These plans were highlighted in Chancellor Rishi Sunak’s first budget speech in which he promised that over GBP600m would be invested in infrastructure such as roads, hospitals, schools, housing and broadband over a five year period1.
In addition to the obvious benefits of improved infrastructure, the building programme is also an attempt to resuscitate the ailing economy, create jobs and generally assist the UK to recover from the devastation wrought by the pandemic. The obvious question is, how will these projects be financed?
From the early 1990’s the Private Finance Initiative (PFI) model was extensively used by Central and Local Government to procure infrastructure projects, notably roads, hospitals, prisons and schools. At this time, private sector contractors found it relatively easy to secure loans to develop these projects. However, many of these projects were eventually found to be poorly constructed, inadequately maintained and generally being poor value for money with investors taking disproportionate dividends. The 2008 financial crisis effectively killed off the PFI model2.
Despite the PFI model falling from favour, the UK government has made it clear that the use of public private partnership (PPP) models are still very much part of their plans for the delivery of infrastructure projects. Contractors bidding to construct and maintain such PPP projects will generally be planning to finance the project through a mixture of equity and debt. The contractors’ ability to borrow from lenders will be very much influenced by the lenders attitude to the project involved. The various financial institutions such as banks, pension funds and other investment vehicles will also have different attitudes to the project opportunities with which they may be presented.
Over the years, with government influence and regulation changes, institutional investors such as insurance companies, pension funds and investment funds have heavily invested in infrastructure projects. However, this has very much been investment in operational PFI/PPP projects where guaranteed revenue for the tenure of perhaps 20 to 30 year contracts has been seen as highly desirable. A thriving secondary market has developed where pension funds and investment funds compete to acquire infrastructure companies that hold such contracts. However, these financial institutions understandably find construction phase risk to be far less attractive as fund investors must generate immediate returns to meet their liabilities. Some banks have specialised in offering short-term construction phase financing with a view to selling the completed asset to institutional investors through the capital markets.
In respect of the entities such as traditional banks that may be willing to lend on the construction of infrastructure projects, certain features of a project have been seen to have a bearing on the lenders’ attitude to providing loans.
Some infrastructure projects may be viewed by lenders as too large scale, complex and therefore inherently riskier than the relatively low risk, self-contained social infrastructure projects that were prevalent during the PFI period. If lenders experience difficulties in understanding the complexities of the project and the potential long-term risks, they will be uncomfortable in lending.
The clarity of the various contractual agreements to be signed by the project company will also be an issue for lenders. No inherent conflict between agreements with visibility of an equitable risk allocation between the counter-parties and a guaranteed revenue stream to the project company will be a prerequisite to lending. An attraction of the PFI model was the certainty provided by the standard Project Agreements with which lending banks became very familiar and comfortable.
Lenders are also often concerned about lending on projects that will operate within a heavily regulated market, such as energy or water, as long-term regulatory and political risk could impact on revenues. Having said that, the UK offshore wind power industry and its associated transmission asset divestment programme has been very successful and mostly funded by debt finance.
It is worth noting the traditional role of the European Investment Bank (EIB) in lending money for infrastructure projects with an estimated EUR 118bn being lent in respect of UK projects since 19733. However, it must be assumed that at the end of the Brexit transition period this EIB source of financing will no longer be available. In response, the UK government is currently exploring options to create a state-owned infrastructure bank specifically to replace the EIB and provide low interests loans for infrastructure projects. Although nothing is certain, an announcement on Government thinking is expected this autumn.
Any lender will scrutinise the long-term viability of a project on which they are being asked to lend and the proposed project insurance programme will be an important element of this scrutiny. The protection provided to the integrity of the project by the insurance programme arranged by the borrower will be of great interest to the Lender. Lenders will wish to be satisfied that insurance is adequate to replace damage to the assets that generate the project revenues and that insurance will also replace revenue lost as a result of damage to assets. Delays during the construction phase are of particular concern to lenders who will be will be anxious to understand the extent of any insurance protection for costs arising from Force Majeure events, such as pandemics, where there may be no recourse to contractor damages.
Lenders will also wish to understand the insurance protection for legal actions from third parties who allege that they have suffered injuries, damage, nuisance or pollution from the activities of the project company.
Despite the enormous economic upheaval caused by the current pandemic crisis, with imaginative support and guarantees from the UK government it should be expected that lenders will continue to be prepared to lend on projects that meet their particular risk appetite.
1. ‘Rishi Sunak to promise 'historic' investment in first budget’ The Guardian March 2020
2. ‘Loss of initiative’ The Guardian Feb 2009
3. ‘Global Vantage: Engineering without the EIB: Infrastructure funding Post-Brexit October 2020’ Lexology
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