Funding tomorrow’s infrastructure

The question of how to build and finance the world’s physical infrastructure – upon which global economic progress depends – is top of mind for public and private sector leaders in Davos this week. For several years now, the World Economic Forum has convened an impressive list of organizations dedicated to seeking answers to these types of questions, several of which have appeared intractable.

On Monday, Standard & Poor’s (S&P) released a report clarifying the scale of the challenge and suggesting a number of remedies. The report estimates that more than $50 trillion is required worldwide to finance transport, power, water and telecommunications infrastructure between now and 2030 – a daunting sum, particularly given government belt-tightening and the ongoing effort by banks to shore up reserves. As a result, S&P expects an annual financing gap of $500 billion over each of the next 15 years – a gap that can, and indeed must, be filled by other revenue sources.

Institutional investors and the capital markets can bridge this gulf. Infrastructure investments are typically stable, with predictable, long-term cash flows that could be attractive to pension funds and insurers. Likewise, these investments align with the interests of many sovereign wealth funds, Islamic finance institutions and other fast-growing funding sources, which seek longer-term opportunities and relatively low default rates.

Despite the great opportunity that infrastructure projects present to private investment institutions, many have yet to avail themselves of it. In fact, on average they allocate less than 2% of their portfolios to infrastructure (a number that has barely increased over the last decade). And yet, S&P research suggests that doubling that small percentage could – almost on its own – close the looming infrastructure funding gap. But unlocking this potential windfall depends on policy-makers and financiers working together in three key ways:

First, investors need to better understand the risk of these investments, with standardized structures, a clear project pipeline and better performance information. Likewise, disclosure standards could provide consistency to analysing governance, operational performance and risk.

Second, a more predictable political and regulatory framework would calm nervous investors wary of unanticipated policy changes (such as last year’s tariff policy in Spain, which is increasing risk of default for renewable energy projects). EU policy-makers might also soothe investor nerves by reducing capital requirements for insurers’ infrastructure assets as the Solvency II regime is finalized.

Third, incentives could entice capital market funding at infrastructure projects’ outset, rather than post-completion. Government and/or multilateral bank guarantees could help inexpensively offset construction risk, making early investment more attractive. More efforts like the United Kingdom’s proposed Private Finance 2 initiative and the European Investment Bank’s project bond scheme are needed.

There is good reason to be hopeful that the infrastructure funding gap can be plugged, with the right actions. In the United Kingdom, six large insurers have said they will invest £25 billion in the British Government’s National Infrastructure Plan over the next five years – around 7% of the total bill. In Canada, local pension funds have tripled their exposure to infrastructure since 2010. And here in Davos, more attention than ever is focused on funding tomorrow’s infrastructure – a critical ingredient for continued global growth and prosperity.

Douglas L. Peterson is the president and chief executive officer of McGraw Hill Financial, the parent company of Standard & Poor’s Ratings Services, and is serving as a panellist on the Infrastructure Imperative session at the World Economic Forum’s Annual Meeting 2014.

Image: Workers use poles to construct a temporary ceiling at an exhibition ground in Mumbai. REUTERS/Danish Siddiqui 

Video: Copyright 2014 PwC. Prepared for the World Economic Forum for general information purposes only.