Public private partnerships and the effect on sustainable fund investments

enjamin attended the 2013 Y20 Summit in Saint Petersburg where he represented the Queensland University of Technology. He is currently studying a Bachelor of Business in Marketing and Korean Language (Honours) and he was a recipient of QUT's Corporate Partners in Excellence Scholarship in 2012. Benjamin was also one of two on the Australian Delegation for ASEAN East Asian Summit in 2010.

Abstract

Governments are currently faced with the challenge of financing for investment in a market with no confidence. There is also an ongoing need to keep up with the already high demands of infrastructure maintenance and development brought on by an increasing population. Australia has a history of infrastructure privatisation but government policy has not adapted to the evolving demands of this new investment class. Developing countries need to invest seven per cent of gross domestic product to new infrastructure and maintenance of existing infrastructure, with current level only being three to four per cent.1 The realisation is a need for alternative private investment sources for infrastructure development.2 The approach this research has taken is to assess Public Private Partnership (PPP) facilitated infrastructure investments as an investment class for superannuation funds.

Recommendations

This research contributes to Russia’s priorities for the 2013 G20 agenda focusing on growth through quality jobs and investment. The Australian infrastructure industry has provided a context for development of a framework of practical recommendations applicable to other G20 nations with differing primary industries, financial sector size, and stage of economic development. Australia has a robust financial services sector and is an international leader in private infrastructure development but lessons can be learned from recent market developments.3

1. Governments should continue to support viable PPPs. Relying on current revenue to pay for the full cost of new investment is not a sensible alternative to government borrowing.4

2. Governments need to consider guarantees as well as risk sharing for certain projects.5

3. Government should backstop potential losses by providing a portion of the debt for development tied in with future key performance indicators (KPIs) as an incentive for surpassing milestones. Alternatively, completion and during project income could be decided, with deviations above or below passed on as additional income to the guarantor.

4. Governments have higher credit ratings and access to lower interest funding which could be used to pass on the savings as an incentive for private sector investors.

5. Private Finance Initiatives (PFIs) have been an important part of green field infrastructure development in Australia. The role of government as a curator of infrastructure investments should be adopted across governments to promote private sector investment.

6. Governments wishing to regulate the process of infrastructure development need to move from a lending culture to an enabling culture by ‘crowding in’ more private capital through the use of guarantees and risk mitigation products.

7. As well as government assessment, independently audited procurement and tender processes are essential to avoid project failures or schedule setbacks.

8. A normative reconceptualisation of the relationship between various government bodies and industry within a nation is required. The traditional boundary of government responsibilities will need to become flexible to market demand.

9. PPPs need to be open to public scrutiny. Secrecy clauses and confidentiality claims should be avoided in PPP contract formation.

10. While larger projects will benefit the most from private sector innovation, not all projects make sense to be delivered via PPP. Given the current market conditions it is a waste of time and financial resources to assess small scale projects.

11. As market demands continue to grow there is a need for further research to identify quicker enabling methods for PPP infrastructure investments that fit with assessment criteria identified in this report for projects of varying specification.

Introduction

In recent years, the issue of investment and economic growth against the background of instability and economic turbulence has been an important topic of discussion for world leaders.9 In the wake of the Global Financial Crisis (GFC), investment options are slowly being explored again by public and private institutions.10,11 Governing bodies play a key role in policy creation which impacts on regulatory reforms for investment financing, a key precondition for economic growth.12 With political support, these reforms drive productivity, resulting in growth.

If political support is undefined and procurement policy lacks clarity, then investors will not establish a presence in the market.13 It is therefore crucial to address the issue of enabling free market economic growth so that policy makers and public managers can prepare for the issues of the future. This should include addressing the repercussions of short-term solutions on risks, challenges, opportunities, and capabilities.14

The purpose of this research is to identify factors affecting sustainable long-term fund investment options. This will provide a framework of practical recommendations for decision makers in fund management and policymakers in government, to develop attractive investment opportunities, assessed against a number of criteria. To do this, a case study of industry and superannuation funds in Australia will look at the antecedents and outcomes of infrastructure investments. This report will start by defining PPPs and identifying their relationship with the Australian superannuation industry. Infrastructure as an investment class will then be explored through an analysis of relevant policy frameworks, social and economic factors, and stakeholder priorities, used in the culmination of the actionable list of recommendations already presented.

