Chancellor of the Exchequer Rishi Sunak poses before presenting the Budget. Details of a national infrastructure bank were included in his speech. (Photo by Tolga Akmen/AFP via Getty Images)

The UK government announced details for a new national infrastructure bank as part of its March 2021 Budget. The institution has been in the planning for several years but no firm details had been published until now.

The UK government has said the bank will provide debt and equity capital, state guarantees and advisory services to infrastructure projects around the country. Based in Leeds, it will be focused on supporting the government’s regional levelling up agenda and net-zero environmental targets.

Its aim is to help projects struggling to acquire finance by assuming some of the revenue risk and crowding in other investors. While investor interest in the UK market remains high there has been a dearth of opportunities in recent years. Institutional investors, such as pension funds and insurance companies that are attracted to the long-term credit profiles of infrastructure assets, are particularly keen to invest more in UK infrastructure.

Aviva Investors, the asset management arm of insurance company Aviva, announced in October 2020 that it was aiming to invest £10bn in UK infrastructure as a response to the government’s plans.

Darryl Murphy, head of infrastructure at Aviva Investors, says: “Post-Covid, there is even more liquidity in the infrastructure market than before. The amount of debt and equity in the market is huge.”

Scepticism surrounds UK infrastructure bank plan

Market participants remain sceptical about the role of any new bank, however. Some worry that instead of crowding in investment, it could actually crowd out private investors by backing projects that are already commercially viable.

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“The mission statement should align with where there is a gap in the market,” says Murphy. “If the mandate is going to be focused on net zero, the energy transition and levelling up, then it needs to be focused on opportunities that are very early stage, that involve new technologies, or where commercial models don’t already exist.”

Ted Frith, chief operating officer at GLIL Infrastructure, says: “There was a concern that the government would just keep printing gilts and crowd out other investors. For this reason, we welcomed November’s plan as it recognised the beneficial role that institutional investors can play in funding local infrastructure projects.

“However, what is the government’s long-term strategy for the bank? Is it going to focus mainly on large projects or will it get involved in regional projects as well as the privatisation market?”

A reliance on private investment in infrastructure

The UK government has said that it expects half of its future infrastructure pipeline of projects to be privately financed.

While private investment provided more than 95% of the funding for energy-related projects since 2018, according to government data, the central government has had to provide almost 80% of the funding for transport projects.

If the mandate is going to be focused on net zero, the energy transition and levelling up, then it needs to be focused on opportunities that are very early stage, that involve new technologies, or where commercial models don’t already exist. Darryl Murphy, Aviva Investors

Matthew Job, a partner at law firm Hebert Smith Freehills, says: “The private sector involvement in the traditional greenfield infrastructure sectors, such as roads and social infrastructure, is virtually zero.

“We are in a sort of impasse where lots of money wants to find a home, lots of borrowers want to take the money, but the two are missing each other. This is because one is offering the wrong product and the other is looking for the wrong product.”

The government had for a couple of decades used the controversial private finance initiative (PFI) to funnel private capital into non-energy infrastructure, but it has abandoned PFI in recent years without replacing it with a new funding model. Instead, major transport projects such as Crossrail and High Speed 2 have been entirely paid for by the central government.

A major role the new bank will be expected to play is to restructure projects not attracting private investment. It will do so by providing some capital and assuming enough project risk to attract co-investment from the private sector.

Replicating the role of the EIB

This type of role has traditionally been played across Europe by the European Investment Bank (EIB), a multilateral institution owned by the members of the EU that provides support to projects across the economic and political union.

Following the financial crisis of 2008, for example, the EIB offered a product called project bond credit enhancement, which saw it take a slice of the risk in projects that weren’t investment grade to help them attract capital market investors.

The EIB was a major investor in UK projects but began to exit the market following the Brexit vote in 2016. In 2015, the EIB’s investment in the UK peaked at just over $9.4bn (€7.8bn) but has since fallen every year and totalled just under $602.73m in 2019.

Energy and infrastructure were the biggest areas of investment for the EIB in the UK.

The EIB has a lower cost of capital so can offer cheaper loans than other banks. This leads to accusations of crowding out, as they undercut commercial banks to win roles on attractive projects. Murphy argues, however, that the institution is successful at crowding in investors in other ways.

“I have seen lots of banks happy to sit in behind them on a deal,” he says. “It is a lot easier for commercial banks to let the EIB do most of the work negotiating because it is much more likely to get its way.”

Not everyone welcomes a UK institution replicating the previous role of the EIB, however.

“Will [a national infrastructure bank] just end up creating more competition in an already very crowded market, just like the EIB, which simply provided long-term money at slightly cheaper rates than banks and bond investors?” says one senior infrastructure banker.

“The EIB is a massive off-balance-sheet funding tool for the EU… I think it has more debt than the Netherlands, but its ownership is divided among its 27 member states, so nobody has to recognise that liability,” the banker adds.

The EIB is able to undercut the commercial market because, as a multilateral institution, it doesn’t need to abide by state aid rules.

While most expect the bank to have to meet state-aid rules, its initially announced interest rate of 60 basis points above Gilts seems much cheaper than debt commercial lenders can currently provide.

Taking a leaf out of the Canadian book

The closest existing equivalent to the proposed UK national infrastructure bank is the Canada Infrastructure Bank (CIB).

Like the UK, Canada is a mature infrastructure market, with a strong institutional investor presence and a long history of private sector investment in infrastructure.

