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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
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?
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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
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,
SPC: Greater Gabbard OFTO plc
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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
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
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)
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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
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
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
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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.
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