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- Why Pension Systems May Find New Opportunities in P3 Infrastructure Investments
Infrastructure investment, whether through direct investments in specific projects or through commingled funds, is an attractive asset class for public pension systems and other institutional investors. In this episode of Pensions, Benefits & Investments Briefings (formerly Public Pensions & Investments Briefings), Yuliya Oryol, Andrée Blais and Shant Boyajian introduce you to public-private partnerships (P3s) and alternative delivery methods for infrastructure projects. In addition to P3 projects in the U.S., they also discuss other countries, such as Canada, that have a more developed and mature market for investing in infrastructure projects by public pension systems and other institutional investors. Yuliya, Andrée and Shant also discuss the Biden administration’s infrastructure plan, which should open up investment opportunities for institutional investors.
Transcript: Why Pension Systems May Find New Opportunities in P3 Infrastructure Investments
0:00:01.1 Yuliya Oryol: Infrastructure investment, whether it is through direct investments in specific projects or through commingled funds is an attractive asset class for public pension systems and other institutional investors. Today, we will look at infrastructure development in the United States and as compared to more mature markets such as Canada, and also discuss how the Biden administration's infrastructure plan should open up investment opportunities for institutional investors.
0:00:37.6 Intro: Welcome the Public Pensions & Investments Briefings, Nossaman's podcast exploring the legal issues impacting public pension systems and their boards.
0:00:58.6 YO: Thank you for joining Nossaman's Public Pensions & Investments Briefings podcast. My name is Yuliya Oryol. I'm a partner at Nossaman and co-chair of Nossaman's public pensions and investments group. Our discussion today will introduce you to direct infrastructure investments for public private partnerships or P3s and other alternative delivery methods for infrastructure projects. In addition to P3 projects in the US, we will also discuss other countries such as Canada that have a more mature market for infrastructure development and investing by public pension systems and other institutional investors. In addition, we will discuss the Biden administration's infrastructure plan, which should open up investment opportunities for institutional investors.
0:01:45.3 YO: I'm joined today by two experienced infrastructure professionals, Andrée Blais is a partner at Nossaman in our firm's nationally recognized infrastructure group, Andrée focuses on delivering major public infrastructure projects through public-private partnerships and other alternative delivery methods. She serves as key member of Nossaman's team, working with public agency clients to advance some of the most complex procurements in transportation and social infrastructure sector, including the Los Angeles County Metropolitan Transportation authorities, Sepulveda Pass Rail Transit Program, the Los Angeles World airports, automated people mover and consolidated rent a car center, she has significant experience in performance-based availability payment P3 projects, Andrée offers the additional benefit of substantial infrastructure experience in Canada.
0:02:38.9 YO: I'm also joined today by Shant Boyajian, who's also a partner in the firm's infrastructure group. Shant advises public agencies on a wide range of innovative methods to procure and deliver the nation's largest most complex infrastructure projects, Shant also has deep experience in the public policies behind infrastructure project delivery. He previously served in the US Senate where he led development of fixing America surface transportation Act, the largest infrastructure bill in the US History. Shant also worked for the House of Representatives on the 2012 transportation bill. Andrée and Shant, thank you so much for joining me today. It's an honor to have this conversation with you, and I appreciate you sharing your expertise with us. Before we discuss the US government's approach to infrastructure in general, and more specifically what is being proposed by the Biden administration, I would like to start with Andrée, since she focuses her legal practice on delivering major public transportation infrastructure projects through P3s and other alternative delivery methods and to explain to us what is meant by a public-private partnership.
0:03:48.4 Andrée Blais: Thank you, Yuliya, for that kind introduction, and thank you for having me on this podcast. Public-private partnership or P3 is an alternative method for public agencies to procure and finance public infrastructure projects. So a P3 is actually not a partnership in the legal sense, instead it's a legally binding contract between the public agency and a private sector entity, requiring that the private party provide design and construction services and deliver an asset, and typically to operate and maintain the asset through a lengthy term, the contractual structure is set up to allocate risks to the party best able to manage each particular risk, so that basically the private party is intended to take on the risks that it can control through construction and operations and financing risks. In a P3 arrangement, the public agency does remain actively involved, so these are not privatization, what we're talking about today, as I said, procurement and financing structures, they're not privatization of typically government-offered services, private sector party is typically responsible for commercial functions such as project design construction finance and long-term operations of the asset.
