PPP Solutions To Climate Change Should Advance Whatever COP-15’s Outcome

COP15By Henry E. Teitelbaum, managing editor, P3Planet.com


The growing use of public-private partnerships to develop on-the-ground solutions to climate change around the world is likely to be undiminished by the widely perceived failure of government to reach a legally binding global agreement at the United Nations Climate Change Conference in Copenhagen this month.


But any comprehensive global climate and energy policy agreement that follows from COP-15 will do much to enable a much wider engagement with the model in a range of new undertakings. Not only would a global deal facilitate public authority planning and cross border coordination in the public and private sectors, it would vastly improve the commercial viability of projects, lowering political and regulatory risks to enable faster delivery and bigger scale. Most importantly, an agreement beyond Copenhagen would move the world towards mobilising vast amounts of private investment that might otherwise remain on the sidelines.


“The democratic, developed world needs to revolutionize current practice in the procurement of large scale climate change solutions,” says Mark Hoskin, partner at Holden & Partners LLP, a financial advisory firm that specializes in ethical and climate change investing. “An agreement in Copenhagen would help educate the electorates of the scale of the problem, giving politicians the political support and confidence in their home countries to countenance this kind of policy shift and financial commitment.”


The public-private partnership model as it is presently being used has been drawing on private capital for nearly 20 years in a variety of projects. In the UK, where the model goes under the name Private Finance Initiative, or PFI, it has delivered schools, highways, light rail and hospitals, as well as increasingly complex military procurement projects. Unlike traditional public sector procurement, where the private contractor simply designs and builds what the public authority orders, PPPs involve a competitive tendering process in which teams of private sector companies and their financial backers vie for a contract to design, finance, and manage the risks involved in delivering public assets. In return, the  private partners earn fees from the government and/or tolls from users for the long-term operation and maintenance of the asset.


The whole life costs of these projects can seem expensive, and PFI’s adoption in the UK has not been without controversy. Some have argued that the tendering process is cumbersome, that private sector participants profit too much and that risk transfer mechanisms are insufficiently robust to prevent taxpayer bailouts on failing projects. The opposition Conservative shadow chancellor George Osbourne recently said he would scrap the PFI name altogether, though it is unclear whether any substantial change in the way the model is used would accompany such a move.


Despite the opposition, the PPP model is being adopted with growing enthusiasm for public infrastructure projects in both developed and developing countries around the world. In the UK itself, notwithstanding the credit crisis, the value of PPP/PFI projects so far this year is at £3.6 billion, or twice the level of a year ago, according to Partnerships UK, a   government-sponsored partnership that supports infrastructure delivery. The  continued use of PFI is partly driven by the inability of public authorities to close massive and long-standing infrastructure deficits through public financing alone. But there’s also pressure to be as efficient as possible with scarce public money.The essence of PPP is that it allows projects to go forward when public sector authorities might not be able to afford them – at least not without borrowing beyond spending limits and risking sovereign credit downgrades, raising taxes, or selling essential public assets outright.


As part of efforts to combat climate change, PPP has been in use in a range of municipal- and regional level projects for cities and their surrounding suburbs for a number of years. Many of these projects have shown promising results in alternative energy, energy conservation, and public transportation.


The Chicago Solar Partnership, for example, has vastly improved energy efficiency in the Chicago Metropolitan area  while also boosting overall air quality and reducing CO2 emissions since it began in 2000. The partnership has even attracted new industry and technology to the city and burnished its image as an environmentally friendly city.


More recent projects include the installation of energy efficient street lighting in cities from New York to Bhopal, India, delivering cost savings of 30%-40% and reducing pressure on energy grids during peak usage hours. Mexico City’s award-winning Metrobus PPP project has reduced carbon dioxide emissions in the world’s second largest city by an estimated 80,000 tons a year by encouraging large numbers of commuters to opt for public transportation and leave their cars at home. There are also major municipal alternative energy PPP projects underway to use wind, tidal energy and gas recovery.


