The affordable metropolis
As emerging economies, in particular the Asian giants China and India, are now pouring vast capital sums into their infrastructure in the race for economic development, cities in the West are struggling with the enormous challenge of replacing and renewing their ageing infrastructure.
In the UK, many power stations will come to the end of their lives in the next decade – and need to be renewed or replaced with alternative power generation technologies. Transport systems are congested and many rail lines into cities are often badly overcrowded as train users increase.
An ageing population growth is also putting mounting pressure on medical care, at a time when austerity budgets are kicking in. Yet infrastructure must be renewed if cities and towns are to remain competitive.
Renewal of infrastructure is a costly undertaking. Considering stretched public finances, it will be simply impossible to fund the necessary investments out of tax revenues alone. According to a conservative estimate from Siemens Financial Services, around £237bn will be needed for urban infrastructure and services development in the UK between now and the end of the decade. The three largest cities - London, Birmingham and Manchester - will require an infrastructure investment of £42bn, £11bn and £10.8bn respectively in this period.
With the supply of long-term bank lending for project finance being no longer a given amid restricted national finances, government and policymakers are increasingly prompted to leverage private financing to facilitate the much-needed investments. PPP and asset finance can prove to be particularly crucial financing tools in providing capital to the public sector.
One of the great attractions of PPP for city infrastructure investment is that not only do the financiers provide the required capital funds for a transparent rate of return over a long period, but they also often share an element of the project risk by classing their investment as equity. This type of investment is therefore likely to encourage minute scrutiny from investors. Since the investors have considerable commercial experience and resources, they are well placed to ensure that contracts are robust, project management is tightly run and controlled and that the technological investment is appropriate for the envisaged outcomes. All this helps to ensure that projects are completed as close to schedule and budget as possible. After all, any deterioration in timings and costs can radically undermine the investors’' rates of return. According to the European PPP Expertise Centre, France overtook Spain and the UK - the first and second largest PPP countries in value terms in 2010 - in the first half of 2011. Nevertheless, the UK is still the most active market in terms of transaction numbers, having closed 20 deals in H1 last year, followed by France (eight) and Germany (six).
While huge infrastructure projects such as the construction of roads or water systems are often facilitated by traditional PPP arrangements, public finance professionals are increasingly looking to hybrid arrangements - which combine long-term PPP finance with shorter-term asset finance. The reason for these hybrid arrangements is clear when a ‘'whole facility'’ financing arrangement is put under the microscope. Finance terms should always be aligned to the useful life of the facility being financed. Infrastructure such as buildings or roads last for decades. However, in the case of, say, financing a new hospital department, the long-term fabric is only part of the picture. The other element is the various pieces of equipment which will be used in the facility, where useful life, or time between upgrades, is much shorter - perhaps three to seven years. Asset finance comes into play here by enabling the hospital to acquire the most efficient and effective technology, with monthly payments spread across the financing term, ensuring patient throughput rates and clinical outcomes are as high as possible.
The advantages of asset finance are manifold. It allows for a fixed equipment lease/rental and maintenance cost against revenue budgets. As monthly payments are fixed for the full financing term, it is not subject to shorter-term volatility of standard lines of credit. Financial managers can therefore gain a much more transparent and accurate visibility of the true cost of the asset over time. A cost-per-use can be easily calculated by correlating the asset finance costs with public service delivery volumes, thus allowing managers to make more acute judgments about the affordability and cost-benefits of each equipment acquisition or upgrade. At the same time, organisations are also provided with the possibility of upgrading their technology in accordance with technology advancements without having to write down the full capital cost of purchase. Suitable candidates for asset finance are very wide, ranging from MRI scanner, LED traffic lights, e-car power distribution to refuse vehicles and air-conditioning systems.
Term financing techniques, ranging from a five-year lease contract on key equipment to a 25-year PPP, are taking on an increasingly critical role in the development of a city’s infrastructure and economy. The use of private finance also entails new issues for the government and policymakers. Governments working to provide a favourable financial ecosystem - reliable regulatory and public accounts framework; viable pricing and subsidy mechanisms; appropriate risk management processes and guarantees; and finally effective finance and legal expertise - create the environment for an even stronger engagement between the public sector and private sector and financiers will have the chance to emerge, thereby helping to transform many infrastructure projects from being merely desirable to being feasible.