London’s M25 orbital motorway has a reputation for bad traffic jams. But in recent months it has suffered from a different type of congestion – the seizure of the financial markets blocked plans for its widening.
The £1bn M25 scheme was just one of many essential infrastructure projects in the UK disrupted because banks became unable or unwilling to put up the cash for Private Finance Initiative contracts. Other schemes affected included new hospitals, defence procurement and waste to energy plants.
Ironically, the collapse in the funding stream for PFI contracts came at exactly the time that the leaders of the UK, US and China were arguing for greater investment in public infrastructure to combat the global recession. And it is PFI – and the related Public Private Partnerships – that are favoured by governments for public infrastructure investment.
PPPs are popular in many countries, including Canada, India, Malaysia, France, Australia, Ireland, Indonesia, Portugal, South Korea and South Africa. Hong Kong entered into its first PPP in 2003, for an exhibition centre at its airport. China is currently making progress on a US$3.5bn PPP metro scheme.
The rationale for PPPs is obvious. The demand for new infrastructure has outstripped governments’ budgetary capacity. Paying by instalments over 25 to 30 years is an attractive option – especially when many PPPs have been off-balance sheet and therefore excluded from public sector net debt. (Accounting standards reforms are changing this.)
But the global economic crisis interrupted the flow of funds. In fact, the list of banks most committed to PFI and PPPs contains many sitting at the centre of the credit crunch. Royal Bank of Scotland was a market leader in PFI finance in the UK and worldwide. Dexia existed initially to fund the public sector and financed many PPP schemes across Europe. HBOS was another sector leader. Failed banks Fortis and Hypo were major funders of PPPs, especially in Canada.
It is not merely that the banks have become less likely to lend to PPPs. Finance is also at higher cost, for shorter periods and in smaller bundles. Where a large PPP might once have gone through with two or three funders, the M25 project, assuming it goes ahead, could now involve 21 funding banks. Moreover, several banks are now reluctant to lend for more than five to seven years. The bond market, previously a favoured mechanism for PFI and PPP financing, dried-up when the crisis first hit, when bond insurers became unable to underwrite new issues because of their exposure to sub-prime mortgage lending and related securities.
In the UK, the response to this market failure has been a big injection of government funds to bankroll the PFI and kickstart stalled schemes. Through a ‘PFI Bank’ situated within the Treasury, £13bn of schemes will now go-ahead. The Government’s funds for the public sector will be structured as loans that are, it is hoped, to be sold to private sector banks once the capital markets unfreeze.
France has undertaken comparable measures though its ‘plan de relance’. The government has guaranteed all PPP bank borrowing at a cost of €10bn and enabled private financiers to access the lower rates of interest available to government. It has also improved the viability of PPP projects by introducing new tax allowances, providing €8bn in cash advances to lenders and approving variable interest rates.
But some countries have been affected in other ways. India’s PPPs have been structured differently and are therefore affected differently, says Glenn Stone, a partner and global head of project finance at Grant Thornton. “The biggest issue in India is the problems with the property market,” he says. “Most of the [PPP] contracts are predicated on ever-increasing property prices.” With India’s property market at risk of a serious collapse, Stone believes this could badly affect PPP contracts in the country.
India has therefore intervened with government support to keep the PPP market on track. The India Infrastructure Finance Company Ltd – IIFCL – has been permitted to raise r400bn to raise finance to support PPPs that were near to financial close prior to the crisis. Additional resources are being made available through IIFCL to refinance loans originally provided by commercial banks, easing liquidity.
India’s distinctive use of property value appreciation to support some PPP projects (see box) illustrates the fact that while PPPs have become global in reach, they remain national in character. In the US, some local transport schemes are structured as PPPs, yet the most famous ‘PPP’ in the US is the Troubled Asset Relief Program. This is a million miles away from the type of service concession normally associated with PPPs.
Next door, Canada is one of the most heavy users of PPPs – or P3 as it is termed there – using it to procure toll roads, public transport schemes and hospitals. It is suffering in an almost identical way to the UK and France, says Jane Peatch, executive director of the Canadian Council for
Public-Private Partnerships . “The Canadian banks of all the banks in all the developed world are doing the best,” she says. “But they are not the funders of P3.” Instead it was the European banks that financed Canadian P3 schemes and “when October hit”, as Peatch phrases it, those European banks stopped funding schemes in Canada, just as they did in Europe.
While there is no federal rescue scheme for P3 schemes, Canadian states have tried to save favoured schemes – but not always successfully. The C$3bn Port Mann Bridge project had to be abandoned as a PPP after funders withdrew and could not be attracted back in, even after the provincial government came in with an extra C$1bn to lend to the project. It then reverted to a traditional design and build contract instead.
