New approach to funding structures will make waves

Transport Scotland is working with the Forth Crossing Bridge Constructors consortium on the biggest infrastructure project in Scotland in a generation

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By Michael Stoneham

A better understanding of how private and public sectors can collaborate is essential to ensure innovative funding that will ensure long-term development

The beneficial impact of public infrastructure investment in stimulating economic development has long been accepted. At last, it seems that we may be on the cusp of a new cycle of development, bringing in new ideas and solutions.

The infrastructure investment cycle is notoriously long term, with large projects taking years to plan and build, and longer still to generate a payback to clear debt and reward investors.

Yet sensitivities remain about the involvement of private finance in the provision of public assets. At a time when public spending budgets are still falling (though not as quickly as previously suggested), private debt can be a saviour.

We need to learn the lessons of the past, where PFI, PPP and myriad other schemes have left a sour taste in some mouths.

There is much talk of partnership between public and private sectors. In some cases, however, this can be an illusion.

A partnership is traditionally seen as a common endeavour which involves the sharing of profits and losses. That profit element is important to the private sector, but it’s vital for others that this should not be seen as enrichment; the public sector is rightly looking for value for money, but this can sometimes be confused with the cheapest price on offer. There is maybe a perception that some public bodies have been left with unsustainable future commitments for facilities that are gradually becoming obsolete, whilst private providers have been raking in the cash.

That is an unfair and superficial analysis, but there are improvements that could be made to the way that payment mechanisms work.

In looking at funding structures which acknowledge the differing interests and objectives of public and private, a joint venture vehicle (not in itself a new concept) is probably the most flexible arrangement available. This is the vehicle that can raise the necessary finance.

Scotland has been ahead of the UK for a number of years in creating an investible pipeline, through the great work of the Scottish Futures Trust (SFT) and Transport Scotland in particular.

This is frequently commented on in London financing circles, as there is now a wall of cash ready and waiting for investment in what is seen as an attractive long term and stable income investment class.

Very few projects have been aborted for lack of debt support, even in the darkest days of the recession. Debt sources have changed, with some UK banks unable to deliver the necessary long-term commitments, due to their capital costs in the new regulatory environment.

Others have come forward, such as Japanese and German banks with access to customer deposits, as well as insurers including Prudential/M&G and Allianz with funds looking for long term investment, and specialist debt funds.

Not satisfying this demand for investment opportunity could be seen as a significant market failure. If the available funding can’t be utilised in the UK, or is expected to be delivered at pre-crisis pricing levels, it may go overseas to comparable projects.

 What sometimes makes this worse is the confusing interface between Scottish and UK Government approaches to infrastructure investment in Scotland.

Activity has been pushed forward by the Scottish Government as quickly as possible, and we can expect to see more prudential borrowing by Scottish local authorities, along with use of new borrowing powers by the Scottish Government, to keep up delivery momentum.

The UK Government has also been supporting infrastructure and housing projects of national significance through its £60 billion UK Guarantees scheme, in addition to pan-UK initiatives such as digital broadband and City Deals – sometimes in collaboration with the Scottish Government.

Two UK guarantees have been issued in Scotland, one at Grangemouth and the other supporting a biomass plant in Speyside. In neither case did a guarantee seem necessary, given the availability of debt, and neither seems to be nationally significant on a UK scale.

It may be better for the value of the Scottish portion of the scheme to be transferred to the Scottish Government to supplement their own guarantee or other support programmes.

The key role of the Scottish Government now must be to address any market failures, bringing forward as many new projects to investment stage as quickly as possible. And in collaboration with the UK, where that makes sense.

In Scotland, the central government/ local government interface is crucial in creating new momentum for project delivery. Scottish Councils are poised to become drivers of infrastructure investment, complementing the successes of the Scottish Government and Scottish Futures Trust.

In the early days of PFI in the 1990s, it was the Scottish Executive’s unified structure that enabled major projects to be advanced.

The Scottish Cities Alliance, which is looking at local infrastructure investment in a co-ordinated way, is an excellent extension of this theme of effective governmental structures.

While no one expects it to result in a city accepting responsibility for the project debts of another city, this innovative approach will inevitably lead to new project structures that can be replicated across areas.

Finance, once again, will not be an issue, but there is scope for some creative structuring of the financial input. Councils themselves have the option of prudential borrowing, whether from the Public Works Loan Board or private finance, and joint ventures could be formed by cities among themselves and/or with private interests.

The roll-out of City Deal mechanisms may work better in Scotland given this council collaboration.

The Northern Powerhouse will need to establish equivalent contacts between Manchester, Leeds, Sheffield and Newcastle, perhaps creating a Northern version of Transport for London, if it is to be as effective.

So what needs to happen to get the new infrastructure development cycle under way? Scotland is the ideal place to move on to the next delivery model. The approach here, from SFT and others, has always been to be pragmatic and look for the best, quickest, way of delivering the desired results.

There has been press coverage recently of the impact on school and hospital building of new EU accounting rules, which relate to whether an asset or project is classified as on or off the public sector’s balance sheet. However, this is the worst way to encourage innovation. Whether an asset is on the public balance sheet or not is surely irrelevant for all practical purposes. SFT will in time be able to rework its models to fit within the statistical straitjacket, and the issue will be largely forgotten.

Private sector suppliers need to continue to be embraced, or they will pursue work elsewhere. So the public sector needs to price in the cost of innovation, and the benefit of the resulting increase in productivity, in its value for money assessment.

And we need all political parties in Scotland to come together supporting an infrastructure investment programme that can be delivered over the next 20 years.

Michael Stoneham is Partner, Infrastructure Group at Brodies LLP