Regulatory factors impacting infrastructure
We delve into some of the regulatory factors that impact infrastructure investment.
Depending on their nature, infrastructure assets can operate in different regulatory environments. These environments can be broadly classified as regulated, partially regulated or unregulated. In this article, we consider some of the regulatory factors that need to be taken into consideration when assessing the merits of a regulated infrastructure investment.
The location of an asset can have a significant impact on regulatory issues that need to be considered. Within some countries, the regulator is a national body with power to regulate all infrastructure assets of a particular type nationally. This is the case, for example, in the UK water sector. In other instances, assets can be subject to multiple levels of regulation. This could occur where an asset is subject to regulation by both national and state regulators, or where an asset operates across multiple jurisdictions, such as across state lines, which can be the case in the US electricity market. Having multiple levels of regulation can significantly increase the complexity of owning an asset.
Frequency of regulatory reviews
Regulatory reviews are typically conducted at set points in time (e.g. UK water utilities are subject to a regulatory review every five years). The outcome of the review process will essentially determine prices that can be charged for services provided by an asset. It therefore has a significant influence on the rate of return that an asset can generate for its owners, so this process is crucial to the investment returns that are achieved by investors. These reviews are generally industry wide, and take into consideration factors that may be affecting all participants in the relevant market.
In addition to regular periodic reviews, in some instances regulators may initiate an off-cycle review. Similarly asset owners may be able to approach the regulator to request an off-cycle review. This would generally occur where certain circumstances may have changed in a way not contemplated during the periodic review process.
Track record of regulator
The track record of a regulator is critical when evaluating a regulated infrastructure investment. Where a regulator has a history of surprising the market participants (either positively or negatively) with regulatory outcomes, this can be considered as a potential investment risk, and should increase the required rate of return for the investment in order to compensate for that increased level of risk. On the other hand, where the regulatory environment is predictable, the required return may be lower, but is subject to a greater degree of confidence on the part of the investor.
Economic and political factors
Regulators operate in a landscape that can be influenced by both political and economic factors. When an economy within which a regulator operates is under stress, there may be political pressure to lessen the burden on consumers at the expense of asset holders. This could materialise through a lower allowable return at particular regulatory reviews. Asset owners seek to mitigate this risk by ensuring that there is a long and stable regulatory regime with a history of rational and predictable behaviour. In addition, this risk is mitigated to some extent by the fact that private funding is needed in many countries in order to fund their infrastructure requirements and, if private investors are not able to achieve a reasonable return, they are unlikely to invest, or maintain their investment in, these types of assets.
About the author
John Julian, Portfolio Manager - Core Infrastructure Fund, AMP Capital