Challenges of private infrastructure investment

January 2020 | FEATURE | FINANCE & INVESTMENT

Financier Worldwide Magazine

January 2020 Issue

Infrastructure is a vital driver of economic growth in both developed and emerging markets. Yet, many markets lack functioning and productive infrastructure networks. One of the main reasons for this is a lack of adequate funding. According to the Global Infrastructure Hub, the world needs around US$94 trillion in infrastructure investment between 2016 and 2040 to close the global infrastructure gap. At the current pace, there will be a funding shortfall of around $18 trillion. With governments globally cutting funding for infrastructure projects, plugging this gap will be a challenge. In many jurisdictions, private investment is an attractive option.

Historically, institutional investors, especially pension funds, have been tapped to invest in infrastructure networks. This class of investor often seeks assets to match their long-term outlook. However, building infrastructure requires a good assessment of needs, thorough planning, large amounts of capital and plenty of time, all of which carry significant levels of risk. For projects to attract investors, risk must be effectively allocated and mitigated.

Attracting private investment is more difficult in certain segments. Some investors are reluctant to invest further in regulated sectors, including water and energy. The threat of Brexit also causes investors to pause. In the UK, the prospect of a Labour government renationalising infrastructure assets including rail, energy and water companies, strikes fear into the hearts of investors. Uncertainty surrounding the global economy also has an impact. In Argentina, for example, the country’s financial situation has affected the viability of several prospective projects. While public-private partnerships (PPPs) have proved popular in certain jurisdictions, lately financial constraints have caused difficulties. “Since the second half of 2018 the Argentine government has been forced to slow down the pace of the PPP programme due to the deterioration of the country’s credit ratings, the volatility of the currency and the impact of a major criminal investigation which involved construction companies and former public officials,” says Enrique Valentin Veramendi, a partner at Marval, O’Farrell & Mairal.

In Brazil, certain areas of infrastructure have suffered from confusing regulatory structures, or a lack of governmental drive to get projects online. However, a stronger relationship between public and private investment has changed the outlook, with the creation of the Investment Partnership Programme (PPI) an important turning point. “With the PPI, Brazil adopted a new integrated system of governance for all infrastructure projects,” says Pedro G. Seraphim, co-head of the infrastructure and energy practice at TozziniFreire Advogados. “Within the PPI there is a system to include new projects in PPI that involves the Ministry of Finance, the Ministry of Environment and public banks. The PPI is also organising the government’s efforts to create new, or enhance existing, regulations in several areas, including the currently chaotic water and sewage sector.”

“To bridge the infrastructure gap, it is vital that additional funding is funnelled into suitable projects in a way that benefits all parties. Where that funding will come from is a source of debate.”

PPPs are not a catch-all solution to infrastructure deficiencies, however. In the UK, for example, the government has moved away from PPP models in recent years. Private finance initiatives (PFIs) and Private Finance 2 (PF2) schemes, which had been widely utilised, are no longer in use. A number of scandals, including the collapse of Carillion, have amplified pre-existing feelings of dissatisfaction with the PPP model.

To bridge the infrastructure gap, it is vital that additional funding is funnelled into suitable projects in a way that benefits all parties. Where that funding will come from is a source of debate. Although certain jurisdictions have moved away from PPPs, it seems certain that private investment still has a key role to play. PPPs do offer governments a way to create and improve infrastructure without bearing the financial strain of the projects alone. Joint venture models also offer some attractive possibilities in the housing sector, for example.

PFI schemes will present opportunities for private investment going forward. In Brazil, given the reduced role played by the Brazilian national development bank (BNDES), foreign banks may step in for PFI opportunities. “In order to make this even more viable, there are even discussions about allowing local contracts in hard currency,” says Mr Seraphim. “It is still too soon to make predictions about this change, but it is worth knowing that this subject, once a forbidden one, is again being discussed, as people in government start to realise that the currency risk needs to be properly addressed.”

For countries like Argentina, the potential impact of PFI could be huge. “PPP projects could be developed not only for roads and power transmission, which so far have been the sectors where the PPP regime has been used, but also for water supply networks, airports, transportation, housing and ports. These projects may regain their initial impetus as long as the local economy recovers,” says Mr Veramendi.

Richard Summerfield