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FDI: Where next for global investment in the UK construction industry?

Foreign direct investment has been increasing across all sectors of the UK economy – including in construction and infrastructure. What impact will this have on these sectors and why is the UK an attractive place for foreign investors?

The growing influence of overseas investors and contractors in UK construction and infrastructure has been a hot topic in recent years market.

The emerging influence is part of a wider trend of increasing foreign direct investment (FDI) across all sectors of the UK economy.

This trend prompted the prime minister to boast in June last year that “the scale of foreign investment is a huge success story, which shows that Britain is the place to do business”.

The numbers certainly appear impressive. The most recent UKTI report on inward investment confirmed the UK’s ongoing status as the leading destination for FDI in Europe, after attracting nearly 2,000 projects in 2014/15 (12 per cent higher than in the previous year).

But this is measured across the full spectrum of the economy, and the concept of ‘projects’ for these purposes carries a wide definition. A large proportion of these simply comprise the establishment by foreign businesses of outlets to market their own goods and services.

So does the hype reflect the real situation on the ground?

Why so much FDI?

The principal reasons for the UK’s attractiveness are probably threefold.

First and foremost, it provides a safe haven for investors’ money, with a historically stable political, social and regulatory environment.

“A vote to leave the EU on 23 June would bring into question the UK’s hard-won reputation as a stable investment environment”

Secondly, the government has taken proactive steps to support FDI. An example is the UKTI’s Regeneration Investment Organisation, a “one-stop shop… to help international investors identify and fund regeneration opportunities in the UK”, according to the prime minister.

The government has also provided assurances to the infrastructure investment market via the UK Guarantees scheme.

Furthermore, it is willing to assume construction risk – in extremis – on the Thames Tideway project (which also has the attraction to its institutional investors of being able to rely on the stable, regulated revenue stream provided by Thames Water customers).

Clyde and Co FDI graphics infrastructure

Clyde and Co FDI graphics infrastructure

Finally, there’s a lot of assets to invest in, whether it be prime commercial and residential property in London and key regional cities, or an eye-catching pipeline of major infrastructure projects in (principally) energy, transport and the utilities.

This infrastructure pipeline has been neatly analysed and packaged in the plans and reports issued by the National Infrastructure Commission and the Infrastructure and Projects Authority – the latest being last month’s National Infrastructure Delivery Plan.

Threats to investment

But, as always, where there are strengths in attracting foreign investment, there are corresponding threats.

Whatever your position on Brexit, a vote to leave the EU on 23 June would bring into question the UK’s hard-won reputation as a stable investment environment.

Long-standing treaties and laws will need to be unravelled and new ones put in their placem, while demands for independence would likely come to the fore once again in Scotland.

There is already a broad consensus in the market that the uncertainty of the referendum’s outcome is having a chilling effect on investment decisions. Whatever your view on the merits of the EU itself, it seems clear that the only way to remove this in the short term would be via a vote to remain and retain the status quo.

As for the detailed impact of Brexit on the industry, the imperative to maintain the UK’s international standing, and to continue trade and co-operation with our international partners, may mean that there will be less practical change than some might anticipate, in respect of a whole swathe of regulation on public procurement, employment, health and safety, and the environment.

Unfortunately the same may not be true in the case of the financial support provided to infrastructure by institutions such as the EIB, which amounted to €5.5bn in 2015.

“Investors from the Middle East have long seen the UK as prime territory, with a historic focus on the real estate market”

While the government deserves credit for its persistent and high-level support of the industry, there have been previous examples of changes in direction that have been less reassuring for investors.

These include the slaying of the Building Schools for the Future programme, the slow death of the private finance initiative, and the neglect (to date) of its offspring, PF2. Even Transport for London’s cancellation of the tube PPPs may come back to haunt it, when the Silvertown Tunnel PPP eventually comes to market.

More recently, the renewables sector is feeling bruised by the government’s reduction of support for solar and onshore wind and its ‘job done’ attitude to energy-from-waste. The recent cooling of enthusiasm for tidal lagoons, all under the (in itself understandable) banner of protecting the consumer from relentless price increases, has drawn industry criticism.

As for the pipeline of investable projects and assets, its momentum remains subject to the cyclical and apparently insoluble problems of price increases, lack of capacity and skills shortages. There is also the risk of over-supply in the commercial and high-end residential property markets, and the general inertia of public procurement.

That’s to say nothing of the political dramas over EDF’s investment decision on Hinkley Point C, or the government’s much-delayed and agonised choice on a new runway at Heathrow or Gatwick.

So the broad picture on FDI throws up as many uncertainties and challenges, as it does answers and opportunities. But how do these issues manifest themselves in some specific examples of FDI initiatives, at different stages of development?

Laying foundations

Investors from the Middle East have long seen the UK as prime territory, with a historic focus on the real estate market.

The government has increasingly sought to facilitate interest from the region, with strong efforts over the last 15 years to establish the UK as the leading centre for Islamic finance outside of the Middle East.

Clyde and Co FDI graphics real estate

Clyde and Co FDI graphics real estate

This encompasses a wide variety of products and structures that are compliant with the principles of Islamic jurisprudence, or Shari’ah (which prohibit the charging of interest, and speculation, in commercial transactions).

The government’s objective has been to make investment in the UK straightforward for anyone requiring Shari’ah-compliant terms. Indeed, in 2014, the UK became the first European country to issue a sovereign sukuk (an Islamic bond) to a value of £200m, and more than 20 international banks now offer Shari’ah-compliant products in the UK, more than double the number in the US.

