Financing the future
Building Canadian infrastructure
by John Chenery
Like nature, money abhors a vacuum. That big hole in Canadian
infrastructure finance left by 10 years of cutbacks in government spending
and borrowing cannot stay empty for long.
Canada's investment bankers, pension fund managers and other institutional
investors are ready to walk down the aisle as soon as governments pluck up
the courage to pop the big question. In the absence of sweeping reform
programs like Britain's Private Finance Initiative or Australia's National
Competition Policy, however, the progress of this courtship has been
"Public-private partnership (P3) in this country is limited only by
courage and imagination," says Liam Rafferty, head of the project
finance group with Société Générale Canada. "The investment
community thought this market was going to explode in the mid-'90s. We are
Which is not to say that those involved in project finance are waiting
idly. Several banks and fund managers are positioning themselves in
readiness for the long-delayed P3 boom and the moves being made now could
be a preview of how public projects and services will be financed as
private sector involvement gains wider acceptance.
One of the more dynamic initiatives is Borealis Funds Management, created
by OMERS (the Ontario Municipal Employees Retirement System, Canada's
fourth largest pension fund) as its infrastructure investment platform.
"To get started we had to go it alone," says Dale Richmond,
OMERS' president and chief executive officer, "but the intention was
always to develop a company that would invest in infrastructure with other
partners and with an ownership structure that wouldn't just be OMERS."
Borealis is jointly owned by OMERS (26 percent), the Canada Pension Plan
(26 percent) and several other private sector companies.
"Our relationship with Borealis is that for any given project they
undertake, OMERS can take all, some or none," says Richmond. "We
also have a contract with Borealis to manage all our P3 projects."
Under a strategic alliance announced earlier this year, OMERS bought a
27 percent equity share of the Canadian investment bank, Dorset Partners,
and is combining its interest in Borealis with Dorset to form a new
merchant bank that will guarantee OMERS a platform for current and future
Richmond says that OMERS' total investment in P3 projects at the moment
is "somewhere between $500 million and $1 billion. That's not very
big compared with our total assets of more than $35 billion, but it is
very big for the projects that we've invested in."
Often hailed as a visionary and a pioneer in financing P3 infrastructure
projects, Richmond prefers to view OMERS involvement in terms of practical
necessity and public responsibility. "As a pension fund, we feel that
there is a real need for infrastructure development in Canada to keep this
country's businesses competitive. Voters and taxpayers have told the three
levels of government to stop borrowing and going into deficit to finance
these investments. As a result, normal spending patterns have been
disrupted and infrastructure - water and sewer systems, roads, transit,
airports - all the things that good economies need to be productive - have
Pension funds had always helped to finance these projects anyway, Richmond
reasons, by being among the biggest buyers of government bonds. "We
should be smart enough to adapt our systems to a new reality where
governments don't want to borrow so much but the need for infrastructure
is still obvious."
The first OMERS venture into this new reality was in Nova Scotia where the
government was looking for a turnkey operator to build and manage 15 new
schools. "We stepped forward and came up with a way to finance and
build those schools for less than the school boards could do and still get
a return over time that justified the investment," Richmond says.
The Canadian Union of Public Employees (CUPE) attacked the deal, calling
it "a chilling twist on the P3 story [in which] the deferred wages of
public sector workers are playing a role in privatizing Nova Scotia
schools." Richmond rejects this, pointing out that OMERS focuses on
finding situations where long-term funding is needed to finance new
infrastructure or expansion into new activities. "We're there to grow
these enterprises. The union that's there when we go into the partnership
remains there and its membership expands."
He cites the OMERS/Borealis decision to buy into the Toronto District
Heating Company as a 50 percent partner with the City of Toronto, creating
a new P3 called Enwave. At the moment, the company provides steam heat to
many buildings in Toronto's downtown core. OMERS investment allows Enwave
to move ahead with an ambitious program to increase market share as well
as move into new environmentally friendly technologies like co-generation
and deep lake water-cooling for air conditioning in the summer.
Richmond also sees an important investment opportunity in the deregulation
of the electricity industry in Ontario, where many municipalities are
reluctant to sell their electricity authorities to big private (and mostly
US) utility companies. Borealis has bought an interest in Hydro
Mississauga and is talking with several other hydros about a possible
amalgamation and funding for their ongoing expansion.
Other recent Borealis investments include providing all the funding to
build and equip eight new long-term care facilities (a combined total of
1,100 beds) to be operated by Extendicare for the Ontario Ministry of
Health, and buying CN's half share of the Windsor-Detroit railway tunnel.
