Investing in the future

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The UK could soon see the election of an explicitly socialist government with an extensive nationalisation programme alongside hostility towards public private partnerships and the commercial funding they involve.

Were the left-leaning Labour party to be elected, specialist infrastructure investors are firm in their view that the backlash to public private partnerships will remain confined to the UK and not spread to other markets.

They also assert that a widespread nationalisation programme faces huge legal and financial challenges not least future demands for more and better infrastructure.

That said, the rhetoric has cast something of a cloud over the sector with suggestions that the prospective Shadow Chancellor John McDonnell wants to bring existing contracts back under public control for less than their current market value.

Of course, Labour has to get elected first, though that does seem at least a reasonable possibility if not quite a racing certainty.

The UK is in throes of a post-Brexit vote political crisis and any number of scenarios are possible, but several polls in June had the Labour Party marginally ahead on around 26 per cent vote share albeit with three other parties, the populist Brexit Party, the ruling Conservatives and the centrist Liberal Democrats with sizeable support. On any measure, it is clearly a significant political risk.

Polling in the UK in the month of June. Source: Britain Elects

Infrastructure investors say that Labour’s ideas are unlikely to spread to other economies which have embraced the public private partnership concept.

Frank Schramm, co-CEO of BBGI S.A, a global infrastructure investor, says: “We don’t see that political risk anywhere in other countries we are invested in, not in Western European, or in the US, Canada or Australia. It is an isolated discussion which we only see in the UK.”#

Giles Frost, manager of International Public Partnerships (INPP), adds:This perceived existential threat to the use of private capital is a uniquely UK phenomena.

“It doesn’t apply anywhere else in the world. When we do business in Germany, we are welcomed by the municipal authorities. When we do business in the US or Australia, we are welcomed by the authorities, simply because the culture is very much one of using private capital. The issues in the UK are very, very local and ideologically driven.

“They are ultimately rooted in the transfer of public sector employment to the private sector, back in the early days of the Private Finance Initiative. I believe it is flawed, not because, it’s not reasonable to have debate as to what infrastructure should be financed by private capital and by public capital.

“It’s unreasonable, because the quantum of infrastructure required is so great, it is not possible to provide it all from public sector sources. Choices will have to be made.”

Did communication let PPP down?

The investors concede that, as it has developed and spread to other economies, PPP has evolved and certain mistakes have been avoided.

Schramm says that some lessons have been learned from the UK market in arguably the next most important market Canada. For big projects, the state might take on the “expensive” senior debt and cover the insurance costs but he says the contracts look around 90 per cent the same.

Frost says there has often been a failure by the sector to communicate where it has offered value for money including making sure stakeholders and not just shareholders can see properly what is being delivered – something that is important when it comes to a school or a health service development for example.

Substantial barriers to nationalisation

Schramm also points out that substantial barriers to an extensive nationalisation programme remain.

Any nationalising country is likely to have to pay international investors a full market price under international obligations.

“It can be quite tricky to nationalise things because if you have investors in Singapore, where you have got bilateral investment treaties, they have a good chance of getting fair market value, if nationalisation really comes. Yet how do you explain that for some investors they get fair market value on the one hand, but UK pensioners may get less than that?” he says.

Frank Schramm: “Where you have got bilateral investment treaties, they have a good chance of getting fair market value, if nationalisation really comes”

Schramm also points to UK legal opinions which confirm this point of view.

Clifford Chance published an update in May entitled UK nationalisation: The law and the cost – 2019 update.

It says: “International law requires fair market value compensation when a business is nationalised, and we are unaware of any previous nationalisation of a solvent business, in the UK or another OECD member country, where this approach was not followed. If Labour really do depart from this international norm then that will, almost inevitably, trigger compensation claims by investors.”

The note points to a range of bilateral treaties including with China, India, Hong Kong, Singapore and the UAE, while energy investments specifically covered by the Energy Charter Treaty involves most EU members and 53 states in total.

The note adds: “Investors who do not benefit from investment treaty protection, including UK investors, would have a potential claim under the Human Rights Act 1998 and/or the European Convention on Human Rights, but these claims are likely to face greater challenges. However, UK and other investors may benefit collaterally by virtue of another investor bringing a successful investment treaty claim.

