Written By: Gregg McClymont
Gregg McClymont of IFM Investors looks at how pension fund capital can assist the UK government’s infrastructure spending initiatives
Just before the Covid-19 pandemic hit the UK in March, the new government delivered a statement of intent on infrastructure, pledging public capital expenditure of £640 billion over the next five years to invest in economic and social infrastructure ranging from the prosaic (potholes filling) to the visionary: building a Net Zero carbon economy by 2050. Roads, rail, hospitals, broadband, electric charging points, clean hydrogen, carbon capture and more are in the government’s sights as it seeks to “level up” the regions outside London and the South East of England, and to make the UK a leader in new green technologies.
This is exciting: improving the air we breathe, shortening the time we spend travelling, increasing digital connectivity, enhancing our National Health Service, and above all else limiting the impacts of climate change, enriches our quality of life now and in the future.
Infrastructure funding policies remain unclear
The Chancellor in his Summer Economic Statement response to Covid-19 announced he was chairing an initiative called “Project Speed” that will review the planning, design and bid processes around infrastructure procurement. The immediate context is the need to stimulate the depressed economy by bringing forward an initial £5 billion investment in decarbonising private households/public sector offices, and improving/building hospitals and roads. Autumn meanwhile promises a series of official statements, including the National Infrastructure Strategy (NIS), Infrastructure Pipeline, Infrastructure Finance Review (IFR), and revisions to the Treasury Green Book value for money criteria, as well as the Energy White Paper, which will set out the path towards Net Zero carbon by 2050.
Private capital’s role
The financing and apportioning of risk in new infrastructure investment projects is often the greatest challenge. Significant cost and time overruns have dogged the enormous publicly-financed HS2 project, with the large Crossrail project (mostly public funded) experiencing similar issues. More acutely still, the Covid-19 crisis reduces the government’s future ability to borrow on balance sheet to fund its five year £640 billion capital expenditure target. UK national debt now exceeds £2 trillion¹ and represents more than 100% of GDP for first time in sixty years. Over the first four months of the financial year, cash receipts paid to the exchequer were down by 29.4% compared with the same months in 2019-20, while cash spent by central government was 54.3% higher. Meanwhile, the current account deficit is rising towards 20% of annual income². This is almost as high as during World War II and almost double the levels reached in the wake of the 2008 financial crisis.
Large infrastructure projects are already using a mixture of public-private partnership models including:
- 1. Thames Tideway Tunnel model (a hybrid Regulated Asset Base (RAB) model) – characterised by consumers paying higher bills upfront, a cap on private sector construction risk and high yielding bonds issued by the Special Purpose Vehicle (SPV).
- 2. Contracts for difference model (agreed for Hinkley Point Nuclear Power Plant) – in return for the constructor-owner, EDF, bearing the whole of construction risks, the government underwrites the future revenue stream via an agreed fixed price (for energy generated).
- 3. Economic-beneficiaries-help-fund model (adopted for Crossrail) – a third of the original projected cost of Crossrail was largely funded by local business tax increases.
For medium-sized projects, however, the future is harder to predict. The Private Finance Initiative (PFI) consortia model, which delivered 716 social and economic infrastructure projects across 25 years, was retired by the previous government in 2018, citing poor value for taxpayers’ money. PFI sought to transfer as much risk as possible to constructors, with equity investors achieving “value for money” by maximising leverage and a passive approach to project management. Constructors as well as government now appear unwilling to accept the debt-heavy, equity light model which pushes risk onto them. According to the CBI’s Fine Margins report in February 2020, “Adversarial behaviours built up over many decades coupled with problematic approaches to risk allocation and procurement have resulted in a [construction] business model that too often remains short-termist and unsustainable.”³
There is an alternative approach that could deliver better outcomes by unlocking billions in pension capital for investment. It offers government an equity partner that has a long-term “whole life of the asset” approach to infrastructure, deep pockets and expertise in large infrastructure project management and delivery. Government balance sheets are stretched but pension funds have money to invest for the long term and they tend to be socially aligned with the values and expectations of the general public. In the UK today, the pension savings of millions of working people are already assisting the government with infrastructure investment projects, and we believe this relationship can be taken to a new level by Pension-Public partnerships.
