But over the past couple of decades, we have witnessed the success of the Regulated Asset Based (RAB) model in bringing significant amounts of capital into infrastructure at both a low cost and a long-term basis. In simple terms, RAB models attract large amounts of private capital into infrastructure (utilities in particular) through a transparent and consistent mechanism that reduces investor risk and places a cap on consumer prices. For the investors themselves, this mechanism represents an important method for preserving the capital invested in the regulated assets.
The RAB model has been spreading across Europe where it has become one of the preferred models for facilitating the privatization of the power and water networks and, to some extent, transport sectors. In the UK, where RAB models were first introduced, it has become a mature and well understood approach for a range of infrastructure assets.
An economic stalwart
RAB models have also proven to be fairly resilient in the face of the recent financial turmoil and have effectively ensured that regulated businesses had access to a continuous stream of funding, even when the cost of that funding had been affected. This is because RAB effectively takes a long-term perspective by creating a well defined asset base and clear rules on how different elements of the overall value (such as costs, capital, returns, and inflation) are recovered.
In essence, RAB is based on the concept of Financial Capital Maintenance, in which investors can recover the exact capital they invest into the assets. As a result, businesses with RAB tend to be highly attractive to investors that are willing to trade higher rates of return for a more stable and better defined cash flow. At the same time, RAB models do not really ‘guarantee’ a return as recovery is based on a regulatory contract. As a result, confidence in the regulatory regime and the assumption that regulatory discretion will be reasonably exercised from one period to the next is paramount for the success of this model.
Creating a successful RAB model is therefore complex and may not be applicable to all markets or sectors. For one, RAB is best suited to natural monopolies facing limited market risk, and works particularly well where there are large investment requirements over time as the model’s development demands a significant amount of planning and structuring from a regulatory perspective. This also means that markets with weak public institutions and less developed regulatory regimes will have a tougher time creating the right environment whereby there is a high degree of understanding between investors and regulators.
The benefits of the RAB model for governments are significant. For example, RAB attracts long-term institutional investors that not only bring stability to the sector, but also fairly deep capital resources. RAB-based models also effectively transfer risk to investors and responsibility to the regulators, meaning that governments are often only involved at the sector policy level of infrastructure development and operation.
A range of RAB approaches
It is worth noting that RAB does not represent a single model, but rather a spectrum of approaches that must be tweaked and adapted to each situation. In the UK, for example, different sectors have adapted slightly different models; in the water sector, companies are able to change their pricing based on customer usage to cover their RAB base amount, whereas airports have to sell different services under ‘one till’ that allows them to net auxiliary revenues against regulated prices.
Critically, RAB is a dynamic model that operates on a rolling rather than a fixed point basis and therefore has no defined starting point or end point. It also allows for adopting the terms and conditions to the current sector needs. The challenge is to resist the temptation to tinker too much with the model, make it too complex or respond to short-term pressures. This might lead to unnecessary complexity and – eventually – erosion in the very investor confidence that underpins the success of the model in the first place.
On March 19, 2012, UK Prime Minister David Cameron set the ball rolling on the possibility of new ownership and financing models for the UK road network. The UK Government has drawn parallels to the privatization of the water industry and the use of a Regulated Asset Base Model, indicating that a key benefit could be greater investment flowing into the road network. However the Government remains determined that road pricing should not apply to the existing road network and it remains unclear as to what extent private companies might be able to influence the price paid by users for road travel, in the way that water companies can propose the level of charges to the Regulator, in order to fund investment in water assets.
By Dr Matt Firla-Cuchra, KPMG in the UK