Private sector participation in public sector financing An introduction May 2018 Private sector participation in public sector financing An introduction Introduction 2 Private sector participation in public sector financing An introduction Nearly every government today is under For members of Deloitte’s Financial Advisory pressure to fund services for citizens. Those team, this document provides an introduction services include building new infrastructure to financing and procurement for public sector and upgrading existing facilities. Governments projects with private sector participation. need to continually invest in roadways, transit It offers information on the gap between systems, buildings, land development, power infrastructure needs and infrastructure and water systems, and many other projects. spending; what a successful infrastructure Due to various constraints (including funding), project looks like; the business model for this most governments have a significant backlog kind of project; how value capture works; how of work. to match a given project with appropriate funding/financing; and the range of available Governments are also perennially short procurement structures. Throughout the on money. But given ongoing demands for report, we illustrate these points with real-world infrastructure investment, this funding gap case studies. needs to be bridged. That means the private sector inevitably will play a role in many public Armed with the information in this document, infrastructure initiatives in the coming years. Deloitte’s Financial Advisory teams should be Corporations and governments will need to able to start productive conversations with collaborate on financing for these much-needed public and private sector clients operating initiatives. Deloitte has extensive experience in the public sector space and pursue new in bringing together these very different opportunities. Then our subject-matter stakeholders to deliver successful large-scale experts will be available to assist you in infrastructure projects. winning new mandates. Deloitte Global Financial Advisory teams have I hope you find this useful. rich experience working with both the public and private sectors. While historically these teams have put greater focus on the private sector market, the public sector clearly offers tremendous opportunity, especially when it comes to financing and procuring Michael Flynn infrastructure projects. Global Financial Advisory Public Sector Leader 3 Private sector participation in public sector financing An introduction Contents Infrastructure spending gap 5 Rising infrastructure needs 5 Forces that drive infrastructure building 6 Declines in public investment 7 Launching a successful business project 9 Understanding the business model 11 What is the revenue/cost model? 12 What are the risks? 13 Potential for risk transfer 16 Understand value generated 18 Introduction 18 Direct value capture – revenue share/profit share 19 Direct value capture – user fees/impact fees 20 Indirect value capture 20 Asset recycling 23 Consider funding and financing options 25 Introduction 25 What type of finance suits the project? 27 Types of finance/funding 28 Characteristics of various types of financing 30 Determine relevant procurement 46 Long-term leases 47 Joint ventures 48 Public-private partnerships (PPPs) 53 Privatization 56 Deloitte services 65 Key contacts 66 References 68 Endnotes 70 4 Private sector participation in public sector financing An introduction Rising infrastructure needs Infrastructure Governments around the world spend a great deal of money on building and repairing crucial infrastructure. But those expenditures amount to far less than is required to meet the spending gap world’s current infrastructure needs, not to mention the new needs that will emerge in the future. Today, governments invest a total of about $2.5 trillion a year in transportation, power, water, and telecommunications systems that provide essential services and support economic activity. That is not nearly enough to meet current demand, especially in the developing world. And the need for investment will only continue to grow. According to estimates from McKinsey, to support expected rates of economic growth, the world will need to spend about 3.8 percent of GDP on infrastructure through 2030, an average of $3.3 trillion a year (see figure 1).1 On top of that, governments will likely have to spend even more to mitigate climate change and cope with its effects. It will take substantial funding to achieve the United Nation’s Sustainable Development Goals (SDGs), particularly in Africa, South Asia, and other low-income regions where residents currently have little access to basic infrastructure. The United Nations Conference on Trade and Development (UNCTAD) estimates that current spending on economic infrastructure will need to increase by a further $1.1 trillion annually to achieve the SDGs. Figure 1. Global infrastructure spending gap Additional financing to meet Spending gap $1.1T UN SDG goals $2.5T $3.3T Current annual Required annual infra infra spending spending (2016–2030) Source: McKinsey report - Bridging Global Infrastructure Gaps, 2016 While the United States and Europe have substantial needs, the bulk of infrastructure investment in the coming years will likely go to emerging economies. China has already invested a great deal in infrastructure, but its needs for the future remain vast. Other recent and relevant announcements include $1 trillion additional infrastructure investment promised by the Trump administration in the United States and about $1 trillion of investment and privatization announced for the Kingdom of Saudi Arabia through 2030. 5 Private sector participation in public sector financing An introduction Forces that drive infrastructure spending will increasingly rely on technological innovations to Several global trends are stimulating demand for make processes faster and more efficient. A greater infrastructure investment. They include urbanization, focus on non-carbon fuels has created a push toward increases in population, the scarcity of natural resources renewable sources such as wind, solar, biomass, and in certain regions, and technology developments that battery solutions. However, strategies based on these are changing the nature of infrastructure projects. new energy sources often require government support, particularly in the early years. Urbanization: Around the world, and especially in emerging markets, the appeal of urban life continues Smart infrastructure: Technological breakthroughs to draw large numbers of people into urban centers, are changing the very nature of infrastructure investing with an estimated 3 million people moving to cities as well as the speed and efficiency of the investments. every week. By 2030, roughly 60 percent of the world’s In addition to increased urbanization, there is also a population will live in cities, making infrastructure an greater focus on smart cities globally. While difficult essential priority for urban planners. As metropolitan to pin down in a simple definition, smart cities involve areas grow, governments will need to further invest greater use of advanced technologies to deliver services, in railroads, highways, bridges, ports, airports, water, including infrastructure, to citizens. Increasingly, plans power, energy, and telecommunications (see figure 2). for infrastructure projects include not just money for building roads, bridges, or sewer systems, but also for Growing populations: Rising birth rates in certain digital technologies that can help to deliver services countries, coupled with increasing life spans, are more efficiently, or to provide additional services. making it necessary to invest in new social infrastructure Providing simple smart services, such as data collection and education. Many emerging markets, with their high or widespread broadband availability, also requires the birth rates, are investing in schools and universities. government to make infrastructure investments. For In many developed economies, a “silver tsunami” is example, it might need to upgrade a data network to prompting investment in health care facilities and accommodate additional traffic, or build more energy- retirement homes. generation capacity. A new complexity arises from the fact that even the most advanced technologies tend Scarcity of natural resources: World population to become obsolete in a few years. Including those is expected to reach 8.3 billion by 2030, placing an in longer-term infrastructure projects can create ever-increasing demand on the world’s supply of challenges for financing and procurement. However, clean water, fuel, and other resources. As countries given the drive for smart cities, governments need to invest in extraction and distribution systems, they address these challenges and solve them for the future. Figure 2. Average annual need, 2016–2030 by sector ($ trillion, constant 2015 dollars) $0.5T $0.5T $1.0T $3.3T $0.1T $0.1T $0.3T $0.8T Roads Rail Ports Airports Power Water Telecom Total Annual 0.9 0.4 0.1 0.1 1.1 0.6 0.6 3.8 Spending % of GDP Aggregate 11.4 5.1 0.9 1.3 14.7 7.5 8.3 49.1 Spending 2016–2030 $ T Source: McKinsey report - Bridging Global Infrastructure Gaps, 2016 6 Private sector participation in public sector financing An introduction Declines in public investment Those investments are unlikely to rebound if Despite these increasing pressures to step up the governments keep financing infrastructure projects rates