5 November 2015

An idea whose time has come: project bonds


Infrastructure spending is flavour of the month right now in the US, the UK and elsewhere. A rising population, spending backlogs and a desire to keep growth moving are among the driving forces.  The big question is how is all this to be paid for? There is a notable lack of structures offering reasonable returns for investors.

In the UK, the chancellor George Osborne wants infrastructure to be the theme of his upcoming Autumn Statement, when he will commit to £100bn of spending. He has already announced a new National Infrastructure Commission, where the board includes big cheeses like Labour peer Lord Adonis and Lord Heseltine (once nearly Prime Minister).

The Commissioners needs to put their thinking caps on. Prior to the financial crisis, there was a political consensus here that using the private sector to deliver infrastructure was best. The Conservatives relied on privatisation and New Labour the expensive Private Finance Initiative. That consensus has collapsed, taking UK infrastructure spending with it, dropping from a peak of £57bn in 2008-9 to £42bn in 2013-14.

The Government is now largely footing the bill itself. Network Rail has been deemed a public sector body by the statisticians, potentially adding £30bn to the national debt and 0.3% to the annual deficit. Next year, spending on HS2 high speed rail project is supposedly to be ramped up to £3.5bn per annum. As there are no outside investors, this too will have to be added to the national debt. PF2, the successor to PFI, has so far been a flop and apparently only produced a single hospital in Northumberland.

Spending of this scale seriously jeopardises the chancellor’s deficit reduction programme. It also puts the UK Treasury back in charge of every road, hospital, and railway station, as in the 1970s.

The situation is made worse by a lack of understanding about what institutional investors are prepared to put money into. There are actually two infrastructure markets. The risky primary market where companies build new projects (like HS2), and the secondary market where they invest in projects which are complete and up and running. It is the primary market which is moribund. The secondary market is awash with investors looking for mature, income producing assets.

So here is an idea, advocated by Alexander Jan, a director of the engineers Arup: infrastructure project bonds. Instead of relying on the public sector to deliver infrastructure, or the cumbersome PF2, create new infrastructure companies, perhaps owned jointly by a combination of devolved administrations, local authorities, private sector investors, which can keep revenues and charges and in turn issue their own debt, partly underwritten by the taxpayer.

This would build on London’s proven capability in financial innovation. It would require the launch of an entirely new capital market by the Treasury, something it has already done successfully by encouraging the creation of the London Stock Exchange’s new ORB market for retail bonds and also for Renminbi trading. A new market of this kind, of bonds perhaps yielding 1-2% points above gilts or US Treasuries, would be extremely attractive to investors who are desperate for income. It would unlock new streams of cheap infrastructure finance, while only featuring as a contingent liability in the national debt. It might even attract institutions and projects worldwide.

All of us could buy, say, M25 bonds yielding 5% or Network Rail bonds yielding 6% or Highway 61 bonds yielding 4%, confident that we would get our money back if things went wrong.

There is a precedent of sorts. London’s CrossRail which, shock horror, is coming in on time and on budget (hat tip, London Mayor Boris Johnson), is effectively funded by a coalition of private and public interests. Transport for London has been licensed by the Treasury to issue its own debt to fund it.

If Lords Adonis and Heseltine want to do something useful, an exciting new international market for project bonds would be a good place to start. But they should not hang about. If London does not move first, then Wall Street might steal a march again.

George Trefgarne is founder of Boscobel & Partners, a communications firm.