In 2016, the UK Government published its National Infrastructure and Construction Pipeline which sets out more than 700 projects and programmes with an investment value of £500 billion. The Government has committed to providing over £100 billion of funding towards these projects, with the remainder to be provided by the private sector. However, the uncertainty caused by Brexit and the 2017 general election results may have added to the usual issues faced by private investors in infrastructure such as the build time during which there is unlikely to be any revenue stream, the risks of defective work, cost overruns and delay, and lack of certainty of operational revenue when compared to fixed income assets. All of those factors require a certain appetite for risk.
Government support can play a useful part in encouraging private sector funding and for some infrastructure projects it is crucial because risks levels would otherwise preclude private funding. In a survey from over 100 industry decision makers, conducted as part of Burges Salmon’s recent report looking into how the delivery of UK infrastructure can be improved, ‘Perspectives on Infrastructure’, 74% of the respondents think that infrastructure investment should be led nationally by the Government In addition, 46% of respondents to our survey think that Government policy commitment is the biggest challenge to securing investment. This article considers what the Government is doing to attract private investment and the types of investors who may step up to fill the public funding gap.
The Government’s National Infrastructure Plan (which has been extended to 2026)outlines a number of policies through which the Government aims to secure private investment in the UK. One such policy is the UK Guarantees Scheme (which has been in place since 2013), which aims to eliminate some of the risk for lenders to infrastructure projects. Under the scheme, HM Treasury provides an unconditional and irrevocable financial guarantee of scheduled principal and interest in favour of a lender to a UK Infrastructure project. The scheme has been used to guarantee a number of large scale UK infrastructure projects such as the Northern Line Extension and the Mersey Gateway Bridge.It is also likely that the scheme will be expanded; the Chancellor’s 2017 Mansion House speech included commitments to broaden the UK Guarantee Scheme by offering construction guarantees for the first time and included a statement that the Government would consider other credit enhancement tools, such as first loss guarantees, to reduce the financial risk that complex projects face.
Shortly after becoming Prime Minister, Theresa May pledged the creation of Government backed treasury bonds. The Government has not expanded on how such bonds would work, however it has been suggested that the bonds would be made available to private investors as well as institutions and would receive additional yield in comparison to mainstream government bonds, to account for any reduced liquidity. In addition, in the Conservative manifesto, Theresa May promised to establish a number of UK sovereign wealth funds, named ‘Future Britain Funds’, which will be backed by revenues from shale gas extraction and receipts from the sale of some public assets. Critics have, however, queried the amount of capital that the Government would be able to raise for such funds.
These policies and frameworks highlight the Government’s commitment to attracting private investment in infrastructure. However, the uncertainty caused by the UK general election result may cast some doubt over the continuation of these policies. One beneficiary of the election result could be Northern Irish infrastructure. Some of the DUP’s key aims during the election were to invest in Northern Ireland’s road network and to create an Infrastructure Action Plan for Northern Ireland. The deal reached between the Conservatives and the DUP pledges £400m to Northern Ireland for infrastructure projects, including delivery of the York Street Interchange and a further £150m to develop an ultra-fast broadband network across Northern Ireland.
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The uncertainty (some might say chaos) surrounding Brexit and the possible impact on the economy, is another cause of concern for investors. One particular concern is the fact that the UK’s access to EIB funding is likely to be affected. The EIB is currently a large investor in the UK, with outstanding loans of over £48 billion and a guarantee fund of over 20 billion Euros. This includes £700 million of funding for Thames Tideway and around £1.5 billion of investment in Crossrail. Following the decision of the UK to leave the EU, the EIB has continued to approve and sign financing deals. However the EIB rules require all members to be members of the EU, and the EIB’s primary activity is with its members. There is, therefore,significant doubt that the development bank will be committed to the UK in the future.
