Written evidence submitted by IFM Investors (MTP0003)

About IFM Investors

Our Australian pension fund owners established IFM Investors 25 years ago to protect and grow the long-term retirement savings of working people, and we have grown to be one of the largest infrastructure investors in the world. IFM’s Global Infrastructure Fund, which has 350 pension funds as investors, has an open-ended ‘evergreen’ structure that incentivises a focus on owning, maintaining and operating infrastructure for the very long-term. IFM owns/co-owns the following UK infrastructure assets: M6toll road, terrestrial TV and radio communications provider Arqiva, Anglian Water, and Manchester Airports Group (MAG), encompassing Manchester, Stansted and East Midlands Airports. Globally, IFM owns airports, seaports, toll roads, energy distributors, and water and wastewater utilities.

MAG is a substantial example of government-pension capital partnership in the UK with our co-owners being the councils of Manchester City and nine Greater Manchester authorities. The Group is the United Kingdom’s largest airport operator, IFM became a co-owner in 2013, and together the owners are currently undertaking a £1bn Manchester Airport Transformation Programme to enhance the airport’s attractiveness to airlines, business, and recreational travellers in line with the shared commitment to enhancing the long-term value of the assets we own.

Scope of response

IFM has significant global expertise in transport infrastructure financing and delivery to maximise long-term value. Our response to this inquiry focuses on the following parts of the call for evidence:

• Oversight, accountability and governance of transport infrastructure projects
• the relationship between the Department for Transport (DfT) and other Government departments and agencies, devolved administrations, and the private sector, in delivering major infrastructure projects

• Factors influencing the cost of transport infrastructure in the UK 
• the reasons for continual high costs of major transport infrastructure projects, both past and present, and whether projects could potentially be delivered in a more cost-effective manner;
• what lessons can be learned from other countries in the delivery of major transport infrastructure projects

At the core of our response is how the Build Britain Model (more information below), which IFM has developed as a means by which more pension capital can be attracted to invest in UK infrastructure projects, can deliver benefits in the areas identified by the Committee and outlined above.

This response also includes IFM’s comments on recent changes made by the Government to the ‘Green Book’ and what further changes might be made to increase the effectiveness of the Government’s decision-making and appraisal processes for transport infrastructure projects.

Background: unlocking pension investment

Pension capital deployed at scale has an overwhelming incentive to build for tomorrow, not just for today. Funds with significant global experience in delivering large infrastructure projects should be governments’ natural equity partner in the building, operating and maintaining of national and local infrastructure.

Drawing on our experience and in line with the evolution in wider industry thinking, IFM has developed the new Build Britain Model, which sets out a roadmap for creating partnerships between government and pension capital to jointly design, permit, procure, construct, and, eventually, operate significant new economic infrastructure.

The conventional approach to greenfield infrastructure projects

One of the unintended consequences of the design of the PFI and PF2 models – the single upfront tender for all aspects – was that if structured incorrectly they would provide an opportunity for private consortia to build at the lowest possible upfront cost and exit with profits once construction was complete. The incentive was therefore to build for today not tomorrow, so costs were back-loaded onto the operation and maintenance contracts across the lifetime of the asset.

The benefits of the Build Britain Model

Pension capital provides meaningful balance sheet equity upfront, co-investing with the government to deliver the build. As investors, pension capital makes its long-term return by operating and maintaining the asset over its lifecycle rather than through high upfront fees and a planned post‐build sell down of equity.

This approach can deliver significant benefits to government, taxpayers and asset users alike, including:

• increased value for money
• a ‘shovel ready’ approach to projects, stimulating job creation
• open book transparency to better manage risks and prevent profiteering
• a maximising of long-term value, through driving positive ‘whole-of-life’ outcomes from the design phase of the project
• a trusted partner in the community seeking long-term, sustainable growth

We offer more detail on the benefits of the Build Britain Model in responses to specific parts of the call for evidence below.

Key steps in the Build Britain Model

1. The Government tenders for the long-term equity ownership of the asset – based on experience and capabilities and incorporating the bidders’ proposed internal rate of return (using an IRR range, a measure to estimate the profitability of prospective investments). This takes account of the construction risk associated with the project, the long-term risks associated with the asset and the duty of pension funds and their managers to deliver a fair rate of return on members’ retirement savings.

2. The preferred bidder prepares a project brief for the design and construction process, working closely with government.

3. A public tender for construction contracts is held, which will include a fixed completion date and price as well as design requirements.

4. A procurement process for operation and maintenance (O&M) contracts takes place.

5. The Government and the equity partner proceed to final investment decisions and a ‘go/no go’ decision on the project. Following a ‘go’ decision, the construction and O&M contracts are signed and the project is delivered.

Response to points included in call for evidence

Oversight, accountability and governance of transport infrastructure projects

A recent report published by the National Audit Office – Lessons learned from Major Programmes, (20 November 2020) – identified a number of issues related to the oversight, accountability and governance of major infrastructure projects. One recommendation from the NAO arising from this was that organisations should ensure that commercial arrangements incentivise greater transparency within the supply chain.

