Funding and Financing Transport Infrastructure

Business Models to Enhance and Enable Financing of Infrastructure in Transport

Athena Roumboutsos, Hans Voordijk, Aristeidis Pantelias, Athena Roumboutsos, Hans Voordijk, Aristeidis Pantelias

• Publisher: Routledge
• Year: 2017
• Print ISBN: 9781138293892
• eBook ISBN: 9781351866217
• Edition: 1
• Topic: Business
• Subtopic: Bookkeeping & Budgets
• Index: Business

This book seeks to enhance understanding of the impacts of project setup and its implementation environment on project performance by leveraging information from the study of a rich set of European transport infrastructure project cases. It puts forward a system's view of project delivery and aims to serve as a strategic tool for decision makers and practitioners. The proposed approach is not limited to specific stakeholder views. On the contrary, it allows stakeholders to formulate their own strategies based on an holistic set of potential implementation scenarios.

Furthermore, by including cases of projects that have been influenced by the recent financial crisis, the book aims to capitalise on experiences and provide guidelines as to the design and implementation of resilient projects delivered both through traditional as well as Public Private Partnership (PPP) models.

Finally, the book proposes a new Transport Infrastructure Resilience Indicator and a corresponding project rating system that can be assessed with an eye to the future, ultimately aiming to support the successful delivery of transport infrastructure projects for all stakeholders involved.

1
Introduction

Athena Roumboutsos, Hans Voordijk and Aristeidis Pantelias

1.1 The need for a transport infrastructure delivery performance rating

Local and global infrastructure needs, the widening ‘financing gap’, and the increasingly important role of the private sector in the delivery of infrastructure have been at the forefront of public and private debate over the past three decades and drawn the close attention of both academia and the industry. Transport infrastructure has always been at the core of these discussions given its economic value-adding nature as a sector and also its strong traditional reliance on public procurement and delivery. The recent global financial crisis (GFC) was only the latest reminder that governments have found it increasingly difficult to maintain a high standard of transport infrastructure in a framework of tight public spending, which has continuously declined since the 1970s (Inderst, 2013). The resulting transport infrastructure investment gap has been estimated to be in the trillion USD range (World Economic Forum, 2012; Mckinsey Global Institute, 2013). Private financing of infrastructure became a popular solution from the 1990s and onwards, as the underlying delivery models did not immediately affect public spending, which was a key driver for many governments (European Investment Bank, 2005; Irwin, 2012).

Globally, a mismatch appears to exist between demand for infrastructure investment and supply of infrastructure finance (Ehlers, 2014). Considerable effort has been made to understand the barriers that create this mismatch and identify the tools/instruments to remove them. In this book, an important distinction will be made between financing and funding, as the two are not quite the same: the former corresponds to raising capital at the beginning of a project to pay for its development costs, such as construction costs; the latter corresponds to the long-term financial streams that will support the repayment of the financing of the project during its operating life and is closely related to its overall economic and financial viability. This distinction is crucial in understanding the three major barriers that have been identified in the literature to create the aforementioned mismatch:

• lack of experience and knowledge on infrastructure both from the technical perspective of project delivery as well as with respect to its characteristics as a potentially new asset class (i.e., its risk-return profile);
• regulatory restrictions in the provision of long-term finance; and
• lack of sufficiently robust and reliable funding streams for infrastructure development.

All three barriers are interrelated: the GFC has affected funding streams and has stressed returns on existing investments putting long-term financial arrangements at risk; providers of long-term finance, seeing their returns decrease and their risk increase, have reduced their tenors and overall exposure to the sector to minimise losses; losses have alarmed regulators who have, in turn, instigated stricter regulation to protect against systemic risk; regulatory restrictions imposed have further reduced the supply of long-term finance, thus making future investment in infrastructure more expensive; expensive financing makes projects more difficult to approve and requires stronger underlying funding streams in order to be viable, which goes full circle to the beginning of the discussion. Unless the vicious circle is broken, the mismatch seems to be hard to abate.

Numerous authors have identified the economic and financial characteristics that can make infrastructure investments attractive: long-term assets with long economic life; low technological risk; provision of key public services creating strong, inelastic demand; natural monopoly or quasi-monopoly market contexts; high barriers to entry; asset regulation; frequent natural (or contractual) hedge against inflation; stable, predictable operating cash flows; attractive risk-adjusted returns and low correlation with traditional asset classes and overall macro-economic cycles (Gatti, 2012; Blanc-Brude, 2013; Valila, 2015).

