Infrastructure: Patient capital

There are numerous examples of failed public-private partnerships (PPPs) in Australian infrastructure. According to IFM Investors, the model needs to be rejigged so that long-term equity investors stay involved for the duration rather than offloading all the risk on day one after opting for the cheapest possible construction option.

It is a topical issue across private markets given the emphasis some investors are placing on stakeholder engagement as part of the post-COVID-19 recovery. Speaking last month in a webinar organized by FCLTGlobal, a non-profit organization that produces research focused on long-term investing, IFM CEO David Neal observed that governments under fiscal pressure had no choice but to explore partnerships with private capital. But what does a mutually acceptable solution look like?

“The key is not just ‘Is it private capital or not?’ but how private capital is deployed to create the most effective long-term outcome. It’s one of the challenges we have been wrestling with in Australia,” Neal said. He pointed to the PPP model – where private sector interests help finance a project and hold it for a set period before it reverts to public ownership – as an example.

It has been difficult to attract institutional investors into greenfield infrastructure projects because they can’t stomach the risk. Why finance a new toll road based on traffic forecasts that could be overoptimistic and undermine the economics of the project, when you can invest in a fully operational port with greater certainty over usage?

IFM believes the problem goes deeper. PPP is designed to accommodate large contractor-led proposals, highly levered investment vehicles, and very little equity. The contractor is focused on a profit margin over a three-year construction period, while investors have been known to exit not long after projects are completed. It means one stakeholder group has little interest in the long-term performance of the asset and there’s a skinny equity layer to absorb any risk.

“With these large, complex projects, it’s tough to know what is under the ground when you are building a tunnel or what is in that soil – whether it’s something toxic that needs cleaning up. These risks arise, and you need a larger equity layer and a more aligned long-term target to help assess and absorb these risks than is currently the case,” said Neal. “A long-term owner can take that risk and spread it over 30-40 years of cashflows and it still makes sense for them.”

IFM proposes selecting a well-capitalized, long-term equity partner early on in a project through a competitive tender process. This partner would take an active role in project development, working with governments on design and engineering, risk allocation, and delivering more transparency. Projects could be broken up into smaller parts and shared among mid-tier contractors, while there could be more active management, ensuring issues are addressed quickly.

Montreal’s light rail network is identified as a model to aspire to, with Caisse de dépôt et placement du Québec (CDPQ) and the government – at state and federal level – each providing half the equity. A similar project has been put forward for Auckland with CDPQ and New Zealand Superannuation Fund as joint venture partners. However, approval has been delayed by local political disputes.

Superannuation funds are being lined up as the long-term patient capital that forms the backbone of this revised model, but persuading them to take greenfield risk remains a challenge. If state governments respond to COVID-19 by plowing money into infrastructure as part of efforts to generate employment and activity in the face of a recession rather than based on strong economic fundamentals, it will not help.

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• Topics
• Australasia
• Infrastructure
• Infrastructure
• Australia