The Bruce Column — Making the long-term work

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17 Jul 2014

The B20 summit is taking place in Sydney. One of the greatest challenges facing the world economy, and one that is on the B20’s agenda, is that of how to enable investment in long-term infrastructure projects. A recent report and roundtable pointed a way. Robert Bruce, our resident, regular columnist, explains.

The really big problem up ahead is how to fund the vast, but essential, infrastructure projects required around the world. Estimates suggest that US$3.2 trillion will be needed each year for the next fifteen years. But they also suggest that there will be a shortfall of US$500 billion every year. The reasons for this are straightforward. Governments, post-financial crisis, have constrained budgets. Banks similarly are under pressure to deleverage. So both of the traditional providers of long-term funding are out of the game, as it were.

Instead the world looks to other traditional long-term investors — pension funds and the insurance industry, for example. But these investors are wary. The information that would provide reassurance is not always available or accessible in a form that would help their decision-making. And this is why the B20 Group, which brings together business leaders from the G20 countries, asked the six largest global accounting networks to provide analysis, insights and recommendations which could promote the necessary infrastructure investment.

It is a huge issue, involving huge numbers, but it also links into much of the current thinking in the world of financial and corporate reporting. Even before the financial crisis, and with significantly greater urgency since then, the focus has shifted to how to encourage the long-term view across business and investment.

And the report from the global accounting networks emphasizes this. And as a recent roundtable on its findings agreed it is not the accounting that is an impediment to investment in infrastructure. In the context of long-term investment it is the political and regulatory risks that are the more relevant. Investing decisions by insurers, for example, ‘are likely to be more heavily influenced by the expected stability of cash flows’. And: ‘Financial statements prepared in accordance with International Financial Reporting Statements also offer the significant advantage of being comparable for investors and potential investors across the globe and are therefore especially relevant in the context of cross-border capital flows’.

That said, as participants at the roundtable were swift to point out, under current regulation corporate reporting can fall short in terms of communicating a company’s long-term value proposition. The narrative reporting which accompanies accounts often provides a review of business performance and, in varying detail, a description of strategy, risks and opportunities.  However, it may stop short of the strategic insight into what really makes the company tick which, in some cases, would account for 80% or so of the company’s market value.  This would include the value not on the balance sheet relating to the company’s order book or ‘pipeline’, or representing the company’s intangibles and risks.

There are also the inherent difficulties in long-term investment. An infrastructure project may represent a 25-year long project to build roads, railways, or airports, for example. As one participant at the roundtable pointed out, 25 years in the US would span ten congressional terms. The political risk and uncertainty over that time would be immense. Investors need extraordinary comfort and contact with the project. Sovereign wealth funds or giant pension funds will gain this by investing directly into the project. Other investors will invest through intermediaries, like fund managers. All investors will have different levels and means of access to information across the project’s term. But they will all require transparency.

So the way forward must be innovation that will unlock an understanding of that critical, and currently unseen project information. And the innovation has to be something that works with the grain rather than against it. So it cannot be direct regulatory action. It has to be something that encourages the innovation that investors in long-term projects need and which allows best practice to emerge rather than be proscribed.

This is not easy. Providing that sort of forward-looking information is not something which CFOs traditionally feel comfortable with; not because they are intrinsically opposed, but because they recognize the dangers for the company, themselves, and the investors. The commercial sensitivity of risk and forward-looking information are difficult. Amongst other things some form of safe harbor provision need to be provided.

Many projects may well be public sector infrastructure looking for private sector investment. And here there will have to be much greater symmetry between the different financial and corporate reporting models for it to work.

But recent developments in corporate reporting have been moving in the right direction to free up the information required to facilitate long-term investment. Internationally the development of integrated reporting is an example. This directly addresses many of the issues of reporting that elusive but vital information. And innovation is also coming into play in other ways. The UK Financial Reporting Council’s financial reporting lab is a good example of how companies and investors can come together and experiment and exchange views as they try to identify best practices. Also, requirements in the UK for a strategic report, and corporate governance “comply or explain” provisions in South Africa for an integrated report, create a good climate for experimentation and innovation in this space.

The answers to the problems are within people’s grasp. It is a question of understanding what is at stake and allowing best practices to emerge. It is all about creating an enabling environment.

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