Keynote speech by Angel Gurría, OECD Secretary-General, delivered at the IIF Conference - The G20 Agenda under the Australian Presidency
Session V - Addressing Barriers To Infrastructure And Other Long-Term Investment
21 February 2014, Sydney
(As prepared for delivery)
Ladies and Gentlemen,
It is a great pleasure to be with you today at this High-Level Public Private Sector Conference of the IIF and to be given the opportunity to introduce your discussion on long term investment with specific emphasis on investment in infrastructure. This is an excellent opportunity for me to share with you key insights derived from the latest work of our Organization, the OECD, on long term and infrastructure investment and from our recent contributions to the G20.
The backdrop: The Infrastructure investment context
We all know that infrastructure needs are huge. Yet, let me recall a few facts and figures. According to the OECD, the total requirement for global infrastructure investment by 2030 for transport, electricity generation, transmission and distribution, water and telecommunications is approximately USD 71tn [Source: OECD Future Programme, Infrastructure 2030: Telecom, Land Transport, Water and Electricity, 2007], which amounts to about 3.5% of global GDP forecast over the same period. Achieving a low-carbon energy sector globally will require an additional cumulative investment of USD 18 trillion by 2035, one quarter of which in China alone, according to our colleagues from the IEA.
The “million-dollar question” is: how are we going to finance that? Infrastructure investments have traditionally been financed to a large extent with public funds, given the typical nature of public goods and the positive externalities generated by such investments. However, increased fiscal pressure and, sometimes, the inability of the public sector to deliver efficient investment spending have led to a strong reduction of public capital committed to such investments.
From 1980 to 2005, the OECD has estimated a fall of the average ratio of public fixed investments to GDP from above 4% to about 3%. And this negative trend seems to be continuing: FDI flows have been declining for 2 consecutive years and are directed away from infrastructure sectors. In 2010-2012, an average 8% only of FDI inflows received by OECD countries were ending in infrastructure sectors as opposed to more than 10% over the period 2007-2009.
What these figures mean is pretty clear: on the one hand, the public sector has been less committed to infrastructure development over the last decades; and on the other hand, the private sector has been unable or unwilling to take over from governments and make up for the reduction in the availability of public finance. How come?
Barriers to infrastructure investment
- First of all, and beyond the immediate uncertainties induced by the weak economic environment, important deficiencies in framework conditions, that are reducing incentives and returns to investors, are holding back investment in infrastructure. They include for instance:
- Restrictive regulations in infrastructure, such as ownership restrictions - which reduce the ability of firms to undertake new activities or enter new markets, especially across borders. The OECD FDI Regulatory Restrictiveness Index shows that infrastructure sectors and capital-intensive network industries are among the most restrictive sectors to foreign direct investment within G-20 economies.
- Lack of predictability and stability of the regulatory environment (pricing, subsidies, standards, etc.) – this is particularly salient for investment in clean and renewables energies;
- There are also specific problems with infrastructure investment, related to limited capacity to plan, prepare and execute projects successfully.
- Long term investment is equally hindered by important barriers to financial intermediation.
Since the crisis, the ability of the financial system to allocate funds to long-term investment both within countries and across borders has been impaired. The weak economic outlook and uncertainty have reduced borrowers’ and lenders’ confidence and raised risk premia. At the same time, many financial institutions – as you know very well - are still grappling with the impact of the crisis on their balance-sheets and structural weaknesses in their business models. ‘Bad’ deleveraging, particularly in Europe, has restrained credit growth which has barely grown in advanced economies (and actually shrunk in the euro-area) since the start of the crisis. This is causing a growing mismatch between the amount and time horizon of available capital and the demand for long-term finance. New banking regulations (Basle III) could also affect negatively the ability of banks to provide long-term financing.
The (untapped) potential of institutional investors
As a result of these trends, the long-term financing gap is particularly acute in the infrastructure and small- and medium-size enterprise (SME) sectors – estimates of the gap vary around 1-2 trillion per year (depending on the perimeter and whether the latter includes social infrastructure and the green upgrading of existing infrastructure).
But it does not mean that there is no available capital out there that could be used for infrastructure investment. I am thinking in particular of institutional investors - such as pension funds, insurance companies and mutual funds – that could scale up their role in these markets.
In OECD countries alone, these institutions held over USD 80 trillion euros in assets in 2012 and pension funds collect around USD 1 trillion in new contributions each year. Sovereign Wealth Funds (SWFs) and Public Pension Reserve Funds (PPRFs) are also growing rapidly. Given the low interest rate environment and volatile stock markets of recent years, institutional investors are increasingly looking for new sources of long-term, inflation-protected returns. Investments in real productive assets, such as infrastructure could potentially provide the type of income which these investors require.
So how come that institutional investors are not pouring more of their cash in this type of investment – less than 1% of their assets under management?
Besides the generic obstacles to private sector involvement in infrastructure which I have already mentioned, there are specific barriers to increased funding of infrastructure projects by institutional investors:
- The lack of appropriate financing vehicles;
- Regulatory disincentives such as valuation and accounting standards and investment restrictions on unlisted or direct investments in infra project in many countries;
- The absence of quality data on infrastructure investment performances; and as a result, the inexistence of a clear and agreed investment benchmark for illiquid assets.
We also need to remember the fiduciary duties of institutional investors which make them specifically risk adverse in their cost/benefit analysis of infrastructure projects.
Addressing the barriers to infrastructure investment: the OECD contribution to the G20
Enhancing private investment in infrastructure requires measures aimed at unlocking the supply of finance and improving the framework conditions to increase investment demand. This includes:
- Easing and simplifying market regulations, notably by reducing barriers to domestic and foreign entry into network industries and improving the fairness, openness and transparency of procurement procedures - notably tackling hidden protectionism in procurement procedures, embedded in technical requirements for instance;
- Ensuring a level playing field between public and private parties, as the dominant position of SOEs is likely to deter independent power or water producers to enter the market. This means adopting appropriate corporate governance standards for state-owned enterprises, sound competition policies, and common principles covering the international investment dimension of competitive neutrality;
- Improving the supply of finance for long term investment by changing the incentives structure of systemic banks through the separation and ring-fencing of their traditional (retail) and most risky (derivatives) activities; as well as strengthening public equity markets, whose role in financial intermediation – especially for the long term – and in price-discovery has been weakened by the developments seen over the last decade [increased use of indexing and Exchange Traded Funds, high frequency trading, development of dark pools, self-listing of stock-exchanges, etc.].
Opening infrastructure markets is a difficult task and the OECD has done considerable work to help host governments address this challenge, including through developing and implementing the OECD Principles for Private Participation in Infrastructure. There is also a lot to do to promote further institutional investors involvement in long term investment as reflected in the G20/OECD High-Level Principles on Long-Term Investment Financing by Institutional Investors endorsed by G20 Leaders in St Petersburg. I would wish to take this opportunity to thank the business community and in particular IIF for the excellent comments they provided on the earlier versions of the Principles.
Going forward, G20 Leaders called on the OECD and other interested participants to identify effective approaches to the implementation of our high-level principles for institutional investment by the next Summit in Brisbane. This will call for further data and analysis on investment trends in infrastructure sectors and on the various obstacles to long term investment, notably by institutional investors, and the development of related policy recommendations. Upon the request of G20 members, we are also conducting an important project analyzing government- and market-based incentives for long term investment financing. Here again, we will consult with you and rely on your inputs. We are definitely looking forward to continuing working with you - and the G20 of course - on the ways and means to unlock financing for infrastructure investment.