A new approach – Pension-Public partnerships
We define a Pension-Public partnership as a collaboration between a government and a pension fund to finance, build and operate a new piece of infrastructure, agreed through a competitive public tendering process. This could include economic infrastructure, like a toll road, rail tunnel or airport terminal, or social infrastructure, such as housing, education or health projects. Both parties usually contribute money to the project and take on some level of risk. In return for its contribution, the pension fund is usually granted a concession to operate the asset, once it is completed, for a predetermined period of time (often 20 to 30 years).
Pension-Public partnerships are attractive as they are mutually beneficial for the economy, the government and the pension fund members. They enable governments to fund the construction of infrastructure assets that the economy really needs, whilst giving pension funds the opportunity to allocate their capital to projects that can generate socially positive outcomes and attractive long-term returns for their members.
Why pension capital?
As investors, pension funds tend to be long-term, active, responsible asset owners. They are naturally long-term and patient because paying pensions is a long-term business.
Instead of being passive investors, many pension funds are actively involved in the management of the assets they buy and are strongly focused on improving operational efficiency and the services provided, whilst also delivering attractive returns to members. We believe careful stewardship of infrastructure assets can improve opportunities and employment outcomes for the community where the asset is located, as well as contributing to wider social and economic benefits. A good example of a Pension-Public partnership is Manchester Airports Group.
IFM Investors (IFM) owns 35.5% of Manchester Airport Group (MAG), along with Manchester City Council (35.5%) and nine other Greater Manchester local authorities (29%). With a portfolio comprising Manchester, Stansted and East Midlands Airports, the group is the United Kingdom’s largest airport operator. The £1.1 billion Manchester Airport Transformation Programme⁴ (currently reaching completion) is an example of what a Pension-Public partnership can achieve in infrastructure development. Featuring two major UK construction company contractors and 75 sub-contracts worth a total of more than £900 million, this investment has created thousands of jobs, over-achieved on ambitious targets for the use of local companies, the green disposal of waste, and the creation of apprenticeships. Across the 10 million man hours worked so far, the Pension-Public partnership’s focus on health and safety has been rewarded with a very low number of RIDDOR⁵ incidents. An £80 million investment in Stansted Airport has also been made.
Across MAG, a carbon reduction programme means all three airports are now carbon neutral, with energy needs met via renewable sources. This efficiency gain has translated directly into improved financial performance for investors. The group has also made substantial investments in the Stansted Airport College, which trains airport industry workers of the future. This initiative builds public trust and contributes to economic prosperity at the individual, industry and society levels; outcomes that better enable IFM to protect and grow the long-term retirements of working people worldwide.
Pension funds invest on behalf of around 8.5 million⁶ UK working people who are the underlying owners of these infrastructure assets that are utilised by millions of members of the public every day. So pension capital tends to be more aligned with the interests of the general public. To fulfil their fiduciary responsibilities, pension investors in infrastructure must be mindful of the public trust that is vested in them when they operate infrastructure assets. They rely on, and need to remain committed to, maintaining this trust.
Utilising pension fund capital to help create new infrastructure in coming years can help rebuild the UK public’s trust in a new PPP through the dual role that pension funds play – maximising and protecting long-term returns to members through investments that create value, whilst also playing a constructive role in society and the broader economy.
Building back from Covid-19 presents the government with an array of challenges. The UK needs to use all the assets at its disposal. One of the biggest pension fund systems in the world is one of them. Together it can be put to work in members’ interest, and the country’s too.
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2. Source: Fiscal Sustainability Report and Policy Monitoring Database, Office of Budget Responsibility, July 2020
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