UK Infrastructure: Innovations in government support

The nature of government support available for infrastructure projects in the UK has seen significant development in recent years following the global financial crisis through initiatives such as the UK Guarantee Scheme. The contingent financial support provided to the Thames Tideway Tunnel Project continues this innovation and is an example of the diverse range of potential forms of government support that could be provided to encourage and facilitate private investment in infrastructure in the UK.

This article looks briefly at the types of government support that have recently been developed for the infrastructure market in the UK, and also summarises the features and benefits of the innovative and multifaceted government support package provided for the Thames Tideway Tunnel Project.

Forms of government support

Infrastructure development in the UK was traditionally based on a model of public procurement and spending public funds. That changed in the 1980s, with more private sector involvement in public services. A decade later, the private finance initiative was developed, heralding a huge increase in private sector involvement in the construction, operation and financing of key public infrastructure in the UK. However, more recently, the global financial crisis has had an impact on that involvement, increasing the need for new private investment in key public assets but at the same time constraining the availability of capital. Further, there has been the much-heralded “flight to quality” seen in the investment market, and overall there has been a reshaping of the private sector’s appetite for risk. During that period, we have also seen the collapse in the monoline market, changes in the credit rating agencies business, and the withdrawal of a large number of commercial banks from long-term lending in infrastructure. Investment cases have become more sensitive to regulatory and political risk, changing requirements around accounting standards, and certainty of cash flow (sometimes because of a lack of historical information about the performance of the infrastructure asset).^[1] Against this background of a changing debt and equity market, we have seen the development of new forms of government support available to the private sector for infrastructure projects.

Technically speaking,“government support” can take (and has taken) many forms in the UK and across the world. At a policy and organisational level, many governments have sought to improve the management and delivery of their key projects and there has been more direct support to projects. Some examples in the UK market include grants, provision of public assets to contribute to a project (for example, free access to publicly owned land), revenue subsidies (such as those available in the renewable energy sector), minimum volumes for transport PPPs, minimum rent for student accommodation PPPs, public co-investment as equity or debt, and state guarantees.^[2] Therefore, government support can come in many forms, including creating better governmental and regulatory environments for private investment, as well as providing financial contributions or assurances to a project to encourage private investment in infrastructure projects.

Recent developments in government support for infrastructure projects in the UK

In recent years, the UK Government has developed a number of measures to support investment in infrastructure in the country. The UK Guarantees Scheme and the creation of the Green Investment Bank are two key examples of these measures.

Under the UK Guarantees Scheme, the Treasury may provide support to infrastructure projects across a wide range of sectors for greenfield construction projects and for the acquisition, conversion, improvement, operation and repair of existing infrastructure assets.

Government support comes in the form of an unconditional and irrevocable financial guarantee of scheduled principal and interest in favour of the relevant lender or investor, and on behalf of the borrower for the project. The flexibility of this scheme to apply to a range of financial structures and project structures is one of its main advantages. The scheme was implemented in response to the adverse credit conditions faced by infrastructure projects flowing from the global financial crisis.

In this context, the scheme has generally been an effective tool in assisting projects to obtain access to funding and getting off the ground. However, the scheme does not provide support for obtaining investor funding for high-risk projects.

The Green Investment Bank was created in 2012 to back green projects on commercial terms and to help fund the creation of new, modern, green infrastructure across the UK. The Green Investment Bank’s involvement in projects also attracts investment from the private sector in the projects with which it is involved. With the Government as the sole shareholder and having committed an initial £3.8bn of capital to invest, the Green Investment Bank is a useful form of government support by providing a source of debt and capital for infrastructure projects in the UK.

Other examples of recent government initiatives include:

• the establishment of Infrastructure UK within the Treasury and the Major Projects Authority to support major infrastructure projects involving public sector capital (and the more recent merger between Infrastructure UK and the Major Projects Authority to create the Infrastructure and Projects Authority);
• the planning permission framework for approvals for “Nationally Significant Infrastructure Projects” intended to speed up the planning process; and
• the Pensions Infrastructure Platform (which is an independent infrastructure investment adviser, set up to encourage and facilitate UK pension funds to invest in UK infrastructure).

However, while these initiatives arguably “support” infrastructure projects in the UK, it is noted that they do not provide actual financial contributions or risk management/mitigation.

Importantly, each of these government support initiatives focuses on a specific element or risk of an infrastructure project or the infrastructure market. For example, the UK Guarantee Scheme focuses on the ability to obtain finance; the Green Investment Bank is centred around debt and equity investment in specific infrastructure sectors; and the planning process for “Nationally Significant Infrastructure Projects” focuses on reducing the risk around delays in obtaining planning approval.

In contrast, the government support package for the Thames Tideway Tunnel Project provided a multifaceted approach to public support for a “private” infrastructure project by focusing on a range of exceptional project risks and providing a support package in order to encourage private investment and achieve better value for money for customers.

Thames Tideway Tunnel Project – government support package

The Thames Tideway Tunnel Project (the Project) will be 25 kilometres long, pass through 12 London boroughs, up to 7.2 metres in diameter and run up to 65 metres below the River Thames. On 24 August 2015, a project licence was awarded by Ofwat to Bazalgette Tunnel Limited as the “infrastructure provider” to design, build, finance, operate and maintain the Project. The Project is important in supporting economic growth in London and in significantly improving the River Thames and the surrounding environment by protecting the river from further sewage discharges. It will be funded by the customers of Thames Water and privately financed by a consortium of investors making up Bazalgette Tunnel Limited.

