenue stream will kick in when you’ve built the asset. In a RAB model you can pass costs onto the consumer before it’s operational. That enables you to go to the capital markets and show them a secure revenue model; and that makes things cheaper because interest is not rolling up and the risk profile is lower.
“It works well in some utility contexts because projects are relatively small in the context of the network and the customer is still receiving their usual supply. It becomes potentially more problematic in the nuclear sector, where you have to wait at least 10 years before you get any electricity from your nuclear power station and costs are high and difficult to predict. But we do think that the RAB model is worth exploring with a wider range of projects, including new nuclear.”
However, such decisions are always subject to political considerations and politicians tend to be bad at making long-term decisions, particularly in relation to potentially expensive infrastructure projects. “There is always going to be a connection between politics and infrastructure investment,” says David Petrie, head of corporate finance at ICAEW.
“What’s important is that you have systems, processes and institutions in place that ensure these decisions are subject to democratic scrutiny, but are not paralysed by the need for that scrutiny.” ICAEW’s view is that government should reject the old obsession with ensuring that infrastructure investment is off balance sheet. Amending fiscal targets in order to allow PPPs to be recorded on the balance sheet would bring more flexibility into the accounting process.
A need for action
What happens when these ideas collide with reality? “Boris Johnson has talked about the importance of infrastructure,” says Prior. “Government could take a Keynesian approach and commit to funding medium- and long-term infrastructure projects. If that means higher borrowing at least it will be a strong value for money investment: it will allow greater economic productivity, which will deliver higher tax revenues and medium- to long-term economic growth. What would be helpful would be for the new prime minister to set out a vision for investment in infrastructure supported by clear funding commitments around projects he has articulated.” It is even possible that this might survive economic damage caused by a no deal Brexit, he suggests. “While almost all economists are saying this would have a major detrimental effect on economic growth, it is also possible there will be a need for an economic stimulus, in which infrastructure could be at the forefront, to rescue economic growth.”
Whatever political and economic events lie ahead, a new infrastructure investment strategy needs to be created and used as soon as possible, Barker warns, or investors will continue to turn away from the UK. “A lot of the capital is very flexible,” he says. “There are other places in the world where a PPP-type model is being used and that’s where the capital will go. We need clear, workable models and a clear pipeline of transactions.”