As the traditional infrastructure financing pipeline dries up, alternative sources need to be found, Gesine Kippenberg writes
The global financial crisis had a great impact on the infrastructure investment landscape, fundamentally altering the dynamics of the relationship between the public and private sector. Prior to the crisis, infrastructure development was largely publicly funded, but current debt levels preclude this norm from continuing, while banks will also be unable to continue their pre-crisis lending patterns due to the new liquidity conditions stipulated in the Basel III agreement. Consequently, since 2007 overall infrastructure investment in Europe has declined dramatically, creating a reported €4trn investment deficit in the EU alone.
The issue was discussed at the Urban Land Institute's (ULI) 2011 Urban Investment Network Summit in Amsterdam at the end of 2011. Ad Buisman, head of real estate for EMEIA at Ernst & Young, said: "The private sector finance required to decrease this deficit is readily available. The problem is it is being diverted into a very small part of infrastructure. Private investors want stable cash flows and a low-risk investment but the available investment opportunities do not meet these criteria."
Clare Breeze, partner at Shearman & Sterling, echoes Buisman's statement that "with banks unwilling to offer finance as freely as they did, other sources of funding are required".
With banks unwilling, or unable, to provide as much finance for infrastructure projects as they once did, cities are faced with growing investment deficits, to which many are unable to provide tenable solutions. Much of the future success of Europe's cities lies in their ability to overcome these challenges.
Matthias Woitok, deputy head of new product development and deployment at the European Investment Bank (EIB), also at the summit, said: "The investment environment has changed drastically. In accordance with this paradigm shift, the packages offered to investors also need to change."
Investment vehicles such as Private Finance Initiatives (PFIs) have proven effective in a variety of circumstances in the past, but they might not be suitable in the post-crisis investment environment. PFIs generally work best when applied to large projects where there is a relative degree of certainty. The problem is that in the current economic milieu the public sector cannot guarantee this certainty.
Uncertainties over potential rising costs due to latent defects, policy changes, demand risks, changes in public needs, or rapid changes in technology, combined with the private sector's restricted access to finance, are conspiring to create a bleak future for traditional infrastructure funding mechanisms.
When financing for infrastructure was readily available, long-term investors were eager to invest in bonds issued by companies involved in specific projects. With virtually all of these bonds guaranteed by insurers, risk for bond subscribers was kept to an acceptable level.
With less long-term finance available, loan syndication uncommon, and monoline insurance for project bonds unattainable, the issuance of credit-enhanced EU project bonds seems to be one of the most practical solutions for overcoming the perceived apathy of institutional investors.
Both the European Commission and EIB recognise they have an important role to play in the credit enhancement process. The EC's Europe 2020 Project Bond Initiative is a step in the right direction: the EC and EIB propose to absorb part of the risk of specific projects, thus improving the rating of the senior debt of project companies and consequently increasing the credit rating of a project, making investments in project bonds more attractive to institutions. The definitive combined goal of the EIB and the public sector has to be to create a class of bonds that institutions once again deem attractive as an investment and such an initiative, on the surface, seems to fulfil this objective.
Breeze, speaking at the ULI summit, urged that "the project bonds must be fit for purpose and must meet the needs of the public and private sector". He further extolled the virtues of "creating momentum".
In a more risk-averse financial climate, institutional investors must be encouraged to invest in infrastructure. With steady cash flows and low risk being the prerequisites to any institutional infrastructure investment, Breeze foresees a potential solution - the issuance of project bonds on developments near their completion and revenue-generating phase. Breeze believes that "success in this area creates precedence and investors will be more likely to invest in earlier-stage projects at a later date".
Other solutions to overcoming Europe's infrastructure investment deficit problem discussed at the Urban Investment Network Summit include the deployment of a range of suitable public-private partnerships (PPPs).
The creation of asset-backed vehicles reduces the risk associated with infrastructure investment on the part of both the public and private sector. Creating a partnership whereby the public sector provides the assets and the private sector provides currency, the partnership is able to use these assets as collateral to raise debt to develop and regenerate their portfolio.
In addition to the creation of asset-backed vehicles, summit participants also discussed the option of using tax increment financing (TIF) to overcome the infrastructure investment deficit. Using TIF as a means of capturing value allows the public sector to create funding for infrastructure projects by borrowing against the future increase in business and property tax revenues. It is an investment mechanism that could prove beneficial to both parties and is already being discussed as an option on high-profile sites, such as London's Battersea Power Station.
While there is much debate regarding the appropriate means by which Europe's infrastructure investment gap should be closed, there is a realisation and agreement that the current investment mechanisms are not conducive enough to attract investors into the marketplace.
Woitok says: "The perception of investment risk is changing rapidly. To successfully attract an investor to a specific infrastructure project investors must have a full understanding of the associated risk, like the rating and be happy with the investment mechanism."
The reality, however, is that too few of these criteria are being met by traditional investment mechanisms.
The solution may be uncertain, and Woitok was keen to emphasise that "PPPs and project bonds are not necessarily the magic bullets required to close the investment gap".
But what is certain is that the gulf that exists between the hopes and expectations of the public and private sector must be closed quickly. Only through transparent partnership working that appropriately considers the needs of both parties will a solution to Europe's infrastructure investment deficit be engineered successfully.
Gesine Kippenberg is Urban Investment Network project manager at the ULI