08 February 2019

By Oliver Bourchier and Norris Riley.

According to the Infrastructure and Projects Authority’s pipeline of projects, over £600billion is set to be invested in the construction of infrastructure over the next 10 years. Government has decided that around half of planned investment must come from the private sector. In this article, we summarise some of the key features of a number of potential funding structures.

PFI/PF2 - Project Finance

A form of project finance, PFI/PF2, has been the most significant source of private investment in public infrastructure over the last 15 years, funding over 700 projects. Under this structure a private sector special purpose vehicle (SPV) raises debt which, combined with equity contributions, funds the construction of the infrastructure assets. The SPV then operates and maintains the infrastructure and makes it available in return for a monthly payment from the public sector customer, which payment covers debt repayment, operating expenditure and profit. Perceived advantages to the public sector include increased cost certainty, delivery of operational efficiency, and keeping the investment ‘off-balance sheet’ and therefore not counting towards government debt figures. This also increases the flexibility of government department budgets by shifting the majority of the procurement cost to future years. However, private companies have higher costs of capital, require surplus cash and incur consultant/management costs, leading many to question whether this form of funding represents good value for the public sector. Critics have also questioned the value for money of the long term service contracts under which the assets are operated and maintained.

In 2011 as the higher costs of financing following the 2008 financial crisis hit, PF2 was introduced, attempting to redress the balance by excluding ‘soft-services’ and requiring the public sector to invest equity and take the risks it is better placed to bear (e.g. change in law and site contamination) along with limiting potential profit and tender timescales to increase efficiency.

Despite good intentions and revisions this form of funding will no longer be used by the public sector. Instead the Chancellor is 'committed to the use of public-private partnership where it delivers value for the taxpayer and genuinely transfers risk to the private sector'. What this looks like is not currently clear, but importantly the Chancellor hasn’t ruled out project finance more generally. There are a number of variants already used by the Welsh and Scottish governments which could be used to plug the PFI/PF2 gap.

Non-profit distributing model (‘NPD’) (Scotland)

This follows a similar structure as PFI, utilising a SPV and private funding. Key differences include a cap on private sector (investor) profit via a fixed rate of return, with the surplus reinvested in the public sector, and equity investors having no dividend entitlement. Companies 'bid' a rate of return, with junior lenders managing the SPV (e.g. one of the parties whose lending is at risk). The public sector also has greater insight and control via a ‘golden share’ in the SPV with increased voting rights, usually resulting in a ‘public interest director’ sitting on the board.

However, this form of investment suffered a setback in 2015 when the Aberdeen Western Peripheral Route project was determined to be ‘on-balance sheet’, having passed excess profits to the public sector. If this accounting categorisation can be mitigated, we may see more of this form of financing.

Mutual Investment Model (Wales)

The Welsh government has designed a ‘mutual investment model’ which is in its relative infancy. It is currently used for accommodation and road projects, although it is potentially applicable across the broader infrastructure sector. This is based on the NPD model, with a fee being paid to the private sector to cover the cost of construction, maintenance and finance, and the public sector taking a minority stake of up to 20% of issued share capital of the SPV. One key difference is that there are no veto rights or profit share for the public body in order to avoid being categorised as ‘on-balance sheet’. However, there is still the option to appoint a director/observer. The contractor also takes the risk of latent defects including a corresponding restriction on the release of funds and is subject to certain additional obligations, such as a local community benefit requirement.

Current projects being funded using this model in Wales total £1billion of new investment, including the dualling of the A465. Their success or failure will be a significant indicator for the future adoption of this model.

Tax Incremental Financing (‘TIF’) (Scotland)

A further form of financing used in Scotland, originating in the US, is TIF. This funds investment by utilising the tax revenues expected to arise from projects e.g. via the increase in land values and future developments. Revenues are generally capitalised through bonds and debt arrangements which are issued as near to completion as possible to reduce risk and the rate of interest. In Scotland this form is restricted to projects which will ‘unlock regeneration and sustainable economic growth’ and generate additional public sector revenues alongside repaying financing costs.

This can be a beneficial model for housing and transport infrastructure and is flexible in allowing the inclusion of development finance, although it does require significant consultation in the project area and public body investment.

Regulated Asset Base model (‘RAB’)

A RAB model gives investors long term returns based on the value of a regulated asset base (an accounting calculation of the asset value), with regular price reviews by the regulator ensuring a ‘fair’ level of profit. This has been used in the water, electricity transmission and transport industries (via Network Rail) and is being considered as a method of financing in the nuclear sector.

The capital value of the project is set based on past investments and capital investment, adjusted for depreciation, with the RAB ‘guarantee’ enabling cheaper cost of capital. Additional benefits include project cash-flow certainty and regulated consumer prices. However, the model only works for projects with end-consumers, passing on the risks and benefits – promoters cite a £60 saving per household due to the Thames Tideway Tunnel 'super sewer' project using the RAB model. This project utilised pension fund financing with the government underwriting certain risks. We may see more of this sort of arrangement as regulation is relaxed enabling pension funds seeking diversified, moderate risk portfolios to invest in infrastructure more significantly and at an earlier stage than usual.


It is clear that the delivery of the projects pipeline will require significant amounts of private capital. In recent years, the infrastructure financing market in the UK has evolved through the development of new structures and it is likely that such evolution will continue as new entrants arrive with different perspectives and requirements. The public sector will need to embrace this innovation and ensure that the UK is seen as open for infrastructure investment, particularly in light of the market uncertainty surrounding Brexit. Burges Salmon’s team of infrastructure development and financing experts is well placed to support contracting authorities, sponsors, contractors and funders in meeting the infrastructure challenge.

Key contact

Keith Beattie

Keith Beattie Partner

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