Perhaps the biggest mistake investors can make today is to underestimate the importance of political risk and its increasing pervasiveness in all areas of infrastructure investing.
While political risk has been, and will probably continue to be, a mainstay of infrastructure investing, it has heightened greatly since the global financial crisis burst onto the scene in 2008. Put simply, politicians across the world today – and especially across the developed world – are under unprecedented levels of pressure from their electorates.
So while it’s fair to say that investors have had to deal with political risk since the dawn of private sector infrastructure procurement, it’s equally fair to point out that they are only now learning how to deal with the particular risks that ensue in the aftermath of a major financial crisis.
As cash-strapped governments prepare to unleash new infrastructure programmes post-crisis, Infrastructure Investor outlines four ways in which politicians are likely to make their presence increasingly felt.
CHANGING THE RULES OF THE GAME
In the good old days, changing the rules of the game midway through an infrastructure project – normally via nationalisation – used to be the sole province of developing/third-world countries. But these days, retroactive action is fair game – with governments across the world prepared to play.
Find this hard to believe? Then tune in to the daily chorus of European citizens complaining how governments have slashed their benefits, salaries and pensions left, right and centre.
Ordinary citizens are not the only ones seeing their previously sacred contracts re-written according to the new rules of the game. Private investors – including infrastructure investors – have also discovered they are liable to suffer the same fate.
The warning shot was fired a couple of years ago when the Spanish government decided to implement retroactive cuts of some 30 percent to its solar photovoltaic tariff regime. No one wanted to believe that the government of a developed country would dare to retroactively change previously agreed contracts. But the Spanish government went ahead and changed them anyway.
Since then, the threat of retroactive change to private infrastructure contracts has loomed ominously on the horizon, like a wall of dark clouds on the verge of a downpour. Of course, the more troubled the country, the higher the probability that retroactive action becomes a reality.
Bottom line: Governments of all stripes going forward will not be shy about assaulting the sanctity of long-term contracts. And even if their threat proves to be more bark than bite, you can be certain future contracts will seek to introduce more flexibility and less long-term certainty for the private sector.
PRESSURING DOMESTIC INVESTORS
“[Insert nationality] jobs for [insert nationality] people!” This has become a common refrain ever since the global financial crisis emerged. And guess what? Once again, it’s not just limited to the common people. It might seem paradoxical that politicians in an increasingly globalised economy are giving in to this sort of nationalist pressure, but giving in they are – and no exception is being made for infrastructure.
These days, nothing brings a bigger smile to a politician’s face than a successful story of domestic investment. As such, it should come as little surprise that politicians are actively manoeuvring to make sure they have reasons to smile.
At this year's Infrastructure Investor Berlin Summit, a panel discussing the acquisition of Amprion, Germany's fourth-largest electricity grid, made no secret about the political success of the deal’s ‘Germanness’ (Amprion was sold by a German utility, RWE, to a consortium of German institutional investors with the help of a German bank, Commerz Real).
Or take the UK government’s push to get the country’s pensions to fund UK infrastructure. Although vague in specifics, the government has been talking to several pension associations to create a framework that would facilitate their participation in funding local infrastructure.
This doesn’t necessarily mean these countries are closing their doors to foreign investment.
The UK, for example, has openly courted overseas investment in its infrastructure, recently helping the South Korean National Pension Service to set up shop in the country. But it does mean that governments will be more active in trying to influence where their domestic sponsors and sources of credit should invest.
Bottom line: Domestic investors should look warily on these ‘national interest’ opportunities lest they get dragged into overly politicised deals that may backfire in the long run. For a cautionary tale, look no further than French water utility SAUR, whose (French) shareholders are now at war with each other after having been lured to buy the company to keep it in French hands.
There was always an obvious mismatch between the short-term duration of the electoral cycle and the long-term horizon of infrastructure investors.
The difference now is that, given the speed with which voters are booting their democratically elected representatives out of office, the people you shook hands with on a particular deal may not be around for longer than a single term.
In the space of just over a year, 11 leaders of various Eurozone governments have been given the thumbs down by their voters over their handling of Europe’s sovereign debt crisis, with former French President Nicolas Sarkozy the latest to join the growing rush for the exit door.
This matters for two reasons: the first is that any successful infrastructure programme requires a great deal of stability and political backing. The UK’s Private Finance Initiative (PFI) would probably not have been the success it was if it hadn’t had the new Labour government’s unwavering support for a good 10 years. The second is that governments, in times of crises, naturally look to differentiate their policies from those of their political opponents – often going to extremes of criticism if needed.
Bottom line: With political consensus becoming a rare commodity, investors will have to look carefully at governments’ new infrastructure programmes and ask themselves how politicised they are and how comfortably they can withstand turbulent electoral cycles.
With living standards decreasing (sometimes sharply) across the developed world, investors will have to come to terms with a new phenomenon: rebellious consumers unwilling to pay for infrastructure – what Thomas Putter, the phenomenon that former co-head of German insurance giant Allianz’s alternative assets business, famously dubbed “social dynamite”.
So far, this “social dynamite” has only manifested itself through ad hoc manifestations of civil disobedience in debt stricken Greece and Spain, where commuters have refused to pay tolls on certain stretches of highway. But were these spontaneous protests ever to coalesce into organised mass acts of civil disobedience, such as the ‘Occupy’ movement, infrastructure investors could wake up to a serious headache.
Add to that the politically sticky issue of foreign investment in national infrastructure assets, and you have a recipe for disaster.
Here’s a nightmare scenario: Alexis Tsipras, the leader of Greece’s increasingly popular left-wing Syriza party, eventually wins power and makes good on his promise of defaulting on all Greek foreign debt, prompting Greece to eventually abandon the Eurozone.
While nationalisation of Greece’s infrastructure assets might be a bit far-fetched if Greece still wants to stay within the European Union, would anyone be surprised if a post-Eurozone Greek government turned the other way as its impoverished population refused to pay tolls on the roads managed by Germany’s Hochtief or France’s Vinci?
Bottom line: Post-crisis, demand risk has been increasingly shunned after investors discovered they had, in some cases, badly underestimated the way assets correlated with economic decline. But while most investors factored in the risks of having fewer cars on roads during a slump, it’s unlikely they considered the possibility of drivers using their roads with no intention of paying for them. Ignore this latest development at your own risk.