Successfully reported this slideshow.
We use your LinkedIn profile and activity data to personalize ads and to show you more relevant ads. You can change your ad preferences anytime. Page 1/5
Non-executive directors (NEDs) are now common-place in ... Page 2/5
These SPCs arrange funding for, construct and then operate projects from schools and
hospita... Page 3/5
how rigorous can their governance oversight be and how effectively can they hold SPC
managem... Page 4/5
funds. This is quite consistent with the value line
of their employer and is usually intensi... Page 5/5
providing a clear and unbiased picture of SPC performance and engendering confidence in
Upcoming SlideShare
Loading in …5



Published on

The engagement of independent Non-Executive Directors in infrastructure companies is examined.

Published in: Business
  • Be the first to comment


  1. 1. Page 1/5 INFRASTRUCTURE NEDs – WHO NEEDS ‘EM? Non-executive directors (NEDs) are now common-place in UK listed companies. They are increasingly prevalent in SMEs. So does this trend extend to the infrastructure sector? Much of UK infrastructure is privately funded, ultimately by institutional investors. Pension funds are being encouraged to directly fund more investment. However, the investment vehicles used to deliver infrastructure projects embody complex financial structures with unique risk characteristics. So, how are the interests of investors safeguarded and by whom? UK corporates and the use of non-executive directors Over the last decade, UK Corporates have increasingly employed non-executive directors to provide breadth of experience and objectivity to their boards. In 2003, following high profile governance abuses such as Enron, the Higgs Report recommended that at least half the board directors of any company listed on the stock market should be independent non- executives. This trend has since extended to most SMEs, accentuated by an increasingly complex and unpredictable business environment and demands for improved governance standards in the wake of the financial crisis. The structure of UK infrastructure companies Much of UK infrastructure is owned by corporates such as BAA, Centrica and BT and these conform to the corporate NED trend. However, according to HM Treasury, £60bn of UK infrastructure has been procured over the last two decades through partnerships with the private sector (PFI/PPP). These have been delivered by over 700 project financed joint venture companies (special purpose companies or “SPCs”) set-up by private sector sponsor organisations and financial investors. The risks of financing, constructing and operating these infrastructure projects is borne by the SPCs. SPC: Severn River Crossing plc Is there an empty chair on infrastructure company boards?
  2. 2. Page 2/5 These SPCs arrange funding for, construct and then operate projects from schools and hospitals, government offices and housing to transportation and energy schemes. The projects are funded by a combination of equity and debt. They tend to be highly geared (typically 90% debt funded) using non-recourse debt (i.e., borrowing that is secured on the future cashflows of the SPCs rather than the balance sheets of the shareholders). The shares in most of these SPCs are sold-on to financial investors once the initial construction risks have been overcome and the shares can command a premium price. These shares are now owned predominantly by listed or private equity funds backed by institutional investors such as pension funds and insurance companies. Owning shares in these SPCs is not without its risks. The equity, is subordinated to the senior debt (i.e., it is the first level of risk funding). The construction and operation of these assets can be complex. Even an SPC operating a relatively simple project comprising a few schools can involve significant risks as the recent news of the closure of 17 PFI schools in Edinburgh shows. So, who is providing objective oversight of the operation of these SPCs? Are independent NEDs used for this purpose? If not, should the appointment of NEDs to SPC boards be more widespread? Board construction in project financed SPCs Typically, the boards of these SPCs tend to be populated by directors nominated by the equity parties (including sponsors still involved) from their own staff. They are sector experts; they understand the market, analysed the risks when they bid or acquired the project and it is their firms’ investments that are at stake. So are interests aligned? Well not exactly! Fund managers raise capital from investors and charge fees on the capital raised or invested. Sponsor organisations usually have vested interests in the companies constructing and/or operating the projects. The debt providers (banks or project bond holders) who provide most of the SPC funding have no board representation relying instead on regular reports by advisers. Furthermore, most equity nominated directors hold multiple directorships, often measured in many tens of SPCs. In these circumstances, ContractOwnership SPC SPC SPC Infrastructure Funds OriginalSponsors Debt Government Service Contract SPC SPCInstitutional Investors BuildingContract Operating Contract Typical SPC Structure SPC: Greater Gabbard OFTO plc equity (~10%) (~90%)
  3. 3. Page 3/5 how rigorous can their governance oversight be and how effectively can they hold SPC management to account? When projects fail to perform, the SPCs attract financial penalties or the contracted payments for use of the infrastructure are reduced or stopped. Due to high debt gearing, this can quickly lead to breaches of lending covenants resulting in equity payments (dividends and shareholder loan payments) being ‘locked-up’ or frozen. If these circumstances persist, SPCs can need refinancing. Typically this involves additional equity investment being required. Part of the debt may be swapped for equity and any project bonds may be downgraded. The result is investor returns are diluted, lenders assume greater risk and the value of the project is diminished. The case for non-executive directors in SPCs The common purpose of an NED is to: · bring diversity, wider experience and independent judgement to board decisions · create a broader