Public Private Partnerships

The definition of PPPs can be broadly conceptualised as a ‘co-operation of some sort of durability between public and private actors in which they jointly develop products and services and share risks, costs and resources which are connected with these products.’15 Innovative PPP methods include build–own–transfer, build–own–operate–transfer, and sale-and-lease-back arrangements with financial organisation, typically on 20 to 30-year contracts.16 As the global trend of infrastructure investment is explored across different economic and political environments, the relationship has become more complex. However, for a naturally evolving market a balance between public and private sectors is mandatory. Collaboration on infrastructure projects in Australia via PPPs has been positively driving the Australian economy.

The neoliberal assimilation of privatisation ideologies into the Australian market has included PFI model adaptation, which is a PPP variation. Projects are designed, built, financed and managed by a private sector entity, typically on a lengthy contract where ownership is retained and payments are made by the public sector until ownership reverts to the public sector.17 PFIs allow private sector innovation to dictate project success and ROI, while government are able to better satisfy tax payers and retain a tangible asset.

Superannuation in Australia

Superannuation funds provide means for individuals to accumulate savings over their working life so as to finance their consumption needs in retirement. Superannuation funds have long term liabilities,

allowing holding of high risk and high return instruments.18 Investors seek to earn a satisfactory return on their funds and to keep a reasonable surplus of assets over liabilities. The nature of liabilities also determines the institutions' liquidity needs.19

Australia introduced a compulsory superannuation fund system in 1992. The market has now matured, with over 500,000 funds and assets totalling USD 808 billion, making the country the fourth largest fund asset market in the world.20 The licensing of trustees being made mandatory in Australia in 2006 has further increased investment decision making capabilities, resulting in accelerated growth of membership and assets.21

Australian funds of varying type and size have been investing in infrastructure for over a decade. This investment has occurred through closed-ended vehicles with a fixed number of shares, or open- ended vehicles, with varying investment options. Closed-ended funds are more prevalent outside of Australia.22

An example of an open-ended fund is Industry Funds Management (IFM), with over AU 23.4 billion in funds under management worldwide, owned by 35 major Australian not-for-profit superannuation funds. IFM has 17 infrastructure assets in its investment portfolio.23 Some of the superannuation leaders in infrastructure investment include UniSuper, Local Government Super Board, HESTA, Care Super, Prime, CBA, and State Super. Access Capital Advisers is a global specialist investment manager of infrastructure and other alternative assets, with $2.6 billion of funds under management and a strong collaboration with the Australian superannuation industry.

Infrastructure Investment

Following the recession of 1989-1990 many infrastructure assets were reformed or privatised.24 Government underinvestment in infrastructure as far back as the 1980s and 1990s contributed to initial private sector investments which were unable to meet mining boom demand, a growing economy, and an increasing population.25

With five per cent of public investment into infrastructure now accounted for by PPP, Australia is considered to have a high model adoption rate.26 The Australian Government’s PPP framework has developed a standard positioning for restrictions on changes in control, ownership, and refinancing.27 Fund members’ significant flexibility to determine investments has led to a focus on short term performance and liquidity, with infrastructure investment seen as a means of diversification.28

Because funds need short-term liquidity, infrastructure debt is treated as an opportunistic investment, considering the regulatory, economic and political conditions case-by-case.29 Infrastructure investments are also liability-driven and provide duration hedging, crucial for fund portfolio management.30 There are three concomitant regulatory frameworks that vitiate PPP infrastructure investments for funds as identified in Figure 1. Consequently, PFI institutions have played a pivotal role in the facilitation process.

