Infrastructure Investment: Bridging the Gap

INSIGHT The global infrastructure magazine / Issue No. 3 / 2012 Infrastructure Investment: Bridging the Gap

In this issue: • The evolution of investors in infrastructure – Changes and trends in the industry • The greening of infrastructure finance – Anticipating benefits of the Green Investment Bank • Putting aid dollars to work – Daniel Yohannes, CEO of the Millennium Challenge Corporation, talks innovative funding models Foreword

et’s face it: infrastructure development collaboration – may help to close the growing is an incredibly expensive business. infrastructure finance gap. By all accounts, the world’s insatiable L Through our work with infrastructure demand for infrastructure will require the financers and developers, KPMG investment of trillions of dollars over the professionals have been privileged to next four decades. While infrastructure participate in many of the innovative financing poses many challenges for governments and approaches currently underway in the market. developers, none are as urgent or as complex We hope that – by sharing our collective as the challenges of how to finance it. insight and experience – we can bring And so, for this edition of Insight Magazine, together not only new ideas and concepts, we have turned the spotlight onto the but also new collaborations and approaches complex world of infrastructure finance. to help solve the infrastructure financing Within these pages, we have gathered challenge. the opinions and insights of infrastructure On behalf of KPMG’s Global Infrastructure investors, developers and sponsors – as well practice, we encourage you to take advantage as a number of KPMG professionals from of these insights so that – together – we across the globe – to examine some of the can develop practical solutions to what is key challenges and opportunities facing the undoubtedly one of the greatest challenges market. facing populations, economies and But readers should be warned: there is no governments today and in the future. ‘White Knight’ on the horizon; no one-size- To explore these ideas and concepts further, fits-all solution. Rather, what we have found is we welcome you to contact your local KPMG that there are a number of potential scenarios member firm or any of the authors who and positive solutions emerging across contributed to this publication. the sector that – with concerted effort and

Nick Chism James Stewart Global Head of Chairman, Infrastructure Global Infrastructure Partner, KPMG in the UK Partner, KPMG in the UK

Julian Vella Stephen Beatty Asia Pacific Head of Global Americas Head of Global Infrastructure Infrastructure Partner, KPMG in Australia Partner, KPMG in Canada

Darryl Murphy Europe, Middle East and Africa Head of Global Infrastructure Partner, KPMG in the UK

© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. © 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. Contents

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4 Around the world in infrastructure 20 The greening of infrastructure finance 36 Will the Year of the Dragon bring By James Stewart, KPMG in the UK a flood of Chinese investment into 6 Up front: An urgent need western infra markets Getting direct about equity By Alison Simpson, KPMG in China investment 22 India’s infrastructure debt fund The emergence of new models By Arvind Mahajan, KPMG in India 38 Building alliances to share risks and 12 Examining the bank’s perspective 24 Incentivizing infrastructure: realize efficiencies of infrastructure finance Government funding in the post-global By Kai Rintala, KPMG in Finland An interview with Gershon Cohen CEO & Fund financial crisis world Principal – Infrastructure Funds, Lloyds Bank; By James Stewart, KPMG in the UK Chris Heathcote Global Head of Infrastructure 40 High speed rail in America: The view Finance WestLB AG; and Scott Dickens Global from the North East and the South Head of Structured Capital Markets, HSBC. 28 Disentangling infrastructure tax West By Darryl Murphy, KPMG in the UK By Margaret Stephens, KPMG in the UK An interview with Amtrak High Speed Rail Authority and California High Speed Rail 14 The evolution of investors in Authority 30 The rise of the regulated asset By Darryl Murphy, KPMG in the UK infrastructure based model By Tony Rocker, KPMG in the UK By Dr Matt Firla-Cuchra, KPMG in the UK 42 Infrastructure and the sovereign debt crisis: Lessons from Ireland and 16 Taking a holistic view of economic 32 Recycling capital Portugal growth An interview with Barry Millsom, Fund Manager By Michele Connolly, KPMG in Ireland and By Lewis Atter, KPMG in the UK of the Lend Lease Infrastructure Fund Fernando Faria, KPMG in Portugal By Jonathan White, KPMG in the UK

18 Talking to pension funds about direct 44 Australia’s infrastructure challenge 34 The rising influence of Asia’s investment By Julian Vella, KPMG in Australia An interview with Alain Carrier Canada Development Banks Pension Plan Investment Board (Canada), Gavin By Richard Dawson, KPMG in China Merchant Universities Superannuation Scheme (UK), and Raphael Arndt Future Fund (Australia) By James O’Leary, KPMG in Australia

46 Putting aid dollars to work An interview with Mr. Daniel W. Yohannes, CEO of Millennium Challenge By Katherine Maloney, KPMG in the US

48 Maximizing returns in infrastructure investment By Greg Pestrak, KPMG in the UK INSIGHT 50 The art of privatization: Setting the ON THE groundwork for a sustainable industry By Julian Vella, KPMG in Australia

52 Tapping into Islamic finance By Neil D Miller, KPMG in the UAE GO! 54 Indian cities: The great infrastructure Read the latest edition challenge By Arvind Mahajan, KPMG in India of Insight anytime, anywhere.

56 Asia rising Download the app for: By Simon Booker and Alison Simpson, KPMG in China Android – kpmg.com/insightmagandroid BlackBerry – kpmg.com/insightmagblackberry 58 Global diary 60 Bookshelf iPad – kpmg.com/insightmagipad iPhone – kpmg.com/insightmagiphone Windows – kpmg.com/insightmagwindows

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An urgent need

Infrastructure is – undeniably – the funds, sovereign wealth funds, lifeblood of society. Those that have insurance companies and the like – it access to infrastructure enjoy immense becomes clear that the most urgent societal and economic benefits; need is actually in finding an approach transportation, communication, to coaxing this money into the power and water are all enabled by infrastructure market in a way that infrastructure. Those without – or delivers benefits to investors, sponsors with substandard – infrastructure are and users of the assets. often deemed to be some of society’s Most developers have found that poorest. accessing equity investment is proving All around the world, governments, easier than accessing long-term debt. businesses and citizens are grappling And since banking capacity seems with what is now increasingly being destined to be more limited in the viewed as one of the great challenges of future, we expect to see an overall the 21st Century. On the one hand, the increase in the need to access debt challenge is related to capacity. Many from new players such as the pension cities, countries and regions simply and sovereign wealth funds. lack the capability to deliver against the complex web of demands that are – every day – becoming more pressing. Blazing a new path Too few developers, a scarcity of natural And while practical solutions are still few resources, and a lack of planning skills and far between, they are emerging. In are just some of the capacity issues that some cases, governments are focused are weighing heavily on governments on freeing up their infrastructure and their various stakeholders. capital by selling existing assets and reinvesting the proceeds into new greenfield developments (see Julian Show us the money Vella’s article on Privatization for more But with the global financial crisis upon on this on page 50). Others are starting us, the more acute challenge is that to rethink and refocus their priorities of raising upfront capital. Assuming into developments that drive economic that the world had the overall capacity growth (Lewis Atter’s piece on Greater to deliver on the massive and urgent Manchester City provides an excellent need (and that is a huge assumption example on page 16). indeed), there is clearly not nearly Regardless of the sector or region, the enough money in government coffers bottom line is that governments will to finance it all. Even those markets now urgently need to reconsider their with significant budget surpluses are approach to infrastructure funding and increasingly recognizing the importance financing. The status quo is simply not of securing new sources of capital in an option anymore and new approaches order to drive forward their economies must urgently be created, tested and and cater to the insatiable demand of deployed if governments hope to ever their businesses and citizens. achieve their infrastructure strategies. Thankfully, the challenge is not wholly The alternative is, frankly, unbearable for insurmountable. When one considers governments, businesses and citizens the capital that is currently sitting in the alike. hands of private investors – pension

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. Regardless of the sector or region, the bottom line is that governments will now urgently need to reconsider their approach to infrastructure funding and financing. The status quo is simply not an option anymore and new approaches must urgently be created, tested and deployed if governments hope to ever achieve their infrastructure strategies.

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Getting direct about equity investment

As governments and infrastructure sponsors kindly on any investment failures that threaten struggle to attract new sources of financing, their ability to meet obligations in the long- the concept of direct investment is quickly run. As a result, any projects that include becoming one of the industry’s ‘hot topics’. unquantifiable risks (such as those posed by And rightfully so: direct private investment into construction, traffic or regulation) are often infrastructure offers a number of significant non-starters for all but the most aggressive benefits to both investors and developers that – of direct investors. if properly managed – could potentially change Another challenge is capacity. Making the the infrastructure financing paradigm. most of a direct investment often takes But – to date – cajoling direct investment out a fair amount of hands-on management of deep pocketed funds has proven to be and governance (check out James exceedingly difficult. There have been a few O’Leary’s round table discussion with notable successes, particularly in the Regulated leading Pension Funds for more on Asset Based (RAB) markets in the UK and this), and – increasingly – an ability to Australia (see page 30), but for direct investment maximize returns (as discussed by to make a significant dent in the infrastructure Greg Pestrak on page 48). financing gap, more will be needed across all What is certain is that sectors and geographies. governments and project This does not – in any way – signal the death sponsors will need to work of infrastructure funds, which will continue to closely with potential direct be an important source of private investment investors to create the right into infrastructure (see Tony Rocker’s article on environment to drive the page 14 for more on the evolving infrastructure market. And while this will fund market). Indeed, in many cases, direct take close collaboration investment will sit comfortably beside the and much discussion to infrastructure funds within consortiums to find a common ground, finance some of the bigger projects on the the benefits – for both books. governments and investors – will almost So what is slowing the flow of direct investment certainly be significant. into infrastructure? Appetite for risk can often be an issue. This is not surprising: the benefactors of Pension and Insurance funds will not look

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The emergence of new models

Governments’ and sponsors’ experimentation with innovative approaches to financing creates a wealth of best practices – and hard-learned lessons – that will undoubtedly help the infrastructure industry evolve and mature.

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. New infrastructure financing schemes Much action is also underway in emerging have been popping up around the world. markets. India’s Infrastructure Debt Fund This is a positive trend: governments’ and shows significant promise in helping that sponsors’ experimentation with innovative country bridge their financing gap and approaches to financing creates a wealth of bring new sources of both domestic and best practices – and hard-learned lessons – international investment into the sector that will undoubtedly help the infrastructure (see Arvind Mahajan’s article on page 22). In industry evolve and mature. China, investors are also starting to evolve their approach to investment and are rapidly The simple truth is that – in many markets – building capacity for investment into foreign the infrastructure finance market remains infrastructure projects (as described by dependant on commercial banks. What’s Alison Simpson on page 36). more, there is an overall dearth of syndication or bond market options for New models are also emerging in Europe. Greenfield infrastructure projects, which has Finland’s experimentation with Australia’s exasperated a situation that has become Alliancing model is already showing results ever more acute since the financial crisis (see page 38 for Kai Rintala’s review of removed much-needed liquidity from the their progress). And, as Margaret Stephens market. Banks are also under increasing notes in her article (page 28), the way pressure not to lend long-debt tenors, infrastructure is taxed is also being reviewed particularly in the face of the impending within Revenue Agencies around the world. implications of Basel III. Clearly, governments are increasingly As a result, many project financing recognizing the need to create practical participants are once again looking to incentives in the market to drive institutional investors – pension funds and infrastructure development. But with a insurance companies in particular – to add variety of different financing models now much-needed liquidity into the market. But on the table, governments will need to the reality is that, even if these new players start to focus on identifying the right mix were willing to become debt investors, of incentives and approaches to properly the market still requires new models and respond to their unique situations. And with innovative schemes to fill the financing gap. a tremendous amount of activity in almost every market, the ability for governments to One such scheme, the UK’s Green view their infrastructure plans in a holistic Investment Bank (GIB), will be keenly and integrated manner will be key. Those in watched by infrastructure investors around doubt will find James Stewart’s other article the world. As James Stewart points out, the (page 24) on incentivizing infrastructure to GIB should lend much-needed confidence be a valuable perspective and a worthwhile to investors concerned about the potential read. for financing gaps in the renewable energy market and, as a result, speed up the pace of investment (see page 20).

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Gershon Cohen Chris Heathcote Scott Dickens CEO & Fund Principal, Global Head of Infrastructure Finance Global Head of Structured Infrastructure Funds, Lloyds Bank WestLB AG Capital Markets, HSBC

Darryl: Let’s start by talking about the state of bank finance in infrastructure. Do you think that we have emerged Banks continue to play a key role in the from the troubles and travails of 2008? provision of project financing. But, with Chris: Even though liquidity has waxed and waned since the crisis began in reduced liquidity, credit challenges 2008, we really need to recognize that and increasing regulation on capital the only form of senior debt financing that has continued throughout has been requirements, will banks continue bank finance. Certainly, banks have been through a bit of a rollercoaster ride as a to participate at the same level as result of the increased cost and reduced they did in the past? KPMG’s Darryl liquidity, but the reality is that there is still some liquidity in the market, particularly Murphy, sat down to talk with for short-term lending. I think we’re still seeing quite a bit of activity, particularly executives from three of the world’s from the Japanese banks, but few seem leading banks; Gershon Cohen at willing to go beyond 10-year tenor. Lloyd’s Bank, Chris Heathcote at Gershon: I would agree with that. One of the reasons that infrastructure West LB, and Scott Dickens remains attractive for banks is that the historic default rates within the sector at HSBC. have remained quite low. So many risk committees within banks see these portfolios as an asset class that – in relation to other sectors – has performed