0:05:07.2 AB: The key element that we want to talk about today is really from the investor perspective, and the fact that P3s include the element of private finance based on project financing principles. So getting into the weeds on this, what we mean by that is that the private entity and not the public agency is financing the design and construction in a P3 transaction, this is contrasted with the more conventional approach where the public agency might issue its own bonds for example, tax exempt bonds to raise the money necessary to do the design and construction. So in a P3 private entity brings together debt and equity to finance the design and construction, and then once the project is up and running, the project will generate a stream of revenues and that stream of revenues is used to pay back the private entity, the stream of revenues can be either availability payments or user fees and tolls.
0:06:09.4 AB: So I want to just say a word or two about these two different types of project revenue streams that can be derived from a P3 deal. Starting with user fees and tolls, which is something that most people know and understand by way of an example, once a P3 toll highway is functioning and up and running, the tolls paid by its many users come together to form a revenue stream that is used to pay back the private entity that pulled together the debt and equity to finance the highway in the first place, paying back what they borrowed so they can pay their lenders, paying them the costs to operate and maintain, and then also including a reasonable profit on their investment.
0:06:53.5 AB: And availability payment deal. On the other hand, the revenue stream is really generated by periodic payments made by the public agency itself instead of through tolls and user fees paid by multiple users, so it's called an availability payment because the idea is that the public agency will pay the P3 developer to the extent that the asset is available in accordance with performance specifications included in the contract and availability payment P3 structure is generally considered by investors to be less risky than a revenue risk deal or a toll deal, because they're not having to count on long-term use which can be unpredictable. The term of a P3 contract is typically 30 years or more, so from an investor perspective, a good and economic P3 transaction can represent a long-term predictable revenue stream.
0:07:51.9 YO: Shant keeping in mind what Andrée just explain about public-private partnerships and the private aspects of the public-private partnerships. I'm curious if you can explain to us how federal infrastructure programs support P3 projects.
0:08:08.4 Shant Boyajian: Absolutely, and it's a pleasure to be with you both today. Like you said, Yuliya as Andrée mentioned P3s are a unique way to deliver critical infrastructure in that this method of delivery includes private finance, but I think before we get into the appropriate role of the federal government, it's important to mention that I think a lot of people misunderstand what that actually means, and maybe I'm speaking more to lay people than to those in the financial industry, but I think many people, including some policy makers misunderstand P3s to mean that the private sector is somehow paying for the project, almost like free money to the public sector. That's obviously not true.
0:08:52.9 SB: The value in P3 delivery is in the incentives that it creates and the way that it allocates risk to the party that's best able to manage it as Andrée mentioned. However, the public owner will have to repay the private financing, whether it's through a user fee, like a toll or through availability payment structure, as Andrée said. At the end of the day, the public owner still needs to have the funding available to actually pay the private entity, and that can be through local funds, state funds, or through federal funds, and that's really where the federal government comes in, it's fairly uncommon for a major infrastructure project to be funded entirely with non-federal funding, especially for highway and transit projects, there are some airport projects, terminal redevelopments that may be funded through non-federal sources of funding, but by and large, if you're looking at a major infrastructure project in the United States, the chances are good that there is federal funding involved in it.
0:09:53.5 SB: As a result, even if a project is being delivered as a public-private partnership, federal funding is likely going to be required to help pay for that project, and so the more public funding available from the federal side, the more infrastructure projects that are likely to be done and the more public-private partnerships that are likely to be done in addition to the federal funding element of this, an additional point I want to make is that there are federal financing programs that will also help promote the use of P3 delivery, these are the TIFIA program, the RRIF Program, and the use of private activity bonds. These are the three federal financing programs that will help lower the cost of private financing and make the project itself more viable, and we'll talk about some of these later on in the podcast as well.
0:10:44.4 YO: If I hear you correctly, in explaining to us what is meant by public-private partnerships and the federal government's role, it sounds to me like what you're talking about are different opportunities for institutional investors to be invested in the infrastructure asset class through direct investments. Today, many if not the majority of Nossaman's public pension clients invest in infrastructure asset class through commingled private funds, this strategy helps them to enhance returns, mitigate risk and diversify as part of a broader investment portfolio, and at the present time, it appears to be the most accessible method of investing in infrastructure through public pension systems and other institutional investors, especially the smaller ones, which is the endowments and family offices, these investments are typically recommended to the investors through their investment consultants who tend to recommend the same infrastructure funds to their group of clients, and the size of the investments in contrast to direct investment, the size can vary between 10 million to 100 million and still be relatively small as compared to a direct investment that you're talking about and the commitment and size of the investment that that would take.