In Copenhagen itself, a free city bike partnership program operating since 1995 has made available some 2,000 bicycles in the city center, cutting CO2 emissions in the city significantly by reducing vehicle use. Along the way, the program has reduced maintenance costs for city center streets, demand for parking spaces and bicycle theft. It has even created new advertising space for corporate sponsors of the program on the bicycles themselves.


Many, if not most, climate change solutions like these will continue to be undertaken at various sub-national levels of government. Quebec premier Jean Charest estimated in a speech at Climate Week NYC in September that 80% of the work involved in implementing any global agreement will be done by provincial and municipal authorities. This, he says, is  because the de-centralization of government  in many countries has put most of the operational decision-making in their hands, rather than at the national level. With a majority of the world’s population now living in urban areas, behavioral changes and efficiencies gained in the use of resources in these areas can have a very significant impact on greenhouse gas (GHG) emissions on a global basis.


The Climate Group, a Non-Governmental Organisation that supported COP-15 has played a pivotal role in bringing municipal governments and corporate sponsors together for many of these projects. It takes the view that municipal level PPP projects will be undertaken whether or not a global framework is agreed because the benefits are so compelling. Their concerns are rather that larger scale undertakings still need a comprehensive treaty that can overcome bureaucracy, overcome conflicting national agendas and enable greater private sector financial participation.


“It would make things much more straightforward,” says Emily Farnworth, senior adviser for the financial sector at The Climate Group. “But the position we’re taking is that with or without it, we absolutely have to move forward.” She says that whatever the outcome of COP-15, “there’s still going to be a huge need for organisations to get on with the solutions that they can under the directive  that is currently available.”


The global scale of the challenge should leave few in doubt about the need for private sector funding and expertise to deliver solutions. Public funding is  likely to be restricted for years to come following the financial crisis. More fundamentally, says Yvo de Boer, executive secretary of the United Nations Framework Convention on Climate Change, engaging private capital is “a much more efficient way to go forward than by trying to subsidize your way out.”


Speaking at a recent forum, Mr. De Boer said public funding and the clarity of an international agreement are both needed to begin to capitalize that private sector investment. But he estimated that some 85% of the financing will still need to come from the private sector to achieve GHG targets. For many who are engaged in developing practical solutions to climate change, the issue boils down to what public sector authorities can do to mobilize that private capital.


“Private companies are unlikely to be willing or able to take on the huge construction costs and risks involved without government support both financially and in the planning process,” says Holden & Partners’ Mr. Hoskin.


Increasingly, the model’s use is being encouraged by policy-driven requirements, particularly those related to climate change mitigation, and these demands can be expected to multiply in coming years.


The shift away from landfill in throughout Europe is one such policy driver. The EU Landfill Directive of 1999, which mandates sharp reductions in the amount of waste going into landfill throughout Europe to avoid specific financial penalties that take effect in 2010, is mobilizing investment not only in waste recycling, but in GHG reduction, and alternative energy technologies. The level of commitment backing the policies was recently demonstrated by the massive package of financial support that was assembled by government, public sector authorities and multilateral financial institutions  to ensure that the first of six planned large-scale waste recycling PFI projects in the UK reached financial close.


In the face of some of the worst conditions ever seen in the capital market, £640 million of  funding for the Greater Manchester Waste Recycling PFI project was raised last April. The  package included  £125 million of PFI credits from the UK Department for Environment Food and Rural Affairs, a £120 million from H.M. Treasury’s newly established Treasury Infrastructure Finance Unit (TIFU), £35 million from the Greater Manchester Waste Disposal Authority (GMWDA) and a generous £182 million of long-term funding from the European Investment Bank.


The decision to use a PPP/PFI structure to deliver the waste recycling project was no accident. “PPP makes sense where you have a public or quasi-public sector body that has some control or influence over some infrastructure project,” says Ben Warren, head of Ernst & Young’s Advisory Services for the Renewable Energy Sector. “It provides us with a transactional framework that is sufficiently clear and transparent and this has been hugely instrumental in getting the UK heading in the direction it needed to go around diversifying from landfill.”


