Insight Article

Cross-border insights for alternative assets

How the public-private partnership model links infrastructure and ESG

Aug 25, 2021
Government & public sector ESG Private equity Infrastructure policy

Lessons from Canada's implementation of public-private partnerships

Public-private partnerships (PPPs) have had success in Canada. In this Q&A, Alex Kotsopoulos, RSM Canada, and Anthony DeCandido, RSM US LLP, explain how the PPP model could help the Biden administration close the United State’s US$2 trillion infrastructure gap while also improving environmental, social, and governance, or ESG, outcomes.

Canada has been very successful with infrastructure investments made by tandem efforts from public and private sectors. How can these partnerships improve infrastructure and economic development, and what can the United States learn from this?

Since the 1990s, PPPs have been used extensively in Canada to develop its infrastructure. Along with Australia and the U.K., Canada has used these delivery mechanisms to improve current infrastructure while also lowering the risk and cost to the state for ongoing maintenance. This risk transfer to a private entity is a key benefit of PPPs, and also works to close a country’s infrastructure gap or the amount of money needed to fund all projects against the amount actually invested in infrastructure projects.

The resulting productivity benefits can be quite extensive—in fact, societal benefits can also be tied to broader ESG outcomes. For example, investments in public transit projects that take cars off the road can lead to a reduction in greenhouse gas emissions, improved emergency response times, and fewer traffic accidents.

Data from the Organisation for Economic Co-operation and Development shows that Canada spends a larger share of its GDP on infrastructure than most developed countries. Current estimates from an April 2021 article from the Council on Foreign Relations put the U.S. infrastructure gap near US$2 trillion,  while the maximum estimated infrastructure gap in Canada is near CA$570 billion according to CanInfra. Adjusting for GDP, infrastructure spending in Canada was about 1.14 per cent of GDP, 30 per cent higher than the 0.9 per cent figure in the United States, suggesting that Canada could close its infrastructure gap at a faster rate.

What are the disadvantages of the PPP model?

PPP models rely on something called a risk transfer, where the risk needs to be quantified before it is transferred over to the private sector. The private sector, in theory, has the capability to better internalize that risk compared with public sector organizations. The drawback of a PPP is that it does require a pretty rigorous assessment of risk—and that may not be immediately apparent.

One of the things we’ve noticed with PPP projects is that it's easy for similar types of infrastructure to be delivered using similar models, given they have a reference point to compare against. For that reason, we’re not seeing the PPP model being used as extensively on innovative or complex projects.

The Biden administration hopes its infrastructure bill will accomplish development and innovation goals while also incorporating ESG principles. What lessons can the United States learn from Canada’s PPP approach?

Infrastructure is critical for any country to achieve its economic development and climate objectives, as well as broader ESG objectives. Looking at the bill itself, the largest allocation—about US$600 billion—is intended to be spent on ports, airports, mass transit, bridges, and highways.

These projects usually require the investor to bear significant upfront costs and ongoing maintenance expenses, but what the PPP model does is transfer the long-term risk to the private sector after an initial cash outlay from the public sector. Both the United States and Canada have substantial infrastructure deficits, and both have spent considerable resources during the pandemic—this is therefore one way to address the back-end drop in productivity. The PPP model can spur faster growth and help improve some of the fiscal anchors, particularly debt-to-GDP ratios.

This division of risk warrants serious investigation in the United States, however, because it can build out infrastructure—such as mass transit, bridges, and highways—at a potentially lower cost and, in many cases, less time. From a development and growth perspective, this poses a win-win for the administration, shoring up long-term government debt and improving infrastructure in the near to mid-term.

While infrastructure investments require initial cash outlays from the government, many of the green initiatives will involve taxation and government incentives to change the behaviour of the private sector. As such, these green infrastructure initiatives will push companies to reduce emissions and carbon output and incentivize individuals for using low- or no-emission vehicles.

Transit is another area that green initiatives could develop. Vehicle types, how people and goods move around, and access to mass transit are particular aspects of the bill that could benefit from PPP investment. Innovation in these areas is a pervasive theme in ESG, but it doesn't get enough hype; standard renewable energy and existing technologies are usually top of mind. Innovative mechanisms toward green economic development can create jobs and opportunities as well.

The PPP model can help to address aspects of social inequality, too. The pandemic exposed the digital divide in broadband access in the United States, particularly in rural communities. In both the United States and Canada, PPPs could help to rapidly upgrade the network, close the social gap and benefit investors.

In the case of broadband networks, investors would benefit from the PPP’s availability model, whereby the end-user pays a fee to use the assets, or subscription fees to the network’s owner or investors. These fees have proved to be quite lucrative for infrastructure investors, not only through telecoms but also through roads, ports, and hospitals, providing the long-term returns that institutional investors need.

Originally published by preqin in the Alternative Assets in the Americas report.

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