As global demand for improved infrastructure rises in tandem with institutional investors’ need to invest large capital pools in long-term assets, allocations of private capital to public infrastructure, as an investment asset class, are set to grow significantly. The public-private partnership (PPP) model is increasingly being deployed by governments and investors around the world to inject private capital into the asset class.
To address burgeoning demand, governments struggling to balance their budgets must encourage private-capital investment in infrastructure. This shouldn’t be a tough sell for institutional investors like pension funds, sovereign wealth funds and insurance companies, whose investment needs align well with infrastructure assets, which offer long-term and stable cash flows to offset long-term liabilities. These assets also often have built-in inflation protection, and their relative illiquidity compared to other asset classes may not be a big issue for such investors.
The most salient trend reported in the OECD’s December 2014 Annual Survey of Large Pension Funds and Public Pension Reserve Funds was an increase in alternative investments, including infrastructure. While actual investment in infrastructure was low on average, there is huge potential demand, with many funds increasing their allocation to infrastructure or opening new allocations to the infrastructure asset class. According to the report, target allocations among the funds with dedicated infrastructure exposure ranged from 1% to over 20% of total assets.
The PPP procurement model is one way to use private capital to build public infrastructure. Although PPP means different things to different people, the Canadian Council for Public-Private Partnerships defines a PPP as “a cooperative venture between the public and private sectors, built on the expertise of each partner, that best meets clearly defined public needs through the appropriate allocation of resources, risks and rewards”.
A typical PPP transaction involves the selection by a public-sector entity of a private-sector partner to design, build, finance, operate and maintain a piece of public infrastructure for a term usually in the range of 25 to 50 years. The transaction may be structured on an availability basis, where the private partner is paid for ensuring that the infrastructure is available to the public in a specified condition, or may include some revenue risk to the private partner, as would be the case with a toll road or bridge. The vast majority of PPP transactions in Canada are availability payment deals.
The financing of a PPP transaction is characterized by high leverage and low debt service coverage ratios, robust security packages from subcontractors to cover performance risks and, ideally, a strong government counter-party with the power to appropriate the funds necessary to pay for the asset over time.
Although some PPP transactions involve the refurbishment or repurposing of established assets (e.g. creating high-occupancy toll lanes on existing roadways), most are best described as “greenfield” in that they involve the creation of new assets needed to replace aging infrastructure or accommodate increased demands resulting from population growth or demographic shifts. In this way, PPP transactions create new assets to be bought and sold by investors in the future.
In Canada, many PPP transactions involve relatively large milestone payments from the public-sector partner to the private-sector partner on the substantial completion of construction. This allows for the use of innovative financing structures involving a combination of short-term bank and/or bond financing to cover the construction period, and long-term bond or private placement financing to cover the remainder of the operational term. Most of the large Canadian life insurance companies are active as debt investors in the PPP arena. The Canadian pension funds also participate, primarily as equity investors.
It was recently announced that La Caisse de dépôt et placement du Québec (La Caisse), which manages public pension plans in the province of Quebec and has almost C$226 billion in net assets, will be given new powers to control and develop major infrastructure in the province. The Quebec government will identify and approve potential projects and La Caisse will undertake the planning, financing and execution of the project on the government’s behalf. It appears that their approach will share some features with the PPP model, including a focus on the overall costs of a project over its entire lifecycle.
Assuming that planned legislative amendments are passed later this year, La Caisse plans to establish a new subsidiary, CDPQ Infra, to execute the projects. The first two projects identified are a public transit system on Montreal’s new Champlain Bridge (which is currently being procured as a PPP project by the Canadian government) and a public transit system linking downtown Montreal to the Montreal-Trudeau International Airport.
Canadian institutional investors have also shown considerable interest in infrastructure investment in India. It can be expected that this trend will continue as attractive opportunities arise.
Torys LLP is an international business law firm that works with clients who expect the best advice and service. Tara Mackay and Mark Bain are partners at the firm.
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