Financing change: How to mobilize private sector financing for sustainable infrastructure (McKinsey&Company)

 McKinsey's Center for Business and Environment published this report in January 2016. The report covers the topics of: Demand for infrastructure, the supply of infrastructure finance, defining the sustainable-infrastructure gap, the private sector's role in closing the gap, challenges to increasing financing to sustainable infrastructure, and cracking the code: creating the conditions for more investment in sustainable infrastructure. Although Rosabeth Moss Kanter's book, Move (please see a previous post), concentrated on transportation infrastructure in the U.S. and the McKinsey report addressed the industry segments of telecom, energy, water and waste, and transport, I thought that comparing the recommendations for financing infrastructure would prove to be a useful exercise. This blog attempts to do that.


The McKinsey report encompasses worldwide needs for infrastructure development and financing in the sectors mentioned above. With the United Nation's Financing for Development Agenda and its Sustainable Development Goals as the baseline, McKinsey examined the plans of each participant of these agreements to ascertain how they would "move its economy onto a lower-carbon growth pathway" (p. 2), specifically in the area of infrastructure development.  The report considers two scenarios, low-carbon and high carbon infrastructure options. Understanding the preference for a more sustainable and energy efficient option, according to the authors, development banks have increased financing to allow for the greater associated cost.


To offer the reader a sense of the scale of future financing required for infrastructure between 2015 and 2030, the authors estimated the world's infrastructure value at $50 trillion. McKinsey derived that amount from the reports of New Climate Economy's working paper, Better Growth, Better Climate. Based on the New Climate Economy's report, McKinsey estimates current world spending at between $2.5 and $3 trillion per year and a projected need of $6 trillion per year until the year 2030.  The authors placed a six percent (6%) premium on the low-carbon scenario. Previously, McKinsey calculated independently a need of $57 trillion in projected infrastructure costs to 2030, a $32 trillion difference from the New Climate Economy projection. The latter, the authors explained, used a broader definition of infrastructure, especially in the energy and the water and waste water sectors.


The definition of sustainable infrastructure in this article incorporated its social, economic, and environmental dimensions. The social dimension of sustainable infrastructure respects human rights of all population strata. The economic dimension "provides jobs and helps boost GDP. It does not burden governments with unpayable debt or users with painfully high charges. It also seeks to build the capabilities of local suppliers and developers" (p. 8). As implied earlier, environmental sustainable infrastructure results in low carbon emissions throughout the asset's lifecycle.


In Part 4, The private sector's role in closing the gap, the authors propose solutions. Because infrastructure encompasses the needs of the undeveloped, the developing, and the developed nations, the article acknowledged the need for the private sector to close the funding gap. This contribution could eliminate one-third of the projected funding gap and pose an attractive return for investors. In addition to institutional investors, the authors looked to corporations to close some of the remaining gap. Corporations in energy, telecommunications, and utilities could incorporate increased spending in sustainable infrastructure into their long-term plans. Through stock, debt, and  the creation of yieldcos and master limited partnerships, companies have found ways to fund infrastructure.


Kanter discusses the methods for financing infrastructure that the U. S. has employed. The dominant method at the regional, county, and city level--municipal bonds--she claimed has provided the country a solid mechanism to pay for road, bridges, tunnels, etc..  However, the gap between what the U. S. spends for infrastructure--2.4 percent of GDP--and what it needs, $1.98 trillion by 2020 according to the American Society of Engineers, forces the nation to look for other options. Additional avenues to pay for infrastructure include privatizing existing and new public assets. Kanter does not recommend privatization, based on the experiences in Chicago, Indiana, and other locations. In the case of transportation privatization, the public, through tolls and parking meter increases, paid for the relinquished assets. To summarize, Kanter states: "There's a long list of pitfalls of privatization, including an opaque public decision-making process, flawed forecasts . . . and, in many cases that have not been discussed here, poor oversight and management" (p. 247).


Kanter does advocate for, what she calls capital partnerships, an alliance of public and private ownership, operation, and maintenance, commonly known as PPPs, P3s, or public-private partnerships. Although contract terms differ, depending on the type of project, the public entity retains ownership of the asset. She cited numerous successful projects that have used this model of financing. Finally, Kanter explained the benefits of infrastructure banks, "a dedicated pool of funds led by experts who pick projects on their merits and fit with national priorities" (p. 251). China has a bank, the China Development Bank, and Europe has the European Investment Bank. Kanter argued that the presence of $180 billion in private equity and pension fund capital could flow into a U. S. infrastructure bank, adequately generating initial funding. At the state level, 33 have legislated for them, but only 22 have created a bank, and only two states have active organizations. The McKinsey authors also discussed development banks and noted the high and unrecoverable transaction costs generated from the involvement "of lawyers, engineers, transaction specialists, and other advisers can account for 1 to 5 percent of project costs" (p. 33).


Because the McKinsey article take a worldwide view of infrastructure spending, it delves into the risks and challenges that governments and investors should consider to realize political, financial, and public goals. Kanter concentrated on the political will required in the United States to commit to the development and maintenance of the nation's infrastructure. 

http://www.mckinsey.com/industries/infrastructure/our-insights/Next-generation-of-infrastructure?cid=other-eml-alt-mip-mck-oth-1603