0:12:01.4 YO: In addition, the fund terms including reporting and transparency are attractive to institutional investors because they're very similar to private fund investments and say infrastructure or other asset class, although I admit the duration of the Infrastructure Funds, given all the extensions are quite long, I mean, you're talking about Andrée, something like 30 years, and it could be more than 30 years as compared to a private equity fund which has a duration of 10, 12 or 15 years, but what it allows the institutional investor to do is to diversify, and it allows them to spread their asset allocation among numerous managers and these investors and some have a history of private fund investing and they're comfortable with this approach to investments. And so given that, I'm very curious to talk with you Andrée, given your expertise in Canada, can you share with us the Canadian model for development of infrastructure projects and investments in those projects, by public pension systems in Canada?
0:13:08.1 AB: Yes, thank you, Yuliya. Let me start with some of the activity that we're seeing among Canadian pensions in Canada. The pension funds that I'm going to mention, are CPP, CDPQ, OMERS and Ontario Teachers pension fund, and also PSP. These large Canadian public pension funds have become very active investors in infrastructure, moving well beyond participating in commingled funds. Several of them do have in-house large and skilled infrastructure investment teams that are finding and evaluating direct investment opportunities that are aligned with the pension funds' goals and long-term strategies, they're looking for stable and predictable returns that line up with their commitments to their pensioners, having a skilled, and in-house team that can do these assessments and evaluations allows these pension funds to not simply be an investor, but they're almost a partner in infrastructure projects and become very engaged in their delivery, execution and Operations, just as one example, OMERS is an active investor in Canada and public schools, long-term care facilities and hospitals, going a step or two further, we see CDPQ almost becoming a developer in infrastructure projects itself through an infrastructure subsidiary that CDPQ owns and runs.
0:14:36.5 AB: It becomes involved in the planning and financing and construction and operation of large infrastructure projects, working together with provincial and federal government. One example is Montreal's REM, which is a large light rail transit project that's currently under construction and a partnership among CDPQ, the province of Quebec and the federal government, so that is a very unique role, I think unique in many respects in the world, what CDPQ is doing becoming very active as an investor and really creating value for its members, and third, I would like to point out, in terms of activity in the P3 marketing Canada pension funds can also be interested in and buy into an infrastructure project after it's designed and constructed and is effectively de-risk because the construction is completed and the project revenues have started to flow and become stable and predictable and have a long-term horizon just as many pensions do, so we see them at times buy positions in the secondary P3 market in Canada.
0:15:48.4 YO: What's interesting about what you're saying is that the Canadian market is so mature that it's really unique in some ways, and what I've seen in the past from commingled fund investments, is having Canadian pension systems as actually the general partner or a sponsor of the fund. What do you think makes them so unique that allows them to take these important roles in infrastructure investment, so not just being investor, but actually the manager of a project and a fund.
0:16:20.8 AB: So you mentioned that when you describe commingled funds, Yuliya, you indicated that that's something that is predictable and comfortable to a lot of pension funds, something that they can fully understand, and I think one of the things about the Canadian P3 market is that it has itself becomes very stable and predictable is very transparent and well understood by institutional investors, and that is in part because there's a fairly long history of using this model among all levels of government in Canada, local, provincial and federal governments, these governments have managed to create a fairly predictable and forward-looking pipeline of projects that allows investors and other market participants to plan in advance and have their resources available, and it makes sense then to develop in-house expertise, if there's sort of a long pipeline of eligible projects, the Canadian procedures, they're based on best practices that have been developed and shared throughout the country, P3 projects really originated in Canada with the provincial governments, but now best practices have been adopted by the federal government and then also municipal governments, and this has created consistent and transparent P3 procurement processes and predictable commercial terms.
0:17:39.3 AB: So again, making investors comfortable and creating some certainty in the market. Also relatively speaking, I guess maybe compared to other jurisdictions, the RFP and procurement process is rapid and very efficient and it lowers bid costs and saves time, and the public agencies that are delivering these projects are considered to be credit worthy and have a very good track record of reaching financial close when they start a project, so I think the key characteristics are stability and certainty transparency that make long-term investors comfortable.
0:18:19.1 YO: So I'm curious, unlike the US, is there a tax-exempt bond market in Canada?
0:18:25.1 AB: No, that's one distinct difference. And that can be an explanation for why institutional investors have developed their private investment strategies so deeply in Canada, we do not have a tax-exempt bond market in Canada offering easy access to low-cost debt for public agencies. That is a very unique US feature. Because there is no tax-exempt bond market in Canada, public agencies have or had an acute need for private financing, and over time that really resulted in the market for private financing that is very diverse. Including this essential role that I've described for pension funds, and another notable characteristic of the Canadian market that makes it attractive and has helped develop in this fashion for institutional investors, is that it has a very stable and more permissive regulatory regime, Canadian jurisdictions, unlike local, state and federal government in the United States have not intensely regulated public procurement and contracting, that's an important distinction, I think between Canada and the United States.
