Utility Week

UTILITY Week 30th October 2015

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Page 20 of 31

UTILITY WEEK | 30TH OCTOBER - 5TH NOVEMBER 2015 | 21 Finance & Investment Market view U K utility regulation is undergoing a step change away from the incre- mental capital expenditure efficiency drive that has characterised the industry since privatisation. In its place, we see the start of a period of wider cost efficiency cost management (seen through RIIO and the totex/menu approach to regulation in the water sector) and potentially quite dramatic structural shis. Policymakers and regulators (together with the EU) are re-imagining the sector. They are splitting out and unbundling dif- ferent aspects of utility businesses as they look to drive further investment and effi- ciency while also lowering costs. They are seeking to do this by optimising risk-reward mechanisms, capital structures and, where appropriate, facilitating the recycling of development capital. The new regimes that have come to mar- ket so far include that for offshore transmis- sion ownership (Oo) and, more recently, the first use of the independent infrastruc- ture provider framework – for the Thames Tideway Tunnel project. Although both have their detractors, they have succeeded in achieving additional investment at an attrac- tive cost for the public when compared with the historic alternative. For wider policy initiatives and regulatory innovation across the sector to be seen to succeed, a similar outcome will be required. A critical factor will be the ability of policymakers and regulators to continue to adapt to maintain investor confidence in a competitive marketplace as the market develops around them. Without investor confidence, the general public will not enjoy the cost-benefit of appropriately priced investment risk. While the chances of mass protests against water policies in the UK seem remote, nobody can ignore the reality that utilities are politically important, and – just as the big banks were shown to be – ultimately "too big to fail". While private capital can be structurally exposed to infrastructure risk, complete private failure will simply require the public sector to step in. It is also perverse for any regulatory regime to create an unrealistic risk allocation that either creates unnecessary cost, where for example the cost is better borne across the industry or the consumer, or in extremis where this is compounded by the private sector being expected to deliver something it never can. Nevertheless, properly structured utility regimes can leverage investor capital into infrastructure and pass economic risk and reward to the private sector in a way that lowers costs to the general public. There is no perfect formula for how this is achieved and, from the investors' perspec- tive, will sit on a scale (or series of scales) of risk. The infrastructure investment case is infinitely variable and represents a calcula- tion balancing various factors. Key elements include: • the robustness of revenues and the challenges on cost; • the supportiveness of the regulatory regime and the policy and political context; • the macroeconomic environment and the availability of alternative investments that represent a better return. What does the above mean to an inves- tor (and ultimately the policymaker and regulator) from an investor confidence and investment pricing perspective? Infrastruc- ture investment is long term: it needs policy and regulatory action that reflects this. His- torically, UK regulators have oen been iden- tified as an exemplar balancing the pillars of the regulatory support that has underpinned investor confidence. These pillars are: • the political necessity and statutory duties for the public sector to ensure the ongoing provision of the service; • an appreciation of the impact of past record in facilitating the ongoing require- ment to attract funds into the sector; • providing for innovation. The successful Oo and Thames Tideway processes have built on this while incorpo- rating innovation from other sectors and models. Conversely, the recent changes to the vari- ous renewables support arrangements in the UK, including a somewhat stop-start process on the implementation of contracts for differ- ence, has dampened confidence in that sec- tor. The Spanish solar market is perhaps the most o-cited recent example of where this can go even more wrong. However, as well as the detail of the regulatory regimes themselves, recent his- tory, including the period in which the Oos and Thames Tideway have been launched, has seen a period of deepening allocations to infrastructure and utility investment by investors. This deepening pool has been driven by a combination of factors. The first is a growing appreciation of infrastructure investment's ability to match long-term inflation-linked liabilities to long-term inflation-linked investment streams by institutions growing increasingly comfortable with the asset class. The second factor is a search for yield seemingly not available to investors with an equivalent risk profile elsewhere. Lastly, the asset class is a perceived rela- tive safe harbour for sovereign wealth from the dilutative effects of quantitative easing. Regardless of the reason, that context of strong liquidity and the competitive pressure it creates has no doubt helped support the investor appetite to accept innovation, but neither the UK nor the infrastructure sector is isolated as a potential home for investor money. Neither is the attractiveness of the asset class in the past a guarantee going for- ward – you only have to look at the availabil- ity of long-term bank debt for infrastructure over the past eight years to appreciate that. The strong demand for opportunity that sup- ported a particular risk appetite simply may not be there going forward. Policymakers and regulators need to be more watchful than ever of the importance of the constantly evolving dynamic between the issues above and the myriad others that are involved in the investment case if they are to maintain investor confidence. Charles Ford, counsel and member of the infrastructure, energy, resources and projects team, Hogan Lovells Investor confidence is key Policymakers and regulators must continue to adapt to maintain investor confidence, a challenge which is becoming increasingly complex, says Charles Ford.

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