Australia’s pipeline of infrastructure financings is healthier than it has ever been, as state privatisation programmes encourage investors to buy brownfield assets. These same states are also using PPP methods to procure infrastructure assets. At the same time New Zealand is developing a PPP market, and its innovations are likely to attract imitators in Australia and even further overseas.

Project Finance gathered eight market participants to talk about the opportunities in Australia and New Zealand. They were:

• Geoff Daley, BTMU
• Paul Foster, AMP Capital
• Michael Hanna, IFM Investors
• David Larocca, Ernst & Young
• Jim Miller, Macquarie
• Paul Oppenheim, Plenary Group
• John Park, NZ Treasury
• Bradley Vann, Clayton Utz

Project Finance (PFM): What is your view on the pipeline of infrastructure transactions in Australia and New Zealand?

Michael Hanna, IFM Investors (MH): If we start by just looking at brownfield opportunities, the pipeline is reasonably strong and arguably getting stronger as the reality of budgetary pressures, and the electorates’ demands for new and upgraded infrastructure to be delivered hit home. New South Wales has been a proactive leader in the space, being versatile in how it is releasing capital to recycle into new assets, and the other states are now taking notice and coming to terms with their own budgetary constraints and infrastructure demands.

Paul Oppenheim, Plenary Group (PO): I think likewise the greenfield market is as strong as it has ever been. We are seeing all four of the biggest Australian states embracing the PPP procurement model for major infrastructure projects.

David Larocca, Ernst & Young (DL): For greenfield projects, we are seeing a big shift towards transport, particularly light rail. The pipeline around social infrastructure probably is not as strong. We’ve also seen a big shift in activity to New South Wales, similar to Michael’s comments around asset sales.

Geoff Daley, BTMU (GD): In New Zealand there has been a good pipeline. This started with the schools project and now we are getting into larger deals like Transmission Gully, which was recently awarded to the Wellington Gateway Partnership consortium, in which we are participating as co-sponsor and adviser.

Paul Foster, AMP Capital (PF): I think one interesting question that comes out of a fairly strong pipeline of both brownfield and greenfield opportunities is with regards to digestion issues from an equity perspective. Will some of these greenfield deals get executed without signs of indigestion, particularly if the procuring authorities seek to transfer more risk within these projects to the private sector?

PO: There is a strong sector of the market that prefers greenfield to brownfield deals and is willing to take additional development risk to earn a higher return. If anything it is the opposite as we have firms jockeying for position within consortiums.

PF: I agree, there is probably more liquidity in the equity market than there is in the debt market, particularly for mature, brownfield opportunities. Given the leverage you need as well there is probably a relative abundance of equity versus debt available for each project.

PFM: Are there any signs that New Zealand might follow Australia’s model in PPPs including the delivery of transport projects?

John Park, NZ Treasury (JP): The Transmission Gully project is a continuation of the existing model we have been working with in New Zealand with a very heavy outcomes focus. That remains the dominant driving force for PPPs in New Zealand and at this stage we are probably not looking at any major shifts away from that framework.

Bradley Vann, Clayton Utz (BV): I think Wiri was probably the first modern generation prison where you are going beyond just looking at outsourcing the fabric maintenance. We have had a healthy dialogue with our counterparts in New Zealand for the Ravenhall project in Victoria. On the other hand, we have been giving our colleagues over there some input on Transmission Gully because of our experience with Peninsula Link. Rather than one following the other, we are helping each other.

JP: I agree, for the latest Auckland prison PPP we have had sat on the steering committee someone from Australia. We can learn from them and hopefully they can learn from us.

GD: We were engaged with Peninsula Link and currently with Transmission Gully and now East-West Link. You do see ideas bouncing between both current transactions, and New Zealand has pushed the envelope in certain areas that are important to their policy objectives, such as safety.

PFM: What explains the progress that New Zealand has made in PPP and has its programme featured any innovations that would be useful in Australia?

GD: I was recently in Japan speaking about the development of their PFI market and I used New Zealand as a case study. The New Zealand government looked at what was happening in Canada, Australia and the UK and then they got on with it with a few pathfinder projects, which is often a better approach than endless policy development.

