Publications

- April 1, 2019: Vol. 6, Number 4

Come together, right now: PPP infrastructure investment holds promise for a better world

by Gershon Cohen

Wherever you look around the world, the clamor for increased spending on critical infrastructure has reached an inflection point. In developed markets, aging infrastructures are in need of repair, while many emerging nations and governments are beginning to recognize repairing and constructing infrastructure will help support their pace of economic growth. Changing demographics are also spurring governments to act. The increase in both younger and older people throughout the globe means different types of infrastructure, such as schools and hospitals, are needed for local populations to thrive.

The numbers help tell the story. From 2016 to 2020, global spending on infrastructure capital projects will reach between $27 trillion and $29 trillion, according to PricewaterhouseCoopers (PwC). Ultimately, and at a time when sovereign balance sheets are still weighed down by debt, we need to move toward more-sustainable financing methods, so development of critical infrastructure can be sustained.

Some critical infrastructure should be considered social infrastructure, meaning healthcare (hospitals), education (schools and universities), public facilities (community housing, government offices and prisons), utilities (water treatment, urban lighting, energy from waste), and transportation (railways and roads). Social infrastructure also demands a new paradigm, in which political decision-makers appreciate the central role infrastructure plays in supporting the economy and future growth.

THE PRIVATE SECTOR APPROACH

A significant disconnect exists between political and infrastructure return-on-investment timeframes. Too often politicians want quick wins, whereas infrastructure investments usually take years to be realized. This is particularly true for large greenfield infrastructure projects that have a robust political profile and generate lots of publicity.

Infrastructure investment options should be evaluated against several metrics, including transparency, urgency, accountability, risk transfer, budgetary flexibility, specification flexibility, project complexity, depth of market competition, and cost optimization.

Given the timeframes, cost efficiency requirements and need for expert oversight, many public-sector entities have enlisted engagement from the private sector via public-private partnerships (PPPs or P3s). PPPs enable private-sector companies to work closely via a contractual concession with governments, or government agencies within the public sector, to complete and operate infrastructure projects.

In exchange for its assistance, the private-sector partner receives a share in the revenue stream generated by the project. Not only can PPPs help propel a project by providing financial assistance, but they can also help increase efficiencies. Projects are typically completed faster with PPPs. Private companies can help bear the burden of various risks associated with these projects, such as completion risk and the risk usage will not be as widespread as predicted.

Private-sector partners also play a key role in the operation and maintenance of the asset that results from the completion of the project, whether it’s a road or a hospital.

The future role of the private sector is also sparking many questions, including how decisions are made regarding infrastructure investment approaches, how a project’s return on investment can be proven and how barriers to entry can be reduced to encourage further competition.

CONCESSIONS TO BOOST INVESTMENT

Granting infrastructure concessions is an important factor when considering a PPP for infrastructure investment and development. Concessions offer cost and project transparency.

Building a new school, for example, is a financial commitment but, under a concession, the long-term costs to the community are defined. Such transparency also enhances accountability. Indeed, throughout the world, concessions are promoted as a way to reduce corruption.

The discipline of whole-life costing, which requires contractors and their capital providers to put their money behind their forecasts to the concession, is highly important. In the right deals, the higher cost of capital required compared with public finance can be more than justified based on risk transfer to the private sector, and enhanced planning, accountability and risk management.

During the past 20 years, concessions have delivered many new public buildings and services, some of which might not otherwise have been commissioned. The United Kingdom alone has 1,000 PPP contracts.

In an era when capital constraints mean public finance is not freely available, many governments now champion these partnerships as a means of renewing infrastructure.

INVESTOR BENEFITS

For institutional investors, PPPs offer the ability to gain access to a steady stream of cash flow that is predetermined by long-term contracts generally lasting 25 years or more.

Often, the contract will include compensation arrangements in the event of a contract termination, as well as provisions to account for unforeseen events. This can reduce some of the risks of being involved in a project that may last decades.

In addition, increased political and economic stability in many Latin America countries — the Andean region, in particular — has provided a new home for PPPs and institutional capital. In mature economies, infrastructure has become so well understood there is an oversupply of capital and less supply of projects, causing returns to decrease. Emerging economies, however, offer a similar risk profile, demonstrate a greater need for social infrastructure and yield returns in the mid-teens.

POLITICAL COURAGE

In general, our political leaders are reticent to approve infrastructure projects. That’s because a good deal of the debate has been unnecessarily politicized.

To make progress, governments should establish a clear framework and policies that create stability for the provision of private-sector capital. They also need to identify and publish detailed national needs, listing credible and rationally financeable and fundable social infrastructure projects.

Detractors often suggest PPP is a form of privatization. Not so. In a PPP concession, projects are built, operated, maintained and financed by the private sector but remain publicly owned.

Furthermore, the public sector is protected from the risks of ownership and has contractual redress if the agreed service or maintenance levels fall below those agreed upon.

The global deficit in social infrastructure is vast and requires private sector capital to join forces with the public sector. The PPP framework is an excellent tool that governments can use for successful social infrastructure investment.

Strong and informed leadership in both the public and private sectors will ensure we can provide invaluable services for this and future generations.

 

Gershon Cohen is global head of infrastructure funds at Aberdeen Asset Management.

 

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