June 2017
A much-heralded element of the federal government’s commitment to an expansion of infrastructure spending in Canada has been the announced intention to create a Canadian Infrastructure Bank (“CIB”). It is through the CIB that the government intends to channel an initial $15 billion of public capital that is to be partnered with private capital invested by many of the world’s largest institutional investors, some of whom happen to be none other than Canadian pension funds. These Canadian pension funds, it seems, are active investors in infrastructure globally, but have few if any comparable investments in Canada.
The response to the creation of the CIB has to date been generally positive, with the usual and expected cynical whispers being of the “the devil will be in the details” variety. While it is certainly clear that this proposal can go radically off the rails with insufficient attention to the details, are we really certain that there is not also a fundamental conceptual flaw to this plan that no attention to detail can paper over?
Let’s start with the basics. There is a very simple model in which an entity like the proposed CIB can provide a very valuable role in stimulating infrastructure spending. Many of the public infrastructure assets that desperately require renewal in Canada are buildings and utilities that fall under municipal or provincial jurisdiction. As the only level of government that has at its disposable an ease of access to the wealth of the country through its ability to tax incomes, the federal government possesses the highest debt rating and thus enjoys the lowest costs of borrowing. Establishing the CIB to provide timely payment guarantees on debt issued by lower rated Canadian provinces and municipalities to fund infrastructure construction makes obvious sense. CMHC has long done the same for funders of residential mortgages, and it is a model that is easily understood and accepted.
This model could be further extended to private funders of public infrastructure, but only in circumstances in which:
- the applicable infrastructure is of a type that could generate sufficient user fees to permit it to be fully self-funding; and
- the private investors are comfortable bearing all the risks associated with the construction and operation of such infrastructure.
In such circumstances, the federal government could, through a timely payment guarantee of project specific debt issued by the private investor group, effectively buy down the cost of financing the project and, it would be hoped, thereby subsidize user fees to the extent of those incremental amounts that would otherwise have been required to repay more costly debt.
Unfortunately, while there are many infrastructure projects that can meet condition 1, there are few private investors that can meet condition 2. Most large infrastructure projects are highly levered to matters of public policy. Take for example a toll road. The expected user load can be influenced greatly by development plans that might redirect population growth patterns, industrial policies that might eliminate or relocate industries or environmental policies that might rebalance personal automobile versus public transit use, to name a few. These risk elements are beyond the control of the private investor and much more firmly in the control of government, and particularly the federal government, who controls the largest portion of Canadian public spending.
In the face of this reality, private partners in public infrastructure development consortiums will necessarily require immunization from this element of risk transference. The federal government will accordingly be forced to retain the bulk of the demand risk associated with these projects. This would leave only the on-time and on-price construction risk and the operating cost risk to be borne by the private investors. A model in which the most material risk to return cannot be shared among parties is not one that lends itself to joint equity investments. The construction risk can more effectively be externalized to private interests through a fixed price construction contract without the need of the creation or involvement of the CIB. Similarly, operating costs can be externalized through a well negotiated management contract. In other words, the risk transference opportunities in infrastructure finance that are truly available to the federal government do not require the creation of the CIB.
Without risk transference, the only benefit that can be realized by the federal government through private participation in the CIB is as a source of liquidity, allowing the federal government to fund more infrastructure development without adding to the federal debt load. However, that can only be justified on a public policy basis in circumstances in which the return that must be paid to the participating private investors is less than the federal government’s cost of borrowing. That will never be the case.
Sadly, the only case that can be made for the CIB as a means of attracting private capital to fund infrastructure is the political expediency of avoiding on-balance sheet borrowing at considerable public expense. Sunny daze indeed.