Jim Miller, Macquarie (JM): The big development in New Zealand has been introducing operating risk into the PPP structure. I think the point is that it is not for everyone but it is great that you had a project like Wiri since it reinforces the focus on operating outcomes.

GD: For some projects in Australia, for example Bendigo hospital, the government has looked at the level of operating risk and judged it to be low. They have decided that they would not be getting value for money with full private sector capital, particularly with the margins in Australia now on senior debt, and so they have provided a government contribution to reduce the senior debt. New Zealand has gone the other way and maintained the senior debt but tweaked the operating risk level. These are things you would expect Australian states to start looking at.

BV: One of the issues we have in Australia is that the pipeline takes a while to develop and then suddenly we have very large projects out to tender, which immediately test the depths of the market. I wonder if that is a factor that’s led to contributions from the state being put forward.

GD: I think that the government contribution that comes in after construction is not there to reduce capital, but rather to reduce the cost of capital. However for large projects like East-West Link where the contribution comes in during construction that reduces overall requirement for private sector capital.

PFM: What opportunities are there for overseas lenders to make Australian dollar loans to infrastructure assets?

GD: We have seen in our advisory capacity a strong interest from all over the globe and that seems to be increasing now out of Europe, whereas it faded away a few years ago. We have also seen many smaller Asian lenders dipping their toes in the water during syndication, especially with the brownfield deals.

JM: Fundamentally it is an attractive place to invest in and there is no shortage of capital in banks for the sector.

PF: We have been pleasantly surprised over the last year at the growing level of interest we have been getting from a number of different North American and Asian banks wanting to lend long tenor Australian dollars to our brownfield PPP assets. We have also seen increasing enquiries from insurers and some of the more sophisticated pension funds.

PO: That is a positive trend because what we would like to see is more foreign lenders willing to take on the Australian banks rather than just club with them. I think that there is still a bit of an issue with regards to competition in the debt markets because the Australian banks are so dominant, but it does seem to be getting better.

PFM: How do sponsors in both markets get comfortable with refinancing risk and can government do more to help?

MH: The situation we have across most assets is that we can source debt with maturities of maybe five to seven years. Our experience over the last five years, including through the GFC, is that the refinancing task has been relatively straightforward with most offerings being oversubscribed. Obviously the cost of refinancing and the margins have increased but provided the asset is high quality, is performing well and conservatively geared, then you have got plenty of headroom to accommodate the additional costs without materially impacting returns.

PO: What has happened is equity has been forced to get more comfortable with the refinancing task and governments have been less inclined to support it. I think governments are increasingly taking the view that it is a matter for the private sector and should be priced by private capital.

BV: I think the idea of government support was a function of the dearth of financing at the time of the crisis. I think government support was a product of its time and going forward I would not expect governments to take any risk of refinancing other than maybe contributing further capital.

GD: I agree but would add there is potentially a different view as to the level of support for base interest rate risk, which is clearly a market risk rather than anything to do with the project. So we have seen some governments retaining that.

JM: During a bidding process, you cannot really access the long-dated facilities but for refinancings going offshore you can access longer maturities, although that does mean that you need a very active dialogue with government to deal with some of the potential residual risk issues with termination event scenarios etc.

PFM: Why has a long-dated project bond market been slow to develop in Australia?

MH: The bond market is starting to gather momentum. I think last year across all industries we probably had about a dozen issuances in the triple-B to single-A space and I think that has been surpassed in this calendar year to date. ConnectEast, Aurizon and just this week, one of our own investments, the Eastern Distributor toll road in Sydney, issued bonds, with AquaSure expecting to issue before the end of the year.

JM: I think that momentum is really the key point. Debt investors have not historically dedicated the resources for triple-B issuers and moving into the lower investment grade space does require more resources. I think there has been a range of factors why that has been the case, but ultimately the deal flow has been so episodic that it is difficult for them to justify committing those resources.

