Life after PFI with Eversheds Sutherland

inspiratia had an in-depth catch-up with Eversheds Sutherland's infrastructure team about what's hot in the UK infra market. In the first of the two-part series, Mark Dennison, partner, and head of infrastructure at the law firm explains how the PFI programme is 'still very much with us', the evolving relationships of the government with the private sector, and all things digital infrastructure outlook

Since the official end of the UK Private Finance Initiative (PFI), the market has had to adapt to a whole new reality. With the government taking a back seat in the market, structured partnerships between the public and private sector have presented numerous challenges for new projects. Almost three years after the news that shook the industry, what is the industry busy with? With a plethora of projects nearing the end of their PFI period, what opportunities arise for refreshing existing assets and renegotiating relationships with procuring authorities?

At the same time, over the past few years, digital has become a staple of the infrastructure picture in the country.  There is every potential for this market to expand further and for digital techniques to find a home across the whole spectrum of infrastructure sectors.

To find out more, we sat down with Eversheds Sutherland's Mark Dennison, a legal specialist in infrastructure, to examine these topics and more. Eversheds Sutherland is an international legal practice with a breadth of experience in government, finance, and infrastructure. 

How has the UK infrastructure market changed since the end of PFI?

The first reflection I would make is that UK PFI is still very much with us. We continue to see a stream of projects refinancing, portfolio consolidations and operational difficulties arise in existing projects. And so, to a degree, the market still has PFI at the forefront of its mind, although there are a number of very significant changes that need to be highlighted since PFI technically came to an end in 2012.

One is the emergence of renewable energy projects, which brought about a major focus on revenue streams other than from local authorities.  Alongside the financing of energy transition assets including battery storage for the very first time, some renewable energy projects are requiring extensive structuring advice of the type never seen in PFI.  In offshore wind, sponsors are questioning whether more than one generating asset can be supported by a common transmission asset.  That presents a whole set of new challenges and gives something of a flashback to the early days of offshore wind.  So, there are a whole range of new opportunities and challenges that are coming through in renewable energy.

Another is the explosion of fibre, data centres and other forms of digital infrastructure, and we have seen market participants, who were previously locked into a particular mindset about how you do the financing of infrastructure, broadening their horizons and thinking differently and questioning whether they need to tick every project finance tick-box.  Bank teams focusing on transport and telecoms historically did more transport than telecoms, but now they do more telecoms than transport.  Many infrastructure market players are bolting in digital, focusing on social objectives, and trying to anticipate the needs of an infrastructure market which, even in 5 years' time, will be very different from the one now.

What is the new relationship between public infrastructure and private finance?

During PFI, there was a set model which changed slightly over time, but now there are several slightly different models.  As an example, we are finding that utilities are developing their own project structures and navigating a route through their own unique environment in a way which was not necessary during PFI when SoPC (Standardisation of PF2 Contracts) ruled and concerns as to its effectiveness were not mainstream. So now we are seeing a lot more time spent developing optimum structures rather than accepting the same structure repeatedly.

But there are also areas of UK infrastructure where there is neither a clear model nor a pipeline of new projects coming through.  In schools, hospitals, prisons, and other types of social infrastructure, there are ideas for how it is going to be taken forward, and some changes are taking place, but we do not have a clear pipeline. Therefore, the market does not really have as close a relationship with government as it did during PFI.

The consequence is that the participants that we had in PFI are already looking further afield and are putting their capital to work in parts of the world.  To give an example, we are seeing pension funds which during PFI, and slightly after it, exclusively focused on the UK, but in the 2020s they are looking at new opportunities across Eastern Europe.  We are being asked to give a view on the legal environment in jurisdictions where those funds have never invested before.  So, the relationship between public infrastructure and private finance in the UK is less clear than it was, and the consequence is capital is being deployed elsewhere.

What happens to assets that are coming to the end of their PFI contracts?

The challenges around the end of PFI are exaggerated, because in many cases there is a natural desire to refresh PFI assets and re-examine the roles of the public and private sector in the 700 plus PFI contracts which are still there.  In some contracts from the late 90s, where handback was not fully thought through, there are compliance challenges. Also, in some PFI-style contracts there are some incorrect assumptions about what the parties really wanted to do 25-30 years later, on expiry. However, we are not seeing quite as much controversy as certain corners of the industry led us to believe. Therefore, I see less of a challenge and more of an opportunity to digitise, to help the route to net-zero, to introduce ESG objectives, and to make assets more fit for purpose in the 2020s and beyond.

