Why governance is key to restoring trust in UK infrastructure
The UK infrastructure industry needs to face up to its failings and act in the best interests of all stakeholders. Developing a code of conduct would be a good place to start, argue Darryl Murphy and Mirza Baig.
The UK, like many countries around the world, is facing the complex challenge of ensuring there is sufficient investment in infrastructure to keep pace with social, economic and technological changes and needs. The Government National Infrastructure Delivery Plan in 2016 stated that over £480 billion of investment was required in the period to the end of this decade and beyond1. Of this, 50 per cent is proposed to be financed and delivered by the private sector.
On July 10, the National Infrastructure Commission (NIC) launched the eagerly-awaited National Infrastructure Assessment (NIA), which will provide a pathway to infrastructure investment to 2050 to build our future society2. The assessment makes a series of recommendations, including a switch to low-carbon and renewable sources for power and heating; a nationwide broadband plan; flood defence; and the move towards electric vehicles.
With the Commission stressing its recommendations are not ‘an unaffordable wish list’ for the government, the private sector features heavily within the NIA as part of the long-term delivery and investment plan. The NIC also asserts that “both government and arms length independent state institutions can help to support this investment, by absorbing risk that the market finds hard to manage and supporting due diligence functions for innovative projects”.
However, despite the centrality of private finance to the current and future provision of essential public services, the sector is facing an unprecedented lack of trust that risks derailing the UK’s modernisation strategy.
How did we get here?
One of the key issues that has influenced the fluctuating stance and policy of government is the long-term nature of infrastructure investments, which can often sit uncomfortably within a shorter political cycle. Ministries charged with providing funding and oversight are often different to the ones who approve projects. Furthermore, megaprojects and services with a direct impact on local communities regularly become hot button topics for opposition parties to contrast their economic and ideological positions.
In this context, Conservative ministers, select committees and the current Labour opposition have all felt compelled to look at how private finance operates, with Labour calling for the termination of Private Finance Initiative (PFI)/ Public Private Partnership (PPP) contracts and the nationalisation of privately-owned utilities2. The demise of Carillion has only intensified the scrutiny around placing essential public projects in the hands of the private sector.
Beyond politics, private investors and operators of public services have scored a series of own goals with the way they have priced and structured contracts. Every headline of a school or hospital being closed under the weight of long-term inflexible PFI payments further cements the perception that the public are being ‘ripped off’ by unscrupulous private operators. This conclusion was drawn more formally in the National Audit Office report on PF2 in January 20183, which raised serious questions over the value for money delivered through the historic use of PFI/PPP. The report estimated the government could have saved between 40-70 per cent on the value of contracts awarded if they had financed the projects directly.
The current debate extends well beyond PPP as a delivery tool and goes to the heart of the infrastructure market that has been shaped over the last 30 years, dating back to the privatisation of state-owned companies in the 1980s. The infrastructure industry has a short window to face up to and address this trust deficit or risk undermining both its own long-term viability and the UK’s ability to remain a leading economy.
Addressing governance failures
The private sector has tried to respond to increasing criticism by pointing out the positive impact its investment in infrastructure has had across many industries, including water, energy, schools, hospitals and transportation. However, the real value to the public has neither been clearly articulated nor sufficiently promoted. This is in part due to a failure of robust and transparent engagement with all stakeholders during the life cycle of the project or service.
Traditionally, private operators of infrastructure and public services have focused on demonstrating their environmental credentials as the primary measure of their responsible practices. While this remains a critical consideration, similar importance has not been given to the governance of their operations, which provides the overarching framework of their conduct and behaviour. This is in part due to a misconception that governance is an issue for public rather than unlisted private companies and entities.
However, good governance is essential in the delivery of long-term value. For businesses to remain sustainable and flourish, they must acknowledge their role in the broader environment in which they operate, and endeavour to develop deep and positive relations with customers, government agencies, suppliers, employees and communities. The revisions to the UK Corporate Governance Code4, which emphasise social purpose, culture and stakeholder relations as foundational principles, are welcome. While the Code is directed towards public companies, lessons from the collapse of BHS have already resulted in demands to raise governance standards in private companies.
There are other long-term trends that will inevitably have an impact, including demands for a fairer distribution of value and wealth in society and the rise of environmental, social and governance (ESG) investing. Although infrastructure remains a unique asset class, the impact of these phenomena to the sector is inescapable. In due course, it will mean that the myopic pursuit of maximising short-term profits at the expense of ‘stakeholder value’ will likely result in business failure, while entities unable to demonstrate strong ESG credentials will be starved of capital or be required to pay a substantial risk premium.
The way ahead
Despite the obvious challenges, constraints on public budgets mean that private finance will continue to have an important role to play in the future of infrastructure and public services. Although the threat of hard and soft regulation looms, private players have an opportunity to proactively shape the reform agenda. This will require the industry to move beyond the outdated approach of viewing projects exclusively through the lens of contractual obligations, and recognise their primary objective is to deliver high quality, cost-effective public goods and services.
Regaining public trust will require industry leaders to set clearer standards; to create a culture that places public interest at the top of board and management agendas; and to engage with critical stakeholders in an honest, transparent and responsive manner. Reading across from the experience of publicly-listed companies, the evolution of the idea of ‘enlightened’ shareholder value should result in a fairer and more balanced distribution of value and benefit. Outsized profits should be exchanged for more considered long-term profitable partnerships. This will help rebase the industry on a more sustainable footing.
A possible mechanism to demonstrate the commitment of the industry to change would be the development of a voluntary code of conduct to address the key issues highlighted, including social purpose, robust board governance with suitable levels of independence, and a detailed framework for engaging stakeholders. The credibility of the code would require the establishment of an oversight committee that monitors compliance and can demonstrate meaningful behavioural change within the sector.
Meeting the UK infrastructure needs over the next 30 years will require effective relations between private investors, the public sector and the public. These relationships have been materially damaged and it will take time and effort to repair the trust deficit.
The private sector must now show itself capable of acting swiftly, decisively and responsibly in redefining how it connects with the government and wider public and seek to overhaul its mission statement, culture and conduct. This would help shift the narrative of the dynamics of private capital and public interest projects from a zero-sum game to an essential and mutually-beneficial partnership for all stakeholders.
An edited version of this article first appeared on The Daily Telegraph
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