"We are now involved in all the infrastructure areas where investment
has been lacking - education, transportation and health care," says
Richmond. "We think that opportunities in this area will continue to
expand. Other pension plans and other types of investors will join in; the
projects will get bigger."
Other pension plans are indeed eyeing the P3 possibilities but, without
the huge financial resources of OMERS, Ontario Teachers and their ilk,
they see as many roadblocks as opportunities. Morgan Eastman, chief
investment officer with Ontario Public Service Employees Union (OPSEU)
Pension Trust, says that for the small- to medium-sized funds the problem
is a lack of expertise, including the ability to carry out risk analysis
on the different types of assets involved.
"Most pension funds, apart from the very large ones, generally don't
have the staff to analyze these infrastructure investments; they rely on
consultants," he says. "And who are you going to ask about these
direct investments? It's not a public market or a publicly traded
instrument. It's a very specialized product."
Eastman believes that the ideal solution is an infrastructure fund along
the lines of the real estate closed end funds - a package of
infrastructure projects selected and managed by experts. "Where you
have this level of complexity and specialized expertise required, it is
much easier for pension fund trustees to do due diligence on a management
group that has put a fund together than on the individual projects. There
is definitely a lot of interest in this kind of initiative. It is
economically targeted legitimate investment and if the returns are there
and it meets the pension plan's risk-return profile then I think we are
obliged to find a way to participate."
Fortunately, at least one banker in Toronto agrees with Morgan Eastman and
has decided to do something about it. "To develop these projects you
need a big team of people to analyze the deal, make the bid, negotiate the
documents and then close the deal," says Peter Salisbury, managing
director of Macquarie North America Ltd. "The issue for a pension
fund is whether it wants to hire a team of 12 to 15 people or put the
money in a fund and use their expertise."
Macquarie North America, the Canadian subsidiary of Australia's Macquarie
Bank Ltd., is currently establishing an infrastructure fund along the
lines of the vehicle described by Morgan Eastman. While reluctant to go
into a lot of detail until arrangements are finalized, Salisbury did allow
this much: "We're getting a group of investors together and pooling
the money. We'll manage the money, find the investments and manage them
once they are made."
What sort of investments? "We're thinking initially at least it will
probably focus on electricity, gas pipelines, maybe some telecom
assets." Macquarie already knows a thing or two about that sector,
having put together and underwritten the AltaLink consortium that recently
paid $850 million for TransAlta Utilities Corporation's electricity
transmission business in Alberta.
"A lot of energy assets that we want to buy are already owned by the
private sector," says Salisbury. "We are not setting up this
fund to concentrate on [P3s] although there are certainly P3 projects that
we'll be interested in. We are having a very close look at the Toronto
airport rail link, for example."
Salisbury says he is "reasonably confident" there is a lot of
money waiting to go into infrastructure investments. "The experience
in Australia supports that. It's an investment that will produce a
reasonable return, nothing spectacular, at relatively lower risk profile
than your typical stock market investment. You don't invest in
infrastructure to get rich quickly. You have to be a committed long-term
Rafferty shares the view that there will be no dearth of investor interest
in P3 infrastructure projects. He even thinks he knows where the hottest
action will be. "Across Canada, you've had years of municipalities
deferring major maintenance, never mind expansion of their
water/wastewater systems. That will be the key market for major P3
financing innovations in Canada in the short to medium term.
"If we actually had a public sector entity here that would say:
'We're not shying away - we are doing a DBFO [design, build, finance and
operate]; there will be a big breakup penalty if we lose our nerve; come
at us with your most aggressive bid,' there are 25 cities in Canada where
you could have a dynamic international competition on a water system and
no one would need to be persuaded that it was a 'flag' investment. You'd
be there because it would be a stable 10 to 11 percent annual return.
Safer than houses."
So why isn't it happening? Richmond says there are problems on two fronts.
"The private sector hasn't quite calibrated all the risks associated
with doing business with the government - the reputational risk, the delay
risk, the possible cancellation risk. And Canadian governments aren't
doing enough to promote the process. They have to change their processes
to lower pursuit costs so you can get involved without committing millions
of dollars that you might lose if your bid is unsuccessful. A lot of
things need to be adjusted. What needs to happen in the longer term is for
the financial markets to adjust sufficiently so that there's a standard
way of delivering infrastructure with equity and debt components that are
acceptable to governments, taxpayers and financial institutions. It's
moving from a structure that's been in place for a long time - government
borrowing - to a new regimen with a different financial model where all
John Chenery has worked as a journalist and editor for national newspapers
in Australia and the UK. Before moving to Toronto from Costa Rica, he was
Director of Communications with the Earth Council.