05 Jan 2012

Australia's public infrastructure financing challenges

While efforts are being made at both a national and state level to address Australia's chronic infrastructure deficit, there is a lack of a strong pipeline of projects. Why is this?

Australia's public infrastructure financing challenges
Brad Vann, Partner, Project Finance, Clayton Utz

While efforts are being made at both a national and state level to address Australia's chronic infrastructure deficit, there is a lack of a strong pipeline of projects. Why is this?

The problem we face in Australia today is that most of the infrastructure that we want to build is in highly urbanised complex city environments so we are faced with constraints that arise from the fact that we retrofitting into those complex environments. This means that we have significant environment issues, planning issues, community issues and the like. What this means is the solutions inevitably are very expensive and we are now faced the situation in a cash-constrained world where liquidity is a challenge in every part of the globe and governments are finding it difficult to get the cash they need to actually fund these complex, expensive infrastructure projects.

What are the main barriers to infrastructure investment in Australia?

Most of the criticism in respect of public private partnerships seems to come from outside industry. And industry of course is quite unconcerned as to whether the delivery vehicle is a public private partnership or some other form of construction delivery approach.

I think the criticisms basically come from the philosophical view point that the private sector should not be involved in the financing of these large-scale infrastructure projects and they are more properly the domain of governments. Probably the key reason advanced for that is the fact that the cost of private sector funding is much more expensive than government funding.

Of course what that fails to appreciate is that typically most PPPs (public private partnerships) involve a significant transfer of risk from the public sector to the private sector and that higher risk absorption by the private sector usually equates to the additional funding cost that is paid to the private sector. In other words if you do these things on the government balance sheet you are not effectively pricing a risk of those projects because you are only looking at the government's cost of borrowing money rather than also looking at the risk margin that should be attached to that particular project if delivered by government.

Why are Public Private Partnerships so controversial? Is the criticism of PPPs warranted?

That's the holy grail question really because what's happening now is we are looking for ways finding funding around the world and whilst the private sector has a role to play there are other roles that can be developed with the leadership of government.

One example is that what they call value capture funding or the most common name, tax increment financing, where you look at the fact that quite large infrastructure projects like transport infrastructure projects typically lead to an appreciation in asset values in the surrounding land that abuts the particular bit of infrastructure in the case of, say, a toll road.

The suggestion is that, because the increase in property values that is associated with the construction of that piece of infrastructure goes beyond what would be perhaps the case of the normal appreciation of property, you should take part of that property appreciation and effectively hypothecate the taxes related to that to pay for the cost of the infrastructure that's actually contributed to that over and above the normal increase in property values.

What other funding options are available?

The superannuation industry is seen as the holy grail for infrastructure projects. There are some challenges however, because you have to bring together the needs of government with the investment aims of superannuation funds. There is no point mandating them because their obligation as trustees for their beneficiaries, for the people who ultimately receive a pension from the super fund, is to make the best investments they can, so you cannot mandate them to invest in infrastructure.

What you can do is design the infrastructure so that ultimately it is attracted to superannuation funds, and what are they looking for? They are looking for an investment stage, consolidation stage and finally a stage where the income that they receive from that particular asset matches their pension obligations outside, and that's the real key to finding the answer.

But if you talk to most people in the infrastructure industry and the dialogue that's been held with superannuation funds what they are actually looking for is a pipeline of projects so there can be some experimentation around the best way to actually involve them in investing in those projects.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.