Shifting regulatory arrangements set to rebalance deal flow across Europe
Global institutional investors have an estimated US$1tn of funds at their disposal for potential investments in European infrastructure over the next ten years but a combination of limited available assets, changing economic regulation and new government incentives are set to alter traditional investment flows.
Linklaters’ research shows that M&A levels remain depressed on pre-crisis levels with $113.45bn invested in the last five years as compared to $1.053tn the previous five years. One factor that remains consistent, however, are those countries which take the ‘lion’s share’ of this investment. For example, the UK took 26% of the total over five years and as much as 39% in 2014.
Stuart Rowson, Infrastructure partner at Linklaters, notes, “A combination of the economic health, availability of assets and the stability and transparency of the regulation will have an impact on how investor friendly a country is perceived to be. We’re already starting to see investment flows in Europe changing because of these factors. A shortage of infrastructure assets in North Western Europe, the resulting high prices and new regulations have in many cases forced infrastructure investors to look further South, or indeed, at new ‘hybrid’ asset classes, in their search for opportunities and higher yields.”
Tightening regulatory arrangements
The Regulatory Risk Analysis, developed by Compass Lexecon and FTI Consulting for Linklaters’ report Routes to Return – Navigating European infrastructure regulation, shows that countries traditionally known to offer stable and transparent regulatory arrangements are becoming less attractive as a result of tightening economic regulation, thus limiting investor returns.
For example, the Regulatory Risk Analysis shows that electricity networks in the UK have seen a 10% drop in their regulatory rating, largely as a result of the latest network price controls, which are currently being challenged by the Competition & Markets Authority.
Ian Andrews, infrastructure partner at Linklaters, notes: “Across North Western Europe there have been a number of instances of regulatory change in recent years which, in time, have the potential to erode some of the hard-earned investor confidence which these countries have built up over many years.”
An uptick in attractiveness
Ian says: “Conversely, we are seeing improvements in the regulatory arangements in countries that previously may have been regarded as offering a less stable environment.”
As an example, the regulatory rating of Spanish electricity distribution has increased by 7.5% whilst Spanish gas distribution increased by 5%. This is the result of changes made by the Spanish Government to the regulatory arrangements, aimed at providing greater clarity about future revenues by setting out formulaically how those revenues will be determined.
Ian, comments: “Governments have a significant role to play in building investor confidence through the type of regulation they apply to infrastructure assets so as to secure investor capital. Governments will be keen to secure investment in their national infrastructure – as our research has shown, it could help to grow their GDP by an additional 1.4% per year between 2014-2023.”
Opening up new opportunities
Governments are being creative their attempts to create an alignment of bill-payer and investor. This is creating new opportunities which are welcomed by investors in a market with limited assets available.
For example, in the UK, Offshore Transmission Owners (OFTOs) take responsibility for offshore transmission assets under long-term OFTO licences. OFTO licences are awarded through a competitive tendering process run by Ofgem and the winning bidder is rewarded with a predictable, availability-based revenue stream. This approach has been highly successful - 14 OFTOs, valued at approximately £2.7 billion have been auctioned off to date.
Given the success of OFTO’s, it is likely that we will see the approach to regulation replicated elsewhere. Ofgem are already gearing up to implement a similar approach to onshore transmission assets. In Germany a similar arrangement is being applied to wind farms as they pilot a new auction based approach to determining the level of Feed-in Tariffs.
Richard Coar, Renewable Energy partner at Linklaters says: “We’re likely to see further innovations in the coming years, particularly in the renewable energy sector, as governments try and create new opportunities and so the flow of investment could once more change as investors look for the best projects to boost return.”