North East JESSICA Evaluation Study - ec.europa.eu · brief, Navigant’s proposal in response to the brief, and Inception report. The study has been The study has been undertaken

North East JESSICA Evaluation Study

Final Report

23 July 2010

This document has been produced with the financial assistance of the European Union. The views expressed

herein can in no way be taken to reflect the official opinion of the European Union.

The sole responsibility for the views, interpretations or conclusions contained in this document lies

exclusively with the author, Navigant Consulting (Europe) Limited. Neither the European Commission, the

European Investment Bank nor Managing Authorities of Structural Funds Operational Programmes can

be held responsible for the accuracy, completeness or use that may be made of the information contained

therein.

This document is expressly provided to the European Investment Bank (EIB) and the Project Steering

Group. Navigant Consulting (Europe) Ltd accepts no liability of whatsoever nature for any use by any

other party.

No investment decisions should be made on the basis of any financial analysis included in this report. All

modelling undertaken has been produced on the basis of estimates and available information, and is not

intended to reflect the likely financial performance of specific projects.

Navigant Consulting

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TABLE OF CONTENTS

Figure References......................................................................................5

Table References .......................................................................................6

Glossary of Terms.....................................................................................7

Glossary of Terms.....................................................................................7

1. Executive Summary ........................................................................11

1.1 Purpose of this report 11

1.2 Introduction to JESSICA, Holding Funds and UDFs 11

1.3 Eligibility of expenditure and fit with the Operational Programme 12

1.4 Potential structure of JESSICA in the North East 13

1.5 Projects that could be funded through JESSICA in the North East 14

1.6 Criteria for selection of UDFs and Investments 14

1.7 Key risks for consideration 15

1.8 Conclusion and next steps 17

2. Introduction to JESSICA................................................................18

2.1 Overview of the JESSICA Mechanism 18

2.2 Summary Advantages of JESSICA 19

2.3 Other JESSICA Projects in the UK 21

3. Market Condition & Regional Priorities .....................................22

3.1 Regional Priorities 22

3.2 Market Gaps and Failures 24

3.3 Availability of Development Funding 25

3.4 JESSICA Potential Financial Products & State Aid 26

4. Eligibility of Expenditure and the NEOP....................................28

4.1 Overview 28

4.2 Priority 1-1 Innovation Connectors 29

4.3 Priority 2-1 Cultivating and Sustaining Enterprise 30

4.4 Which ERDF monies could be used for JESSICA? 31

5. Implementing JESSICA in the North East ..................................32

5.1 Size of JESSICA Fund(s) 32

5.2 Options for JESSICA Structures 33

5.3 Holding Funds 33

5.4 Corporate UDF structures and existing vehicles 36

5.5 UDF Legal Structures 37

5.6 Single or Multiple UDF structures 39

5.7 Potential Sources of Match Funding 40

5.8 Using Land as Match Funding 42

5.9 Set up Costs 44

5.10 Procurement and Selection of UDFs 45

5.11 Governance Arrangements 47

6. JESSICA Project Pipeline...............................................................48

6.1 Case Study Projects 48

6.2 Alternative pipeline projects 50

6.3 Investment Criteria for project selection 52

7. Risks & Mitigations........................................................................53

8. Conclusion and Next steps ............................................................58

8.1 Further work required 58

8.2 Implementation Timetable 60

Appendix 1: Market Review..................................................................61

Appendix 2: Case Study Project Summaries.......................................72

9. Approach to Hypothetical Financial Modelling ........................72

9.1 Assumptions on JESSICA financial products 72

10. Project Assessment against Investment Criteria ........................75

11. Financial Performance at Project Level........................................76

12. Financial performance at UDF level.............................................79

12.1 Single UDF 79

12.2 Two Sectoral UDFs 80

13. Project A ...........................................................................................82

13.1 Project Overview 82

13.2 Strategic Fit and Eligibility 82

13.3 Delivery Mechanism and Key Issues 82

13.4 Potential for JESSICA Funding 83

14. Project B............................................................................................87




14.4 Potential for JESSICA Funding 88

15. Project C............................................................................................91



15.3 Delivery Mechanism and key issues 92

15.4 Potential for JESSICA Investment 92

16. Project D ...........................................................................................97




16.4 Potential for JESSICA Investment 97

17. Appendix 3: Case study of Potential UDFs ...............................100

17.1 1NG - Background & Current functions 100

17.2 How 1NG might take forward a UDF 101

17.3 Investment Strategy and Operations 102

17.4 TVR and Sunderland Arc as UDFs 103

17.5 A Public-Private or Private sector led UDF 103

FIGURE REFERENCES

Figure 1: Potential benefits of JESSICA for the North East.................................................................. 12

Figure 2: Overview of JESSICA ............................................................................................................... 19

Figure 3: The Three Pillars of the North East Regional Economic Strategy ...................................... 23

Figure 4: Illustration of set up and management costs......................................................................... 35

Figure 5: Sectoral Multiple UDF Structure (Indicative only)............................................................... 40

Figure 6: Potential Selection process for UDFs...................................................................................... 46

Figure 7: Indicative Investment Selection Criteria ................................................................................ 52

Figure 8: Suggested JESSICA North East Implementation Work-streams ........................................ 59

Figure 9: Office Availability ..................................................................................................................... 63

Figure 10: New Build Supply versus Take-Up...................................................................................... 65

Figure 11: Prime North East Office Rents .............................................................................................. 69

Figure 12: Prime North East Industrial Rents........................................................................................ 69

Figure 13: Prime Office Yields ................................................................................................................. 70

Figure 14: Prime Industrial Yields........................................................................................................... 71

TABLE REFERENCES

Table 1: Summary of key risks and responses....................................................................................... 15

Table 2: Potential output categories for Priority 1.1 – Innovation Connectors ................................. 29

Table 3: Potential output categories for Priority 2.1 – Cultivating and Sustaining Enterprise ....... 31

Table 4: Potential sources of match funding.......................................................................................... 41

Table 5: Risks & Mitigations..................................................................................................................... 53

Table 6: Indicative implementation timetable ....................................................................................... 60

Table 7: New scheme development ........................................................................................................ 64

Table 8: Project information summary ................................................................................................... 73

Table 9: Summary of interest rate assumptions for JESSICA Investment ......................................... 74

Table 10: Summary assessment against proposed investment criteria .............................................. 75

Table 11: Project cash flow summary...................................................................................................... 77

Table 12: Project financing summary...................................................................................................... 78

Table 13: Financial performance at UDF level ...................................................................................... 81

Table 14: Project A - Financing summary............................................................................................... 84

Table 15: Project A - Hypothetical Development Appraisal outputs ................................................. 85

Table 16: Project B - Summary outputs from hypothetical modelling ............................................... 89

Table 17: Project B - Hypothetical development appraisal ouptuts ................................................... 90

Table 18: Project C - Cash flow summary............................................................................................... 94

Table 19: Project C - Financing Summary .............................................................................................. 95

Table 20: Project C - Hypothetical development appraisal outputs ................................................... 95

GLOSSARY OF TERMS

Term Name

1NG Newcastle Gateshead City Development Company

ADZ Accelerated Development Zones. A form of Tax Increment Financing.

Arrangement Fees Fee charged by the senior debt provider, expressed as a percentage of the

total facility size committed to the project. This term is used in the

hypothetical developer projects and reflects standard market practice.

BSSP Business Support Simplification Programme

CIL Community Infrastructure Levy

Commitment Fees Fee charged by the senior debt provider on the undrawn amount of the

facility, expressed as a percentage of the facility size committed but not

yet drawndown. This term is used in the hypothetical developer projects

and reflects standard market practice.

CPRG DCLG Central Projects Review Group

CPO Compulsory Purchase Order

COCOF Coordination Committee of the Funds

DCLG Department for Communities and Local Government

DG Competition EC Directorate General for Competition

DG Regio EC Directorate General for Regional Policy

DV Developer

EC/ The Commission The European Commission

EIB The European Investment Bank

EMUDF The East Midlands Urban Development Fund

ERDF European Regional Development Fund

ERR Economic Rate of Return

EU European Union

Enterprise Zone Areas designated by the UK government where reductions in taxation

and relaxed or speeded up business regulations or statutory controls

were offered as a means of encouraging greater private sector economic

activity in those areas. Each zone was normally designated for a fixed life

of 10 years and the final designations came to an end in 2006.

Gap Funding Funding provided to a project by the public sector, traditionally in the

form of grant to fill the gap created when costs of development exceed

development values (the revenues generated by the project).

GVA

Gross Value Added

HCA Homes and Communities Agency – the UK Regeneration Agency

HF Holding Fund

IFI International Financial Institution

Innovation

Connectors

A priority within the RES. There are 7 identified projects within the

NEOP.

IRR Internal Rate of Return

IPSUD Integrated Plan for Sustainable Urban Development

JESSICA Joint European Support for Sustainable Investment in City Areas

JV Joint Venture

JVA Joint Venture Agreement

LCEAs Low Carbon Economic Areas

LDA London Development Agency

LLP Limited Liability Partnership

LP Limited Partnership

MRV The total rental income achievable on an income-producing property.

Rental Area (m2) x Rent £/m2 = MRV.

NAV Net Asset Value of investments - The NPV (Net Present Value) of the

future projected net cash flows of investments (including all investments

made as senior debt, subordinated debt, equity if applicable, and

guarantees for third party debt), discounted at the open market rate (on

the basis of willing buyers and willing sellers).

NEOP North East Operational Programme

n+2 The requirement for ERDF funds to be defrayed on eligible expenditure

by the end of two years after the end of the programme period; in this

instance n= 2013 and n+2 = 2015

NWUIF North West Urban Investment Fund

Member State Member States that are part of the European Union

OBC Outline Business Case

OJEU Official Journal of the European Union

ONE One North East. The regional development agency for the North East.

PEG Project Executive Group (which reports to the PMC within ONE on the

NEOP)

PMC Programme Monitoring Committee

PPP Public Private Partnership

R&D Research and Development

RDA Regional Development Agency

RES Regional Economic Strategy

RICS Royal Institution of Chartered Surveyors

RIFW LLP Regeneration Investment Fund for Wales. The Welsh UDF.