0:19:41.3 AB: This allows investors to more readily understand the regulatory regime in Canada and to have confidence in the Policy Network underpinning their investments, that it's something that they can know and understand and is not likely to change or be inconsistent frequently as between levels of government.
0:20:01.4 YO: Yeah, thank you. So, Shant, now that we've heard from Andrée about what they're doing in Canada, let's talk about the United States. Can you briefly discuss with us the Biden administration's proposed plan for improving US infrastructure?
0:20:17.1 SB: Absolutely. Let's look back to the campaign, and after COVID relief, President Biden's hot priority, even going back to the campaign, like I said, is really dealing with America's infrastructure needs. Back in March, President Biden unveiled his infrastructure plan, which is known as the American jobs plan, and this was roughly $2 trillion that he proposed an additional government funding that included many categories of infrastructure that the federal government currently funds, like highways and transit, as well as many types of infrastructure that the federal government does not typically fund, such as child and elder care facilities and other types of "soft infrastructure," like research and development and workforce development activities.
0:21:04.6 SB: Again, this was the President's plan that he released publicly back in March, but it's up to Congress, the House and the Senate to determine what elements of that they want to actually incorporate in their legislation. And so, the House passed its version of the infrastructure bill in July. This was known as the Invest In America Act, and the Senate passed its version of the infrastructure bill in August, which is known as the Infrastructure Investment And Jobs Act. And right now, in late August 2021, the house is considering kind of the way forward to react to the Senate bill. Let me say that there are some similarities between the House and the Senate bills. Both bills provide over $300 billion in funding over the next five years for highways and bridges, both bills provide nearly $100 billion in funding over the next five years for transit.
0:21:53.3 SB: Now, the Senate bill also deals with other types of infrastructure such as airports, ports, waterways, broadband and power grid infrastructure, which are not addressed in the House bill. And there are always different priorities that are competing for legislative time in the House and the Senate, and right now, there is an incredibly congested schedule in the house between now and the end of September. The house is considering many different bills that are priorities that need to be considered before the end of this fiscal year, including the infrastructure bill. So the house is considering what strategy to take in the way forward on actually getting an infrastructure build at the President's desk. Historically on the two bills that I worked on in 2012 and 2015, the way that this is typically done under regular order, you may read about that, that's talking about the typical procedure in the House and the Senate for actually getting a bill negotiated and to the President for signature.
0:22:51.8 SB: What that would normally look like under regular order is that both House in the Senate after they passed their versions of the bill, they would appoint conferees, which are members of the House and members of the Senate to form a conference committee to negotiate any differences between the two pieces of legislation and ultimately come up with a compromise package that each chamber would then pass again and send to the President, because until both chambers pass an identical piece of legislation, the President can't consider it and sign it. That's the typical way that this would happen, however, given the condensed schedule that we have between now and the end of the fiscal year, what may happen is that the house may actually just pass the Senate Bill verbatim with no changes and send to the President's desk that way, or one other option is that the house would actually make some slight amendments to the Senate bill, or maybe some significant changes to the Senate bill, and then send it back to the Senate for the Senate to then re-pass.
0:23:49.0 SB: Ping ponging it back and forth, but ultimately getting a bill that both the Senate and the House pass verbatim and sending it to the President that way, that would avoid the need of going to conference and the procedural delay that that would have before getting the bill to the President. Now currently, it's looking like that is more and more likely that the house will just consider what the Senate has done, but there are other things that the house is currently looking at, like budget resolution that would set the table for a large "reconciliation" bill, that would deal with other types of infrastructure investment and other priorities of the President. There is voting rights legislation, there is a debt limit that needs to be increased, and so, these types of activities, including the normal just funding of the government, all need to be done before the end of this fiscal year, that's kind of the reason for the condensed schedule right now.
0:24:50.6 SB: The one additional point I want to make is that the Senate bill does provide roughly $1.2 trillion in funding for infrastructure over the next five years, and this is just from the federal government. The state governments and the local governments all by additional funding in addition to this amount and so, it's likely that the final package that Congress ultimately sends to the President is going to be at least this large. As you mentioned earlier, Yuliya, I worked on the largest infrastructure bill in history back in 2015, and I'm hopeful that before too long, I'll have to change my bio and that we'll have a new bill that's much, much larger than that even.
