This article was sponsored by First State Investments
What innovation have we seen in the way that infrastructure transactions have been financed over the past decade?
Marcus Ayre: On the equity side, the last decade has seen a material growth in direct investment in infrastructure by large pension funds and sovereign wealth funds, especially in relation to very large transactions.
However, there is still very much a place for established fund managers, such as First State Investments and our focus on the mid-market.
In terms of debt funding infrastructure acquisitions, the biggest change has involved the rise of long-term institutional capital. A decade ago, deals were typically funded with short-term bridging facilities – usually underwritten, usually syndicated – and then up to 18 months later that was taken out by a more permanent bank solution, a bond solution, or a mix of the two. The arrival of these long-term institutional investors and the evolution of the banking market away from short-term bridges to more mini-perm structures has meant that longer-term financing is often put in place from the outset, and that in turn has materially reduced risk.
Alongside that, there are constant innovations creeping into the market – deal contingent swaps, for example – all designed to de-risk transactions for equity. As risk-free rates and returns have compressed over the past decade, managers have had to work hard, not only to maximise returns but to minimise risk.
Danny Latham: If you think back 10 years, we were still in the midst of global financial turbulence.
We were trying to raise our first European fund, and everyone was putting up the shutters and dousing fires in their portfolios. Despite the challenging market conditions, we were able to successfully launch in August 2009.
That turbulence also affected the risk capital that banks were prepared to allocate to long-term project finance debt.
The prevailing financial crisis in 2009 has been replaced by an emerging geopolitical crisis in 2019, as well as a shift in economic power from west to east over the decade.
Those factors are affecting how governments look at themselves from a regulatory and fiscal perspective, and that has implications for the way they view infrastructure.
The sector is so intimately linked to the communities it serves that it is not immune to those macro themes.
A lot of innovation is having to go into the way we make businesses resilient, not only to increasingly severe and frequent natural disasters, but to a more volatile geopolitical environment.
Can you give an example of innovation creating asset resilience, in the face of either geopolitical or climate uncertainty?
DL: Strong passenger growth at Brisbane Airport since we acquired it in 1997 resulted in the asset becoming increasingly congested and the need for new runway infrastructure. The initial planning for a new A$1.4 billion ($960 million; €860 million) parallel runway goes back to the 1970s, with the federal government approval granted in 2007 and construction commencing in 2012. It is on track to open in 2020.
The planning process involved substantial stakeholder management and deep thinking regarding the impact of climate change. We had to consider how the airport was ‘fit for the future’, particularly when constructing a 50-plus-year asset. The airport sits on a river and on the coast, so it had to be resilient against rising sea levels and freak storms.
We needed to move beyond the old rear-view mirror approach and ask ourselves what height the runway needed to be. We looked at a one-in-a-hundred-year storm scenario and then we talked to the consulting engineers. The Atlantic Climate and Ecosystems Cooperative Research Centre was then engaged to explore the impact of rising sea levels. Their view was that the appropriate height for a runway was 4.1 metres above sea level, whereas the one-in-a-hundred-year storm scenario result was 2.3 metres. This very material difference is what’s required to ensure assets are resilient over the next 50-plus years.
Tech advancement over the past decade has been huge. How are infrastructure investors embracing that to add value to their portfolios?
MA: The last 10 years has indeed witnessed huge change but it’s worth noting that technological advancement is an ongoing process and is constantly developing across all sectors, which is why we have always believed in the necessity of a proactive approach to asset management. Investors need to be actively engaged in and focused on opportunities to innovate and evolve, and ensure businesses remain sustainable over the long term. There are many examples of this and some of the more significant areas include automation, AI and data-driven analysis. It’s already happening and having a huge impact on infrastructure assets. We need to keep pushing frontiers. For example, we own Electricity North West in the UK. ENW has rolled out something called CLASS [Customer Load Active Systems Services], which alters the voltage of the entire network in response to demand.
In the past, distribution networks were largely passive. Now, control automation of the network means in times of peak demand, such as half time of the World Cup Final when everyone is putting the kettle on, we are able to imperceptibly lower the voltage, which puts less strain on the demand for additional energy. If this technology was rolled out nationally it would have the potential to reduce the amount of additional new generation required by 2GW – that’s a large nuclear powerplant.
Data is also having a revolutionary impact. Take Anglian Water as an example. Anglian, which is operating in one of the driest regions in the UK, recently upgraded its telemetry system. It’s now one of the largest telemetry systems in Europe, second only to the amount of data collected by the Large Hadron Collider. Just having access to all those millions of points of data means we have a lot more control over the network. It helps massively with predictive maintenance and detecting leaks, a big issue in a dry region, and it helps provide value for money to consumers.
DL: Continuing on the water theme, as the driest continent on earth, Australia’s water resources are very precious – it’s almost the new black gold. In response, we are building a water investment platform with one of the businesses re-purposing recycled water, that was previously pumped into the ocean, and applying it to irrigating the McLaren Vale wine region. This also has an additional environmental benefit of displacing groundwater, which is becoming depleted and more saline, with recycled water. It is also more predictable compared with increasingly more variable rainfall patterns.
