DRAFT – NOT FOR DISTRIBUTION MARCH 14, 2013
District of Columbia Public-Private Development Trust Federal City Council Concept Paper
April 15, 2013
Draft for Member Comments at the Federal City Council Spring Meeting
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
District of Columbia Public-Private Development Trust Federal City Council Concept Paper
Table of Contents Table of Contents........................................................................................................................................2 I.A Widening Gap between Needs and Spending........................................................................................3 The Need is Considerable and Expanding.......................................................................................3 The District Does Not/Will Not Have the Necessary Resources to Address these Challenges. ......5 II.Innovative Financing Tools.......................................................................................................................6 Infrastructure Banks.......................................................................................................................7 Hybrid Infrastructure Funds..........................................................................................................10 Social Impact Bonds......................................................................................................................13 III. A Proposal for the District of Columbia.................................................................................................15 Governance...................................................................................................................................16 Financing.......................................................................................................................................17 Project Delivery.............................................................................................................................17 Keys for Success............................................................................................................................20 IV.Conclusion.............................................................................................................................................20 Appendix I: D.C. Possible Projects..............................................................................................................21 Appendix II: Major Capital Initiatives Could Help D.C. to Achieve Great City Qualities.............................22 Appendix III: Two Main Options of Traditional Financing for Infrastructure.............................................22 Appendix IV: California I-Bank Program Details.........................................................................................23 References.................................................................................................................................................26
Page 2
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
District of Columbia Public-Private Development Trust Federal City Council Concept Paper
“Washington, D.C. is the Capital of the United States of America. Let us make it a city of which the Nation may be proud – an example and a showplace for the rest of the world.” President John F. Kennedy, 1963
I.
A Widening Gap between Needs and Spending
The Need is Considerable and Expanding. The economic climate in the District of Columbia has evolved over the past decade and now it is among the top tier investment markets in the Nation. 1 • D.C.’s economy added an estimated 8,200 jobs in 2011. • Since 2001, over 42,000 residential units have been built. In August 2012, D.C. had 10,357 residential units under construction for delivery in 2012 and beyond. • As of 3Q 2012, as a result of its efforts to improve environmental sustainability, D.C. has a total of 316 LEED certified buildings/projects. • As of August 2012, over 1.7 m sq. ft. of education space is under construction including public high schools, medical space, and college and university facilities. • By 2013, more than 434,000 sq. ft. of new mixed-use developments will deliver. • In 2014, several pipeline projects are expected to deliver, which account for additional 587,000 sq. ft. retail spaces. With D.C.’s thriving economy and impressive urban transformation, more and more new residents – especially singles, young couples, and baby boomers – are flocking to the city. According to the U.S. Census Bureau, the District’s population grew at an annual rate of 2.15 percent to 632,323 in July 2012, ranked the second fastest in the U.S. 2 These new residents are attracted to a “24/7” environment including walkable neighborhoods and easy access to neighborhood services. While the growing population generates new jobs and investments and energizes communities in the Greater Washington region, the demand for District infrastructure is also growing, compelling the city to improve and expand service through rapid and substantial capital investments in transportation infrastructure, utility functionality, education facilities, community economic development, and public services such as parks and libraries. One example of the type of community infrastructure that has the capacity to help address the Washington region’s transit needs, facilitate economic growth, and enable community development is the proposed revitalization of Union Station which requires an investment of $7 billion for modernization and expansion in order to serve the 21st century transportation needs and help expand our economy. Other 1
2012/2013 DC Development Report, Washington DC Economic Partnership. Available at http://www.wdcep.com/wp-content/uploads/dcdr.pdf. 2 http://www.census.gov/newsroom/releases/archives/population/cb12-250.html.
Page 3
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
investments in the social infrastructure of the District include potential large savings for governmental operations and improvement in the quality of life, such as green promotion to improve the environment, workforce development to train job hunters through a supply-demand model, tourism promotion to induce more tourism-related investments and economic activities, and government operational savings by investing in system improvements and enhancements. Yet D.C.’s infrastructure investment has lagged behind overall economic growth. A joint report by DC Appleseed and Our Nation’s Capital 3 concludes that “our Nation’s Capital falls short on many of the measures of a great [capital] city because much of the District’s infrastructure is in demonstrably poor shape.” (Appendix II highlights some specific capital improvements, proposed by the Joint Report, needed in Washington, D.C.) One of the causes of our critical infrastructure backlog is a limited budget for capital investments. The District has made remarkable progress in achieving its fiscal responsibility. It has balanced its budget for fifteen consecutive years since its economic low-point in the mid-nineties. Nonetheless, this conservative approach in capital investments has diverted funds away from critical infrastructure maintenance and renewal. Under the D.C. government’s self-imposed 12 percent debt cap, the District’s ability to invest in future capital needs is limited because merely implementing plans in the approved Capital Improvement Plan will push D.C. to its debt cap by FY 2019. 4 The result of the forthcoming underinvestment will be substantial deferred maintenance and improvements in many city buildings, roads, bridges, public transportation, utilities and schools. 5 If we do not think innovatively and accelerate capital investments, this trend will lead to compounded investment requirements in the future. This infrastructure deficit not only impacts services used by workers and residents, but it reduces the city’s economic competitiveness. Further, the Joint Report points out that the city must invest to reduce economic and social disparities among the District’s residents. “Despite its status as the capital of the world’s wealthiest Nation, the District suffers from high and concentrated poverty and unemployment.” To build a strong and stable community, the city needs, among other, quality public education, community social activities, affordable housing options, reduced chronic homelessness, and accessible health care services. Unfortunately, given the nature of its “structural deficit” that is discussed next, the District falls behind other great capital cities in efforts to provide some of most critical social services the city’s economic and social wellbeing depends on.