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. well. The difficulty here is that, in the structures which also played a key part Gershon: I think it’s really about trying to current environment, the cost of capital in providing an exit for bank portfolios. harness the intellectual capacity that is seems to be out of sync with today’s Securitization has also suffered a already available to create the inevitable pricing. Add in the impact of regulatory reputational hit since the sub-prime patchwork of solutions that will form capital charges and the restraint on fiasco and now investors are exhibiting around the projects. The UK government liquidity, and I think we are going to see some fear around anything that is seen went on record to say that the majority a significant increase in the cost of bank as a structured securitization. of financing for infrastructure projects debt even compared to post-financial would have to come from the private Chris: Absolutely right. The constriction crisis pricing. sector, which is basically an admission of liquidity has also meant that sponsors that the required funds simply can’t be Scott: I’d add that the increasing cost are now rounding up as many banks as raised through taxation or other types of of capital for the banks has created they can to ensure the deal gets done. user charging, so it is very much in the more pressure for them to act in a more The downside is that you are effectively government’s interest to understand disciplined manner in how they price going to end up with the maximum what it will take to unlock the potential risk. This will create more opportunities credit quality of the lowest bank meaning that exists within financial institutions. for the capital markets to take a bigger that sponsors may end up with credit requirements that may be less palatable Darryl: Looking ahead, are you to them. The other related issue is that optimistic about the market going banks are now forced to compete with forward? each other to sell their portfolios of debt. Chris: I’m feeling very confident. I Banks Scott: I think that the UK’s move towards subscribe to Gershon’s view that there ‘‘continue to infrastructure senior debt funds will is a massive need and a limited supply be an interesting development here, of public capital which means that play a key role particularly if they can create a vehicle we need banks to continue to finance in the provision that can offer a bit more certainty and infrastructure. I don’t think we’ll be as relevance to sponsors. Funds that can act active in developed countries as much of project on behalf of a number of institutions and as in the emerging markets who will financing. can bring specialist infrastructure credit essentially mop up all of the excess skills to the table will be able to deliver capital in the market and – as a result – ’’ a solution that can compete alongside will require the skills and experience that the banks. So more certainty of funding will be needed to maintain that growth. for the sponsor, more control over the Gershon: Actually, one of the markets pricing for the end purchaser and a bit that is giving me the most optimism is role in financing projects. The key issue more ease of delivery. At the same time, the United States. I think that much of driving this trend will be duration and there does seem to be an increased the success that we’ve seen over the capacity constraints, particularly for desire from the institutional investors past decade in places like the UK and larger projects where there might not be themselves to put more of their capital Canada will soon be replicated in the US enough capital readily available to enable to work in this space due to the shift in which, by all accounts, will be a huge a bank-led model. banks’ pricing. market. That said, there are certainly Darryl: One of the big changes for Darryl: So does project finance still bright lights on the horizon from the bank financing seems to have been have a real role to play in delivering emerging markets like India, China and in their ability to syndicate the debt the level of infrastructure that is Turkey, but when banks look at these in the same way that occurred before needed on a global basis? markets I think they worry about the 2008. Is syndication no longer an underlying contractual and legal structure Scott: There’s no doubt that banks will option for banks? that needs to be in place. continue to have an important role to Gershon: That has certainly been a play in this market in terms of financing, Scott: I’m also an optimist for the future. big change over the past four years. but governments around the world Obviously the changing nature of banks Before the crisis, most of the banks need to be very careful about what risks means that we need to seek out new that participated in this sector were they are trying to transfer to the private financing models and, given the different focused on an ‘originate to distribute’ sector and how financing is procured. asset classes involved, we’re going to model where the key was in their ability I think that governments will need to see a lot more innovation in the markets to syndicate out the debt and gain look at all of the different sources of from governments, supranationals, value through fees rather than from capital in the markets and come up banks, institutional investors and net interest income. But the primary with different models for different asset sponsors. It’s going to change the very syndication market seems to have classes to create sustainable, efficient nature of PPPs and the underlying become quite constrained in the past few and optimized Public Private Partnerships financing of those transactions. It’s going years. We have also seen the departure (PPPs) to deliver all the infrastructure that to be a very exciting time to be involved of the Collateralized Debt Obligation/ is required. in infrastructure. Collateralized Loan Obligation type

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By Tony Rocker, KPMG in the UK

Infrastructure funds have recently been roaring back into action. Indeed, over the past year the market has seen significant equity raising activity by many of the larger infrastructure fund managers: Energy Council Partners raised around US$4 billion, Alinda Capital Partners closed a second fund of around US$4 billion, and Goldman Sachs captured almost US$3 billion. Clearly, the death of the traditional infrastructure fund has been grossly exaggerated.

e are, however, seeing a within the portfolio to make sure that Challenger Financial Services and Mitsui number of significant changes they meet their investment goals. (a Japanese trading house) closed and trends in the industry that a US$275 million fund focused on W In this, many sector participants and are starting to alter the fundamentals China and India and JP Morgan raised observers will recognize the impact of the managed infrastructure fund and then quickly deployed more than of some high-profile scuffles between model. Some are related to the global US$850 million into assets in India investors and managers over the financial crisis and Europe’s continuing and China. underlying asset class of their funds. sovereign debt challenges. But they The very public admonishing in 2010 of There is also ample evidence that the are just as much driven by more active Henderson Group over the deployment trend will extend to other emerging and influential types of investors who of their PFI Secondary Fund II into the markets as well. In South America, a are demanding more value from their assets of John Laing – an infrastructure growing maturity in PPP structures is infrastructure investments. development company – has sharpened starting to spin out a strong secondary minds within fund management circles market in countries like Chile and A core preference as to what investors will and won’t Brazil, which are starting to attract the For example, most infrastructure funds accept. attention of fund managers, and Peru have started to place an almost single- and Colombia seem set to follow. minded focus on investing into core The West goes East (and South) infrastructure (such as regulated utility Eurozone crisis slows sales There has also been increased assets or regulated transport) which, momentum in the trend towards But the move towards the emerging in turn, has driven some fairly feverish developing and emerging market markets is also being driven by investor activity around some of these assets investments evidenced by a rising concerns over the ongoing debt crisis (HS1, OGE, Vattenfall, Endesa). What number of funds focused on Asia, and in the Eurozone which has created is interesting is that this trend is being in particular, China and India. Macquarie significant uncertainty in both country driven largely by the fund’s Limited Group joined China Everbright to close and currency risk. So while Greece Partners, who are starting to take a a fund of almost US$500 million, has put – or is about to put – more hard look at the types of assets that are

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. Energy Council ‘‘Partners raised around US$4 billion, Alinda Capital Partners closed a second fund of around US$4 billion, and Goldman Sachs captured almost US$3 billion. ’’

than 50 assets on the block and Ireland CPP and Borealis who have developed Full speed ahead has made overtures in the port, airport, a significant capacity for not only gas, electricity and utility sectors, directing, but also closely managing, That said, the managed fund model many fund managers are sitting on the their infrastructure investments. Their is certainly not disappearing any time sidelines worried that an investment lead has been taken up by a number soon with some two-thirds of Limited that is made in Euros today will saddle of other Pension funds: PGGM in the Partners indicating they still intend to them with liabilities in some other Netherlands has signed a spate of invest in unlisted infrastructure funds, currency in the future. infrastructure deals, as has USS, the demonstrating a strong future for the second largest pension scheme in the growth and development of future And while this has meant that some UK who made their first significant funds, particularly from the managers of the countries most in need of the purchase in the infrastructure space at that have already raised and deployed revenue brought about by secondary the end of last year. second and third funds. asset sales to infrastructure funds are holding back their divestitures for As a result, some of the fund managers Infrastructure is clearly building a fear of mismatch between buyer and (particularly those with a track record) reputation as a unique asset class in seller expectations, it has also forced are starting to evolve their service its own right and – as managers and the funds themselves to look to other offering to provide pure advisory investors start to engage in greater markets in order to deploy their capital. services to direct investors and we are dialogue about what does and does not also seeing a significant increase in the constitute an appropriate investment – Cutting out management costs number of co-invests being required we expect to see a strong future in the and taken up by Limited Partners. Given cards for infrastructure investors overall. The fund model is also starting to evolve that many new investors are somewhat as a result of a growing number of large inexperienced and understaffed in institutional investors moving towards their direct investment capabilities, more direct investment strategies. this change in model should be both a Most pronounced have been the rise welcome and successful change. of the Canadian Pension Funds like

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By Lewis Atter, KPMG in the UK

It is clear that economic growth can be enhanced through infrastructure development: roads carry products to ports; mass transit brings people to cities to work and shop; sufficient generation capacity enables factories to operate without interruption; and improved sewage systems allow denser, more productive development.

hese tend to be approached as investment options – different forms simply building out inter-regional fairly simple equations responding of infrastructure might be developed transportation systems in order to save Tto a specific challenge (“we need to enhance job creation and drive commuter travel times, they began to to move people and goods faster and productivity growth, and – critically – think more clearly about how housing, more reliably”, “we are running out of how they might address the inevitable planning and transport can be improved generation capacity”, or “we cannot go trade-offs. to not only boost labor markets, but also on polluting our rivers”). Investment to deliver a catalyst to communities that is generally rationalized using sector Creating connectivity as a were less connected. specific methodologies (such as road platform for growth users’ value of time saved in traffic Getting bang for the buck versus net costs to taxpayers). And when viewed against those criteria, one quickly starts to rethink Essentially, what it comes down to Rethinking the investment the way that infrastructure delivers is the question of what investment will deliver the most potential for job paradigm value to the economy. Digging deeper into transportation investments, for creation and productivity. And suddenly, But what happens when one takes a example, it becomes apparent that, rather than deciding on the value of a step back to look at the wider challenge rather than simply linking two points single mass transit system, the field of economic growth and how it can on a map, mass transit delivers value is thrown wide open to also include be delivered through infrastructure by connecting businesses to labor civic planning, business promotion, investment? Is moving people from markets, businesses to businesses, urban regeneration and a host of other point A to point B really delivering the or businesses to consumer markets. approaches and investments that may greatest value for the city or region In other words, it’s about improving deliver a bigger bang for the investment overall, or should we instead be moving connectivity. buck. where they live? But there are other ways to improve Of course, this path of thinking In the UK, a number of city councils connectivity. In Greater Manchester, creates a number of organizational and and sub-regional governments have this discussion led civic leaders to start institutional challenges for governments started to rethink the way they to think about regeneration programs as at all levels. For one, it requires civic approach infrastructure investment a way to improve business connectivity, authorities to consider their investment by asking themselves how – when and housing programs as a means to options across a wide range of compared against a range of potential improve labor markets. Rather than government departments that – on the

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. Greater ‘‘Manchester is now seen as the best practice for driving economic growth from investment. ’’ whole – do not operate as a cohesive Being disciplined about cited by national and local governments unit. So rather than thinking about a prioritization around the world as a case study to ‘transport budget’ or a ‘housing budget’, be emulated. planners and administrators need Finally, it also necessitates authorities The torch has now been picked up to start thinking about an ‘economic to rethink the way they prioritize by dozens of regional governments growth budget’ where every dollar is their investments. Again, Greater around the UK (with the strong support channeled towards the programs that Manchester provides a valuable of Whitehall) and is quickly gaining deliver the greatest value. example. The first step was to agree amongst the various councils and civic traction in a number of international It also requires cities and civic departments about what metrics they markets as well. And while each leaders to think about the impact wanted to achieve and how they would region will approach the challenge of their investment on their wider balance the overall regional impact somewhat differently (as no two economic region and the net impact against the localized benefits that would places have identical economic or on its tax base. This necessitates close need to be distributed amongst them. political geographies), one thing will cooperation with a variety of different remain constant: a single minded governments and institutions. Greater This led to a set of very disciplined focus on driving economic value from Manchester’s focus on creating criteria that was used to (independently) infrastructure investments. economic value started long before assess each of the proposals to On March 21, 2012 the UK Government the city’s formal establishment of ensure that investments were not only signed an innovative deal with a combined authority to address all achieving their objectives, but also were Greater Manchester, allowing Greater dimensions of economic growth, distributed in a way that delivered the Manchester to ‘earn back’ a portion and was initially formed on a basis of most value for the economy as a whole. of the additional tax generated by voluntary collaboration between the This is done on a ‘whole life cost’ basis, investing in infrastructure. Manchester various city and local authorities. The and after taking into account the net is the first ever city in the country to combined authority was established impact on the whole city’s tax base. And secure such powers and will be able to once they had defined the mission and while this process certainly required reinvest the money in local economic realized that a critical part of this was to a significant investment of time and development and infrastructure. The city break through traditional silos. coordination, it has paid off. Greater Manchester is now seen as the best has calculated that the deal will lead to practice for driving economic growth 3,800 new jobs for local people and will from investment and is constantly protect 2,300 existing jobs.

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In recent years, pension funds have been increasing hands-on you plan on being. So, for example, when we co-invest in an asset their participation as direct investors in infrastructure with a fund, we are sometimes happy transactions globally. KPMG’s Head of Investment to rely on the manager and don’t need Consulting, James O’Leary, sat down to talk about direct additional governance over and above what they are doing. But in other cases, investment in infrastructure with executives from three governance control can increase our of the world’s leading pension funds; Raphael Arndt at liquidity profile by letting us manage Future Fund (Australia), Alain Carrier at Canada Pension our exit and maintain the value of the investment even if the other co- Plan Investment Board (Canada) and Gavin Merchant at investors exit. Universities Superannuation Scheme (UK). Gavin: By being at the top table, we are jointly responsible for how the deal is James: The move towards direct significant and we recognized that we structured. And by making sure our key investment into infrastructure by pension can take stronger control over where governance requirements are dealt with, funds is relatively new. Can you tell me our capital is being deployed by being we can also help set the agenda for the what has motivated your organizations to more direct in our investments and more consortium as a whole. There are always take this strategy? specific in our investment terms. exceptions to the rule, but by taking a meaningful level of control, we can Alain Carrier: I think we’d all agree that Raphael Arndt: Right. It is also useful become much more comfortable with to see direct investment as a way to one of the fundamental reasons for the the structure and management. move towards direct investment is the diversify the fund portfolio by tailoring broad recognition that infrastructure the exposure to match the objectives of Alain: Sometimes taking a controlling investment does not always lend itself to the fund. By investing indirectly through position on an investment is, quite the private equity-type fund model. For an infrastructure fund, you are more frankly, the only way you can make sure example, at CPPIB, and I would argue restricted by what the manager might the deal gets done. In some cases, we’ve for the broader pension fund sector, we choose to buy and that is often driven been able to execute deals that, without don’t typically have formal requirements by the activity of the market at a certain our active participation, likely wouldn’t to exit our investments within 5, 8, or point in time. It’s also about managing have been done at all. your risk profile. At Future Fund, we have 10 year cycles and so, if we are going to James: So what have some of the a number of higher risk investments take long-term views on infrastructure, challenges been in your move towards where other LPs in a fund are usually we can actually make more of our capital direct investment? structure by investing directly. looking at it as a low-risk asset class, so direct investment allows us to control our Alain: The obvious issue usually Gavin Merchant: I’d agree. It is also risk as well. comes down to people. If you want to about gaining stronger control over our implement a direct strategy, you have James: And is governance a key investments. At USS, for example, we to have the right resources; individuals component of exerting that control? looked at our balance sheets and asset who have done it before and can lead a base which – as the second largest Raphael: I think it all depends on your team through it. As we expand and move pension scheme in the UK – is quite approach to direct investing and how into new geographies and sectors –

