Income received can depend on service level agreement terms or future levels of revenue associated with the project.
For example, the current extension to the Northern Line and development in Nine Elms in south-west London is financed against the future expected income stream to be generated by future business rates in the area.
In theory, the installation of new tube stations will drive redevelopment of the area and increase in business and economic activity, which will then generate a return for the infrastructure investors.
Also regarding financing, infrastructure investors should be aware of developments related to the ‘Action Plan on Base Erosion and Profit Shifting’ (BEPS).
The BEPS agreement originated within the Organisation for Economic Co-operation and Development (OECD) and is designed to combat tax avoidance by multi-national companies who structure their income and profits to shift tax liabilities to more favourable jurisdictions.
Infrastructure investments will be affected due to their dependence on financing structures involving international investors, as well as the nature of infrastructure projects which frequently require large initial capital outlays and deferred income repayments.
Discussions regarding BEPS began in 2013, while an announcement of new requirements was made last October.
While the industry is still considering the full impact of these new rules, their impact will likely be significant. As BEPS contains restrictions on the deduction of interest payments from earnings, project gearing levels may be affected.
Additionally there are rules pertaining to the use of financial intermediaries, which have sometimes been used to create offshore investment companies in favourable tax jurisdictions.
Hence, infrastructure investments tend to face a broad array of risks:
■ Market risk: changes to discount rates, cost of capital, or changes in the inflation rate
■ Government and political:changes in tax treatment, subsidies or other guarantees to projects
■ Regulation: changes in level of oversight, KPIs or planning permissions
■ Demographics: changes in population characteristics at local or national level, such as age of population or workforce participation rates
■ Technological: returns on an investment can be eroded by competing technological improvements which result in the investment’s obsolescence.
Institutional investors attempt to diversify these idiosyncratic risks through a large, diversified portfolio, thereby spreading the risk across different asset types, financing structures and geographically across different countries.
How is infrastructure investment accessed?
For UK investors, infrastructure assets can be accessed through pension funds or client retail portfolios. For retail portfolios, the most common vehicle is a closed-end investment trust. There are also equity income funds that use a fund-of-funds approach to gain exposure to these same investment trusts.
