2.3.1 Business Risk

The first TICCS® pillar is the business-risk classification of infrastructure companies. Broad families of business-risk or business-model profiles can be identified on the basis of how stand-alone, investable infrastructure is created using different forms of long-term contracts. In turn, these are fundamental drivers of the financial structure and total risk profile of the companies. TICCS® business-risk profiles are found across various industrial activities classifications (the second TICCS® pillar).

Academic Insights

While infrastructure assets are usually understood to be tangible assets – physical structures of steel and concrete – from the point of view of financial economics, infrastructure investment is better defined as a high-sunk-cost, long-term investment in immobile, relationship-specific assets. It is contracts, not concrete, that matter.

In other words, the physical characteristics of tangible infrastructure only determine the need for long-term contracts, which in turn determine a company's investment profile. Outside of contractual and regulatory relationships, tangible infrastructure assets have no or little value. This is what fundamentally differentiates infrastructure from other so-called real assets: infrastructure is almost never a store of value. It needs to be used to have value. And its usability is entirely determined by a combination of long-term contractual commitments.

The contracts that allow infrastructure investment to take place are characterised by risk-sharing mechanisms embodied by their revenue model. While numerous risk-sharing agreements can be envisaged, in practice, three types of contractual arrangements are used:

• The first type are contracted or availability-payment schemes, by which a public- or private-sector client commits to paying a fixed income over a pre-agreed period, typically in excess of two decades. In exchange, the investor accepts more or less unlimited responsibility for the investment, operating, debt, and equity cash flows incurred to invest in the delivery of an infrastructure service, according to an agreed output specification. Terminal value can be set to zero and control of the physical assets is returned to public-sector clients at the end of the contract. This model is typically used to deliver social infrastructure projects like schools, hospitals, or government buildings. It is also common in the energy sector, such as renewable-energy projects, but it can also be found in a range of other sectors including transportation projects such as roads or port terminals.

• The second type of arrangements are merchant or commercial schemes, by which the public- or private-sector client enters into a similar long-term contract with an investor but in exchange for a risky income stream. This is typically the case with tolled transportation projects, for which an investor is granted the right to collect tolls/tariffs from users. Likewise, terminal value is frequently zero. This model is typically used for transport projects with real tolls but also energy projects connected to a competitive power or gas market, as well as privatised airports or certain rail projects. Merchant telecom companies are also common.

• Regulated schemes are typically associated with large network industries that benefit from a natural monopoly, such as water or gas utilities or power distribution networks. They require regulation in order to ensure efficient operations at a reasonable cost to end users, who are typically captive and receiving 'essential services' from the companies in question. Terminal value may not always be set to zero; for example, privatised utilities own tangible assets outright and in perpetuity. Regulators set tariffs to achieve multiple economic and financial objectives and often aim to mimic competitive market forces through so-called yardstick competition. Such schemes exist because of the universal tendency of monopolies to overcharge and underinvest (irrespective of public or private ownership). They also create up- and downside limits on business risk, which sets them apart from contracted and merchant infrastructure companies.

For a detailed discussion of these three types of arrangements and of the related academic literature, see Blanc-Brude (2013)^[1]. For a discussion of the role of contracts in infrastructure finance see Brealey (1996)^[2]. An empirical analysis of the difference of cost of capital and credit risk between contracted and merchant infrastructure business models is provided by Blanc-Brude (2007)^[3] and Blanc-Brude (2018)^[4]. For a detailed discussion of regulated infrastructure, see Gomez-Ibanez (2003)^[5].