RLV Residual Land Value

RSS Regional Spatial Strategy

Sunderland Arc An Urban Regeneration Company operating for the benefit of the

Sunderland sub-region.

Structural Funds Funds from the EU, targeting specific areas. The structural fund that will

be used for part of the JESSICA programme is the ERDF.

SME Small and Medium sized Enterprises

TVR Tees Valley Regeneration. An Urban Regeneration Company.

UDF Urban Development Fund.

UK United Kingdom

URCs Urban Regeneration Companies

WAG Welsh Assembly Government

WEFO Welsh European Funding Office

Yield The determinant of the multiplier used to capitalise rental income for the

investment valuation of income-producing property. Market Rental

Value (MRV) x (1/Yield) = Capital Value

JESSICA North East Evaluation Study – Final Report – 23.7.10 Page 11

1. EXECUTIVE SUMMARY

1.1 Purpose of this report

This report provides information on the work done between January and June 2010 on the

evaluation study of JESSICA in the North East, in line with the agreed methodology in the study

brief, Navigant’s proposal in response to the brief, and Inception report. The study has been

undertaken by Navigant Consulting with input from DTZ, commissioned by the European

Investment Bank (EIB) in co-operation with its regional partners. The study has reviewed the

rational for, and the commercial and financial feasibility of using JESSICA in the North East,

specifically addressing the options, risks, costs and benefits of using JESSICA, in the context of

the North East ERDF Operational Programme 2007-13.

The study has involved meetings with stakeholders, desk top research, review of potential

projects that could be funded through JESSICA, and hypothetical financial modelling. The study

has been managed with the input of a Steering Group of key stakeholders who approved the

terms of reference and have monitored the progress of the study.

1.2 Introduction to JESSICA, Holding Funds and UDFs

JESSICA (Joint European Support for Sustainable Investment in City Areas) is an initiative

developed by the European Commission and the EIB in collaboration with the Council of Europe

Development Bank (CEDB), for the use of existing European Regional Development Fund

(ERDF) allocations.

Whilst ERDF has traditionally been provided to projects as grant, JESSICA seeks to use the

monies as investment provided by an Urban Development Fund (UDF). UDFs can invest ERDF

into urban regeneration projects by means of loan, equity or guarantee. Returns on investment

can then be recycled for reinvestment in further projects, creating a lasting legacy from ERDF and

a greater volume of investment in regeneration across the region. The implementation of JESSICA

in a region can be supported by the use of a ‘Holding Fund’ which acts as an independent

intermediary between the Managing Authority and the UDFs.


Some of the potential benefits of a JESSICA in the North East are summarised in the following

diagram:

Figure 1: Potential benefits of JESSICA for the North East

JESSICA

Flexible mechanism –

develop/ expand over

time to take on further funding

streams

Projects can deliver outputs in Operational

Programme and wider benefits

Access to expertise eg.

from the private sector, IFIs and the

EIB

Integrated and holistic approach to

RegenerationMeet market

need for development finance and

take forward stalled projects

Financial Leverage;

recycling of funds – move from grant to investment

culture

Assist with n+2 targets

Recycled funds can be

directed towards broader

regeneration

1.3 Eligibility of expenditure and fit with the Operational Programme

The North East has received an allocation of ERDF from the Commission to fund the delivery of

its 2007-13 Operational programme. The priorities within this programme align closely with

those set out in the Regional Economic Strategy and Regional Spatial Strategy, with interventions

to support people, business and place. This includes investment in ‘Innovation Connectors’ – key

hubs which will encourage the development of pivotal new industries, technology and research

and development activities, as well as supporting other forms of new business and enterprise,

and the redevelopment of brownfield land.

The work undertaken indicates that there should be sufficient eligible expenditure within

priorities 1 and 2 to support a JESSICA mechanism if taken forward. In particular, priority 1, field

of action 1, on ‘Innovation Connectors’ and priority 2, field of action 1 on ‘Cultivating and

Sustaining Enterprise’ include eligible activities which fit with urban regeneration. The

Operational Programme in the North East was produced following extensive research and

consultation with stakeholders, and has a specific focus on the promotion of innovation and

development of SMEs as the strategic priority of the agency for the ERDF programme. This

means that the NEOP is more focussed in its definitions than some other regions of the UK,


although the outputs required and eligible activities could still provide an opportunity to utilise

ERDF through JESSICA. Whilst many projects could align with priority 2.1, we understand that

limited capital allocation remains in this funding stream. It may be that a JESSICA fund would

focus instead on Innovation Connectors. In order to broaden access to JESSICA across the region

and take forward key strategic priorities a review could also be undertaken as to the potential for

new innovation connectors which would align with the NEOP and would reflect recent policy

developments and updated priorities, for example around the Low Carbon agenda.

1.4 Potential structure of JESSICA in the North East

This report recommends that JESSICA in the North East would be viable using circa £20m of

ERDF, which would need to be co-financed with £20m of match funding. The size of this pot is

sufficient to justify expenditure on set up and operating costs, whilst also practically being able to

be spent within the timetable, and being available within current uncommitted ERDF funds. Set

up costs for a fund of this size could include in the region of 1-2% of fund value in upfront costs

in fund structuring, legal and financial advice. Once established, Holding Fund costs are

generally up to a maximum of 2% pa on a cost recovery basis (although it should be noted that

this can be offset against interest earned on monies held by the Holding Fund.)

Use of a Holding Fund, managed by an independent third party entity such as the EIB, is likely to

benefit the North East, as it allows ERDF to be drawn down at an early stage and provides access

to expertise and resources to take forward the development and selection of UDFs, and to

monitor the progress and performance of JESSICA. The Holding Fund could establish an

Investment Committee as part of its governance arrangements, which includes representatives

from ONE and other stakeholders, as well as the private sector.

As a rule, cash is the most straight forward source of match funding for JESSICA if available, but

given the current funding climate it is unlikely that the full £20m could be secured. A

combination of single programme monies with land and property assets provided by ONE and

other partners could provide the necessary match at Holding Fund level. Match could then be

substituted by alternative finance – for example local authority land or private sector

contributions at the UDF level. It should be noted that identifying match funding is crucial to the

success of JESSICA, and understanding what resources are available and how to ensure the fund

structure protects the interests of those providing assets to the fund is considered by stakeholders

to be a major challenge for the North East.

A one or two UDF structure may be the most appropriate for the North East at this time – this

recommendation is linked to, and needs to be taken in the context of, further work required on

both potential projects and UDFs. However, this initial view reflects the benefits of establishing a

simple structure which focuses on the first round of investments in a small number of ‘ready to

go’ projects. This will minimise risks of not defraying funds by the 2015 programme deadline,

and reduce set up and operating costs associated with multiple UDFs. Once funds have been

defrayed and returns are available to be recycled, the structure, number and investment

strategies of UDFs can be reviewed and amended if necessary to take forward other key priority

projects.


1.5 Projects that could be funded through JESSICA in the North East

JESSICA funding is designed to meet market need in areas of market failure; both in terms of the

property market and lately in terms of the development finance market. The credit crunch has

severely restricted the availability of finance for regeneration projects, and also adversely

impacted values and demand. As a consequence many high profile projects of strategic

importance have stalled. As long as they meet the eligibility requirements, JESSICA can provide

loans to these projects on ‘commercial’ terms (as defined within the current state aid guidance on

reference rates), and with the necessary state aid approvals, can also provide loans on better than

‘commercial’ terms, take equity in projects or provide guarantees.

The study includes a review of four indicative projects used as examples to illustrate how

JESSICA might work in practice. Three out of the four projects are mixed use developments and

one project is a renewable energy project in Blyth. The first three of these projects have been

impacted by current market conditions, and have significant gap funding requirements or

upfront land acquisition/ infrastructure costs. JESSICA is suited to projects which are viable and

require development finance, and therefore any gap funding requirement must be filled before

JESSICA finance could be utilised. Hypothethical modelling based on estimates suggests that

development finance provided through JESSICA, alongside provision of public sector grant,

could play a valuable part in taking forward the projects, (particularly if state aid is utilised to

allow sub market terms to be provided to projects.). In terms of the renewable energy project, it is

currently envisaged as a purely grant funded project supported by the public sector without any

expectation of commercial return in the short term and hence is unlikely on current information

to be able to repay investment. However, there are revenue streams associated with the project,

and financial modelling and investigation of the commercial opportunities could possibly

support a future JESSICA investment.

In terms of a first wave of projects which could support a loan on a no aid basis and fulfil the

other investment criteria suggested below, it is important to consider further sources of projects

that may be suitable for JESSICA in addition to those included in the case studies. A high level

review indicates that there are other projects in the ONE capital programme and being sponsored

by the private sector which would benefit from JESSICA investment. We recommend further

detailed work is done on these projects as part of next steps.

1.6 Criteria for selection of UDFs and Investments

Criteria for selection of UDFs should be agreed by a Holding Fund/ ONE with the Programme

Monitoring Committee, to take in to account the priorities of the operational programme and the

strategic objectives of JESSICA in supporting investment in urban regeneration projects. These

criteria are likely to cover three core areas:

Strategic Fit – being the alignment of the projects to be funded with the operational programme,

including eligibility of expenditure, and the regeneration benefits that will be realised.

Deliverability – the ability of the UDF and the projects to invest ERDF and match funding in

urban regeneration projects by 2015, including status and risk management approaches on key

issues such as the delivery mechanism proposed, planning, abnormals (unexpected upfront


costs), land acquisition, community consultation, stakeholder support and sponsor capacity to

deliver

Financial viability – the need for a robust business plan and supporting financial appraisals for

both the UDF and the projects it will invest in, which set out the quantum, type and timing of

JESSICA investment required, how and when this will be repaid, and the potential to generate

any return.

The original study brief referred to the potential to assess an ‘Economic Rate of Return’ (ERR) as

an indicator of the value generated through JESSICA investment and as a potential tool to help

quantify state aid. The usefulness of such calculations at this early stage of JESSICA development

for the region was caveated during the project inception meeting, as is dependent on the quality

of data available on specific projects and outputs, and can be misleading if not using appropriate

data. Specific ERR calculations are not included in this report, as much of the case study analysis

is based on hypothetical data, and as work has been undertaken on interest rates as the most

useful mechanism by which to quantify state aid. We would however recommend that UDFs

seek to develop an appropriate ERR or alternative Social Return on Investment metric as part of

their approach to project selection and appraisal.

