New Zealand

Details

  • Service: Advisory, Corporate Finance, Infrastructure Financing
  • Type: Business and industry issue
  • Date: 9/05/2012

Infrastructure Financing

We help clients in the public and private sectors develop and finance infrastructure projects in new and innovative ways.

Infrastructure delivery models: One size does not fit all 

Infrastructure delivery - Christchurch

 

New infrastructure financing schemes have been popping up around the world. It’s a positive trend: governments’ and sponsors’ experimentation with innovative approaches to sourcing investment undoubtedly help the infrastructure industry evolve and mature.

 

The redevelopment of Christchurch will require significant investment and, in all likelihood, the use of non-traditional delivery models.

 

The scale of infrastructure redevelopment in Christchurch is wide ranging. Core ‘enabling’ infrastructure is required:

  • buildings in the CBD
  • utilities such as water and waste water
  • social and economic public infrastructure like the convention centre, stadium and emergency services.

 

All of these need to attract private investment and, in terms of delivery model, one size certainly does not fit all.

Partnerships to deliver public infrastructure


Public private partnerships (PPPs) allow public bodies to pay for the cost of infrastructure over the life of that infrastructure.  The private sector finances the development the infrastructure, borrowing privately in the process,and recovers this through a public payment based on the availability of that infrastructure during its life.

 

With this the private partner takes the risk of cost overruns and payments are linked to the performance of the infrastructure. If the infrastructure isn’t available to the required standard over the life of the asset, the private partner loses money. In an environment of scarce public funds, the injection of private finance can make projects more affordable. But this is only part of the benefit.

 

Many people think that having the private sector involved in providing public infrastructure is ideologically wrong – especially if a profit is made from it. This misses a critical point – the private sector already makes a profit from it. Under traditional contracting structures the private sector makes its money building assets, even if these turn out to be poor quality. Stories of substandard public buildings, many of which leak, are never far from New Zealand press.

 

A different private sector contractor will then make even more money for fixing these properties and signing up to long-term maintenance contracts – making money because the private sector didn’t build them as best they could have in the first place.

 

Optimising the whole of life cost of infrastructure

 

Under a PPP these contracts are bundled together as one so the focus at design is on reducing the cost of the contract over the whole life of the building. This transfers the risk away from the public sector, and incentivises private contractors to build them to a high quality in the first place.

 

Further, having the team who will maintain the asset in the room as part of the design process will ensure they innovate in materials selection and design to reduce cost of maintenance. Throw in heightened competitive tension and most of this benefit will come back to the public sector.

 

Incentivising performance

 

Under a PPP, if the private sector doesn’t perform, they don’t get paid. It is true that the public sector can generally borrow cheaper than the private sector, but ‘having skin in the game’ provides a strong performance incentive that often delivers better value over the long-term.

 

Design, build, finance and maintain PPP contracts such as that described above could be successfully used for anchor projects within the emergency services and justice sectors.

 

Purchasing capacity from private infrastructure

 

Not all of Christchurch’s anchor projects are for public infrastructure. Take the convention centre – its benefits are multi-tiered. The users of the centre should pay for their use, and these are mainly private users. A convention centre provides an ideal location for other commercial development – like restaurants, cafes and shops.

 

In our experience of working on the Melbourne Convention Centre Development and the forthcoming Sydney Convention Centre, the revenues from these activities should underpin much of the lifetime cost of the development.

 

Additional benefit flows to the wider economy. A world-class convention centre in the heart of the central city can help drive economic recovery in Christchurch by driving employment (in the construction and operation stages), tourism, business and hospitality activity in the area. It is this GDP gain that encourages the public sector to invest.


This does not mean that the Council or Central Government needs to fund the development. Where the balance of benefit lies heavily with the private sector, this could be a private development – with the Government’s role being to agree a long-term contract to purchase capacity or to make an ongoing performance linked payment to ‘top up’ the private revenue making the project financially feasible.


This would be in return for the economic benefit the development would bring, and purchasing any capacity or usage rights the Council or Government want to retain. The reliance of the private provider on this top up payment for commercial feasibility would still mean that the Council would retain bargaining power over the requirements of the scheme – but the financing burden would be shifted to the private sector.

 

Capitalising future economic growth

 

Economic infrastructure development, such as a commuter rail network, is unlikely to be financially viable in its own right. Yes, users will pay for their use, but in our international experience of such projects, this is unlikely to be sufficient to generate a commercial return. On a project basis, the business case is likely to look weak, and we understand that for this reason such a project in Christchurch is not currently a priority.

 

Once a holistic approach is taken to assessing the economic gain from such a project then theremay be more merit in continuing to explore the possibility. This economic gain should consider the connectivity of different parts of the city and the region – of connecting the labour force with business and industry.

 

Local economic growth

 

Even if the long-term economic benefits can be shown to make the project worthwhile, there is still an affordability problem. Christchurch City Council will be capital constrained throughout the rebuild. Their ability to borrow based on future growth is difficult.

 

Tax Incremental Financing (TIF) is a model that has grown in popularity across the USA, and is starting to be deployed in the UK. TIF allows local or regional councils to borrow to fund infrastructure on the back of increases to rating income that will flow from economic development.
 

National economic benefit

 

The difficulty with TIF for most councils will be that the economic benefit will be captured by government centrally through income and corporate tax, not through local rates. Funding purely on the back of local rating gains undervalues the economic benefit.

 

KPMG have been working closely with a number of UK regional authorities to ‘earn back’ a portion of the additional tax generated by investing in infrastructure. Critically, this ‘earn back’ is based on actual performance and indicators of economic growth over time, so it is the regional authority and not central government bears this economic risk.

 

KPMG advised the Greater Manchester Regional Authority who signed up with UK Government to this innovative approach in March 2012 – the first authority to do so. Progress in Manchester is being followed by a number of progressive international cities.

 

Who pays, wins

 

Or preferably, who wins, pays. Incentives are best aligned where the ultimate beneficiaries of infrastructure are the ones to foot the bill. This will ultimately lead to higher quality infrastructure.

 

There is no ‘one size fits all’ for infrastructure delivery models. Different models apply to different types of infrastructure and differing affordability constraints. Continued innovation and a first principles approach to infrastructure development and financing will ensure the right outcome for Christchurch to fulfill short-term needs and long-term sustainability.

 

By Rosie Pearson and Gwyn Llewelyn, KPMG in NZ