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Reading between the lines (weekly)

When a regulatory intervention strikes, should investors have seen it coming?

“Infrastructure is at the junction of public sector demands, industrial interests and the vision of financial backers. These three worlds don’t understand each other well… A regulatory accident becomes possible when these three visions start to diverge.”

This statement, which emerged from the keynote interview with French fund manager InfraVia featured in our July/August issue, underlines how regulatory adversity has become a major talking point within the infrastructure asset class – especially with increasing interventions since the Global Financial Crisis (GFC) having brought an added intensity to discussions of the topic.

Towards the end of last month, Infrastructure Investor brought together a select group of individuals with experience of the investment, advisory, regulatory and political worlds to explore the nature of risk for infrastructure investors today. All participants contributed to our recently released book on the topic and a summary of their discussion will be found in the September 2015 edition of our magazine.

One of the talking points was the extent to which investors should be able to anticipate regulatory changes. There is universal agreement that the context for infrastructure investment is a more dynamic one – which may sit uneasily with the asset class’s reputation as a safe and steady investment option, at least in the regulated space, but is nonetheless a fact of life. For example, if a subsidy regime is perceived to have been too generous to investors, it seems that regulators will these days not think twice about intervening to adjust it.

Where investors get stung by such interventions, however, opinions differ regarding their own culpability – or at least partial culpability.

Some would say it’s possible to read between the lines. In other words, your financial modelling should create room for regulatory ‘known unknowns’. When these ‘known unknowns’ are manifested, you will not be among those accusing the regulator of “capriciousness” – a word that been bandied around a lot by asset class professionals in recent years. Some would see the perception of capriciousness as resulting from a failure to have properly appreciated the likelihood (or at least possibility) of certain contributory factors leading ultimately to an intervention.

Reference is sometimes made to “scenario analysis” whereby obvious pressures such as a weak fiscal environment and the cost of living – as well as potentially harder-to-fathom elements like the interplay between various actors such as large corporates and government – are taken into account in assessing whether an investment is being made within a sustainable framework.

Scenario analysis may suggest that the terms of your investment really are too good to be true – as would be the case, for example, with a highly generous subsidy regime offered by a country whose economic prospects appear shaky. If that country subsequently experiences a downturn, claims of unpredictable regulation in the event of a subsidy reset would appear either naive or mischievous.

The regulators themselves insist their door is always open and that the best way for investors to avoid misunderstandings and missteps is a good, open dialogue. Some say that investors often fail to undertake sufficient political and regulatory due diligence in advance of an investment decision.

There is a counter-argument, which is that the best possible dialogue may still lead to the worst possible outcome. For example, there is a view that investors caught up in the Spanish solar photovoltaic debacle had every right to have expected a better outcome. They didn’t flinch from forking out for top-notch advisers and there was no forewarning of the chaos to come at the point at which commitments were made.

Some would say that the increasing complexity of infrastructure’s risk environment plays into the hands of smart investors. This is all to the good, they say; watch the dumb money flee for the hills. But does the Spanish example (and there are others) tempt you to reflect on whether considered scenario analysis and interpretation of regulatory nuance evidence smart investment – or merely obscure good fortune?