1.7 Key risks for consideration

A summary of the key risks identified in the implementation of JESSICA, and actions that can be

taken to address these, are set out below:

Table 1: Summary of key risks and responses

Key Risks Response and Mitigation

Match funding

JESSICA monies must be co-financed. It

appears that land or property assets would be

the best source of match within the North East,

(as cash is in short supply) but no specific

assets have been identified at this time. In

addition the JESSICA structure across the

region would need to ensure that individual

sub-regions and local authorities could benefit

from the provision of their assets as match

funding.

If JESSICA is to be progressed in the region,

work should be undertaken to review potential

sources of assets that could provide match

funding. Fund structuring work should also

ensure that asset owners can secure local

benefits from provision of match funding.

Project Pipeline

JESSICA provides development finance not

grant. ONE and its partners are likely to

require greater certainty that a pipeline of

viable, eligible, deliverable projects is in place

or coming forward in order to ensure that any

Soft market testing and awareness raising

could be undertaken as part of next steps to

take forward a dialogue with potential private

and public sector project sponsors and

establish whether a pipeline currently exists or

whether projects could be adapted to fit within


Key Risks Response and Mitigation

JESSICA fund can defray eligible expenditure

within the deadlines.

the eligibility criteria of the NEOP.

Technical and operational risks

JESSICA is a new type of financial engineering

instrument, and the interpretation and

implementation of the regulations is still in

development with the Commission. Important

queries remaining which will have an impact

on how JESSICA projects operate in the UK

include clarification on the deadlines for

defrayal of ERDF expenditure and delivery of

outputs, the audit requirements for projects

receiving investment through JESSICA, and the

process for securing state aid approval for

investments through equity and guarantee.

The JESSICA Steering group has included

representatives from both CLG and the

Commission, in order to commence dialogue

on these issues. Continued liaison with both

these authorities, securing relevant input from

expert advisors, and seeking to access lessons

learned from colleagues in other RDAs will be

essential in allowing ONE to benefit from

precedents established elsewhere.

Accounting and financial risks

Ensuring an off balance sheet treatment for the

preferred JESSICA structure will be essential to

securing necessary approvals and to protect

both ONE and its partners to exposure to

liabilities. Risks of clawback must be identified

and managed in light of the technical and

operational risks highlighted above.

Holding Funds have successfully been

established off balance sheet elsewhere in the

UK, and precedent is hence established for an

off balance sheet treatment. Further work will

be required on financial and legal structures,

ownership, risk and reward at both the

Holding Fund and UDF levels to ensure that

this classification can be secured.

Institutional and political risks

Any decision to proceed with JESSICA must be

taken in the context of the new coalition

government in the UK, significant budget cuts

to tackle the national deficit, and current

uncertainty over the future role of RDAs. This

may impact the appetite of ONE to take

forward a new initiative such as this, and could

affect the time taken to secure the necessary

approvals.

There will be a responsibility to deliver the

targets within the operational programme

independent of any changes in the UK political

or institutional frameworks, and JESSICA fits

within a common policy shift from use of grant

to investment to secure better value for money

from public sector funds. Any contracts or

vehicles established or funded through

JESSICA would be able to be novated/

amended to fit within any changes to regional

or institutional structures.


1.8 Conclusion and next steps

The study concludes that from the work undertaken to date the implementation of a JESSICA

fund in the North East would provide considerable advantages to the region, and would provide

a valuable source of finance to help take forward regeneration projects. Important further work is

required to ensure that suitable projects can be identified that contain eligible expenditure under

the NEOP and which are sufficiently developed that this spend can be made by 2015. It is also

likely that in the current climate, a number of the priority public sector projects require grant

funding alongside JESSICA investment in order to reach a financially viable position. State aid

clearance for soft loans or no aid loans based on the lower end of the reference rate margins

would assist significantly in increasing the number of projects that could benefit from JESSICA,

and also in the ability of JESSICA to support the strategic priorities of the region.

There is an appetite from partners to investigate the opportunity presented by JESSICA,

particularly on the working assumption of the ability to reinvest any recycled funds for wider

regeneration uses (including mixed use development and housing that would not be eligible

under the first cycle of investment.) As awareness of how JESSICA operates increases, it is likely

that further projects will come forward and that UDF propositions will clarify. Existing

regeneration delivery vehicles such as 1NG, Sunderland Arc and Tees Valley Unlimited possess

many of the skills and the necessary powers to establish UDFs as subsidiary vehicles, but would

likely require support and resources to develop UDF business plans and bring in the necessary

funds management expertise.

It is suggested that further work to progress the proposal focuses on 4 workstreams; Project

pipeline, UDFs, match funding and fund structuring/ legals. These work streams could be

developed in parallel to one another to condense timescales, and could be undertaken directly

following completion of the feasibility study, and potentially funded through ERDF Technical

Assistance. Assuming that this work continues to support the case for JESSICA, and that the

necessary approvals can be secured, an indicative timetable would suggest that a Holding Fund

could be established by late 2010, with UDFs in place by the beginning of 2011. The first

investments through JESSICA could then be expected during 2011.


2. INTRODUCTION TO JESSICA

2.1 Overview of the JESSICA Mechanism

Joint European Support for Sustainable Investment in City Areas (JESSICA) is a policy initiative

of the European Commission (EC) supported by the European Investment Bank (EIB). It is

designed to help the authorities in the Member States of the European Union exploit financial

engineering mechanisms to support investment in sustainable urban development. JESSICA

does not provide new or additional money, but is a tool that Member States can use to utilise

existing European grant funding to invest in regeneration investment vehicles, known as Urban

Development Funds (UDFs), in order to accelerate investment in urban areas.

A JESSICA mechanism creates the opportunity for European Structural Funds to be used to

leverage other public finance, and potentially private investment. European Regional

Development Funds (ERDF) and match funding are invested through UDFs into projects, with an

expectation that the public funding will be returned and recycled. In this way, JESSICA is very

different from traditional grant funding which does not anticipate a return. UDFs must make

investments into regeneration projects which are part of an Integrated Plan for Sustainable Urban

Development (IPSUD). The definition of an IPSUD must be set out by the Managing Authority,

but is likely to be met by a range of existing plans and strategies in existence, (e.g. the Regional

Economic Strategy, Regional Spatial Strategy and local planning frameworks.) UDFs can invest in

projects by providing loan, equity or rental guarantees. The returns on these investments can be

recycled into further projects in the future, thereby creating the potential for an ‘evergreen fund’

and a sustainable legacy for European funds over a longer period of time.

In order to help establish JESSICA, a Holding Fund may be used as an intermediary vehicle. A

Holding Fund allows the Managing Authority to draw down ERDF, and hold it with the match

funding whilst UDFs are developed and appraised. Use of a Holding Fund can provide a number

of advantages, which are described further in section 5.3.


Figure 2: Overview of JESSICA

2.2 Summary Advantages of JESSICA

The advantages of JESSICA may be summarised as follows:

� Financial Leverage - More efficient and effective use of existing ERDF allocations by using an

investment mechanism rather than grant, which means that funds can be recycled. Through

JESSICA each £1 of ERDF may be used say 2-3 times over the life of a UDF to support a range

of projects, and hence deliver much greater value for money. This is further enhanced by the

ability to leverage not only required match funding, but also the potential for other

investment at the fund level and third party finance at the project level.

� Outputs - The ability to recycle and re-use funds should also provide potential to deliver

increased outputs for the NEOP, and significant additional outputs in excess of those required

by the Programme but linked to the use of ERDF funding.

� Grant to Investment - The move from a grant to an investment culture is a hot topic within

the UK public sector at present, and is particularly salient given the current UK budget deficit

and the likely reduction of public sector capital budgets over the coming years. Investment

mechanisms such as JESSICA hence align well with current policy and financial drivers.

� Flexibility - If structured correctly a JESSICA mechanism can embody considerable flexibility,

which means that it can adapt to future changes in policy, take on new funding streams, and

evolve to meet changing market conditions or demand. The initiative can therefore be

positioned as a long term contribution to achieving regeneration in the region, which could be


expanded to include, for example, development enabling funds, other public sector funding,

private sector investment, or any new or transitional European funds.

� Additionality – linked to the above, a JESSICA mechanism can be complementary to other

financing routes and funding streams; it should not be seen as an alternative to other

infrastructure funding options such as Accelerated Development Zones (a form of Tax

Increment Financing) or the Community Infrastructure Levy; rather JESSICA can operate

alongside these routes, with funding raised either coming into the UDF for investment or

administered separately by other bodies.

� Future use of funds – Navigant’s enquiries in the context of this study suggest that once

invested in a UDF and defrayed on eligible expenditure, returns coming back in to the Fund(s)

(ie. repayments of principle plus any interest or profit) may be reinvested without the

requirement to meet the same eligibility rules. The JESSICA regulations specify that

throughout the life of a UDF it must invest in urban regeneration projects included in an

IPSUD. On the basis of our enquiries, after the first cycle these could include elements such as

housing, retail, and grade A office space which may not be eligible under the NEOP but are

important in achieving the region’s strategic priorities.

� Integrated Regeneration - Through the requirement for projects to fit within an IPSUD,

JESSICA ensures an integrated approach to regeneration that takes into account social,

economic, physical and community priorities, and aligns with best practice in sustainable

development and EC cohesion policy.

� Expertise - The use of JESSICA to assist regeneration can support the development of capacity

within PPPs (Public-Private Partnerships), bring additional private sector investment and

expertise in to the area, build long term partnerships between the public and private sector,

and give access to financial and managerial expertise from relevant international financial

institutions (such as the EIB).

