Standard & Poor's backs institutional investors to fill global infrastructure 'funding gap'

Out-Law News | 21 Jan 2014 | 2:06 pm | 2 min. read

Institutional investors, such as pension funds and insurers, could be persuaded to invest as much as $200 billion in global infrastructure annually with sufficient incentives, according to new analysis by Standard and Poor's.

The ratings agency said that given the right investment conditions, institutional investors could fill the 'funding gap' identified by McKinsey as a result of "sustained downward pressure" on resources from national governments. A clearer pipeline of projects, policy incentives, less onerous regulation and better information about the expected returns from projects in various stages of development would encourage them to do so, it said.

"As it stands, the long-term global project finance market consists of a handful of banks and various capital markets players, including insurers, infrastructure fund managers, and investors in public bonds," said Joe Maguire, author of the agency's report. "Of these competing businesses, institutional investors have shown the biggest increase in appetite for such investments."

"A September 2013 Prequin survey showed that 58% of investors plan to increase their funding allocation for infrastructure in the long term. Almost two-thirds of respondents said they plan to allocate more capital to the sector in the next 12 months than in the previous year ... All of this comes at a time when many governments – especially those in Western, developed nations – are cutting back on infrastructure spending because of budgetary concerns," Maguire said.

Global management consultancy McKinsey has estimated that around $57 trillion needs to be spent on infrastructure projects worldwide by 2030. Assuming that national governments allocate 3% of gross domestic product (GDP) to infrastructure, this leaves an estimated $500bn annual funding gap. Standard and Poor's projections are based on a scenario where banks continue to lend around $300bn annually to projects, but notes that its findings are heavily dependent on "public policy decisions and investment incentives".

The figures were dependent on institutional investors' infrastructure investment allocations rising to a weighted average of 4%, Standard and Poor's said. Although this was considerably higher than the amount that they were currently investing, the agency noted that recent reports and statements from these investors pointed to an investment target of between 3% and 8% of their assets under management over the next five years. About 40% of this would come from the pension fund sector, which is already one of the largest private-sector funders of infrastructure in North America and Australia.

The report also noted recent commitments to UK infrastructure investment by six major insurers. L&G, Prudential, Aviva, Standard Life, Friends Life and Scottish Widows announced plans to collectively invest £25bn in UK infrastructure over the next five years last month, citing changes to the upcoming Solvency II risk management framework as no longer discouraging them from making longer term investments. According to Standard and Poor's, institutional investors' "need to match long-term assets and liabilities - while at the same time picking up higher yields than they might get from traditional investments" made infrastructure an ideal investment opportunity if the risks could be managed effectively.

"Many insurers and pension funds remain reluctant to directly invest in projects before completion (so-called 'greenfield' projects)," the report said. "This is partly because of the possibility of delayed yields and the potential effects that loan prepayments have on long-term returns - but is perhaps more directly a reflection of their wariness of taking on construction risk. In our view, however, construction risk is seldom the main reason for a project to default."

Perceived political risk and the potential for regulatory or government interference could also discourage institutional investors, particularly in those countries with less-established track records of successful public-private partnerships, the report said.

"The reality is that the 'safe haven' markets are going to attract institutional investment - mainly in existing infrastructure assets - while new construction of assets and emerging markets will need to work harder to reduce risk to private investors," said Graham Robinson, a global infrastructure expert with Pinsent Masons, the law firm behind Out-Law.com.

"However, for rich countries to benefit, they need to privatise public infrastructure. The UK has attracted little institutional investment to new construction of infrastructure, which the McKinsey report highlights," he said.