Investment Instruments

Note:

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.

  1. 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.
     
  2. 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

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

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

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

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.


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