A growing number of other large scale policy driven projects are in the pipeline and multilateral institutions such as the EIB, the European Bank for Reconstruction and Development, the World Bank have allocated substantial financial resources towards financing waste recycling, water resource management, sustainable forestry and agriculture management, and alternative energy. As part of its effort to compensate for the credit crunch, the EIB sharply raised its bond issuance in 2009 and is funding up to 50% of project costs within the euro-area, among EU accession countries, and even in the Middle East. The bank has also launched the European PPP Expertise Centre (EPEC) in collaboration with European Union member and candidate countries and the European Commission to centralize public sector expertise and resources and disseminate best practice between countries engaged in PPP procurement.


For many large scale climate change-related undertakings, including the shift from landfill, it is broadly accepted that public sector partners will need to take the lead because the technologies are either too new and unproven, the markets too undeveloped, or the risks to private sector partners too high to attract equity investment or long-term private institutional funding.


But Nick Robins, head of HSBC’s Climate Change Centre of Excellence, says there are also ways to take these risks off the table to make projects more investable. “You could package public finance, particularly risk mitigation measures – loan guarantees, currency risk, political risk and other measures to essentially de-risk investments in emerging markets or developed countries, particularly for institutional investors,” he says.


“What we haven’t done is deploy them at scale for the low-carbon agenda and make the use of those mechanisms more business-friendly,” Mr. Robins says. “They’re still very bureaucratic.”


There are also basic economic issues in low-carbon projects stemming from the fact that most countries in the world do not have market mechanisms to reflect the cost of carbon. So far, the European Trading Scheme, which has given rise to five exchanges for trading carbon credits in little more that four years is  the only established market to provide such a pricing tool, though exchanges are planned in the US and elsewhere.


But there are good reasons to expect that conditions will change rapidly as more people and governments realize the critical importance of reducing greenhouse gases. “There are a lot of big institutional investors recognizing that this is going to change and they need to be on the right side of this transitioning,” says HSBC’s Mr. Robins. “They’re expressing their interest and want to be more involved in this. But at the moment the raw economics don’t add up.”



Henry Teitelbaum is a London-based international financial journalist and author, most recently of the PFI Market Intelligence Report, PPP: Challenge and Opportunity After the Financial Crisis, which was published by Reuters in September 2009. He is reachable at Henry@P3Planet.com.


The original of the article appeared in Business Green, Infrastructure Journal, and numerous other  publications. This version was updated Dec. 23, 2009

Texas Cedes Leadership After Moratorium Puts Toll Road PPPs On Ice

The great state of Texas takes pride in the grandness of its visions, the ambitiousness of its undertakings and the scale of its achievements. From the wild-catting days of the late 1800s to Mission Control, Houston, the pioneering spirit of Texans has been an inspiration to the nation and the world.

So when the idea of building a new 4,000-mile network of giant multi-modal super-corridors took shape to supply modern transportation infrastructure, move people and goods from the Gulf Coast and Mexican border through to the major population centers and on to the Oklahoma border, it was bound to be big.

And so it was. The Trans Texas Corridor project, I-35, would have been 370 meters wide, four American football fields,  and run for 6,400 Km. It was going to supply multiple lane toll highways for passenger traffic, separate lanes for freight travel, rail lines, water pipeline, natural gas and oil pipelines, fiber optic cable lines and even power transmission infrastructure for wind energy. In so doing, it would have resolved increasingly dire traffic problems for Texas’ most congested highways, and prepared the state not only for the alternative energy revolution, but for the flood of goods from Asia that are due to start arriving there after the Panama canal widening project completes in 2025.

The plan for TTC-35 wasn’t just big, it did real justice to Texas’ visionary traditions. The private partner companies that undertook the design and construction of the route, Cintra-Zachry, were committed to providing long-term infrastructure maintenance – resolving an increasingly important issue as gas tax revenue continues to dwindle.

