Market focus: infrastructure

Whether in the UK or overseas, infrastructure spending is increasingly seen as crucial to help boost the global economy. Encompassing a myriad of social and economic projects, from schools, hospitals and prisons, to roads, airports and energy, infrastructure is a huge business and is set for a major boost.

Worldwide infrastructure spending is expected to rise to more than $9tn per year by 2025 (from $4tn in 2012), according to PwC. Deals completed globally reached an estimated value of $349bn in 2015, Preqin research shows.

And that forecast was made before construction magnate Donald Trump was swept to power as the 45th president of the US. Trump has pledged to spend $1tn to rebuild the nation’s creaking infrastructure. More modestly, last November UK chancellor Philip Hammond announced £2.6bn of investment in the UK’s transport networks over the next five years and more than £1bn of investment in digital infrastructure.

Waiting in quiet anticipation for increased mandates in the world’s biggest economy, corporate and commercial law firms have nevertheless reaped success from an almost endless pipeline of projects – both in UK and overseas.

‘The great thing about infrastructure is that economies need it,’ says Michael Pearson, a partner in Clifford Chance’s energy and infrastructure practice in London. ‘Developed economies need to replace and upgrade existing infrastructure, while developing economies need to put [it] in place to meet growth.’

And, as Patrick Mitchell, global head of infrastructure at Herbert Smith Freehills, notes: ‘The trend towards being environmentally friendly is creating quite a lot of infrastructure demand in itself.’

Investment is also a driver. ‘There is an insatiable appetite in the market to invest in infrastructure,’ says Ian Andrews, partner at Linklaters. ‘Fundraising by unlisted infrastructure funds is at its highest-ever level, as is the volume of dry powder [cash-like securities or cash reserves] for investment.’

‘Infrastructure remains, and increasingly is seen as, a very attractive asset class for private investors,’ Mitchell says. By private investors he means pension funds, private equity houses, sovereign wealth funds and specialised infrastructure funds that are investing in both greenfield (yet to be built) and brownfield existing, or operating, projects.  

‘Since the global financial crisis, interest rates have been at record lows, so big institutional investors are looking for other places to put their money,’ Mitchell explains. He says infrastructure is regarded as a ‘safe’ investment, which provides ‘decent returns’. Take Ontario Teachers’ Pension Plan Board and Borealis Infrastructure (the investment vehicle of Ontario Municipal Employees Retirement System). It led a consortium which last year bought London City Airport for £2bn. Linklaters advised the consortium in the deal.

To meet rising client demand, law firms have been bulking up their infrastructure offerings. HSF’s focus on the sector dates back to the 1970s. Today, 250 lawyers globally, including 65 partners, spend all or a substantial part of their time working on infrastructure projects. ‘It is a big thing for us,’ Mitchell says.

Many law firms now have a ‘sector approach’, which means pooling in-house expertise from multiple legal disciplines. Colin Wilson, who leads the London projects team at DLA Piper, says: ‘When I say infrastructure, think of anything that you need for building a city – from transport, accommodation and energy, to leisure centres, roads and rail aviation links.’ There are about 450 lawyers (globally, but excluding the US) involved in the sector at the firm, he says.  

As CMS partner Paul Smith observes: ‘Long-term, externally financed infrastructure projects tend to be extremely complex. The negotiation and documentation of the deals requires input from legal specialists from a variety of disciplines, including in project finance, infrastructure, construction, services, real estate, corporate, insurance, and employment. ‘

Smith is head of the infrastructure and project finance group, which consists of 15 partners and more than 40 ‘assistants’ in the UK. ‘The coordination of these disciplines is essential,’ he says.

Brexit dividend

Brexit may have increased political risk in the UK, but investors are being ‘pragmatic’ and ‘recognise that uncertainty brings with it significant opportunity,’ Andrews says. ‘There is still a good appetite for UK assets, despite Brexit and while the pound remains weak. International investors still view [them] as good value.’

Infrastructure is essential for the functioning of society and ‘has to be used where it is’, Mitchell observes. ‘It is not like a portable financial services business that can be upped and moved somewhere else.’