To enable better risk management and to prevent profiteering, the Build Britain Model process means that, where there is relevant contingency allocated to government and equity-linked risks during delivery of a project, allocation of the contingency is applied transparently on an open-book basis, meaning that profits cannot be ‘padded out’.

Factors influencing the cost of transport infrastructure in the UK 

The NAO report cited above also made a number of recommendations around understanding the risks relating to cost and schedule estimates for major projects and avoiding persistent schedule re-planning. Compared to PFI/PF2, the Build Britain Model would deliver a streamlined bidding process, resulting in significantly lower fees, bid costs and financing costs.

It enables a flexible and transparent approach to risk management to limit windfall gains and secure against excessive losses by highlighting the potential for severe cost overruns or delays to the project timetable. By providing an appropriate capital structure with an equity cushion it enables genuine long-term risk transfer to the private sector at a capital cost that accounts for risk and balanced returns to ultimate investors, as well as a willingness on the part of the equity sponsor to accept package interface and program related risks due to their early involvement in the design of the project.

In addition to credible long-term risk transfer, IFM envisage that the Build Britain Model would drive cost savings and improved value for money through:

• more collaboration upfront on design and engineering, reducing problems down the track

• more efficient procurement processes (i.e. lower bid costs and unbundling procurement, rather than a single unwieldly contract with a large contractor contingency), which would enable project contingency to be held at an equity level, applied transparently and used to manage issues in a timely manner, without needing further bailouts from governments

• greater opportunity to optimise user charges and value capture arrangements by integrating design outcomes and financing arrangements at an early stage of the project’s development. This may reduce upfront taxpayer funding commitments and enhance amenity outcomes for customers

• ‘whole-of-life’ asset management. Long-term investment provided by pension funds has a financial incentive to maximise the value of an infrastructure asset over its lifetime, increasing the owner’s focus on the long‐term environmental and social impacts of the projects, from construction throughout operation. Through an upfront partnership with government, positive ‘whole-of-life’ outcomes can be driven right from the design phase of the project, leading to enhanced customer outcomes. This also allows the pricing and locking in of these lower ‘whole-of-life’ costs, thereby transferring these risks of increasing operating costs away from taxpayers

What lessons can be learned from other countries in the delivery of major transport infrastructure projects – relevant case studies

Greater Montreal light rail system

A major project being delivered by government-pension capital equity partnership.

In Quebec, CDPQ Infra (the specialist infrastructure arm of Quebec’s largest pension fund) has partnered with government in funding the CAD$6.5 billion construction of the Réseau express métropolitain (REM)—a 67km, 26 station, all-electric, public-transportation network —which will interconnect multiple communities as well as the business centre with the Montreal–Trudeau International Airport. Offering a one-stop shop for project delivery and development, this infrastructure specialist provides capital and the technical expertise required to carry out major infrastructure projects of this kind from end to end – across design, permitting, procurement, construction, and, eventually, operations. CDPQ Infra worked closely with the Federal Government, the Government of Quebec and the Montreal municipality over a period of two years to develop the project and get it off the drawing board and into the build phase.

Brisbane Airport runway

Private investment to successfully deliver a major aviation project.

Completed in 2020, the $1.1 billion privately funded runway is the largest completed aviation project in Australia, ultimately delivered on time and under the original project budget of $1.3bn after eight years of construction. During construction, the runway project involved more than 3,740 people and 324 different subcontractors, with a peak of 650 people on site in mid-2019.

The new runway is 3.3km long, 60m wide, and has more than 12km of new taxiways. It provides Brisbane with the most efficient runway system in Australia, offering the additional capacity necessary to support the long-term growth of passenger volumes (estimated to reach 50 million passengers a year by 2035).

IFM Investors acquired the airport in 1997, and has supported the project since its inception, including through planning, commercial negotiations with airlines, debt raising and construction. The second runway effectively doubles current capacity to over 100 flight movements per hour, which is on par with Hong Kong International and Changi in Singapore.

Government’s decision-making and appraisal processes for transport infrastructure projects

As highlighted above, pension capital focuses on the successful long-term management of assets in order to support the retirement incomes of working people. The Government’s changes to the ‘Green Book’, as announced in the National Infrastructure Strategy, focus on whether proposed projects will deliver certain policy objectives and reinforce relevant local strategies and major interventions already in place in a given area.

Given IFM’s focus on long-term management of assets, we believe that the ‘Green Book’ assessment of any potential project, whether through the benefit cost ratio or its alignment with existing place-based strategies, should focus on the question of value for money over the same time horizon. This may well require looking beyond the published growth strategies related to a given place (which may only cover a five to ten-year period, for example) and at the longer-term opportunities and constraints on growth in an area and how a proposed project can help take advantage of or address these, as appropriate.

Further information

IFM would be happy to provide additional information on the Build Britain Model or our work both internationally and in the UK upon request.

December 2020