0:25:25.1 YO: Fingers crossed. I mean, it's clear that the Senate and now heads to the House, and assuming it passes, I want to know what your take is on what this will mean for P3 and for opportunities for institutional investors in the infrastructure asset class?
0:25:40.7 SB: As I mentioned before, Yuliya, I'm hopeful that if this does pass and become enacted, that the mere fact that it's going to provide so much additional funding from the federal government for infrastructure projects, that, that on its own will mean that many more P3s are delivered and that many more public agencies consider P3 delivery for their projects. But there are three different provisions from the Senate Bill in particular that I want to talk about briefly, that I think what will have a particular benefit to the P3 market in the United States. The first is a provision that would raise the cap on private activity bonds for highway and freight transfer facilities. We mentioned private activity bonds earlier, this tool, the tool of using productivity bonds, gets to the issue that Andrée mentioned about the Canadian market and the lack of public tax-exempt bond market in Canada, and that being a reason for use of P3s in Canada, because of the parity between private and public financing options.
0:26:47.2 SB: In the United States, we do have a tax-exempt market for public bonds, and the private activity bonds are a tool that the federal government has established to try to allow additional parity between public and private activities, and public and private entities in accessing the bond market. PABs allow private entities to benefit from tax-exempt bond treatment to finance certain Public Works improvements such as highway and freight transfer facilities. However, the current cap in law of $15 billion, which is allocated to these types of PABs has been exhausted. Essentially eliminating the ability of private entities to access tax-exempt bonds for these projects. The Senate provision that would increase the cap from $15 billion to $30 billion would address the current demand and lower the cost of private financing on future P3 projects for highways and freight transfer facilities.
0:27:41.4 SB: The second provision from the Senate bill that I want to talk about is really interesting in that it would provide $100 million in direct grants to public agencies that are sponsoring projects for technical assistance with their P3 procurements. This may seem a little bit esoteric, but it's very challenging, especially for public agencies that have limited institutional abilities, given their constrained budgets to actually consider P3 delivery for its project delivery needs. And so, this provision from the Senate bill would provide $100 million in direct grants that would not need to be repaid to public sponsors of these infrastructure projects to actually go out and get the kind of technical support, whether it's engineering or financial or legal support to actually consider whether P3 delivery makes sense for their project and then actually use a P3 delivery model to deliver those projects.
0:28:36.9 SB: This kind of funding for Technical Support will actually provide a great benefit for some of these agencies that have not been able to access the P3 market before, and result in an increased market for public-private partnerships and for institutional investors in those projects. The final provision I want to mention would actually get at the TIFIA and RRIF programs. I mentioned these before, but these are federal programs that would provide credit assistance for certain types of projects and for any project seeking assistance under TIFIA and RRIF that has estimated capital costs of $750 million or more, this provision from the Senate bill would require that the public sponsor conducts a value for money analysis, to actually evaluate the benefit of P3 delivery for those projects.
0:29:23.7 SB: And the way that this would work is that it wouldn't require that the project seeking credit assistance under TIFIA or RRIF actually use P3 delivery, but what it would do is it would force the sponsor to consider the long-term life cycle of the asset and the project costs over that life cycle and consider whether a public private partnership delivery method would actually be more efficient for the public than a conventional delivery such as design bid build or design build. And so, I think what this would do, again, it wouldn't necessarily force a project sponsor to consider or use P3 delivery, but it would require them to think about the benefits that P3-delivery could provide for a certain type of project. And again, these three provisions are all in the Senate bill, and if enacted, I think they would help expand the market for public-private partnerships in this country, in addition to the general increase that I think we will see just by nature of the increased investment from the Federal Government.
0:30:22.3 YO: Thank you both for joining me today, we could talk for hours and still only scratch the surface of this fascinating topic. I really appreciate each of you sharing your time and expertise with us. I hope to have the opportunity to continue our discussion at a future time. And thank you to our listeners for joining us for this episode of Public Pensions and Investments Briefings. For additional information on this topic and other public pension topics, please visit our website at nossaman.com, and don't forget to subscribe to Public Pensions and Investments Briefings, wherever you listen to podcasts, so you don't miss an episode. Until next time.
0:31:01.8 S2: Public Pensions and Investments Briefings is presented by Nossaman, an LLP, and cannot be copied or re-broadcast without consent. Content reflects the personal views and opinions of the participants. The information provided in this podcast is for informational purposes only, it is not intended as legal advice, and does not create an attorney-client relationship. Listeners should not act solely upon the information without seeking professional legal counsel.