The UK remains a ‘very strong’ market also because it is investor-friendly. ‘Money comes here because it can leave,’ Mitchell says. ‘It sounds obvious but that is one of the reasons to invest.’ Furthermore, there is a system of economic regulation of infrastructure and utilities that protects consumers while providing a clear regulatory framework for investment: ‘It is a big feature of the UK landscape and one which I would always stress is crucial.’

Firms are certainly working on very large schemes. HSF, for instance, is advising project company Tideway on the Thames Tideway Tunnel – a £4.2bn ‘super-sewer’ involving financing, construction, delivery, maintenance and operation of a new 25km tunnel, largely beneath the bed of the River Thames.

HSF is also acting for France’s EDF in another British landmark project – the £18bn Hinkley Point C power station in Somerset that received government approval in September, and is the largest ever investment by China in the UK. Clifford Chance also advised EDF in the development of the plant.

 

‘The UK still gives us a regular diet of infrastructure projects and some of them are quite large, particularly in the energy and transport space,’ Wilson says. A DLA team led by Wilson recently advised the Department for Transport on the third runway at Heathrow Airport, another large infrastructure scheme to receive the green light in October. DLA Piper is also advising the UK’s Highway Agency on a project to widen the M25.

At Osborne Clarke, ‘the majority of projects in the UK have predominantly been in the energy and social accommodation sub-sectors, for example in renewables, student housing and build-to-rent,’ observes Omar Al-Nuaimi, head of the firm’s infrastructure and finance group.

‘We’ve [also] had a healthy pipeline of secondary market activity, supporting investors who are buying and selling stakes in existing infrastructure projects,’ he adds.  

‘Over the past 18 months, the trend has been towards less greenfield deals and more brownfield deals in UK and Europe,’ says Mark Richard, a partner and head of projects, energy and infrastructure finance at Berwin Leighton Paisner.

‘The brownfield deals we are seeing are a combination of funds selling assets (short-life funds and need to sell), privatisation and utilities disposing to improve their balance sheet [and] recycle capital.’

One explanation for this shift away from new projects is that there have been some very large and complex deals, but fewer of them. ‘The demand is definitely outstripping supply on the greenfield side,’ says Pearson. ‘You are seeing much brownfield activity because corporates are taking advantage of that appetite for investment by disposing of their shareholdings or refinancing those projects.’

Examples of brownfield projects include EQT Infrastructure II’s acquisition of GB Railfreight, the third-largest rail freight operator in the UK (Clifford Chance advised the private equity fund); and Osborne Clarke advising another private equity investment firm, Foresight Group, on the purchase and subsequent £190m refinancing of its UK-based solar park portfolio.

‘The pipeline of new greenfield infrastructure has changed,’ Pearson notes. ‘It is no longer social infrastructure such as schools and hospitals. It is economic infrastructure such as roads and railway that is aligned to the real economy, because the UK government is looking at that type of infrastructure to help drive the UK economy.’

Social infrastructure projects are typically funded through public-private partnerships. ‘Looking back over the last 18 months, we’ve seen less primary investment activity in new-build infrastructure because government-backed private finance initiatives and public-private partnerships schemes have been few and far between,’ Al-Nuaimi observes.

The UK was the first country to introduce the private finance initiative (PFI) in 1992 as a means of creating public-private partnerships to fund infrastructure projects; the controversial model has since gone through a series of reforms to address inefficiencies and is now known as PF2.

Firms are still working on such projects. CMS recently advised Laing O’Rourke and Equitix on the Yorkshire Batch Priority Schools Building Programme – a £120m project that was delivered as a PF2 transaction and financed by Aviva and the European Investment Bank, and secured through a new ‘aggregator vehicle model’.

‘Now that we are in the operational phase of a number of PPP/PFI projects in the UK, we are seeing an increase in work relating to settlement of disputes, refinancings, benchmarking and market testing, replacement of subcontractors, equity sales of project companies and variations,’ Smith says. Large-scale ‘variations’ include the addition of the outpatients department at the Alder Hey Children’s Hospital in Liverpool; and the extension (worth £1.1bn) of the £8bn Allenby & Connaught project, the largest accommodation PFI undertaken by the Ministry of Defence. CMS is advising the project companies in both schemes.  