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. By James O’Leary Alain Carrier Gavin Merchant Raphael Arndt KPMG’s Head of Canada Pension Plan Universities Superannuation Future Fund Investment Consulting Investment Board (Canada) Scheme (UK) (Australia) (KPMG in Australia)

particularly if we are trying to execute that is very intensive in terms of the I think that the risk profile of getting multiple transactions or overly complex asset management phase and the need involved in Greenfield is certainly real, transactions at the same time – a key to really understand the information but where the projects are attached to challenge is ensuring that we have the that is flowing from our investments. or form part of an existing Brownfield right people. opportunity, then yes, we would look at Gavin: I think that – for USS – we need it. At the end of the day, the question will Gavin: Absolutely. Apart from the to keep thinking about how we deploy always be about whether we are the right resourcing challenge, one of the biggest our capital prudently to create a well- investors to underwrite that type of risk. challenges – probably for all direct diversified range of investments in our investors – is filtering the deal flow. A lot core sectors: diversified in geography, Gavin: I agree that pension funds, by of things cross your desk and you need in core assets, GDP links, economic and large, are nervous about Greenfield to be able to quickly filter them to make assets and such. We’ll also seek to projects and that’s probably an area sure you stick to your course of action match our resources to our deployment where governments and pension funds and know who you are going to do that of capital so we’re likely to see growth might need more dialogue to see what with. So there are lots of deals that are in our asset management capabilities as kinds of structures can be put in place clearly within our core profile, but we time goes by in order to deal with things to allow pension funds to play their part need to look at whether we really have like monitoring, refinancing, expansion and – in time – I think that will naturally an angle to maximize the opportunity and of existing assets, and so on. happen. then spend time working through that. Alain: I’d agree with that. We need Raphael: It’s really about the reward for Raphael: Both resourcing and filtering to continue to leverage our team, but the risk that you are willing to take. And the deal flow are challenges. I also think also be smart enough to know what since the returns that you can achieve the cultural challenges of developing a we don’t know. Oftentimes, we’ll face from investing in assets with known direct investment program are worth situations that we haven’t seen before risk profiles have been quite good noting. A fund would normally focus either from a geographic point of view from our point of view, and the risks of on how much it has in equities or how or a new segment that we haven’t faced Greenfield – construction risk, traffic risk much in bonds or alternatives, and while before and we will need to know when or some other types of market risks – all of that is extremely important, it is we need to get help are often an unknown quantity, which very different from a direct infrastructure on that. means that these projects haven’t always investment. It’s very dangerous for justified the investment for long-term James: Finally, I think there is a a fund to go to a transactional-based investors like pension funds. perception in the market that pension culture and try to fit it into a traditional funds, as direct investors, are less asset allocation culture. attracted to Greenfield versus Brownfield James: Looking ahead, do you think investments. Is that the case for each of KPMG Investment Consulting there will be any significant changes your funds? advises pension funds globally on the to your model based on your past Alain: I wouldn’t say that we have a development and implementation experiences? particular philosophy on that. I think, of direct investment strategies into Raphael: I’d expect to see some traditionally, there has been a large infrastructure. For more information incremental change, certainly. I think number of attractive Brownfield please contact James O’Leary our team will grow to reflect a model opportunities that keep us occupied. [email protected]

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By James Stewart, KPMG in the UK

With the impending launch of the UK’s Green Investment Bank (GIB) in April 2012, many infrastructure stakeholders are trying to understand how the initiative – and similar ones already under development around the world – will change the way infrastructure is financed and delivered.

n designing a GIB, planners anticipate a Setting green objectives number of key outcomes for infrastructure funding. For one, the bank could act as a Government backers will also need to be clear I about their objectives for the bank. In the UK, catalyst for early stage projects that are currently struggling to attract private sector funding but for example, the GIB seems at risk of being which – with sufficient initial investment – could stretched between three – sometimes conflicting help deliver on carbon reduction targets and other – sets of policy objectives: a preference for ‘green’ policy objectives. the bank to invest in green projects (almost regardless of their commercial viability); a desire The bank could also provide implicit benefits to grow the green economy, but not at the to the market; the very existence of a GIB may expense of fiscal stability; and thirdly a belief that bring confidence to private investors concerned investments should be biased towards growing about funding gaps and therefore speed up the the national economy (particularly small to pace of investment. It is also expected that a GIB medium businesses). will increase competition in the marketplace, particularly within the small-to-medium market Floating the green boat segment. Another key question will be how much to invest What exactly IS a ‘green bank’? into the bank’s initial capitalization. The UK’s initiative will start with £3 billion, while Australia’s Creating a GIB is anything but straightforward. recently-announced Clean Energy Finance For one, governments will need to be clear about Corporation is expected to have almost A$10 billion how the bank will operate, its proposed scope in seed money when it starts operations in 2013. and how it will invest its capital. Of course, the impact and reach of those One scenario would see the GIB seek to make investments will be strongly influenced by the a commercial return on its investment, and bank’s ability to borrow against its capital. In other therefore would leverage its capital to increase words, the UK’s bank – which has been given the impact and return of their investments. permission to borrow as of 2015 – may be able Countries with less active capital markets and to multiply the impact of its investment, versus low private investment may consider creating a Australia’s bank which is not expected to bring GIB that primarily invests in uneconomical money in alongside their capital. but ‘green’ initiatives by providing grant-like funding for specific projects. Others may choose Not surprisingly, many developers and investors to have the GIB structure investments on a are carefully watching the progress in both the commercial basis, but where expectations of UK and Australia to see what suite of products returns are balanced against an equal expectation the banks might offer and how they might be able of defaults. to tap into that funding to reduce the risk and strengthen the financing of their green projects.

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. The UK’s initiative will start with £3 billion, ‘‘while Australia’s recently-announced Clean Energy Finance Corporation is expected to have almost A$10 billion in seed money when it starts operations in 2013. ’’

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By Arvind Mahajan, KPMG in India India’s infrastructure deficit is creating significant challenges for the country’s continued economic growth. Accordingly, India will need to significantly step up infrastructure investment going forward in order to reach double digit GDP growth. Indeed, India plans to spend more than US$1 trillion over the next five years, representing approximately 10 percent of GDP annually.

ut current projections However, India faces a number of AA+ ratings. For foreign investors, the indicate a massive shortfall fundamental challenges that will need challenge is compounded by the low Bin funding – particularly in to be overcome for the IDFs to make credit ratings at the country and state debt financing – that will require the a positive impact. One is the need for levels, which are generally only slightly country to find innovative ways to new, long-term investors to participate above investment grade. bring new sources of both domestic in infrastructure funding. To date, debt and international investment into financing has largely been led by the Creating an IDF Mutual Fund the marketplace in order to close the banking sector which – with significant structure growing funding gap. assets already on the books – is fast approaching their debt limits. As a Both of the proposed IDF structures Setting the stage for result, the market is looking to new may well overcome these challenges. investment types of investors such as pension The first is a Mutual Fund style IDF funds and life insurance companies that effectively allows investors to To that end, India’s Ministry of Finance who are generally well capitalized and pool their resources across a range recently announced guidelines for two seeking long-term returns. of infrastructure assets in order to types of Infrastructure Debt Fund (IDF) reduce their risk. Investments can structures that show significant promise The country must also seek new ways be made in any kind of infrastructure towards creating an environment for to reduce the risk of infrastructure project – from early stage through to attracting new investment into the investment. In part, this will require late stage – and may be income tax sector. Both face significant challenges new approaches to enhancing the exempt for participating sponsors. but – if successful – may well provide a credit ratings of infrastructure projects However, the structure also contains framework for future funds, not just for to make them more attractive to certain drawbacks. For example, the India, but also as a model for the rest of risk-averse investors who are largely entire credit risk would effectively be the developing world. unwilling to extend credit to projects outside of the ‘safe’ category of AA or shouldered by the end-investor with

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An IDF Company Currently, the market is largely focused 10 percent of GDP on the potential for the creation of a The second planned structure would US$10 billion fund through the NBFC annually. see the creation of a non-bank finance model that, at the time of printing, was ’’ company (NBFC) that is effectively rumored to involve the government- restricted to investing in PPP projects owned India Infrastructure Finance that have passed the one-year Company Limited, the Life Insurance The path ahead commercial operations date and Corporation of India as well as a can therefore offer a very focused number of other Indian banks like the The next few months will prove to be a investment outlook. It can also put in Industrial Development Bank of India. critical watershed for the government’s place credit enhancement mechanisms It is also expected to include the Asia IDF plans as key players review their to attract different categories of Development Bank as a multilateral and options and gain clearer insight into the investors. As a result, the structure possibly a large foreign bank such as guidelines that have been articulated by is likely to be able to achieve a credit HSBC. the Ministry of Finance. rating that would be acceptable to risk- Both options may be pursued in parallel It seems more than likely that the averse investors. The NBFC may also as investors will more than likely find first batch of IDFs will be dominated issue bonds in both Rupee and foreign attributes of each that reflect their by domestic investors but – with currencies, thus further reducing the investment strategy and risk profile. growing interest from international risk for international investors. But regardless, the Indian government investors seeking exposure to the The NBFC will also face a number of will almost certainly need to intervene Indian infrastructure marketplace – challenges. For example, the sponsor in some way in order to attract the there is every indication that significant will be limited to less than 50 percent types of stakeholders and investors international players will also participate of the shareholding, meaning that other that will be necessary to overcome the in these structures, both to test the institutional investors will be required sovereign credit challenges and provide waters and to gain more experience in to take a stake in the fund. The forced guarantees on bonds for overseas this rapidly emerging and potentially focus on late-stage assets also means investors. highly rewarding marketplace.

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. Incentivizing infrastructure By James Stewart, KPMG in the UK Government funding in the post-global financial crisis world

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ut the global financial crisis changed all of that. One important tool in the government funding drawer Tax revenues crashed in many jurisdictions is to charge consumers for their use of infrastructure, Bas unemployment skyrocketed and corporate rather than taking from the tax base as a whole. Not profits plummeted. As a result, government spending only does this shift the costs ‘off balance sheet’ from was summarily slashed and program funding starved. the government’s perspective (thereby freeing up fiscal Most prominently in Europe – but also in other major capacity to focus on other priorities), it also places the economies – governments are now engaged in an burden of financing on those that receive the most ongoing life-and-death struggle to bring down their debt benefit from the asset over its lifecycle. and stabilize their economies in the face of continued market uncertainty. Tapping the consumer purse

The unrelenting demand for infrastructure From a political perspective, user fees may not be the ultimate panacea to infrastructure funding. For one, Interestingly, even in the midst of stagnating national surcharges tend to be strongly disliked by voters, growth and high unemployment, the demand for particularly in cases where costs are increasing with infrastructure has not abated. Indeed, if anything, the no visible corresponding benefit to consumers (such as drive to revitalize economies through infrastructure capital-intensive maintenance projects or the move to investment has only accentuated the infrastructure gap ‘greener’ yet more expensive power generation). and – with it – the cost of development. For example, What’s more, many politicians see tax as a fairer in Italy the new Government recently announced, mechanism than user paid charges. And while this may alongside stringent austerity measures, a €4.8 billion seem counter-intuitive, there is a general belief that investment in infrastructure1. taxation is essentially ‘means tested’, and therefore As a result, many governments are increasingly looking ensures that the greater share of the cost is shouldered for new and innovative ways to cover the costs of their by high income earners and more profitable businesses ballooning infrastructure bills without jeopardizing their rather than struggling families or nascent enterprises. balance sheets.

1 The Associated Press, 6 December 2011. Available at: http://www.businessweek.com/ap/financialnews/D9RF4R3O0.htm

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. Governments at all levels are also starting to Take, for example, an average London resident. Within acknowledge the real and significant difference between their affordability envelope would sit council taxes, central taxation and local funding. And as central funding income taxes, fuel bills, utility bills (widely expected to starts to dry up, cities increasingly need to take their mushroom as renewable sources come online) and a destiny into their own hands. In India, for example, the range of other charges such as the London Congestion Mumbai Metropolitan Region Development Authority Charge and others. So in planning for the Thames (MMRDA) has unlocked a sustainable source of local Tideway Tunnel (a massive project designed to ease the funding by monetizing land values. The authority flow of sewage out of the city), the government has to essentially recycles the proceeds of land sales back consider what is ‘affordable’ for residents and structure into infrastructure investment, thereby making the city the overall funding accordingly. growth much less reliant on central funding or consumer- The affordability envelope applies equally to government pay schemes. In London, over £4bn was raised from a coffers. Today’s finance minister must balance the cost supplemental business rate to fund Crossrail. of infrastructure against a host of other priorities, some immediate (such as debt refinancing in Europe), and Understanding affordability some long-term (the UK’s Renewable Energy Targets, Of course, the debate over who pays is deeply for example). Add to this the rising cost of capital, influenced by affordability. As a result, an increasing uncertain economic forecasts and unrelentingly high number of governments are starting to think about their unemployment in many jurisdictions and it becomes spend in terms of the overall ‘affordability envelope’ that clear that the public affordability envelope is packed very consumers and governments are willing to bear. tightly indeed.

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. Governments are‘‘ increasingly looking for new and innovative ways to cover the costs of their ballooning infrastructure bills without jeopardizing their balance sheets. ’’

Time for government intervention What size an intervention? Clearly, if governments plan to meet their infrastructure Unfortunately, there is no magic yardstick by which to obligations, they will need to take more of a role measure interventions. Indeed, judging the appropriate intervening in the market to catalyze private sector level of intervention is an incredibly difficult thing to do and capital towards financing for infrastructure. Some may is anything but an exact science. Much will depend on the choose to simply provide grants to sectors of the market state of the local market, the availability and willingness that either lack proper pace or are seen as uneconomical of private capital to invest and the pace at which the in the near-term. Other tools may include revenue government is seeking to achieve their objectives. subsidies, price or volume guarantees, tax incentives or reductions. Governments will also need to place a Looking at funding through a holistic lens particular focus on creating the enabling conditions for private sector investment, such as strong central With a variety of different funding models and payment planning capabilities and transparent policy. options now on the table for governments, the ability to balance all of those sources to ensure sustainable, Timing and scope of the intervention are also critical secure and appropriate funding within an overall questions. Too small an intervention, and governments affordability envelope will become a key capability for run the risk of achieving little for their investment governments at all levels. (many of the infrastructure projects funded by the US economic stimulus plan in 2009 may have suffered this Ultimately, those countries that are able to construct fate). Too large an intervention not only wastes precious their infrastructure plans in a holistic, joined-up and budget, but may also cause bubbles in markets or create integrated way will stand a much better chance of unsustainable financial obligations (such as Spain’s solar responding to their infrastructure challenges... without panel subsidies which were slashed in 2011). bankrupting the country.

