Essay 11

PLAN
FINANCING TO INFRASTRUCTURE PROJECTS
Introduction:
Importance of financing to infrastructure due to its impact on politics
Discussion point for this essay

Public financing: traditional financing, increased cost on tax payer, full control on the project
easier to obtain loans and run the project. Uncertainty of finance for mega project- requiring
huge finance

Advantages and disadvantages of public financing

Private financing: New initiative from government, promoting involvement of private finance,
risk transfer to private company, certainty of completion, value for money and promoting
innovations to reduce cost.

Mechanism of private financing.

Public/ Private financing: partially financed by public and private (joint venture), benefits of
getting loans as public sector are involved. Complex contract documentation. Looks like
private finance.

Advantages and disadvantages of private and public/private finance.

FINANCING TO INFRASTRUCTURE PROJECTS

Financing of infrastructure is a primary concern to governments due to the role that efficient
infrastructure play in economic growth and social activity. In the UK, infrastructure provision largely
has been the responsibility of the public sector, since the Second World War. For example all
motorways in the UK were initially constructed through the finance provided by the government. In this
essay I would discuss the three main source of financing to the infrastructure project. These sources
are public financing, private financing (PFI) and public/ private partnership (PPP) financing. I would
give emphasis on the private financing mechanism in infrastructure development project.
Public financing: Traditionally, infrastructure procurement was viewed as asset procurement;
decisions relating to provision, production, and financing of assets as well as operation and
maintenance of the services were undertaken by the public sector. Assets were procured from private
sector contractor whose responsibilities were limited to the construction of the asset, and the risk
associated with operation of the facility remained with public sector. Various advantages and
disadvantages of public funding are:
Advantage:

Able to use infrastructure to control construction sector

Financing directly from Government
Government can get better interest rate than private sector
Government controls the whole process of procurement ie design, construction and
maintenance and operation.
Government has to answer to electorate rather than to shareholder- therefore act in public
interest.

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Probably easier to obtain European Union funds

Disadvantage:

Money can only come from government where funding is limited

Taxes are increased to pay back loans
All risk associated to the project ie financing, design, construction, operation and maintenance
lie on to the public sector
Public sector finance and management are subject to the uncertainties of general/ local
election and change in policies throughout development of project (more stability in private
developers).
Need to maintain staff and resources for the project ie design development and construction
supervision
Need the funds to borrow as mega project which require huge capital would not be available
from public course only.

Private Finance Initiative

Recently, responsibility for financing, producing and operating infrastructure facilities has shifted from
the public sector to the private sector. This has come about in the UK within wider ideological setting
in the 1980 that was manifested in various forms such as privatisation, contracting out, and build
operate and transfer (BOT) arrangements.
In 1992, the government introduced a new policy, the private finance initiative (PFI), to promote the
private sectors involvement in infrastructure and public service provision. At the heart of this policy is
attracting private sectors funds, management and innovations to the provision of infrastructure
services. It was intended to facilitate close co-operation between the public and private sectors and
introduced private sector skills and disciplines into delivery and management of projects and services
traditionally undertaken by the public sector. PFI emerged as a result of concern that public sector
infrastructure development is subject to unacceptable cost and time overrun. PFI attempts to deliver
better value for many for these projects.
PFI covers a wide range of infrastructure services such as prison, roads, rail, health, and defence,
higher and further education. The main objectives of using PFI in road sector are:

To ensure that the project road is designed, constructed, maintained and operated safely and
satisfactorily so as to minimise any adverse impact on the environment and maximise benefit
to road users.
To transfer the appropriate level of risk tothe private sector
To promote innovation, not only in technical and operational matters, but also in financing and
commercial arrangement
To foster the development of private sector road operating industry in the UK; and
To minimise the financial contribution required from the public sector.