However, the Government acknowledged that there were some risks in the Project that were unlikely to be borne by the private sector at a viable cost. On this basis, the Secretary of State for Environment, Food and Rural Affairs entered into a government support package (GSP) with Bazalgette Tunnel Limited to provide contingent financial support under Section 154B of the Water Industry Act 1991 for extraordinary project risks where this offered best value for money for customers and taxpayers. The GSP provides support in relation to a range of risks across six key agreements designed to support the Project should exceptional, low-probability but high-impact risks occur, which the private sector could not cover at an acceptable cost, or at all:

• Insurance risks: based on expected capacity in the commercial insurance market, it was considered that the financial limits of commercial cover might not be sufficient to cover all potential losses that might be sustained by the Project, and that commercial cover may become unavailable at subsequent renewals. Accordingly, the Supplemental Compensation Agreement provides financial support in respect of loss suffered in excess of the insurance policy limit and in respect of claims that would have been covered under unavailable insurance. The coverage provided under this limb of GSP relates to low-probability events but the occurrence of such events could be potentially catastrophic for the Project.
• Disruption in the debt market: where the infrastructure provider relies on the debt capital markets for its senior debt finance, any sustained periods of disruption in those markets risk turning a liquidity issue into a solvency issue. If the Project is not able to raise debt due to an identified and defined “market disruption event” resulting from certain national or international economic or political events, the Secretary of State will provide a back-up temporary liquidity facility under the Market Disruption Facility Agreement (subject to satisfaction of certain conditions).
• Cost overruns: due to the size and complexity of the Project, the potential for cost overruns created a significant risk for investors and for the success of the Project. To mitigate this risk, while the Project will continue to have the obligation to raise finance to complete the Project, existing shareholders will not be obliged to provide such additional finance. Rather, the Government will inject sufficient equity to enable the Project to reach completion under the Contingent Equity Support Agreement (subject to the right to elect to discontinue the Project – see below). While the risk of cost overruns is remote, the assurance that the private sector will not be required to invest additional equity mitigates this risk and encourages investment.
• Public sector shareholders: where the Government injects equity pursuant to the Contingent Equity Commitment Agreement, it will become a shareholder in the Project. In this regard, the Shareholders Direct Agreement then creates a contractual link between the Secretary of State and the private sector shareholders, and provides a framework for the Government’s involvement in the Project when it is in this distressed situation.
• Insolvency: special administration under the Water Industry Act 1991 applies when water undertakers, sewerage undertakers or certain qualifying licensed water suppliers become insolvent or fail to carry out their statutory Under the Special Administration Offer Agreement, the Secretary of State will either make an offer for the equity and debt instruments issued by the infrastructure provider or discontinue the provision of the GSP in accordance with the Discontinuation Agreement, should the infrastructure provider remain in special administration for more than 18 months. This is intended to provide greater certainty to debt and equity in the event of special administration of the infrastructure provider.
• Termination: the GSP is intended to provide the support necessary to ensure that the Project can weather extraordinary circumstances and continue to completion. However, where certain significant, prescribed events occur, the Secretary of State will be entitled to elect to discontinue the provision of the GSP and pay compensation to debt and equity providers under the Discontinuation Agreement. This protection is required in order to avoid potentially unlimited liabilities, but the Discontinuation Agreement provides comfort to debt and equity regarding their return should the exceptional project risks occur.

The GSP will remain in place throughout the construction period of the Project, but will expire on completion and acceptance, subject to the Secretary of State’s right to elect to discontinue the Project, or early expiry of the GSP in accordance with its terms.

Benefits of multifaceted government support

The approach taken to government support for the Thames Tideway Tunnel Project differed from previous approaches to support in a range of ways. Arguably, the main difference is the concept of “bundling up” a variety of different types of support to create a package which mitigates a range of risks across the project.

This approach potentially has a range of benefits when compared to the other types of support available for infrastructure in the UK which tend to focus on dealing with, or mitigating specific risks in, an infrastructure project. Examples of such benefits include:

• encouraging the project participants to assess at any early stage of the project the barriers or risks it presents, and to work with government and other stakeholders to customise the support required to deal with these identified risks;
• highlighting the fact that there are a variety of reasons on account of which infrastructure projects might not get off the ground or why the private sector might be reluctant to get involved, and seeking to address these reasons rather than exclusively focusing on a single risk, such as cost of finance;
• increasing the likelihood that the supported project will successfully complete by mitigating significant project risks; and
• creating a risk “envelope” for private sector debt and equity providers which optimises risk pricing, thereby improving value for money for taxpayers and customers.

Importantly, it should be recognised that the GSP was specifically developed for, and tailored to, the Thames Tideway Tunnel Project to address Project-specific risks, to fit in with the unique delivery model adopted for the Project, and to complement the regulatory framework in which the Project will be completed. Accordingly, the direct application of the GSP to other projects may not be appropriate. Nonetheless, the use of the GSP as an example of multifaceted and bespoke government support should serve to encourage the public and private sectors to explore different approaches to supporting private sector investment in a bid to encourage private investment, achieve better value for money, and boost the infrastructure market in the UK.

Ashurst advised Defra on the Thames Tideway Tunnel Project and the Government Support Package.

This article is part of our InfraRead (Issue 7) released in March 2016. To download the full PDF publication, please click here.

_{Notes
[1] OECD report “Private Financing and Government Support to Promote Long-Term Investments in Infrastructure”, September 2014.
[2] Ibid.}