3
Building the Best Capital City in the World, A Joint Report by DC Appleseed and Our Nation’s Capital, December 2008. 4 The District’s Capital Budget, Mayor’s Office of Budget and Finance, January 2013. 5 Mayor Vincent Gray mulling debt cap hike to spur development , The Washington Business Journal, May 18, 2011, available at http://www.bizjournals.com/washington/print-edition/2011/11/18/mayor-vincent-gray-mulling-debt-cap.html? page=all. “We haven’t hit the cap yet, so it hasn’t prevented anything from happening, but it has prevented things from being planned,” said Gerry Widdicombe, director of economic development with the Downtown BID. “And if things aren’t planned, they don’t happen.” Widdicombe added that those projects though requiring costly initial investments could generate attractive returns on investment, which does not factor into consideration of the debt cap. Page 4
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
The District Does Not/Will Not Have the Necessary Resources to Address these Challenges. The District faces severe challenges in revenue generation, including a unique federal law 6, applicable only to the District, that bars it from taxing income earned within its borders by non-residents. The half million non-residents who work in the District currently earn over $36 billion per year, meaning that the District is barred from taxing roughly 2/3 of the total personal services income earned in the District. D.C. is also barred from taxing over 40 percent of the real property in the District because it is owned by the federal government, international organizations, embassies, and nonprofit groups. 7 The District cannot realistically expect to raise tax new revenue by increasing income, property and sales tax rates because those rates are already quite high by regional standards. Although it cannot tax the economic activity taking place within its borders, the city nevertheless bears the obligation to provide services to all non-residents who work in the District and all the taxexempt entities that own property in D.C. As a result of these unique economic burdens and revenue restrictions, the city’s operating budget will be stretched for the foreseeable future, notwithstanding the recent surpluses that have resulted from higher tax collections generated by the recent increase in the District’s population and business activity. In order to restore the District’s credit rating after the city nearly went bankrupt more than a decade ago, the city’s borrowing capacity was severely limited by a self-imposed debt cap. This cap constrains D.C.’s ability to finance large projects no matter how meritorious they might be. The District already has one of the highest debt per-capita rates in the country. As a result, resorting to traditional public funds alone, such as issuing more general obligation bonds or raising tax level, is no longer feasible because it will risk damaging the District’s credit rating, endangering its borrowing capacity, and driving residents away. More importantly, G.O. bonds backed by a city’s general funds misalign risks and incentives. The risks associated with new projects are placed on the taxpayers instead of persons/populations who invest in projects or use the services. (Appendix III gives some details on two main traditional financing tools for infrastructure – pay-as-you-go and public debt financing.) Furthermore, the U.S. Federal Government, which serves as the District’s state in certain limited circumstances, is faced with its own financial resource limitations. Although the Federal Government has provided limited funding for D.C. infrastructure in the past, there is lack of stable and dedicated federal funding sources for the District’s capital investments and improvements in the long run. Worse, because of the fiscal issues at the federal level, the outlook of the District’s G.O. bonds was downgraded to “negative” in 2011.8 According to Moody’s Investors Service, the downgrade “reflects the District’s unique exposure, as the nation’s capital, to federal government downsizing and the risk that such a downsizing could have on the finances of the District.” Taken together, these factors suggest that relying on public funding alone is insufficient to cope with the numerous claims for the city’s infrastructure and other critical services. While ultimately we need to right D.C.’s fiscal system to enable the sustainable growth of the city and the region, right now, with the 6
The District of Columbia Home Rule Act, Pub.L. No. 93-198, 87 Stat. 774 (enacted December 24, 1973). Building the Best Capital City in the World, supra. 8 http://www.moodys.com/research/MOODYS-REVISES-DISTRICT-OF-COLUMBIA-GO-RATING-OUTLOOKTO-NEGATIVE--PR_226434. 7
Page 5
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
concern of “sequestration” and political gridlock, attracting additional private investment through various innovative financing tools offers a promising way to invest in large scale and expensive improvements in a vastly expedited manner.
II.
Innovative Financing Tools
In recent years, while retaining authority and ownership over public projects, governments have experimented with innovative financing tools to complement traditional funding sources. These tools include federal and non-federal credit programs, tax incentives, the municipal debt market, and public private partnerships (P3). Unlike budget financing and public bonding, these non-traditional financing mechanisms have two important advantages – to tap into more capital and to deliver performance-based public projects. Innovative finance, first introduced a decade ago, covers a multitude of things and means different things to different people. According to the World Bank, 9 innovative finance means any financing approach that does the following: • Generates additional funds by tapping new funding sources or by engaging new partners; • Enhances the efficiency of project delivery; or • Makes financial flows more results-oriented by properly aligning incentives with risks. Although the concept of innovative finance, especially for infrastructure, has been widely tested around the world, it is still relatively new in the U.S. 10 Three notable examples, particularly for our purposes, are infrastructure banks, hybrid infrastructure funds, and social impact bonds. Infrastructure banks offer the efficiencies of streamlined funding decision making and a merit-based selection process. An initial capitalization for an infrastructure bank often comes from a government grant that requires neither repayment nor expected return. The vast majority of financing is through loans and loan guarantees. A market-based hybrid infrastructure fund, on the other hand, is a pool of funds – using a small amount of state and/or federal dollars as equity to leverage much larger sums of private capital – for infrastructure investment. By utilizing fund management techniques, this method allows more private sector participation in infrastructure development and links funds to results. Projects conducted through this type of investment funds are likely designed, built, operated, and/or maintained through P3 agreements. In the domain of financing social intervention, social impact bonds, also known as Pay for Success Bonds, are the latest innovation that brings governments, private investors, and nonprofits together to tackle specific social problems. Through an investment agreement with private investors, impacted public agencies only need to pay for improved social outcomes that result in public sector savings.
Table 1. Examples of Innovative Finance Technical Tools 9
Innovative Finance of Development Solutions, Initiatives of the World Bank Group, 2010. Available at http://siteresources.worldbank.org/CFPEXT/Resources/IF-for-Development-Solutions.pdf. 10 Among others, leading practitioners include Australia, Canada, the UK, and the European Union.