The CIB was established in 2017 with a mandate to fill a market gap between government-funded and privately funded infrastructure projects.

At the time, the bank was seeded with $27.66bn (C$35bn) but only managed to spend C$1.34bn in its first three years, most of which was on a single light-rail project in Montreal.

While government spending rose from $8.46bn in 2016–17 to $11.78bn in 201920, the total value of projects announced has declined since the CIB was introduced in 2017.

The CIB is principally mandated to lend money to projects, but it also has the ability to invest equity.

After attracting criticism for not bringing to market the number of projects, and indeed of institutional capital, that the government had hoped for, in January 2020 Canada’s House of Commons commissioned an audit and complete review of the bank.

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Public opinion has often pointed at governance as the main issue, claiming that the CIB was built in a system that was far too bureaucratic for it to work alongside business partners such as pension funds, insurance companies, and other institutional and private investors.

I think the CIB is on the road to getting where it needs to be. The new growth plan more clearly defines and expands its mandate. Shariq Alvi, CIBC Capital Markets

One year on from the review, the CIB has new leadership having appointed former McKinsey partner Ehren Cory as CEO and more recently chief executive of Vancouver Airport Authority Tamara Vrooman as chair.

“The potential of infrastructure banks to generate growth, create jobs and meet the government’s goal of decarbonising the economy is immense,” a CIB spokesperson tells Investment Monitor.

“The Covid crisis makes the relevance of an organisation such as the CIB even greater. Last October, we announced a C$10bn ($7.9bn) Growth Plan to help Canada’s economic recovery,” they add.

In line with the plan, the CIB is involved in an irrigation project in Alberta ($322.05m commitment); the Calgary-Banff rail project, a hydro-fibre link project; and the Oneida energy storage project, among others.

Shariq Alvi, managing director at CIBC Capital Markets, sees signs of improvement. “I think the CIB in on the road to getting where it needs to be,” he says. “The new growth plan more clearly defines and expands its mandate, allowing the bank to focus on key initiatives providing near-term investment opportunities, and that have been pre-approved by the Ministry of Infrastructure and Communities.

“People need to realise that banks don’t make public infrastructure projects happen; local authorities, provincial governments or private sector developers do.”

Is this a second Green Investment Bank?

A comparison closer to home is the Green Investment Bank (GIB), a state-funded institution launched by the UK government in 2012 and sold to Australian investment bank Macquarie for £2.3bn in 2017.

The GIB was active at a time when investment in offshore wind and other renewables technologies was ramping up in the UK. Renamed Green Investment Group since privatisation, it has gone on to become one of the most active participants in the European energy market. However, like the EIB, the true impact of the GIB on the UK infrastructure market is up for debate.

If you look at the GIB, the reason it was successfully privatised is because it was invested in things the private sector would have invested in anyway. Michael Dinham, ING

Michael Dinham, global head of infrastructure at Dutch bank ING, argues that the GIB did not really mitigate a market failure. “If you look at the GIB, the reason it was successfully privatised is because it was invested in things the private sector would have invested in anyway,” he says.

Murphy agrees that the GIB “wasn’t really additive in terms of doing things the market wasn’t already doing” and that more recent claims that it led the whole offshore wind market are “somewhat rewriting history”.

Job says that the GIB did evolve past its original purpose and started competing with the private sector, but argues that in its early stages it helped stimulate market activity in new areas. “By doing the first two or three battery storage deals, for example, the GIB not only worked out with borrowers how to present them as bankable deals but established a market,” says Job.

Could the new national infrastructure bank have a similar life cycle to the GIB, helping to create a market for emerging assets such as electric vehicle charging infrastructure or hydrogen production facilities, before being privatised?

Murphy thinks this is unlikely given conversations he has had with the UK government, which suggest the new bank is intended to be a “long-lasting public institution”.

It is all about the mandate

The success or failure of the UK national infrastructure bank seems directly linked to its mandate, which seems very broad.

It has an initial budget of £22bn, split between £12bn of debt and equity and £10bn in state guarantees. Its policy design document suggests a broad remit, stating it will invest “across different sectors” with investments decided on a “case-by-case” basis.

Will the bank only supporting projects that are struggling to attract finance in an attempt to fix a market failure? Or will it be less disciplined and risk being drawn towards more commercially viable projects, leading to accusations of crowding out?

“It is important that the UK government sets a clear mandate for its infrastructure bank,” says Alvi at CIBC Capital Markets. “Drawing from the Canadian experience, it is crucial that the bank identifies gaps and issues in the UK market that it can help fill in. The CIB is now focusing on economic infrastructure with a greenfield risk component, which the bank is coming in to take on so that it can help crowd in other private equity investors, for instance.”

Michael Likosky, partner at US-based consultancy Advantage Infrastructure Advisors, says: “Ultimately, a successful, carefully formulated national infrastructure bank should address three points. It should aim at putting together a procurement pipeline with government backing; it should push a mission by the government to create a programme of projects that is useful for the market; and it should create a functioning and efficient financing mechanism.”

The decline in infrastructure investment in the UK has principally been caused by the government abandoning the PFI funding model, creating a dearth of projects that investors are happy to support.

In its latest National Infrastructure Strategy, the government has hinted that it may extend its use of contracts for difference and the regulated asset base funding models to other sectors. If it really wants to stimulate investment in infrastructure, a new funding model to replace PFI would likely be a bigger catalyst than any state-funded bank.