Governments must incentivise private sector investment in infrastructure. New models for repayment need to be examined to maximise the use of governments' funding sources.
Australia's infrastructure needs cannot be met with government finance alone, and how to fund it in the future is one of the key issues facing governments at all levels. The sources of repayment of private sector investment are traditionally general taxation revenue or direct user charges, but new models are needed.
A new report from the Infrastructure Finance Working Group sets out some options, but for them to help fund Australia's large and growing infrastructure deficit will require some serious reforms.
Infrastructure Australia, in its fourth major report to the Council of Australian Governments (COAG) in June this year, "Communicating the Imperative for Action", reported concern that our infrastructure networks are barely adequate for current needs, are beginning to impose significant long-term costs and potential productivity losses, and that there is a powerful need for change, especially in the way we fund our infrastructure.
A month later, the Infrastructure Finance Working Group (IFWG), an expert advisory panel to Infrastructure Australia, published its issues paper, "Infrastructure Finance Reform", focuses on two major issues:
- increasing the pool of finance available for investment in infrastructure, and the reforms needed to do this; and
- how to maximise the use of the government funding required to repay this investment in infrastructure.
How the pool of finance available for infrastructure can be enhanced
IFWG identified six methods of maximising the pool of potential infrastructure funding investment available – three merit close attention:
- greater investment by superannuation funds;
- the creation of an infrastructure bond market; and
- the establishment of an infrastructure bank.
Greater investment by superannuation funds
IFWG identifies the following obstacles to obtaining greater investment by superannuation funds in infrastructure:
- The need for deal flow: superannuation funds need a long-term pipeline of planned investment opportunities to assist them with investment certainty (they suggest a 20-year pipeline). The Commonwealth Government's decision to create a National Infrastructure Construction Schedule should help build this.
- The capacity for infrastructure expertise: superannuation funds must build up experienced teams of investment professionals if they are to directly invest in infrastructure. This may pose a problem for the smaller superannuation funds.
- The preference for brownfield over greenfield projects: Superannuation funds prefer brownfield projects because they don't have to bear construction risk and can see the proven returns before they invest in them, but there aren't many of them available for investment, and they are outnumbered by greenfield projects.
- The taxation treatment of greenfield projects: more favourable taxation treatment would encourage superannuation funds to invest in these types of projects, and the Commonwealth's announcement it will look at more favourable treatment of early stage tax losses over time and on a change in ownership is a welcome move.
- The scale of bid costs: with tender processes running up to 18 months or more, investors spend time, money and effort, and these substantial costs can only be recovered by the winning tenderer. The issues paper looks at various means to reduce bidding costs.
- The need for liquidity: superannuation funds
are statutorily bound to maintain a level of liquidity sufficient
to match expected outflows of retiring and transferring members.
There is a perceived mismatch between this need for liquidity and
the long-term nature and size of infrastructure investment. IFWG
suggests, to overcome this obstacle:
- splitting large infrastructure projects into more manageable investments;
- structuring and listing investment vehicles owning a pool of infrastructure projects. This allows smaller investment, and greater liquidity in dealing with that investment; or
- the creation of a highly liquid and tradable infrastructure bond market (discussed below).
Infrastructure bonds (often in the form of revenue bonds) are secured against specific infrastructure assets and the cash flow from them. Ways to enhance the infrastructure bond market might include:
- tax concessions or direct grants to the issuer of the bonds or to bond holders, although IFWG suggests that financiers and tax planners in the past may have captured more of the benefit of tax concessions than the infrastructure borrowers;
- the use of covered bonds, where the bond issuer has a pool of projects, the revenue streams from which can secure the bond issue. This is good for funding infrastructure projects too small to otherwise attract bond interest. A bank could pool its infrastructure project loans for sale to investors as a large, liquid covered bond, traded on the market. The Australian Government is amending the Banking Act to allow banks, credit unions and building societies to issue covered bonds in Australia, but query if they will do so in respect of infrastructure projects within their commercial loan books; and
- the development of a more liquid retail corporate bond market in Australia. The Australian Government's commitment to trade Commonwealth Government securities on a retail security exchange should provide a more visible pricing benchmark for fixed-income securities, thereby reducing barriers to retail bond issuers and encouraging diversification into fixed-income products, an option which is notably lacking for Australian investors. Its announced reduction of disclosure obligations and liability requirements associated with corporate bond issues to retail investors should reduce the costs of these issues.
A Government-created infrastructure fund would finance infrastructure projects by way of grants, equity injections, concessional loans or raising funds on the capital markets for eligible projects, along the lines of the European Investment Bank. Advantages of an infrastructure fund include:
- supporting projects with high net public benefits but not necessarily a revenue potential strong enough to interest the private sector;
- better decision-making on project selection, as the infrastructure fund would be operationally independent of governments;
- a willingness to fund greenfield developments, which once operational could be sold off as brownfield assets with the proceeds recycled into the fund for future projects; and
- the ability to raise capital for large projects through the issue of tradable bonds, structured to be attractive to investors such as superannuation funds.
IFWG cautions, from a Government perspective, that the creation of a revolving infrastructure fund might effectively limit the impact of Government contributions on their budgets, could possibly be undermined by political interference or poor processes, leading to poor project selections and because of the range of expertise needed to maintain (in particular equity) positions in individual projects, could be prohibitively costly.
How can the funding available for infrastructure be maximised?
IFWG explores the issue of how infrastructure finance, once raised, is to be repaid to investors. There are two fundamental sources of funding, either an allocation from general taxation revenue or direct user charges. IFWG explores the concepts of:
- availability payments;
- user charges including tolling freight vehicles to fund freight-specific road upgrades and bypasses that will improve freight efficiency;
- tax increment financing; and
- joint development of revenue-producing commercial enterprises adjoining required infrastructure, to offset the cost of that infrastructure.
The availability payment and tax increment financing models warrant particular attention.
Under the availability payment model (used in Australia for social infrastructure projects and recently for the Peninsula Link and Gold Coast Rapid Transit projects), the private sector develops, finances, operates and maintains the infrastructure asset over a concession term. Periodical payments are made by government for the availability of the infrastructure asset. Payments commence once the infrastructure is operational and are reduced if it is not available in its contractually agreed condition. Government does not need to raise debt in the short term to meet availability payments over the term of the concession, and it's also insulated from design and construction risk.
Ways to maximise the efficiency of this funding method include:
- using improved loss offsets and infrastructure tax concessions to provide projects with early stage funding;
- revenue generated from any commercial services provided as part of the project can be returned to Government to offset the availability payments; and
- at the end of the concession, the Government can sell the asset or add it to the public network for further leverage.
Tax increment financing
Tax increment financing (TIF) is widely applied in the United States and increasingly so in the UK.
A local authority levels a tax surcharge on land owners and/or businesses which benefit from the development of a piece of infrastructure in a designated TIF district. Alternatively, the increase in real estate taxes which a government can expect over time through the revaluation of land in a TIF district can be set aside from general tax receipt funds and allocated to that TIF district.
The additional revenue funds repayment of the finance that the government authority has raised to build the infrastructure services for the TIF district or to fund the ongoing costs in the TIF district.
Implementing a TIF scheme needs legislative change.
IFWG points out for discussion some criticisms of TIF:
- to the extent it may involve additional taxes, it might encourage businesses to move away from the TIF district;
- there is a substantial risk that the expected increase in tax revenue fails to emerge, which may deter investors and financiers;
- unless there is some central government guarantee of returns, the price of borrowing by the government authority may be inefficient; and
- more prosperous areas will attract investments which might otherwise have been directed to areas in more pressing need.
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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.