14 Ways to Meet Victoria’s Infrastructure Funding Shortfall 1

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Monday, August 11th, 2014
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Victoria needs to look at new and innovative ways to finance its long term infrastructure needs, according to a new report which examines 14 mechanisms of funding used on domestic and international projects and assesses their suitability for key projects in the state.

Launched last month at a Property Council of Australia event in Melbourne, the Finding $50 billion report argues that the state has a current infrastructure deficit which – combined with future expectations regarding population growth and urbanisation, demographic change and climate change – means it will need $50 billion worth of new investment over the next 10 years.

The report also says governments will need private sector support in order to meet funding requirements, and that both Victoria and Australia generally have relied too heavily on traditional financing methods in the past.

“The lack of sustainable infrastructure funding and financing mechanisms is a significant obstacle to reducing Victoria’s growing infrastructure shortfall and meeting future demand,” the report says. “’Business as usual’ funding, which relies heavily upon government funding infrastructure projects, significantly limits the capacity of government to fund the infrastructure the community desires or needs without significant borrowings.”

Despite having looked at major construction projects around Australia and the world, the report’s authors stress that not all mechanisms identified in the report are appropriate for all types of infrastructure.

Mechanisms like the toll equity loan agreement, which is being used to finance construction of three additional sections of the partially complete Texas Grand Parkway ring road around Houston in the US, for instance, would be suitable for major road projects such as the North East Link but not for smaller projects such as station redevelopments.

Other mechanisms such as social impact bonds and non-for-profit funding, meanwhile, are best suited to local developments such as cultural or community centres, where the impact is primarily social rather than commercial.

Still, the authors argue a number of the alternative mechanisms have considerable potential and say their research aimed to promote greater understanding about how different mechanisms could be used on different projects.

“For every problematic example of alternative funding and financing, there is a successful counterpart,” they say. “Real examples and real experiences can provide government and private sector the courage to successfully harness alternative mechanisms.”

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The mechanisms, divided into state government focused, local government focused and any government level, are as follows:

State government focused

1)      Special purpose borrowings

Description: Similar to general government borrowings but involves the state borrowing against specific projects rather than consolidated government funds.

Current use:  Commonly used in the US but not Australia.

Best suited for: Borrowing by government owned enterprises (e.g.: ports corporations).

Example project where method was used: Denver International Airport, $US720 million funding raised, starting in 2013

Advantages/disadvantages:

  • Can be used to finance government owned enterprises in a way which quarantines recourse to the state and limits recourse to particular projects being run by that enterprise
  • Of limited use in terms of lowering government debt ratings as ratings agencies consider financial obligations of such bodies to be effectively government guaranteed

2)      Capital recycling (asset recycling)

Description: Raising funds for new projects by selling off existing government assets.

Current use: Gaining in popularity in Australia with recent introduction of federal incentive scheme.

Example project: Sale of Port Botany and Port Kemble (to fund WestConnex and upgrades to Pacific Highway), Sydney, $5.07 billion, 2013.

Suited to (assets to be sold): Public assets of less strategic value, such as offices which are similar to commercial offices but merely house government departments.

Advantages/disadvantages:

  • Frees up capital without further borrowings
  • Can result in efficiency gains (of assets being sold) through greater efforts to reduce costs, faster responses to changes in customer demand and capital allocation decisions which are free from political interference.

3)      Special purpose financial instruments

Description: Tax relief or other preferential treatment to private investors with regard to certain assets, such as tax offsets (rebates), subsidies or grants.

Use: Not uncommon at either federal or state level in Australia.

Suited for: Broad range of projects of various sizes.

Example project: Waratah Bond Series (enabling retail investors to invest in critical state infrastructure), New South Wales, (open ended funding size), 2011.

Advantages/disadvantages:

  • Attractive as a way to channel private investment into projects of significant public value
  • Can be criticised if they are seen to be a way by which governments ‘pick winners’  (after the first insolvency of Sydney’s Cross City Tunnel, for example, some media reports characterised a Commonwealth scheme as private investors being subsidised by the public purse, notwithstanding that the ‘public good’ was arguably of greater value than the incentives given).

4)      Minimum Revenue Guarantee.

Description: Similar to a public private partnership (PPP) arrangement on toll roads, but with the government effectively providing a guarantee or ‘floor’ on revenues for a set period of time should traffic volumes not meet anticipated projections and also sharing in any upside of higher than anticipated traffic flows.

