Eurozone crisis may have a silver lining for Australian infrastructure
It is a moot point that the Eurozone crisis is of fundamental concern for global economic stability. The possibility of a nation state leaving the European monetary union is no longer unthinkably remote. Respected financial analysts, such as UBS, and commentators, such as economist Nouriel Roubini, have gone so far as to play out the cost consequences of a collapse of the EU.
The crisis continues to impact financial markets geographically far-removed from Europe, and in Australia we have seen some European lenders retreat from the Australian loan market to repatriate funds to their home jurisdictions. The immediate impact of this retreat is a decrease in liquidity for the Australian loan market and a capital gap for Australian borrowers. Neither the Federal government nor the major Australian trading banks can be relied on to fill this capital gap in all instances. However, the silver lining is that there may be increased opportunities for large industry and public sector superannuation funds – and sovereign wealth funds or other special purpose funds like the Future Fund – to increase their participation in debt financing Australian infrastructure.
The magnitude of our nation’s superannuation industry is stark. Australia has the fifth largest pool of superannuation funds in the world, behind the USA, the UK, Canada and the Netherlands. Current funds under management of APRA regulated superannuation funds is about $1.4 trillion. This could rise to $5 trillion by 2026 according to a May 2011 report by the Association of Superannuation Funds of Australia.
Bridging the infrastructure gap
Unfortunately, the rapid growth in funds under management since the 1990s has been accompanied by a marked widening of Australia’s infrastructure gap. Over the next decade, between $450 billion and $770 billion will need to be invested to meet Australia’s infrastructure requirements. Yet recent statistics show that Australian governments have never spent on infrastructure at these levels for any sustained period.
This considerable gap could become even wider if the Eurozone crisis triggers a significant loss of debt liquidity. The major Australian trading banks operate under their own lending limits, and credit and prudential requirements, and cannot be expected to fill this shortfall on their own. State and Federal governments provided short-term solutions to a lack of debt liquidity during the GFC, but it is not realistic to expect governments to provide long-term solutions to debt funding shortfalls faced by Australian infrastructure projects. Additionally, if the rate of growth of the economy in the September quarter of 1 per cent continues (with business investment reportedly recording its biggest jump in 13 years), the likelihood of any government moves which could be seen as stimulus measures would seem much lower.
Attention naturally moves therefore to the superannuation industry as a possible alternate source of funding.
Currently, the majority of APRA regulated superannuation funds are heavily weighted towards equities, property, cash and fixed interest investments. On average, they allocate around 5 per cent of their total asset allocation to infrastructure assets. Of the one-third of superannuation funds that invest in infrastructure assets, such investment usually makes up between 2 and 10 per cent of the total portfolio.
Subject to each fund’s own appetite for risk, it is likely that going forward superannuation funds will have an increased appetite to lift their benchmark exposures to infrastructure assets in general and that funds will seek to source opportunities in domestic and offshore markets.
Until now, the difficulty for most funds has been accessing the available opportunities and finding suitable senior debt tranches.
If superannuation funds are able to provide longer tenor debt than the major trading banks they might be able to find increased funding opportunities at the right entry point. Their participation could mitigate refinancing risk on existing projects, including the potential cost to infrastructure investors of having to break interest rate swaps on a refinancing.
Infrastructure investments are by their nature significant. The largest Australian superannuation funds, although smaller than some of their global counterparts, are now of a size that makes their direct participation possible either on their own or in a co-investment vehicle. These funds also have in house investment teams or specialist investment managers capable of undertaking the necessary sophisticated risk analyses of both debt and equity positions in major projects. Access to infrastructure for those funds that sit outside the top 10 in terms of size remains however an issue.
Some commentators argue that Australian superannuation funds do not appropriately differentiate infrastructure as a separate asset class, or between projects that carry patronage risk and those that do not, or between greenfields and brownfields projects. This is not borne out in practice. It is true that most funds have a strong preference to avoid the risks inherent in a greenfields project, or a toll road where patronage risk lies with the private sector, but there are several examples of superannuation funds like Unisuper and AustralianSuper (or a superannuation funds manager like IFM) participating in greenfields PPPs.
A closer analysis of the larger funds and their investment profiles (such as the 2010 survey undertaken by the Financial Services Council and PricewaterhouseCoopers) bears out the following observations as to why they have not been clamouring to fill the capital gap on major infrastructure projects:
- The pipeline of projects in the Australian market is still too lumpy, with insufficient coordination of procurement between levels of government and between States and Territories.
- Australian projects often miss the minimum hurdle rates for returns on investment, particularly when looking at the senior debt tranche.
- Infrastructure projects are often not structured properly for institutional investment. The funds need to have a high level of flexibility around liquidity and assignability of their investments, and are often uncomfortable with the regulatory or “change in law” risks that are borne by infrastructure projects.
- The procurement processes for Australian PPPs are inconsistent, complex and expensive by comparison to several overseas jurisdictions. In a global war for capital, and as the superannuation industry moves towards a “low fees” environment, the opportunity cost of committing significant time and resources to a highly competitive procurement process can be too high.
The impediments described above require considerable work and close attention by Government and industry. While the Federal Government’s discussion paper on proposed amendments to taxation legislation (in relation to conserving early stage tax losses for projects of national significance) is a step in the right direction for infrastructure projects, it isn’t enough.
Australia needs only to look to the UK for an example of how it might unlock further infrastructure investment in the face of a Eurozone crisis. The UK Government recently released its 2011 Infrastructure Plan, which targets £20 billion in investment by pension funds. UK pension funds are not generally in a position to undertake due diligence in relation to debt (or equity) investments in infrastructure projects. Under the UK Infrastructure Plan, a collective action vehicle, allowing for pooled investments, is being established to address this issue. The cost of establishing and staffing this collective action vehicle is to be borne by the pension funds that use it. The intent is that this vehicle will employ a significant number of people who know how to manage and structure infrastructure investment from both a debt and equity perspective. Such an approach is worthy of consideration in Australia now, before the debt markets contract further.