Smart Cities. Smart Thinking about Innovative Financing?

Malcolm Turnbull and Angus Taylor, Assistant Minister for Cities and Digital Transformation unveiled the Smart Cities Plan on 29 April 2016.

I had high hopes for the plan and I like the basic argument that we need to focus new infrastructure investment on developing precincts within our cities to create economic activity and create jobs. The Plan highlights the agglomeration benefits of forming clusters around hubs stimulated by education, health and transport initiatives. The Knowledge Economy needs to be built on relevant research, which can be commercialised. Macquarie Park is evidenced as a shining example.

The Plan discusses the need for transport connectivity and creation of the right enabling environment with use of smart technology; difficult to argue with that.

However, my high aspirations were brought down to earth when I turned to the discussion on innovative financing. I accept the logic that by focusing on developing economic precincts, we are investing today to create a future stream of income, some of which will be reflected in higher taxes. And the concept of value capture is founded on the principle that people who benefit from investment in infrastructure should pay, or at least make a contribution to the cost of that infrastructure. But there are some critical challenges that need to be overcome. Value capture provides a “future” funding source when all that income is earned and tax payments start to flow. But we cannot readily access this future funding source to finance the cost of infrastructure, which obviously has to be paid up-front. This is where we need innovative financing to bridge this gap. Otherwise this attempt to unlock infrastructure funding through value capture fails unless we can demonstrate to financiers how they are repaid.

The Plan rightly advocates for the establishment of value capture schemes but basically stops there. A link is provided to the Department of Infrastructure and Regional Development “DIRD” website and a flyer setting out the new innovative financing principles, which are best described as policy settings, but there is no substantive discussion of an innovative financing mechanism that explains how we are going to use value capture to actually finance the cost of infrastructure. Value capture, through the imposition of special infrastructure contributions (“SIC”), may allow a proportion of infrastructure to be financed up-front by beneficiaries, but I suspect the amount will be relatively modest. We want to encourage developers to step up and be forward thinking around investment for the future but, if we are trying to encourage investment in innovation and new technology-based industries, shouldn’t we be providing incentives rather than imposing new taxes dressed up as SICs? Moreover, the new prospective revenue streams are only realisable in the long term and even then fraught with uncertainty. Getting developers to pay up-front a SIC as an entry ticket to an innovation incubator can only lead to heavily discounted payments.

I believe there is a significant opportunity for the Australian Government to intervene and address this gap by providing innovative financing along the lines of the Northern Australia Infrastructure Facility (“NAIF”). There is far more developed smart thinking about innovative financing mechanisms in the Investment Mandate for NAIF (the Act passed on 3 May 2016). The approach builds on the concessional loan structure, as used on WestConnex, which provides for the Australian Government to provide financing which:

  • Provides a longer loan tenor than offered by Commercial Financiers, up to the longest term of Commonwealth borrowings;

  • Offers lower interest rates than offered by Commercial Financiers, by being based on the rate at which the Commonwealth borrows:

  • Offers extended periods of capitalisation of interest beyond construction completion:

  • Offers deferral of loan repayments or other types of tailored loan repayment schedules:

  • Offers lower fee structures than those offered by Commercial Financiers

  • Is subordinated to loans from Commercial Financiers.

The above list provides an appetising menu for a creative investment banker to develop a scheme, whereby a developer could be provided with the time necessary for the new Knowledge Precinct to be in a position to have access to finance to pay the SIC. For example, on the WestConnex the project, a company is relieved of the obligation to pay interest for the first ten years; this feature would be highly attractive to investors in new start-up businesses and could not be provided in the commercial market.

Moreover, the finance provided by the Australian Government under NAIF is not a grant but a sophisticated debt instrument that is shaped to provide a return based on the time profile of the prospective revenues to be earned by the developer.

The Australian Government is cleverly leveraging its balance sheet, minimising the short-term budget impact, yet properly participating in any upside revenues. And the Australian Government will be playing this role in partnership with the private sector, specifically benefitting from the skills of the Commercial Financiers. This takes some of the strain off the shoulders of the Australian Government as the credit assessment workload is shared. But it does require experience to ensure the partnerships are appropriately structured.

The Smart Cities Plan talks about the establishment of an Infrastructure Financing Unit (“IFU”) to explore innovative financing, including private partnerships, balance sheet leveraging and value capture for major projects. My suggestion is that one of the first tasks of this new unit is to explore the application of the NAIF principles. This begs the question how will the IFU be resourced? And I note that EFIC is involved with administering the NAIF.

The Australian Government is intending to be an informed and involved investor requiring key conditions to be met as a prerequisite for funding, with involvement in project development and delivery teams, and requiring approval at major decision points in a project. I hope it backs up these objectives by mobilising a smart unit fully equipped with smart thinking based on relevant experience.

This article was written by Adjunct Professor Martin Locke, Course Director of:

Infrastructure Project Finance Masterclass 


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