The European Commission says Europe should be spending €2trn through to 2020 on infrastructure. But with governments in austerity mode, innovations in financing are required to enable funding of key development projects. By John McKenna
A modern society depends on its infrastructure. When we talk about a country developing, infrastructure goes to the very core of its development. Public private partnerships (PPPs) and private finance initiatives (PFIs) have been innovative over the past two decades – with the exception of some controversial financing mechanisms – turning revenue funding streams into schools, hospitals, toll roads and rail links. However, despite the long-term nature of such schemes, austerity measures have made the underlying funding of such projects somewhat less certain.
‘The whole PPP /PFI concept was born out of the UK’s financial crises in the 1980s and 1990s, as a way of building social infrastructure without the government having to fully fund it, giving the government access to a greater pool of liquidity,’ says Hadrian’s Wall Capital (HWC) chairman Marc Bajer. ‘In the current environment PPP, and in particular PFI in the UK, provides an outstanding and highly successful model of how to use private markets to finance public infrastructure, even in difficult times. It came out of crisis, so it should operate fairly well in a crisis, even though there may be bits and pieces that need to be modified.’
In April 2011, Portugal became the latest EU nation to come cap-in-hand for a bailout. Just two months earlier, the European Commission (EC) launched its Europe 2020 report, estimating the continent needs to invest between €1.5trn and €2trn on infrastructure through to 2020 – quite a sum. And in June 2011, Portugal pulled the plug on the €3.3bn Madrid-Lisbon high-speed rail link, despite the €1.4bn Poceirão-Caia section reaching financial close in February. PPP is a funding method that, in theory, should grow as governments’ purse strings tighten, but this PPP project was a victim of Portugal’s chastened fiscal situation. So as nations retrench, who will pick up the slack for Europe’s future infrastructure needs?
‘I think the institutional investors will play a bigger role in infrastructure investing in Europe,’ says Cressida Hogg, 3i infrastructure managing partner. ‘If you compare allocations with those in the US and Canada, European investors have been remarkably conservative. Most sovereign wealth and pension funds in other parts of the world are much more advanced in terms of their understanding of the infrastructure asset class. I think infrastructure will come to be regarded as a core part of any alternatives portfolio, potentially taking up to 2%-3% of portfolio allocation, and maybe more for yield-hungry investors.’
PwC head of infrastructure finance and PPP Richard Abadie highlights the extent of the problem: ‘All of those countries that are fiscally constrained are cutting back on infrastructure investment and we are seeing almost a reverse stimulus package.’
Indeed the UK, where PPP was born, has but a handful of projects. In July 2011, the government announced it was looking at saving £1.5bn by trimming spending on its 495 existing PFI projects. ‘The amount of money the UK government is pumping into infrastructure is at an historic low,’ adds Abadie. ‘At the same time, the government is being highly critical of private finance, renegotiating PPP contracts, asking for rebates. The rest of Europe is also quiet – Portugal cancelled its high-speed plan, and Spain is cutting back, too.’
One innovative solution to the infra financing gap being examined is publicly provided subordinated debt, based on products already operating in the private marketplace. In February 2010, Aviva Investors launched the Hadrian’s Wall Capital Fund I, a fund with a target close to €1bn, which will raise subordinated debt.
This debt acts as a first-loss tranche, shielding senior debt from revenue risk, so enhancing the credit rating of the senior debt being traded on the capital markets.
The EC and European Investment Bank (EIB) – which pledged €50m to the Hadrian’s Wall fund in March 2011 – are looking at the possibility of launching a similar product [LINK TO: ‘The Return of Liquidity’ article, same issue]. The EC hopes such a fund would effectively provide a means to move the long-term debt from banks, where it is not best suited, to institutional investors (life insurers and pension funds), where it is. The EIB ’s launching of project bonds reflects its strategy to decrease its investment in infrastructure – from a peak of €80bn in 2009, when it stepped into the void left by banks – to €50bn annually, going forward.
In May, the UK government revealed that among the range of products its proposed Green Investment Bank would offer is likely to be a first-loss contingency fund for the construction phase of projects and a subordinated debt fund to enhance the credit rating of operational assets.