Current use: Some use in recent Australian projects.

Suited to: Major toll road projects.

Example project: Seoul-Chuncheon Expressway (toll road) in South Korea, 2 trillion won ($2.1 billion), commenced 2009.

Advantages:

  • Greater certainty for (and therefore ability to attract) private investors, especially in light of dramas associated with projects such as Brisbane’s Airport Link
  • Government may reap windfall gain if traffic exceeds forecast
  • State assumes some financial exposure in the event of lower than expected traffic volumes.
  • Key challenge in developing revenue forecasts on which to base the guarantee.

5)      Toll Equity Loan Agreement

Description: Similar to a minimum revenue guarantee, but without the government sharing in higher than expected revenues from any higher than expected traffic volumes and structured as a loan (usually subordinated) recoverable by government rather than a straightforward payment.

Current use:  Overseas only for roads so far. Has been examined in Australia in the past.

Suited to: Road projects but could be expanded to other projects.

Example project: Texas Grand Parkway (Toll Road), $US2.9 billion raised, 2013.

Advantages/disadvantages:

  • Provides flexibility for governments as its subordinate nature allows them to make provision of such funding in any given year subject to budget availability.

Local government focused

6)      Tax Increment Financing/Growth Area Bonds

Description: An up front form of local government borrowing from capital markets for infrastructure projects which are expected to drive increases in property values and property tax receipts (or, in the case of state government, mining tax receipts or utility receipts) which is secured by the ‘ring fencing’ of future tax receipts over and above a specified level, with the ring fenced funds being used to repay the borrowing.

Current use: Mainly in the US and Scotland.

Suitable for: Most projects involving local government funding/contributions.

Example project: Portland Streetcar (13-kilometre tram loop in Portland) in Oregon, US, $103 million, 2001.

Advantages/disadvantages:

  • Allows governments to borrow against future revenues and to match cash outflows from repayments against inflows from increased revenues.
  • Where infrastructure projects are not unexpected, however, care must be taken about assumptions of future property value increases arising from projects as expectations of these may already be reflected in existing property values (such as was the case for the EastLink and Peninsula Link roads in Victoria where the price uplift occurred well before construction began).

7)      Special Assessment Districts

Description: A property-based fee imposed throughout a district to pay for new infrastructure, either at a flat rate based on either property value or proximity to the infrastructure.

Current use: Not uncommon in Australia.

Suitable for: Most projects involving local government contributions.

Example project: Portland Streetcar (see above; this project was financed using a variety of methods).

Advantages/disadvantages:

  • Matches financing costs to residential/commercial residents who gain most benefit from the infrastructure.

Either state or local government focused

8)      Certificates of Participation

Description: A similar arrangement to special purpose borrowing in that it involves borrowing against a specific project (usually a building) instead of general revenue. In this case, however, the investor is repaid by effectively leasing the asset back to the government rather than through borrowings.

Current use: Used primarily in US but something similar has been attempted by County Court in Melbourne.

Suitable for: Buildings/infrastructure set to be operated by government owned enterprises (court houses, etc.)

Example: San Francisco Courthouse, ($US 39 million raised in re-financing), Lease executed in 2001/refinanced in 2004.

Advantages/disadvantages:

  • Allows investors to earn immediate returns through lease payments and to take control of infrastructure through normal insolvency procedures in the event of default, thus making instrument attractive to investors
  • May enable governments to raise funds without incurring balancing sheet debt and thus impacting debt covenants
  • Community may not desire vital infrastructure to be owned by the private sector, though effective leasing arrangements could mitigate such sentiments
  • Ratings agencies often look at ‘substance over form’ and still treat such arrangements as effective state liabilities for debt rating purposes.

9)      Joint development company

Description: Involves the government entering into a joint partnership with a private sector developer to develop whole or part of a project – somewhat similar to a public private partnership (PPP).

Current use: Not stated specifically in report.

Suitable for: Projects (usually locally based) where there exists both strong community interest and commercial potential, such as housing developments which involve a portion of social or affordable housing – especially in localities where the cost of land is high relative to the value of construction works.

Example project: Sheffield Housing Company, United Kingdom, £250 million, 2011 (joint project to address localised housing shortage/affordability crisis).

