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The consequences of Brexit go on – now our infrastructure finance is leaving the UK, too

20/06/2019

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United Kingdom

Everywhere you look, the impacts of the Brexit vote are evident. One potentially unforeseen consequence of the UK's decision to leave the EU is that its relationship with the European Investment Bank ('EIB') will necessarily change. As a result, the Treasury is carrying out an Infrastructure Finance Review ('Review'), which is looking at the toolkit available to the government for supporting private investment in critical public projects.

As the deadline for consultation nears, it is important that all aspects of the consultation document are fully thought through: against the backdrop of an estimated £500bn infrastructure funding gap, this Review has so far fallen worryingly under the radar.

Since 1973, the EIB has lent €118bn to the UK for investment in critical public infrastructure – however, the UK's departure from the EU will remove its access to that source of investment. Indeed, under the terms of the UK-EU Withdrawal Agreement, the UK's €3.5bn of paid-in capital will be returned, with the first €300 million instalment due this December.

Partly as a result of this change, the Review's consultation document estimates that half of the country's infrastructure spend over the next ten years will need to be financed by the private sector. The Treasury is therefore looking to explore new ways to privately finance public infrastructure projects.

In the 2019 Budget, however, the Chancellor announced that the Private Finance Initiative ('PFI') and Private Finance 2 ('PF2') models would be scrapped for new projects. This means that government will no longer procure off-balance sheet projects where the taxpayer directly pays for the project.

Despite the decision to abolish the PFI and PF2 models, the government recognises that private finance can bring benefits in risk management, project discipline and innovation, and it therefore remains open to exploring new ideas for use of private capital in government projects. In particular, the Review is seeking views on whether regimes like the regulated asset base used in energy and water services or the 'contracts for difference' model used in the renewable energy industry are appropriate for application elsewhere.

Regardless of the government's preferred model, it has stipulated that the benefits brought by private finance "must outweigh the additional cost to the taxpayer of using private capital, and the government will not consider proposals demonstrating the same characteristics as PFI or PF2".

This new test raises questions from a public law and procurement perspective, and may present issues for potential providers of capital about how they best position themselves for projects going forward.

This new requirement does not take account of widespread industry concern that government does not possess suitable data and measurement frameworks to properly consider the advantages and disadvantages of the various financing models. While the new requirement (that the benefits brought by private finance must outweigh the additional cost to the taxpayer) may be a logical policy position, it will be difficult for industry and government to apply in the absence of a robust and readily identifiable framework for measuring those costs and benefits. 

In addition, while the government explores options for a new relationship with the EIB – bearing in mind that the nature of the UK's departure from the EU is far from certain – it is also considering the establishment of a new infrastructure investment entity. Given the substantial role that the EIB has played in the UK's infrastructure investment, it is difficult to see how central government money, even paired with private sector capital, can plug the gap that the EIB presently fills.

Nevertheless, the Review aims to establish a new institution by 2021 in the event that the UK loses access to the EIB. A stand-alone consultation on its design is due to begin in spring this year, and it will be essential that industry's response to the current Review is carefully considered so that its contribution aligns with the next review.

In particular, it will be important to ensure that the new entity's functions, risk appetite and mandate are clearly defined. For example, the Review explicitly focuses on private sector investment in "economic infrastructure" like broadband, roads and rail. It is unclear whether the new institution's scope would extend to social infrastructure like schools and hospitals.

In addition, it will be important to secure the new entity's political independence – a longstanding concern in the infrastructure investment industry. Lack of political independence or long-term commitment can unnecessarily raise the risk and unpredictability of infrastructure finance investment.

Alongside this Review and the consultation due this spring on a post-EIB entity, 2019 will also see the publication of a National Infrastructure Strategy and the government's spending review. It is therefore critical that Ministers and the Treasury hear a coordinated and strategic voice from key industry players. Amongst the cacophony of noise in Westminster, it is perhaps unsurprising that this Review has so far failed to attract the attention and thought it deserves. Industry and government alike need to carefully consider these and other issues while they have the chance over the coming months to reset the UK's critical infrastructure finance settings.

The Review's consultation document is available here. Submissions are open until 5 June 2019.

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