The Future of Infrastructure Projects

This article first appeared in Business Insider on 10 March 2017.

In the midst of advising Aberdeen City Council on its recent, ground-breaking £370 million bond issue, the potential for this pioneering initiative to act as a template for other local authorities and, indeed, the Scottish Government soon became apparent.

This bond issue achieved three separate firsts - it was the first time that a Scottish local authority had issued bonds, the first time that such bonds were listed on the London Stock Exchange, and the first time that a credit rating was awarded to both a Scottish local authority and its bond securities.

The bonds were admitted to trading on the main market of the London Stock Exchange on 8 November 2016 and the proceeds are being used to part-finance the council's transformational capital and infrastructure programme.

If Aberdeen could do this, then certainly some other Scottish councils could follow a similar path to support their own capital projects. Equally, the Scottish Government could also raise a fund for investment in its own national programme of projects and to support the projects of smaller local authorities that may not be able to access easily the bond markets.

In truth, the availability of finance has not been a major constraint on delivering infrastructure projects in recent years. Whilst most commercial banks (with a few honourable exceptions) have departed the long-term project finance markets since the financial crisis, the gap has been filled by specialist funds (largely led by former bankers) and by the capital markets.

However, the liquidity available for projects may be about to be put under some strain. One potential consequence of Brexit could be the European Investment Bank's departure from the Scottish funding scene.

The EIB has been a strong supporter of Scottish projects, and indeed has 19.5% of all debt raised for UK infrastructure projects over the last 5 years. However, its rationale has been mainly to invest in improving infrastructure in member states, related EFTA states and potential accession states.

This volume of investment would be difficult to replace, especially as it has been provided at a relatively low cost. So funding costs for projects will rise, and availability will, to some extent, be reduced - raising a potential financing issue that will need to be resolved.

Perhaps some of the savings the UK might make in no longer having to fund its 16% shareholding in the EIB will find their way back to Scotland in the form of an increased capital expenditure budget. But that is by no means certain.

The capital markets might be a part of the solution for this issue. Now that the Scottish Government has enhanced borrowing powers, which it has indicated it will use to the maximum possible extent, the scene is set for raising funds for investment in a portfolio of new Scottish projects.

The advantages of using the capital markets as demonstrated by the Aberdeen example are, broadly:

• the flexibility of the interest and capital payment terms, which can be shaped to meet particular borrower requirements, for example during a construction period;
• the very long-term nature of the financing, well over 30 years where most banks are limited to 15 years presently;
• the relatively light level of investor scrutiny over the term of the bond, compared with the more intrusive nature of a bank financing;
• the positive impact of the council being awarded a strong credit rating, in Aberdeen's case only one notch below UK sovereign level; and
• the public impact of the bonds being listed on the London Stock Exchange, which is enabling the council to develop its governance processes to ensure compliance on disclosures of price-sensitive information which may affect the daily price of the bonds.

On the other hand, there are potential disadvantages too:

• the process of issuing the bonds is time-intensive and complex, and requires a large amount of internal resource with the capability to deal with the bond issue alongside day-to-day commitments;
• obtaining, and then maintaining, a credit rating requires financial discipline and ongoing awareness of how any developing financial and reputational issues might affect perceptions of credit strength; and
• the targeted investor base is largely found in the City of London. Sentiment and appetite will be shaped by the news of the day and by relatively low levels of knowledge of the Scottish marketplace. Part of the Aberdeen exercise involved educating the investors on the Scottish dimension.

In Aberdeen's case, under half of the cost of the council's proposed capital investment programme has been provided by its bond issue. Traditional sources of finance, such as the Public Works Loan Board (funded by the UK Treasury), as well as commercial development finance, remain a part of the funding mix.

We cannot be complacent about the availability of financing. One critical issue identified in our recent infrastructure survey was the lack of a significant pipeline of projects. There is a risk that many in the supply chain will find more profitable activity elsewhere in the world if they are not kept fully occupied. The United States, which under Donald Trump is bringing forward increased infrastructure activity, is just one example.

So the key message is, if we are serious about infrastructure investment, and about leveraging public investment by attracting private finance to modernise our infrastructure over the next few years, there needs to be a visible, credible pipeline that engages sponsors and investors. This needs to be underpinned by a strong funding/financing plan, along the lines of that delivered by Aberdeen Council with considerable aplomb.

Michael Stoneham is Head of Infrastructure at Brodies LLP. For more information, contact Michael.

Michael has nearly 40 years' legal experience in financing capital projects. Brodies has worked for the issuers (Wheatley Housing Group and Aberdeen CityCouncil) on the only significant Scottish bond issues to date, and has advised the Scottish Government and Scottish Futures Trust on numerous infrastructure and housing matters.