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By Margaret Stephens, KPMG in the UK

As governments around the world struggle to close their infrastructure gaps, tax reliefs and subsidies have long tax been seen as a key tool for catalyzing private sector investment. But today, governments are starting to rethink their fiscal regimes in an all-out effort to shore up government revenues and realign priorities; incentives are being slashed, tax holidays are being cancelled and headline rates are rapidly changing.

nd while all this activity Reducing uncertainty has certainly helped many In India, for example, the government governments to eliminate A has embarked on a journey to revise the distortions in the system and safeguard 50-year-old tax code which will likely have their overall tax take, it has also created deep implications for both domestic and significant uncertainty in the market foreign infrastructure participants. While and – in many cases – forced private the government has indicated that it is infrastructure players to rethink their committed to increasing foreign direct approach to investment in many key investment into infrastructure through a regions. liberalized regulatory regime and specific

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. The elimination of solar panel ‘‘subsidies in Spain has dramatically altered the economics of renewable energy generation in that country and created waves across the European industry. ’’

tax incentives such as profit-linked to reintroduce a relief which would for example, has instituted a number exemptions, investors seem reluctant to encourage capital investment and of specific tax incentives aimed at commit resources until greater clarity is growth. encouraging the PPP sector. However, provided on the future direction of taxes the overall corporate tax rate in South in the country. Short vs. long term goals Africa remains high and – while the regime is somewhat simpler than most Similarly, a number of governments One of the greatest challenges for tax developed markets – the tax litigation have – almost overnight – introduced authorities and policy makers is the environment is exceeding complex amendments to their tax systems that need to balance short-term political and with some cases taking several years to have created increased uncertainty and economic pressures against long-term resolve. dampened investor confidence. For goals. example, the elimination of solar panel subsidies in Spain has dramatically But infrastructure is – overall – a long- Looking into the crystal ball term investment; projects typically altered the economics of renewable The simple truth is that tax regimes, take many years to plan, implement energy generation in that country and even when they intend to be transparent and bring to fruition and the project’s created waves across the European and free of distortion, are necessarily ultimate profitability can often depend industry. complex. Indeed, when specific on cash flows extending over many incentives are introduced to encourage And in Italy, lawmakers took just decades. As a result, investors need certain categories of investment, the 24 hours in early December 2011 to stability and certainty. introduce and pass an austerity budget result is usually greater complexity and often increased uncertainty. that – amongst other measures – Creating a hospitable included a 10 percent tax hike on profits environment One thing is for sure: disentangling the for the energy industry. rhetoric from the reality of infrastructure The broader tax environment also has In a controversial move in 2008, the tax will require careful analysis, keen a direct impact on the attractiveness UK abolished tax allowances for insight and a higher tolerance for of the overall fiscal environment to infrastructure structures and buildings uncertainty going forward. infrastructure investors. South Africa, and is now struggling to find the money

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By Dr Matt Firla-Cuchra, KPMG in the UK

Attracting private investment into infrastructure is no easy feat, particularly when you are talking about assets with very long lives that demand investments in the tens – or even hundreds – of billions of dollars. ut over the past couple of decades, we have witnessed Bthe success of the Regulated Asset Based (RAB) model in bringing significant amounts of capital into infrastructure at both a low cost and a long-term basis. In simple terms, RAB models attract large amounts of private capital into infrastructure (utilities in particular) through a transparent and consistent mechanism that reduces The RAB model has been investor risk and places a cap on ‘‘spreading across Europe where it consumer prices. For the investors themselves, this mechanism represents has become one of the preferred an important method for preserving the models for facilitating the capital invested in the regulated assets. privatization of the power The RAB model has been spreading across Europe where it has become one and water networks and, of the preferred models for facilitating to some extent, transport the privatization of power and water networks and, to some extent, transport sectors. sectors. In the UK, where RAB models ’’ were first introduced, it has become a mature and well understood approach for a range of infrastructure assets. An economic stalwart RAB models have also proven to be fairly resilient in the face of the recent financial turmoil and have effectively ensured that regulated businesses had access to a continuous stream of funding, even when the cost of that funding had been

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. affected. This is because RAB effectively public institutions and less developed Critically, RAB is a dynamic model takes a long-term perspective by creating regulatory regimes will have a tougher that operates on a rolling rather than a well defined asset base and clear rules time creating the right environment a fixed point basis and therefore has on how different elements of the overall whereby there is a high degree of no defined starting point or end point. value (such as costs, capital, returns, and understanding between investors and It also allows for adopting the terms inflation) are recovered. regulators. and conditions to the current sector needs. The challenge is to resist the In essence, RAB is based on the concept The benefits of the RAB model for temptation to tinker too much with the of Financial Capital Maintenance, in governments are significant. For example, model, make it too complex or respond which investors can recover the exact RAB attracts long-term institutional to short-term pressures. This might capital they invest into the assets. As investors that not only bring stability to lead to unnecessary complexity and – a result, businesses with RAB tend to the sector, but also fairly deep capital eventually – erosion in the very investor be highly attractive to investors that are resources. RAB-based models also confidence that underpins the success willing to trade higher rates of return for effectively transfer risk to investors and of the model in the first place. a more stable and better defined cash responsibility to the regulators, meaning flow. At the same time, RAB models do that governments are often only involved On March 19, 2012, UK Prime Minister not really ‘guarantee’ a return as recovery at the sector policy level of infrastructure David Cameron set the ball rolling is based on a regulatory contract. As development and operation. on the possibility of new ownership a result, confidence in the regulatory and financing models for the UK road regime and the assumption that A range of RAB approaches network. The UK Government has drawn regulatory discretion will be reasonably parallels to the privatization of the water exercised from one period to the next is It is worth noting that RAB does not industry and the use of a Regulated paramount for the success of this model. represent a single model, but rather a Asset Base Model, indicating that a key spectrum of approaches that must be benefit could be greater investment Creating a successful RAB model is tweaked and adapted to each situation. flowing into the road network. However therefore complex and may not be In the UK, for example, different sectors the Government remains determined applicable to all markets or sectors. have adapted slightly different models; that road pricing should not apply to the For one, RAB is best suited to natural in the water sector, companies are existing road network and it remains monopolies facing limited market risk, and able to change their pricing based on unclear as to what extent private works particularly well where there are customer usage to cover their RAB base companies might be able to influence the large investment requirements over time amount, whereas airports have to sell price paid by users for road travel, in the as the model’s development demands different services under ‘one till’ that way that water companies can propose a significant amount of planning and allows them to net auxiliary revenues the level of charges to the Regulator, in structuring from a regulatory perspective. against regulated prices. order to fund investment in water assets. This also means that markets with weak

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. Recycling capital An interview with Barry Millsom, Fund Manager of the Lend Lease Infrastructure Fund

By Jonathan White, KPMG in the UK

In December 2010, Lend Lease launched the UK Infrastructure Fund with £220 million in committed capital available to invest in social infrastructure assets over the next five years. On launch, the Fund purchased established healthcare, education and accommodation Public Private Partnership (PPP) assets from the Group and had committed capital to fund the acquisition of future assets being delivered by the Group. Lend Lease has a minority co-investment in the Fund alongside majority investor, Dutch pension fund PGGM.

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. Jonathan: By setting up a successful On the Fund subscription side, we a significant refinancing risk which Infrastructure Fund, Lend Lease have been hugely successful and now creates a series of other challenges. plays a rather unique role in boast more than 50 investors who are There seems to be a common belief infrastructure financing. Can you participating in our UK fund. At the end that pension funds are going to be set the stage for our readers by of 2010, we were joined by PGGM, the answer to the huge infrastructure explaining how the Fund supports the second largest pension fund in the funding gap that is looming over the organization’s infrastructure Netherlands, who invested over £200 most markets, but that is not likely development goals? million in capital to the Fund to invest to be the case. The reality is that the in social infrastructure assets. Barry: For those unfamiliar with Lend requirement for long-term debt in the Lease, we see ourselves as a fully We seeded the Infrastructure Fund near future is going to require more integrated infrastructure organization with a number of Lend Lease assets than just pension funds to come into providing a range of infrastructure that – in the initial phase – realized the market, so – in my mind – there services from construction and more than £75 million, with an are going to have to be a number facilities management, through to additional £30 million of assets of solutions developed to fill that asset and funds management. It that were still in construction and gap, with or without pension fund is our combination with the fund commissioning. participation. management side that gives us a truly Jonathan: Clearly, governance Jonathan: Do you think that the unique position in the infrastructure and Fund independence are major financial crisis or Europe’s debt sector. concerns for investors around the crisis has impacted the way that Essentially, the Fund allows us to world. Has that been a challenge institutional investors approach recycle our capital effectively so that for you? infrastructure? we can continue to bid on and deliver Barry: At the fund raising phase, it Barry: The crisis has forced a bit a range of new projects in the future. was certainly a consideration. But of a shift in the appetite for social In the same way that traditional banks we’ve put a heavy focus on stressing infrastructure investments in the are not natural holders of long-term and reinforcing our independence most heavily impacted markets debt, nor are developers – who are within the fund management area. such as Southern Europe. Economic usually the key sponsors of PPP and We believe that our primary duty of infrastructure like roads and airports PFI deals – natural holders of long- care within the fund management are crucial to the national economy term equity. In simple terms, we operation is to our investors, not and investors tend to link social look at our investment management Lend Lease, so while we are the infrastructure with the ability of a operations as a way to source and fund manager and the operator, we government to repay the revenues. manage long-term external capital have taken substantial measures to But outside of the region, there does which in turn allows us to free up maintain that independence. not seem to have been much of a shift. our own capital to reinvest into new In the UK, for example, there have projects. Jonathan: Signing PGGM onto been more than 800 PPP/PFI projects the Fund is a major achievement. Jonathan: The Fund has seen closed and less than half are currently Looking at the wider infrastructure significant success, both in held by infrastructure funds, so there market, do you see pension funds attracting long-term investors are still a lot of assets to be traded taking a more active role in funding and deploying the funds into the in what is overwhelmingly seen as the development of infrastructure market. Can you tell us about a pretty safe environment for social rather than simply investing in your success to date? infrastructure. listed assets? Barry: Lend Lease Funds primarily I think a more significant trend is for Barry: I don’t think pension funds invests in projects where Lend institutional investors to move towards have been averse to taking equity Lease has played a role in the asset’s direct investment into infrastructure. stakes in the development stage lifecycle, either through construction, Interestingly, because of our of a project, but – to date – it has facilities management or asset integrated approach and our history of been quite difficult to unlock the management. In fact, we have about having minimal leakage on our fund, pension funds in the debt side of 16 projects currently within our many of the institutional investors the equation. I think that is going UK Infrastructure Fund where the tend to see Lend Lease as more of a to continue to be a major challenge organization was involved in one way direct investment. I think this is where for developers and governments or another in the development. On Lend Lease is going to appeal to both alike. The natural conclusion would our Retail Partnership Fund in the fund investors and direct investors be some type of bridging program UK, which includes the Blue Water alike. where banks or government bonds Shopping Centre as a key asset, we are cover the early stages to essentially the operator, the manager and one of de-risk the investment, but that leaves the developers that built the complex.

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. Indeed, the China ‘‘Development Bank (CDB) has, over the past few years, stumped up several hundred billion US dollars for a range of infrastructure projects both inside and outside of the country. ’’

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By Richard Dawson, KPMG in China

Asia’s meteoric economic growth faces a crucial challenge. Without a massive investment in critical infrastructure, many of the region’s economic powerhouses are likely to face significantly constrained growth. In most cases, power generation is already insufficient, transportation networks are inadequate, and ports and airports are running at overcapacity.

hereas whereas Europe and emerging markets such as Indonesia, development banks – the sovereign North America are – in large Vietnam and Malaysia. wealth funds of Singapore. part – focused on upgrading W The ADB has also taken a lead role Armed with mandates to encourage and maintaining much of their existing in trying to stimulate growth in growth within their national economies infrastructure, Asia’s focus is on building infrastructure funding and capital. Most and often their national champions out a vast range of new assets and recently, the bank has been developing overseas, these heavyweights have services to help maintain growth and a local currency bond guarantee fund been quietly supporting a range of drive up GDP. designed to help borrowers raise debt infrastructure projects around the world. capital from an investor base that – Africa and South America have been Filling the gap without explicit guarantees – would popular destinations, but significant Clearly, securing appropriate capital otherwise find it difficult to tap into levels of investment have also been to meet the region’s infrastructure the local debt securities markets. flowing into the economies of North requirements will be a significant Infrastructure projects will almost America and Europe. challenge as regional governments certainly be a strong focus for the fund. are unlikely to have the financial Priming the pump of private muscle to fund the colossal associated National scope, global capital investment. Financing is the most ambitions obvious problem; developing the legal However, even with the support of the and regulatory frameworks conducive to Likely the bigger story, however, deep-pocketed national development attracting private debt and equity will be is the growing clout of the national banks, Asia still faces an extraordinary an equally high hurdle. development banks in China, Korea, infrastructure development burden that Japan and Singapore. Indeed, the China cannot conceivably be filled without the In the meantime, a growing proportion Development Bank (CDB) has, over the participation of private capital. of the funding gap is being filled by past few years, stumped up several To achieve this, Asia’s national the regional and national development hundred billion US dollars for a range of governments will need to place renewed banks. The Asia Development Bank infrastructure projects both inside and focus on developing legal, regulatory (ADB) – the main regional development outside of the country – more than the frameworks, and market based financing bank – has been very active across the aggregate funding support of the Asian schemes that offer private investors region, particularly in projects where it focused multilateral organizations put and lenders a transparent, consistent is clear that private finance will not be together. Also active are the Korean and reliable structure for investing in the forthcoming. What’s more, much of the Development Bank, the Development region’s infrastructure projects. ADB’s activity centres on the region’s Bank of Japan and – while not natural

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By Alison Simpson, KPMG in China ? Unlike their wicked western cousins, Chinese dragons are considered to be divine creatures, astute and benevolent, bringing prosperity. They are also said to have power over water, in particular the ability to control rivers, seas, rain and floods.