‘We are regularly in discussion with the UK government,’ says Bajer. ‘We are very interested to work closer with them on anything that will support the market and which has as its basis a concept very similar to ours.
Obviously, I think it’s a very good idea and I think it will be good for the government. It will ease the ability of the government to get projects financed’. According to alternative asset research specialist Preqin, European infrastructure equity fundraising peaked in 2007 when 12 funds raised an aggregate $15.1bn in capital, before dropping to $13.7bn raised by 22 funds in 2008. In 2009 it bottomed out, fingers crossed, with just $2.6bn being raised by four funds.
So far this year, three Europe focused infrastructure funds have held a ?nal close, raising an aggregate $1bn. A further ?ve held an interim close and another 16 are expected to be launched by unlisted managers in 2011. Funds are said to be taking longer to close as investors undertake greater levels of due diligence, but this year’s activity should increase the amount of equity available for European infrastructure projects.
Transport and energy are the two most favoured sectors for investment, in particular availability-based toll roads and regulated utility assets. The two largest deals to close in Europe in Q1 2011 were Arcus Infrastructure Partners’ £760m acquisition of all outstanding shares in Forth Ports, an owner and operator of commercial ports in the UK, and Morgan Stanley Infrastructure’s €450m purchase of a series of gas connection points in Madrid.
Much of the equity investment is focused on the infrastructure M&A market. ‘The crisis has probably built on the infrastructure deal flow, with companies making non-core asset disposals,’ says Hogg, pointing in particular to utility giants’ disposals, such as EDF’s £5.8bn sale of its electricity network last year. ‘I still think other utilities will come to the market, selling assets such as electricity networks. A number of assets are likely to be put up for sale as large multinational utilities pull out of non-core geographies.’
Regulation will continue to be a driver for disposals. Italy is selling off its gas distribution network. In the UK, there is BAA ’s forced sell-off of both London Stansted and Glasgow or Edinburgh airport. Cutting national debt is also a driver. The UK government’s proposed sale of its stake in the national air traffic control operator is probably more pressing than ever. In France, there are proposals for the privatisation of several French regional airports, and Spain has put up for sale a 49% stake in its airport and airspace operator AENA , as well as both Madrid’s and Barcelona’s main airports.
Both Hogg and Abadie say that while assets in the UK, Ireland, Portugal and Spain may be attractive, investing in Greece’s €5.5bn panic asset sale is far less so (see ‘Greeks bearing gifts’, opposite). Abadie believes the sale of nationalised or distressed banks’ project finance loan books will trigger some key deals. RBS sold its loan book for £3.8bn at the end of last year, while Bank of Ireland is selling its €3.3bn book.
The £2bn Thameslink rolling stock deal is one of the few PPP s actually going ahead and 3i is part of a Siemens-led consortium that in June was named preferred bidder to design, build, finance, operate and maintain 1,200 electric rail carriages.
While concerned about an escalation of the sovereign debt crisis, Hogg is optimistic about the liquidity of Europe’s infrastructure investment market in general: ‘The availability of debt is there, although pricing is not quite the same as before the crisis.’
There have been some notable deals over the past year. The UK’s high-speed rail link between London and the Channel Tunnel – HS1 – was sold to a consortium of Canadian pension funds for £2.1bn. And there was the landmark agreement of two Danish pension funds – PensionDanmark and PKA– to invest $1.1bn for a 50% stake in the greenfield 400MW Anholt offshore wind farm, being built by state utility DON G Energy (which holds the remaining 50% stake).
As governments across Europe cut back on national spending, it is acting as a reverse stimulus, more of a tranquiliser. The Netherlands and France are the pockets of activity. The €7.8bn Tours-Bordeaux high-speed rail PPP recently closed and both the €3.4bn Bretagne-Pays de la Loire high-speed rail PPP and €1.2bn-€1.6bn Nîmes-Montpellier high-speed rail PPP are in advanced stages of procurement. In June, the French ministry of defence also reached financial close on its €1bn Pentagon PPP project. The Dutch government, meanwhile, has an active programme of large road projects.
‘We are seeing massive amounts of debt going to projects in France, although the debt benefits from state guarantees,’ says Abadie. ‘It’s working very well, which is good for France.’
Last year, $81bn of project finance debt was raised, according to project finance website Infrastructure Journal – an increase of 35% on the $47bn raised in 2009. Western Europe continues to be the largest project finance region, accounting for 52% of the global project finance market in 2010. But the vast bulk of project finance debt is loaned by Europe’s leading banks, all of whom, under Basel III , are facing the prospect of needing to increase the amount of capital they set aside to support their activities, which is likely to lead to a tightening of liquidity.
At the same time, a large number of loans on existing assets that were originated in 2006 and 2007 on a short-term, or ‘miniperm’, basis are now coming up for refinancing. This will place an additional drain on the amount of debt available to finance the construction of new infrastructure projects and create a greater need for institutional investors to step up to the plate.
But Bajer is confident institutional investors will have the appetite for longer-term tenor debt: ‘There’s always going to be a substantial place for banks, but clearly the rules of engagement for banking arising from Basel III are going to change the way they behave,’ he says. ‘This doesn’t mean they will exit financing of infrastructure, but they will gradually pull away from longer duration debt. As a rule, their ranks are diminishing, and I hope so because that is what my business is about.’
John McKenna is a business journalist specialising in infrastructure finance and former energy editor Of Infrastructure Journal
In an attempt to pay down a portion of its crippling sovereign debt, Greece has put €5.5bn of assets up for sale, including the Port of Piraeus, Public Power Corporation (PPC), Athens International Airport and the Hellenic Railways Organisation (OSE).
Who will buy the assets is debatable. 3i managing partner of infrastructure Cressida Hogg says that while these are the sorts of assets 3i would look at, it would not take on the geopolitical risk.
‘There is a real prospect of Greece not being in the euro in the near future, and with debt in euros but revenue in the drachma, or any other currency they would use, these assets would be exposed to massive currency risk,’ she says. ‘This risk might be reflected in the price you buy at, but for us it might nonetheless be too high a risk.’ China’s state-owned shipping giant Cosco has already acquired two of the Port of Piraeus’s three container berths for £2.8bn, and investors from emerging markets may be more willing to take the risk on Greek assets. ‘Chinese and Indian investors may be interested,’ says PwC head of infrastructure finance and PPP Richard Abadie. ‘However, the Chinese will be looking for movement of goods and commodities. A port or an airport would be a logical investment. Domestic toll roads and railways are less likely to be of interest.
After Europe, the world’s largest infrastructure investment market historically has been North America. According to Infrastructure Journal, $32bn of project finance debt was arranged in the US and Canada last year. According to Preqin, last year, nine North America-focused infrastructure funds raised $13.7bn to invest and six infrastructure equity deals were completed.
But last year, twice the number of deals was completed in the Asia-Pacific region, and marginally more debt was loaned ($35.6bn). However, just $0.8bn was invested in regionally specific equity infra funds during 2010.
The strong activity in the region has been largely driven by Australia’s oil and gas and mining markets, which have sizeable projects attracting high levels of both debt and equity.
In Australia, some investors have infrastructure allocations of around 10%. It has a very active PPP market, supported by European banks with Australian bases. Indeed, Australia is home to the world’s most active infrastructure fund manager: Macquarie. India, too, has embraced PPPs as a means to finance social infrastructure and transport projects. It has also used project finance for its Ultra Mega Power Plants programmes. On the equity side, it is also growing rapidly. In July, Bangalore-based holding company GMR Infrastructure raised $131m from four private equity investors for its airports subsidiary.
Elsewhere in the world, significant private sector involvement in infrastructure investment is only significant where strong commitments are made by development banks and export credit agencies. The exception is the Middle East, which continues to see a steady stream of project finance deals in the energy sector and transport, using PPP. However, international participation is by and large restricted to international commercial banks lending debt or advising on any transactions.
This article first appeared in Corporate Financier, magazine of the ICAEW Corporate Finance Faculty, in September 2011.