Keynote Address at PPP Days 2015 on 16 June 2015 by
Thomas Maier, EBRD Managing Director for Infrastructure
It is said that often, statistics are used less for illumination than for support of one’s own position, but in the case of infrastructure, I think it’s important to remind ourselves of two fundamental numbers:
First, only 10 per cent of current global infrastructure delivery is through PPPs.
Second, only 10 per cent of the estimated annual global infrastructure gap can be covered directly by international financial institutions (IFIs) – old or new, I might add.
Why are these 10 per cent statistics so important? Because they highlight the key challenges that we face today:
First, given the hard limits globally on the capacity of the public sector to spend, we simply need the private sector to deliver much more of the required infrastructure. The public sector alone won’t be able to cover the gap.
Second, we not only need private sector expertise to develop and run infrastructure, but we also need much more private sector financing to be deployed. There is enough global liquidity but not nearly enough projects that have investment characteristics for these monies to flow where they are needed. And to think that IFIs could bridge this financing gap and substitute private financing is no longer a remotely credible option. It may have been a few decades ago, but those times are gone.
Therefore, achieving global uplift in infrastructure critically depends on mobilising the private sector. Private sector involvement is no longer a “nice to have”, but a mission critical to deliver better quality of life, jobs and competitiveness globally.
Uplift of private sector participation will take a concerted and sustained effort by all of us. And as we all know, there is no silver bullet that delivers PPP solutions for all.
As successful PPP markets show, it rather requires a sometimes complex web of activities that together form the bedrock of a system that is predictable, sizeable and creates a win-win between the private and public sectors while delivering better services for the consumer and voter.
In the next few minutes I would like to dwell on some of the critical factors that may help boost PPPs, and with it, the role that the international and national financial institutions can play in:
- supporting workable project structures that can be replicated
- strengthening the capacity of governments and markets to build credible pipelines
- adapting legal and regulatory frameworks where necessary
- designing market-based credit enhancement products to mitigate some of the perceived risks, bringing a higher number of bankable projects within reach of institutional investors
- providing real peer-to-peer learning opportunities through knowledge sharing.
Today, as we open PPP Days 2015, I will give you my views on these key issues to set the stage for these next two days.
Setting the scene
The global need for infrastructure is significant, including in emerging markets. According to consensus estimates from the OECD, Boston Consulting Group and the World Bank Group, the estimated annual global infrastructure investment need is about US$ 3.7 trillion – of which only about US$ 2.7 trillion is currently met on an annual basis. This much-discussed “infrastructure gap” is, of course, large and it is widening. Even if fiscal conditions in both developed and emerging economies improve, the infrastructure financing gap is unlikely to be met from public sources alone. This generates a need and expectation that the private capital and user charges must be mobilised to fill these gaps.
Over many years the international community has made efforts to provide assistance in building PPP capacity in emerging markets. Finding a way to leverage private sector investment through sound, consistent and sustained public sector policies should be a focal point for governments all over. IFIs, given their unique relationships with emerging market governments, can and do play an important role. Our collective agenda here evidenced also by the increased cooperation over the past few years, also in support of PPPs, I think shows that the multilateral development bank (MDB) community is listening and that the multilaterals, as well as many national development banks, are willing and able partners.
Now for a few key issues at the top of my mind.
Point 1: Because PPP projects are often politically sensitive, there is a need to manage political risks during the PPP lifecycle.
PPPs are a form of outsourcing the financing, operation and user charge systems for public infrastructure, and therefore political support to allow the private sector to participate is crucial.
We know there is a fundamental timing mismatch between typical election cycles and the long-term nature of infrastructure projects. Changes in government following elections may often be associated with changes in attitudes towards PPPs. Therefore, strong political will, vision and continuity are important factors for the long-term success of PPP projects.
We need to pay significant attention to this issue when preparing and implementing PPPs, and the adequate and balanced handling of political risk/renegotiation risk is a must!
As we will discuss today in the breakout sessions, managing political risks by using robust value for money methodologies is a key requirement for generating cross-party political buy-in and for warding off arbitrary attacks on PPPs during and after tender award.
I would also like to add that we need to become better at explaining to the public the benefits of infrastructure and engaging upfront in a balanced exercise of explaining benefits and costs of a particular project. Good quality public consultation is not a “nice to have” option; it’s critical to sustain long-term political support across election cycles.
Point 2: Off-budget or on-budget, PPPs still need robust and long-term public sector backing.
We know that PPPs may sometimes be pursued by governments primarily to counteract fiscal constraints, and by treating PPPs as “off-balance”.
Whatever the reason for doing a PPP, PPPs should provide value for money over a whole life-cycle compared with the public sector procurement alternative. Regardless of which accounting convention one adopts, governments should pay close attention to the efficiency benefits derived from locking in long-term PPP projects. This we know: governments must have the ability to service such ongoing obligations, and the money to sustain a PPP must be secure, credible and lasting.
This leads me to my third point.
Point 3: The credibility of the underlying sources of funding of PPPs is crucial. Both user charges and direct government payments contain inherent challenges.
Whilst there are many instruments for financing the upfront investment costs of infrastructure projects – plain budget financing, long-term loans, bonds, equity – for most types of PPPs there are essentially only two sources of paying the ongoing cost of infrastructure: either from the budget through general taxation, or directly from the users of the infrastructure.
Unless there are adequate fiscal resources and/or an end-user willingness to pay that can cover the full cost of the new service, it is not possible to develop bankable projects, whether public or private.
And often a combination of these two sources of funding is needed.
Where full cost recovery tariffs are not feasible due to affordability or political constraints, public budget financing is needed and this must be stable over the life of the PPP contract.
