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Caisse de dépôt seeking higher returns

- Scott Deveau

Caisse de dépôt et placement du Québec, Canada’s second-biggest pension fund, has developed a unique model for infrastruc­ture investing in its home province of Quebec. The Caisse has struck a deal with the local transit authority in Montreal to develop a 67-kilometre rapid transit network, known as the Réseau express métropolit­ain (REM), in conjunctio­n with funds from the provincial and federal government­s. The whole project is expected to cost $6.32 billion, with the first trains scheduled to run in early 2021. Michael Sabia, chief executive officer of the Caisse, discusses the project and the bumps it’s encountere­d.

Q: How does this investment differ from the other infrastruc­ture investment­s the Caisse has made? A: It’s the first time a pension fund has ever done this. There are two differenti­ating elements here. The first is that this is an entirely greenfield project. I’ ll give you the history. The government did not have the financial wherewitha­l to pay for two projects it initially presented to us as something that needed to be done. The one was a link from the South Shore suburbs to downtown, and another one was a link from downtown toward the West Island. We looked at that and decided that wasn’t the best solution and that the best solution was to build a new integrated network that would run from the North Shore to the South Shore and from downtown to the West Island to the airport. It was an entire network that we proposed to build and connect to the existing Métro system — much bigger than the original plans. Our role was from conception, developmen­t and planning, financing, and overall overseer and project manager. We will build it. We own it. We will operate it. It’s from nothing to an operating transit system, and we’ve been responsibl­e for the total span of that.

Differenti­ation No. 2 is in the financing of it. There we’ ll have 53.5 per cent of the equity in the business, and the two levels of government (provincial and federal) will have subordinat­ed equity both in the amount of 23.3 per cent each. The way that works is that we are able to earn a return of something of the order of eight per cent or nine per cent. The two levels of government earn a return of up to approximat­ely 3.8 per cent each, which is significan­tly higher than their cost of borrowing. Typically, government­s finance these things as an expense where they get no return whatsoever and they borrow the money to do it.

Q: Pension funds usually prefer to buy assets that are mature, or so-called brownfield assets, because it removes the risk associated with building the infrastruc­ture. So why have you decided to go for greenfield assets?

A: Because it’s not the only thing we’re going to do. In other parts of our infrastruc­ture business, we continue to do more traditiona­l brownfield. But we think that the market is changing. Having conceived, planned, developed, owned and operated infrastruc­ture is an important differenti­ator for us in the years ahead. It’s, in effect, new product developmen­t. It’s what we’re doing to differenti­ate ourselves in a market that we think is increasing­ly commodifie­d and where brownfield assets are becoming very expensive to prohibitiv­ely expensive.

Q: The eight per cent to nine per cent return is typically a little smaller than what you would get on an infrastruc­ture investment, isn’t it?

A: Well, no, I wouldn’t say so. There are brownfield deals being done at astonishin­gly low rates of return. There have been recent things in the market getting done at 5.5 per cent or six per cent. That sort of demonstrat­es the extent to which investor interest in infrastruc­ture is bidding down brownfield returns. That’s why we want the capability of delivering greenfield because we do believe there is a significan­t dividend so long as you believe you can manage the risks. Those are the capabiliti­es we are developing.

Q: Those lower returns are a function of increased competitio­n and billions of dollars chasing the same assets, I presume.

A: Yes.

Q: Have you had to do fairly dramatic changes internally to accommodat­e this shift in strategy?

A: Yes, we’ve had to build an entirely new team that (is capable of ) project planning, project management, engineerin­g and tender process management. We’ve had to build all those skills in an entity that will become a subsidiary of the Caisse, an operating subsidiary.

Q: Outside of Quebec, is there an opportunit­y to export this model?

A: We have had a great deal of interest in the United States from both mayors of major cities and governors of major states. I can’t go further than that, because those conversati­ons remain confidenti­al. All I can say is there has been a great deal of interest and we are actively engaged in at least two or three conversati­ons with respect to doing this in the United States.

Q: Will you have to prove out the model before those projects proceed?

A: I don’t know yet. But I’ll tell you how we think about this. Before we embark on another project of this kind, we will want to have made some meaningful progress in the actual constructi­on of the network here. We want to stay focused on making sure we deliver here, because this project has always been proof of concept in our mind. We’re using a market that we know well — Montreal — that’s right in our backyard, to prove out the concept, and then we want to take that concept in effect on the road and export it. I’m convinced there’s a very interestin­g market out there for a pension fund like ours to do these projects elsewhere. There’s also interest, a little less advanced than in the U.S., but we’ve also had expression­s of interest from other provinces.