Financing was to be provided through similarly innovative structures, with Cintra-Zachry funding 22% of the initial construction costs through equity investment and the remainder coming through tax-exempt bank bonds. In return for shouldering the initial $8 billion of costs and risks associated with construction of  infrastructure, Cintra-Zachary would have gained the right to charge tolls, and to collect anywhere from $104 billion to $142 billion in toll revenue over the 25 years of the concession. It would have not only been by far the largest Public Private Partnership ever undertaken in the U.S., but one of the largest in the world and set an example for the rest of the nation.

But so big were TTC-35’s ambitions in delivering comprehensive 21st century solutions that it wasn’t long before the concept ran into trouble. Some of the opposition was valid, some of it ideological, some of it opportunistic, and some of it just plain bizarre.

There were property owners who were rankled at the indiscriminate use of eminent domain to seize land for the project. Property rights are taken seriously by Texans, notwithstanding the physical size of the state, and it didn’t help that the lack of clarity on the exact path of the corridor necessitated seizure of more acreage than would actually be used in the project. It also stirred the hackles of environmentalists, for whom the scale of the project seemed unjustified. Much of this opposition was legitimate, and should have been better anticipated.

More attention should also have been given to the anti-tax lobby, which is perhaps uniquely influential on both sides of the aisle in Texas. Here the libertarian notion that the government has no right to tax anyone for anything other than to support national defense, (or to defend the Mexican border) is widely entertained. The idea of paying for access to motorways, however necessary to maintain them, was always going to be a tough sell to this crowd, notwithstanding the best efforts of then-governor Rick Perry to convince them otherwise.

Opposition to TTC-35 also began to probe the paranoid reaches of the Texas psyche, tapping into anti-foreign sentiment with help from a book written by a far right conspiracy theorist, who postulated that TTC-35, or the “NAFTA Superhighway” was nothing less than a plot to surrender America’s sovereignty to some mythical North American Union with Mexico and Canada. It didn’t help that some of his ideas were picked up by future presidential candidate Ron Paul. But the icing on the cake for xenophobic crackpots was that Cintra is part of Spain’s Ferrovial SA,  leading to some amusing, but ultimately damaging tales about the Spanish crown having an interest in the project.

While all of this was happening, local public sector highway authorities such as the North Texas Toll Authority, and the Harris County Toll Road Authority went to work on legislators to get them to wind back the clock on PPP, which had only been adopted in Texas in 2003. They worried about losing the most lucrative toll road projects to the private sector, and NTTA in particular was determined to get back in the game, by any means necessary. So in early 2007, soon after Cintra and its financial backer JPMorgan  won a competitive tender for building and running the state’s first PPP toll road, SH 121, with a $2.8 billion 50-year concession bid, the Texas Department of Transportation was told to reopen bidding on the road. This ultimately led to NTTA trumping Cintra with a $3.3 billion offer that relied on dubiously assembled public funding that would leave the taxpayer far more exposed to toll revenue shortfalls in the event of recession than a fully private financing package.

The combined forces of opposition to PPP that began with TTC 35 culminated with a vote by the Texas Legislature in mid-2009 not to reauthorise long-term highway PPPs in Texas, at least until 2011. That puts PPP on hold for the next two years just when the rest of the U.S. is waking up to its potential.

I mention all of this because there are broad consequences to think about. While the legislature ponders whether to reauthorise PPP in 2011, Texas will be doing things the old-fashioned way, straining public coffers and risking its credit rating while trying to build transportation infrastructure to meet the needs of a population that’s growing at the rate of 1,000 people a day. Other states have already learned from Texas’ experience in crafting their own PPP legislation, and are avoiding the pitfalls that undermined efforts there. States like California and Arizona,  which have set up PPP units within the past year, are actively soliciting private investment and expertise from companies that might otherwise have been looking to fund projects in Texas.

And while Cintra still has plenty of business coming its way in Texas, including two huge projects in and around Dallas, other companies with the expertise to deliver and maintain long-term PPP concessions might think twice about setting up shop in a state where contracts can be withdrawn after they are awarded. There’s also some real fence-mending that will need to be done to reassure foreign-based  companies, particularly the several other Spanish construction firms with strong technical qualifications, that Texas is still open to their business and their capital.

