Infrastructure Investments - Regulatory Hurdles, Real Opportunities

Infrastructure needs private capital; investable projects remain scarce Regulatory reforms at investor and fund level open up new leeway The biggest bottleneck lies in state project structuring and budget law. The investment backlog in the German infrastructure is considerable. Despite the special fund, the Germany Fund and numerous political initiatives, the modernisation of transport, energy, digitalisation and municipal infrastructure is lagging behind the actual demand. Public funds alone cannot close this gap. Capital from the private sector, especially from institutional investors, is therefore indispensable. In practice, however, this encounters structural and regulatory hurdles. Against this background, Christoph Kraiker, CEO of Hauck & Aufhäuser Fund Services, Dr. Dirk Krupper, Managing Director of Helaba Invest, as well as Martin Hüwel and Dr. Thomas Gohrke, partners of Luther Rechtsanwaltsgesellschaft, discussed how regulatory requirements on the investor side, fund structures and government framework conditions can be better interlinked.

"Whether institutional capital flows into infrastructure projects depends on the interaction of three levels," says Martin Hüwel. "At the first level are the regulated investors themselves. Insurance companies, pension funds, pension funds and banks are subject to strict regulatory requirements that have a significant impact on risk appetite, maturities and forms of investment. The second level is the fund level, where these regulatory requirements are translated into concrete investment vehicles. Finally, at the third level, the state project and transaction level decides whether investors can dock at all." None of these levels work in isolation. Only when investor regulation, fund structure and government project logic intertwine do functioning infrastructure investments emerge.

Infrastructure investments are characterised by long maturities and stable, often regulatory-backed cash flows, which means that they can generally be easily reconciled with the long-term obligations of institutional investors. At the same time, the regulatory framework determines the form in which investments are possible. "For infrastructure investments to be investable for institutional investors, there must be stable cash flows, a clear allocation of risks and a clear regulatory classification," explains Dr. Dirk Krupper. "Regulatory reforms such as the independent infrastructure quota in the Investment Ordinance or the planned adjustments within the framework of Solvency II open up additional leeway; however, as long as these basic conditions are not met, regulatory relief does not automatically lead to a broader investment base in practice." According to Krupper, many investors continue to focus on established, low-risk investments such as regulated networks or existing infrastructure assets. Development and greenfield projects, on the other hand, are often difficult to reconcile with regulatory requirements due to construction, market or demand risks. The more uncertain cash flows and risk profiles are, the faster regulatory limits are reached. In addition, the investor's perspective is changing due to the current interest rate environment. The increased returns on alternative forms of investment mean that infrastructure investments are now valued even more strongly in relative terms – both on the equity and debt sides. In this context, credit-based infrastructure solutions are becoming more attractive, as they are often more efficient from a regulatory point of view and better suited to the risk budgets of many investors.

At the fund level, legal adjustments in recent years have led to significantly more flexibility. National reforms such as the Fund Location and Future Financing Act as well as European regulations such as AIFMD II or ELTIF 2.0 are expanding the structural possibilities for infrastructure investments. "The regulatory toolbox is much better filled today than it was a few years ago," says Christoph Kraiker. "But a good vehicle alone is not enough – the decisive factor is that the investment strategy fits the requirements of the investors. This must be examined on a case-by-case basis." In addition to traditional infrastructure funds, club deals and co-investments are gaining in importance, especially for large institutional investors. "We see that many investors are initially getting in via funds and later sharpening their investments in a targeted manner through co-investments," says Kraiker. "However, standardised fund structures remain the most important lever for broad capital mobilisation." At the same time, there is an increasing demand for transparency. Investors also expect a clear overview of portfolios, risks and cash flows in long-term, illiquid investments. Fund structures must therefore not only be suitable from a regulatory point of view, but also operationally convincing. Hüwel confirms this: "The more standardized and transparent structures and processes are, the easier it will be for investors to provide capital – and for the state to implement projects."

The experts identified the state project and transaction level as the biggest obstacle to infrastructure investments. Budgetary requirements, the debt brake as well as public procurement and state aid law have a significant impact on how public infrastructure projects are planned, evaluated and implemented. These conditions often make it difficult to structure projects in such a way that they meet the requirements of institutional investors in terms of maturities, risk allocation and cash flow stability. "The state is legally geared towards financing infrastructure itself," explains Dr. Thomas Gohrke, partner at Luther Rechtsanwaltsgesellschaft. "In practice, private models are often compared with an ideal-typical self-realization, which is not feasible in this form at all." This benchmark leads to private financing and operating models being structurally disadvantaged in a profitability comparison – regardless of whether they could be more efficient or less risky in their implementation. Public-private partnerships could basically close this gap, as they combine private financing and expertise with public responsibility. Nevertheless, such models are still subject to political and administrative skepticism. "Successful examples show that public-private partnerships can work – if risks are appropriately distributed over the entire life cycle and procedures are pragmatically designed," says Gohrke.

The political will is there, as is the interest of institutional investors. It is now crucial to consistently transfer regulatory progress into investable projects. This includes standardised project models, the bundling of small-scale projects – especially at the municipal level – and an understanding of partnership between the public sector and investors from the private sector.