n the run up to the arrival of the Year billion Hambantota Port in Sri Lanka of key procurement, project and risk of the Dragon we saw a number of currently being built. However, most management skills that are important to Ihigh profile Chinese transactions in investment has been in the developing remain competitive in markets globally. European infrastructure, such as China world, commonly using a combination This trend is being supported by political State Grid into Portugal’s REN and, of engineering, procurement and initiatives such as the ‘Memorandum rather appropriately, China Investment construction (EPC) and debt finance of Understanding on Enhancing Corporation (CIC) into UK’s Thames structures. They are also often politically Cooperation in Infrastructure’, signed in Water. As a result, many infrastructure driven or part of larger deals to secure September 2011 by the UK and Chinese stakeholders in mature markets are natural resources. Most Chinese governments, which is hoped will lead looking east to try and determine infrastructure companies still consider to increased Chinese investment into exactly how much wealth the Chinese Africa, Latin America and South East UK infrastructure projects. dragon will bring in this auspicious year. Asia as core markets due to their continually high construction margins. Despite much optimism in the The answer will depend in part on West, many challenges still exist – which type of investment we consider: However, increasingly open competition particularly around adapting to the greenfield/project investment, strategic and the introduction of Public Private planning, regulatory and procurement investment or financial investment. Partnerships (PPP) in certain developing idiosyncrasies of mature economies, markets, as well as the increasing which can act as a major barrier to entry awareness of political risk (due in Greenfield activity will remain in the short-term for Chinese entrants. part to some losses resulting from challenging The Chinese will become major players the Arab spring), is resulting in much in western greenfield infrastructure The Chinese have been investing in key greater consideration being given to markets, but probably not this year. international infrastructure for many entry into mature markets such as years, from the 1,870km Tanzania- the UK and US. It is hoped that such a Zambia Railway in 1970, to the US$1.4 move will also help the development

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. Strategic investment will be The Chinese will certainly continue to Commission (which supervises the where the action is take advantage of the ongoing financial activities of all State-owned enterprises) crisis and resulting sell-off in Europe. for effective risk management, An important part of China’s ‘going This should bring opportunities to substantial overseas equity investment out’ strategy (as encouraged by the secure strategic assets at advantageous will likely continue to be driven by 12th Five-Year Plan) is to create global valuations. We are likely to see the most trusted of the State-owned leaders. In the oil and gas sector, the big significant strategic investment into enterprises. Chinese petrochemical companies have, non-power sectors, including ports for a long time, been respected global and airports, while the construction Sovereign funds will continue market players. The focus of many companies may well start acquisition steady portfolio expansion mergers and acquisitions have recently programs to secure local technical moved to power, with deals by Huaneng experience and expertise in target The real success story is sovereign into Intergen, State Grid into a portfolio markets. funds, particularly CIC. These funds are of grid assets in Brazil then REN in developing into sophisticated investors, However, the lengthy approvals process Portugal, and Three Gorges into EDP, modeled in part on the Canadian for equity investment by State-owned also in Portugal. With all these deals, key pension funds and focused on taking entities will continue to be a challenge considerations were the synergies that stakes in investments which generate where sales processes are rapid. the investments could bring – selling in long term inflation linked to stable cash- Further, given the requirements of the products and services or jointly entering flows. The funds are likely to go from State-owned Assets and Supervision new markets. strength to strength as their portfolios expand and their confidence increases. Their greatest challenge could well turn out to be identifying sufficient suitable investment opportunities to meet their voluminous appetite and capacity to invest and therefore maintain their target returns. Overall, this will almost certainly be a year of intense outbound activity for the various Chinese infrastructure investors across the world’s markets. However, though the dragon is wealthy, it is also wise, and investment into mature infrastructure markets will only come at the right price and terms. Many deals will certainly be done; but it is likely that we will still see more smoke than actual fire from the dragon in the west this year.

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. Building alliances to share risks and realize efficiencies By Kai Rintala, KPMG in Finland As the sovereign debt crisis lurches on and governments come under increasing financial pressure, many jurisdictions are starting to explore alternative procurement models for their critical infrastructure projects.

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. The selection ‘‘process is also much more collaborative and transparent than what the construction industry is traditionally used to.’’ n Finland, for example, the Finnish Transit Agency (FTA) has recently Ilaunched a new project aimed at upgrading and modernizing more than 90 kilometers of rail line along a major freight and passenger route. And while the deal will involve capital expenditure of some €90 million, the agency is keen to ensure that the potential Choosing the right partners for innovation is realized so that risk The selection process is also much develop a better understanding of is appropriately shared across all more collaborative and transparent the type of outputs and problem participants in the project and the final than what the construction industry solving skills that could be price remains in line with market norms. is traditionally used to. In the case expected from each bidding party. of the FTA, five consortia submitted The FTA worked with the two The birth of the European outline proposals and participated bidders to develop the commercial Alliance Model in in-depth interviews to ascertain contracts and agree on the their ability to service the contract To achieve this, the FTA has launched definitions of the reimbursable and meet the project requirements. Europe’s first Alliancing project. The costs and, following an external Alliancing Model, which has already From here, two parties were audit to ensure that the projections seen strong utilization in Australia, selected to participate in one- were within normal parameters, effectively creates a partnership on-one workshops with the FTA the bidders were then invited to between the public sector and private where specific project challenges submit their consortia’s overhead sector contractors and consultants were discussed and debated. and profit margin requirements to where all parties share a proportion This allowed the FTA to test the the selection team who considered of both the upside benefits and the working relationship with each these as part of the process of downside risks of the project. of the candidate consortia and selecting the preferred bidder. It is important to note that the Alliancing Model tends to also include a floor on the downside that caps a developer’s exposure to risk at a reasonable level, while offering incentives around key metrics such as (in this case) the overall A new tool for infrastructure Finns have used this opportunity to effect on rail traffic and environmental procurement? develop experience, capacity and insight impacts. into the model for more technical future Based on this experience and that projects such as a major city-centre As a result, in comparison to a fixed of more than 350 similar projects tunnel that is already in procurement. price design and build contract, the already concluded in Australia under model piloted by the FTA limits project the Alliancing Model, this approach is Based on the current market response risk to the private sector with the aim of particularly suitable for projects that to the FTA’s approach and early results reducing the overall cost to the public carry significant technical risks which from the project, it seems clear sector by stripping the risk premiums – under a fixed price contract – would that alternative models such as the out of the pricing while – at the same have inflated the overall contract price. Australian Alliancing Model will soon time – encouraging the two parties to take their place within the infrastructure And while the FTA’s rail upgrade project work together effectively in managing procurement mix in Europe and – if is not necessarily overly-technical, the the project risks. successful – further afield.

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By Darryl Murphy, KPMG in the UK and investment approaches to drive change across all of the segments that we already serve. KPMG sat down with executives from California: For our part, we’re seeing some significant Amtrak High Speed Rail Authority population growth, particularly in two very separate areas. and the California High Speed Rail So we really need to connect the state, both to reduce congestion on the roads, but also to create efficiencies to Authority to talk about the challenges help drive the State’s economy. In comparison to the North and opportunities facing High Speed Rail East, we’re fairly lucky in that we still have a relatively open in the United States. – albeit agricultural – central valley system that gives us the space to build across some pretty long distances by laying KPMG: California and the US North East Corridor are down a fairly small footprint, particularly when compared to developing plans for high speed rail systems. What’s other transportation systems like roads. driving that renewed interest in both of those regions? Amtrak: That’s a good point. Our population density in the Amtrak: In the North East corridor, we already have a very North East is a bit of a double-edged sword for high speed successful rail system, so our challenge here is centered on rail. On the one hand, it gives us the critical mass to create taking an asset that is – today – doing a pretty good job, but real value for a huge segment of the population by pairing has some major challenges, and improving and expanding major cities, but it also means that we have some of the it for future needs. For us, it’s really about expanding the most expensive land and an ingrained and highly trafficked capacity of the corridor overall using different technologies system that sees roughly 2,200 trains travelling the system

We are building assets that‘‘ will deliver value for 100 years or more. – Amtrak High Speed Rail Authority’’

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each day. We are dealing with a network that includes infrastructure. There is a similar story in Spain and France with commuter trains, regional trains, some freight activity and the tunnel investments, real estate and station area developments higher-speed, limited-stop network that all work together, so that are being delivered with private participation. integrating high speed rail technology within the system will KPMG: Is there a need for a cultural change before the be a challenge. US sees broader acceptance of high speed rail? KPMG: Is there an appetite from stakeholders to Amtrak: Certainly there will need to be a cultural shift, but develop the system? that is already underway. America is currently in the midst California: One of the biggest challenges we face in the of a change in terms of travel patterns that is being driven by US – particularly in California – is that there isn’t a really rising fuel costs and a significant change in the way people good understanding of the efficiencies that high speed rail live, move and work and I think that high speed rail is ready to can deliver. Most mass transit systems in existence today capitalize on that if we can create the right product in the right are generally highly subsidized, but this is not the case with markets. If we can create a competitive and reliable service, I high speed rail in various parts of the world; it’s really a very think that Americans are very interested in that. attractive investment opportunity and economically viable, at California: The bigger challenge from our perspective is least from an operations perspective. That’s been very hard for getting policy-makers to acknowledge that we need to work Americans to understand. together to find the funding and to create a longer-term Amtrak: Absolutely. I think the hard part is not only painting vision. The US tends to make shorter-term project decisions, that picture, but then connecting actions to it; taking that whereas high speed rail spans many political election cycles. broad idea and turning it into investment. It has always We certainly have capacity for longer-term investment, been – and will continue to be – a challenge to explain particularly in infrastructure; California has built dams, and help people understand the broader impact of these viaducts and freeways, so the challenge is to ask – if our types of investments, not only in transport or rail, but the forefathers could do that – why can’t we repeat it? general benefits that these investments will provide through Amtrak: In essence, we are building assets that will deliver infrastructure improvement. We’re really trying to gain a level value for 100 years or more, so a big question is what America of awareness among the business community around the role is going to look like in 2100. Looking back 100 years, the of high speed rail and the possibilities and opportunities that railway is one of the only things that has stood the test of an expanded and improved service can provide for the region. time. It is one of the things that we are really excited about California: To that end, we’re trying to bring forward the and that makes us deeply confident that high speed rail is not business case for private investment by looking at examples only needed, but also a very noble and important function. But from other parts of the world. In Italy, you see NTV cutting as with any project where you are planning that far into the through as both an operator with rolling stock and depots and as future, no one knows for sure what the nation will need in a partial investor in Public Private Partnership arrangements for 50 years, let alone 100. It’s a major challenge indeed.

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By Michele Connolly, KPMG in Ireland and Fernando Faria, KPMG in Portugal

A Q&A with Michele Connolly (KPMG in Ireland) and Fernando Faria (KPMG in Portugal)

Editor: Ireland and Portugal were some of the first from project-finance transactions. So financing became countries to be impacted by Europe’s sovereign debt considerably more expensive. crisis. How did this impact infrastructure financing in the But as the crisis deepened and country sovereign credit region? ratings started to drop, many of the international banks Michele: Infrastructure has certainly been one of the began to worry that if governments defaulted on their debt casualties of the sovereign debt crisis. One of the first obligations, then infrastructure debt may also be written off. challenges arose from the rising yields on government bonds And then, finally, affordability of infrastructure spend – no which – with margins on Government bonds anywhere matter how it was financed – became the crunch point with from five to ten percent – were far more attractive to governments left in the difficult position of prioritizing their international banks than the three percent being realized spend against a range of critical needs such as paying public sector employees and servicing ever-increasing levels of debt.

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. Editor: Both Portugal and Ireland seem to have Editor: Clearly, this has also had an impact on the reversed some of those trends over the past two years. infrastructure developers operating in these countries. Is the infrastructure market starting to rebuild as How have they fared since the crisis began? the situation becomes less precarious? Fernando: Much of the developers’ activity tended to be Fernando: Certainly there have been a number of projects nationally-based in the past, meaning that many of them that have been completed since the crisis began. But many continue to be exposed to the risks of their assets. As a of these projects were actually legacy investments from result, most are actively working to diversify their business 2007/2008 which proved to be very hard to renegotiate. In internationally. But this also requires a significant amount other words, while many of the projects that were already of equity and finance which – when entering a brand new funded did progress, others that were not as far along were market – is exceptionally hard to secure. put on hold due to lack of funds. We’ve also seen projects – However, we expect this gap to be narrowed through a such as Portugal’s high speed rail – where concerns about more dynamic secondary market where players from affordability have led the government to put the project on emerging markets may look at markets such as Portugal as hold, even though funds had already been secured. an opportunity to acquire existing projects and – at the same What we are seeing today, particularly in Portugal, is a time – build expertise in the PPP area. drive towards extracting additional value from existing Editor: Are you optimistic about the future of infrastructure assets in order to shore up government infrastructure finance in these markets? coffers and reduce the annual expenditure of these projects. Some of this is driven by the requirements Michele: I think we have started to separate our challenges imposed by the EU bailout, but governments are also trying from those of Greece, but we have some way to go still to get their arms around the whole-of-life cost of their before we regain our stride. The overall uncertainty in the investments to ensure the affordability of those costs in Eurozone is still tending to overshadow whatever gains we the long-term. might individually make at a national level. With that in mind, I believe that Ireland is making good headway given the extent Editor: In hindsight, is there anything that the national of the crisis. governments could have done to staunch the impact of the crisis on infrastructure? That said, the underlying economics of many of the infrastructure projects fundamentally remain the same, Michele: On a macro-level, probably not. The problem despite the current debt crisis. As long-term and relatively wasn’t necessarily in the way that infrastructure finance low-risk stable cash flows, these investments should always was being structured, but rather the lack of liquidity of prove an attractive investment on their own. So while project funding at an affordable level within the international banks. finance in Europe tended to be highly dependent on the That said, part of the lack of confidence in the market balance sheets of the EU banks, there is now an emerging related to a level of uncertainty as to how the situation opportunity to explore other forms of financing. would play out and where exactly infrastructure debt would rank in order of priority in the event of a government Of course, with the virtual collapse of the monolines, the default. And uncertainly almost always reduces interest capital markets have become a difficult source from which to in lending. secure funding and – as a result – we anticipate that initiatives like the EU Project Bond program will be encouraged But given that Ireland and Portugal were essentially by national governments and infrastructure developers. treading a new path, it is unlikely they could have forecast However, we need the credit ratings of countries like Ireland the impact of the crisis or provided any assurances that and Portugal to improve before we can even qualify to access would have changed the course of events substantially. that funding source. The affordability of infrastructure spend is also likely to remain an issue for some time.

