How the chancellor can satisfy pension funds’ hunger for infrastructure
Death and taxes are said to be the only two certainties in life, but you could now add “rumours about increased government infrastructure spending” to the list.
Infrastructure captures the imagination as it literally provides the building blocks of the nation. It can be a contentious topic, as seen with HS2 and the Heathrow-Gatwick debate, but we all recognise, as taxpayers, how important it is to get a good deal on the funding of these projects. This means opening up investment opportunities to as many players as possible.
Shortly after Philip Hammond was appointed chancellor, he alluded to the new administration’s intention to invest in infrastructure to boost growth. In particular, he cited the prospects of tapping into capital markets to fund a building programme through the creation and issuance of so-called “infrastructure gilts”.
Whether intentional or not, the use of the term “infrastructure gilts” has set an expectation that the chancellor will announce a programme of borrowing at gilt rates and ring-fence it for infrastructure investment in the Autumn Statement.
But the returns from an infrastructure gilts programme are currently unlikely to attract the government’s desired target market of insurers and pension funds in sufficient volume. Gilt auctions have not been particularly well subscribed to of late, as appetite has been hit by falling yields.
Hammond's infrastructure gilts are unlikely to be attractive given falling yields (Source: Getty)
To secure the best deal for taxpayers, we need to ensure that all the institutions that can invest in long-term infrastructure projects are encouraged to and enabled. For pension funds and insurers, this would mean being able to lend through new ways which align with regulatory requirements around what they can invest in.
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In the past, they have been limited or excluded from participating in infrastructure projects due to the restrictions placed on them around how they safeguard the money they manage. If the government could provide a number of specific guarantees and an attractive risk-reward ratio, this could change, and we should get a better deal as a whole.
There are three key measures that could achieve the best sponsors for the £483bn project pipeline set out in the National Infrastructure Delivery Plan.
First, one assurance that would allow pension funds and insurers to participate from the early stages of a project through to the operational phase would be income from day one. In a project such as UK airport expansion, this would mean some repayment before the planes have taken off. Certain protections may also be required if a project stalls early on; for instance, if engineers “hit a water main” on Britain’s new high-speed rail network, significantly delaying the project.
Investors should ideally be able to make a return before the first plane takes off from Heathrow's third runway (Source: Getty)
With these measures, pension funds and insurers could compete with early-stage debt and equity investors, who can take on initial development phase risks in exchange for the promise of high returns further down the line.
This brings us to the second key measure: smoothing the yield out over, say, a 25 year period, and ensuring investors are paid in full even if a project finishes early to provide the certainty over future cashflows that they need.
Finally, many of these projects naturally provide inflation-linked cashflows (as anyone who travels on toll roads or trains can attest to). Enabling borrowing which provides inflation-linked coupons would be a real step forward in meeting the demands of pension funds and insurers.
The UK’s infrastructure conundrum currently resembles a ravenous diner without cutlery – the appetite is there, the product is ready and waiting, but the means to consume it are lacking.
With greater transparency on the financing needs of the government’s infrastructure projects, combined with an attractive proposition designed to remove barriers that have prevented participation by long-term investors, the chancellor would be able to satisfy the hunger of pension funds and insurers for infrastructure opportunities and ultimately get taxpayers a better deal.