Figure 1: Frameworks relevant to Pension Fund Investment in PPPs31

 

Governing Policy

Within Australia’s political dichotomy there exists mutual support for infrastructure development, albeit varying methods for delivering results. One side holds long-standing policy to pursue government controlled expansion and the other is focused on developing relationships with the private sector. It is evident that output over the decades is inextricably connected to standing political leadership. For example, under the Howard Government during 2005, Australia re- discovered infrastructure development as a policy framework.32 Democratic governments play a critical role in determining market direction. However, they cannot be responsible alone for representing the capability and capacity of the market to achieve future success.33

Australia’s political myopia is a focus on short-term issues at the expense of long-term issues, including an under-investment in major infrastructure.34 Although government formalises rules and regulations, they do not lead the process of promoting principles of innovation in long-term investment, which relies upon a social commitment to the common law principles of fiduciary duty otherwise rejected in their regulation of superannuation funds.35

The responsibility for substantiating theories of long-term investment and formulating a practical framework for investment management has been left to private sector investors. PPPs are significantly affected by government policy, which directly impacts on financial regulation. Research suggests that government policies should support financial market choice and innovation, and tax policies that encourage business investment will boost productivity.36 Free market reform stemming from 1980s Australia and the rise of ‘economic rationalism’ in Australian policy has been argued to be responsible for the shift from government to business led infrastructure development.37 In a decidedly post-Keynesian age, government’s role has simply been reduction of regulatory or policy barriers to market participation.

Case Study One: Victorian Comprehensive Cancer Centre (VCCC)

VCCC is a $1.26 billion project due to be completed in 2015, and is operated by the Plenary Group on a 25 year contract.38 Several superannuation funds invested both debt and equity in the project; UniSuper owns 49 per cent and other investors in the project include HESTA Super, CARE Super and IFM.39 This PPP, facilitated by VP, represents a $9.3 million saving on PSC estimates. A further $65 million was saved in net present cost terms, due to a Commonwealth contribution during construction.40 This project identified the importance of risk estimates in Public Sector Comparator (PSC) development, and the need for benchmarking key assumptions during implementation to detect deviations from projection costs.41

The Council of Australian Governments’ National Reform Agenda has established a strong framework for good regulatory design, efficient infrastructure provisioning, and finalisation of the competition agenda.42 This has resulted in quadrupled infrastructure spending and increased skills training and job creation.43 Private financing provides a method for infrastructure development without increasing the public-sector borrowing ratio and reducing pressure on public-sector budgets.44 While government still provides financial incentives for private sector involvement, they realise substantial cost savings of as much as 10 to 30 per cent.45

Social and Economic Implications

Infrastructure mobilises productivity and growth. However, because infrastructure requires replacement at a rate of two per cent per annum46, it is an impediment for any government budget, especially in developing markets. Large scale privately funded infrastructure investments therefore alleviate some of these ongoing financial pressures, decreasing deficits, and allowing government to operate as infrastructure service providers rather than owners or managers of the underlying assets.47 To have a substantial impact on the budget deficit, increased superannuation investment needs to focus on new domestic green field assets.48

Infrastructure financing is vulnerable to high political, regulatory, and execution risk. Raising long term debt financing can be a challenge.49 As financial markets begin to re-establish confidence and seek to diversify portfolios, investments in infrastructure can generate a virtuous cycle of higher demand, productivity, and growth that is consistent with long-term deleveraging.50 Investment interest in Australia has increased but processing times have not changed. This has led to a demand excess and supply shortage, with Australian funds now seeking investment in foreign infrastructure assets.51 Government needs to simplify the PPP formation process to rejuvenate local investments and provide incentives to generate private sector investments that share risk and alleviate direct budget management constraints.