Page 6
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
Tools Infrastructure Banks
Trailblazers California I-Bank*; Virginia Public Private Transportation Act and Public-Private Education and Infrastructure Act; The proposed National Infrastructure Bank
Targeted Projects Transportation, water and sanitation, green energy, environment, and public schools
Hybrid Infrastructure Funds
Chicago Infrastructure Trust; Rebuild NY Bank
Revenue-backed and results-based P3 infrastructure projects
Social Impact Bonds
NYC Adolescent Behavioral Learning Experience Program; MA Social Innovation Financing Trust Fund; U.K. Social Outcomes Finance Fund; Obama’s “pay for success” pilot projects
Efficient and effective government: workforce development, special education, health care, children in care, drug rehabilitation, and homelessness
* See Appendix IV for program details.
As presented in Table 1, each innovative financing tool is right for certain sectors and issues. Let’s take a look at each one in detail. Infrastructure Banks Infrastructure Banks (IBs) are publicly regulated revolving loan funds capitalized from a variety of government grant sources to assist projects across a range of infrastructure modes. IBs can provide a combination of low-interest loans, loan guarantees, and a line of credit to public and private sponsors. Some also offer bonds and other financial instruments. According to a recent research from the Brookings Institution11, since 1995 thirty-three states have used state IBs to invest nearly $7 billion in over 900 different projects. However, this activity is highly concentrated in the 100 largest metropolitan areas as many state IBs are underutilized or inactive. The TIFIA credit program 12 serves similar functions as an IB at the national level, but only applies to eligible surface transportation projects of regional or national significance. (A proposed National Infrastructure Bank is discussed later.) The U.S. Department of Transportation (USDOT) through the credit program provides three forms of credit assistance – direct loans, loan guarantees, and standby lines of credits – to sponsors of major transportation projects. 13 In general, IBs: • are owned and controlled by government, and housed in a public agency; • are initially capitalized through government-sourced revenue (federal, state, or both), and can be leveraged in capital markets; • recycle funds to provide financing for future infrastructure projects; • provide low-interest loans with flexible financing terms; • expect no market returns, only maintain the operation and level of capitalization; and 11
Banking on Infrastructure: Enhancing State Revolving Funds for Transportation, Brookings-Rockefeller, September 2012. 12 The TIFIA credit program is established by the Transportation Infrastructure Finance and Innovation Act of 1998. 13 The amount of federal credit assistance may not exceed 33 percent of total eligible project costs. TIFIA project sponsors may be public or private entities, including state and local governments, special purpose authorities, transportation improvement districts, and private firms or consortia. Page 7
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
•
generally lend only a portion of project costs.
State IBs can be federal or state capitalized. These state IBs differ in size and investment scope. The size of state IBs varies from under $1 million to more than $100 million. As illustrated in Table 2, among thirty three states with established state IBs, every state has an IB for water/wastewater projects that was created with a federal grant and a minimum 20 percent match from the state. 14 Some transportation state IBs were initially capitalized through federal apportionment and cooperative agreements with the USDOT. Ten out of thirty three federal capitalized state IBs are currently inactive because of federal restrictions15, low capitalization16, and already very low interest rates in the municipal bond markets. Additionally, there are multistate IBs: Nebraska-North Dakota-South Dakota-Wyoming, ArkansasTennessee, and California-Oregon-Washington-British Columbia (West Coast Infrastructure Exchange). Regional coalitions are promising but have experienced challenges due to disagreements among states. Table 2. State Infrastructure Banks across the United States 17
14
Federal Water Quality Act, 1987. Ten state IBs were established through an initial pilot program in the 1995 National Highway System Destination Act. These state IBs could contribute up 10 percent of federal apportionment and must maintain separate accounts for federal and state funds. Subsequently, in 1997, more appropriation was added. However, the 1998 Transportation Equity Act for the 21 st Century, while excluded both restrictions in 1995 Act, added a new one – the application of federal regulations for all state IBs’ projects once the initial federal capitalization had revolved one time. The same is in the 2005 Safe, Accountable, Flexible, Efficient Transportation Equity Act. This restriction significantly deters states from signing up cooperative agreements using the funds under the 1998 Act and 2005 Act. 16 For example, both California and Virginia are among those 10 states in the 1995 pilot program. Similar to Virginia ($20 million), California’s federally-capitalized state IB ($4million) has supported only two road projects. On the contrary, both states have created their own state-capitalization state IBs with much more in capitalization and investment. 17 Banking on Infrastructure, supra. 15
Page 8
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
Also, state IBs vary in the domain of funding sources and financing instruments, project selection and prioritization, and the process of project development and delivery. These elements are tailored to each state’s specific needs and business environment. Among states that have state-capitalized IBs, Table 3 shows a variety of state funding sources including budget appropriations, bonds, and dedicated taxes and fees. Most state IBs, though broadly defining types of investment, have a predefined set of selection criteria covering creditworthiness and financial stability of project sponsors and revenues, economic benefits to the locality and state, and/or innovations in terms of technology or project delivery. Some state IBs award project funds on a first-come-first-serve basis. Others have a formalized process for prioritization. Table 3. Sources of Capitalization for State-Capitalized Transportation State IBs 18 State
Name
Source of Capitalization
California
Infrastructure and Economic Development Bank (I-Bank)
Florida
SIB (state-funded account)
Georgia Kansas Missouri Ohio Pennsylvania Virginia Washington
Transportation Infrastructure Bank (GTIB) Transportation Revolving Fund (TRF) State Transportation Assistance Revolving Program (STAR) SIB (state-funded account) SIB (state-funded account) Transportation Infrastructure Bank (VTIB) Freight Rail Investment Bank (FRIB)
State general revenue, now selfsustaining State general revenue, state transportation trust fund, bond proceeds State fuel taxes State highway fund appropriation State general revenue State general revenue, fuel taxes State general revenue State general revenue State license permit and fees
Thus far, the state-capitalized California Infrastructure and Economic Development Bank (I-Bank) has the broadest mandate for lending among all state IBs. The I-Bank is located within the California Business, Transportation and Housing Agency and is governed by a five-member Board of Directors. It runs the operations through five programs: Infrastructure State Revolving Fund, Industrial Development Bond, Exempt Facility Bond, Nonprofit Revenue Bond, and Public Agency Revenue Bond; its borrowers range from government, public agencies, private businesses, and nonprofit organizations; its financing instruments include direct long-term low-cost loans, taxable and tax-exempt bonds, and state bond securitization transactions. (For details, see Appendix IV.) After its initial capitalization, the I-Bank is now entirely self-sustaining, with a portfolio of $32 billion as of 2012. It has built eleven P3s valued over $7 billion. Stan Hazelroth, its executive director, attributes part of its success to having a list of welldefined and standardized project selection criteria. At the federal level, the Obama Administration first proposed its version of National Infrastructure Bank (NIB) fall 2011, but failed to gain enough support in Congress. The formation of an NIB is still a part of President Obama’s most recent 2013 budget proposal 19. The proposed NIB aims to provide a centralized facility to increase the funding availability and to improve the merit-based selection process for those capital investments with “national importance.” Under the proposal, the NIB would have a $10 18 19
Banking on Infrastructure, supra. Available at http://www.whitehouse.gov/sites/default/files/omb/budget/fy2013/assets/investing.pdf.