These considerable benefits must be weighed against associated risks and opportunity costs,

including:

� costs of set up and ongoing operation;

� balance sheet treatment for the Managing Authority and UDFs;

� securing necessary approvals, including the Programme Monitoring Committee (PMC), and

potentially Her Majesty’s Treasury (HM Treasury), the Central Projects Review Group

(CPRG);

� time to establish the fund(s) particularly given the 2015 deadline for defrayal of ERDF,

certainty and availability of match funding;

� alternative uses to which ERDF and match funding could be put;

� availability of a sufficiently robust pipeline of viable and deliverable projects for eligible

investment; and

� ability of projects to deliver outputs by 2015 if this is required by the Commission .

A fuller discussion of these issues is set out in section 7.


2.3 Other JESSICA Projects in the UK

The JESSICA model has been met with considerable enthusiasm by Managing Authorities in the

UK, and a number of regions are now progressing with JESSICA funds. In light of the different

regional priorities, risk appetites and available resources, a number of different structures and

approaches are emerging. This emphasises both the common belief that this sort of public sector

intervention is the right thing to do in the current market, and also the flexibility of the model to

fit local circumstances. There should be an opportunity for the North East to learn the lessons of

those that have already taken forward Holding Funds and UDFs, and we would recommend

close collaboration with regional colleagues to this end. A comparison of different structures and

status is not within the scope of this study, but we have included below a summary based on our

understanding for information.

London – the ‘London Green Fund’ is a Holding Fund, managed by the EIB, and set up in 2009,

after 1-2 years of development work. The London Development Agency (LDA) were the first to

establish a Holding Fund in the UK, and hence the time taken to establish the agreement. The

fund includes £50m of ERDF and £50m match funding provided by a portfolio of LDA assets.

The Holding Fund is governed by an advisory board which contains representatives from key

public sector stakeholders. The LDA and the EIB are currently developing a procurement

strategy to support the selection of UDFs and Fund Management services for those UDFs. It is

envisaged that there will potentially be three UDFs on a sectoral basis, covering Waste,

Decentralised Energy and Energy Efficiency. A call for a Waste UDF was launched in April 2010,

which looks for a fund manager to set up and operate the fund and bring an additional £35m of

private sector finance.

North West – the North West recently signed a Holding Fund agreement with the EIB in a

relatively short period of time, using the template agreement developed with the LDA. We

understand a key driver was the ability to meet n+2 targets by establishing the Holding Fund.

The North West Urban Investment Fund (NWUIF) includes £50m of ERDF and £50m of match

funding provided by the North West Development Agency. The North West are also working

with the EIB and have recently launched a procurement process for two regionally split UDFs

(one for Merseyside and one for the rest of the North West.) Project investments are likely to

include the development of employment sites, creation of new commercial floor space,

reclamation of derelict or contaminated land, and provision of site servicing and infrastructure.

Wales – the Regeneration Investment Fund for Wales (RIFW LLP) was established in early 2010

as a UDF by the Welsh Assembly Government (WAG).. Wales have not pursued a Holding Fund,

instead opting for a single UDF structure which will include £25m ERDF, £15m match provided

by WAG land and cash, and a further £15m of land and cash which will be available to be

invested outside the convergence areas and outside ERDF eligibility rules. A procurement

process for a private sector Fund Manager and Investment Manager is currently in the final

stages, and is due to conclude in Summer 2010. The first investments are envisaged in quarter 4

2010. WAG have a stated intention to attract private sector investment to the fund as part of a

second phase, and the Fund Manager will be targeted with raising £55m during 2010-11, to take

the total fund to £110m.


East Midlands – The East Midlands Urban Development Fund (EMUDF) was set up in early 2010

as a company limited by guarantee, again without the use of an intermediary Holding Fund,

using £10m or ERDF and £5m of EMDA Single programme funding. The aim is to grow the fund

to circa £20m over time. King Sturge Financial Services Ltd have been appointed to manage the

fund and source potential projects, as well as raise further investment. The fund will focus

primarily on ERDF’s Priority Axis 1 which is about creating the physical environment for

businesses to innovate and grow. We understand that negotiations are currently taking place for

the fund to make the first JESSICA loan in the UK.

Scotland – The Scottish Executive are currently working towards signature of a Holding Fund

Agreement with the EIB. It is expected that the Holding Fund will contain £25m of ERDF and

£27m of match funding through a combination of public sector land and cash.

West Midlands – Advantage West Midlands are in the process of completing a scoping study to

assess the potential for JESSICA in the region.

3. MARKET CONDITION & REGIONAL PRIORITIES

3.1 Regional Priorities

Strategic economic development in the North East takes place under the oversight of the

Regional Economic Strategy and the Regional Spatial Strategy. These complementary strategies

share the same regional vision. This is that:

‘The North East will be a Region where present and future generations have a high quality of life. It will be

a vibrant, self reliant, ambitious and outward looking Region featuring a dynamic economy, a healthy

environment, and a distinctive culture. Everyone will have the opportunity to realise their full potential.’

Regional Economic Strategy (RES)

Published by One North East in 2006, the RES 2006-2016, Leading the Way, sets out economic

development priorities which will contribute towards closing the productivity gap with the rest

of the UK. The aim is to increase Gross Value Added (GVA) per head to 90% of the national

average and achieve significant job and new business creation, over the next 10 years.

It has three main themes: business, people and place, all linked by the theme of strong leadership.

Under the Business strand, nine key industry sectors are identified as strategically important:

automotive; chemicals and pharmaceuticals; commercial creative; defence and marine; energy;

food and drink; health and social care; knowledge- intensive business services; tourism and

hospitality.

The strategy also singles out work around ‘Innovation Connectors’, aimed at driving

technological progress. These are also designed to complement the ‘Three Pillars’ agenda, on

which investment in emerging technologies will be focused.


Figure 3: The Three Pillars of the North East Regional Economic Strategy

Regeneration within the Place strand links to the Northern Way initiative and in terms of urban

areas concentrates on the North East’s city regions: Tyne and Wear and Tees Valley. There is also

a focus on: providing business accommodation, improving transport and ICT connectivity and

safeguarding the region’s natural and cultural assets. The People strand focuses on raising productivity through up-skilling and increasing output via

promoting economic inclusion.

Regional Spatial Strategy (RSS)

The North East of England Plan Regional Spatial Strategy to 2021 was produced in 2008 by the

Government Office for the North East. It is closely linked to the RES and covers Northumberland,

County Durham, Tyne and Wear and the Tees Valley. It is an extensive development strategy

and includes the key challenges for the region and priorities for the local area.

Whilst not overlooking rural areas, there is a particular drive for promoting regeneration and

economic development in the city regions: Tyne and Wear and Tees Valley. Specific mention is

made of the role of Science City and the surrounding network; the Centre for Renewables, Blyth;

Durham University and NetPark.


3.2 Market Gaps and Failures

Appendix 1 provides a macro and micro overview of the commercial property market within

North East England. In particular, it examines the key market drivers in order to understand the

current and future barriers to city and town centre development. This provides a basis to

consider the demand for and added benefits which could be derived from a JESSICA fund in the

North East. Findings include:

� The economic decline experienced in recent years has certainly impacted upon this region, as

with all parts of the UK, and its effects will likely still be felt for some time, despite the

tentative signs of economic recovery we are now beginning to see.

� Most notably the economic viability of developments has been called into question with rents

and capital values falling and demand for accommodation remaining low. For the North East

region one of the key sources of demand in recent years has been the public sector, but with

proposed government cuts on the horizon, this key market group may reduce and put further

pressure on vacant schemes.

� Over the short term therefore there will likely be a financial shortfall for a number of schemes

which will inhibit their ability to be delivered. This will be particularly apparent in schemes

which have high initial start-up costs, for example in compact urban sites with high levels of

demolition or in brownfield locations with which require remediation.

� As a result this may represent a need for public sector intervention, subject to the necessary

financial assessment, and allow for bridging this financial gap over the short to medium term.

� While current indications are that the UK economy has turned the corner and entered into a

period of recovery, there will remain a number of issues which put pressure on the

development market over the longer term. These include the willingness of commercial

lenders to fund new development given the losses they have experienced in this sector over

recent years and the availability of large amounts of accommodation within Enterprise Zones.

� Within the North East in particular the effects are yet to be fully realised from the significant

building programmes which have been undertaken with Enterprise Zones and in particular

the abnormally high amounts of new build accommodation which is nearing completion.

� The tax efficient status of such schemes has enabled them to deliver vast amounts of

accommodation while offering occupational leases on significantly discounted terms which

non Enterprise Zone schemes are unable to compete with. As a result the majority of large

corporate requirements (those in excess of 929 sq m) will most likely be satisfied within these

schemes, and there may currently be an oversupply of commercial accommodation relative to

demand. This will have the effect of limiting growth in rental values and increasing the levels

of incentives (such as rent free) being offered by landlords to attract tenants. At the opposite

end of the occupational market there is anecdotal evidence of strong demand for incubator

space and we are aware that many of the serviced business centres, particularly in the

Tyneside area, are oversubscribed. This demand has been particularly focused on office suites

of less than 100 sq m. It appears however a greater issue may be in providing accommodation

for those moving out of incubator units and looking for that next step. Most incubator


accommodation imposes a time limit on how long the tenant can stay in occupation and so as

they vacate tenants are looking for accommodation within a similar location to the incubator

unit and with similarly flexible occupational arrangements. These tenants will typically be

seeking office suites of between 100 sq m and 275 sq m. A potential solution to this problem

could include provision of JESSICA finance to a UDF which seeks to take on surplus space

and let it out to business incubators or as ‘move on’ space, rather than have it remaining

vacant.

� In terms of Research and Development (R&D) space this is primarily driven by universities in

this region with much of the economy being driven by low skill industries. As such there is

no discernable market for this accommodation and there may be a need for further public

grant to attract occupiers to the region.

3.3 Availability of Development Funding

Over the last two years most commercial lenders have removed themselves from the property

development market as they have focused their attentions on internal recapitalisation and shown

reticence towards risk. As such, where developers have wished to pursue schemes, they have

often encountered barriers in their ability to secure debt funding.

To secure funding, developers have often had to secure a pre-let of at least 50% of

accommodation prior to start on site and as a result, with demand having reduced, few

developers have been able to provide such assurances.

