EUROWEEK: How positive has the response from the private sector been to the infrastructure programmes and initiatives announced by the government this year, including the new PF2 format for PPP projects?
Deighton: The PF2 format was developed from a very extensive engagement process with the private sector. We received more than 150 written responses and conducted a large number of roundtables and events, so what came out of the process really reflected what the industry at large — not just the finance sector but also the people who build and operate these projects — wanted to see in an improved and amended PFI approach.
On the financing side, the most relevant change is of course the government’s decision to become an equity partner in these projects, and so far people seem to be very happy with this approach. The first new programme that is being developed that way is a schools building programme, which in fact incorporates two interesting innovations. One involves the government co-investing as an equity partner and the second one is a concept that we call an aggregator, which allows us to collect up the debt that we effectively need school by school so we can then finance it as a bulk loan. This really gives us the flexibility to go to whichever market is the most efficient, which brings the bond market in as a possibility for financing. So we are seeing quite a bit of innovation there and the response from the market has been very positive in terms of interest in participation. It is still relatively early days but so far so good on that front.
Even more significant from our point of view is the UK infrastructure guarantees scheme. I always refer to it as the Treasury rolling out the heavy artillery, partly because of its sheer scale — we have a facility of up to £40bn. We have just extended the scheme through to 2016 because of the level of interest and also because infrastructure projects, as you would expect, have very long gestation periods and it does take a while to get these things up and running. However, we have had around 140 enquiries relating to the scheme and, as we set out in our Investing in Britain’s Future report published, there were already around 20 prequalified projects at the time of publication in June, adding up to about £13bn in total. In addition to that, there is almost the same amount again — or perhaps slightly less, in terms of the guarantee amount — for the Hinkley nuclear power project. This shows that the scheme is developing real momentum.
Interestingly, the challenge initially for us with the guarantee scheme was that people thought it was just too good to be true, and we had to go out and explain in detail that this really was what we were prepared to do to help get these important infrastructure projects off the ground. So to the extent that financing was the major obstacle, this programme is a very important part of our armoury.
EUROWEEK: How important is developing new investor bases for UK infrastructure (e.g. pension funds, foreign sovereign wealth funds), what are the hurdles to bringing in new investors and what can the government do to promote this?
Deighton: The most recent national infrastructure plan published last December alongside the Autumn Statement identified a pipeline of just above £300bn over the next 15-20 years, and clearly when you have an investment programme of that scale diversifying your potential sources of finance is very important strategically.
First of all, it is important to note that the £300bn is expected to comprise funding from both the private and public sectors. Indeed, the vast majority — over two-thirds — is going to be financed in the private markets. That’s why we want to make sure that the private markets understand these projects and that structures are being developed which accommodate their inclusion.
On a practical level I would say that, generally speaking, finance is not usually an obstacle to these projects getting done. When we have a financeable proposition the markets are highly creative about finding solutions, so a fair amount of my time is actually spent on pulling projects together and getting them into the right shape to take them to market, which includes getting through challenges around planning permission and making sure that the right technical solutions are in place.
Putting that to one side, however, what we are obviously trying to do is to make sure that banks continue to have the opportunity to participate, in the way that we saw recently with the Thameslink rolling stock deal, which involved a big bank syndicate. We also want to make sure the capital markets can participate, whether that is under the UK guarantee scheme, whether it is under the wrap of a monoline insurer — and we’ve seen something of a resurgence of that market — or whether it is under the aggregator structure of the new PF2 format.
We have done a lot of work with the domestic pension fund industry, working with key players in developing the Pensions Infrastructure Platform for investment. That already has commitments of around £1bn and we expect considerably more commitments as pension funds develop the credit analysis skills to understand infrastructure projects, which is something they are currently very focused on.
I also spend quite a lot of time in discussions with big overseas investors, for example the sovereign wealth funds, which are extremely attracted to investing in the UK. They regard our rule of law and general environment as easily as attractive as anywhere else in the world. What is more, in a world where government bond markets are not yielding very highly, the notion of investing in an infrastructure project with long term secure cashflows that tend to be inflation adjusted is a very attractive alternative, so they are very keen to be part of it.
Generally speaking, investors are very interested in owning and investing in mature operating assets, as you would expect, and any time you see an airport or a water company there is usually a very competitive reaction to trying to be part of the capital structure that owns it. Unsurprisingly, the more difficult issue is people’s appetite to be involved during the construction phase. However, there is a lot of work being done on that, and it is where the sponsors of these projects themselves come in and where potentially our own government infrastructure guarantees can play a part. It is also where, over time, one or two of these institutional and international investors may find their understanding of the projects will allow them to participate at the earlier stage of development where of course the returns are commensurately higher.
Overall, I would say that the financing picture is developing well on all fronts and at the moment it is definitely not a major barrier to the inauguration of most infrastructure projects.
EUROWEEK: One issue that has been cited regularly as a barrier to investment, particularly for overseas institutions, is the very long approvals process in the UK. What can be done to overcome that problem?