As for the more recent mega-deals such as Hinkley Point C, Pearson notes: ‘They are not PF2 projects, they are financed in a completely different way.’ State-owned EDF and the Chinese government are meeting the cost of building the nuclear station (and several UK pension funds are investing in the projects), while the UK government has guaranteed EDF a fixed price for the electricity it produces for 35 years.

Meanwhile, the ‘super-sewer’ is financed through a complex model that will see water consumers pay for a third of construction costs out of higher utility bills, while UK taxpayers will be liable for additional costs from overrunning construction work, or, for example, sharp shifts in global credit markets. Some £3bn will be provided by a consortium led by insurer Allianz, with a mixture of equity and debt.

‘HS2 or Crossrail 2, for example, are not really drawing private finance save in relation to new rolling stock and perhaps some of the new stations,’ Pearson adds.

Clifford Chance, for instance, recently advised Rock Rail and SL Capital on the financing of new fleets of Stadler trains for the Abellio East Anglia franchise in a contract worth more than £600m; while DLA Piper is representing Hitachi Rail Europe in the Intercity Express Programme, which includes replacing older intercity trains currently running on the rail network in mainland UK.

‘We are seeing a mix of funding,’ Wilson observes. ‘People are getting more creative in the nature of the financing they are putting in play to get a competitive advantage.’ The mix includes bonds, private placements, ‘project financing in the usual form’ (typically, a long-term loan that is paid back from the cashflow generated by the project) and receivable finance (a type of asset-based lending).

Projects need to be attractive for banks, funds and other investors – this is where lawyers play a key role. In response to client needs, DLA Piper has been hiring finance expertise, including Mark Dwyer (from Slaughter and May) and Vincent Keaveny (from Baker McKenzie). Both join the London office. In the highly competitive infrastructure sector, corporates and lenders, among other clients, can gain an advantage through ‘the more challenging new [financing] structures, and you need people to understand them’, Wilson says.

Other factors are influencing the way projects are funded, and lawyers need to adapt. Al-Nuaimi expects technology to become increasingly important in major infrastructure projects, especially those involving renewable energy, mobile and broadband. ‘Recently, we’ve seen solar power technologies becoming a more significant contributor to global energy production, and soon the need for subsidies will potentially end,’ he says. ‘This is in turn disrupting traditional models of infrastructure investment and payback.’

Cheap finance

Investors craving more infrastructure projects are looking beyond the UK and law firms with overseas offices are exploiting this opportunity.

‘An oversupply of equity and cheap long-term debt finance in the market are increasing competition for good assets and driving down yields for investors, Al-Nuaimi says. ‘As competition continues, investors are looking further afield to emerging markets.’

UK firms have a competitive advantage. ‘A number of infrastructure projects are based on the traditional PPP model, which was developed and proliferated in the UK,’ Smith says. ‘Many of our clients are looking to export and [use] the PPP structure in emerging markets. CMS is able to provide advice not only on the PPP mechanics but also on the local laws and regulations and how these may impact the traditional model.’

Turkey is a case in point. The government is building or expanding up to 60 hospitals in partnership with the private sector. CMS recently advised on the Izmir and Kocaeli Integrated Healthcare Campus PPP projects, which are financed by the European Bank for Reconstruction and Development (EBRD), and in which private company GE Healthcare is investing. Clifford Chance has acted for the lenders in another hospital PPP project in the Turkish city of Elazig. The EBRD is backing the €288m euro-denominated bond to finance the project, Turkey’s first-ever greenfield infrastructure project bond.

‘We are seeing less PPP/PFI in the UK, but if you go to places like Africa or the Middle East people are looking at how they can bring in private funding,’ Wilson says, adding that overseas offices afford DLA Piper ‘a fantastic opportunity’ to deliver projects across the globe.

Through DLA Piper Africa, an alliance of 15 independent law firms working together across the continent, the firm has worked on schemes in Kenya, Zambia, Uganda, South Africa and Tanzania. Wilson highlights a recent $500m medical equipment services PPP project at 94 hospitals in Kenya. In PPP schemes, private entities typically bear the up-front costs and the government pays them back (with interest) over a long period. Wilson says a combined team from DLA Piper in the UK and Kenya’s IKM (a member firm) was able to structure the financing of the 10-year project to make it ‘more acceptable to international contractors and banks’ and ‘more affordable. Spreading the payment over the period means that they can get equipment they couldn’t necessarily have afforded if they had to buy it all up front’, Wilson says.