Q: Some of the risks associated with this project have already manifested themselves: It’s gone over budget and been delayed by about a year. Does that concern you? A: We said pretty much from the beginning it would be about $6 billion to $6.1 billion, and we’re at $6.32 billion now. That’s with firm turnkey proposals from the two consortia (led by SNCLavalin and Alstom SA) that are going to build this thing. We had some negotiatin­g to do as of November, and to get that done at the prices we wanted, which we have now done, imposed a threeor four-month delay. We had said our hope was to have the first trains running on one of the lines we’re going to build by 2020. Now it will probably be in the winter or very early spring of 2021.

Q: Do you have any concerns about the pace of progress?

A: No, to be honest, this whole thing has gone better than we had expected in terms of the process of getting all this stuff approved and the financing we needed from two levels of government and the tender process, which was a very complicate­d process. We did have to do some negotiatin­g to get the prices in a zone that we thought was appropriat­e and would protect our returns. But at every turn this thing has gone reasonably well.

Q: Wasn’t the original budget meant to be about $5.5 billion?

A: No, that was before the final configurat­ion of the network. We added three stations from the initial proposal to better connect to the existing network. That and some other adjustment­s in the network itself [were made] to make it go a little farther west. Q: There seemed to be a lot of enthusiasm around the project, but lately it appears to have become a political punching bag. The Montreal mayor has called for greater transparen­cy on the terms of the deal, including its fees and noncompete clauses, and the provincial separatist party, the Parti Québécois, has even called for it to be scrapped. What do you make of these complaints?

A: There’s a lot of misunderst­anding around this. I’m not going to comment on the political situation in Quebec. You can draw your own conclusion­s. We’re just in the business of building an infrastruc­ture project, and the political class will do and say as they wish in the election season that is under way here. We will be releasing the texts of these agreements, and I think people will see there has been a lot of miscommuni­cation, so we’re going to put them out publicly. This concern about incrementa­l costs hitting the municipali­ties, there’s no issue there. We have said for the last year or year and a half that this project will cost the totality of the municipali­ties — all of them — something like a potential increase of $40 million to $60 million annually. But that’s it. They will have an entirely new transit system for that incrementa­l expense over what they’re paying today. The more recent concern is that it will be higher than that. No, it will not be higher than that. Period. Full stop.

In terms of this sort of non-competitiv­e thing, this is how the transit authority here works. It’s not just for us. It’s for other transit systems as well. The objective is really no more complicate­d than if we’re going to build a rail system over the Champlain Bridge and into downtown—it’s to protect us from somebody starting a competing bus service. If that were to be the case, then we can’t fulfil our fiduciary duties to our depositors because, all of a sudden, there’s a competitiv­e system running parallel to ours. It throws off our revenue and traffic projection­s. There’s been people here saying that it means they’re not going to be able to build any more transit systems in Montreal. That is wrong. There’s nothing in the agreements we’ve signed with the province or the transit authoritie­s here that would preclude the developmen­t of any transit system across the Isle of Montreal.

Q: You’ve had to make some tough decisions already. The decision to award train manufactur­er Alstom the train car and related equipment came as a surprise to many in Quebec because it’s a competitor to Quebec’s Bombardier Inc., whose rail division the Caisse has a significan­t investment in. How did you come to that decision?

A: Because we ran a competitiv­e process, and Alstom won. We’re an investor in a lot of companies, and many of those companies were involved in the bidding on this project. So we thought from the very beginning it was important to create a tender process that was beyond reproach. We set up very specific criteria for which the bidders would be judged. We set up a process whereby two external auditors audited everything that was done and attended virtually every meeting we had with the bidders. Then we set up a committee chaired by a former justice of the Supreme Court to oversee the whole thing so there could be no concern around conflict of interest or anything else. We went through that whole process, and our experts went through all the bids. The people who won on the rolling stock won on the merits of their bid.

Q: It’s sort of interestin­g this project was being developed outside of the federal government’s Canada Infrastruc­ture Bank, which has been set up to help finance projects like this across the country.

A: Well, yes and no. We wanted to secure the federal funding in a manner that allowed us to keep to our schedule. The federal government made a commitment to this in the amount of essentiall­y $1.3 billion with the option — and we’re working on this right now — in effect transferri­ng that investment from the federal government to the Infrastruc­ture Bank itself. So it may be that that funding comes as one of the investment­s or potentiall­y one of the first investment­s from the Infrastruc­ture Bank.

 ?? JOCELYN MALETTE / POSTMEDIA NEWS FILES. ?? Caisse chief executive Michael Sabia says the fund has “had a great deal of interest in the United States” from “mayors of major cities and governors of major states.”
JOCELYN MALETTE / POSTMEDIA NEWS FILES. Caisse chief executive Michael Sabia says the fund has “had a great deal of interest in the United States” from “mayors of major cities and governors of major states.”

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