Where funding has been available a further issue has been the terms under which banks will

lend. Over the last two years the credit rating of certain property firms has worsened and the

risk premium attracted to property has increased and as a result the costs of funding have

increased. Furthermore, we have seen the financial requirements from developers also increase

(for example requiring higher viability thresholds, guaranteed returns or greater public sector

equity contributions) which combined has left certain schemes unviable.

The following observations can be made with regards to the availability and terms on which

finance is being provided in the development market:

� The current market for funding development transactions has been hit hard by the financial

market turmoil. A number of the UK clearing banks are significantly exposed to property

lending and have little clarity over the current valuations of their property books. As a result

banks are in a ‘workout’ phase rather than actively seeking lending opportunities.

� The key challenge within the current financing market is the lack of availability of long term

debt finance to support long term development programmes or the holding of assets for rent.

Currently very few banks are able to lend longer term and these all have limited capital

available and are directing it primarily to low risk government lease type projects.

� Up until around 2007/8 a number of specialist Mezzanine property funds had been

established and operational, particularly within investment banks but also on a wider basis.

These funds would typically provide funding into what had traditionally been the equity

tranche of the capital structure. This funding would be priced in the region of 10% and would


rank behind senior debt and given the aggressive gearing provided by banks would in effect

be cheap equity. This source of funding has almost entirely disappeared from the market.

� With regards to equity, property funds have suffered significant write-downs in investment

value over the last 12 months and as a result IRR requirements have increased significantly

during the same period.

Moving forward, developers are expecting restrictions on finance to continue for some time

despite anecdotal comments from lenders on an improvement in conditions. As such it is

expected that there will be an ongoing opportunity for alternative funding streams such as

JESSICA to target stalled regeneration projects.

3.4 JESSICA Potential Financial Products & State Aid

There are a range of financial products which may be provided by JESSICA UDFs within the

terms of the regulations. The primary focus of existing JESSICA operations appears to be on

loans; this is likely due to the relatively more straightforward State Aid position with regards to

the provision of loan finance, whereby standard reference rates and guidance exists1. Loan

instruments may include:

� Senior Loans to Regeneration Projects

Where a UDF provides loans to projects it is expected that such loans will be on terms

competitive to those provided by other senior debt providers. This will allow the UDF to

make a return on its investment, whilst still providing an advantage to regeneration projects

through attractive rates as well as crucially providing finance to regeneration projects where

many lending institutions currently will not invest. As long as rates provided to projects are

at or in excess of those calculated through the use of the EU reference rate methodology,

there will be no state aid. This approach has secured state aid clearance for the Welsh (and

we understand also North West) JESSICA Funds. State aid is a specialist area and JESSICA

project sponsors should seek expert legal advice. From an initial review of the reference rate

guidelines there is scope for some differences in interpretation as to how the reference rate

would be calculated in each case. The current UK reference rate is 1.16%, but this is before the

application of an appropriate margin. The margin is determined based on a matrix which

considers the characteristics of an entity’s credit rating (AAA to >CCC) and the collateral

against which the loan is to be provided (ie. high to low), and any special circumstances, (for

example where a project SPV is used it is assumed that a risk margin of at least 4% will be

appropriate.) Whilst using this guidance the lowest reference rate compliant senior loan

could be in the region of 2.16%, given the use of project SPVs common in UK regeneration

projects, and the higher risk nature of some of these projects, UDFs may calculate higher

rates more aligned with pure commercial terms. For the purposes of this study, a

1 http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:52008XC0119(01):EN:NOT

http://ec.europa.eu/competition/state_aid/legislation/reference_rates.html


‘commercial rate’ of 7.5% has been used as a comparator for senior debt provided by the

private sector to projects with similar risk profiles, without a JESSICA mechanism. This is

based on experience of pre credit crunch terms, increased to reflect the fact that banks are

currently reluctant to engage in financing urban regeneration projects. Given that there is

scope to interpret the reference rates at a much lower level than this, and that if deemed

compliant by the Commission this would not require a state aid notification, it may be

possible for JESSICA to provide ‘soft loans’(below private financing terms) on a no aid basis

which would significantly increase the viability of JESSICA. Further dialogue with the

Commission would be required to confirm the position on these issues.

� Mezzanine Loans to Regeneration Projects

It is envisaged that UDFs may wish to advance mezzanine loans. State Aid compliance

requires that such loans need to be for a fixed term, with a fixed rate of interest and, unlike

some commercial practice, not convertible to equity. As above however, a no aid approach

has been agreed for the JESSICA fund in Wales as long as reference rate guidance is followed.

In addition to these, there are a number of products that are being actively investigated as part of

the development of JESSICA funds within the UK.2 These are more complicated to utilise and

still others may require special exemptions, guidance or state aid notifications. We would

recommend that a dialogue with the Commission is pursued with regards the process and

current thinking on the state aid position on these products. This is included in the risk register at

section 7. It is important to note that if structured with adequate flexibility in its terms of

operation, a UDF may start off initially as a loan fund, but could broaden its range of products

over time in response to both market need and to any approvals secured.

� Guarantees for Senior Loans to Regeneration Projects

It is possible that projects may be brought to a UDF where senior debt has been identified and

negotiated by the project promoter but where the promoter has an inability to provide

appropriate security to the lender. Under these circumstances the Fund may choose to

provide a guarantee in return for payment from the promoter. The pricing of this guarantee

can be challenging, but the provision of the guarantee is not, in principle, problematic,

although it is unclear as to how the defrayal of ERDF monies will be calculated for

guarantees3. One of the key advantages of using guarantees within a JESSICA type fund is

2 The Welsh Assembly Government and the North West Development Agency (with CLG, BIS

and the EIB) are currently pursuing a discussion with the Commission on these products.

3 Correspondence with the Commission during the course of this study indicates that as for all

eligible expenditure guarantees can be declared as expenditure when paid by beneficiaries

(UDFs). A promise to pay (commitment) may not be sufficient. Expenditure declared needs to be

based on a traceable financial transaction. A guarantee needs of course not to cover 100% of the

investment value it enables. This means that unless called upon a guarantee may not count as

expenditure even though the UDF has provided a guarantee (and set aside funds to cover it).


that it may allow for a greater number of projects to be supported than would otherwise be

the case, on the basis that the full capital value of the guarantee does not need to be

committed; although this requires clarification with the Commission.

� Equity into Regeneration Projects

Equity investment into PPPs (Public-Private Partnerships) or other regeneration delivery

vehicles will have to comply with State aid rules. Our current understanding is that it is likely

to be the case that a UDF will not initially be able to invest equity or quasi-equity debt into

projects other than alongside an independent third party investor (in accordance with the

Market Economy Investor Principle ‘MEIP’), unless a State aid approval is secured. Work is

now ongoing in the UK on a potential pre-notification to DG Competition on how compatible

state aid could be assessed for JESSICA equity investments. Provision of equity is an area

where demand from regeneration projects may be significant, particularly if provided

alongside a grant or gap funding arrangements, and we would recommend that this is

therefore progressed as part of next steps.

4. ELIGIBILITY OF EXPENDITURE AND THE NEOP

4.1 Overview

Any JESSICA initiative must be able to make a demonstrable and proportional contribution to

achieving the outputs and results of the Managing Authority’s Operational Programme. The

requirements with regards to eligibility of expenditure and delivery of outputs that apply when

seeking ERDF grant also apply to UDFs and investee projects under JESSICA.

Some members of the Steering Group and other stakeholders have expressed their concern that

JESSICA may not be well suited to the NEOP (the North East Operational Programme) on the

grounds that the NEOP does not contain specific allowance for broad-based physical

regeneration. As a competitiveness programme developed several years ago in a differing

economic climate, the principle drivers through the NEOP are support for SMEs, job creation and

significant revenue based interventions, which were the agreed focus for the programme

following extensive consultation with key stakeholders.

Our review indicates that whilst not the primary focus of the NEOP, there are significant links

between the vision and outputs that the programme is seeking to deliver, and the benefits that

could be accrued through investment of funds in a JESSICA mechanism. The closest alignment is

within Priority 1 Innovation Connectors, and Priority 2, Cultivating and Sustaining Enterprise.

This study does not set out to consider the overall appropriateness of the NEOP to the current

needs of the area, or to recommend changes to the programme. ONE are shortly to embark on the

mid term review of the NEOP, and through this process it may be possible to propose

amendments to the NEOP Priorities, allocations and associated outputs. However, this would

require agreement with the Commission and our understanding is that the review itself will take

significant time to conclude. Given the importance of timescales and the need to defray ERDF in

advance of 2015, this approach is unlikely to be feasible for JESSICA.


4.2 Priority 1-1 Innovation Connectors

The concept of Innovation Connectors within the North East region originates from the Regional

Economic Strategy and Regional Spatial Strategy, and in particular to the 'Three Pillars'; the key

sectors for development in the region of; energy and the environment, healthcare and health

sciences, and process industries. There are seven identified Innovation Connector projects

specified in the NEOP, as set out below. Each Innovation Connector is overseen by a partnership,

which is responsible for implementing the agreed Investment Plan for the site.

� Regional Energy Centres, including at Blyth operated by NaREC - focussing on the

development and application of new and renewable energy technology

� Newcastle Science City - with a focus on life sciences, energy and molecular engineering

� The Design Centre for the North in Gateshead - linked to the region’s universities and

supporting SMEs in developing new products and services

� Digital City in Middlesborough - linked to the University of Teeside and connections with

digital media SMEs

� The Wilton Centre (Tees Valley) - focus on materials technology research and applications

� The Software City (Sunderland) - focus on creation and growth of software SMEs

� NetPark, (Sedgefield, County Durham) - R&D centre concerned with innovation in electronics

and electronic engineering.

ONE has indicated that this list is not considered exhaustive; appropriate additional sites or

initiatives could be considered eligible under this section of the programme, so long as a strategic

case can be made.

Under this priority, the following activities are specified as eligible:

� reclamation and preparation of sites and associated infrastructures, including management of

environmental risks;

� premises and other capital works associated with exploitation of innovation, science and

energy; and

� associated environmental and public realm improvements.