In the Middle East the firm has advised on Dubai’s new PPP law and worked on transport schemes across the region. Firms are also assisting clients chasing infrastructure projects in the more difficult jurisdictions. Wilson’s team has been busy with projects in Afghanistan, where DLA Piper has formed a strategic alliance with Kabul-based law firm Kakar Advocates. After years of war, the country has been slowly rebuilding its devastated infrastructure. Iran is another new frontier market. ‘We have recently established an office in Iran, which is is a growing market for us following the lifting of trade sanctions,’ Smith says.

It seems investors are spreading their wings in all directions. ‘Infrastructure projects in Africa and India are becoming increasingly viable options,’ Andrews observes. Linklaters has advised lenders on the $5bn financing of the Nacala rail corridor and port facilities in Mozambique. Investors are also targeting southern Europe and increasingly eastern Europe and South America, he adds.

But there is also plenty of scope in the stronger, more stable economies. ‘Australia has been one of the leading infrastructure investment markets in the world for over a decade now,’ says Mitchell. Regional governments have been ‘asset-recycling’ or privatising public infrastructure assets and reinvesting the proceeds in rail, roads and other infrastructure. HSF recently advised the Lonsdale Consortium, which includes Canadian pension fund Omers Private Markets and the Future Fund (a sovereign wealth fund), on the acquisition of a 50-year lease of the Port of Melbourne from the Victoria government. The consortium reportedly paid almost A$10bn (£6.1bn).  

‘Northern European destinations, particularly regulated assets, will remain hot property as the majority of investors want stable regulation and low risk,’ Andrews says.

Lawyers single out Norway, where there has been a comeback of the PPP model to finance the construction of rail, road and other infrastructure. Wilson says: ‘Norway has got a big PPP programme coming to market so there is a lot of interest there.’

If much of the world is opening up to infrastructure investment, other promising jurisdictions are closing. ‘Russia was a hugely active market which had a need to replenish much of its infrastructure,’ says Mitchell. ‘But the current geopolitical situation means that [the country] is not seeing a lot of inward investment.’ International sanctions, including from the US, were imposed on the Russian Federation over its annexation of the Crimean peninsula in March 2014.

Keynesian revival

But the geopolitical scenario may change again, especially with new US president Donald Trump, who has indicated a potential thawing of relations with Russia and championed large-scale infrastructure spending – and not just on walls – to create US jobs.

‘Infrastructure is quite political. It is driven by politicians,’ observes Mitchell.

‘We are going to fix our inner cities and rebuild our highways, bridges, tunnels, airports, schools, hospitals,’ Trump said in his November acceptance speech. ‘We’re going to rebuild our infrastructure – which will become, by the way, second to none.’ The Organisation for Economic Co-operation and Development has since backed Trump’s plans to increase spending on infrastructure – and this has not escaped lawyers.

Exciting new projects are already under way in the US.

For instance, a landmark $4bn public-private partnership scheme to redevelop and operate New York City’s LaGuardia Airport Terminal B was finalised last year with a consortium led by Swedish builder Skanska.

P3 schemes (of which LaGuardia is the largest to date) are the US equivalent of the UK’s PPP/PFI, and an increasingly popular option for major projects in the US.

‘Many people are paying attention to the US market because they see a pipeline of opportunities there,’ Pearson says.

‘We are seeing a lot of European sponsors move across there because they have expertise in working on those types of deal in different jurisdictions and see that the US is deploying similar methodologies which they are comfortable with.’ Sponsors include contractors, developers and funds – for example, Skanska, British developer John Laing, and France’s Meridiam, a global investor and asset manager of public infrastructure projects.

Political winds are increasingly unpredictable and so most lawyers remain cautious. But some risk a prediction: ‘We do expect a general shift in economic policy away from monetary low-spending economics, to a more Keynesian-style of borrow-to-invest economics,’ says Al-Nuami.

‘We have already seen indications of a shift to a Keynesian model here in the UK in the autumn statement. Any successful ramping up of US-led infrastructure investment will have a positive knock-on effect in other western economies, which will ultimately directly benefit our practice.’

Marialuisa Taddia is a freelance journalist