The nature of infrastructure funds has changed significantly over the past decade. Is that an area where the industry has proved particularly innovative?
MA: Yes. It’s not just about how we manage assets; it’s about producing the right structures in response to investors’ needs. Our global product is an open-ended evergreen fund, for example, while our European funds are 15-year closed-ended funds, but with the opportunity for investors to extend in five-year blocks. There are no catch-up fees and huge amounts of transparency. There has been a lot of innovation in terms of structures across the industry, to improve alignment and make vehicles more investor friendly.
DL: As the infrastructure sector grows, develops and matures, coupled with advances in technology and investor knowledge, the relationship between GP and LP will also evolve. We see it as more of a long-term symbiotic partnership with high levels of transparency and alignment. In a low-return environment that is expected to persist for the medium term, we need to ensure we deliver value for our management services in meeting our pension fund and policyholders’ objectives.
Where has innovation had the most impact in the past decade?
MA: In terms of the underlying companies, I would have to say data. The sheer amount of data that our businesses are now capable of collecting is transformative. We’ve gone from thinking conceptually about how we collect data, to implementing significant telemetry monitoring systems, to now just scratching the surface of how we can use that information to improve our assets and businesses.
Our wind farms were used to schedule maintenance. Then they reached a more interactive stage, where they would only plan works when the wind was low, so we were not losing energy and money. Now, they are starting to look at scheduling maintenance, not based on a timetable, but by using AI to analyse over two billion data points collected annually, detecting exactly when a part is likely to fail and needs to be replaced. That adds value and longevity to the turbines.
The other innovation I would point to is communication. A decade ago, we had very staid communications with our end customers. Now we have myriad channels including, of course, social media. That means we can give information to consumers in a timely manner, which is a big part of the social contract. A few Christmases ago, there was very severe flooding in Cumbria which affected the ENW (Electricity North West) network.
Communication with our customers was critical. Research has shown that our customers understand that in severe weather events there may be disruption, but what annoys them is any lack of communication about what we are doing to address the issues and them not knowing when their service will be resumed. Therefore, we constantly updated them on what was happening with the network across multiple channels and also to let people know that we had hired just about every fast-food truck in the north-west to feed families that couldn’t cook Christmas dinner. It’s about innovation in the way we engage stakeholders and the evidence suggests this works when we see that, during the storms, we sent out 455 messages to customers via social media, which generated almost 4,500 responses and almost 5,600 retweets.
Which areas of infrastructure are most ripe for disruption over the next 10 years?
MA: It has to be the energy transition. A huge part of that is about energy storage. There is a lot of early-stage innovation ongoing, but it’s not yet certain how it will all play out. It is clear we are looking to retire coal assets and move towards renewable generation. But there are still intermittency issues that need to be solved and energy storage, of some kind, has to be part of the solution.
If we start to look at decarbonising gas next, what will happen to the gas networks? Could we find a better way to use those networks as energy stores? There’s a lot of work being done in terms of using electricity to make hydrogen, with the gas networks as a clean energy store. We have to do something about climate change and infrastructure investors have a huge role to play.
DL: In direct correlation with the energy transition, I would point to urbanisation. Half of the world’s population currently live in cities, which is expected to increase to 70 percent by 2050, with 41 cities of more than 20 million people. Urbanisation will create huge issues and a shift towards distributed generation will be key. Smarter use of water, and the recycling thereof, will also receive greater attention. That means getting a lot closer to our customers and it means customers will have a lot more choice. You already see that with buying preferences around where energy comes from. As demographics change and the population becomes more climate-change focused, the pace of innovation will only accelerate.
Combating climate change is at the heart of much of the industry’s innovation.
MA: Climate change is a central concern. An example I would give is the ferry operator we own between two small cities in Denmark and Sweden. We have recently converted the two largest ferries into fully electric vessels. Silent, non-polluting ferries running from city centres have created a huge amount of public and political goodwill. Furthermore, as we buy our electricity from local wind farms under long-term contracts, it also improves the operating costs for the business and helps promote the development of renewable energy projects in the local economy.
But innovation isn’t restricted to the improvements we are making to the assets themselves. We are always looking at how we can finance projects differently, including the use of things like green bonds. Anglian Water raised the first UK utility green bond in 2017, specifically targeting a capital programme that enhances the environment.
We’ve also recently completed an almost €800 million refinancing of our Portuguese wind farm, extending the maturity of the tenors and reducing the cost for us. Again, we were able to get a Loan Market Association-accredited green loan as part of that process. From technology to decarbonisation to capital structures, innovation is about always trying to find new and better ways of doing things.
Marcus Ayre is a partner in the Direct Infrastructure investments team based in London, and a member of the European and Global direct infrastructure investment committees
Danny Latham is a partner in the Direct Infrastructure investments team based in Sydney and a member of the European and Global direct infrastructure investment committees