Page 9
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
billion initial capitalization appropriated by Congress and would be led by infrastructure and financial experts. By issuing loans and loan guarantees, the NIB would offer investments to large-scale ($100 million minimum or at least $25 million for rural projects) transportation, water, and energy infrastructure projects. Projects would go through a well-defined and rigorous selection process, including consideration of needs and the funding gap, public benefits, economic, technical and environmental standards, and dedicated revenue streams. Geographic, sector, and size considerations would also be taken into account. State and local governments and private investors would match at least 50 percent of the total costs of any project. Investment decisions would be made by an independent and non-partisan board of directors that would consist of seven members, no more than four from the same political party, and a CEO chosen by the President. IBs offer several major benefits. First, for the purposes of filling market gaps, IBs are willing to take more risks than commercial banks. A project with significant public benefits would otherwise be rejected for a financing opportunity because of large upfront capital injections and slow payouts. Therefore, IBs induce more private investment by lowering the financial risk and creating a stronger market condition. Second, interest rates, set by government typically below market rate or even near 0 percent, can make a large project affordable. Third, the loan term could be as long as 35 years. Hence, IBs can help promote and meet the needs of financing large, impactful, and long-term infrastructure projects. Even so, IBs are not without limitations. First, the need for government-sourced capitalization could be the most important challenge facing the nation and states that have been severely constrained by soaring budget deficits and deteriorating credit ratings in the midst of the biggest financial downturn since the Great Depression. Second, offering an attractive low-cost loans, and maintaining levels of capitalization and long-term sustainability are two competing mandates. If the revenues an IB generates through near-zero-interest loans are not sufficient to sustain its operation, it may need another round of recapitalization. Besides, as infrastructure needs grow over time the lending capacity of an IB must grow as well. Again, more public funding may be needed to meet growing demands. Since IBs are housed in government, the burden of additional funding is likely to fall on taxpayers. Third, IB projects require long-term monitoring, typically longer than the time frame for grant assistance. Significant resources need to be allocated to manage ongoing projects. Lastly, IBs are only appropriate for projects that can sustain funding streams that pay back the associated loans. Thus, the success and sustainability of IBs rest on how well project selection criteria and evaluation are defined and executed. Hybrid Infrastructure Funds New York State and the City of Chicago are both experimenting with hybrid infrastructure funds (HIFs) to facilitate the funding of transformative infrastructure projects through a wide range of innovative financing tools and strategies. In Chicago, Mayor Rahm Emanuel and President Bill Clinton unveiled an infrastructure trust in March 2012. The Chicago Infrastructure Trust (CIT) is the first municipal hybrid infrastructure investment fund in the U.S. It aims to match public infrastructure needs to private dollars by creating efficient capital structures and results-based P3s. The CIT projects will achieve a better alignment of risks and rewards – shifting project risks to private investors and offering them a higher financial return on investment than government-issued bonds. The CIT will also improve
Page 10
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
government efficiencies and capacities in terms of long-term infrastructure planning and investing by serving as a single coordinator and knowledge center for different governmental agencies. The City of Chicago has committed $2.5 million, in the form of equity, as seed money. The CIT aims to tap into new funding sources that would be otherwise unable to invest in the city’s infrastructure, including charitable organizations, foundations, unions and pension funds, and sovereign wealth funds. An affiliate, known as a single-purpose agency, will be created to issue the debt and enter into the P3 agreements. The inaugural project for the CIT is Retrofit Chicago 20, retrofitting approximately 100 municipal buildings that will save more than $20 million a year in wasted energy costs and create about 2,000 jobs.21 To date, the Retrofit project has attracted an initial private investment of $200 to $225 million. Investors will be paid back through the savings in city energy bills over the course of about 15 years. Although the CIT has not yet spelled out the detailed terms of the project, it is certain that return on private investment depends on whether the project achieves predefined results. That is, if savings aren’t realized as expected, the private investors will take the loss; and if energy savings accumulate beyond the benchmark, investors could turn a profit. Table 4. A Summary of Differences Between IBs and HIFs Financing Mechanism
Infrastructure Banks
Hybrid Infrastructure Funds
Pros
Cons
• Provide a large-sum of upfront capital through low-interest loans with flexible financing terms • Can be leveraged in capital markets • Recycle of funds to provide financing for future infrastructure projects • Take more risks than commercial banks
• Potentially attract more private dollars with higher financial returns • Evaluate alternative financing structures and strategies – properly aligning incentives with risks • Risk transfer through contracting • Effective cross-governmental coordination • Effective project management • Build up a dedicated professional capacity for PPP deals
20
• Owned and controlled by government; housed in public agency • Initially capitalized through governmentsourced funds; large-sum needed to sustain a healthy volume of projects • The revenues generated through low-cost loans may not be sufficient to maintain levels of capitalization and sustain operation. • Only good for large-scale infrastructure projects with dedicated revenue streams • Public skepticism on substantial private involvement in public services and assets • Investment agreements are extremely complex and have to be customized on a case-bycase basis. • Balancing public oversight and investor interest is challenging. • Only good for large-scale infrastructure projects with dedicated revenue streams; higher returns expected
Retrofit Chicago actually has three components: the municipal buildings program, a commercial buildings program and a residential program. Only the first program will be financed by the CIT. 21 See the official announcement of the approval of the CIT at http://www.cityofchicago.org/city/en/depts/mayor/press_room/press_releases/2012/april_2012/city_council_passesc hicagoinfrastructuretrust.html. Page 11