The mechanism used for implementing PFI is concession contracting and variant, such as designbuild-finance-operate (DBFO), on project basis. Under the umbrella of the concession contract the risk
associated with provision and productions are transferred to private sector. Hence, parallel to the
concession agreement there is the design and construction contract, on one hand, and the operation
and maintenance contract on the other. On M25 DBFO project the concessionaire is Connect Plus (a
consortium of Skanska, Belfour Beatty, Atkins and Egis), which have DBFO agreement with Sectary of
State. Then, Connect plus has design and construction agreement with Skanska Belbour Beatty
(Construction Joint Venture) and operation and maintenance contract with Belfour beatty and Atkins
(Operation and Maintenance Joint venture). These sub contract serve the purpose of allocating risks

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to the parties best able to manage them. In addition, the roles of the contractor, the operator and the
concessionaire are separated to prevent role prevent.
A PFI project generally passes through five phases: planning, implementation, construction, operation
and transfer. In the planning phase, the government department classifies its objectives; identifies the
need for a project; identifies assets to be provided; investigates the market; produces on outline plan;
advisors and assembles the project team. Careful project planning by the government client is crucial
to the achievement of the public sector objectives. Only projects of the scale and complexity where
private-sectors participation could be beneficial should proceed along this route.
In the implementation phase, the client develops the output specification taking into accounts the
service requirements. A significant part of the implementation phase is the bidding process. Bidding
for PFI projects follows negotiated procedures under the European Union procurement rules. The
choice of the successful bidder is based on the most economically advantageous proposal, the tender
that provide most value for money to the client.
Following the award of the contract, detailed engineering design and contruction work begins under a
fixed price design and build contract. All the risk associated with construction are transferred to the
design and build contract. A bidding consortium invariably includes an operator who takes on the
responsibility of delivering the services specified by the client and carrying out routine maintenance
with minimum disruptions to operations. On M25 DBFO contract, there are provisions within the
contract to ensure effective service delivery with minimum disruptions to traffic flow during routine
maintenance operation, in addition to maintaining safety standards. At the end of the specified
concession period, the assets revert to the public sector.
The mechanism by which the DBFO Co is reimbursed for service delivery is the shadow toll. That is,
payment is made by the client (as opposed to direct road users). It involves payment per vehicle
kilometre of the project road in accordance with a adjustment made for the lane closure and safety
performance.
Public & Private Partnership (PPP)
This type of financing is aimed at the sector level rather than the project level. PPP is a joint
arrangement between public sector client agent such as the Highway Agency (in case of road project),
and a consortium of long term investors. The investors setup an investment fund to make equity
investment in specified types of projects within a particular sector (for example, road investment fund).
The investor and the client agent would be jointly involved in the early stages of project identification,
planning and feasibility study. This is particularly beneficial in the case of road projects where
technical innovation is restricted due to the limited involvement of private consortia in the outline
design stage of the project. PPP provides an opportunity to assess which projects can and cannot be
financed and provides a setting for a more realistic view of the risk apportionment between private
and public sectors at an early stage of a project life. This allows PPP to facilitate a sound assessment
of individual projects based on their business and economic merits. It provides opportunity of weeding
out projects that are not fundable through PFI at an early stage.
PPP brings together public and private sector parties that have a mutual long-term interest in the
project helps separate long and short term objectives. Moreover, PPP provides the opportunity of
increasing equity funds in these projects, hence reducing the high debt-equity ratio.
However, public perception is often that PPP is actually privatisation by the back door.
The various advantages and disadvantages of the PPP/PFI project are:
Advantages:

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Reduce costs to taxpayer and release public funds

Private sector carries financial risk. This includes risk of completing project to programme and
cost as the implications of late delivery would cause huge financial penalty.
Private sector tends to be: be more efficient; have good organisation and management
abilities; and have an aggressive cost reduction culture. This gives chances for adopting
innovations and developing project by considering whole life cost therefore quality
maintained.
More stability of financing to project as private sector not influence by politics
Payment of capital cost is spread over an extended time period rather paid upfront
Government policies encourage private funding

Disadvantages:

Complex contract documentation. Lenders need to spend a lot of time evaluating risk.
Bidding for PFI can be lengthy and expansive process.
Money has to be repaid with interest.
Non-recourse to sponsor- if the scheme fails- investor will loose
Public perception is often negative in terms of control, ownership and accountability of assets
Government have less control
Only large firms can compete

In conclusion, infrastructure development can be funded from a variety of sources. Three sources
have been discussed in this essay. PFI and PPP have potential benefits to the taxpayer, but these are
highly variable from project to project and from sector to sector. The main advantage of private
finance is that the financial risks are transferred to the private sector.
The current emphasis of Government policy on PFI and PPP is likely to continue for foreseeable
future.