This progressive stance and openness towards Islamic financing has meant that the UK is at the forefront of the development of what was previously seen as ‘non-conventional’ financing.

“In 2014, the UK became the first European country to issue a sovereign sukuk (an Islamic bond) to a value of £200m”

In recent years, Islamic finance has funded or been involved in syndicated funding for several major UK developments – at the Shard, Chelsea Barracks, Harrods and the Olympic Village.

The hope is that the active encouragement of this growing sector of finance should give rise to a significant increase in Islamic-financed projects in the coming years.

A work in progress

While the dominance of the US as the largest source of inward investment into the UK is unlikely to be challenged anytime soon, it is conceivable that China may pull away from the chasing pack in the next few years, and eclipse more traditional investment partners such as France, Germany and Japan.

Indeed, if success in this respect were to be measured by media coverage alone, the Chinese would already be disappearing over the horizon.

In October last year, David Cameron welcomed president Xi Jinping for the first state visit from China in 10 years and both governments heralded this as a new, golden age in Sino-British relations and investment.

Clyde and Co FDI graphics China

Clyde and Co FDI graphics China

In fact, the UK has already proved to be more open than most countries in welcoming Chinese investors. Unsurprisingly, commercial property in London has led the way, including Dalian Wanda’s Nine Elms development, and the Chinese are also making a significant contribution to the seemingly unstoppable growth of Manchester (see below).

The government has, of course, also encouraged Chinese investment in the nuclear power industry.

EDF and its Chinese partner, China General Nuclear Corporation, have “committed” to Hinkley Point C – even if the small matter of approval by EDF’s board and the finalisation of legal documentation remains outstanding and uncertain.

“The chancellor has been keen to dangle the carrot of future involvement in HS2, even if there doesn’t currently seem to be an obvious gap in the gallery of UK and European contractors making up the shortlisted consortia”

Perhaps less imminent than Hinkley Point is Chinese investment in UK high-speed rail. China has developed its own impressive network at breakneck speed, not just to meet domestic demand, but also to showcase its capability overseas.

In this respect, the chancellor has been keen to dangle the carrot of future involvement in High Speed 2, even if there doesn’t currently seem to be an obvious gap in the gallery of UK and European contractors making up the shortlisted consortia for the project.

Its chief executive Simon Kirby told Construction News last week he would “be surprised” if Chinese firms didn’t bid for rolling stock and systems deals.

Even if the Chinese can reconcile themselves to the snail’s pace of planning and procurement in the UK, however, their favoured model of maximising their return on investment, by actually building and supplying the assets themselves, is likely to prove challenging, both in the UK and the wider European context.

Although the deal to build their own reactor at Bradwell (assuming Hinkley Point C goes ahead first) may prove an exception, there appears to be a growing recognition that the way forward on the contracting side will be through acquisitions from the local supply chain. It remains to be seen to what extent this becomes a reality for the industry in the UK.

Powering ahead?

One of the selling points (literally) of the chancellor’s trip to China last September to promote UK plc was the Northern Powerhouse, and all of the opportunities for investment that it affords – so much so that it even merited its own glossy brochure for the trip.

At the forefront of this has been Manchester, reaping the accumulated benefits of years of assiduous and astute management and development by its local leaders. Indeed, the city provides something of a template for investment from the two global regions that we’ve just discussed.

Clyde and Co FDI graphics jobs

Clyde and Co FDI graphics jobs

As yields have become compressed in London and the South-east, overseas investors have been attracted to Manchester as a strategic alternative. Good connectivity, devolution, a stable local government and business-friendly policies are all major attractions.

Manchester was initially a tentative location, but it is clear that investors are now more confident, particularly when projects are underpinned by the same quality and national/international covenants that would underpin investments in London.

“Despite successes to date there is an assumption that, as Manchester prices - relative to investment income - are driven up due to supply and demand, investors will look elsewhere”

An example of a key project with foreign backing is Airport City, an £800m business park with investment from Beijing Construction and Engineering Group and the International Construction Bank of China. The airport itself will include a £130m China Cluster to provide Chinese firms who re-locate to Manchester with a “soft landing”.

At the time of President Xi Jinping’s visit to Manchester, it was also announced that Beijing Construction and Engineering Group would invest in Salford’s Middlewood Locks Urban Village.

And a Chinese sovereign wealth fund was among the consortium of investors that acquired One Angel Square, part of the major Noma development by The Co-operative Group.

High-profile Middle Eastern investment is best illustrated by Abu Dhabi’s ownership of Manchester City Football Club and its surrounding land, as well as its investment in Manchester Life (a £1bn fund investing in residential projects around East Manchester). This is a key component of Manchester Place, a Manchester City Council project for promoting overseas investment.

Meanwhile, Abu Dhabi’s £70bn investment vehicle, Mubadala Development Company, is investing in Manchester University’s £170m Fallowfield campus development.

Despite these successes to date, there is an assumption that, as Manchester prices – relative to investment income – are driven up due to supply and demand, investors will look elsewhere.

Will they look at other Northern or Midlands cities, or move back to London?

Wherever the next investment hotspot appears, it will wish to adopt at least some of the strategies that have contributed to Manchester’s leading role in attracting FDI to the UK’s regions.

And the combination of strong UK government support, a stable investment environment, and a large project pipeline seems set to ensure that FDI will continue to make its way to UK shores for some time to come.

Robert Meakin, Liz Jenkins, Adil Hussain, Andrew Rourke and Stelios Coutsavlis are partners at Clyde & Co

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