Infrastructure financing: what next?

United Kingdom

This article was produced by Nabarro LLP, which joined CMS on 1 May 2017.

Three weeks after the historic vote, some of the possible impacts on infrastructure finance are becoming clearer, though many questions remain unanswered. The UK Government’s policies under Theresa May’s leadership are yet to emerge, but her initial statement made earlier this week hinted at greater road investment, housing and use of infrastructure bonds. A period of reflection and review is upon us, without doubt, and in the short and longer term this will play out in the financing of projects, though in some cases this may well exacerbate factors already in play rather than setting a wholly new direction. Against this backdrop, liquidity remains high and infrastructure continues to be seen as a relative safe haven in uncertain times.

Caution, costs and contingencies

Financing may well become more costly for UK projects, and more conservative ratios may be sought by lenders, though this is likely to be constrained by the sheer competitiveness of the market. One very practical concern is that the overall costs of a project may be impacted by Brexit negotiations – think labour costs, taxation and tariffs/import costs for materials and equipment. We can expect lenders to require contingencies to deal with possible rises in these costs, even greater scrutiny of risk allocation in the project agreement and supply chain, and appropriate control and oversight on budgets.

What now for EIB?

The UK has a stake of over 16% in EIB at present and is a key contributor to the EFSI programme. At the recent Inspiratia panel hosted by Nabarro, there was a stark reminder that last year EIB invested £6bn in the UK – and only €200m in Norway. European Economic Area nations who are not member states receive a mere 1/43rd of the EIB's financing. We understand that projects in the pipeline for the next year or two are likely to continue to be supported, though this is not guaranteed. What seems clear is that projects with a longer time horizon cannot count on the additional liquidity and competitive rates provided by EIB to date. It is not expected that EIB would seek to unravel its existing UK lending portfolio, though any planned refinancing may need to be rethought if EIB decides to exit its investment at that point.

Credit enhancement

The Government will need to consider how it steps up to provide a similar support to the EIB's subordinated "first loss" tranche. These products have assisted in opening up the infrastructure market to bond investors, institutional investors and funds. For the scale of projects envisaged particularly in transportation, without EIB involvement there will be a significant increase in the level of private sector funding that has to be sourced. Even with current levels of liquidity, the scale of investment will demand multiple funding sources including capital markets and institutional money.

How will this be facilitated? May's statement of intent on 11 May for "more Treasury backed project bonds for new infrastructure projects" signals a wish to ensure Brexit's effect on the debt markets is minimised despite legislative uncertainty and EIB's likely withdrawal; a resurgence of the so far under-employed UK guarantee scheme could prove a crucial bolster.

Creative thinking

Local and regional government will need to think more creatively about funding sources, particularly if gaps left in regional investment plans by the loss of EU funds are not to be filled by central government. Models such as Tax Increment Financing – a method of raising funds against the uplift in business rates for an area once infrastructure and regeneration projects have been delivered – have now been successfully deployed several times in England as well as in Scotland.

Twin-track financing

Procuring authorities can be expected to take a keen interest in ensuring the most efficient funding terms and the right to call for a preferred bidder funding competition has been expressly reserved in recent OJEU notices for UK projects. Beyond that, will the UK follow the example of Germany in requiring a twin track financing approach pre-bid that enables the most efficient financing to be brought forward, whether that is bank debt or capital market solution?

Competing pressures on refinancings

Refinancing may become a less attractive option from the sponsors’ perspective, but continuing budget cuts (as well as the aforementioned reduction in funds available to local government through loss of EU funding) are likely to mean public sector pressure to refinance continues, even if the gains generated are slight.

Is it a MAC?

A final word on typical PPP facility agreements – these may well contain "material adverse change" provisions relating to the business condition of the borrower/SPV. These should be reviewed on a case-by-case basis, but given the current uncertainty about the nature and terms of Brexit it would be a brave lender who triggered a MAC default for this reason without other concerns about the project or borrower that unequivocally entitle it to act. However, with regard to the other type of MAC – "market flex" provisions in mandate letters which allow the lender to withdraw due to adverse market conditions – these may well attract some debate on forthcoming projects particularly if as noted earlier, pressure increases to commit funding at bid stage.

A changing of the guard

Infrastructure is often held out as a saviour in economically challenging times, and this has been stressed repeatedly by commentators in the weeks since 23 June. The new guard at Downing Street will likely recognise this too, but we wait to see if the opportunity is seized upon to drive projects through the political quagmire to minimise uncertainty and delay.

For a discussion of this note or any aspect of your infrastructure financing please contact Lucy Plowright.