“We are doubtful that the UK Government will want to pay higher compensation to foreign investors than to UK pension funds. Hence the final result may be that there is little practical choice, but to offer a fair value to all.”

Break clauses could cost a great deal

Of course, before anyone starts suing anyone else, most infrastructure funds and investment companies have built in substantial break clauses, which should protect any investments they have made to date. There is also a long list of nationalisation targets in Labour’s sights.

Schramm adds: “We are less affected because we have got a contract where we put explicit clauses in there for voluntary termination. Across the board, there are breakage costs for banks to be paid, which in a low interest rate environment can be huge, and there’s also equity compensation to be paid. So there are mitigants but also lots of hurdles, before it gets to us.”

Philip Kent, manager of GCP Infrastructure Investments, which is a UK-focused company, points to the sheer scale of the infrastructure challenge in the UK.

The current UK national infrastructure plan which runs until 2028 and was last updated in February this year, involves around £600bn of investment with £300bn coming from the private sector.

But alongside this relatively ambitious programme, even the current Conservative Government wants to see changes in the nature of contracts with PFI and PF2 style contracts being brought to an end. The fund managers say that they are watching the developing government proposals with interest.

Ambitions will collide with reality

Yet all the managers see a gap between ambitions for infrastructure and the current incentives to invest or lend.

Kent says: “Our observation of this pipeline would be a lot of the planned assets that are listed against energy and in the private sector investment bucket need something to change to motivate those assets to be built, whether that’s a change of planning policy, in the case of onshore wind. subsidy-support mechanisms in the case of some of the more advanced waste technologies, more support for heat networks, and a new replacement of heat infrastructure with renewable heat infrastructure. We would identify quite a large inconsistency.

“To layer on top of that climate change targets that have increased recently to a net zero position by 2050 – well let’s not underestimate the scale of change that would require in terms of the way we generate electricity, generate heat, the implications for transport, waste and agriculture. There are really material changes to our infrastructure required to hit those targets. On the one hand, you have a massive ambition and need for infrastructure and the other, we have, PFI and PF2 being stated as models that the government doesn’t want to see moving forward.

Phil Kent: “Climate change targets have increased recently to a net zero position by 2050 – let’s not underestimate the scale of change that would require”

“We have renewable energy probably at a decade low in terms of the availability of support. There’s an inconsistency there, that needs to break down at some point and be resolved.”

Frost is also sure that many of these inconsistencies will have to be addressed, but that applies even more to the Labour position.

He says: “Ultimately, even the Labour party plans don’t really involve providing infrastructure from public capital or only in a sense that they will borrow from the gilt markets. It’s not sufficient, in my view, to say, we’re going to nationalise all these things by borrowing lots and lots of money from other private sector investors because private sector investors are not stupid.

“There’s not going to be a willingness to lend billions and billions to the UK Government at current interest rates at the same time as those investors are also having assets taken away from them at potentially less than market value.”

Giles Frost: “There’s not going to be a willingness to lend billions to the UK Government at current interest rates, if those investors are also having assets taken away from at less than market value.”

Infrastructure not trackers

Frost adds: “The UK Government wants everyone to invest in tracker funds and nothing else, but there are real political benefits in a diversity of investment opportunities. What could be more appropriate for people to invest in, as well as socially beneficial, than the long term infrastructure needs of the country.”

“It seems to me to be counterintuitive. On the one hand, the political left is castigating the use of private capital infrastructure, but at the same time, pensioners would like nothing more than the steady investment returns, infrastructure brings. So that is a fault line in the ideological debate that needs addressing.”

What Labour is proposing

Labour’s nationalisation policy concerning what it still calls the private finance initiative, was first proposed in detail at a speech by Labour Shadow chancellor John McDonnell to the UK’s leading business organisation, the Confederation of British Industry in 2017.

The policy was accompanied by the broad accusation that the UK taxpayer has paid out around £28bn in costs in terms of bailouts, interest rates and management fees.

Clearly all manner of public and private contracts are potentially included so not just infrastructure but also other areas such as facilities management where they have been some dramatic corporate failures.

A Labour spokesman told the Financial Times that shareholders would be compensated in the form of government bonds, exchanged for shares. Parliament would then assess the appropriate level of compensation. A party source also told the FT that compensation for PFI shareholders could be lower if they were based in tax havens with compensation higher for pension funds.

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