Financing the future

19 January 2017

How will governments worldwide finance an estimated $49 trillion of infrastructure investments by 2030? 

Around the globe, demand for new and refurbished infrastructure is rocketing. 

Governments need to fund $49.1 trillion on new infrastructure over the next 13 years, according to the McKinsey Global Institute. That’s $3.7 trillion a year. 

But there’s a funding gap. The World Economic Forum estimates the current annual shortfall in investment to be $1 trillion a year – or $14 trillion between now and 2030.

So how will this be financed, and at what risk?

Worldwide infrastructure activity

There are three broad categories of infrastructure project, according to Richard Gurney, CEO of Construction at JLT Specialty.

First there is the renewal of existing infrastructure – transport, utilities, power and telecoms – which is prevalent in North America, and to a lesser extent in Europe.

“The American Society of Civil Engineers recently gave US infrastructure a D+ rating,” says Gurney. “Rebuilding these assets obviously means considerably more construction risk compared to green-field projects.”

In Latin America and Asia, he says, there is a surge in transport infrastructure demand – particularly airports, metro systems, rail and ports – as a result of rapid economic development and population explosion. 

Finally, in the developing world, chiefly Africa, infrastructure needs are more basic – power, water and sewage. But as Gurney says, “the political and business risks can be higher”.

Financing models for infrastructure projects

Financing models vary from project to project.

Sovereign wealth funds

Sovereign wealth funds, chiefly from oil-producing countries, continue to grow. They currently own around $7 trillion of assets globally, according to the Sovereign Wealth Fund Institute.

Chinese investment 

Then there’s Chinese money. As well as emerging markets such as Africa, China has moved into developed economies. In Australia, China’s investment grew almost a third to $11.1 billion last year – notably in real estate (45 per cent) and renewable energy (20 per cent). 

China accounts for 54 per cent of Australia’s mineral exports, despite a slump in domestic demand. It has also backed associated infrastructure projects like the Darwin Port expansion, for which Chinese firm Langridge Group agreed a 99-year leasing agreement with the Northern Territory government.

China has also put money and construction expertise into Turkey, including the country’s first high-speed rail line between Ankara and Istanbul. 

The $4.1 billion line has been built by the China Railway Construction Corporation, in partnership with two Turkish companies. Some $750 million of the investment was a loan from China to Turkey, according to the People’s Daily.

Institutional investment

Western governments are also keen to foster institutional investment in infrastructure. 

“Infrastructure projects can offer a steady long-term return, targeting 4+ per cent over 20 years, which is ideal for pension funds,” explains Paul Fenwick, Partner in the Construction Division at JLT Specialty. 

“Historically, institutional investors have looked for assets that were already built, such as hospitals, schools or wind farms, where they took no risk from the construction phase.” 

But he says: “Because more and more funds want these projects, they’re becoming quite expensive. So the next logical step is new build.”

Five years ago, the UK government announced the Pensions Infrastructure Platform (PiP) to encourage long-term investment in infrastructure by pension schemes. PiP is promoted as a mutual with much lower management fees than those available from other fund managers.

To date, the PiP has secured half the £2 billion target it hopes to draw into infrastructure projects. This includes £370 million for the Thames Tideway Tunnel, and £130 million for the Aviva Investors PiP Solar Photovoltaics (PV) Fund. 

Public private partnership (PPP) 

PPP remains an attractive option where public sector entities are unable to secure finance – over 100 countries are using it, according to the World Bank. The LaGuardia airport expansion in New York demonstrates how the PPP model can be used to finance the upgrade of an existing asset.

Although its popularity has dwindled in the UK, PPP continues to evolve as a financing model in the country. 

A hybrid version is being used on the Thames Tideway Tunnel. A group of funds – Allianz, Amber Infrastructure Group, DIF and Dalmore Capital (including PiP investors) – will finance around £2.8 billion of the project. The remaining £1.4 billion will come from Thames Water. 

In addition, the UK government is reported to be considering the new Private Finance 2 (PF2) model across multiple sectors for a pipeline of projects promised for early 2017.

Construction risk management

At the front end, construction risk management has improved considerably, says Paul Knowles, CEO of JLT Specialty. “The loss record has come down by over half during the last ten years,” he says.

Tunnelling, for instance, was considered almost uninsurable after the Heathrow Express tunnel collapse in 1994. But increased demand has brought technical improvements, Knowles notes.

“Contractors spend more time understanding the risks, such as utilities locations, so third-party liability losses have fallen,” he explains. 

“Clients also allocate the risk more appropriately. That’s made the insurance sector more prepared to work with construction companies to offer flexible solutions, which can make them more competitive.” 

Parametric products for weather-related losses are an example. Knowles says the number of insurers writing the class has increased threefold over the last decade. There’s now a surplus of capital wanting to be involved with projects.

Risks can be more of an issue at a geopolitical level, he points out, although the political risk market has expanded its offering markedly in recent years – most notably terms of depth of market capacity and the resultant competition.

“This benefitting pricing and availability of longer cover, which can go out to 15 years, sometimes beyond,” says Knowles. 

In the past, PPP investors, for example, would only go into a country with a stable political environment. But the potential for support from insurers is changing this.

“Generally, government agencies want to promote trade,” Knowles says. “On the Ho Chi Minh metro in Vietnam, for example, we’ve provided cover for the Japanese banks and contractors who are financing and building the system.”

As the infrastructure market grows, Knowles is encouraging clients and contractors to work with JLT to help manage their risks, develop bespoke insurance solutions, and make their projects more cost-effective.

For further information, please contact Richard Gurney, CEO of Construction on +44 20 7558 3880