If you build it

Jay Fortin and Timothy Pfister are corporate partners in the New York office of Patton Boggs. Norma Krayem is a Senior Policy Advisor in the firm's Washington, DC office and focusses on homeland security and defence issues. Fortin and Pfister practice in the areas of structured transactions, including project finance, infrastructure development, and in mergers and acquisitions. Fortin can be contacted at jfortin@pattonboggs.com, Pfister can be contacted at tpfister@pattonboggs.com, and Krayem can be contacted at nkrayem@pattonboggs.com. Adam Gold also contributed to this article.

US investors have been investing in infrastructure in emerging markets for many years now, supplying expertise and badly needed capital for the privatisation and improvement of everything from power plants and electric transmission and distribution systems to ports, airports, toll roads and water and wastewater treatment systems. More recently, after years of neglect and underinvestment in infrastructure, governments in developed countries including the United States have become more receptive to private investment as a way to bridge the growing gap between the limited funds available from tax revenues and other sources and the increasing amounts needed to repair and maintain aging infrastructure.

Rather than outright privatisation, developed countries have generally turned to public private partnerships (PPPs) as one of the preferred methods of raising capital from private investors for infrastructure. In a typical PPP structure, a special purpose entity (SPE) owned by the private investor constructs, maintains and operates the underlying asset and leases it from the government for a term of 20 or more years. The UK has been a leader in the use of PPPs. It developed the Private Finance Initiative (PFI), a form of PPP, in the early 1990s and has since completed hundreds of PFI projects. Many more are currently underway or on the drawing board in the UK, including projects involving schools, hospitals and other similar infrastructure. Dozens of other countries including Australia and Spain have followed suit, developing PPP models of their own based on the UK's experience, although they vary greatly in their level of understanding and sophistication.

As its name implies, the PPP structure involves a partnership between a governmental entity and private investors pursuant to which the private investors invest capital and share risks with the government entity, which continues to own the underlying asset. It is particularly effective for financing assets which the governmental entity does not want to sell outright.

The US has not embraced the PPP model as fully as other countries, and there continue to be disagreements over PPPs at the federal and state levels. This is changing, however, as the US faces an estimated $1.6 trillion infrastructure funding shortfall by 2010 and governments at all levels – federal, state and local – face mounting deficits and lack the resources to provide the services that they have historically provided. The capital requirements to modernise existing infrastructure and to build new infrastructure are so great that public funding alone will not be sufficient. Private capital will be required and much of it will have to come from foreign sources.

The US Congress has already begun the debate on PPPs for transportation- related assets and is expected to speak to these issues in the upcoming reauthorisation of the Safe, Accountable, Flexible, Efficient Transportation Equity Act (SAFETEA-LU) bill in 2009. The debate centers on how PPPs can be regulated in a way that will protect the substantial public investments that have been made over time in these assets and ensure that the public sector reaps the short-, mid- and long-term benefits of the deal. Wherever Congress comes down on this issue in 2009-2010, it is clear that these actions will affect the nature of PPPs in the US for years to come. Political risks are higher in infrastructure projects than in other types of investments, as there is often disagreement over the extent to which public infrastructure should be placed under private control, and whether private ownership should be permitted at all, particularly foreign private ownership. Consequently, in addition to understanding applicable laws, rules and regulations, it is critically important to understand the political environment and the political dynamics of any proposed transaction. US investors and their advisors have years of experience investing in infrastructure around the globe and have faced these issues many times. That experience should be valuable to foreign investors who are considering investing in US infrastructure for the first time.

Political risks for foreign investors in US infrastructure increased exponentially after 11 September amid growing concern that foreign ownership of certain US assets might give foreign interests too much control over critical infrastructure on home soil. That concern was evidenced recently when Dubai Ports World, a United Arab Emirates company, attempted to purchase another company that ran US ports. The fact that the proposed purchase did not violate any law and had already been reviewed by the Committee on Foreign Investment in the United States (CFIUS) did not matter. It set off a Congressional firestorm and Dubai Ports World was eventually forced to sell the US operations to an American company.

Heightened concern over deficiencies in the approval process for foreign investment in US infrastructure following the Dubai Ports World incident led to the passage of the Foreign Investment and National Security Act of 2007 (FINSA), which amended the law governing CFIUS. FINSA requires the president, acting through CFIUS, to review foreign acquisitions of controlling interests in US businesses with national security implications, including, any potential effect on “critical infrastructure”, which is defined in the proposed regulations under FINSA as “systems and assets, whether physical or virtual, so vital to the United States that the incapacity or destruction of the particular systems or assets … would have a debilitating impact on national security”.

In 2003, The National Strategy for the Physical Protection of Critical Infrastructure and Key Assets submitted by the Bush administration outlined eleven sectors of critical infrastructure: agriculture and food, water, public health, emergency services, defense industrial bases, telecommunications, energy, transportation, banking and finance, chemical industry and hazardous materials, and postal services and shipping. In addition, the following were identified as “key assets”: national monuments and icons, nuclear power plants, dams, government facilities and commercial key assets. Suffice it to say that the proposed FINSA regulations greatly expand the potential range of what might be considered “critical infrastructure”.

It should be noted that a CFIUS review is required only where the proposed transaction results in “control” by the foreign entity. In other words, foreign companies are free to earn money from investments in critical US infrastructure so long as they do not have actual control, which has obvious implications for the structuring of such investments. Control is very broadly defined in terms of the ability of the acquirer to make certain important decisions affecting the acquired entity, but, perhaps in recognition of the growing importance of PPPs, the proposed rules state expressly that long-term leases may be considered transactions that transfer control only if the lessee “makes substantially all business decisions concerning the operation of a leased entity, as if it were the owner”. An example is provided in which a foreign company signs a concession agreement to operate a toll road business in the US for 99 years. Because the US owner of the toll road is required to perform safety and security functions and to monitor compliance by the foreign company with the operating requirements of the agreement on an ongoing basis, and may terminate the agreement or impose other penalties for breach of such requirements, the lease would not constitute a transaction transferring control, and consequently would not be subject to CFIUS review.

Prospective foreign investors in US infrastructure should simply be aware that notwithstanding the increasing need for foreign investment, the visibility of such investments, and consequently the risk of politicisation of the approval process, has also increased to the point in the US where Congress will be debating these transactions and potentially regulating them in the short term. Even when a proposed investment does not appear to raise any CFIUS issues, the potential political and policy aspects of the investment must be carefully considered and proactively managed in order to ensure the best possible chance for success.