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Infrastructure Insights - key trends for 2018

March 01, 2018

Contacts

Partners Josh Cairns, James Hawes, Simon Vannini, Michael Weatherall

Infrastructure funding Local government Urban transformation

This issue of Infrastructure Insights focuses on three key trends for 2018.

1. The funding challenge - alternative financing solutions required

The convergence of existing affordability issues, and heightened levels of demand for new infrastructure driven largely by rapid metropolitan and regional growth and ageing assets, has led to financing issues taking far greater significance in the overall strategy for the delivery of infrastructure projects.

Both at a regional and national level, significant pressure to reduce or maintain debt levels is driving a need to explore alternative financing solutions for the delivery of large-scale infrastructure projects. This is particularly acute at the local government level, with many local authorities at or near debt funding limits and facing further funding constraints presented by an ageing population.

Innovation in the structuring of procurement solutions to address funding constraints will continue to be a key focus point in 2018. Some level of legislative change to facilitate new solutions may also hit the regulatory radar - with the new Labour-led Government having set up a working group to explore alternative financing structures such as ‘value capture’ models and the use of infrastructure bonds.

2. Local authorities - BOOT models remain an attractive option

Given the financing issues referenced above, local authorities have to develop structures that will allow private money to be applied in a manner which does not offend public policy. To this end, public private partnerships have become increasingly common worldwide and are often based on the “BOOT” model (build, own, operate, transfer). Under a typical BOOT model, the private partner (or a consortium of partners) builds the infrastructure and is granted a concession to operate for enough time to generate a commercially attractive return on its investment. The asset is transferred to the public authority at the end of the concession period.

We expect BOOT models to remain an attractive option.

3. Global economic events - potential volatility

Globally, economic confidence remains strong notwithstanding recent market wobbles. The US Fed has indicated an intent to normalise monetary policy and the RBNZ seems set to follow. Geo-political stability and economic resilience are key to this programme. Potential sources of instability abound: The German elections have compromised Europe’s leadership just when local sovereignty is offering a challenge to the European Project. China looks stable but it remains to be seen how President Xi’s reformist agenda will impact the economy. Finally, the US continues to perform strongly but this could be impacted by changes to trade policy or the results of November’s mid-term elections.

A focus on infrastructure - key concerns and challenges

New Zealand urgently needs investment in its infrastructure and the new Government has made lavish commitments in this regard. The financing of these projects, planned at both central and local government level, is the subject of much debate but there is a general recognition that private money will be a part of the solution.

However the projects are paid for, as a result of the high profile issues faced by Fletcher Building and Carillion in the UK, financiers will be concerned to ensure that the chosen contractors are capable of completing the project on time and to budget. This is no longer a given as more and more projects are plagued by cost and timing overruns.

The causes of these issues are complex but, at heart, construction contractors are operating in a fiercely competitive market. As a result, many have entered into dangerously unfavourable contracts offering them almost zero margin and their customers very favourable payment terms. The result has been mounting debt and, in Carillion’s extreme case, corporate failure.

In our experience, it is fundamental to carefully structure these complex infrastructure arrangements.  Service scoping, delivery timelines, KPI’s and funding triggers are all areas where we see the need for careful focus.  With examples all over of people being burned, now is not the time to take on unintended risk.