The outputs specified in the NEOP to be delivered from Priority 1.1 which could potentially be

delivered through investment in urban regeneration projects through JESSICA are as follows:

Table 2: Potential output categories for Priority 1.1 – Innovation Connectors

Potential Output categories for JESSICA NEOP Target

Area of R&D premises developed (m2). 51,238

Brownfield land reclaimed &/or redeveloped (ha). 21.4

Private sector expenditure on R&D levered £450m

No. of gross jobs created 3605

No. of people in the workforce of SMEs working in collaboration with 2,233


Innovation Connectors and/or Centres of Excellence, or in those

organisations, assisted with skills development

No. of businesses assisted with improved environmental management,

of which related to improved energy efficiency, micro-renewables and

other management of carbon footprint

671

Within Priority 1.1 there is an allocation is £60m of capital ERDF funding4. Circa £40m has

already been committed to the seven innovation connectors identified in the NEOP. The

remaining £20m is currently uncommitted, and would potentially be available for investment

through a JESSICA mechanism if appropriate. In order to support a business case for the use of

these funds in JESSICA, ONE will require it to be illustrated that the funds can be spent in the

timeframe and on eligible expenditure. It appears that the following options are available to

support this:

Option 1: Review with the current Innovation Connector partnerships whether there is scope for

further eligible ERDF spend, on an investment basis, within their existing Investment plans. Our

understanding through discussion with the ONE ERDF secretariat is that this is unlikely at this

point in the programme, particularly as a number of the projects have now also secured

alternative public sector funding (eg. Strategic Infrastructure Fund).

Option 2: Review with the current Innovation Connectors partnerships whether their Investment

Plans may be revised or expanded, in order to include a wider remit and/or new sites, projects or

initiatives now coming on stream which were not included in the original drafting. This would

require the agreement of the relevant partnership, and for a suitable business case to be put

together demonstrating fit with the overall Innovation Connector model in each location. Within

the case study projects listed at section 6, we would recommend that this option is considered for

Project A, in terms of potential linkage with either the Wilton Centre and or Digital City.

Option 3: Consider whether within the region there is a case for any new Innovation Connectors

at this point, to take into account the development of the markets and evolving strategic

priorities. We would recommend that this option is considered for Project C, linking up with the

recent designation of the sub region as a Low Carbon Economic Area. This may require PMC

(Programme Monitoring Committee) approval but may not need to go to the Commission. In

order to align with the overall aims and objectives of the NEOP, ONE have indicated that the

strongest case could be made for new Innovation Connectors where there is a link to the sectors

already identified in the NEOP, as well as links to the Lisbon, Europe 2020 and structural

economic change agendas.

4.3 Priority 2-1 Cultivating and Sustaining Enterprise

The NEOP includes under Priority 2, Field of Action 1, a strand of activity which could also be

linked with physical regeneration initiatives. Eligible expenditure where justified by market

4 The allocation of ERDF between capital and revenue is an issue for the Managing Authority to

manage and is based on their decisions relating to the Operational Programme.


failure, such as in disadvantaged areas, would include creation or refurbishment of premises for

business incubation, and support with environmental management actions including energy

efficiency and waste minimisation.

The outputs specified in the NEOP to be delivered from Priority 2.1 which could potentially be

delivered through investment in urban regeneration projects through JESSICA are as follows:

Table 3: Potential output categories for Priority 2.1 – Cultivating and Sustaining Enterprise

Potential Output categories for JESSICA NEOP Target

Area of business premises developed (m2) 26,000

Brownfield Land reclaimed &/or redeveloped (ha) 10.3

No. of gross jobs created 6,580

No. of businesses created or attracted to the region 3,006

Our view is that this Priority may be less suited to a JESSICA fund at this time. Within Priority

2.1 there is an allocation of £15m for capital funding, of which the significant majority is already

allocated. There is therefore less capital funding, and less flexibility within this priority of the

ERDF programme that is currently available and could be ring-fenced for JESSICA; but also as

business incubation units tend not to make a commercial return and to require considerable gap

funding as opposed to being able to support and repay an investment approach.

4.4 Which ERDF monies could be used for JESSICA?

It is possible within the regulations to fund a JESSICA project from different priorities of an

Operational Programme. This could allow for a larger JESSICA fund and associated economies of

scale.

However, discussions with the Commission indicate that such an approach would need to be

supported by separate business plan applications to the PMC for funding, calculation of separate

outputs aligned to each priority, and the ability to separately report and monitor spend and

delivery against priority. This may create additional administrative requirements if different

priorities are combined within a single UDF. The options to consider are therefore:

Establish separate ‘account codes’ for different priorities at Holding Fund level, and UDFs make

separate applications under each priority, or a joint application with a claim for a portion of

monies under each priority.

Seek permission from the Commission to transfer funds, and the associated outputs and results

from one priority to another, so that a larger sum of money can be administered under one set of

reporting and monitoring requirements. This approach is being adopted in Wales, and we


understand has now been approved by the Commission. It may not be suitable for the North East

where different priorities have more starkly contrasting objectives.

Make a single ERDF application to the PMC under Priority 1, Field of Action 1, on the basis that

this will be easier to set up and operate, and this is where funds are available and where there is

a strong link between what a JESSICA fund can do and the region’s strategic priorities. This

would be our recommendation at this time.

5. IMPLEMENTING JESSICA IN THE NORTH EAST

5.1 Size of JESSICA Fund(s)

There is no minimum or maximum size specified in the guidance or regulations for JESSICA.

Holding Funds vary in size from circa £20m to over £100m, and each Holding Fund is likely to

invest in a number of UDFs, which will again vary in size depending on the number and type of

projects they are intending to invest in. The key principles to consider in deciding the size of any

JESSICA initiative should include:

� The amount of uncommitted ERDF available within the NEOP

� The availability of an equal amount of monies to provide match funding to the ERDF

� The ability of potential UDFs to defray ERDF plus match funding in eligible expenditure by

2015 (and potentially to also deliver outputs by that date.)

� Economies of Scale: as a general rule both set up and operating costs for both a Holding Fund

and the UDFs should decrease inversely as a proportion of the size of the investment; so a

bigger fund may offer better value for money.

� If private sector investment is to be secured as match funding or as additional finance within

the fund, market experience indicates that a bigger fund is likely to be more attractive to

institutional investors, private equity providers and property funds.

� If a private sector fund manager is to be sought, a larger fund is likely to be more attractive as

potentially provides greater opportunity for returns, (as carried interest charged by private

sector fund managers is generally on the basis of a share of fund performance.).

� It is important to acknowledge that as long as set up and structured appropriately, there is no

reason why a Holding Fund or individual UDFs can not increase the value of funds under

management at a later date should additional monies become available. Such further funding

could include any transitional ERDF funding or new European funding streams, private

sector investment if market conditions improve, or other public sector funds. A Holding Fund

may be helpful in this regard, as it can allow for both swift draw down in to the HF and swift

allocation of monies to established UDFs, in line with the revised funding environment and

revised priorities.

Based on our review and experience from elsewhere, it appears that a £40m JESSICA fund in the

North East of £20m ERDF and £20m match would be of a sufficient size to support

implementation of the initiative, (although other factors such as UDF structures and projects as

set out in the rest of this report, should also be taken into account in assessing overall feasibility).


5.2 Options for JESSICA Structures

There is considerable flexibility as to how a JESSICA fund may be structured. The main variables

to consider are summarised below, and the following sections analyse the advantages and

challenges of each in the context of implementing JESSICA in the North East.

� With or without a Holding Fund?

� As a separate legal entity or as a block of finance within an existing institution?

� How many UDFs should there be?

� If there are multiple UDFs, should these be structured by region or sector?

� What projects may JESSICA be likely to fund; and what are the implications of this in terms of

how JESSICA delivery should be structured?

5.3 Holding Funds

A standard approach is the creation of a Holding Fund (HF), which may be managed by the EIB

or other accepted financial institution. To date, the EIB is acting as Holding Fund manager for

London, the North West and Scotland within the UK, as well as for 11 other JESSICA Holding

Funds on the continent. The Holding Fund includes the ERDF drawn down from the

Commission, as well as committed match funding at the specified intervention rate.

The Holding Fund then transfers money into a variety of UDFs which in turn invest in projects

which are included in an IPSUD. There are a number of benefits that are widely accepted to be

associated with the use of Holding Funds. These include:

(i) Timing of set up– A template HF agreement is now established and has been used with a

number of managing authorities. This, alongside the fact that no formal procurement is

required if the EIB is used as HF manager, means that a HF can be established relatively

quickly (potentially in the region of three months, approvals permitting.)

(ii) Defrayal and n+2 - Under the terms of the new EU legislation, Holding Funds represent

‘eligible or qualifying spend’ and can therefore secure investment in an area prior to an

eligible UDF or project being identified that requires JESSICA investment. This has been a

key attraction to some Managing Authorities as by establishing a HF ERDF counts as

defrayed, it can therefore assist in meeting n+2 targets. It should be noted however, that

funds are still required to be transferred to UDFs and invested in regeneration schemes by

2015.

(iii) Flexibility – through using a HF, the Managing Authority has more time to agree and

develop its strategy for the development and implementation of UDFs, including key

considerations as to the number or type of UDFs to be funded. Without a HF these decisions

must be made upfront.

(iv) Income - Funding is drawn down at the HF level as a cash transfer, therefore enabling

interest to accrue within the HF from the point of draw down, which increases the amount

of monies available for investment in the region. Although this factor was of greater


significance during higher interest rate periods, it is still a consideration; £40m at 1% held for

a year could provide an additional £400k.

(v) Credibility – The establishment of a Holding Fund demonstrates to the private sector that

funds are in place for project development thus providing greater clarity and certainty, a

stronger field of UDFs coming forward to the fund, a more robust pipeline of projects

seeking funding through JESSICA, and potentially greater interest from the private sector in

investing finance at the Holding fund or UDF level.

(vi) Expertise - The use of an HF provides for a dedicated expert interim Fund manager function

that is tasked with overseeing the deployment of JESSICA funds. If provided by the EIB, it

also allows access to lessons learned through the establishment and operation of other

Holding Funds and financial engineering instruments. The EIB operates on a not for profit

basis, and currently acts as a Holding Fund on a cost recovery basis for Managing

Authorities.