Transport infrastructure, in particular, is related to economic development and, therefore, creates direct and indirect beneficiaries. These beneficiaries provide direct (such as tolls, fares and other forms of user fees) and indirect (such as potentially greater tax revenues) funding streams in support of the respective investment(s). A stream of funding (expressed as project revenue) is a necessary (but not always sufficient) underlying condition for financing, whether public or private. The terms of financing depend significantly on the reliability of the funding/revenue stream, which in turn, relies on the infrastructure’s ‘ability’ to sustainably achieve the designed (planned/anticipated) direct and indirect benefits described by its business case and wider business model. Given such potential to generate revenues, private finance and alternative project delivery models supporting the involvement of the private sector in design, construction, operation and maintenance, as well as financing, have been adopted in various parts of the world for the provision of transport infrastructure (Engel et al., 2010).

However, relying solely on the private sector to deliver infrastructure would lead to suboptimal levels of investments due to its market nature (Helm, 2009). This is even more pronounced in the case of transport. Transport infrastructure may generate substantial benefits to a wide range of sectors. These are usually difficult to measure and/or monetise. Even if measuring them was possible and accurate, monetising their impact and charging for it might still be difficult or even undesirable. In this context, some form of public sector contribution is, often, expected in transport projects, such as the provision of initial (grant) financing during construction and/or subsidies during operation.

Infrastructure projects are complex and unique. Transport infrastructure projects are no exception and have been characterised by enormous cost over-runs (some transport modes more than others) due to optimism bias in their exante evaluation phase, among other possible reasons (Flyvbjerg et al., 2004). To competently address this complexity, developers and investors need to build respective capabilities, which is only efficient and feasible if a pipeline of projects is available.

Transport projects are usually revenue generating. As such, revenue-related risks are significant for their viability and reflect the uncertainty in predicted traffic volumes and the willingness of users to pay for the relevant service(s). Transport pricing, apart from determining the characteristics of the corresponding revenue stream, is also highly correlated to travel behaviour, social acceptance and the feeling of fairness. Pricing becomes crucial in cases of private involvement in transport infrastructure delivery as motives may differ: while the government would aim to spread the resulting benefit at a low price by allowing service access to many users, the private sector would tend to set higher prices attracting fewer users and thus reducing its operation and maintenance costs. Additionally, in cases where the private sector acts as ‘owner’ of the asset, it usually requires the establishment of a ‘temporary monopoly’. This condition, which can result from the natural location of the asset with respect to the underlying network or can be contractually induced, may be affected by the planning of other new or upgraded transport assets/services and general spatial planning by the public sector. In some cases, these plans may work in support; in others in competition, reflecting ultimately on revenue risk.

Additionally, many transport infrastructure projects only reach forecast traffic levels and, therefore, generate healthy cash flows, many years after their commissioning, rendering demand/revenue risks during their initial phase of operation (ramp-up) notoriously high. Asset specificity and the uniqueness of provided services also make investments in transport infrastructure projects sunk in nature and subject to hold-up risks (Evenhuis and Vickerman, 2010).

Risk exposure is very different during the different phases of transport infrastructure development. Ehlers (2014) argues that each phase requires a different mix of financial instruments to cover different risk and return profiles and so attracts different types of investors. At the same time, the issue of (lack of) expertise in the sector makes some investors dependent on others. For example, banks have built great capabilities in understanding technical due diligence and monitoring progress during construction, which are recognised and valued by other potential debt investors. Banks, hence, often serve as an implicit ‘insurance’ to other groups of investors with fewer monitoring capabilities, thus enabling them to participate in the financing package. However, despite these capabilities and their strategy of syndication and securitisation of loans, many banks did not survive the collapse of the inter-bank lending market during the GFC (Hellowell et al., 2015).

In response to the effect of the GFC, stricter international regulations were put in place introducing more stringent capital requirements for banks (Basel III), increasingly limiting their appetite and potential to provide long-term financing instruments. This regulatory intervention led project developers and sponsors to investigate the potential of other financing instruments, such as project bonds, and other sources of long-term capital, such as institutional investors¹ (Della Croce, 2011). It should be noted, however, that institutional investors’ appetite for long-term infrastructure financing has also been affected by similarly adverse regulatory interventions (Solvency II). Furthermore, capital market solutions bear a significant limitation. As bond ownership is fragmented and dispersed among multiple holders whose infrastructure-specific expertise is limited or inadequate, due diligence can no longer be kept ‘in-house’ as in the case of banks. While certain institutional investors have the necessary skills to evaluate and monitor such investments on their own, most capital markets infrastructure investors need to rely on third-party due diligence and relevant market signals. These are provided in the form of ratings issued by specialist rating agencies. Notably, ‘creditworthiness ratings’ or ‘credit assessments’ concern the assessment of a project ‘owner’s likelihood of default’ (including delayed payment of debt).

