Few UK pension funds have invested significantly in infrastructure, but could this be about to change? Mayer Brown partner Tim Nosworthy reads the runes
The emerging trend for UK pension funds to get involved in infrastructure opens up new possibilities for the funding of these types of projects.
In recent years, there have been many examples of overseas pension funds (notably Canadian plans but also others from countries such as the US, Australia and The Netherlands) participating in "direct" investments in UK infrastructure (as opposed to "indirect" investment through third party funds). Could UK pension funds be set to follow suit?
Typically, these foreign funds investing in UK infrastructure are very large, having made significant investment over a number of years in developing their in-house investment capabilities. To date, only a few UK pension funds have adopted this approach, and it is likely that only a small number of UK pension funds would be of sufficient size for this to be a realistic approach in any event.
Perhaps more likely is that further "club" arrangements will evolve, of the type that already exist involving some local government pension schemes, to make or facilitate infrastructure investment. Indeed, at the end of 2016 it was reported that five of the UK’s biggest local government pension schemes pooled £1.3bn into the GLIL fund, rivalling the Pensions Infrastructure Platform (PIP) set up in 2011 by the Government.
The need is there. The UK has suffered from a shortage of available capital for the provision of new infrastructure since long before the credit crisis. In recent times, and in part as a result of changes implemented in response to the crisis, this shortfall has become more acute as regulatory changes such as increased capital requirements for longer term loans have made access to traditional sources of long-term project finance from banks and commercial lenders less available and in some cases, noticeably more expensive.
In the face of this shortfall, funding from sources other than banks, such as pension funds, mutual funds and insurance companies, has long been touted as a potential source to fill the gap. The potential for these sources of non-bank funding was documented in an OECD report which estimated the total amount of global infrastructure funding required from 2010 to 2030 at $50trn, while also reporting the total sums held by sources of non-bank funds to be in excess of $65trn. In the UK, the government's National Infrastructure Plan, updated at the end of 2016, includes projects requiring £500bn of investment, the majority of which is expected to come from the private sector.
In the face of dwindling returns in other more traditional areas of investment, many UK pension funds are currently seeking more diverse, and potentially remunerative, investment opportunities. Although infrastructure projects can provide this diversification and level of return (often with attractive RPI linked returns), appraising and structuring infrastructure investments requires highly specialised skill sets which rarely reside with trustees and asset managers in traditional (and in particular smaller) pension funds.
There are also legal obstacles that might hold back investment in infrastructure. A pension fund wishing to become involved in funding infrastructure transactions should be aware that while in the UK lending activity on a wholesale basis is generally not regulated, there are some activities for which they may need to be authorised under the Financial Services and Markets Act 2000.
In addition, the trustees of pension funds are usually subject to statutory investment restrictions in relation to funds held in occupational pension schemes (for example trustees and asset managers of pension funds are generally required to exercise their discretion to invest in the best interests of the scheme, the members and beneficiaries). Further, many potential participants must also comply with internal rules on investment, for example it is relatively common for funds to have an "investment grade" threshold on investment into a given project or rules requiring participation to be structured by way of a subscription for securities rather than by way of a loan.
But these legal obstacles are not insurmountable. With Chancellor Philip Hammond teasing further focus on infrastructure in his Budget this month, and the clear appetite of pension funds to explore new investment frontiers, 2017 could be the year this area finally takes off.
Tim Nosworthy is a partner in Mayer Brown’s fund formation and investment management group in London. Kieron Dwyer, partner at Mayer Brown, also contributed to this article .