(vii) Relationship with the Commission – if a HF is provided by the EIB, it allows the Managing

Authority to take advantage of the close EIB relationship with both DG Regio and DG

Competition within the European Commission. These links may be critical in securing

answers to queries and facilitating the development JESSICA funds.

(viii) Independence – through involving an independent third party in the development of

governance structures, investment criteria and the selection of UDFs, use of a HF can assist

in removing political considerations from decision making processes.

(ix) Balance Sheet Treatment – the use of a Holding Fund may secure an ‘off balance-sheet’

opinion for the Managing Authority at the point of draw down of ERDF and the placement

of match funding within the Holding Fund. This is particularly important if the Holding

Fund includes debt, as in the current climate significant on balance sheet liabilities are

unlikely to secure HM Treasury approval. Balance Sheet treatment for the UDFs receiving

funding from the HF would need to be separately considered and reviewed at the point that

monies are transferred to UDFs and when the UDFs themselves make investments in

projects.

The HF manager will charge a fee for the provision of services. This is usually at a maximum of

2% per annum of funds under management. These services would include key activities that

would be required in any case in setting up a JESSICA fund, (and it should be noted that the set

up costs discussed in section 5.9 may therefore be included as part of the HF costs). Without a HF

these activities would either be carried out in-house by the Managing Authority if there is

sufficient capacity and expertise, or otherwise with the assistance of external consultants. Clarity

would be needed as to who would lead in the provision of services, which costs were included or

excluded from the HF Management fee, how the Managing Authority was represented through

the governance arrangements, and what other, if any, additional resource or support would be

required (eg. in house or specialist advisors). The activities of the HF would be likely to include:

� Establishing HF governance arrangements, including recruitment of an independent

Investment Committee/ advisory board;


� Agreeing and implementing the overall investment strategy for the HF and the investment

criteria for investing monies from the HF to UDFs;

� Designing and administering a call for UDFs to generate applications to the HF, whether this

be through a open process or a formal OJEU procurement;

� Review of applications from UDFs to the HF and approval of UDF business cases;

� Credit checks and due diligence on potential projects and UDFs, including providing

assurance on appropriate UDF fund management arrangements and project delivery;

� Depending on the capacity and experience of UDFs the activities of a holding fund may also

need to allow for the provision of advisory services to UDFs in preparing, implementing and

managing investment; as well as

� Ongoing monitoring and reporting of UDFs to the HF governing board/ committee.

In view of these factors, and particularly given the following analysis with regards to the

likelihood of multiple UDFs in the region, our initial view would be that implementation of the

JESSICA initiative in the North East if taken forward should seek to make use of a Holding Fund.

The following chart indicates the various set up and fund management costs that may be

expected over the first years of the fund (assumed at £40m). Set up costs are discussed in section

5.9, and are those shown below in Year 0 (assumed below at 1.5%). These costs could be covered

through the HF if established at an early stage. HF costs in year 1 (assumed below at 2%) would

mainly cover the call for UDFs, and in subsequent years would be expected to decrease as the HF

moves to a monitoring and oversight role. The ongoing fund management costs would be

payable to fund management services for the UDF(s), which again may be expected to be in the

region of 2% per annum of fund value. These benchmarks are guidelines only.

Figure 4: Illustration of set up and management costs


5.4 Corporate UDF structures and existing vehicles

The JESSICA regulations provide for two main options with regards the set up and operations of

UDFs; as a separate legal entity or as a block of finance within a financial institution. Within the

North East there are a number of existing delivery vehicles which have expressed interest in the

process, opportunity and implications of becoming or setting up UDFs. This includes Sunderland

Arc Urban Regeneration Company, 1NG City Development Company, and Tees Valley

Regeneration Company. Two short case studies setting out how this might work in practice and

the issues to be considered, using 1NG and a private sector led UDF as examples, are included at

Appendix 3. In principle, the regulations could include the following variants:

� Option 1: Completely new stand-alone entities (as is being developed in Wales with the

Regeneration Investment Fund for Wales “RIFW LLP”, and is also being considered in other

regions for the funding of specific projects or where there are no existing regeneration

vehicles). This provides a bespoke investment vehicle that can be structured specifically to

achieve local/ regional objectives within the context of the relevant regulations. It may be most

appropriate when a single UDF structure is being developed. Creation of a new entity could

provide a direct route for the Managing Authority to take a leading role in the development of

the UDF and the direction of the JESSICA mechanism if they take a majority stake in the new

UDF, (although both balance sheet impacts and RDA approval processes would be relevant

here). However, it does not necessarily encourage efficiencies or synergies in terms of linkages

with existing vehicles, and may not take advantage of the skills, experience and capacity

currently held within them. In the current climate, when the total quantum of regeneration

vehicles across the UK is under scrutiny, and the number of vehicles receiving public funding

may be rationalised, there may also be limited appetite for the development of a new UDF in

the North East and other options may be more appropriate.

� Option 2: Existing legal entities adapted to fulfil the function of a UDF - in order to count

as a UDF it is likely that an existing vehicle would need to review and potentially amend/

restructure its current constitution, objectives and functions. We understand that an

investment/ development vehicle in the East Midlands was engaged in preliminary

discussions with regards to becoming a UDF, but that this was deemed not possible due to the

vehicle’s development activities. Any economic activities (such as direct property

development) which are undertaken by a UDF may have State Aid consequences and this

would require specialist legal input and discussion with the Commission. Any change to the

existing structures would also require board approval, and would need to be carefully

considered in terms of any impact on balance sheet treatment for the owners of the vehicle.

� Option 3: Separate subsidiaries set up by existing vehicles to fulfil the function of a UDF as

an addition to current functions. Our view is that this may be the most appropriate

mechanism for the implementation of JESSICA in the North East. This may be an attractive

option for private sector led vehicles, which may not need the same approvals processes as the

public sector. Existing Joint Ventures such as those between ONE and UK Land and Langtree,

or bodies set up directly by the private sector could provide an option, (although no direct

conversations with these bodies has been undertaken at this time).


� Option 4: Block of finance within a financial institution; we understand that discussions

with parties interested in providing this service are ongoing, although none have been

implemented as yet. Under this route, it is envisaged that an existing bank or property/

regeneration fund would manage JESSICA monies and play the role of the UDF in making

investments in projects. The advantages of this are that existing infrastructure and funds

management expertise would be present within these institutions, and hence both set up costs

and timescales may be decreased. It is unclear whether a public procurement process would

be required to award ERDF monies to a UDF set up in this way, or whether this could be

achieved through provision of grant to these bodies. We would recommend that this option,

and its practical implications, are considered by ONE as part of next steps. Informal market

intelligence indicates that some entities may be interested in taking this forward, but a more

detailed soft market testing programme would be required.

5.5 UDF Legal Structures

There are no specific requirements as to the legal structure to be adopted by UDFs. In Wales a

Limited Liability Partnership (LLP) structure has been adopted, and either this or a Limited

Partnership (LP) are the most common for investment funds of this type.

It will be important therefore to ONE that, as the accountable body for the JESSICA Funds, (and

other funds through match funding), the funds are safe and that the structure adopted is flexible

and straightforward. The appropriate legal structure is crucial to the successful establishment of

UDFs and it goes without saying that there must also be appropriate and regulatory compliant

operating policies, procedures such as reserved matters and delegated powers.

The main legal structures available to the UDF are: a company limited by guarantee, a limited

partnership or a limited liability partnership. The exact structure is driven by a number of key

factors - namely, tax efficiency and robust governance and control mechanisms. Limited

partnership and limited liability partnerships can offer certain tax efficiencies as they are

generally invisible for corporation tax purposes. As such profits are treated as being received

directly by the partners in such partnerships and this can be particularly attractive to institutional

investors who themselves will participate through fund structures. At this stage we would

recommend that the LP structure may be the most appropriate for a UDF, but this does need to

be considered further in the light of the other issues impacting structure (for example vehicle

ownership.) A brief summary of certain key issues relating to the three structures are set out

below:

Company Limited by Guarantee (CLBG)– In British and Irish company law, a CLBG is a type of

corporation used primarily for non-profit organisations that require legal personality. A

guarantee company does not usually have a share capital or shareholders, but instead has

members who act as guarantors. The guarantors give an undertaking to contribute a nominal

amount (typically very small) in the event of the winding up of the company. A Company

limited by guarantee (or shares) has historically been a typical investment vehicle, particularly for

equity investments. However when compared to certain partnership structures it is tax

inefficient as company pays tax on profits (save in relation to dividend income from other UK

companies). Sales of shares in investee companies may be tax exempt if substantial shareholders


relief applies (subject to qualifying conditions) and stamp duty on value of land transferred to the

Company (although reliefs may be available).

Limited Partnership (LP) - A limited partnership is a form of partnership formed by one or more

general partners (GPs), with one or more limited partners (LPs). The GPs have management

control, share the right to use partnership property, share the profits of the firm in predefined

proportions, and have joint and several liability for the debts of the partnership. The GPs have

actual authority as agents of the firm to bind all the other partners in contracts with third parties

that are in the ordinary course of the partnership's business.

Like shareholders in a corporation, limited partners have only limited liability, meaning they are

only liable on debts incurred by the firm to the extent of their registered investment and have no

management authority. The GPs pay the limited partners a return on their investment (similar to

a dividend), the nature and extent of which is usually defined in the partnership agreement.

General Partners thus carry more liability, and in cases of financial misfortune, the GP becomes

"the generous partner". The role and expertise of the GP is therefore very important in the success

of the vehicle.

Limited partnerships are distinct from limited liability partnerships, in which all partners have

limited liability.

