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PF2: A missed opportunity

PFI’s successor should have been the framework that conclusively brought institutional investors into the mainstream of greenfield infrastructure debt financing.

After months of taking swipes at the “discredited” Private Finance Initiative (PFI), Chancellor George Osborne finally unveiled the UK’s new private sector procurement framework – the Private Finance 2 (PF2). 

Unfortunately, PF2, as its name indicates, is really more sequel than reboot. PF2 is PFI airbrushed; a more polished version of the original, better suited for prime-time. 

Remember the days of paying £400 (€493; $644) to change a light bulb? They’re gone, because government can now change service providers midway through PF2 contracts. Frustrated with PFI’s opacity? PF2 will publish profits and its off-balance sheet liabilities from day one. Apoplectic about “excessive” private sector PFI profits? Rejoice, taxpayers will now be able to share in them. 

Every one of PFI’s headline-grabbing faults has been tackled by PF2. But PF2 feels like a tremendously missed opportunity because it fails to address the most important question affecting the European infrastructure market: how to get institutional investors to replace banks in funding greenfield infrastructure?

Treasury will surely beg to differ. On the contrary, it will say: PF2, by design, makes it easier to attract institutional investor equity and debt. But let’s look at PF2’s most substantive design change, its greater emphasis on equity financing. PF2 projects will now be financed with up to 25 percent of equity, compared to PFI’s 10 percent. How is this beneficial?

Treasury argues more equity will make PF2 companies “more robust […] more capable of achieving investment grade rating, and more attractive to a broader range of long-term debt providers including […] pension funds and life insurers”.

It’s hard to disagree with the assertion that more equity will make PF2 companies more robust. But it’s another thing entirely to say it will be decisive in making these companies investment grade material. And it’s even riskier to suggest more equity is all that’s needed to make institutional investors overcome their long-standing aversion to construction risk.

Let’s not lose sight of the obvious here: 75 percent to 80 percent of debt – while less than 90 percent – is still a lot of debt. Where’s that debt going to come from?

Ian Berry, fund manager for infrastructure & renewable energy at Aviva Investors, nailed it in his response to the government’s announcement: “Interest in infrastructure from long-term investors like pension funds is undoubtedly increasing. However, converting this substantial interest into commitments and investments remains the challenge.”

PF2 could – and should – have attempted to forcefully address that challenge. And it should have done it by focusing on debt instead of equity. By promoting a solution that would see banks fund construction and institutional investors step in for the long-term, with government guaranteeing the refinancing risk. Or by guaranteeing construction risk to get institutional investors directly involved in greenfield financing.

PF2 is vague on all these fronts when it should have been clear and assertive. 

Still, there is a dark horse here: the government’s £40 billion infrastructure guarantees scheme. If used wisely, it can make all the difference in getting institutional investors involved in providing infrastructure debt. But if this happens, it will be despite – and not because of – PF2. 

In the end, it’s hard not to be cynical about what PF2 looks like: a politically expedient facelift for a procurement solution widely criticised by government, rolled out to allow the private sector to fund a new pipeline of infrastructure projects desperately needed by an economy in dire straits.