Tim Philpotts, national sector head for P3 at Ernst & Young in Canada, stresses there is no lack of demand. “There are a lot of deals in the market at the moment,” he explains. But there is not just a lack of financiers, but also a reluctance by contractors to come forward as scheme sponsors. Those sponsors, like the banks, are retrenching to their core markets, typically in Europe. Philpotts predicts that the Canadian government will soon announce its own PPP rescue scheme, similar to that of the UK.
The situation in Australia is equally difficult. A recent study by the body advising the federal government on PPPs, Infrastructure Partnerships Australia, reported that the PPP market is badly disrupted. “The capacity of Australian industry to secure the debt needed to deliver large infrastructure projects is severely constrained,” it concluded. As a short-term measure, Australia’s Treasury should copy the measures adopted by its UK counterpart, recommended the report.
While some schemes in Africa are progressing, the African Development Bank has warned that the banking crisis is putting infrastructure development at risk. This is particularly true in Nigeria, which is seeking to invest heavily in modernising infrastructure through PPP and similarly financed projects, backed by the country’s oil revenues.
The World Bank’s Public-Private Infrastructure Advisory Facility found that in August to November last year, there was a fall of 40% in PPP infrastructure schemes reaching financial closure compared to a year before. Another World Bank report suggests that about $81bn of public infrastructure schemes – not all of them PPPs – had been put at risk by the global crisis.
Financial support is now being provided by the World Bank to enable PPPs to go through to completion. Initiatives include an Infrastructure Recovery and Assets Platform to support PPP projects, ensuring projects are initiated and completed where they are essential for a developing country’s infrastructure.
Much of Asia will need World Bank support to proceed with their PPPs and will be unable to rely on their national governments to provide extra cash, says Michael Flynn, a Deloitte global PPP sponsor based in Dublin. “Governments may not be strong enough to guarantee the required infrastructure,” he warns, particularly where they are propping-up their banks.
The situation is different in the Gulf States, suggests Flynn, because of the strength of the sovereign wealth funds, which will need to invest more heavily in national and regional infrastructure to meet the strategic needs of their home states. “A report recently concluded that about $100bn is needed over the next five years in infrastructure [in the Gulf region], a significant amount of that in water,” Flynn says. “More sovereign wealth funds are now moving into infrastructure as a more defensive asset class. They may have to become lenders [through PPPs], not just equity funders.”
Some European countries, particularly Ireland and Spain, have hit additional problems as government debt has been either downgraded or put on negative watch by credit ratings agency, potentially raising the cost of PPP financing.
The situation is similar for some Asian countries, says David Larocca, an Ernst & Young PPP specialist, based in Sydney. “It is difficult to raise finance against triple AAA rated governments, let alone for those that are lower rated,” he explains. Moreover, while Australia at least has a mature market with established processes, these are still being developed across most of Asia.
In several countries with mature PPP markets – including Australia, Canada and the UK – there is interest from banks not previously involved in lending to projects, but on shorter terms than the full length of a PPP. There is also a willingness by some life assurers and pension funds to invest more heavily in the sector.
The current crisis may, then, be a short-term difficulty, rather than a long-term disaster. Yet any easing of the PPP market place is of limited assistance to world leaders who want to boost employment by investing in public infrastructure. “PPP is not really quick enough [for that],” says Grant Thornton’s Glenn Stone.
In the US there is an emphasis now on ‘shovel-ready’ projects that can go ahead almost instantly. With processes that can take several years from gestation to financial close, PPPs are a long way from that. But for the long-term, they probably remain the only game in town for much public infrastructure development.
$100bn – the public infrastructure needs of the Gulf States over the next five years.
$81bn – the value of public infrastructure projects currently stalled by the financial crisis.
€60bn – the value of PPP contracts currently in place in the European Union.
PPPs are a generic name for long-term contracts between the public and private sector. The structuring and financing of PPP contracts varies significantly in different countries.
The Malaysia Multimedia Super Corridor (MSC)
The Malaysian government structured its electronic super corridor – running from Kuala Lumpur’s Petronas Towers to the city’s airport, an area 50kms by 15 kms – as a PPP. The infrastructure was supplied by the private sector on contract to the Multimedia Development Corporation, a government company.
PPPs are widely used in India to build new roads and improve existing ones. Some are financed by allowing the contractor to levy tolls; others are financed by the public sector client charging tolls; others are toll-free, with the developer given development rights adjacent to newly built roads, earning a return from appreciating property values.