Yes, TTC-35 as originally envisioned was too big to push through as a first-time project in a state that’s just getting started with PPP.  Future undertakings, should they be allowed to resume in 2011, will need to be more targeted, and better planned before going through a tender process. Until then, the Lone Star state will just have to watch the use of PPP in highway redevelopment gain momentum across America from the side of the road.

Balfour Beatty Fires First Salvo In U.S. Infrastructure Consolidation

Balfour Beatty PLC’s acquisition of U.S.-based privately owned Parsons Brinckerhoff Inc. could well mark the beginning of a signifiant consolidation of the evolving U.S. infrastructure delivery landscape. Indeed, with the U.S. market for infrastructure experiencing fundamental shifts on the buy-side as state and municipal governments look to change the way they procure everything from highways to schools, it seems a good time to consider last month’s merger in the context of what will be needed in the U.S. in an age of increasingly scarce public sector resources.

Balfour Beatty, already the largest construction and engineering concern operating in infrastructure in the U.K. and one of the top three in PPP investments, knows what it is doing in both areas. An early and significant participant in major U.K PFI projects, BB has built up one of the most successful track records in the delivery of PFI projects and one of the largest portfolios of investments in the sector in the U.K.

The company has also been steadily building up its U.S. infrastructure activities in rail transport and military accommodation, most recently with the acquisition in April 2008 of GMH Military Housing for $350 million. But the acquisition of Parsons Brinckerhoff for $626 million puts BB into a whole new league, positioning it to challenge the biggest players in the U.S. just as budget pressures are forcing states and municipalities to turn to the private sector to fund, deliver, operate and maintain infrastructure.

It’s increasingly obvious that governments at all levels in the U.S. will need to ramp up their use of alternative long-term financing to get big infrastructure projects off the ground, particularly in transportation. There are some 27 states that have enabled the use of PPP as a means for delivering infrastructure assets, with Arizona and Massachusetts becoming the latest two to enact state legislation – and that was just over the summer. The speed with which PPP is moving to the forefront of state and municipal thinking now is an important, if little noticed trend in the U.S. market for infrastructure, especially considering that a framework for the use of PPP in the U.S. was first put in place as far back as 1995.

PPP is a model for infrastructure procurement that involves public authorities selecting through a competitive tendering process a consortium of private sector developers and their financial backers for the design, delivery, operation and maintenance of a public asset. In return for the providing the financing necessary to build or restore the asset, the private consortium earns the right to recoup its investment and earn a share of long-term revenue through the charging of tolls or from tax revenue for its operation. It has been in use in the UK since 1992, and has seen increasing acceptance in countries in Europe, Canada, Africa, Asia and Australia.

One clear area where businesses operating in public sector contracting in the U.S. need to adjust their models is to accommodate a market where PPP plays a significant, if not dominant role in the delivery and long-term management of public infrastructure. Among the new skills that these companies will need to develop will be to manage the life-cycle demands of contracts that will typically run 30 years or longer. It is a challenge to do without greatly expanding the size of a business, though developing or acquiring those services can be very rewarding because the work produces steady and reliable revenue flows that help to reduce the notorious boom-and-bust cycle of traditional contracting work.

What BB has successfully achieved in its home market, and what the Parsons Brinckerhoff acquisition moves it towards achieving in the U.S. (and to a significant extent in other nascent markets for PPP around the world) is to give the combined company both critical mass and a leading position among the relative handful of active project management service providers in the U.S. that can offer the full range of skills that are needed to build, operate and maintain these big projects throughout their life-cycle. In particular, Parsons Brinckerhoff brings its own extensive experience with alternative financing learned from international activities, which should make for a healthy cultural fit with BB as they work to grow the business in the U.S. But it also brings excellent, well-established long-term relationships with public authorities and people in policy-making positions. This strength is not to be ignored in a country where foreign company motives are continually viewed with suspicion, and where their participation in large projects can lead to unpredictable and unfortunate outcomes. (Consider the furore over the Trans-Texas Corridor and failed effort to lease the Pennsylvania Turnpike)

