Come back bankers – all is forgiven

Financial engineers. You could be forgiven for holding them in contempt after their starring role in the banking fiasco that led to the fall of Lehman Brothers and the mire that construction is now wading through.

Loathsome beasts, I hear you say. But the talents of financial engineers could prove vital in thawing billions of pounds worth of frozen projects and generating construction work through the more efficient tapping of private (and indeed public) funds.

I claim no great knowledge of this subject, but I suspect if I threw a stick randomly into one of the major management consultancies, it would land close to some of these financial toolmakers. So, too, if I threw it in the direction of the City or the smart Mayfair streets where hedge fund managers hang out.

These are the guys that know how to slice, dice, package and sell risk. And, with a bit of training and the input of other industry-based experts, they appear to be the ones most likely to be able to deconstruct project risks and repackage and sell them to the financial markets.

Why is that important? Surely that is what developers do? Well, in a tough market developers generally retreat. It’s the smart move. They know better times will arrive and they know they can sit it out and wait.

The question is whether, with a different approach to financing and a different appetite for risk, projects might be freed. Maybe not all, but the point is, if financial models were re-engineered, if risks were reallocated or passed on and new funding streams were found, there would be more work for contractors.

Let us consider one idea now being examined: the “pay as you save” scheme being explored by the Energy Saving Trust with funding from the Department of Energy and Climate Change, which the UK Green Building Council has been promoting for some time.

The basic concept is simple. Raising, say, £5,000 or £10,000 to buy energy saving kit would be beyond the reach or interest of many homeowners, so why not finance the improvements out of future savings?

The industry does not appear to be looking to create opportunities. Rather it wants featherbedding from
the government in the form of ready-made packages of work

Assess the risks. Is the capital cost realistic? How best can it be controlled, and what are the associated risks? Are the paybacks realistic? What is the default risk and how might it be reduced? What other risks need to be taken into account, such as energy price fluctuations, interest rates, exchange rates and inflation? Then structure a package or packages to sell to the markets.

Okay, so, simply put, you do your basic sums, feeding in the variables for hedging for risks such as fuel price changes, interest rate or exchange rate fluctuations, make sure contracts with the supplier and the customer are tied down sufficiently and you are insured against defaults, and you have a package that either works or doesn’t, given your particular appetite for risk.

The industry does not appear to belooking to create opportunities. Rather it wants featherbedding from the government in the form of ready-made packages of work.

Or how about “neighbourhood bonds” for regeneration projects? Why not seek to sell bonds or shares in a project to neighbours (local residents, businesses, landowners, long-term commercial tenants), or indeed prospective tenants and residents within the project?

The bondholders/shareholders would not only receive a dividend but would also benefit from the capital value uplift from the regeneration. And you could give the neighbourhood bondholders collectively a seat on the project board to improve local engagement.

This might provide cheaper capital finance than is available from the market and so capture some of the value of the “regen uplift” that normally drains into the sands. It might also provide a useful vehicle for targeted tax breaks in priority development zones.

We have heard much talk of tax increment financing (that is, using the likely increase in taxes stimulated by a development to pay for the development) over recent years, and it has been used successfully in America. And there will be other tools that might be considered. But to pull these together you need smart financial engineers working alongside smart technical engineers and smart commercial people.

If the construction industry could attract such people and provide them with a career path, it might find it becomes less reliant on clients and more reliant on its own wit and wherewithal. And I for one would rather have these boffins working on developing financial tools to help create real things like buildings than dabbling in the alchemy that creates bizarre “products” in the financial markets.