In this context it is interesting to note that according to the World Bank PPI database, close to 80 per cent in 2013 of new PPP projects used an availability payment mechanism in 2013 – and full demand risk structures accounted for only 4 per cent. Therefore, the government’s ability and willingness to pay is a must when designing PPPs.
Point 4: The private sector prices in risk and uncertainty. Risk taking is not free as the private sector needs to meet its own hurdle rates of returns given the project placed before them.
Investors compare the risk-return profile in PPP projects in one country with alternative investments in another, and in other non-PPP sectors in general.
If the comparison is unfavourable for a particular PPP, capital will not flow.
Therefore, the importance of striking the right balance between risk and reward in a project structure is critical. There is no one size fits all and unfortunately for the public sector, pioneering PPPs may require more public credit support then later operations, when a track record has been established.
However, let’s remember what we’ve seen over the last 20 years in PPPs: if a project is well structured and has credible public sector support, money will flow to that project.
As a corollary to this argument, if the public sector entity has little or no prior PPP experience, the use of experienced – usually international – PPP transaction advisers contracted by the public sector is an indispensable upfront investment.
The new Project Preparation Facilities (PPFs) from the MDBs, coupled with countries’ own PPP centres, are vital in my view, as these approaches enshrine the use of highly qualified, experienced advisers.
As the old adage goes, you get what you pay for, and this is true also in the PPP industry.
Now I’d like to touch on some structuring issues.
Point 5: It is clear that no single formula fits all requirements: different types of PPP structures are appropriate at different times and for different sectors.
Thus, private sector involvement can come at different levels and within different contractual structures. For example, in the water sector, structures can include a management contract, an operational lease, and full 30-year build-operate-transfer (BOT) arrangements.
The Yerevan water utility example demonstrates the benefits of an incremental approach that the Armenian government took in order to ensure increasing risk transfer to the private sector. To begin with, Yerevan started with a simple management contract without investment obligations by the private party.
After a successful implementation (that is, after the end of the initial five-year contractual term) the authorities moved to a leasing arrangement supported by the EBRD and EIB in 2013.
The example also shows the vital role of IFIs at the early stages of private sector involvement by supporting public utilities in countries where governments often lack institutional capacity to engage with private operators on their own.
Our sector-based sessions later today will delve into these nuances, based on real-world experiences from across the globe.
Implied in the above example is the issue of local capacity strengthening.
Point 6: Local capacity-building for PPP transactions needs to be built.
In the long run, the capacity of local PPP players needs to be scaled up to broaden PPP investment. The EBRD has seen good progress towards such local capacity development in central Europe and Turkey, to name just a few examples. In emerging markets, IFIs can help develop viable PPP projects, through capacity-building and playing an “honest broker” role to develop reasonable risk allocations between the private and public sectors. We seek to see knowledge transfer happen on the ground through technical assistance projects. But let’s be clear: external parties like IFIs and their support cannot substitute permanently for the absence of local capacity to plan and deliver PPPs.
Therefore, the new PPFs, created by the IFIs and to be presented tomorrow afternoon at this event, can all be used not only to create a broader pipeline of bankable projects but also to help in the short to medium term, working closely with local and national counterparties and/or line ministries and PPP centres to build domestic capacity. Our collective challenge is to find ways to make this process more efficient and lasting.
A second aspect of local capacity-building is the creation of a sizeable local operator market that can broaden PPP investment. The EBRD has seen good progress towards such local capacity development in central Europe and Turkey, for example. Here good local quality players now drive delivery of infrastructure solutions across a wide range of sub-sectors.
Now, beyond institutional issues, I would also like to mention product innovation.
Point 7: PPPs in emerging markets need additional financial products to enhance PPP attractiveness for institutional investors.
Many emerging market countries do not yet have access to international institutional investor finance. This excludes them from a market which in other countries is the logical choice under a refinancing scenario and even in some cases for greenfield projects.
Under these circumstances, well-designed market-based credit enhancement mechanisms could have real potential by attracting long-term institutional investors into emerging markets that have a sovereign rating at or near investment grade, but where PPP projects remain a notch below investment grade. This might be accomplished by applying a credit enhancement overlay such that the enhanced project is elevated, or “re-rated” in effect, to investment grade status.
This is critical since nearly all international pension funds and insurers require a project to be rated at investment grade before they are allowed statutorily to invest in the project.
Point 8: Knowledge sharing is key
Surveying the gathering of experts in this room, from both the public and private sectors, and reflecting on the issues I have presented briefly, leads me to a final point:
We simply must find a way to share more effectively this great collective body of knowledge gathered through experience across literally hundreds of PPPs in all regions of the world.
We know that while the infrastructure challenge is global, the solutions to finding bankable, sustainable structures are local. And by “local” what are we really talking about? People “in the know”. The key is knowledge transfer from those who know to those who need to know, and investing in people.
The “knowledge platform” concept, where interested parties can go to find real-world PPP examples documented and discuss interactively with experts from across the globe, is an idea whose time has come.
We know that there is a real hunger out there from our clients. In this respect, the MDBs’ efforts with the “PPP Knowledge Lab” will complement and enrich the newly established Global Infrastructure Hub of the G20 and available private sector systems. There are also critical offerings from the Organisation for Economic Co-operation and Development (OECD), the United Nations Economic Commission for Europe (UNECE) and the World Economic Forum (WEF). All this should lead to a much greater ability to learn from one another.
I am convinced that knowledge transfer will be a key element in closing the infrastructure gap, because as we all know: there is enough liquidity out there. What needs to be generated is an increased supply of investible projects and legal and regulatory frameworks that bring predictability, replicability and the right win-win opportunities.
At the end of the day, this is our mission and this is why we’ve organised PPP Days 2015. Let’s get to work!