PF: In the past there has been at times some reluctance from governments with refinance consent rights in PPP arrangements to embrace non-traditional forms of financing. Encouragingly we are seeing more receptiveness and flexibility in recent times from those authorities to consider longer tenor bond market refinancing solutions.

PO: There will be a natural shift as superannuation funds start doing a bit more asset-liability matching. In Canada most of the big pension funds are defined benefit funds and therefore have to keep a keen eye on their liabilities.

MH: For any new deals the reality of the situation is that trying to issue bonds is just too hard. Bank debt is just the easier option and the banking market is capable of writing some big cheques. The bond market is, however, a serious alternative after the initial couple of years of ownership, and offers a viable and attractive refinancing option.

PFM: Has Australia’s state-level procurement process held back new infrastructure development and what efforts can state and federal governments take to overcome this?

DL: I think both the state and federal government have made great efforts at looking at ways to streamline the bidding process and whilst there is still work to do I do not think the bidding process has been a factor in holding back infrastructure development. One of the things that has held back infrastructure development is the lack of alignment between state and federal priorities. I think for larger projects the federal government needs to be there and needs to be aligned in its views with the state government in question. Obviously the new Commonwealth government has outlined a different approach on how it intends to participate in infrastructure development so we might see that come together a bit more.

BV: I am a supporter of the principle of the federal system, which encourages competition among the states in the hope of gaining efficiencies in procurement and delivery of public services. The problem is that the sponsors bid across the states and so they are immediately aware of the differences. But that being the case, there have been efforts to improve upon that, with Infrastructure Australia having established national commercial principles for PPPs a few years ago.

MH: There is always the potential to make incremental improvements but the reality of the situation is that all greenfield PPPs that have been put to market in the last ten years have attracted sufficient interest from the private sector. However, I would challenge the extent to which this offers a better value for money outcome compared to an alternative approach to procurement. The option of government seeking to procure the long-term equity investor upfront and then, in partnership, procuring the other components of a PPP including the design & construction, operations & maintenance and debt arguably offers a better value for money outcome and a more aligned, long-term partnership. Increasing the volume of PPP projects coming to market compared to the historically patchy pipeline has also not been conducive to attracting established, long-term equity investors into PPP bid processes.

PFM: What explains the recent increase in privatisation activity, especially in New South Wales?

MH: I think that Mike Baird, the Treasurer for New South Wales, would have learned some lessons that he would have seen in Queensland, where the privatisation programme was run during 2010 and early 2011. A key one has been the need to allocate the proceeds from a privatisation process to fund specifically identified new projects. The electorate has been able to see a clear link between the decision to sell an asset and the use of the proceeds to deliver much needed, new infrastructure.

DL: I think the other thing we have seen in New South Wales is that the government has engaged the community on the spend side of the equation – in other words the major infrastructure projects it sees as important for New South Wales – and probably earlier than the asset sale discussion. I think engaging the electorate on the need side of things and the fact that money has to be raised to fund these priority projects has helped take a lot of the emotion out of privatisation debates.

JM: I think that the level of public awareness of the benefit of recycling capital from privatisations gives governments confidence. There was some work carried out by Infrastructure Partnerships Australia which showed that the flow of tax revenues from infrastructure projects went mostly to the federal level so the federal government has a lot to gain as well by working with state governments to facilitate these initiatives.

PFM: How do governments and advisers unlock value from state assets but balance retaining some control and minimising balance sheet exposure?

DL: What we are seeing is increasingly some of the more sophisticated governments are talking to the market a lot earlier, thinking hard about how they move from being an owner to a policy setter or regulator, specifically what controls they want to have and being cognisant of the price they will pay for retaining some control. There is a lot of dialogue with the market and a lot of internal due diligence before they go to market with a clear position.

BV: I have a quote here. “The healthy state of economic life was largely spontaneous growth and the result of private enterprise. The state interfered as little as possible.” This is actually a quote from Augustus in 10AD. He inherited a highly centralised economic system, and state ownership and monopolies were decreased. We are talking about something that has been debated for a couple of thousand years in terms of the balance between public and private sectors. It is a debate that will go on and it is always a function of getting the balance right.