Considered approach required to the private sector investment necessary to meet UK infrastructure needs

How to do this is occupying the thoughts of UK chancellor Rachel Reeves as she prepares for her first UK Budget later this month. The International Investment Summit has demonstrated a willingness for the private sector to help deliver significant infrastructure investment across several sectors.

A recent report from the Future Governance Forum provides a useful overview and comparison of successful (and some less successful) models from across the globe which could help inform the strategy here. Its core recommendation is the development of a new “Infrastructure Investment Partnership” (IIP) to sit within a wider framework of infrastructure options available to the government.

Those options extend from conventional direct procurement through to the existing toolkit of public private partnerships – namely the Regulated Asset Base (RAB) model underpinning procurements such as Sizewell C and Thames Tideway Tunnel; the contracts for difference model that has delivered huge investment in renewables; or the Mutual Investment Model (MIM) developed by the Welsh Government, most recently used to procure the Velindre Cancer Centre. The proposed IIP, which draws from experience of successful schemes in the Australian state of Victoria, certainly has much to recommend it in the right circumstances, but the scope for its deployment will be inherently limited by its complexity.

For the UK to successfully attract the required levels of private sector investment into infrastructure, it will need to simplify the routes to delivery of infrastructure and use models that reflect current market circumstances – and which are attractive to investors, lenders, constructors and operators who can select from numerous markets across the globe where the environment for capital investment is considerably less challenging.

The political and economic context

When it swept to power in July, the new Labour government promised to deliver economic growth in the UK while operating within tight fiscal rules.

Growth is premised on getting the UK building. The government has, among other things, committed to: deliver 1.5 million new homes before the next general election (due in 2029); improve school buildings and build new, and modernise existing, hospitals; make the UK a clean energy superpower, by scaling up renewable energy generation capacity and supporting carbon capture usage and storage (CCUS) and green hydrogen projects; support road and rail network improvements and investment in electric vehicle charging infrastructure; and facilitate data centre development to underpin investment in AI and other new technologies that can support business innovation and efficiencies.

There are several levers that the new government can pull to enable the delivery of new infrastructure at speed. It has already approved applications for development consent for four major solar farms and directly intervened to grant planning permission for data centre projects, and is bringing forward proposals for significant planning reforms. It also intends to introduce a new 10-year national infrastructure strategy and create a new National Infrastructure and Service Transformation Authority – to set strategic infrastructure priorities and improve delivery of them – which, together, the industry will hope provides it with direction on how the government will start to deliver an infrastructure pipeline.

From a financing perspective, however, the government faces constraints, with low growth and an apparent budget deficit serving as a financial straitjacket. Reeves has vowed to shake the UK free from those constraints without unbalancing the UK budget, increasing national debt or raising income tax. So while Reeves is reportedly considering ways to maximise public spending on infrastructure, the reality is that the government will be heavily reliant on private sector investment to deliver the new infrastructure so important to its growth agenda.

PPP models

Across the globe, Public Private Partnership models are being successfully deployed to inject private investment into infrastructure schemes. Those models are often evolutions of the UK’s own PFI model, first introduced in the early 1990s.

Here in the UK, the PFI model evolved over time, with the short-lived ‘PF2’ model developed by the UK Government in 2012 and regional variants developed in both Scotland (NPD/hub) and Wales (MIM). However, setting aside a very limited number of Welsh MIM schemes and targeted use of the RAB model where the underlying asset class allows, there is no active programme in the UK for deployment of a structured PPP model to deliver infrastructure.

The challenges in incentivising investment

Currently, there is significant debate and discussion about the direction that new private finance models might take in the UK. What is clear is that to benefit from private sector investment and expertise in financing, building, operating and maintaining infrastructure assets, the government must incentivise the private sector to participate. It faces challenges in this regard.

Research published by JP Morgan Asset Management earlier this year indicated that the yields and returns that the private sector might expect to generate from investment in infrastructure are not zero – whilst many forms of infrastructure are low risk, they are not risk-free and government will want to exact the right amount of risk transfer to justify the use of private sector capital and the additional costs that this will incur.

Modest returns may be justifiable in the context of proven low risk investments. However the current environment of tensions and distress in the UK PFI market and concerns around the current direction of travel as we approach the peak period for expiry and handback of those previous waves of PFI projects, as well as well-publicised challenges for the water sector, are difficult to reconcile with a lower risk investment assessment.

Construction risk is a key area for consideration. The JP Morgan Asset Management research focused on returns for operating assets and does not account for significant construction risk which also needs to be priced into any new infrastructure asset.

For example, the cost of construction materials is prone to sharply increase, while legislative and regulatory requirements around connectivity, biodiversity, sustainability and building safety continue to ramp up and further drive up costs. Industry is also bearing some of the cost of addressing risks identified with reinforced autoclaved aerated concrete (RAAC), which has a relatively short lifespan as a building material. It is in this environment that many construction contractors have become unwilling to agree to fixed price construction contracts under which they sign up to hefty potential liabilities. This is apparent from the slow pace of school rebuilding, where almost 500 schools await a construction contractor to be appointed in what ordinarily might be seen as easier-to-navigate social infrastructure.

A new risk profile

To crowd in investment quickly, the government needs to be willing to look again at the principles of risk transfer against the potential financial returns to both investors and the businesses that could construct, manage and operate our infrastructure assets. Those businesses will need a sufficient ‘carrot’ to persuade them to invest in time and resource heavy bidding processes where there is public procurement involved. Some form of certainty will be required that investing in private sector skills to respond to public sector needs won’t just end up as another cancelled programme or a change in direction. The 10-year National Infrastructure Strategy should help here, but only if it is given the right status. But this also means that the private sector needs to hold a mirror up to itself and reflect on the behaviours and issues that have damaged the assertion that partnering with the private sector to deliver and operate public infrastructure is a good thing.

Whatever models for investment the government favours, there needs to be honesty around the fact that private sector capital will need a fair return for the risk that it might be asked to shoulder in providing infrastructure assets – that simple statement contains many pitfalls and hazards for both the public and private sector, which only highlights the need for the spirit of partnership and cooperation in the decade to come.