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By Julian Vella, KPMG in Australia

Much like any other country in the world, Australia is grappling with a significant need for infrastructure investment. By some estimates, the country will need to invest more than A$750 billion over the next ten years alone.

s many will note, Australia To respond to this challenge, enjoys a number of important Infrastructure Australia, a statutory Aadvantages over peers in other authority created to plan and countries and regions. The country has coordinate infrastructure projects a mature and thriving Public Private across the country, recently Partnership (PPP) market that, over established the Infrastructure Finance the past decade, has successfully Working Group (IFWG) with a mandate delivered a number of critical assets. to identify current barriers to attracting PPP regulation is well-tested and infrastructure finance and develop transparent, providing a strong possible options aimed at encouraging environment for future activity. greater private sector investment.

The country is also one of the biggest The IFWG, a ten-person group that Searching for alternative holders of institutional capital in the includes five public sector leaders and world with Superannuation funds (the five private sector leaders (including approaches equivalent of Pension funds in other myself), has therefore come together These challenges raise a number of markets) holding some A$1.4 trillion to consider four main challenges now important issues that must be tackled in assets under management. What’s facing infrastructure development in head on if the country is to meet its more, the ‘Superfunds’ have been fairly Australia: investment goals. For one, we must active in investing in infrastructure • What reforms can the government look at alternative measures for raising with somewhere between five and bring to bear in order to maximize capital that do not expose government ten percent of their assets allocated the pool of funds available for balance sheets to increased levels of to the sector. In comparison, the UK infrastructure investment; debt. This must include a frank and pension funds are thought to contribute honest discussion about our existing less than four percent of their assets • How can the national investment asset base with a view towards which to infrastructure, and only 1.4 percent pipeline for infrastructure projects assets can and should be privatized of European pension funds invest in be further developed; to effectively recycle capital back into infrastructure assets at all. • How can the costs related to the infrastructure. bidding process for infrastructure Taking a fresh perspective Some activity has already been projects be reduced, thereby undertaken in this space: Queensland But Australia still faces a significant lowering the cost of infrastructure recently privatized its railways and ports; infrastructure funding gap. Neither the overall; and New South Wales has also announced federal nor state governments have the • What role should user charges play the privatization of its port and is budget capacity to meet rising demand in funding infrastructure projects. currently in the process of refinancing and the flow of private investment is its desalinization plant, and a number not – to date – sufficient to close the of states have made some advances, shortfall.

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. albeit in the late 1990s, in privatizing Eliminating barriers to much risk to the private sector which their power sector (for more on this, investment has added unnecessary costs to the see my other article on page 50). But delivery of projects. In Europe, for there are still a number of states that Both state and federal government example, the CIB and EU have proposed hold significant assets in the power players will need to place renewed providing a level of guarantee over and utility sectors, as well as other focus on bringing greater consistency project debt thereby creating a tiered potentially high-value sectors such as to the PPP process. So while there system of debt that would potentially roads and bridges. is currently significant capacity and be attractive as a bond to institutional experience in structuring PPPs, there investors. There will also be significant discussion is a general belief that the approach is on how to properly structure the disjointed between the various levels of Reporting back market in order to drive greater government that hold responsibility for participation from the Superfunds infrastructure. Solving this challenge will As a next step, the IFWG has been who – to date – have been active require a greater level of coordination tasked with delivering a preliminary investors in listed assets but have when taking transactions to market report on these challenges and possible been shyer about participating in the across the country. solutions to the government over the PPP market. That being said, there is next few months. Readers of this a general indication from many of the Risk also poses a continuing challenge magazine can look forward to a further Superfund mangers of an increasing to enhancing private investment in review and analysis of the group’s appetite for allocating a greater portion infrastructure. In the past, a number of findings in the next edition of Insight of their asset management towards PPP programs have met with failure, Magazine. direct investment. Achieving this, not because of a lack of capacity within however, will take concerted effort from government or the private sector, but governments. rather because of a propensity on the part of governments to offer up too

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Created in January 2004 by the US Congress, the goes towards infrastructure-related projects which are vital for promoting Millennium Challenge Corporation (MCC) is an trade and investment. One of the innovative and independent foreign aid agency focused biggest constraints to economic growth on helping lead the fight against global poverty through in developing countries is a lack of infrastructure such as airports, ports economic growth. The MCC has approved more than and roads, and this is where most of the US$8.4 billion in compact and threshold program funding requests are focused. funding worldwide, often to support infrastructure Katherine Maloney: The sustainability projects in developing and emerging markets. of infrastructure has become a key topic, particularly in the developing world. How Mr. Daniel W. Yohannes, CEO of MCC, spoke about is MCC working with partner countries to ensure that the investment provides value the organization’s innovative funding models with long into the future? Katherine Maloney, a Director with KPMG’s International Daniel Yohannes: Sustainability is very Development Assistance Services (IDAS) practice in important to MCC. We don’t want to New York. spend five years building roads only to have them fall apart after we are done. That is why we consider sustainability at all phases of our project design and Katherine Maloney: I understand that rigorous analysis on the factors that are implementation and pro-actively look the MCC is very involved in supporting the constraining their economic growth. We for ways to reinforce sustainability – for development of infrastructure in compact look at their proposals and then make example, by requiring governments, recipient countries. Why is infrastructure decisions based on the projects that are before the project even begins, to put so important to reducing global poverty? expected to return the greatest economic aside a significant portion of maintenance benefit for the countries and their Daniel Yohannes: Our investment costs and by requiring them to invest in populations. priorities are actually decided by our improving the capacity of public works partner countries, who come to us What we have seen is that about 65 to departments. We want the assets we with proposals after conducting some 70 percent of our portfolio ultimately fund to deliver value for a very long time.

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. About 65 to ‘‘70 percent of our portfolio ultimately goes towards infrastructure- related projects which are vital for promoting trade and investment. – Daniel Yohannes’’

Our project in Nicaragua is a great country’s water security. Our funding is has greatly increased their attractiveness example of this. Before we arrived, the being complemented by a private sector to private investment. country was only able to maintain about builder and operator of water treatment Katherine Maloney: Looking ahead, 500 kilometers of road on a budget of plants who is bringing about US$85 what trends do you see gaining traction in US$2.5 million. But before we would million to the program to leverage our the markets in which the MCC invests? invest in new roads, we needed to make investment. Another example is our sure that the government could secure project in Namibia where we have a three- Daniel Yohannes: There is a growing the funds to properly maintain them way partnership in which we are providing demand for infrastructure that supports into the future. We required that the substantial funding to improve the inter-regional trade. For example, in government levy a national fuel tax; with management of national parks in the north Tanzania, the government has invested a the proceeds the country now maintains of the country and about 25 percent of the significant portion of their compact into 3,000 kilometers of road from an annual costs of establishing new joint venture building a major road to connect northern budget of about US$31 million. Some tourism lodges, which are partnerships Tanzania to Hora Hora on the border of those are roads that we built, but the between communities and tourism with Kenya. That is going to help Tanzania government has also been able to service investors. The government is providing the become more competitive and increase the national road network. wildlife and the private lodge owners are its balance of trade within the region. As a providing the remaining 75 percent of the result, private investors can now think of Katherine Maloney: MCC has always put costs. The local population benefits from Tanzania as a conduit to markets in Kenya a significant focus on encouraging private the construction of these lodges and the and Uganda. sector participation in infrastructure resulting infrastructure and jobs. development. How is this helping to Growth in Africa is actually projected to reduce poverty in the regions within But we are also working with the outpace that of Asia over the next few which you work? national governments to create the right decades and to help fund that growth, environment for private investment from we are seeing increasing partner country Daniel Yohannes: Countries cannot a policy perspective. In Benin, where we interest in leveraging relationships with rely on public sector investment alone are helping to build a port, the government the private sector to create infrastructure to bring about long-term prosperity. So has introduced major policy reform to assets to help those countries become we make sure that the private sector is help reduce the customs burden. Before more competitive in the global market. involved from Day one. The private sector we became involved, businesses would Businesses are looking at these countries is often involved in the development of have to go through 25 different windows to see if they can be competitive by the constraints analysis at the outset, but to clear customs and now they are only allowing them to lower their cost of doing they are also usually the first to recognize required to go through one. As a result, business. that these investments are effectively we have seen significant improvement in opening up markets and increasing trade. One of the great attributes of the MCC the port’s efficiency as the time to unload The private sector is also often involved is that we have no specific earmarks a ship has fallen from four days to just in project design and development in our or sector requirements imposed by two, and that number is continuing to fall. partner countries, and is certainly involved Congress. So everything we do is in contracting to implement projects. We Another example is Georgia, where they primarily based on addressing both the are also focusing increasingly on sector have really focused on creating a positive needs of the country and the opportunity policy reform to encourage private sector environment for business. Just a few for businesses to participate and benefit investment. years ago, the country ranked 118 in terms from our investments. That’s what makes of ease of doing business, but with some us so successful; we look at every deal For example, we have a US$275 million concerted effort they now rank 12th which from the perspective of business. contract with Jordan to enhance that

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The days of taking a passive approach to infrastructure investment may be over. In the past, investors in the infrastructure sector could be fairly confident that – if they could identify strong assets with a consistent Adapting to change Today, the dynamics have changed. The cash flow – they could expect to current economic environment has increased the pressure on portfolio companies and achieve relatively stable returns of put their historically stable cash flows under 10 percent or better. What’s more, threat. Business plans that – just four or five years ago – seemed like safe bets are now given the high initial investment in need of review: power companies are facing pricing pressure from governments requirements and significant while consumers struggle to pay bills in the capital expenditures involved, face of underperforming economies; ports are feeling the impact of reduced traffic and there has historically been margins as consumer spending declines force down manufacturing activity and limited competition for good imports. quality infrastructure assets. At the same time, competition for strong infrastructure investments has increased with new investors such as sovereign wealth funds and emerging market investors moving into the market and pushing up asset prices. Add to this the pressure of pending refinancing requirements for businesses that were highly leveraged in the credit boom in the first half of 2000, and it quickly becomes clear that historic assumptions can no longer be taken for granted.

Recalibrating for the future Today’s infrastructure investors are quickly recognizing what Private Equity realized in mid-2000: that relying on financial engineering or multiple arbitrage will no

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. The challenge, however, is how best assets have traditionally not had the Competition for to accomplish this. The majority of same focus on cost optimization as infrastructure investors are typically other sectors in recent years, the ‘‘strong infrastructure steeped in financial experience, but importance of driving performance investments has are often lacking the skills needed to improvement has certainly risen up drive operational improvements within their agenda. increased with their individual assets. As a result, new investors such there has been an increasing focus The case for active on determining the optimal operating management as sovereign wealth model for forward-looking funds: should funds and emerging they be hiring operations professionals, As a result, infrastructure investors appointing non-execs with operations are starting to take a more active role market investors experience to their boards, or simply in ensuring that these opportunities moving into the market relying on the capabilities of external are delivered by developing a clear advisors? understanding of the financial and and pushing up asset operational baseline, analyzing prices. A differentiated approach to performance through internal and driving value external comparators and identifying the ’’ key operational levers required to drive a The reality is that there is no right step change in the performance of their longer deliver the necessary returns answer and the final decision will portfolio companies. likely be dependent on a number of and that operational improvements will Indeed, those investment managers factors such as the size of the fund, be necessary to achieve the requisite that are able to quickly develop their mandate, the level of ownership returns or limit any downside risk. an ability to influence operational they have in their portfolio companies, And with mounting pressure from performance improvements, while the strength and capabilities of their the new investors – many of whom operating within the boundaries of management teams and the location or are co-investors who are focused on their risk profiles – either by developing proximity of their investments. shorter time horizons – infrastructure the capacity in-house or by leveraging investors are quickly realizing the What is clear, however, is that external advisors – and that can create need for increased scrutiny on infrastructure investors now recognize an effective governance process management teams to ensure that the value that can be released by to ensure that the performance they are sufficiently focused on driving ensuring that their portfolio companies improvements that are achieved are value from their investments while not are managing their operations more sustainable, will be better positioned to increasing the portfolio risk profile. effectively. So while infrastructure outperform their peers.

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. The art of privatization: Setting the groundwork for a sustainable industry By Julian Vella, KPMG in Australia

Thinking about privatizing your infrastructure assets? Before you hang the ‘For Sale’ sign in the window, you may want to think carefully about how to make sure the deal is a success for everyone involved.

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. he simple truth is that privatization All of this restructuring happened early become unaffordable or the new is not a strategy to be taken lightly. on in the privatization process through owners run the company down to a TManaged properly, the sale of a transparent transition process that point where the asset was forced back government infrastructure assets can allowed each entity to establish a track into public ownership. provide a number of valuable benefits: record for performance in their market We can expect to see a steady flow competition can be increased in the before being sold to the private sector. of privatizations over the foreseeable market leading to lower consumer As a result of this groundwork, Victoria future as cash strapped governments prices and better quality services; risk has consistently enjoyed some of seek to reduce debt, or alternatively can be transferred off of government the lowest energy prices in Australia raise funds for investment in new balance sheets and into the hands of a and continues to be one of the most infrastructure. These assets should private enterprise who – arguably – may competitive markets in the world, with also prove to be very attractive to be better prepared to manage it; and obvious benefits to consumers. the growing number of institutional valuable cash can be released from investors who are seeking to increase the asset to be reinvested into new Protecting consumers and their investment allocation to infrastructure programs and projects. taxpayers infrastructure because of its relatively low risk, long term profile. Setting the stage for success Of course, it was critical that the government structure all of this in a With proper groundwork and But achieving these worthwhile goals way that ensured that efficiency gains preparation, governments and will require governments to create were shared with the consumer and regulators should find that they can the right environment for not only the not just captured by the industry. not only create a sustainable and sale to succeed, but also to ensure There are a number of cases around efficient industry, but also retrieve that what is left behind is an efficient the world where governments have some much needed capital from their industry that can be sustained as a privatized assets only to see prices existing infrastructure assets. private enterprise while delivering benefits to the consumer. Indeed, when privatizing major infrastructure like power and utilities, Table 1. Examples of asset privatization deals worldwide ports or airports, governments must Value of put a significant amount of work into Country Year Entity Segment Transaction Type ensuring that those assets will operate ($mil) within a well-regulated framework United British Energy 2009 Power 16,938.36 Trade sale that also provides clarity around future Kingdom Group PLC prospects for the new owners. This may mean creating an environment where competition is embedded into Netherlands 2009 Essent NV Power 10,410.73 Trade sale the industry or, where competition is not possible (such as in the airports or Nippon Telegraph & Tele- Japan 2000 8,760.22 IPO power transmission sectors), creating Telephone (NTT) communications as much certainty as possible to allow private investors to minimize their risk. Autoroutes du Sud France 2006 Roads 7,121.51 Trade sale de la France (ASF) The power of regulation Turk Tele- Tur ke y 2005 6,550.00 Trade sale Take, for example, the experience of Telekomunikasyon AS communications the power industry in the Australian state of Victoria. The vertically Republic of Venezuela 2010 Power 4,848.00 Trade sale integrated state-owned power Venezuela-Carabobo company was effectively broken up into three separate sectors. On the United Infraco SSL, 2003 Rail 4,710.30 Trade sale generation side, the state established Kingdom Infraco BCV a number of power companies that owned one or more generation plants Russian Fed 20 11 PGK Rail 4,222.70 Trade sale that could properly compete against each other within the market. Separate distribution and retail companies Mexican Mexico 2007 Roads 4,030.27 Trade sale were also created to effectively act Toll Roads as the interface with consumers. For transmission, one entity was Philippines 2009 Transco Power 3,950.00 Trade sale created to ensure the grid operated as efficiently as possible.

