Government encourages banks to underwrite private sector investment risk in exchange for guarantees

A report in the Financial Times (registration required) said that the scheme, aimed at stimulating investment from traditionally risk-averse pension funds and insurance companies, would see banks agree to underwrite losses in exchange for a fixed fee to be paid from future project revenues.

The Government identified £250 billion worth of infrastructure investment opportunities as part of its National Infrastructure Plan (NIP) last year; however it has acknowledged that much of the money will need to come from the private sector. The NIP set out alternative private sector funding approaches to the controversial private finance initiative (PFI) funding model, such as encouraging investment from pension and insurance funds. However the Government has struggled to attract the necessary investment due to a lack of relevant knowledge from fund trustees and concerns about project risk.

A 'call for evidence' on a replacement to PFI that would "draw on private sector innovation but at a lower cost to the taxpayer" was announced by the Government last year. In a PFI agreement the private sector pays the upfront cost of major public infrastructure projects such as roads, prisons and schools and is typically repaid by the taxpayer over a 30-year period.

A Treasury spokesperson told Out-Law.com that the Government was currently exploring "a number of ways" to boost private sector investment in infrastructure, "including how guarantees can be used to help reduce the risk profile of projects and make them more attractive to potential investors".

However, he added that there was still no fixed timetable for when the result of the Government-commissioned review of the Private Finance Initiative (PFI) would be published.

Infrastructure law expert Barry Francis of Pinsent Masons, the law firm behind Out-Law.com, said that while it was good to see the Treasury "continue to explore new ideas to enable infrastructure projects to be financed", without more detail of how the potential 'guarantees' would work it was difficult to be enthusiastic.

"We still face the problem that risk appetite with banks and others is low, and project finance teams are disbanding or reducing so expertise is dissipating and cannot be remobilised just like that," he said. "Serious investment in developing models requires confidence that the pipeline of projects is there and that the rules are stable. Recent experience in solar energy is not encouraging."

Jon Hart, infrastructure law expert at Pinsent Masons, said that more had to be done to encourage risk-averse private investors to take on 'greenfield', or brand new, projects as there were not enough post-construction 'brownfield' projects available to be of interest.

"A possible solution for new projects, consistent with banks' reluctance to lend long term, would be for short-term debt to see through construction phase and into a steady state, post practical completion," he said. "Once in a steady state, funds would then come in and invest in the project. However, this may require a realignment of thinking from construction contractors who will be keen to disappear over the horizon once tests on completion are done."

He added that there was a "big structural problem" in ensuring that debt could be refinanced by private sector investors on attractive enough terms once projects had reached completion without proving "ruinously expensive for Joe Public".

"Ultimately, I'd be astonished if banks would put all their debt up for grabs – they will want it kept pretty much whole by contractors or underlying Government guarantee, as was mentioned in both National Infrastructure Plans," he added. "Maybe this is the 'fee' that the Financial Times alludes to - presumably, banks would want to make sure that the Government would be waiting in the winds if a pension fund 'sugar daddy' wasn't willing to join in."

In a report last month, business group the Confederation of British Industry (CBI) suggested that pension funds look to build up "in house skills" through partnerships with more experienced players in the market. It also recommended that smaller pension funds pool their assets to create wider investment opportunities, whether through the Treasury's proposed Pension Infrastructure Platform or independent models.