Can the UK create a new asset class that encourages trustees to invest in crucial infrastructure projects? Australia is not alone in its ongoing battle for sufficient funding for infrastructure. The US, Canada, France and the UK are all facing similar crises brought about by rising costs, decreasing flows of capital and severely constrained government budgets.
Since the GFC, the pursuit of alternative financing sources for major infrastructure projects has intensified. The UK alone requires more than £200bn worth of new infrastructure investment in the next five years and the British government is looking to the private sector to support its plans.
The trillions of dollars and pounds under management in superannuation and pension funds appear an obvious source, however major challenges still exist to attract investment by fund trustees.
In an effort to engage pension funds, the UK government recently announced its commitment to reform its infrastructure sector and develop an investment platform that will appeal to fund trustees.
A new Cabinet Committee has been given responsibility for the reforms. It is tasked with coordinating whole of Government intervention in the industry, tackling planning and regulatory delays and addressing policy and commercial issues.
The UK’s planning and consent systems are often blamed as major sources of cost and delay in infrastructure development. In June 2011 the UK Treasury entered into a charter with industry to reduce delivery costs for infrastructure by making the industry more transparent, increasing the focus on whole of life outcomes, and improving collaboration between industry and Government. The Costs Savings Implementation Plan, setting out how the Government planned to embed changes in Government and industry to realise costs savings, was issued in March 2011.
UK pension funds hold over £1 trillion in assets, but only around 2-2.5% of this is currently invested in infrastructure. The UK Government is targeting an additional £20 billion worth of investment from this source.
Late in 2011 the government signed a Memorandum of Understanding with the National Association of Pension Funds (NAPF) and the Pension Protection Fund (PPF), to facilitate the development of a new pension infrastructure platform to help pension funds invest more in infrastructure.
The Association of British Insurers (ABI) also announced its intention to work with the Government to create a new asset class of infrastructure bonds to encourage insurers and pension funds to invest in infrastructure projects. Acknowledging that fund managers have a responsibility to make sure their investments deliver in the long term, the UK Government has agreed to set up an Insurers’ Infrastructure Investment Forum to address the risks associated with developing this new asset class.
It is not yet clear what arrangements will be made to facilitate pension funds investment in infrastructure. There is speculation the UK Government may create an internal fund management-type structure. However, if the Government is too involved this might present a conflict of interest given the relevant infrastructure is likely to be a government asset.
While the promise of long-dated, inflation protected cashflows is attractive to pension funds, this must be reconciled with the risk exposure during the operations phase of any project, the huge variation between infrastructure projects, and the risks posed by investing in an illiquid asset class. The volatility of equity remains a concern and pension fund trustees might seek a vehicle that balances equity investment with access to debt.
The profile of UK pension schemes presents a challenge to the UK Government’s attempts to encourage investment in infrastructure. Many defined benefit schemes are closed to future accrual, have a maturing liability profile, and are underfunded. This means that access to cash is limited and exposure to debt and illiquid assets is risky. Conversely, the defined contribution fund market (otherwise known as accumulation funds) is in its infancy. It is likely those funds will not have sufficient assets available to invest while still ensuring a diverse portfolio that meets the interests of members. The cash ratio in most funds is small, requiring asset reallocation in order to invest in any new platform.
The big question overhanging the UK Government’s proposal is whether there will be sufficient uptake by pension fund trustees. The proposal might be attractive to the larger schemes, which have dedicated teams of investment professionals able to understand the varying risk profiles of infrastructure projects and assess the complexity of the deal structure.
However, the reality is the majority of UK pension funds are relatively small schemes that may not have adequate resources to undertake the relevant due diligence, tendering process and long term management required to ensure that an investment in infrastructure is in the best interests of their members.
It is yet to be seen whether the UK Government will be able to create a product that overcomes the structural issues inhibiting pension fund trustees investing in infrastructure. Investment vehicles do already exist but the complexity and risks associated with long-term projects often make these types of investment unsuitable for a prudent trustee. In addition, taking a stake in a significant infrastructure project requires not just cash but management time and expertise. Many UK trustees may well find the value ratio unappealing.
In contrast, Australian trustees may be able to overcome some of the systemic problems apparent in the UK. With larger economies of scale enabling prudent risk allocation and the certainty of continued investment income due to compulsory superannuation, Australian trustees are well placed to seize on alternative investment propositions – if the UK does develop a new asset class that addresses volatility, illiquidity and default risk, it just might attract the interest of trustees here.
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