The government has grand ambitions to upgrade the highways network – but can it convince UK pension funds to take a measured risk and fund these projects?
It was encouraging to see that, in the latest Spending Round, the government underlined its commitment to treble investment in major new road enhancements by 2021, to invest more than £28 billion in enhancing and maintaining national and local roads, and to undertake an overall planned programme of works worth up to £50 billion over a 10- to 15-year period.
The UK has failed to keep up with competing countries in spending on road infrastructure – and this major investment commitment could be just the tonic we need to start catching up again. In 2010 Japan spent almost three times as much per head as the UK did, and Australia and Canada spent more than four times as much.
The government has yet to identify a procurement method for its planned programme, but we can plausibly expect private finance to play a role, building on previous experience with maintenance PFIs and design, build, finance and operate (DBFO) contracts.
However, as an industry we have seen that private finance has become much more difficult and costly to secure since the financial crisis made banks less willing to offer long-term debt. As a result, the Prime Minister has proclaimed an “urgent” need to woo institutional investors – including pension funds – into the infrastructure arena, in order to reinvigorate the roads network.
In my view, the government’s commitment to channel money into UK roads and catch up with our international competitors can only be good news, given the current underinvestment and lack of activity. However, the bad is that the UK has failed to keep up with other countries in another area: persuading pension funds to invest in new infrastructure.
We already frequently see pension funds in countries such as Canada making investments in new infrastructure domestically and abroad, yet UK pension funds seem determined to invest in operational ‘brownfield’ infrastructure only, and shun the higher potential risks of ‘greenfield’ projects involving new construction. Nevertheless, UK pension funds are being eyed as the new saviour of infrastructure investment.
Accordingly, the government has unveiled a range of measures to tempt pension funds from brownfield to greenfield. The government has worked with the pensions industry to establish the Pensions Infrastructure Platform (PIP), a pension fund collective which the Treasury hopes will invest around £20bn. PF2, the successor to PFI, has been designed to offer a more attractive deal to institutional investors through lower gearing – meaning that PF2 requires a greater proportion of equity than PFI – and shorter procurement periods, at a maximum of 18 months.
The government has amended regulations to allow pension funds to invest up to 30% of their funds in high-risk schemes, an increase on the previous 20%. And last year it launched the UK Guarantees Scheme, to underwrite £40bn of infrastructure projects.
But is this enough? UK pension funds have a deep-rooted predilection for low-risk investment, and the government cannot erase the fact that any project with a construction phase will carry greater risk than one without. In highways, risks include ground conditions, utilities, planning permission and, where user charging is involved, local demand. The addition of a bridge or tunnel brings another raft of hazards.
Then again, those of us familiar with construction know that a straightforward road project could have a very tame risk profile. The challenge for pension funds is to ascertain which scenario is which.
Most pension funds almost certainly do not have the required expertise in-house, and so their willingness to invest may ultimately depend on whether this paucity spurs them to engage a technical consultant for advice and guidance, or to close the door on greenfield altogether.
Size also matters. In contrast to countries like Canada, the UK’s pension funds are generally too small to be able or willing to stump up adequate project investments alone. Collective funds such as the PIP could be the answer to this, as long as those funds can also access the necessary technical advice.
The crucial challenge now is to help pension funds recognise and seize the opportunities in new infrastructure. Technical consultancies can play a key role in this – but only time will tell whether long-standing preferences can be reversed.