September 30, 2015    4 minute read

Pros & Cons of Infrastructure Financing Sources in the UK

   September 30, 2015    4 minute read

Pros & Cons of Infrastructure Financing Sources in the UK

Infrastructure is the basic physical systems of a business or nation; it includes services and facilities necessary for the operation of a country or enterprise. The United Kingdom having one of the most developed infrastructure systems in world is constantly under the challenge of upgrading its economic infrastructure assets. Because of constraints on the government’s budget, there have been increasing efforts to transfer control of infrastructure projects to private industry.

After the 2008 credit crunch, banks are required to hold more capital against their assets which made them less animated to lend. This has proven the government’s requirements to replace bank lending with some other form of private financing such as equity financing, infrastructure funds, sovereign wealth funds (SWFs) Private Finance Initiative (PFI) and Public Private Partnerships (PPPs). Equity financing will be considerable under the government infrastructure pipeline as the insatiable demand for lower-risk returns provided by infrastructure projects continues to attract long term pension fund and other institutional investors. Sovereign Wealth Funds are another major source of equity, and the UK has attracted more than £15 billion of foreign capital investment into infrastructure since 2010. PFI is a method of financing which necessitates the private sector to build, design, finance and operate facilities; it is very similar to the PPP which involve more flexible methods of financing.

Institutional investors have recognised infrastructure equity investments as a source of inflation-linked, long-term and stable cash flows, equity financing also aids the government to lessen its budget deficit by having less of an impact in infrastructure projects. However there are a number of concerns that might threaten the availability of equity financing. The equity returns demanded of infrastructure investment are still struggling to match the yields available on senior debt which are considered to be less risky. The impact of economic slowdowns on the lucrativeness of infrastructure projects is likely to reduce equity financing. For example, the M6 Toll Road has seen traffic fall by nearly 12% in the first half of 2008 compared to the previous corresponding period. Of the myriad ventures in construction as of 2014/2015 National Infrastructure Plan, the construction of the Crossrail will for the first time, deliver a direct connection between all of London’s main employment centres. As Europe largest Infrastructure project, it has benefited from the UK government commitment to support private funding with over 60 percent of the funding coming from the Londoners.

Private funding reduces the leverage of the project and enhances the confidence of other funders for the sustenance of the projects. Bank funding guarantee the project the money needed for a certain period and even interest must be paid on the loan; there is no requisite to provide the bank with a share in the projects. But since the financial crisis and the Basel 3 regulation, banks are constrained in terms of financing long term projects and banks usually require the project to meet certain requirements which may not be effective for the scheme. SWFs funds could become the lender of last resort in the same way that the International Monetary Fund acts as such in the conventional space. For example the Kuwait Investment Office has planned to invest up to $5bn in UK infrastructure assets but SWFs are hardly regulated, and it may be tedious for the government to know the motive of foreign governments. PPPs enhance the level of service delivered to the public by introducing private-sector efficiencies as well as creativity in working methods and uptake of new technologies. But PPPs may not always have lower costs than traditional delivery methods, with major concerns about excessive private investor returns and conflicts of interest between the public and private entities.

Private Investors shares a common goal of maximise their returns and this may lead to rational behaviours which may cost society while the government wants to maximise use of new infrastructure assets, this conflict of interest usually hamper private investment in the government most regulated industries. This the case of the transportation industry where 62% of financing sources are public, for example the high speed two is fully publicly financed.

Despite the drawbacks encountered by private investors, the governments has established several regulation such as the UK guarantees scheme to ease the implication of private investment in the UK infrastructure industry, and this has resulted In the private sector accounting for 63% of the 2013 Infrastructure orders, which augurs well for the future of private investment In the UK infrastructure Industry and the decline of the government budget deficit.

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