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Encouraging California Pensions to Invest in Resilient Infrastructure in California – a Win/Win Opportunity

Incentives for CA pensions to invest in resilient infrastructure –

how to help pensions to do what both the Governor and Legislature have asked for

California needs $500 to 900B over the next ten years for resilient infrastructure due to climate change impact from wildfires, coastal erosion, floods, landslides, access to clean drinking water and planned power shutdowns

Governor Newsom’s 2019 Executive Order seeks to leverage >$700B in California pension assets to advance California’s climate leadership
California state law (Gov. Code Section 7514.2) encourages California pensions to prioritize investments in instate infrastructure over other infrastructure investments

Thus, it is clear that our leaders recognize the need to tap these large capital pools for the State’s urgent need for resilient infrastructure.
This capital is needed in addition to the State’s issuing bonds and the Infrastructure Bank, which alone or combined cannot meet the State’s infrastructure needs


Q: Why haven’t the pensions responded yet?

A: The primary reason is that they don’t like risk.  The need a demonstrated proof of concept generally before they will make a particular set of investments. And, they generally only invest where there is an established track record. California pensions invest infrastructure projects around the world (but not much if any in California) that are well understood, established and demonstrated that have been built over and over again, like public buildings, airports and water treatment facilities.  In some cases, they invest directly where they have hired in house staff and in other instances they make investments in private equity funds dedicated to infrastructure. Most California pensions do not have large in-house staffs; therefore, their direct investments tend to be co investments in large projects with other investors. Investments in private equity infrastructure funds are generally 10-year commitments that also carry high fees and costs plus an obligation to pay the fund owners a share of any profits (known as a carried interest).  The projects the private equity infrastructure funds invest in also tend to be large standardized investments much like those the pensions directly invest in, but with a high fee/cost structure.

Q: How to get CA pensions to invest in California resilient infrastructure that they haven’t done before?

A: We need to address and eliminate the risks to the pensions in order to turn the Governor’s and the Legislature’s encouragement into actual investment of pension dollars into the resilient infrastructure projects our local communities need.  That can be done, at very low cost. It just takes a willingness to lead and innovate. The Legislature and Governor can do this by passing the Resilient Infrastructure Financing Act, ABXX. The proof of concept risk could be addressed by setting up a State Task Force (involving expert representatives from across the government including environmental and department of finance) that would establish project criteria based upon best practices and climate goals. Local communities could define the types of projects they urgently need that fit those criteria as well as identify how to pay for them over 20-30 years (new local taxes, special districts, fees, rate base etc. all determined locally) and how they would address local planning and zoning compliance, all of which reduce project risk. The Task Force would vet and evaluate the projects against the criteria, including the repayment risk, to certify projects that would be eligible for investment. The State would contract with or make a grant to one or more for profit qualified direct investment vehicles (that are defined in the bill) to help the Task Force establish the criteria, manage stakeholder and local outreach and support the Task Force as it gets started as well as to build at least two demonstration projects from the initial projects certified by the Task Force. 

This is the proof of concept. It shows the pensions that there are in fact resilient infrastructure projects ( and a mechanism for producing future deal flow) that can be identified, certified and built with an acceptable repayment risk (essentially the creditworthiness of the local community).

An established investment track record is also needed. The qualified direct investment vehicles that will be formed to invest in these potentially smaller and in some cases new types of infrastructure (think microgrids with battery storage to eliminate the impact of planned power shutoffs and help protect against wildfires) will not have an established track record.

The solution to the lack of established investment track record is to make the investments in Task Force certified local resilient infrastructure projects essentially risk free so the pensions would be willing to invest in the qualified direct investment vehicles. The pensions should be comfortable ultimately committing significant capital as a guaranteed 7% return over 20-30 years is superior to most, if not all, of their other investments.

The beauty of the RIFA approach is that the pensions should be comfortable finally doing what the Governor and the Legislature have wanted, the State gets access to billions of dollars of capital in projects generated at the local level. And, the program has been designed to manage risk at every level, starting with the backstop risk. This is in no way a blank check.  The 7% backstop only applies if the local community cannot pay what they committed to do. But, before the project is even certified and eligible for financing, the Task Force representatives from the department of finance would assess the repayment risk. The Task Force is in the position to scale up the number or shut down all new projects depending on the its assessment of risk and the actual performance of projects in the field.

Project risk is mitigated by having the projects come from the local communities who upfront define what they actually need and what can actually be built politically in locally. This bottoms up approach also lets the local community determine how they can pay for the projects over time. Local buy in upfront reduces risk.

The qualified direct investment vehicle(s) that receive the initial grants or contracts from the State for the proof of concept work are fully accountable to deliver on the Task Force support and the two demonstration projects. The qualified direct investment vehicles will be owned and controlled by pensions with at will employees who are paid market rates and eligible for employee stock options. The pensions control the board and budget. The employee teams can be replaced if they are not performing.

Since the qualified direct investment vehicles are for profit they are motivated to deploy as much capital as they can in certified projects. This addresses the risk of delaying urgent investment worthy projects.  The Task Force can ameliorate any environmental concerns via the certification criteria. RIFA will result in a number of good paying jobs throughout the state and included a prevailing wage requirement. 
The market can work its magic once the proof of concept is done and the backstop in place.

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