According to the OECD (2014), project ratings are of particular interest to most institutional investors as in order to comply with their fiduciary duties they can only invest in investment-grade securities (rating categories BBB-/BAA and above). However, data from the period 2006–2010 show that a large part of project bonds were concentrated around BBB rating (OECD, 2014). As such ratings are too close to the threshold of noninvestment grade debt (junk), and various credit enhancement solutions have been introduced, aiming to further raise the creditworthiness of such bonds to safer categories (Hellowell et al., 2015).

Pantelias and Roumboutsos (2015) profess that there are two important difficulties in achieving reliable credit assessments for infrastructure projects, especially in the case of Public–Private Partnerships (PPPs): (i) the fact that the special purpose vehicles (SPV) delivering these projects are independent entities with no financial history; and (ii) that infrastructure assets have particularities that are not equivalent to typical financial investments. Credit assessments are based on bespoke methodologies that are many times asset or sector specific. In many methodologies concerning PPP projects, the focus of the assessment is mostly on the ability of the contracting (public) authority to bear the credit risk of the project as opposed to the ability of the project to achieve forecast performance.

However, before resorting to the assessment of the project ‘owner’s’ ability to honour debt obligations or assessing their riskiness of default, it is equally important – if not more so – to assess the likelihood of the project itself achieving its target performance outcomes. These outcomes encompass economic, social, environmental, and institutional targets, with financial targets such as debt repayment, being a smaller subset of them. Consequently, while credit assessment methodologies are concerned with risk bearing, that is, with determining whether the (legal) entity that is liable to honour (pay) debt obligations will be able to do so during the life time of the project, what seems to be missing is an assessment tool that estimates the likelihood of a project delivering on its various performance targets. This different focus places the emphasis on risk management that comes a step earlier than the ability to bear risk, under the logic that various circumstances that can jeopardise the ability of a project to deliver its expected outcomes (and to repay its debt obligations as a sub-set of them) can be anticipated and potentially mitigated through managerial actions/decisions before the need exists for one of the project stakeholders to bear the financial consequences of a risk that has eventuated.

Providing such a tool in the form of a new indicator with an underlying rating system that describes the ability of a transport Infrastructure project to withstand, adjust and recover from changes within its structural elements with respect to its ability to deliver specific outcomes (such as cost and time to completion, expected traffic and expected revenue targets) has been the objective of the BENEFIT (Business models for ENhancing funding and Enabling Financing for Infrastructure in Transport) H2020 funded project.² This indicator is termed Transport Infrastructure Resilience Indicator (TIRESI).

1.2 Business Models for Enhancing funding and Enabling Financing of Infrastructure in Transport: introducing the system and its rating

The TIRESI stems from the consideration of transport infrastructure delivery and operation (including maintenance) as a system of interrelated elements. The system’s overall behaviour depends on its constituent elements and for a project to attain pre-specified outcome targets, the risk characteristics of these elements need to be considered and understood.

A core element of the system is the business model. Notably, the wider and more encompassing the business model value propositions are the wider the range of anticipated performance outcomes, which may include the following:

• direct, indirect and induced economic (and financial) outcomes;
• environmental outcomes;
• social and societal outcomes;
• institutional outcomes.

These outcomes generate varying streams of revenues stemming from public sources, captured either as direct revenues (from users of the business model value proposition), or indir...

Table of contents

• Cover
• Title
• Copyright
• Contents
• List of figures
• List of tables
• List of contributors
• Foreword
• Acknowledgements
• List of abbreviations
• 1 Introduction
• 2 Key mode-specific issues in funding and financing of transport infrastructure
• 3 Transport infrastructure delivery in context
• 4 Measuring transport infrastructure project resilience
• 5 Analysing scenarios of transport infrastructure funding and financing
• 6 Investing in transport infrastructure: a stakeholder’s view
• 7 Conclusions and recommendations
• Appendix: BENEFIT project cases dataset
• Index