Advantages/disadvantages:

  • Allows government to share the funding burden with private sector yet affect public policy outcomes through its ‘quasi’ interest in the project
  • Can bring private sector experience to project types in which the government does not have a great deal of expertise.

10)   Commercial developments

Description: Similar to joint development companies except that the government does not own assets. Instead, the government grants the private sector developer land rights in return for the private sector either investing in public infrastructure directly or providing funds for the public sector to pay for infrastructure development (the government would own and operate the public infrastructure once built).

Use: Under consideration in Fed Square East and Flinders Street Station redevelopments in Melbourne.

Suitable for: Highly congested urban environments, particularly developments around or above rail infrastructure.

Example Project: St Leonards Forum, Sydney, $350 million, 2003 (train station plus mixed use commercial, residential and retail development).

Advantages/disadvantages:

  • Infrastructure delivered without any form of public money being used.

11)   Social Impact Bond

Description: Investors fund a program or development but only receive a return when a given social outcome is achieved, with the level of return varying according to the extent of achievement of the social objective.

Current use: New type of instrument first trialled in UK in 2010. Currently being trialled in criminal justice, housing, family relationships and healthcare.

Suitable for: Projects/programs with high social impact.

Example project: Peterborough Prison (prison treatment services), United Kingdom, £5 million, 2010.

Advantages/disadvantages:

  • Allows for experimentation with new social programs by tapping private rather than government expenditure until results are proven
  • Can be difficult to appropriately measure outcomes that are specifically related to or caused by the measures funded by the bond.

12)   Alternative User Charge Models (user pays system)

Description: A mixture of fixed and variable charges which usually (apart from toll roads) involves a fixed fee to fund the infrastructure  and a variable charge to fund ongoing service delivery based on factors such as duration and number of uses (e.g. public transport, toll roads) or duration and time of usage (e.g. electricity).

Current use: Common in Victoria in areas such as toll roads, water, sewerage, schools and public transport.

Example project: Transport for London, £137 million net in one year, 2003 (London congestion charge to fund public transport and road changes).

Advantages/disadvantages:

  • Effectively matches infrastructure costs with those who use it most
  • May be politically unpopular where public perceives that infrastructure should be ‘free’.

13)   Not-for-profits

Description: Involves not-for-profit organisational support in contributing to infrastructure development.

Current use: Limited. Not-for-profit participation is currently primarily directed toward operating and maintaining infrastructure originally developed by the government (childcare facilities, community health care etc.) rather than developing infrastructure.

Suitable for: Infrastructure with high social impact (childcare centres, pre-schools, community leisure facilities, community health centres).

Example project: Pay for Success, Massachusetts (USA), 2012 (project size unknown, the social project was aimed at addressing local homelessness).

Advantages/disadvantages:

  • NFP involvement may enhance public support for project
  • May unlock philanthropic funds for infrastructure investment
  • Volunteered labour/materials/services/equipment may lower cost of development
  • Govt. loses some control over project timing
  • NFP may have to undertake extensive/time-consuming fundraising process.

14)   UK City Deals

Description: A revolutionary approach which can encompass several of the above mechanisms. The UK government has reached agreement with eight major cities thus far to download provision of certain infrastructure or services to that local government.

Early agreements include a pay for result model (cities invest in local growth assets and receive share of national taxes), allowance of incremental tax financing, allowing localities to pool funding streams with private sector capital to fund infrastructure, increased local control over rail services, localised asset management and various incentives aimed at increasing local capabilities (locally matched venture capital funds, training, apprenticeships, youth programs etc.)

Current use: The report only lists uses in the UK. This form of funding is in its early stages.

Suitable for: Whole of government approach to infrastructure.

Example Project: Greater Manchester City Deal

Advantages/disadvantages:

  • Reflects a wider viewpoint which focuses attention on broader infrastructure and its contribution to society and economy as opposed to specific infrastructure pieces in isolation.
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  1. John

    Interesting that the Property Councils report highlights many positives and few if any negatives for the funding options that involve private equity and profit. However they seem to highlight mostly the negatives for the options that focus on government funding.

    The bottom line is that whenever private industry is involved, profit is always the first and most important driver. Profit is normally correlated to risk, however the hisory of privately funded public infrastructure in Australia is that when the project goes pear-shaped the public picks up the bill anyway ..