Photo provided by Fulbright & Jaworski
Many roads, bridges and railroads – in fact entire infrastructure systems – are in a state of disrepair. The economy is in a tailspin. Infrastructure law practices are cropping up all over, but the practice is complex, and the investments require creativity and know how. Working with the government will be key in assuring the success of these ventures. Through a combination of public and private investment and shared responsibility, America will be revamping its infrastructure systems and participating in projects abroad.
In a Lawdragon interview, Joel Moser, co-chair of Fulbright & Jaworski's global infrastructure group, discussed infrastructure investment and financial strategies, government-private shared projects and responsibilities, opportunities in the emerging markets and what we can expect under the Obama administration.
Lawdragon: Just briefly, what would you say the infrastructure practice entails?
Joel Moser: The practice of infrastructure law is both inter-disciplinary and multi-disciplinary. It is multi-disciplinary in that infrastructure is an industry in its largest sense so lawyers from all practices may be participants in the infrastructure industry. More narrowly, infrastructure practice is inter-disciplinary, drawing on many skills and practices, including project finance, public finance, government contracts and aspects of specialized practices, such as environmental law, transportation and energy.
We look at infrastructure as an asset class, including its traditional components which are energy, water and transportation in all of its components which are land, sea and air. That includes all forms of aircraft and airports, mass transit, highway and road transportation, ports and terminals and shipping.
LD: So would you say that it's all about structuring the deals, finding the financing for the projects and making them happen?
JM: Yes. The role that we play very much depends on which party in a transaction we represent. For example, we could represent the lenders who are providing leverage capital for these transactions, either in terms of acquiring existing assets or in the construction of new assets. We do quite a bit of that around the world. We can represent the developers developing these assets. We often represent the investors. We also may represent the government-there is frequently, but not always, a government component. For example, a port can be entirely privately owned and operated or it can be a government-owned asset with long-term concessions or leases to the private sector.
LD: What's hot in the area now?
JM: There's a significant and fast growing component of the industry called infrastructure funds which are private pools of capital that are seeking investments in infrastructure assets. They will invest either in a greenfield asset, which is the construction or development of a new asset, or they may look to purchase an existing asset, which we would call a brownfield asset.
LD: How do infrastructure investments differ from other alternative investments such as hedge funds or private equity investments?
JM: Let's just look at that from a business and then from a legal perspective. From the business perspective, one might easily imagine an infrastructure fund looking much like a private equity fund, and, in the most outward respects, it does have many similarities. There is a leveraged investment in a business, which may actually be an operating business. But the difference is in the asset class. A private equity investment is more about finding an asset that is perhaps undervalued and seeing its value grow significantly and then eventually finding an opportunity to realize that growth in value. An infrastructure investment is more typically a long-term investment, and infrastructure investment from the investor's perspective is more like a moderately higher yielding bond investment.
These are assets of known value and reliable steady long-term return. Sometimes they are very long-term assets - 75- or 99-year assets - and these are very attractive investments for investors such as pension funds or insurance companies. So lawyering these kinds of investments really is somewhat different than lawyering a private equity investment. What's most significant is analyzing infrastructure assets on a life-cycle basis, realizing that your client - the investor - is looking to own this asset for a very long period of time. So it's an entirely different due-diligence exercise. What is often the key to these investments are the contracts - the government concession agreements.
LD: It would seem that, going forward, there will have to be a government component in most of these projects in light of the financial crisis. What can we expect?
JM: Government involvement is a big characteristic of the infrastructure asset class. It is one of the distinguishing features, and we see expertise and experience with governments, whether in public finance or government contracting, as a big part of understanding infrastructure assets and how they are different from typical corporate assets. State and local governments will be the counterparty to many of the necessary agreements. The federal government will potentially be a funding source and certainly a regulatory body for many of these transactions. And then we see government as an investor because the public pension funds are starting to invest in these assets.
LD: What types of deals are being structured and what will such projects mean in terms of reducing energy costs and foreign dependence on oil?
JM: A big component of infrastructure investment in the U.S. is investing in energy infrastructure assets. The energy assets that infrastructure investors will be looking at are what we might call mid-stream and down-stream - that is energy transportation and transmission such as grids and pipelines - and then retail distribution of power. These are important assets that need to be rebuilt and expanded in this country. Also renewables, depending on how they are financed and structured, are potential candidates for infrastructure investment. So as the infrastructure investment community grows - and there are hundreds of billions of dollars of inflows into these investments by the major institutional investors - we are likely to see significant private investment side by side with the public sector investments that we are expecting from Washington in these core asset classes. The more we build out energy transmission, alternative energy and other forms of mid-stream and down-stream capacity, the more we are going to reduce the nation's reliance on imported energy sources.
LD: Is it the interplay between government and private investment that presents so many unique challenges when investing, structuring and operating infrastructure projects?
JM: That's exactly right. Many infrastructure investments are public-private partnerships. Some are simply straight private investments in private assets and those are sometimes called P2P as opposed to public-private partnerships, which are often called PPPs or P3s. But a very large number are done as P3s. In fact, that is the international standard and we as a firm do this work around the globe. We recently represented the lending group on the PPP (public-private partnership) transaction for the Sao Paulo metro, which was the first PPP under the new Brazil statute. The PPP model is the international gold standard of how private investment in an infrastructure asset is done. And at the core of a PPP is an agreement with government - a concession agreement - between the public sector and the private sector. It is not a privatization. It is not as though the asset is sold or taken over by the private sector. But it is not full government control either.