Despite these concerns arising from the UK’s political situation, the UK appears to remain an attractive investment choice for FDI. Whilst the short-term economic outlook of the UK may be uncertain and difficult to predict, the UK remains a large, wealthy economy with transparent regulations and tax rates with a pipeline of long-term infrastructure investment opportunities, and currently, for those purchasing with foreign currency, exchange rates make UK assets attractively priced. The A.T. Kearney Foreign Direct Investment (FDI) Confidence Index 2017 has the UK listed in 4th place, behind China, Germany and the United States.
Sovereign wealth funds (SWFs) have been noticeably increasing their direct investments in UK infrastructure in recent years. Commentators suggest that this may partly be due to an increasing appetite for higher risk/return assets, due to decreasing return on traditional oil and gas assets. Initial SWF investments focused on built assets, such as the Qatar Investment Authority (QIA) acquisition of 20% of BAA, the company that owns Heathrow Airport. Sovereign Wealth Fund Institute data shows that the value of assets invested in infrastructure has grown rapidly over the past two years in comparison to fixed income investments. Speaking in March this year at the Qatar-UK Business and Investment Forum, Qatari finance minister Ali Sharif al-Emadi pledged £5 billion of investment to fund UK infrastructure projects. QIA made its first infrastructure investment this year as one of the sponsors of the acquisition of National Grid Gas, alongside China Investment Corporation’s subsidiary CIC Capital Corporation. The Abu Dhabi Investment Authority (ADIA) and Kuwait Investment Authority also bid for the opportunity. ADIA, which does not publish much information in relation to its investments, also reportedly bought a £612m stake in SGN, a UK gas distribution company.
UK pension schemes have traditionally not been active investors in the infrastructure sector in significant volume. Whilst trustees often manage large amounts of capital, they must abide by regulations and their scheme rules that require them to invest in the interests of their members. The rules also require investments that give certain and steady yield, and maintain the liquidity of the portfolio (to ensure schemes can make regular pensions payments to the members). However, defined benefit pension schemes have begun to buck the trend. In the 2015 Autumn Statement, George Osborne announced the intention that Local Government Pension Scheme (LGPS) assets would be pooled into six new British Wealth Funds, each with a value of around £25 billion. The primary reason for this was to boost pension fund investment into infrastructure, by giving each pooled fund more capital to invest with less risk for each individual LGPS fund. This year, HCIL Infrastructure announced it was advancing in its discussions to sell a £25m stake in Affinity Water to a pooled group of local authority schemes. In addition, the London, Greater Manchester, Lancashire, Merseyside and West Yorkshire pension funds have pooled together around £500m of funds and have recently announced joint venture funding for new Bombardier trains for FirstGroup and MTR
A recent Law Commission report on pension fund social investment found that UK defined contribution pension schemes are lagging behind the rest of the world in investment in infrastructure, finding little evidence of any infrastructure investment by these schemes. In comparison to defined benefit pension schemes, the trustees of defined contribution schemes have less flexibility when investing due to the requirement to take individual members’ concerns in relation to risk into account (and in most cases individual members will determine their own broad mix of investments). However, as reported by the Law Commission, the law does allow trustees to make investment decisions based on non-financial factors (such as social concerns) if there is no risk of significant financial detriment to the fund and if the trustees have good reason to think that its members share the same social concerns (recognising that this latter requirement is difficult to evidence). In order to change the behaviour of these funds the Law Commission has identified steps that could be taken by the Government, the Financial Conduct Authority and the Pensions Regulator (for example, consolidation of defined contribution pension schemes) so that they are more able to invest in illiquid assets, which could open up more opportunities for investment in infrastructure.
Despite economic and political uncertainty in the UK following the UK’s EU referendum result and the results of the 2017 general election, there remains an appetite amongst private investors for funding UK infrastructure projects. The challenge for the Government will be to identify those projects which are socially and economically a priority for the UK and ensuring their delivery by providing an attractive investment environment, providing direct credit support where necessary.
Graham Soar is a partner and Ffion Archer a trainee solicitor in the Banking team at independent UK law firm Burges Salmon.