While demand for new infrastructure continues to grow, pressure on government funding has never been greater. Value capture presents real opportunities and will inevitably be considered for new projects. The principles are well documented but how does it work in practice? We have put together this practical guide for governments to make the most of the options open to them. Here is a summary of the five practical issues.
The successful procurement of major government infrastructure typically relies on two to three high-quality bidding consortia competing strongly to deliver the best bids to government. In turn, government will undertake a robust evaluation process to determine a preferred bidder with whom to close the deal within its required timeframes.
Both considerations can be impacted by incorporating value capture into a project. So, careful procurement process design is required to achieve the highest quality outcomes. We outline the considerations around limiting competition, certainty and transaction execution and evaluation challenges.
Government will always be interested in the commercial opportunities associated with infrastructure development primarily because of the contribution these opportunities can make in reducing the public-sector funding task. Structuring choices can be important in maximising this contribution. There is a trade-off between maximising value over time compared with providing a certain, but typically reduced, value at contract close.
If government is prepared to share upside and downside with the developer and get paid as returns are realised, a developer is typically able to offer greater forecast returns – forecasts based on generally accepted market norms used by developers for their own businesses. However if, as is often the case, government requires upfront certainty, developers will materially discount their offer to government to account for the development risk they alone will carry.
Here we consider trade-offs with risk. While government needs to appropriately price the risk it retains in any transaction, in raw revenue terms, it can maximise revenue from commercial opportunities from structures which separate the two aspects of the project.
Commercial opportunities raise a number of interface issues between the contractors involved in the project. They are ‘hard’ interface issues in the sense that they are physical interfaces rather than purely financial interfaces, although they may also give rise to hard issues to solve. They potentially place constraints on the delivery of the core infrastructure if not carefully thought through and managed.
Here we explore design interfaces and construction interfaces. We also consider post completion - the interface issues do not fall away following completion, although the level of risk reduces.
PLANNING AND APPROVALS
Obtaining approvals, be they for planning, environmental or cultural heritage, takes time. These typically need to be obtained so that the conditions attached to the approvals can be fed into the bid process and taken into account by bidders in preparing their submissions to government. At the latest, they need to be locked away before financial close of the project to provide the parties involved with the certainty required to commit to a fixed completion date, fixed price and, if applicable, financing.
Government typically takes the running on this and is able to seek approvals based on a reasonably detailed understanding of the nature of the infrastructure to be delivered. For commercial opportunities, it is different story as we discuss here.
TAXATION AND DUTY
Commercial developments have a different tax treatment from that applicable to government infrastructure. Core infrastructure is often delivered by a special purpose project vehicle. If the commercial development sits under the umbrella of the project company’s business, or revenue from the commercial development flows through the project company, it can adversely affect the project company’s tax profile with a consequential reduction in the value which can be delivered to government.
Value capture can make an important contribution to funding major infrastructure. The value of that value capture is not simply a function of market forces. There are many decisions government can make in planning the procurement of major infrastructure which impact on the value that can be realised. Whether the issues impact on the bidding process, the costs of risk inherent in different structures or key approvals and taxation, upfront consideration of these matters will place government in the best position to maximise the benefit of value capture. Why not download our more expansive PDF on this subject here.