As noted in a previous post, the world needs a gazillion dollars in infrastructure development and redevelopment. To be precise (or as precise as any estimate can be), the estimated shortfall in global infrastructure debt and equity investment is at least $1 trillion per year — that’s PER YEAR, not in total.
This is a huge need, yet there is an equally huge amount of capital being raised. You read about multibillion-dollar funds closing on a monthly basis (Ardian/AXA, Blackstone, Brookfield, EIG, GIP, IFC, KKR, Macquarie, Meridiam — and I’m only up to “M” in the IREI FundTracker database of recently closed infrastructure funds closing with more than $1 billion raised). Yet despite these huge fundraises, investors are still falling short of fulfilling their target allocations.
So it appears there is no fundamental scarcity of capital. What there is a scarcity of, however, is deals that investors find competitive on a global risk-adjusted return basis. Investors don’t invest in a vacuum. Every asset class and investment is judged against a myriad of other choices. No matter how much LPs might want to invest in infrastructure, if another investment offers better returns with a lower risk profile, that’s where the capital will flow.
How do we solve this fundamental problem? How do we structure investments so investors get the risk-adjusted returns they need, and governments get the infrastructure they need? Enter the World Economic Forum and its Global Agenda Council on Long-Term Investing. This group has just published the “Infrastructure Investment Policy Blueprint,” which attempts to offer a practical set of recommendations for governments on attracting private capital for infrastructure projects.
The Blueprint report focuses on three areas that government entities need to look at to encourage additional private investment:
- Infrastructure strategic vision, which includes a project pipeline, a viable role for investors and communication strategy
- Policy and regulatory enablers, which mitigate renegotiation risk and increase the efficiency of key processes
- Investor value proposition at the individual project level, which focuses on maximizing value for governments and ensuring a competitive risk-adjusted return for investors
Although all three areas are important, it’s the second point that typically thwarts even the best deal. According to the report, investors frequently cite four main policy impediments that kill interest before it ever has a chance to get to the “what’s in it for me” stage:
- Renegotiation risk. The strain on many government balance sheets, coupled with headline-grabbing regulatory decisions (think Gassled), has positioned political risk — and specifically renegotiation risk — as a critical concern for many investors in developed and emerging markets alike.
- Procurement process. Bidding for a public-private partnership project is time-consuming and costly for investors. A lack of standardization is a major obstacle to an efficient process.
- Permitting processes. Complex permitting processes that lack coordination and predictability will constrain investment even for the most financially attractive projects.
- Tax policy. Taxes need to be stable over time. This risk is a kissin’ cousin to renegotiation risk — investors don’t like changes.
Investors are risk averse. When these four risks are mitigated, then they will be ready to commit capital — or at least look at the deals.
The Blueprint offers ways that government can move ahead on developing an attractive strategy, diminishing regulatory and policy risk, and increasing the value proposition. But of course, pointing out what needs to be changed is easier than implementing those changes. The report speaks for many in the industry when it concludes:
“Finally, these recommended actions are deceptively simple to outline but considerably harder to implement. They may require a substantial build-up of expertise and capabilities within government, investment of significant political capital and engagement in the lengthy process of building consensus among stakeholders. All the while, government leaders have to balance infrastructure needs against other high-priority issues. Yet, the rewards are worth the labor. Even in a situation of significantly limited resources, by prioritizing the recommendations that are most relevant and feasible, governments can do much to attract quality long-term financing and set the foundation for future prosperity.”
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Sheila Hopkins is managing director – Europe and infrastructure with Institutional Real Estate, Inc.