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
Public Private Partnerships, alternatives to public provision and privatization, are not a new concept and have been widely used for many years in different sectors, in different forms, and for different purposes (See Appendix V for different P3 delivery models.) Europe and Asia have been the most active P3 users for their infrastructure needs and have invested $353.3 and $187.2 respectively from 1985 to 2011 (Figure 1.) Similar centralized infrastructure investment facilities that leverage private monies and promote the use of P3s have been used around the world to fund public infrastructure. A few notable examples are Infrastructure UK, PPP Canada, and Infrastructure Australia. 22 If properly structured, P3s can provide access to private capital, reduce public cost and/or debt requirements, accelerate project delivery, shift project risk, spur innovation, and provide for more efficient management. 23 Figure 1. P3s Worldwide, Nominal Total Costs, 1985-201124 (in billions USD)
In the U.S., 24 states have undertaken at least one P3 transportation project since 1989. 25 One of reasons why U.S. lags other countries in terms of P3s utilization is because its public bond markets are substantially more developed than those in other countries and regions. However, with interest at historically low rates, the cost advantage of tax-exempt financing mechanisms is diminishing. This Chicago model could be attractive for the private investors who desire more than simply low tax-exempt interest payments. Also, given the current constraints on public spending – rising budget deficits, debt ceiling crisis, and soaring public outcry against government inefficiency – using a CIT-type model to leverage private money and expertise for public good may be a better strategy to bring forward much needed investment and achieve long-term sustainable development and economic growth.
22
Moving Forward on Public Private Partnerships: U.S. and International Experience With PPP Units, BrookingsRockefeller Project on State and Metropolitan Innovation, December 8, 2011. Available at http://www.brookings.edu/~/media/research/files/papers/2011/12/08%20transportation%20istrate %20puentes/1208_transportation_istrate_puentes.pdf. 23 America’s Infrastructure Gap: The Role of Public-Private Partnerships, Deloitte Research, 2006. 24 Public Works Financing, 2011. 25 Florida, California, Texas, Colorado, and Virginia were accounted for 56% of the total dollar amount. Moving Forward on Public Private Partnerships, supra. Page 12
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
However, the CIT has yet to prove its ability to overcome public skepticism about private involvement in public services and assets. 26 If projects go bad, will private investors abandon half-built roads or schools, or will the government be pressured to bail them out? Will private investors become too greedy – forcing the public to pay unduly high user fees? Also, P3 agreements are extremely complex and have to be customized on a case-by-case basis. Technical challenges include the determination of appropriate level of return on investment for the private sector, the decision on the revenue sharing ratio between private and public, and rigorous up-front analysis of environmental issues and public protection. All of the above require careful analyses and negotiations to minimize risks and align incentives, and yet a deal has to remain financially attractive to private investors. In addition, CIT-type structures, like IBs, may not be appropriated for large-scale infrastructure projects whose dedicated revenue streams are not sufficient or cannot be clearly identified. They are probably still best funded by traditional public sources. Social Impact Bonds Social Impact Bonds (SIBs) are the latest addition to the impact investing model. In order to increase funding, promote social innovation, and maximize measurable impact, SIBs leverage private sector capital and utilize performance-based models to change the ways in which governmental social service interventions are financed and programs are delivered. SIBs are government innovations that have the potential to save taxpayers millions. New York City is the first in the U.S. to put this innovative idea to a real test. In August 2012, Mayor Michael Bloomberg announced that Goldman Sachs would provide a $9.6 million upfront investment to MDRC for a new four-year social program that aims to lower the 50 percent recidivism rate among youth offenders jailed at the Rikers Island correctional facility. NYC Adolescent Behavioral Learning Experience Program (ABLE) is partially modeled after the U.K.’s pilot program in its Peterborough prison in September 2010. 27 The Department of Corrections of New York City will pay for the program with the savings resulting from the long-term reduction in prison or correction costs, but only if the targeted reductions in re-incarceration are met. Otherwise, Goldman Sachs will take a partial loss. The Michael Bloomberg Foundation, Mayor Bloomberg’s personal foundation, will issue a 75 percent credit guarantee – $7.2 million – limiting Goldman’s downside to $2.4 million. Also, Goldman’s upside is capped by the Bloomberg Administration, up to $2.1 million profit if the program achieves better-than-expected results. This puts the internal rate of return on this four-year deal at about five percent annually. MDRC, a third-party intermediary, will design the program and oversee the implementation. The day-to-day operations of the program will be carried out by two nonprofit service providers, Osborne Association and Friends of Island Academy. The Vera Institute of Justice serves as an independent evaluator. Table 5 illustrates the detailed payment terms after a final evaluation. Table 5. NYC Adolescent Behavioral Learning Experience Program 28 26
The Chicago Skyway and the Indiana Toll Road are often cited by P3 critics where the public suffers a long-term loss for the short-term political gains and minimal economic benefits. More details see Public-Private Partnerships to Revamp U.S. Infrastructure, The Hamilton Project, February 2011. 27 In November 2012, the British government announced its plan to set up a new Social Outcomes Finance Fund with a commitment of £20 million from the government and at least £60 million from private sector. http://www.cabinetoffice.gov.uk/news/new-boost-help-britain%E2%80%99s-most-vulnerable-young-adults-andhomeless. Page 13
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
Reduction in Reincarceration Rate
City Payment to MDRC ($)
Projected Long-Term City Net Savings ($)*
≥ 20.0% ≥ 16.0% ≥ 13.0% ≥ 12.5% ≥ 12.0% ≥ 11.0% ≥ 10.0% (breakeven) ≥ 8.5%
$11,712,000 10,944,000 10,368,000 10,272,000 10,176,000 10,080,000 9,600,000 4,800,000
$20,500,000 11,700,000 7,200,000 6,400,000 5,600,000 1,700,000 ≥ 1,000,000 ≥ 1,000,000
* Savings after repayment and continued funding for program delivery.
