Infrastructure Dialogue “Off the beaten track” took place on 22-23 June 2016 at the Villa Kennedy in Frankfurt. Having attended both days, these are my perspectives on three highlights that were of particular interest to me.
A glance at the market: putting recent Brexit developments into perspective.
While this conference took place, the UK held a national referendum for its people whether they wish to stay inside or outside the European Union. The day that followed I suspect many of the attendees will remember as sombre and with a sense of disbelieve. The shockwave following the announcement to vote ‘out’ seems to affect the UK itself more than the rest of the world.
For the ‘Brexit’ camp, the assertion that bigger is better and that centralisation is easier to resolve problems is perceived as a mistake, especially given that UK problems are different to those of the EU. For the ‘Bremain’ camp it does not mean that everything would stay as normal. In the EU, a banking union, capital markets union and energy union are all much needed however these need time and flexibility from EU countries to come to fruition.
In the UK, the Brexit vote requires a new foreign policy that sets out how it wants to trade and collaborate with the EU and other countries in the future. There was also a recognition that the UK outside the EU will become a test for the Euro as it might inspire other countries to hold a referendum. Fact is that there is more uncertainty after Brexit than before. With elections in the USA approaching, and increasing turmoil around the European borders it is likely that political risk and uncertainty will continue in 2016.
What does this all mean for the infrastructure market? Given that the market thrives on predictability, confidence and stability, the result of the referendum is unlikely to provide any positives to the sector in the UK. Although there may be a time when ESA10 accounting rules are no longer a threat to the UK PPPs being regarded as off the government’s balance sheets.
Partnership Capital – Infrastructure Investors and Cooperates: best ways to collaborate?
Infrastructure is now seen as a separate asset class by institutional investors. When searching for yield they can be convinced by structuring the deal with stable cash flows, good local partners and trusted people. Beyond the developed markets, this can occur in those emerging markets and OECD countries where political regimes are more stable and the local language and culture are understood. The level of yield depends on how portfolios are structured and construed to diversify the risk, combined with the specific investment mandate that managers are given by their fund directors.
It certainly requires a lot of skill to win deals and enhance asset value: when investors acquire 100% equity the governance becomes easier, especially when complex assets don’t perform opportunities to shake up become more apparent. Large investment platforms can be effective but require a lot of due diligence. It was felt that institutional investors prefer individual assets to the more complex platforms.
Structuring Infrastructure Investments: how can projects be syndicated more widely?
A number of solutions were put forwards such as exclusivity or pre-emption rights in existing portfolios, use of platforms for PPPs, react to market activity (e.g. currency volatility), introduce new funding mechanisms elsewhere (e.g. Thames Tideway Tunnel), but also value enhancement opportunities in operational assets, and ESG performance lifecycle assessments (e.g. GRESB: Global Real Estate Sustainability Benchmark).
The debate moved on whether the role of SPVs should be restructured to become more independent, i.e. more separate to the investor or contractor business. This pertains to both investors allocating development risk, and to those involved in operational risk. It was posited that investors reverse engineer SPVs before the building contractors sell their equity. It was recognised that the ‘independent SPV’ is a concept that so far is only applied in the UK and that most of the SPVs in other mature markets and developing countries work with local contractor-led SPVs.
What about longer term SPV ownership via the secondary market? In order to understand the pros and cons better, one
might look at SPVs at two levels: (1) the day-to-day administration and management of SPVs, and (2) the owners’ management of SPVs.
The latter should be sophisticated active management by Directors with strong project finance, problem solving and relational skills, who draw their decision making upon the intelligent data and reporting that is supplied by their day-to-day Asset Managers.
How SPVs will evolve in the future will depend on multiple factors: who becomes lead investor, will the original lead investor still act as co-investor (similar to a GP–LP relationship), whether investors develop a centre of excellence (a separate entity that can retain portfolio knowledge and skills, and learn as projects go through their asset life), or go 100% direct with skilled and experienced specialists inside the investment team.
Concluding remarks
There was a consensus that an ‘independent’ model may help to sustain the rates, gearings and covenants to levels that (except for interest rates) we have seen 10 years ago. Longer term SPV ownership via the secondary market might be a solution for the mature markets in Europe and developing countries.
Infrastructure is not as risk free as it seems. With often de-risked operating assets once sold into the secondary market, Government’s austerity impacting commissioning of new projects or programmes involving Private Finance, or sudden changes in regulation or political regimes. The underwriting of risk should be modelled within controllable assumptions (e.g. upside priced into assets, and the creation of operational volatility).
Daan Vermeer is currently completing his PhD thesis on the critical evaluation of strategic PPP/PFI investment vehicles for social infrastructure portfolios. His doctoral work is linked to UCL’s MSc course in Infrastructure Investment & Finance, and supported by the UK’s Major Projects Association, the Education Funding Agency, and PARIO. Daan also works part-time as SPV General Manager at PARIO, a specialist SPV management firm in the UK and Ireland. He provides PPP/PFI contract and commercial management services on behalf of lenders and investors for social and economic infrastructure projects.