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By Neil D Miller, KPMG in the UAE

On the face of it, few things are more perfectly aligned than Islamic finance and infrastructure investment. Indeed, the theory behind Maqasid al-Shari’ah (Shari’ah Law) is that wealth should be deployed for the good of humanity. And clearly, participating in the development of roads and bridges, schools and hospitals, water and power utilities falls firmly within that scope.

Tracking the flow of Islamic finance Striking a new path Scratch the surface a little deeper, and it On closer inspection, it seems that a large quickly becomes apparent that the movement part of the Shari’ah-compliant infrastructure of Islamic Finance into infrastructure has been financing activity that has occurred in the sluggish at best. In part, this is a consequence Muslim world (and predominantly in the GCC) of size and scope; ‘pure-play’ Islamic financial over the past decade or so has actually been institutions tend to be much smaller than their conducted by larger Western banks who – conventional counterparts and rely largely with significant experience in infrastructure on short-term deposits of one to two years development and deep pocketbooks – have for much of their funding. Clearly, tying up carefully structured their deals in these deposits in 20 year deals places a significant jurisdictions to be Shari’ah-compliant. risk on the liquidity of these institutions. Although booked by the bank’s Islamic finance As a result, many Islamic financial ‘windows’ the ultimate source of the funding investments have been centered on has not been provided by Muslim investors. An short-term debt financing and pure equity interesting side effect of the GFC has been that investments that offer clear mid-term exit funds held by many Islamic financial institutions strategies. Notwithstanding the positive have significantly increased and are often impact that many infrastructure projects perceived as safe havens by now much more offer, their relative illiquidity and limited cautious depositors; there is now a massive equity upside made them less attractive than amount of capital standing on the sidelines other asset classes. Ultimately, this means waiting to be deployed into Shari’ah-compliant that – in recent years – much of the available investments. And while a small number of finance has been directed towards real estate Islamic financiers are crying out for more investments (often speculative in nature), Shari’ah-compliant infrastructure investment which – through the course of the Global activity to take place across the Muslim world, Financial Crisis (GFC) – have lost significant it remains unclear if depositors want to commit value. The irony of this has not been lost on to this asset class with the current implicit some in the Islamic finance industry. liquidity restraints and lower returns than they became used to in previous years.

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. Adapting approaches for may require third party involvement success to facilitate the deal and can impose Many Islamic additional costs and complexity. One of the most significant challenges ‘‘financial investments for those investing through Islamic Not so different after all finance comes in the form of tax; only a have been centered relatively limited number of countries – For Western infrastructure developers on short-term even in the Muslim world – have adapted and investors, unlocking the power their tax frameworks to facilitate Islamic of Islamic finance may well provide a debt financing and finance. For example, most tax regimes rich source of project equity and co- pure equity operate on the premise that loans carry funding. And while the Islamic approach interest and therefore have a defined to financial intermediation may seem investments that offer deductibility and treatment for tax somewhat confusing at first, foreign clear mid-term exit purposes. banks and export credit agencies will often find that Islamic contracts are not strategies. But Islamic transaction are often all that different from Western ones. ’’ characterized as ‘trading’ contracts, and address short-term liquidity demands, Indeed, with the proper analysis, and therefore tend to attract sales especially if they can be structured using overlaying funding guarantees or gaining taxes and VAT, without receiving the sovereign ratings. Already, there are signs clarity into how the contracts will hold beneficial deductibility treatments. of activity in this regard. Cross-border payments may also be up under certain circumstances should treated less favorably under withholding be relatively straightforward and – if The events surrounding the Arab Spring arrangements. This means that investors structured appropriately – should be no will also eventually result in the rebuilding in Islamically-structured deals need less lucrative than conventional methods. and development of the affected to pay close attention to the structure countries, and much of the needed of their deals to ensure that their tax The spring of Islamic financing will likely be funded by other position is treated no less favorably than infrastructure finance Muslim states along Islamic lines. What’s they would be under an equivalent form more, the Islamic Development Bank of conventional finance. The bottom That said, there are a number of factors and several other Islamic investment line is that investors are seeking a that may eventually encourage the institutions are becoming increasingly ‘level playing field’, not advantageous infusion of more Islamic funds into aware of the attraction of Shari’ah- treatment. infrastructure. For one, there is a growing compliant infrastructure funds and realization that Islamic capital markets many industry commentators expect Ownership may also be a particular require additional depth and breadth. This to see an increase in the launch of such issue for foreign banks seeking to will likely result in tradable instruments funds over the next two years. Clearly, invest through an Islamic structure as based upon (or at least backed by) there is good reason to be optimistic many jurisdictions restrict the foreign infrastructure assets which would help to about the potential for Islamic finance in ownership of certain assets. This both develop the capital markets further infrastructure.

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A synopsis of a round table discussion on the need for transformation in India’s Urban Infrastructure sector

By Arvind Mahajan, KPMG in India With an estimated 700 million people moving into India’s urban areas between now and 2050, the country needs to build the equivalent of 500 cities over the next four decades. Clearly, development of this scale would be a massive challenge for any country. But India also struggles with a number of significant barriers that continue to hamper the development of urban infrastructure: complex leadership structures, land valuation challenges, capability gaps, and funding shortfalls are all part of the urban challenge that is effectively holding India back from a new round of dramatic economic growth.

n advance of the World Economic 1. Creating an urban vision: India be facilitated by developing smaller Forum Meeting in Mumbai, India requires a strong national vision cities that are more vertical in nature I(12–14 November 2011), KPMG’s for the development of cities that and support the growth of important Global Infrastructure practice convened a integrates infrastructure into a wide sectors such as manufacturing. round table discussion of leading Indian range of urban priorities such as jobs, 2. Empowering urban institutions: Infrastructure practitioners. The group education, social services, housing, In many urban areas, responsibility discussed a wide range of challenges as well as the population’s desire for for urban infrastructure falls under unique to the Indian marketplace and an aesthetically pleasing experience. a number of different agencies and developed consensus on six key urban This will require governments at all institutions. This lack of clarity around infrastructure issues that must be levels to increase their capability to leadership has resulted in conflicting overcome: conduct ‘Master Planning’ and may

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. priorities, duplicated investments and urban development. And while this 6. Securing long-term funding: With lost efficiency. There is, therefore, a will almost certainly be facilitated no real municipal bond activity or debt strong need for cities to centralize by the wider sharing of central markets for city development and low responsibility for urban planning and experience and knowledge, projects tax revenue recovery in many urban infrastructure development under a are often also impacted by decisions areas, governments and infrastructure senior technocrat with the power and taken at a local level. As a result, planners will find securing long-term scope to span all of the interested the central government may need funding increasingly challenging. In parties, agencies and institutions. to bring the knowledge capital and many cases, local municipalities are initial trunk investment to spur urban looking to unlock value through land 3. Realigning project procurement: development, but local governments monetization, thereby providing a Rather than focusing on delivering will need to provide the leadership, sustainable and off-budget approach individual assets or projects, urban planning and on-the-ground to infrastructure funding. But developers and government planners implementation support to ensure the there is still an urgent need for the will need to think about infrastructure projects succeed. development of new instruments to in terms of services to residents by encourage the local financing of urban leveraging output-based contracts 5. Building capacity for growth: As infrastructure. and project structures that take India’s focus starts to shift towards into account the value that urban urban development, the government The next few years will ultimately be infrastructure provides to residents. and developers will need to quickly the real test of India’s ability to radically In part, this will require a stronger build capacity and gain much-needed transform the status-quo of urban focus on developing a Total Cost capabilities to meet the growing infrastructure development. There will of Ownership perspective, as well demand for infrastructure. From be much change and – indeed – some as borrowing best practices from developing greater capacity for uncertainty. But if the hard questions international participants. Master Planning within all levels of are asked – and answered – by all government to building stronger infrastructure stakeholders: government, 4. Supporting effective abilities in implementation, India will developers, funders and citizens working implementation: Integrated and need to develop and enforce policies together, there is much optimism that a well-planned implementation will and regulation while also exposing sustainable and visionary path forward require India’s central government town planners to global approaches will soon be found. to take a leading role in catalyzing and methodologies.

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. Asia rising By Simon Booker and Alison Simpson, KPMG in China By all accounts, Asia Pacific is quickly becoming a hot topic for infrastructure investors. Indeed, the past year has seen a flurry of activity in both the primary and secondary markets, and the attention of global investors has clearly been captured.

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. Asia Pacific certainly presents opportunities,‘‘ investors will need to be clear about their objectives and savvy about adapting their investment model in order to adapt to – and benefit from – each individual market. ’’

ake a closer look, and it does cost competitive due to budgetary Infrastructure Funds predominantly not take long to realize that Asia surpluses and reserves which dampen focus – there are also challenges TPacific presents challenges as the need for courting private investors. in finding quality assets in many of well as opportunities for infrastructure But China may be on the cusp of the Asian markets, often as a result investors. On the one hand, there some significant changes, mostly of the slow development of basic are a small number of markets that driven by recent actions of the central infrastructure. have achieved a significant level of government which have resulted maturity in structuring and executing in limiting the borrowing power of Emerging markets, indeed infrastructure projects using private local authorities for infrastructure finance through Public Private development. As a result, we expect to That said, investors with an appetite Partnerships (PPPs). Australia and see the country mature more quickly for long-term returns may find Asia Singapore are the most obvious in this respect, coupled with a growing Pacific to be exactly the panacea that examples, but other markets such as recognition of the merits of risk transfer they seek to balance investments the Philippines and Thailand have also and commercial expertise in the in the ailing markets of Europe and recently improved their regulatory delivery of infrastructure. America. Asia Pacific’s populations are environments to promote PPP growing and becoming more affluent; structures, and Vietnam is not far Some challenges persist governments are trying to quickly adapt behind. regulation to deliver more transparency While many of the larger infrastructure and confidence to private investors; Learning to walk before funds have earmarked significant and economies are continuing to capital for investment into Asia – and expand and mature despite the they run China in particular – there still seems economic turmoil being felt in other Digging a little deeper however, it to be some concern over country risk, regions of the world. driven in part by new, unsophisticated becomes clear that infrastructure It is worth remembering that it took the or untested regulatory environments. delivery models in Asia Pacific are in UK more than two decades to develop As a consequence, there continues to a state of transition. Much of Asia has and formalize the PPP/PFI model into be a critical role for multilaterals and been gaining experience in the letting a sophisticated tool for driving private aid agencies in delivering fundamental of operating concessions (particularly investment. Most of Asia has been infrastructure in these markets. roads, water utilities and airports), working towards this goal for only five but the region has yet to make the Other challenges are also impacting to ten years and the pace of change is leap into more complex financing investor confidence in the region. The accelerating markedly. arrangements that transfer significant Philippines, for example, has seen So while Asia Pacific certainly presents risk to operators in order to deliver some rather public disputes over the opportunities, investors will need to be sophisticated infrastructure assets security of revenue flows for PPP clear about their objectives and savvy such as hospitals and schools. concessionaires who, having had their about adapting their investment model fingers burnt, have taken their cases In China, private finance for in order to adapt to – and benefit from – to Washington for arbitration. In the infrastructure is largely non-existent each individual market. and, regardless, is essentially not secondary asset market – where the

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. Global diary KPMG firms’ professionals are committed to sharing insights and exploring issues and opportunities through industry events. Here we share a selection of recent and upcoming forums organized, or with significant involvement, by KPMG. Follow the links to learn more or email us at: [email protected]

New York City, US Montevideo, Uruguay

Climate Change and Sustainability Summit – Inter-American Development Bank (IDB) Annual Business Perspective on Sustainable Growth: Meeting Preparing for Rio+20 16-19 March 2012 14-16 February 2012 KPMG’s Global Infrastructure Chairman was invited to participate KPMG’s Global Chairman Michael Andrew presided over KPMG’s first three-day as a panelist at the Inter-American Development Bank (IDB) and global summit designed to address one of the fundamental challenges of our time: the Inter-American Investment Corporation (IIC) Annual Meeting driving sustainable business growth in a resource-constrained world. Business in Montevideo, Uruguay. The panel discussed PPPs and creating Perspective on Sustainable Growth: Preparing for Rio+20 provided business and partnerships for infrastructure development. Participation at the policy leaders with an important forum to identify and prioritize key sustainability Annual Meeting is by invitation only. issues. www.iadb.org/ www.kpmg.com/sustainability

Siem Reap, Cambodia Sydney, Australia

Environmentally Sustainable Cities Seminar Energy State of the Nation Forum (ESON) 6-8 March 2012 23 March 2012

KPMG presented at the 3rd High Level Seminar on Environmentally KPMG will host a session at the Energy Policy Institute of Sustainable Cities (HLS ESC) in Cambodia. The main objective of the Australia Energy Forum on Investment and finance. The seminar is to provide a broad platform for fostering partnership, sharing objective of the Institute is to provide a mechanism for all of best practices and to promote achievements on environmentally stakeholders in Australian energy to collaborate on risks and sustainable city development in the ASPAC region. concerns impacting energy finance, production, supply and export. http://cleanairinitiative.org/ www.energyalliance.com.au/