This so-called pay-for-success model allows governments to focus on outcomes, and transfer the risk of expanding prevention programs to investors. It brings together policymakers, philanthropists, private investors, and social entrepreneurs to solve some most pressing social problems we are facing. Presumably it could potentially improve the inadequate performance of social services funded through the traditional grant-making process. Instead of following the ABLE model relying exclusively on service intermediaries, Massachusetts adopted a model with both financial and service intermediaries. 29 In January, Massachusetts became the first state in the nation to formally establish a trust fund through state legislation “for the purpose of funding contracts to improve outcomes and lower costs for contracted government services.” Governor Deval Patrick and his administration intend to focus initially on two areas: chronic homelessness and juvenile justice. In addition, Massachusetts decided to conduct a separate public procurement to select the service providers while in the ABLE model, choice and oversight of service providers is primarily the responsibility of the external organization, MDRC. At the federal level, the Obama Administration has included Social Impact Bonds in his last three budgets, FY 2012, FY 2013 and FY 2014, for up to $100 million, $109 million and $495 million respectively. The pilot projects considered in the budget plans are aimed for the following seven categories: job training, education, juvenile justice and care of children with disabilities. Major programs that receive funding for Pay-for-Success strategies in FY 2013 include: • Workforce Innovation Fund (DOL): $20 million • Investing in Innovation Program (ED): $10 million • Fund for the Improvement of Postsecondary Education (ED/Higher Education): $10 million • PROMISE (ED/Special Education): $6 million • Social Innovation Fund (CNCS): $10 million • Second Chance Act (DOJ): $20 million Despite the many appealing aspects of SIBs, there is unavoidable public skepticism. 30 Critics regard SIBs as just another PR stunt by banks, and worry about greater corporate control of the public sector. 28
Bringing Social Impact Bonds to New York City, Mayor Bloomberg’s presentation, August 2012. Available at http://www.nyc.gov/html/om/pdf/2012/sib_media_presentation_080212.pdf. 29 Harvard Kennedy School's Social Impact Bond Technical Assistance Lab provided analytic support to MA. 30 The world’s first SIB, the Peterborough SIB in the U.K., is expected to deliver its first performance report in 2014.
Page 14
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
The Economist questioned: How will the impact of something as nebulous as counseling be accurately measured? And could metrics be designed to ensure that the program always meets its stated goals regardless of whether it’s actually improving people’s lives? 31 One has to recognize that the most critical and controversial issues of whether pay-for-success models work for better social outcomes is measurement of social impact and its link to investor returns. Better metrics must be developed to show that targeted results have been achieved because of a SIB’s social service program, not external factors. This means that only service programs with evidence of efficacy and savings, scale, measurable impact, and causality fit the SIB model. Nonetheless, we will not know the answer until we experiment with this promising and innovative model.
III.
A Proposal for the District of Columbia
The Federal City Council proposes the creation of the D.C. Public-Private Development Trust as a means to leverage private money to fund vital infrastructure improvements, green energy initiatives, government efficiency investments, and preventive social services in the decades ahead. Its mission is to improve economic competitiveness, government efficiency, and human capital of the District and the region. If adopted by the Council of the District of Columbia with the consent of Congress, the Trust would be the first coordinated investment trust in the U.S. that aims to invest in both infrastructure and social interventions through a mix of innovative financing tools. Box 1. Six As – Benefits of a Hybrid Investment Trust Accelerate economic and human development through scaling up P3s – –
Leverage private money and expertise for public good Fill market gaps
A single cross-governmental “shop window” for private sector investors –
For large and complex public projects, less navigation and more information means lower upfront costs and a higher rate of return.
A streamlined process from project selection to delivery –
Professionally managed - financing structuring, contract negotiation, and monitoring
Alignment of incentives with risks – –
Shift appropriate project risks from taxpayers to investors Ease the city’s reliance on government-issued bonds
A centralized entity for technical assistance and knowledge sharing A self-sustaining operation – Reduce the adverse impacts of government fiscal challenges and political gridlock – Improve the long-term planning of vital and transformative investments The proposed D.C. Public-Private Development Trust is modeled after the Chicago Infrastructure Trust and the Massachusetts Social Innovation Financing Trust Fund with a few modifications to address D.C.’s unique status in the country and the region. As a streamlined facilitator partnering with government agencies, private investors, and other stakeholders, the Trust would support much-needed 31
Playing with fire, The Economist, February 25, 2012. Available at http://www.economist.com/node/21547999.