perspective in the interests of the company and its stakeholders · transfer knowledge of a variety of management styles and governance structures The current modus operandi in SPCs perpetuates boards dominated by directors sourced from a narrow investment banking or transaction background. Transaction due diligence may well identify some of the theoretical risks facing a project. However, the skills in bidding or acquiring an investment are quite different to the practical asset management experience that can help to manage those risks when they arise. Homogenous boards typical of these types companies can be ill equipped to deal with the complex interplay of contractual obligations, regulatory compliance, performance monitoring and often contradictory demands of clients, shareholders, lenders and other stakeholder groups. Actual risks tend not to replicate those predicted at a transaction stage and many SPC directors do not have the pragmatic technical and operational experience to most effectively guide, question and oversee remedial plans. Furthermore, despite the number of directorships held by nominated directors, this may not be their principle role. Many are employed to originate and close future deals for their SPC: CGL Rail plc (DLR extension) SPC: Capital Hospitals Ltd (Barts & London Hospital)
  4. 4. Page 4/5 funds. This is quite consistent with the value line of their employer and is usually intensive work. The focus on this priority can undermine how thoroughly the performance of closed investments are monitored. Effective oversight is key to identifying and avoiding risks before they occur and both time consuming and critical to resolving them when they do. It is a dynamic, forward looking SPC management team with a constructively challenging and focussed board that most effectively manages risk. It is also more likely to identify and pursue opportunities to enhance the value of and returns from an investment. However, you seldom get one without the other. An experienced and pro-active board of directors is the precursor to a well-motivated, progressive management team. But aren’t these low risk investments? Historically, an advantage of investment in public infrastructure has been that revenues are backed by a government covenant or the asset is in a highly regulated environment, resulting in low volatility in revenues and profits. However, at a time of increasing economic uncertainty and mounting public sector budgetary constraints, pressure is growing on public sector clients to find revenue savings or to extract greater value from built assets. This is driving an increasingly combative approach from some public sector clients. Consequently, the contractual, operational and financial risks confronting many infrastructure SPCs are growing. As these risks mount, so should the time and attention expended by SPC boards. Boards can be slow to respond and reticent in asking for help. By the time investors have recognised a problem, it can be too late. Once revenues fail to sufficiently cover debt payments or contractual disputes arise, shareholder cash flow is impacted and the time and cost consumed by the executive team increases exponentially. An independent NED – justifiable cost or unnecessary expense? So how vulnerable is the structure of many SPC boards and would the appointment of independent NEDs increase their resilience? The appointment of a good NED should bring external knowledge and a depth of experience needed to constructively challenge SPC management. It should also transform the board’s capability to respond to exceptional risks and/or opportunities. A benefit of such an appointment should be concise, objective and independent reporting to shareholders, SPC: Viridor Laing (Greater Manchester) Ltd (Waste to Energy PFI) SPC: Connect M1-A1 Ltd
  5. 5. Page 5/5 providing a clear and unbiased picture of SPC performance and engendering confidence in future investment returns. But at what cost and is it worth it? NED costs vary according to the expertise and experience of the person and the size and complexity of the SPV. On an individual company basis, most experienced and pro-active NEDs can perform the role on the basis of 1-2 days per month (less if board meetings are only quarterly). This may rise if chairing board sub- committees or the SPC is suffering some form of distress. Economies of scale are possible if an experienced NED is engaged to manage a portfolio of assets for the same investor. Costs typically range from 5% to 15% of SPC management overheads but with the prospect of safeguarding exposure to risks costing considerably more. In distressed cases, I have seen performance restored and equity value rebuilt at a cost of 1.5% - 3.0% of the valuation gain. Conclusion The adoption of independent NEDs in project financed infrastructure companies has lagged behind that of the corporate sector despite investments being exposed to real and unfamiliar risks. In cases of under-performance, equity investments in these assets are vulnerable to high levels of debt gearing which can quickly trigger a ‘lock-up’ in shareholder cashflow and impact investment returns. Yet investors have been lulled into a false sense of security due to historically low levels of impairment. However, the investment environment is shifting and the number of assets suffering from some form of distress is increasing. This is not a time for boards to be populated by inexperienced nominee directors with priorities elsewhere. Unfortunately, many investors are unaware of the NED capabilities that exist in the market or how to source them. About the writer Nigel Brindley is a turnaround executive and non-executive director currently chairing a project company in London. With an engineering, construction and operations background, he has managed infrastructure investments for investment banks, private equity funds and industrial sponsors for 16 years. By combining financial investor and technical/operational experiences, he works effectively with management teams whilst aligning the interests of investors, lenders, contractors and clients in order to secure investment objectives. SPC: Modern Courts (East Anglia) Ltd SPC: Modern Schools (Exeter) Ltd