Besides helping to quell suspicions of foreigner intentions, Parsons Brinckerhoff brings to Balfour Beatty a particular strength in U.S. domestic transportation infrastructure development that could prove decisive to winning much of the coming wave of projects that go to tender. It brings not only experience, and an operating margin that is roughly twice that of its acquirer, but size to a business where size really matters. Unlike the U.K., distances in the U.S. tend to be much larger, so that questions about the capabilities of bidding consortia are never far from the minds of decision-makers. The combined business takes BB’s U.S. revenue base to 32% from 29% immediately and significantly towards its goal of a 40% U.S., 40% U.K. balance, and towards taking the perception of dependency on U.K. sources off the table once and for all.

From a business diversification perspective as well, the acquisition makes great sense for BB, which faces not so much the risk, as the certainty of seeing its U.K. public sector project pipeline shrink. This is due in part to public spending cuts, but also to the reality that government spending on big PFI projects in healthcare and transportation are now moving towards completion. Indeed, with 50% of BB’s current group earnings coming from the public sector, and 25% linked to U.K. public sector work, a move to diversify geographically would appear to be well-timed.

The overwhelming enthusiasm that has greeted the Balfour-Parsons deal should logically lead one to ask who might be next to go. The question has special relevance now, while the weak dollar would seem to favor companies making a play out of Europe or Australia. Parsons Brinckerhoff occupies a fairly special place in the firmament of leading U.S. project management service providers, but there are others. There are publicly traded companies in the sector with international expertise, but these are generally of a size that would make them too big to swallow. However, the shifting landscape of procurement in America could shake up thinking at Fluor Corp., KBR Inc, and Jacobs Engineering Group Inc. And it certainly will cause companies with similar profiles to Parsons Brinckerhoff to consider their future as part of something larger. With eight times 2008 earnings the new standard by which they might expect their businesses to be valued, it seems likely there will be more tie-ups of the Parsons Brinckerhoff variety in the very near future.

Arizona Wrestles With its Fiscal Gremlins

By Henry Teitelbaum

State budget problems are a fact of life across America these days. In this regard, Arizona is no different than California, Michigan or Florida, to name just  a few. It’s all just a matter of degree. But what tests the mettle of a state government most in times of fiscal stress is how creatively they go about addressing the  budget shortfalls that accompany these downturns.

For Arizona, the government response has been decidedly mixed. In one month, the state governor signed well-considered  legislation that could set the standard for the nation in planning for the development and long-term care of essential assets.  But little more than a month later,  the governor hastily approved a ruinous short-term response to the fiscal crisis that runs totally against any concept of good governance, while virtually guaranteeing that the budget crisis weighs on state finances for years to come.

In July Governor Jan Brewer in July signed into law HB 2396, a bill granting the state contractual authority to enter into virtually any project delivery arrangement with private developers and their financial backers  As a result, the state will have the flexibility to choose the best model for procuring all future infrastructure assets from among a wide range of options. These include public-private partnership models that vary from granting concessions on existing assets to innovative DBFO, DBFOM, and other arrangements that ensure the selection of the most efficient long-term financing solutions while also addressing the need to repair and maintain public assets over their life-cycle. Critically at a time of economic stress and budgetary shortfalls, the government has gained the right to do procurement deals that engage private financing resources now, when they are needed most, and on terms that will ensure that repayment can be managed to coincide with a recovery in the the state’s finances as the economy recovers.

What’s more, the bill allows Arizona to introduce innovative solutions that clear away many of the issues that have hobbled PPP in other states, such as the past relinquishment of eminent domain rights over property needed for new development, concerns over “double-taxation” on existing roads, and non-compete agreements with existing privately developed roads.

But no sooner has the ink dried on this piece of innovative legislation than the state sets forth plans to sell and then lease back up to 32 properties, including state capitol buildings, on highly disadvantageous terms, to try to close a $3 billion budget deficit. Governor Brewer, who signed the bill allowing the sale of state buildings on Sept. 3, still has to decide what to sell and lease back, but it already looks like he has sent up the white flag, and is willing to surrender the  keys to the state capitol to anyone with $735 million in cash to spare and a desire to double that sum over 20 years, (with no risk to principal and no responsibility for anything, not even  repairs and maintenance for the buildings in question).