Deighton: The UK planning system is something that we have continued to reform. If I look at the different parts of the process, this is clearly one part where — certainly from a project development point of view — there may be aspects where we are not quite internationally competitive. That is why we introduced the National Planning Policy Framework last year to simplify the planning process, under which nationally significant projects have a special unit to see them through.
However, I wouldn’t say that the current planning situation acts as a deterrent to investors. Where it has been a problem it just means that it takes longer for a project to get to the stage where investors and lenders have a proposition which they can look at. The extreme example would be that, for plenty of very cogent reasons, it is clearly taking us some time to decide where we might like to build additional airport capacity in southeast England. We are now going through the process with the Davies commission, which presented its report in August and out of which we will come up with some final recommendations in 2015. There are clearly good, democratic reasons why we have to be very careful about where we site a new runway, but when we have made a decision to proceed I am sure that the financing interest in being part of that airport increase will be very strong. British airports generate a lot of cashflow and are extremely financeable. So yes, it does take time for us to decide what to do, because we go about these things extraordinarily carefully, but I wouldn’t say that it deters the investors, it just means they maybe have to wait longer than they would like to be part of what is a very attractive opportunity.
On the other hand, in the UK we are clearly pioneers in terms of privatisation. Our utility industries are privately owned in the main, particularly the energy industry and the water industries, but also the airport sector. They are governed by an independent regulator whose job it is to make sure that the pricing settlements give a fair deal to the consumer but also create an environment in which the companies can privately finance the capital development they need. For example, Heathrow will shortly be opening the new Terminal 2 building, which was simply financed by the corporate entity based on the cashflow from the existing business. The situation is the same with our water industry, where the pricing settlement allows the constant refurbishment and development of the capital that is necessary to keep the water supply in good shape. So there is an enormous amount of infrastructure development that effectively takes place through the corporate form within the privatised utility sector, which works incredibly efficiently.
EUROWEEK: The major infrastructure project that has dominated headlines recently is the high-speed rail link HS2. Some industry participants have suggested that a focus on such high profile, controversial infrastructure projects can divert interest and investment from smaller projects. Is that a valid criticism?
Deighton: I don’t really understand the logic of that — I think you have to look at each one of these big projects and its impact individually. HS2 is an absolutely fundamental investment in the capacity of our railway system, which would grind to a halt if we didn’t make it. You could chop it up into lots of little projects if you like — into the phases of the railway, the station developments etc — but the fact is we need to create another transportation spine. We haven’t built a railway north of London for more than 120 years and we’ve underinvested in the railways overall for the past 40 or 50 years, and this is what we have to do to give us the capacity we need. It will free up capacity on the existing line to allow for much better services on the commuter side and on the freight side, and that in turn will have a considerable stimulating effect on economic growth. It’s as simple as that.
I don’t think that the fact that we are doing HS2 makes any difference to the financial attractiveness of smaller or medium sized projects. Indeed, it gives people a context within which they can understand the logic behind the other things we do on the railway and the road system, because it fits into an overall strategy. And from a governmental point of view we continue to invest in the other projects alongside it to make sure that the overall performance of the road and rail network makes sense.
Similarly, in the energy sector we are very focused at the moment on the Hinkley project, which represents the first potential power station in the new nuclear build out. That is a very significant project, but I don’t think a focus on that makes it any more difficult to look at smaller wind farms or other renewable projects. On the contrary, I think it helps people understand the broader context of the government’s energy strategy, and I think the fact the government is such a proactive participant in ensuring that important deals get done leaves a lot of capacity for the private markets — assuming we’ve got the policy environment right — to take care of the small and medium sized deals.
EUROWEEK: What do you expect to achieve over the next 12 months?
Deighton: The principal focus of the government now is really on delivery, getting things done. We have done a lot of work in putting in place the various financing schemes and we have done a lot of work on defining and pushing ahead very big symbolic projects such as HS2 and Hinkley, as well as the Thames Tideway Tunnel that will upgrade London’s sewers from the current Victorian system. We have underinvested chronically in infrastructure for a very long time in the UK, so we need to demonstrate that this type of symbolic project, where government involvement is really necessary, is getting done.
We also need to follow through on the plan we have announced for a spending round with a big investment programme in roads and in the rest of the rail system. It is incredibly important that we make sure that that is getting delivered and that we will have the transportation capacity we need in future.
Energy is equally important. Around two-thirds of the investment envisaged under the National Infrastructure Plan is in this sector, and we need to ensure that our energy policy and the market reforms that we work through from a policy point of view are finally passed through parliament. We also have to ensure, in turn, that the regime we have translates into a set of contracts for developers to undertake the building programme we need across a range of sectors to replace our coal fired power stations and to achieve a blend of renewables and nuclear that will secure our energy supply for the future with the right mix of decarbonisation. That is an area where translating issues from policy into practice is hugely important, so we will be extremely focused on that.
Overall, I am very focused on making sure that people here in government are equipped with the skills to be able to deliver with urgency and focus the projects that are on the table. With the economy in its recovery stage and with confidence improving it is really important that we do the work on our productive capacity which infrastructure allows us to do to make that growth sustainable. I would say we are in a very sweet spot to get on and deliver the projects that will help us modernise the economy.