Page 15
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
projects that otherwise would not be financed because of either their large/complex scale or market gaps, and help generate savings and growth for the District over the long-term. Private investors would receive a financial return if and only if savings accrue to the public as well. Figure 2. A Hybrid Investment Trust for the District of Columbia D.C. D.C. Public-Private Public-Private Development Development Trust Trust
Infrastructure Infrastructure Fund Fund
Social Social Impact Impact Fund Fund
Capital Capital and and Infrastructure Infrastructure Improvements Improvements
Green Green Energy Energy Initiatives Initiatives
Government Government Efficiency Efficiency Investments Investments
Preventive Preventive Social Social Services Services
Dedicated Dedicated Revenue Revenue Sources Sources
Public Public Funding Funding
Private Private Funding Funding
Efficiency Efficiency Savings Savings
Governance • The Trust would be funded as an independent nonprofit entity subject to the oversight of the Council of the District of Columbia. • The Trust would have a board of directors that is composed of members representing different interest groups including the D.C. government, the Federal government, labor unions, and experts in P3s, capital markets, municipal finance, and law. They would be appointed by the Mayor with the approval of the City Council. There shall be staggered director terms. (CIT’s directors receive no compensation, only reimbursement for expenses occurred.) • A CEO and specialized staff members • The Trust would fulfill its mandates via two professionally managed and governed investment funds: an Infrastructure Fund and a Social Impact Fund. Each would have a fivemember advisory council appointed by the Board with the approval of the Mayor. Potential appointees would be from impacted stakeholder groups. For example, for the Infrastructure Fund, they could be members from Union Station Redevelopment Corporation, Amtrak, and
Page 16
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
•
•
Washington Metropolitan Area Transit Authority, the District Department of Transportation, and the United States Department of Transportation; for the Social Impact Fund, they could be members from Office of the State Superintendent of Education, Office of Community Affairs, Department of Youth Rehabilitation Services, Department of Corrections, and social enterprises, social impact investors, and foundations. Agendas, annual reports, meeting records, and investment disclosure statements shall be posted online for public review. The details of full disclosure should be carefully defined in order to gain public trust without deterring private actors from investing. An independent third party shall annually assess the impact of the Trust and the projects through two funds it has undertaken (e.g., the added value of various forms of financing structures and contractual designs; strengths and limitations; scores on transparency and accountability.)
Financing • •
• • • •
The D.C. government, matched by a federal grant, could provide seed money in the form of equity investment in the Trust. The Trust would be responsible for seeking private sector capital from labor union funds, public and private pension funds, endowments, private equity funds, mutual funds and sovereign wealth funds. Depending on the nature of a project, traditional public funding sources such as bonds or grants may be needed. Performance-based P3 agreements would be promoted for projects financed through the Trust. Other factors to consider are whether the Trust will have the ability to leverage its investment and whether it will have grant-making capabilities. The Trust would be expected to be self-sustaining through its operations.
Project Delivery The essence of a P3 in investing in infrastructure has been well articulated: to allocate projectspecific risks to parties best able to bear them; to control performance risk through incentives; and to effectively use market hedging instruments for covering market-wide risks. The Trust is designed to: 1) negotiate a better deal for taxpayers on projects through efficient financial and contractual design; 2) facilitate the financing of socially beneficial projects that would never happen otherwise; 3) serve as a single streamlined entity to coordinate among various stakeholders; and 4) provide technical assistance and knowledge sharing. For investments in government efficiency and social intervention, the Council proposes to adopt a model with both a financial intermediary and a service intermediary. The Social Impact Fund of the Trust serves as: 1) a facilitator who brings together government agencies, philanthropists, social entrepreneurs, and private investors to tackle key challenges the government and the community are facing; 2) a negotiator who is responsible for designing financing structures, and negotiating timeline and payment; and 3) a trustee who holds and distributes investments from private sector investors and outcome payments from government agencies (An independent evaluator shall be retained to assess the final
Page 17
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
results of a social impact program before releasing the funds appropriated by impacted government agencies. A sinking fund may be created.) The basic ecosystems of the Infrastructure Fund and Social Impact Fund are illustrated in Figure 3 and Figure 4. Figure 3. How Infrastructure Fund Works Public Sponsors (the District and Federal)
TA, Coordination, and Negotiation
TA and Coordination Grants and/or Bonds
Shared revenue, and captured economic benefits and efficiency savings
Infrastructure Fund of the Trust Procurement & Contract Management
Private Investors
Debt and/or Equity
Program fees
Repayments and/or Performance-based ROI
Special Purpose Entity (to enter partnership agreements) Maintenanc Maintenanc ee and and Rehabilitati Rehabilitati on on
Design Design and and Constructio Constructio nn Job creation and other economic benefits
Operations Operations E.g., user fees and taxes, parking, etc.
Efficiency savings and job creation
Figure 4. How Social Impact Fund Works Impacted Government Agencies
Savings
Service Intermediary and Service Providers
Innovative Services
Beneficiary Groups
Working Capital Distributions Performance-Based Payments
Social Impact Fund of the Trust
Performance Assessment
Independent Evaluator
Upfront Capital Repayments + Capped ROI on results Partial Credit Guarantee if the program fails
Guarantor
Page 18
Private Sector Investors
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
Box 2. High-Level Project Selection Criteria – Infrastructure Fund Project selection should be output-oriented, instead of input-oriented. Scale and Complexity • Financial threshold: large enough to offset the transaction costs of P3s ($50 million) • Project Complexity: the necessity to effectively leverage private sector innovation and expertise Funding Sources • Quantity and quality of revenue streams (direct, indirect but dedicated, predictable, bondable, and stable in the long-term) • Government co-funding (District, Regional, Federal) • Private financing (debt, equity, hybrid) • Value capture mechanisms (joint property development, BID, TIF) Risk Transfer • Ability to transfer project risks to the private sector on a long-term basis • Optimal risk allocation: ability to efficiently align risks with rewards Bundleability and Connectivity • The ability to bundle/package with other projects to increase their investability and improve project efficiency • The project interfaces with existing and planned projects. Market Appetite • Market gap: to mitigate the risk of crowding out traditional private financing • Market interest: the ability to raise sufficient private funds and the ability to develop a competitive process Policy Priorities • Satisfying public needs • Policy objectives (Mayor’s priorities, Federal interest, potential for regional collaboration) Broader Benefits • Economic (job creation) • Social (community building) • Environmental (less pollution) • Innovation (technical, financial)
Page 19
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
Keys for Success • • • •
• •
Secure solid political will and sufficient private interest Sufficient financing capacity to sustain a healthy volume of large and complex capital investments Clear and well-defined project selection criteria. (See Box 2.) A set of standardized guidelines for developing financing structures and contract negotiation o To attract potential investors and developers (need a clear set of rules of engagement) o To maximize efficiency – aligning incentives and shifting appropriate life-cycle risks to investors o To protect public interest – the public sector retaining a certain level of control Sufficient in-house staff capabilities (e.g., technical assistance and knowledge sharing; intergovernmental coordination) High standards of transparency and accountability
IV.
