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It hub to be you 

mark williams | the mj | 21 april 2015

This article first appeared in The MJ 

A welcome range of energy, road, rail and flood defence projects are being developed, both by regulated utilities and central government. However, investment in social infrastructure such as schools, health facilities and social housing has received less attention. There is a pressing need to invest in these areas; not just in maintaining existing buildings, but also in providing new ones.

This is difficult at a time of significant constraints on public sector capital. However, there is a wide array of alternative financing models available which could be used to secure this investment. The challenge is to understand where these can be deployed and to ensure their benefits are fully evaluated.

The most widely known alternative finance model is the Private Finance Initiative (PFI). This has been used over 700 times, mainly to develop social infrastructure, such as schools and hospitals.

Despite this broad portfolio and a number of successes, the focus has been on projects that, in hindsight, have not offered good value for money. Equally, there has been little analysis of the benefits of risk transfer and innovation that PFI can bring.

To address the concerns around PFI, HM Treasury launched the PF2 model in 2012 but to date this has had limited take-up.

In parallel, there has been an effort to persuade institutional investors, both overseas sovereign wealth funds and UK pension funds, to invest in the country’s infrastructure. This has been successful. There has been significant investment in UK-regulated utilities to provide corporate finance. There has also been funding of the secondary market for infrastructure, including that held under PFI arrangements.

However, none of this is guaranteed to create newbuild social infrastructure and tends to result in inflated prices of existing assets. An example of this is the share price of regulated utilities, as we have many potential buyers chasing a finite supply of investable projects.

Investment managers cannot be blamed for the lack of funding for newbuild social infrastructure. Pension fund managers have a duty to balance risk with return for their members. This means they will favour a safe index-linked return and not want to take on any of the risk associated with either the procurement or construction phase of infrastructure projects. They also find it hard to navigate through the wide array of alternative funding models and secure a degree of certainty as to which projects will progress without needing to switch to the use of public sector capital.

Switching to the use of public sector capital should happen if, as the business case is developed, it becomes clear that the public sector capital option offers better value for money. This might happen when private sector funded offers are received. However, switching to the use of public sector capital on the basis of political or policy preference is more difficult to justify to private sector funders.

Recently, the Greater Manchester Pension Fund and the London Pensions Fund Authority announced that they are to create a £500m investment platform to provide economic and social infrastructure funding.

This could fund regeneration, including that linked to development of the proposed high speed rail lines between London, Birmingham, Leeds and Manchester. The managers of this new platform will, however, need to ensure that it only invests in new infrastructure and that investments are limited to regeneration projects. They will also need to secure the expertise to deal with procurement, contracting, delivery models and risk arrangements. In addition, they may find themselves competing for the best projects against overseas sovereign wealth funds, larger UK private pension funds, public capital spending or prudential borrowing.

What is needed is a hub mechanism to help investors, including risk-averse pension fund investment managers and government navigate through the opportunities and different models. This is important because even with readily available funding, money will go elsewhere if the process of navigating through the opportunities and models is too challenging.

This hub mechanism could encourage them to invest more in newbuild infrastructure. In some cases this might require some form of government underwriting, but this can be available provided a compelling business case can be made.

There is evidence that such hubs are starting to emerge organically at a local level. For example, Bristol City Council, together with the local universities and civic groups, including the Society of Merchant Venturers, are supporting a regional initiative to set up the Great Western Regional Capital investment scheme.

This body is seeking to channel public and private investment into local social enterprises and invite local citizens to invest in major projects that will enhance local social capital such as housing and green projects.

At the same time, mechanisms like PF2 need to be reappraised and reconsidered. There needs to be a recognition that private partnerships are now being used successfully around the world for infrastructure projects. At the same time, greatly enhanced contract management is providing significant savings in aggregate, running into billions for government, from operational PFI deals.

All this underlines that there is a real need for investment in new social infrastructure but also some solutions that can provide the funding needed for these projects.

Mark Williams is a government finance expert at PA Consulting Group

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