It wouldn’t be so galling that the government is being short-sighted with future taxpayer revenue if the sale/leaseback deal wasn’t being done for assets already purchased with taxpayer money. The fact that maintenance of the increasingly dilapidated assets will still have to come from public coffers, while the state pays $60,000 a month in rent  only  adds insult to the taxpayers who will have to foot the bill.

It’s a study in contrasts when one takes the time to craft intelligent PPP legislation to safeguard and respect taxpayer interests over the long-term, only to blow it on silly short-term giveaways that waste their money, invite abuse, and undermine the state’s long-term interests. Just don’t blame the private sector for what happens next.

P3 Investment Model Ensures Market Stability Where Regulation Can’t

It is by now broadly acknowledged, even by market regulators, that signals were ignored or misunderstood about the nature of the systemic risks that were mounting due to the unfettered sale of toxic investment instruments. But the remedies that are so far attracting the most attention in trying to restore stability; tightening up risk procedures at banks, shifting OTC derivatives onto multilateral clearing facilities, and improving accounting for off-balance sheet investment vehicles, suggest they still don’t appreciate the full nature of the problem.

In particular, they need to examine the buy-side conditions that led to such explosive growth in markets for these inherently dangerous engineered financial tools. If they did so, they would quickly find that among the fundamental pre-conditions for the crisis was a chronic structural shortage of liquid, high-yielding, and widely available assets for long-term investors.

For more than 10 years, while interest rates and government bond yields remained at historically low levels, easy credit terms allowed mortgage borrowing to expand to unprecedented levels. In the near absence of  safe, high-yielding alternative investments, mortgage-backed securities and then the newly engineered CDOs became almost the default investment for banks, insurers, hedge funds and others in search of yield. It is to a large extent because investors could find no safer, higher quality long-term assets to buy that the market for these instruments became so large, so quickly.

Going forward, regulating markets will certainly have a role to play, but what financial markets and society need even more to restore stability is a wider choice of liquid long-term investments, particularly ones that encourage and reward value creation, rather than just those that cater to opportunist instincts. Indeed, if alternative investments had been identified and made available to investors during the early stages of the credit boom, the same low interest rates that lured investors into the real estate bubble might have drawn some of that money into financing alternative energy projects, rebuilding highways and bridges or other more stable, long-term assets.

And it’s by no means clear that markets are yet structuring the kinds of assets that will attract that investment in the future. There are funds that make equity investments in infrastructure projects, and these are increasingly widespread. But the amount of equity available to date in these projects is far too little to meet the demands of large pension funds, life insurers, university endowments and other institutions with long-term Liability-Driven Investment (LDI) needs. Nor has infrastructure equity, particularly through the recent equity market decline, demonstrated any of the presumed non-correlated performance that many were expecting.

Elsewhere, prospects for creating investable assets for these institutions are no better.  In the U.S., for example, neither federal, nor state, nor municipal authorities can any longer be relied upon to develop public assets on a scale that they did in previous decades. The federal deficit is over 12% of GDP and rising after the bailouts and stimulus program, while the municipal bond market, traditionally a key source of infrastructure financing, is under scrutiny as never before as states absorb the impact of job losses and a collapsed housing market. It’s not by accident that Moody’s Investor Service has warned that municipal credits face their first-ever across-the-board downgrade following the credit crisis.

From a long-term investor perspective, this has deep meaning. In a world already short of investable opportunities for pension fund investment, it’s hard to see how muni bonds, the new Build America Bond program or any other government-sponsored investment vehicle can be relied upon to supply the size of issuance that is needed to keep them invested. Considering the already diminished capacity for borrowing that states face for years to come, can municipal bond issuance even begin to cover a nationwide infrastructure deficit that the American Society of Civil Engineers recently revised upward to $2.2 trillion?

