Most PPPs aren't attractive investments for superannuation funds. Governments and other project sponsors need to structure infrastructure investment opportunities in a way which is attractive to superannuation funds in order to attract them as investors.
Australian superannuation funds are crying out for opportunities to invest in Australian infrastructure. At the same time, Australian governments are keen to tap into superannuation funds to help bridge Australia's infrastructure gap. So why isn't it happening?
Superannuation funds exist to provide retirement income for their members. They need to make a return on their funds to do so. Superannuation funds will only invest in a piece of infrastructure if the risk/return equation makes sense. Governments and other project sponsors need to structure investment opportunities in a way which is attractive to superannuation funds in order to attract them as investors.
Is a PPP model suited to superannuation funds investors?
When Australian governments want the private sector to invest in a new infrastructure project they will often develop the project as a public private partnership or PPP. Australia has a long and successful track record in attracting private sector investment in new infrastructure projects via the PPP model. But is the PPP model well suited as an opportunity for superannuation funds to invest in infrastructure?
While there is no doubt that infrastructure as an asset class is an attractive investment opportunity for superannuation funds, most PPPs are not attractive investments for superannuation funds, particularly at the development stage. There are many reasons for this, the principal ones being:
- PPPs are too risky, particularly those where investors take demand or patronage risk;
- construction risk is also a concern for superannuation funds, as is the high level of refinancing risk associated with Australian PPPs;
- PPPs are generally too highly geared – a characteristic which driven by the desire of government to minimise its financial contribution to a PPP project by minimising the project's financing costs;
- because of the low levels of equity relative to debt, the "ticket size" of equity investment opportunities in a PPP is usually too small to be attractive to superannuation funds;
- high bidding costs and the lack of a pipeline of PPP deals; and
- restrictions on the transfer of equity in PPP projects, which adversely affects the liquidity of the investment.
Although PPPs and PPP bidding process can be adjusted to:
- improve the risk/reward equation (for example by structuring the PPP as an availability payment PPP where government takes the demand risk, as is proposed for the East West Link in Melbourne);
- reduce the bidding costs; and
- relax restrictions on equity transfers,
most PPPs will continue to struggle to attract equity investments from superannuation funds at the development stage, prior to construction.
The Canadian experience also bears this out. Canada has a well-functioning PPP model, and yet its pensions funds are not major investors in it, despite Canadian pension funds being recognised as among the most significant and expert investors in infrastructure in the world.
The sorts of adjustments to the PPP model just mentioned, particularly government taking more risks, can also undermine the business case for doing the project as a PPP. If the risk transfer to the private sector under a PPP is no greater than that achievable under a publicly funded delivery model, government will usually achieve a better value for money outcome by adopting a publicly funded delivery model, and avoiding the higher cost of private sector finance, as is proposed for Stage 1 of the WestConnex project in Sydney.
The delivery of more infrastructure under this sort of delivery model, where government funds the construction of the infrastructure facility and then sells the right to generate tolls or other revenue from it, after construction is completed and the revenue stream has been proven, will create more infrastructure investment opportunities which meet the investment criteria of superannuation funds.
Similarly the sale of existing publicly owned infrastructure assets would create attractive infrastructure investment opportunities for superannuation funds and at the same time enable the public capital invested in such assets to be "recycled" and applied to the development of new infrastructure assets.
What about the debt piece in PPPs?
The debt piece in a typical PPP is much larger, and less risky, than the equity piece. Moving forward, there may be an opportunity to attract superannuation funds to provide debt finance to PPPs, particularly if a deeper market for corporate bonds can be established in Australia.
If the Federal Government were to raise debt for the purpose of investing in infrastructure, and did so by issuing long-term bonds, this would help create a pricing benchmark for privately issued bonds, and assist in the development of the corporate bond market.
Improving the deal pipeline
Superannuation funds continue to call for a deeper, more certain infrastructure investment pipeline, to enable them to invest in the people needed to assess and bid for infrastructure projects as they come to market.
Government's ability to improve the pipeline of new infrastructure projects is largely a function of its capacity to fund the projects. There is plenty of private sector finance available to finance the construction of infrastructure projects, but that finance needs to be repaid by someone. Politicians would love to announce an extensive pipeline of new projects, but Australian governments don't presently have the sources of funding required to repay that finance.
There are three main sources of funding for new infrastructure:
- user charges (eg road tolls); and
- asset sales (recycling of capital).
To improve the pipeline, superannuation funds, government and other industry participants need to convince communities that the benefits to communities from better infrastructure funded from assets sales, or user charges, outweigh the additional costs and risks.