Case Study Two: Adelaide Airport Limited (AAL)

The long term leases of Adelaide and Parafield Airports were purchased by Access Capital Advisers on behalf of Adelaide Airport Limited (AAL) in 1998, from the Commonwealth of Australia. This has been a lucrative brown field infrastructure investment.52 AAL ownership includes UniSuper with 49 per cent, Local Super with 19.5 per cent, and IFM with 12.8 per cent. AAL has overseen a 74 per cent rise in passenger numbers since privatisation despite overseas market collapses, industry restructures, and debt management all affecting performance. Private sector innovation since privatisation has been an important factors in the recent performance of this asset.

The transfer of public assets into private hands under the pretext of improving efficiency and promoting choice has caused privatisation fatigue in the community and a degree of public unease.53 Blame falls on government for attempts to keep the details of PPPs shrouded in secrecy.54 Resistance to PPPs is formed when tax payer money disappears without justification.55 Therefore, from a social perspective, the need for transparency in large scale infrastructure projects is almost compulsory.

Case Study Three: Victorian Desalination Plant

The Victorian Desalination Plant was successfully constructed, despite private sector financial reporting issues, resulting in delays. This is a $3.5 billion project that was enabled by PV in 2009 as a PFI between AquaSure consortium and the Department of Sustainability and Environment. The 30 year contract period maintains an equal share of risk, with operational and financial considerations primarily borne by the private sector. Innovative cost optimised methods represent a 14.1 per cent saving on the PSC.56 Fund investors in this project include UniSuper, with four seats on the board and a 26 per cent ownership of Aquasure, and IFM with a $20 million investment.57 This project is the largest public sector investment in water infrastructure in Australia’s history and required substantial investments from the private sector. A transparent planning and prioritisation process and a transparent procurement process were essential to attracting capital which comprised of senior and mezzanine nominal bank debt, state supported debt, and equity investment.58 The Victorian Desalination Plant has been the latest step in the trend towards PFI mega projects in Australia.59

Stakeholder Priorities

Despite pioneering innovation, PPPs are still highly regulated and biased in their formation which is typically handled by the government itself on a case-by-case basis. These are essentially two-way government–business deals that do not involve the community or any other independent accountability body to protect public interests.60 PPP constituents and public perception must be included in risk assessments as much as the infrastructure investments themselves.

Case Study Four: Southern Cross Station (SCC)

SCC’s redevelopment was completed in 2006 as a $309 million PPP between the Department of Transport and Civic Nexus consortium. The project was part financed by IFM and facilitated by Partnership Victoria (PV), the pioneering government body in Australia overseeing PFI projects. KPIs were not clearly defined, so when construction failed to meet deadlines, losses of $122.6 million were declared with claims made against the state resulting in a $32.25 million settlement.61 The PFI model has contributed to the stringent risk assessment of subsequent projects. Taking full advantage of private sector strengths, a level of design innovation which would not have been attainable by government alone was contributed to the project.62

Infrastructure is an inflation linked investment.63 Via hedging, this investment category is perfect for funds seeking diversified portfolios with investments more closely resembling member life cycles. It can also provide a balance between managing assets and liabilities. Negative impacts of the GFC on investment returns vary greatly between countries. It has been greatest among funds in countries where equities represent a large part of total assets, including Australia.64 Infrastructure investment by Australian superannuation funds is estimated at between $40 billion and $65 billion.65 Infrastructure investment 10 year average annual returns are 8.47 per cent for listed and 11.53 per cent for unlisted categories.66 The investment option between listed and unlisted ultimately depends on the means of the individual fund investing, but these two options basically provide investors with multiple options to access the same asset class.67

Conclusion

An intrinsic link has been identified between sustainable fund investments in infrastructure, and PPPs, which is moderated by government regulation and policy frameworks in the industry and within the funds themselves. These frameworks don’t always work in unison and hence the market has developed accordingly. Despite how new models for collaborative investment are developed, in their endearing pursuit to satisfy stakeholders, decision makers must consider the implications of their actions on society and the economy.

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