It is here where I see a singular opportunity for investors in a market for the delivery of public infrastructure through public-private partnerships. PPP, or P3, involves the public tendering of the design, delivery, operation and maintenance of public infrastructure over the long- to very long-term through the use of private sector investment, expertise and risk management. By its very structure, it involves long-term commitments from all sides; on the part of the private sector partner for the initial financing, operation and maintenance of the assets, and on the part of the public sector partner for the repayment of the initial investment, plus interest. The model, which has been used successfully for more than 15 years in the U.K. and is being rolled out in nations around the world, has a proven track record of delivering projects on-time and on- budget. Moreover, the experiences of governments with the P3 model at all levels are extensively and publicly documented.

P3 creates investable assets of a size and credit quality that can be sufficient to meet the long-term structural investment needs of many institutions. The debt of such assets is not only secured by highly reliable cash flows linked either to the asset’s use or directly to the government’s tax revenue, it tends to be indexed to the rate of inflation, which allows pension funds to more easily match their long-term  commitments to providing for people’s retirement needs.  That’s true as well for life insurers and other institutions with LDI requirements.

But a program of P3 investment does more than just incentivize long-term investment from pension funds. Construction companies and their sub-contractors, who build or maintain P3 assets, themselves become invested in the long-term success of projects, whether through the flow of maintenance work that they are eligible to win, or through a share of equity in the project. Increasingly, contractors are looking to mandate renewals and equity investments to produce the long-term revenue streams that help smooth the notoriously cyclical construction business. Whether its cleaner healthcare facilities, well-functioning schools facilities, or safer, well-maintained roads, they too are incentivized to think long term and to work towards delivering the best outcomes for the people they serve. Other private sector participants in P3 projects are drawn towards a long-term view of the service they deliver, whether its in facility maintenance or risk management.

Not to be overlooked in this virtuous circle of long-term investment are the many benefits of P3  to the public sector, which has often been forced by what might be called the “tyranny of the ballot box” into taking too short-term an approach to its long-term investments. We have all seen or read about projects that came in way over budget or were never delivered; where the investment was too much or too little, or the asset that was built was unusable. Too often, this is the result of inadequate planning. In today’s political reality, if public money isn’t spent soon after it’s been budgeted, there are other administrative bodies that will be all too happy to have it reallocated to their own departments.

Through P3, public servants can instead of hastily using public money just to have control over it or procure assets mainly with a view to the next election cycle, choose the best solution from among a variety of design proposals and project delivery partners. P3 takes  the risks of under-delivery, late delivery or spiraling costs off the public sector’s hands and places them with private sector partners, who are better able and better incentivized to manage and mitigate them.

In the wake of the worst financial disaster since the Great Depression, public sector authorities can no longer afford business as usual. Public sector unions need to understand this. After stimulus spending programs run their course, there will be little in the way of major public sector contracting work available for years to come as governments at all levels rebuild their balance sheets. Unions need to adapt to the changes that are underway in the market for their skills, or risk becoming irrelevant. The jobs created through P3 programs will require the trade skills of every unionized public employee that transfers to the private sector and a whole lot more. Public sector authorities and private sector contractors must do everything in their power to encourage broad acceptance of the P3 model, whether it is by guaranteeing public sector pensions, providing work guarantees or offering membership in private sector trade unions. Public sector pension funds can also play a role in encouraging participation in delivering P3 projects by investing directly in the equity and debt generated through the financing of P3. This would link a portion of their union members’ retirement benefits to the performance of the assets they help to build – yet another way to incentivize long-term oriented behavior.

One way or another, innovative solutions need to be found for all aspects of the way our markets operate, and government has a responsibility to set an example by incentivizing long-term investment and the creation of long-term asset management solutions.

P3 is  a model that mobilizes the private sector to play a larger and increasingly indispensable role in financing, delivering and maintaining  the public infrastructure that will be needed for all of society to function and thrive.

(This article appeared in American Banker and Global Pensions magazine, October 2009)

Public Private Partnerships