Europe’s politicians dream of an infrastructure boom to kick-start growth. But governments can’t fund it, and Europe’s private investors are reluctant to step up to the plate. Pension funds are one source of cash: Infrastructure investments make up less than 3% of assets for a typical European fund, versus about 10% in Canada and Australia. But making up that gap won’t be easy.
There are three problems with encouraging institutional investment. The first is structural. Europe has many small pension funds in different countries that lack the scale of their Australian and Canadian counterparts, where enrollment in funded plans is often compulsory. Large funds like the Ontario Teachers’ Pension Plan have teams that invest directly in infrastructure. Thus, unlike their European peers, they can bypass infrastructure funds, where management fees of up to 2% and performance fees of as much as 20% eat into returns, making them look less attractive.
The second is regulation. Coming changes to solvency rules for Europe’s insurers look set to deter them from infrastructure investment by applying high capital charges for holding long-dated bonds and those with low credit ratings. The European Commission is discussing ways these rules can be adapted to apply to corporate pension plans, too. That could prompt such plans to invest more assets in sovereign bonds and less in “riskier” investments like private equity and infrastructure.
The third is financial. As banks shrink their balance sheets, project funding has become harder and more expensive to secure. Pension funds like the inflation protection that many infrastructure projects provide, but many are reluctant to invest in new, “greenfield” projects, fearful of taking losses if they overrun. Project bonds often have subinvestment-grade credit ratings, which they consider too risky. Monoline insurers that used to guarantee credit risk haven’t been active.
Plans are afoot to make infrastructure investment more attractive. The European Investment Bank is setting up its own credit insurance for project bonds. It plans to commit funds from the European Union budget to take first losses on projects and boost credit ratings as high as single A.The U.K. wants pension funds to pool capital nationally and invest in projects directly. But the EIB’s budget for a pilot credit insurance plan is a measly €213 million ($269.1 million), and has yet to be approved by the European Parliament and Council. The U.K.’s target for pooled pension-fund capital is just £2 billion ($3.1 billion), a drop in the ocean compared to the £250 billion the government forecasts will be needed in the U.K. by 2015. Finding homegrown funding still looks tricky.