If old infrastructure can be refurbished and brought up to date, it may not be so expensive as to require long-term concession. This means that these assets could be financed on a shorter-term basis rather than the 25-30 years concession-tenor requirements of the past. One of the reasons PFI was so difficult was because you were locked into an overly long period of time for something which was always going to change, like streetlighting. For example, UK streetlighting PFIs were written just before LED lighting became a thing.

Where do government institutions fit into this new landscape?

The new UK Infrastructure Bank has an important role to play in facilitating innovative projects, but the question which will understandably only be answered over time is what it can finance and what it cannot.  We know that the UKIB is intended to bridge the gap between projects which are unbankable and those which the market can already support, and we know it is looking at CCUS (Carbon Capture Usage and Storage), biofuels, electric vehicles, but we are still feeling our way around what else might fall into that basket.  For example, do alternative networks, which in some cases have received local authority financial support, land in this category?  It is clear that the test is not simply whether banks and institutional lenders cannot support it, because they need to lend alongside it too.

In Wales, the Mutual Investor Model (MIM) – a funding model developed by the Welsh Government to build public infrastructure with private partners – has been used in the A465, the Velindre Cancer Centre, and the Schools Programme. Utilities such as Welsh Water are developing new projects using this model too, but we do not have a recognised replacement for government institutions in England to utilise.  So even though the UK Infrastructure Bank is capable of providing finance for innovative projects, there is still a question mark as to the extent of projects which will be put to the UKIB.

Although this means that folks can come up with structures themselves and approach the appropriate procuring authority, central government department or NHS trust, this route is very much the exception rather than the norm.  In other parts of the world that is a more common thing to do, where you come up with a plan and you go to the procuring authority and say, 'How's about it?'. In the UK that is not something which the market has historically done at scale.

Where is digital infrastructure going next?  

The growth of data centres in various parts of the world is well known, as is the transition to clean energy sources for data centres.  But we are now looking at the finance of new types of digital infrastructure – and what I mean by that are things like fixed wireless (to bypass copper or fibre from the street to the inside of the building), internet of things, alternative networks (alt-nets) in local communities.  The stable source of revenues to make these financeable is not always clear, and in some cases may never be, but it does happen. 

The growth of alt-nets, small-scale local networks is also a live opportunity, and we are seeing potential for these to be acquired by recognised digital infrastructure and broadband players.

What does it mean to synergise digital infrastructure with core infrastructure?

If we were in a PFI2 era and a whole raft of new concession agreements were being launched, digital infrastructure would be bolted into all of them. Whether it be a school, a hospital, a prison or a road, there would be a digital infrastructure component in all of those, and a very material one. It would probably give rise to additional revenues to make it an even more attractive proposition for all, but we do not have a whole raft of concession agreements coming through to do that. So, we are seeing digital infrastructure as a component in ad hoc projects and schemes and the fact that it is consistent is important.  We are seeing some holistic developments, where you have a data centre connected to a source of renewable energy, with offtake directly into district heating, but these are the exception more than the norm.  We are not yet at the point of coordinating all these activities within a single new scheme which requires digital infrastructure.

In other parts of the world, particularly in the Middle East, we are seeing the emergency of new cities with digital infrastructure, or a digitised core infrastructure. You might say that is an unhelpful comparison for the UK because the financial environment in the Middle East is different, but the fact that it can be done makes me excited about the future of digital infrastructure in Europe and other parts of the world.

As PFI contracts naturally come to the end of their life, for those which can be retendered, there will undoubtedly be a digital infrastructure component, but as to how successful that will be depends on the procuring authority.

Will digital infrastructure remain a distinct sector or will we see it diversify and baked into more core projects?

There is no real upper limit as to how much data you can put through fibre.  You are only limited by the technology on each end. So, once you've have installed the fibre in the ground, the question is 'What next?'. How do you have a financeable proposition?  We see a transition of financeable hardware-based digital infrastructure to financeable software-based digital infrastructure. This could include things like, the financing of apps which make a difference to those who live and work in the local area, the integration with open-source smart cities and the finance to allow platforms to integrate between different types of premises, different types of organization and the individuals who use them, and whether that is a monetizable infrastructure asset.

This is some way outside the hardware and fixed infrastructure that we are all familiar with, but I do think that there will come a point where the hardware and fixed bit of the digital infrastructure spectrum is done, and financeable propositions will be in the software layer.