Conclusion
The District of Columbia faces a number of trends including increased population; infrastructure that is reaching the end of its useful life; demand from residents for additional transportation investment; everincreasing federal austerity; and an increasingly restricted capital borrowing position resulting from the city’s self-imposed debt cap. If we do not think innovatively and accelerate capital investments, this trend will lead to compounded investment requirements in the future. While ultimately we need to right D.C.’s fiscal system to enable the sustainable growth of the city and the region, right now, with the concern of “sequestration” and political gridlock, attracting additional private investment through various innovative financing tools offers a promising way to invest in large scale and expensive improvements in a vastly expedited manner. To address this need, the Federal City Council proposes the creation of the D.C. Public-Private Development Trust as a means to leverage private money to fund the city’s vital infrastructure improvements, green energy initiatives, government efficiency investments, and preventive social services in the decades ahead. In addition to tapping into new funding sources, the Trust would serve as a streamlined facilitator partnering with government agencies, private investors, and other stakeholders to enhance the efficiency of financing structures and project delivery by developing the city’s P3 market, and making financial flows more result-oriented. D.C.’s private sector is not fully unleashed. Now is the time to unleash it.
Page 20
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
Appendix I: D.C. Possible Projects D.C. Possible Projects: •
Transportation Projects: o Union Station including H Street Bridge; o Downtown Congestion; o Maryland Avenue SW; o National Mall Flood Control/Parking; and o Streetcars
•
Government Operations: o Energy Efficiency; and o Tourism Promotion;
•
Social Impact Bonds: o Special Education Facilities; o Anti-Recidivism; and o Job Training
•
Economic Development Priorities: o Poplar Point; o St. Elizabeths Hospital; o Walter Reed; o McMillan Reservoir; and o Soccer Stadium
•
Utility Infrastructure: o Underground Power Lines; o National Mall Flood Control/Parking; and o Bloomingdale Flood Mitigation
Page 21
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
Appendix II: Major Capital Initiatives Could Help D.C. to Achieve Great City Qualities
Source: Building the Best Capital City in the World, a joint report by DC Appleseed and Our Nation’s Capital, December 2008. 1 Includes road and bridge improvements for Anacostia Crossings Note: a unique identity/sense of place and vibrant neighborhoods are also major components of a great city. They are not listed on the matrix although each of the capital initiatives would contribute to these components.
Appendix III: Two Main Options of Traditional Financing for Infrastructure
Source: Closing America’s Infrastructure Gap: The Role of Public-Private Partnerships, Deloitte Research, 2006.
Page 22
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
Appendix IV: California I-Bank Program Details
Page 23
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
Source: California Infrastructure and Economic Development Bank (I-Bank) Programs Fact Sheet.
Page 24
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
Appendix V:
Different P3 Delivery Models
Source: Closing America’s Infrastructure Gap: The Role of Public-Private Partnerships, Deloitte Research, 2006.
Page 25
DRAFT – NOT FOR DISTRIBUTION April 15, 2013
References U.S. GEN. ACCOUNTING OFFICE, GAO-03-666, DISTRICT OF COLUMBIA STRUCTURAL IMBALANCE AND MANAGEMENT ISSUES 42, 2003. America’s Infrastructure Gap: The Role of Public-Private Partnerships, Deloitte Research, 2006. Building the Best Capital City in the World, A Joint Report by DC Appleseed and Our Nation’s Capital, December 2008. Outlook for Global Infrastructure, UBS Global Asset Management, 2009. Innovative Finance of Development Solutions, Initiatives of the World Bank Group, 2010. Paving the Way: Maximizing the Value of Private Finance in Infrastructure, World Economic Forum and PwC, 2010. Liebman, Jeffrey B., Social Impact Bonds, Center for American Progress, February 2011. Public-Private Partnerships to Revamp U.S. Infrastructure, The Hamilton Project, February 2011. Moving Forward on Public Private Partnerships: U.S. and International Experience With PPP Units, Brookings-Rockefeller Project on State and Metropolitan Innovation, December 8, 2011. Challenges and Opportunities Series: Public Private Partnerships in Transportation Delivery, U.S. Department of Transportation, May 2012. Infrastructure Banks and Surface Transportation, Congressional Budget Office, July 2012. Bringing Social Impact Bonds to New York City, Mayor Bloomberg’s presentation, August 2012. Banking on Infrastructure: Enhancing State Revolving Funds for Transportation, Brookings-Rockefeller, September 2012. Innovative Infrastructure Financing, Accenture Management Consulting, November 26, 2012. Frequently Asked Questions: Social Impact Bonds, Center for American Progress, December 5, 2012. Chicago Infrastructure Trust Ordinance. Chicago Infrastructure Trust Bylaws. 2012/2013 DC Development Report, Washington DC Economic Partnership.
Page 26