London, UK Bogota, Colombia

ACI Airport Economics and Finance Conference & 2nd BNamericas Andean Infra Summit Exhibition 28-29 March 2012 7-9 March 2012 KPMG is proud to be a sponsor of the 2nd Andean Infrastructure Airport Council International (ACI) is hosted the 4th Annual ACI Airport Summit. The summit will bring infrastructure sector leaders Economics and Finance conference on Airport Investment, Financial from the Andean region and Central America together with Management and Economic Sustainability. KPMG’s Amber Dubey international players. participated in the panel discussion on “What PPP means for your www.andeaninfrastructuresummit.com/ airport: Understanding the financial, management and operational implications of PPP schemes”. www.aci-economics.com

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Modernization of Public Management The World Cities Summit Seminar 2-4 July 2012 3-4 April 2012 The World Cities Summit is attended by ministers and senior policy KPMG is proud to sponsor the Modernization of Public makers, business leaders, practitioners and futurists, and will cover Management Seminar. The forum will provide leaders and public cross-cutting issues around the interplay of people, technologies and policy makers the ability to discuss efficient models of success. markets facing cities today, with specific emphasis on leadership and The seminar will focus on five sectors: Public Management for governance, sustainable and eco-friendly cities as well as harmonious results, Public Employee Training and Management, Intelligent and sustainable communities. This year’s theme will be “Liveable and Cities, Healthcare Management and Education Management. Sustainable Cities – Integrated Urban Solutions”. www.worldcities.com.sg/

Puerto Vallarta, Mexico Miami, US

World Economic Forum on Latin America Infrastructure Summit: An Island Perspective of a Global Challenge 16-18 April 2012 23-25 September 2012 The World Economic Forum is a world class summit attended by business, political and academic leaders who will shape regional and global practices KPMG is proud to host the Second Annual TOG Infrastructure Summit. The to improve the state of the world. The Latin America Forum will address the event focuses exclusively on the unique opportunities and challenges involved in region’s role and contribution to the governance of the global economy, the developing islands’ infrastructure. Participants include Premiers and Ministers of creation of innovative models for a sustainable future and the improvement State for island economies around the world. of capabilities for a regional transformation. www.kpmg.com/infrastructure http://www.weforum.org/events/world-economic-forum- latin-america-2012

Munich, Germany Vienna, Austria

Global Issues Forum: City, Climate, KPMG Global Power & Utilities Conference CO -reduction: an attractive business case? 2 28-29 November 2012 24th April 2012 This conference is KPMG’s premier event for CEOs, divisional heads and Stephen Beatty, Americas Head of Global Infrastructure, will participate in financial executives in the power and utilities sector. The intensive program a panel discussion on “Low carbon infrastructure: an attractive investment focuses on strategic, financial, environmental and risk related issues, case and an opportunity for our insurance business?” at the Allianz Global including related to infrastructure, and providing insight into the tools and Issues Forum in Munich. strategies to help manage them. www.allianz.com http://www.kpmgpowerconference.com/

Vienna, Austria Various Locations

EMEA Tax Summit Women’s Infrastructure Network (WIN) 20-21 June 2012 Various Dates

Tax professionals from around the world participated in the firm’s annual Global KPMG is proud to have played an integral role in the formation of WIN. Europe, Middle East and Africa Tax Summit. Tax implications for infrastructure will KPMG, in collaboration with Freshfields Bruckhaus Deringer, initiated WIN be a key topic of discussion, including industry trends, indirect and corporate tax in the United States in 2008. Since then WIN has expanded and created rate changes and implications, regulation, and the ways environmental tax can chapters in the United Kingdom, Ireland and Canada. WIN’s mission is to contribute to saving the planet. help women to emerge as leaders in the infrastructure sector and to assist collaboration between the public and private sectors in the development and www.kpmg.com/taxviews provision of infrastructure globally. For a list of upcoming events in your region visit www.womensinfrastructure.net/events/ www.womensinfrastructure.net

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. Bookshelf A selection from our library of global infrastructure reports and insights. To access these publications, please visit: www.kpmg.com/infrastructure or email us at: [email protected]

Insight – The Global Infrastructure Magazine

Insight is a semi-annual magazine that provides a broad scope of local, regional and global perspectives on many of the key issues facing today’s global infrastructure industry.

Insight: Infrastructure 2050 – Insight: Urbanization – First Edition Second Edition The first edition of Insight explores The second edition of Insight explores one of the great universal challenges the infrastructure challenges currently of the 21st Century – infrastructure. being faced by cities, and includes In this issue, our professionals share feature interviews with key city leaders insights from global experiences, across and private sector executives from many sectors, and throughout the around the world to shed light on how infrastructure lifecycle. they are responding to the infrastructure challenge.

Reaction Magazine: Fourth Agenda Magazine Issue 7 Edition This edition discusses how strategic This issue looks at M&A trends divestments and rigorous risk from both an emerging market management led to the growth and and established market company success of GMR, India’s market leader perspective and examines how M&A in infrastructure development, how the activity may change the shape of the ‘Made in China’ label is becoming a global chemical industry over the high-value brand proposition and how coming years. We consider current the modernization of rural banking can trends in the global construction change the investment landscape. It industry and see how tax efficiency also discusses how global regulations in the supply chain can provide a in the banking sector might change the competitive advantage. way businesses access liquidity.

KPMG and UCL Infrastructure Intelligence Club Series

A series of reports investigating the operational impacts of the use of private finance. Rather than opinion and assertion, these reports offer an objective analysis based on available data.

Operating Healthcare PFI in School Building – does Infrastructure: Analyzing the it Influence Educational Evidence Outcomes? How does private finance affect Our second report further investigating hospital operational performance? This the impact of investment in school report explores the findings of data building, and the use of private finance, analysis on the topic. on educational outcomes.

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KPMG member firms are privileged to be involved in many of the exciting changes that are happening in every corner of the world, across many sectors, and at various stages of the lifecycle of infrastructure. We continuously seek to share the insights we are gaining in the process. To access our most recent publications and reports, visit: www.kpmg.com/infrastructure.

Financing the growth of Power Sector Development your city in Europe – Lenders’ This paper highlights alternative Perspectives 2011 financing mechanisms and structures This report highlights the key findings for urban infrastructure financing. from a survey of top European banks on These financing options, including the prospects for power infrastructure Public Private Partnerships (PPP), could financing in Europe. help cities gear up to not only meet the challenge of rapid growth but also become global cities with world class infrastructure. New nuclear – an economic The green challenge for perspective telecoms This paper discusses the recent events According to some estimates, the at the Fukushima Nuclear Power Plant. Information and Communications Nuclear power is already playing a Technology sector directly accounts substantial role in the decarbonization of for between 1 and 2 percent of global the global economy and currently offers energy consumption and emissions. the sole cost-comparable, low-carbon This paper reports on the status of alternative to fossil fuels. responsible low energy design options for the communication sector. Project Finance and the KPMG Global Power & Capital Markets Utilities Conference – Europe This paper examines the barriers to 2011: Conference Report accessing the debt capital markets This publication provides a for project financing and provides a comprehensive summary of the key qualitative and quantitative analysis of issues and perspectives discussed the potential solutions that are being during the KPMG Global Power & developed – in particular the product Utilities Conference – Europe 2011. being offered by Hadrian’s Wall Capital as compared to the current project finance bank market. Infrastructure 100 Construction Risk in New From KPMG and Infrastructure Nuclear Power Projects – Journal – a look at 100 of the most Eyes Wide Open exciting infrastructure projects This report draws on KPMG experience underway globally. A distinguished advising on new nuclear builds around group of judges selected these the world. The report focuses on game changers from hundreds of construction risks and shares examples submissions. of models in new nuclear power projects. It also discusses other critical considerations for investors. Project Delivery Strategy: Success and Failure in Urban Getting it Right Transport Infrastructure What are the various project delivery This joint report with University of options available to owners? What are London College explores the findings the factors that might influence the of nineteen case studies from cities selection of one method over another? around the world, including New York, This paper explores the options. London, Hong Kong, Singapore, Dublin, Bogota, Manila, Manchester, and Bangkok.

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During 2009 and 2010, KPMG commissioned a series of surveys with the EIU into issues and the way forward for infrastructure development worldwide. The three resulting surveys show a clear consensus of opinion by business leaders, infrastructure providers and government officials that as infrastructure ages around the world, we are making insufficient investments to protect our future.

Bridging the Global The Changing Face of Infrastructure Gap: Views Infrastructure: Public Sector from the Executive Suite Perspectives A survey of 328 C-level executives and Survey of 392 public sector board members from 22 countries. infrastructure policy developers and The majority of respondents expressed procurers from 50 countries worldwide. concern about the adequacy, quality and The majority of respondents agree availability of infrastructure to support that the politicization of infrastructure both their business growth and that of priorities and lack of funding are their national economies. biggest impediments to infrastructure development. The Changing Face of Infrastructure: Frontline Views from Private Sector Infrastructure Providers A survey of 455 executives from 69 countries worldwide. The majority of respondents expressed concern regarding governmental effectiveness inhibiting infrastructure development.

Rail at High Speed: Doing The Roll-out of Next large deals in a challenging Generation Networks: environment Investing for 21st Century Many countries are preparing and/or Connectivity implementing high-speed rail projects. A spotlight report on approaches being This paper shares lessons learned from taken by governments around the world work performed by KPMG member relative to the roll-out of high speed firms advising Portugal’s first high speed broadband networks. rail project.

The Great Global Delivering Water Infrastructure Opportunity: Infrastructure Using Private KPMG Global Construction Finance Survey 2012 We examine the risks and rewards of The last three years have, without a using private finance to fund water doubt, been full of uncertainty for many infrastructure, including how municipal in the engineering and construction governments and potential investors industry. Interviews with senior can benefit. executives from 140 of the world’s leading engineering and construction companies highlights that one constant is the insatiable demand for energy and infrastructure in all forms.

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Opportunities in the Indian KPMG-PMI Study on Drivers Defence Sector for Success in Infrastructure A joint study by CII-KPMG reveals the Projects 2010 India is upbeat about the opportunities KPMG in India and the Project in defence and aerospace, and eager Management Institute undertook this to grow its industrial capabilities in this survey to decode the issues inhibiting space, but is looking to government to successful project delivery. Includes continue its process of developing and the views of over 100 top management fine-tuning the procurement regime and personnel representing leading industry drivers that will enable industry Indian companies across multiple to grow. infrastructure sectors.

KPMG’s Global Infrastructure Trend Monitor Series The Global Infrastructure Trend Monitor is a series of publications allowing infrastructure investments to be compared across geographies. Our aim in developing the series is to help improve the quality of debate in identifying the geographically attractive markets for infrastructure investment.

European Transport Edition: Indian Healthcare Edition: Outlook 2008–2012 Outlook 2009–2013 Spain emerges as a “star” market – Of the 32 states considered in our both large and expected to grow rapidly. research, the six states of Maharashtra, Other smaller markets expected to Rajasthan, West Bengal, Uttar Pradesh, grow rapidly fast are Bulgaria, Estonia, Tamil Nadu and Andhra Pradesh are Iceland, Ireland, Latvia, Lithuania, forecast to represent approximately Poland, Portugal and Romania. 50 percent of expenditures for the 2009-2013 period.

North American Roads Southeast Asian Transport Edition: Outlook 2009–2013 Edition: Outlook 2010–2014 In Canada - Alberta, British Columbia, Of the 10 nations included in our Ontario and Quebec are expected to research, Indonesia, Malaysia, continue to attract nearly 90 percent of Singapore, and Thailand are forecast to Canadian road investment. In Mexico, represent over 80 percent of the total expenditure is predicted to shrink by cumulative expenditure for the 2010 to an average of 8.6 percent per annum. 2014 period. In the US, California, Florida, and Texas lead in terms of combined public and private investment in road infrastructure and are projected to maintain their dominance through the medium term.

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© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved. INTRODUCING FORESIGHT A Global Infrastructure Perspective In the complex world of Infrastructure, hot topics of conversation and industry ‘buzz’ are constantly changing. Foresight: A Global Infrastructure Perspective is a new e-blast we’ve developed to feature our take on some of the hot topics, trends and issues facing our firms’ clients.

Access copies of Foresight at: www.kpmg.com/foresight

Subscribe to the Foresight e-blast: [email protected]

KPMG is pleased to announce the Infrastructure 100: World Cities Edition, a detailed Infrastructure 100: publication that will showcase the most fascinating urban infrastructure World Cities Edition projects from around the world. Coming July 2012

Find out more: www.infrastructure100.com

What will cities of Download the first Infrastructure 100: the future look like? Global Projects Report www.kpmg.com/infrastructure100

Integrated services. Impartial advice. Industry experience.

When it comes to infrastructure, KPMG firms know what it takes to drive value. With extensive experience in most sectors and countries around the world, our Global Infrastructure professionals can provide insight and actionable advisory, tax, audit, accounting and compliance-related services to government organizations, infrastructure contractors, operators and investors. We help our clients to ask the right questions that reflect the challenges they are facing at any stage of the life-cycle of infrastructure assets or programs – from planning, strategy and construction through to operations and hand-back. At each stage, KPMG’s Global Infrastructure professionals focus on cutting through the complexity of program development to help member firm clients realize the maximum value from their projects or programs. Infrastructure will almost certainly be one of the most significant challenges facing the world over the coming decades. That is why KPMG’s Global Infrastructure practice has built a practice of highly-experienced professionals (many of whom have held senior infrastructure roles in government and the private sector) who work closely with member firm clients to share industry best practices and develop effective local strategies. By combining valuable global insight with hands-on local experience, KPMG’s Global Infrastructure practice understands the unique challenges facing different clients in different regions. And by bringing together numerous disciplines such as economics, engineering, project finance, project management, strategic consulting, and tax and accounting, KPMG’s Global Infrastructure professionals work to consistently provide integrated advice and effective results to help our member firms’ clients succeed. For further information, please visit us online at www.kpmg.com/infrastructure or e-Mail: [email protected]

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The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. © 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Designed by Evalueserve. Publication name: Insight: Investment. Editors: Peter Schram, Laura Jablonski & Cristina Cerqueira. Publication number: 120293. Publication date: April 2012

Infrastructure: one of the biggest and most complex challenges of the 21st century. An estimated US$40 trillion of investment will be needed by 2050 to sustain global growth. Our Global Infrastructure practitioners, on site in 146 countries, advise governments, developers and investors across the lifecycle of projects – from strategy and financing to delivery and hand-back.

Dig deeper at kpmg.com/infrastructure

© 2012 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG.