Aggressive government belt-tightening and financial market deleveraging in the post-crisis era have led to restraint on infrastructure investment globally. Coupled with this predicament, the world is facing a crisis as ageing infrastructure is crying out for renovation and replacement.
According to a report from McKinsey Global Institute, an estimated US$57 trillion of infrastructure investment will be needed globally between now and 2030, around 60 per cent more than the $36 trillion spent over the past 18 years.
What’s more, the Organisation for Economic Co-operation and Development’s (OECD) Infrastructure to 2030 report says global infrastructure investment needed across the land transport (road and rail), telecoms, electricity and water sectors will amount to around $53 trillion over the period of 2010 to 2030, while global infrastructure investment needs for airports, ports, rail, and oil and gas could amount to more than $11 trillion.
Although the need for infrastructure development across the world is clearly evident, the onset of the global financial crisis in 2008 has hampered growth and led to the scaling back of procurement pipelines for infrastructure in many economies.
Alistair Higgins, a director at ING bank, says: “Politically, governments are saying they are spending on infrastructure, but the truth is they are not. Everyone is good at talking up infrastructure as a mechanism for economic growth, but in reality the procurement pipeline has substantially dropped off.”
The UK is a prime example of this. Government spending cuts have led to a reduction in infrastructure spend. Recent statistics for public sector net investment, which includes infrastructure investment, show that it fell from 3.4 per cent of gross domestic product (GDP) in 2009-10 (around £49 billion) to 1.9 per cent of GDP in 2011-12 (around £29 billion). It is forecast to fall to 1.4 per cent of GDP (around £26 billion) by 2016-17.
Institutional investors need a third-party asset manager or transaction manager to be able to help structure those projects
However, the need for infrastructure development in the UK will only increase as the population grows, which the Office for National Statistics expects to reach 70 million people by mid-2027.
Richard Threlfall, UK head of Infrastructure, Building and Construction at KPMG, says: “The UK government needs to spend around £400 billion on infrastructure development over the next ten years. Around £200 billion is needed in energy, both conventional and renewables, about £100 billion in transport, and the balance in everything else. The need is significantly more than we have managed to spend on infrastructure in the past.”
It is not government spending cuts alone that have hampered infrastructure development across the globe as financial market deleveraging has meant that commercial banks have scaled back lending to infrastructure projects.
Nick Prior, a partner at Deloitte, says: “The financial crisis has led to significant contraction of private financing of infrastructure, both in terms of bank debt and the capital markets, as well as pipeline. The number of banks lending to infrastructure pre-crisis was about 40 to 50, now we are talking single digits and the terms on which they are willing to lend are significantly less attractive. Meanwhile the collapse of the monoline insurance market has led to a contraction in the role of the capital markets.”
According to data from Infrastructure Journal, in 2012 the overall volume of project- financed infrastructure schemes fell dramatically with just 419 deals, worth $182 billion, closed – less than in 2009. Meanwhile, the total value of project finance transactions in the UK in 2012 was $10 billion, compared to $32 billion in 2007.
Since the financial crisis banks are facing growing pressure to shrink their balance sheets and deleverage, and as a result have become increasingly selective in their investments. In addition, the impending Basel III banking regulation, designed to strengthen bank capital requirements after the crisis by increasing bank liquidity and bank leverage, will apply further pressure to those banks wishing to lend long-term capital to infrastructure projects.
Mr Higgins says: “Banks are stuck in a quandary. The government and public view is that they should be supporting public infrastructure, but regulatory pressures are stopping them. There is real pressure on balance sheets to be shrunk; infrastructure lending with its long-term investment horizon is particularly hard hit.”
As a result, governments are increasingly searching for a new private sector solution to the infrastructure deficit. The UK itself is on the brink of some major developments; it has refocused its attention on infrastructure as a catalyst for economic growth and is looking to the UK pension fund community as a source of long-term capital to fund its National Infrastructure Plan (NIP).
The pool of capital available within the UK’s pension fund community is vast, with £1.8 trillion of assets under management in 2012, according to Towers Watson. The NIP, launched in 2011, outlines a pipeline of more than 550 planned public and private infrastructure projects, worth £310 billion, to be developed over the next decade, and the government is hoping the majority of this will be financed with institutional money.
The National Association of Pension Funds has also teamed up with the UK’s largest pension funds to develop the Pension Infrastructure Platform, a government-backed initiative, to facilitate UK pension fund investment in UK infrastructure.
“It is a necessity to attract the private sector to fund infrastructure given the constraints on government. The solution is to use private finance to bridge the gap between the lack of affordability and the infrastructure need of tomorrow,” Mr Threlfall says.
Pension funds and insurance companies are a natural fit for infrastructure investment as the asset class can provide investors with a long-dated stable cash flow to match long-term liabilities. Over the last decade there has been a sea change in the way that pension funds, particularly, are investing with a shift away from equities and gilts to alternatives, including infrastructure, as investment focus moves to liability-matching above overall return.
It is not the UK alone that sees the vast amount of capital locked away in pension funds and insurance companies as the key to infrastructure investment in the future. This has become a global campaign with governments around the world hoping to attract institutional capital into infrastructure.
Mr Higgins says: “There is a strong case for pension fund and insurance money to invest in this space, but the investment opportunities are complex, creating substantial hurdles.”
Mark Richards, partner in the Projects and Infrastructure Finance Team at law firm Berwin Leighton Paisner, adds: “Institutional investors have large pots of money sitting there waiting to be deployed. They need someone to be a third-party asset manager or transaction manager to be able to help structure those projects. It will be really important for the transition of the market to have somebody there, whether it is a bank or an asset manager, to facilitate these deals.”
In the UK the issue is also one of scale; the country’s pension fund industry is large and fragmented and individual pension funds have neither the size nor the expertise to invest directly in infrastructure.
Mr Higgins concludes that pension funds and insurers are not set up to invest in infrastructure. They currently lack the expertise and resources for what is a relatively complex asset class. Banks and specialist assets managers can support these institutional investors by providing the expertise and oversight needed to deliver infrastructure for the government and public good.