In February, at PEI's second annual Infrastructure Investor Forum in Berlin, Michael Queen, the managing partner of the infrastructure business at 3i, delivered a brilliant keynote with an urgent message. Get out there, he told the audience, and tell the world how you do business. Explain the way you create social and economic value and document your commitment to socially responsible investing. Do not do what private equity did. It ignored its social impact and woke up to a massive public relations problem only when the threat of regulatory intervention was already hanging over it.
I paraphrase, by the way: Queen, with billions of dollars at his command one of the biggest private equity infrastructure investors of all, didn't say “you”. He said “we”.
Transparency, he went on, will be the key to protecting an outstanding investment opportunity. As an asset class, infrastructure finance is still in its infancy, but its scope is vast. According to the OECD, the world's infrastructure-related funding requirement to 2030, including new builds and upgrades in transport, telecoms, water and power, is a cool $2 trillion per year. On top of that, there are schools to build and hospitals to fund, assets often classified as “social” infrastructure – and which make up another potentially enormous segment of the class.
Much of the demand for infrastructure capital resides in North America and Europe. An arguably even bigger requirement exits in the growth economies of Asia and the Middle East, Africa and Latin America. Governments have made it clear that they do not have the means to shoulder the financial burden by themselves. The private sector is required to contribute, and many private equity firms are already investing significant amounts of money. According to data compiled by InfrastructureInvestor.com, a new PEI Media product that will launch in May, private infrastructure funds being marketed at the moment are looking for a combined $65 billion in equity commitments – nearly twice the total raised in 2006.
There are of course obstacles facing infrastructure-focused private equity operators. For example, it is not easy to adapt private equity fund structures, investment horizons and compensation models to suit the long-term nature of infrastructure finance. In addition, competition for assets is keen, with a plethora of investors invariably lining up when projects start looking for funding. Banks, pension funds, public-private-partnerships, insurance companies, sovereign investors, real estate groups and hedge funds are all active, and often armed with a lower cost of capital than private equity.
But the most serious challenge facing investors in infrastructure is the political risk it takes by replacing the public sector as the traditional provider of funding. Care homes and nurseries, even toll roads and airports are highly emotive assets, and the general public usually finds it hard to accept that they should be owned privately and run for profit, let alone generate capital gain for shareholders.
Moreover, large-scale infrastructure projects in particular tend to have far-reaching social repercussions. The building of a dam in a rural area that requires families or even entire communities to relocate has a serious social cost attached to it. Investors need to be mindful of the public scrutiny they will encounter in the process, today and in years hence when the consequences of the project will be fully assessable.
Such are the social sensitivities attached to infrastructure finance that a cavalier approach to dealing with them will not do. Last year's many controversies surrounding the ethics of private equity have made all too clear what happens if the outside world decides, however unreasonably, that the industry's moral standards are wanting. As they spread their wings in the infrastructure asset class, private equity funds must do everything they can to prevent this part of its recent history from repeating itself.
Queen believes what is needed is an industry body for infrastructure financiers, modelled on the likes of the European Private Equity & Venture Capital Association in Brussels and capable of communicating with authority on the industry's behalf. In addition, infrastructure funds must agree universally binding valuation and reporting standards, as well as ethical guidelines it can credibly point to when challenged by outsiders.
“The pressure on the infrastructure industry will grow,” he said, once again evoking the troubled experience of the private equity community. “Transparency is not an option – it is essential.” And the point is to act now. Keeping their heads in the sand of the brown fields they invest in is a luxury that infrastructure investors do not have.