LD: What are the risks and what strategies and solutions exist to mitigate the risks and enhance returns?
JM: Risk allocation is about looking at what can go wrong over the development of a greenfield project and then the operation and life cycle of a long-term project. So risks of completion, cost and operating overruns, unforeseen circumstances in development, underutilization of an asset, and long-term maintenance are just a handful of the kinds of risks that exist in the life cycle of a project. In a public-private partnership, an appropriate risk allocation allocates some of those risks to the private sector and some to the public sector, usually based on who is better able to control those risks.
LD: How are these risks mitigated and the returns enhanced? Obviously insurance will be important.
JM: One of the critical goals of a public-private partnership is to mitigate risks by allocating them appropriately. So the risks of cost overruns or design errors are probably best borne by the private sector if you let the private sector control that entire process. One of the benefits of the PPP versus public ownership is that the government is not then subjected to the -change order to death-experience we've seen in the past. Utilization risk is a different question. In some cases, the private sector may be interested in taking utilization risk and may feel it can operate a facility in a fashion to maximize utilization and therefore bring more capital to the project.
But in other cases, the government may want an asset available under certain circumstances that may not necessarily maximize its utilization, in which case the government will make what is called an availability payment to the private sector for keeping the asset open and available for use and will keep the risk of utilization. You look at an entire investment or transaction and work through what the risk parameters are and figure out from a business perspective - or in the case of the government, a policy perspective - which of those risks are best borne by each party to that transaction.
LD: What do you expect to be the up and coming infrastructure focus and initiatives under the Obama administration?
JM: Senator Obama was a co-sponsor of the infrastructure bank proposal, which sought to provide $60 billion of funds back when that seemed like a lot of money. Then the Democratic platform included as a component of its infrastructure investment plans the concept of leveraging private investment - a concept that was also originally in the infrastructure bank proposal. So moving into this last cycle, one presumes that the new administration's focus on infrastructure would be a modern focus of looking to leverage private capital to maximize the potential for infrastructure investment in this country. In early December, President-elect Obama announced a massive public works program to get the economy going, including significant investments in infrastructure such as energy, roads and bridges - all the classic infrastructure asset classes. But the details are yet to unfold. One presumes that even if there is some initial outlay to what have been called "shovel ready" projects, we imagine that ultimately, whether in the short term or the long term, there will be a continuing trend toward leveraging private investment in these assets.
LD: What developments and regulations should we expect over the next few years?
JM: In announcing the public works program, President-elect Obama talked about "use it or lose it" - imposing requirements on state and local governments to actually put this money to work quickly. So one would imagine that that will be a focus of the regulatory scheme. In the past, public works projects - even when funding was hypothetically available - have languished through very long public procurement processes. Another benefit of the public-private partnership model - by including the private sector in a larger scope and a more concentrated array of the project development tasks such as designing, building, financing and operating infrastructure assets - it is likely that these things can happen quicker. If the focus is going to be on getting projects started and done on an expedited basis, the likelihood is that that is going to involve earlier and greater private sector involvement, probably on a concession or public-private partnership basis.
LD: Won't expediting the pace of projects raise a concern of inadequate due diligence?
JM: An interesting thing about private investment is that since private capital is on the line, people with money at risk have a stake in the outcome. So sometimes involving the private sector leads to greater due diligence.
LD: How can we expect the credit crunch to impact the ability to finance these projects?
JM: The general unavailability of credit is just as challenging for the infrastructure asset classes as it is for others. If banks and other financial institutions are not lending capital it is very hard to get projects done. What we have seen in the last few months, in this very aberrant period, is some infrastructure projects are moving forward with financing on an all-equity basis because the funds are flush with equity and they are prepared to take some financing risk down the road. But certainly the banks and the credit markets need to get back engaged in order for the dollars to flow effectively.
LD: How about the emerging markets - what are the risks vs. rewards?
JM: Generally the global infrastructure investors like to invest in OECD members and investment-grade nations. But there are also significant opportunities in the emerging markets beyond those classes. When you move into an emerging market project, there are a number of additional risks that need to be focused on, such as currency risk. But there are a number of ways to mitigate currency risk such as changes in availability payments to account for shifts in the currency. Then there are basic country risks. One of the ways a lot of the folks address country risks is to work with the multilateral lenders who are part of a larger network of relationships with the countries involved and that has a tendency to quiet some of these concerns.
The good news is that in the emerging markets you can find two things that you can't find in the mature markets. First, you find a huge pipeline of infrastructure projects to be done which are sometimes harder to find in the more established markets. The second thing is that you certainly get better returns because with that additional risk comes additional rewards. So there are certainly opportunities for investors in those markets and there are lots and lots of infrastructure projects going on around the world.
LD: Why has the U.S. infrastructure market been so slow to develop?
JM: I really don't think that it is slow. I think it is slower than a lot of the international investors expected who thought that the U.S. was going to be the next gold rush opportunity, just quickly doing lots of big deals. But I think that state-by-state, city-by-city, and with some encouragement from Washington, this market is going to grow and flourish.