Investment Instruments

Note:

This Toolkit item relates to Part 2 - Investment Governance, Funding and Financing of the Commonwealth Investments Resource Management Guide.

Key considerations when choosing an investment instrument

Alternative financing using the right investment instrument can provide benefits to the Government including increased involvement in project delivery decision-making, the opportunity to build and recycle capital and the opportunity to better allocate risk between parties.

Where there are barriers to the private sector achieving commercial returns, well-directed and well-timed Government financing can unlock private sector investment. Options include:

Equity: involves the Government taking an ownership interest in a business with an expectation of financial returns over the longer term. Having the Government as an equity partner can reduce costs and risks for private investors. Alternatively the Government may be the sole owner at the early stages of greenfields projects, but bring in private investment once a project is more mature and less risky. In general, equity investment requires that the Government has a higher tolerance for risk and loss than other investments like loans. For example, the Commonwealth provided the NBN Co equity in exchange for ordinary shares. NBN Co only has fully paid ordinary shares in issue, all of which are owned by the Commonwealth.

Guarantees: involves the Government taking on financial obligations if certain risks eventuate. Government guarantees reduce the risk to private sector partners and can strengthen a project’s credit profile to attract private sector financing instead Government financing. For example, the Government provides guarantees through the Accommodation Payment Guarantee Scheme for the repayment of aged care residents’ refundable accommodation payments if the approved provider becomes insolvent or bankrupt and defaults on its refund obligations.

Commercial Loans: to support projects and priorities as a debt partner until projects are sufficiently developed to be wholly supported by private sector financing. Government debt financing is generally used to bridge a commercial market finance gap. For example, the Government has provided a loan on commercial terms to NBN Co so it can focus on the remaining rollout as it significantly scales up toward completion in 2020.
Where there is no private financing compatible with the Government’s policy objectives, investment options include:

Concessional Loans: which can be provided when a proposal is expected to generate some financial return but private financing is either unavailable or unaffordable. Features of concessional loans include more favourable terms than terms offered by private debt markets. For example, the Commonwealth provides a concessional loan facility to a company wholly owned by the Sydney Motorway Corporation to finance a motorway.

Characteristics of investment instruments

There are a number of considerations to be balanced in determining the most appropriate alternative financing option (or blend of options). The pros and cons outlined for each option listed below are assessed from the perspective of the Government taking the role as investor.

The stated policy objectives of the project or program will help guide which considerations carry the greatest weight.

Investment Instrument	Equity Injection (Part-Ownership)	Equity Injection (100% Commonwealth ownership)	Guarantee	Commercial Loan (Market Gap Finance)	Concessional Loan	Grant
Ability to influence financed objective Ability for the Government to provide direction in relation to the investment	Medium control	High control	Low control	Medium control – depends on loan conditions	Medium control – depends on loan conditions	Low-medium control
Level of market intervention The significance of the intervention in the market and how determinative the instrument will be on future market conditions	Medium intervention	High intervention	Low-medium intervention – depends on the value of the risk guaranteed	Medium intervention	Medium intervention	Low-medium intervention
Commercial discipline incentive The financial discipline achieved through the structure of the investment	Low-medium incentive	Low-medium incentive	Low incentive	High incentive	Medium-high incentive	Low incentive
Certainty of financial return Probability of the investment making a financial return	Low certainty	Low certainty	Nil or high certainty (if fee charged)	High certainty	High certainty	Nil certainty
Opportunity to realise upside gain The ability for the financier to benefit from over performance	Medium-high capacity	High capacity	Nil capacity	Nil capacity	Nil capacity	Nil capacity
Level of financial risk The potential loss of the investment instrument	High risk	High risk	Medium risk	Medium risk	Medium risk	Not applicable
Security of asset The reduction of financial risk that can be achieved through the ability to structure the instrument	Low security	Low security	Nil security	High security	High security	Nil security
Administration cost Governance and management costs of the investment	High administration	High administration	Low administration however Medium-high if called	Medium administration	Medium administration	Low-medium administration

Budget classification

In addition to the Finance Advice Paper - General Principles for Recognition of Expenditure in Budget Aggregates, the below table sets out the implication on key Budget aggregates of the different investment instruments:Note - the PDI impacts are reported as a consolidated line item at the Whole-of-Government level.

Statements		Cash Flow Statement		Operating Statement		Balance Sheet
Metrics		Underlying Cash Balance	Headline Cash Balance	Net Operating Balance	Fiscal Balance	Net Debt	Net Financial Worth
Equity	Initial	No impact	Worsens by value of equity injection	No impact	No impact	Worsens by value of equity injection	No impact
Equity	Ongoing	Dividend improves PDI worsens	Dividend improves PDI worsens Sale improves	Dividend improves PDI worsens	Dividend improves PDI worsens	Depends on differential between PDI and dividends	Depends on valuation of equity and differential between PDI and dividends
Guarantee	Initial	No impact on establishment	No impact on establishment	Worsens as recognise obligation to pay	Worsens as recognise obligation to pay	No impact on establishment	Worsens as recognise obligation to pay
Guarantee	Ongoing	Worsens if guarantee is exercised	Worsens if guarantee is exercised	No impact (assume value of guarantee remains constant)	No impact (assume value of guarantee remains constant)	Worsens if guarantee is exercised	Improves after guarantee expires
Commercial Loan (Market Gap Finance)	Initial	No impact	Worsens by value of principal payment	No impact	No impact	No impact	No impact
Commercial Loan (Market Gap Finance)	Ongoing	Improves by differential between interest and PDI	Improves by differential between interest and PDI, and principal repayments	Improves by differential between interest and PDI	Improves by differential between interest and PDI	Improves by the differential between interest and PDI (assuming no revaluation)
Concessional Loan	Initial	No impact	Worsens by value of principal payment	Worsens by value of concession (which is unwound)	Worsens by value of concession (which is unwound)	Worsens by the value of the concession	Worsens by the value of the concession
Concessional Loan	Ongoing	Interest improves PDI worsens	Interest improves PDI worsens Principal repayments improves	Interest improves PDI worsens Value of concession unwinds over course of the loan	Interest improves PDI worsens Value of concession unwinds over course of the loan	Improves/Worsens depending on differential between interest and PDI (assuming no revaluation)
Grant	Worsens by value of grant (and PDI impact)	Worsens by value of grant (and PDI impact)	Worsens by value of grant (and PDI impact)	Worsens by value of grant (and PDI impact)	Worsens by value of grant (and PDI impact)	Worsens by value of grant (and PDI impact)

Note - the PDI impacts are reported as a consolidated line item at the Whole-of-Government level.