An LP (with its General Partner being an English Limited Company) is a vehicle frequently used

for investments, particularly for UK pension funds, and public private delivery vehicles (such as

Blueprint in the East Midlands). To accommodate investors of differing tax profile, particularly

those who may be non tax paying (eg. government) or overseas investors, a partnership structure

is typically most effective for UK tax purposes. This is because a partnership is tax transparent or

“look through” for tax purposes, avoiding tax at the level of the vehicle and maximising partners

post tax return, with parties deemed to receive the partnership profits or gains directly for tax

purposes. With regards to stamp duty, Stamp Duty Land Tax (SDLT) cost may potentially be

lower on initial transfer of land assets when compared to a Company limited by guarantee, and

depending on the approach taken with regards to match funding this may be an important

consideration (particularly given that SDLT is 5% over £1m)

Limited Liability Partnership - A Limited Liability Partnership (LLP) shares many of the

features of a Limited Partnership - but it also offers reduced personal responsibility for business

debts. Unlike members of ordinary partnerships, the LLP itself is responsible for any debts that it

runs up, not the individual partners. The main area of difference between an LP and an LLP is

with regards to the holding of real estate assets, where the LP has certain tax advantages over the

LLP structure.

Prior to establishment of any vehicle we suggest that expert tax advice is secured to ensure that

the proposed structure is tax efficient. Particular queries would include:

� Tax implications of equity disguised as debt (it can be important that the vehicle is deemed a

financing rather than a trading vehicle in order to ensure that finance costs to the extent

possible (subject to application of the UK’s transfer pricing rule) are deductible for UK

corporation tax purposes for the investee company and are not treated as non tax deductible

distributions);


� Tax implications on investors of debt repayments treated as taxable income (this is linked to

the point above as the tax treatment of financing versus trading vehicles looks both to

investors and investees);

� Stamp duty.

5.6 Single or Multiple UDF structures

There is no specification as to the number or type of UDFs that should be set up within a JESSICA

initiative. The Commission’s COCOF note (DOC COCOF/07/0018/01-EN FINAL) suggests that

‘Where possible, more than one financial engineering instrument should be selected, with a view to

producing the best possible leverage effects for scarce public resources contributed by the operational

programme, and in order to involve any available energy, resources and expertise of good quality from the

private sector, and to achieve the investment and development objectives of the operational programme.’

A single UDF structure is being taken forward in Wales, as was considered by the Welsh

Assembly Government as the best mechanism to ensure economies of scale, leverage private

sector investment, and provide a long term fund that can invest pan-Wales. Within the North

East a single fund for the region could create challenges as there are a strong sub-regional

differences both in terms of markets and political considerations which would benefit from more

localised structures, and there are existing vehicles which could support the development of

UDFs in different regions.

However, this needs to be balanced against the benefits of a simple structure in terms of ease of

set up, defrayal of expenditure, and size of the fund(s). For practical reasons, a single or potential

two UDF structure which focuses on providing loans to a small portfolio of larger projects, could

offer the best way of managing a number of the risks set out in section 7, including that of finding

a longer project pipeline, state aid considerations, and set up costs.

It should be considered whether a multiple UDF approach should develop along spatial, or

sectoral lines (see Figure 5). A spatial approach may provide opportunities for better integrated

investment to meet the needs of an area, whereby a sectoral/ industry themed UDF could be

more specialised in terms of the investment products offered and may also be more attractive to

private sector investors (for example specialist investors in renewable energy). A further factor to

consider is the eventual product next adopted by the UDF(s)- there may be benefits to specialist

funds focusing on, for example, provision of debt or equity.

In order to benefit from the potential of cross-subsidy between projects and economies of scale,

and to minimise risks through a portfolio approach, the optimum position may be for each UDF

to invest in a number of projects. However, there is nothing to prevent a UDF, either initially or

in the long term, being established to invest in a single project. This may be the case if UDFs are

small in value, or if projects require a significant amount of, or all of, the investment funds

available to the UDF.


Figure 5: Sectoral Multiple UDF Structure (Indicative only)

It is difficult to pre-judge the outcome of this debate at this time, as the best structure for UDFs

should be linked to the number and type of projects likely to come forward for funding across the

region, and should therefore be considered in the context of the information in section 6.

5.7 Potential Sources of Match Funding

All ERDF monies must be match funded at the appropriate ‘co-financing’ or ‘intervention’ rate

calculated by the Managing Authority for each Priority of its Operational Programme. As a

working assumption this is taken as 50%, which is the rate for most areas of the UK.5 Should

£20m of ERDF be invested through JESSICA, a further £20m of match funding must therefore be

identified (unless there is an over or under commitment of match funding elsewhere within the

NEOP). This must be available and committed as a pre-condition of draw down of ERDF to a

Holding Fund if used. The co-financing rate must apply to the funds within each UDF (ie. each

UDF must contain an equal proportion of ERDF and match funding for investment in projects.) If

5 The precise intervention rate for the project would need to be calculated by ONE at the point of

approving a grant for JESSICA, and would depend on the current levels of match already secured

by the programme on different projects. There is flexibility for the Managing Authority in terms

of the co-financing rate as long as the average at the level of each priority is respected. So co-

financing rates for UDFs can differ from the average priority rate where needed and feasible

within the overall picture of the priority. ONE has suggested a working assumption of co-

financing at 50% be used for the purposes of this study.


no Holding Fund is used, then each UDF must bring forward its own source of match funding to

support its application to the Managing Authority for ERDF.

It is possible to ‘substitute’ match funding, both at a Holding Fund and UDF level; therefore

match (in the form of say, land or cash) could be committed by ONE (for example) at the Holding

Fund level in order to facilitate ERDF draw down, but then be replaced by a contribution of equal

value by a UDF at a later date (for example through contribution of local authority land or

private sector investment).

Our review indicates that the following sources of match funding may be available should

JESSICA be implemented in the North East.

Table 4: Potential sources of match funding

Advantages Challenges

ONE/ HCA/ Local Authority Land

Opportunity for UDFs to benefit from

rising market in terms of land value

uplift.

Creates buy in from local partners who

become stakeholders in UDFs. Local

Authority land may be more readily

available than cash.

Majority of ONE land assets have already been

invested in two successful public-private joint

ventures.

Land values are not high in current market.

Due diligence required on land pre-transfer – can

increase costs and time to set up.

Realising land values requires investment

management expertise, additional time and resource.

The potential to use Local Authority land as match

funding was discussed. It was felt that there would

be land assets available, but that there may be

political/ sub-regional issues and that a structure

would need to be designed which allowed Local

Authorities to ensure that their area benefitted from

their investment, including any uplift in land value.

ONE Single Programme/ Local Authority/ other public sector Cash

Cash is liquid and easily used for

investment.

JESSICA aims are in line with Single

programme strategic objectives.

Single Programme resources are already

overcommitted.

Other public sector capital budgets are stretched.


Advantages Challenges

Debt Finance from EIB, CEDB, Capital for Enterprise or the private sector

Debt within a Holding Fund may be

structured to be off balance sheet for the

Managing Authority.

EIB has experience and precedent in

providing debt to Holding Funds.

Potential for additional leverage in

excess of minimum match funding

requirement.

Due diligence and credit risk assessments required –

debt likely to be secured against projects and hence

comfort needed that projects are viable.

Balance sheet issues if debt is consolidated up to

Managing Authority or potentially if liabilities are

passed to publicly owned UDFs.

Capital for Enterprise is focussed on providing debt

to SMEs rather than investment in urban

regeneration vehicles.

Private Sector Investment

Unlikely to be forthcoming given

current market conditions in the North

East at this time (although could be

added/ substituted at later date.)

Potential for additional leverage in excess of

minimum match funding requirement.

Brings private sector expertise into the region and to

UDFs/ PPPs.

The combination and quantum of sources sought should be linked to the JESSICA and UDF

structures taken forward. Our review indicates that in the context of the North East, and taking

into account the advantages and challenges below, a package made up of some Single

Programme Cash and land assets from either ONE or local authorities may be the best potential

option.

5.8 Using Land as Match Funding

Using land or property assets as match funding is an established mechanism, and has been used

both by London and Wales in the set up of their JESSICAs. There are however a number of issues

that need to be considered if this route is to be pursued, in order to ensure that the interests of

those providing the land are protected, that sufficient match funding can be realised, and that

state aid rules are met.

There appear to be three main scenarios as to how land could be used within JESSICA:

� Substitution - Assets put in at holding fund level could be substituted for alternative land

assets or cash at either holding fund or UDF level, or if a co-investment approach was used, at

project level. This means that the original assets provided as match can be removed once a

substitute is found. This is the approach which is being taken forward in London, whereby


UDFs are being asked to provide their own match and hence allowing land at the holding

fund level to be taken back out of the fund.

� Disposal - If assets put in as match are ‘surplus’ (ie. not held by the public sector for strategic

reasons or as part of specific development projects), and can be disposed of, then they may be

sold by either the holding fund or UDFs, and the cash used for investment in projects. This is

the approach being used in Wales, where an Investment Manager is being procured by the

UDF in order to manage the assets, enhance their value and realise cash through disposals.

� Investment – Alternatively, it is possible that land could be used as a direct project

investment by a UDF. Title on the land would need to be transferred from the UDF to a

project SPV, at a value agreed by the UDF with the SPV. This could be either as equity and or

as loan notes6 (i.e. repayment of capital and a variable/ fixed interest rate) although this may

count as quasi-equity and require state aid clearance. This would only be possible where the

land counted as eligible spend - in the case of the North East, an example could be if land in

an Innovation Connector project was used. It would need to be considered whether in this

case the value of the land would count as part of the 10% limit for land acquisition which is

part of ERDF rules.

One model of how land could be used as match funding is as follows. In this example it is

assumed the land is owned by a Local Authority.

� Land valued at current market value (e.g. using RICS red book)

� Local Authority commits land to the Holding Fund, which takes a charge over the title, to

provide match funding and allow draw down of ERDF. At this point the value of the land can

be declared as expenditure to the Commission.

� Responsibility for managing and maintaining the land remains with the Local Authority,

which is also liable for any ongoing costs incurred and receives benefit of any income (e.g.

Rental income)

� Any decrease in the value of the land in between transfer in to the Holding Fund and transfer

to a UDF could be the risk of the holding fund/ Managing Authority in terms of being able to

provide sufficient match funding to ensure retention of the ERDF. If the amount declared to

the Commission at the point of land transfer in to the fund has not been invested in projects

by the end of the programme, then the ERDF contribution would need to be reduced

proportionately.

� The Holding fund agreement would need to have as a 'reserved matter', that investment of

monies to atleast the value of the land at the point of establishment of the holding fund or of

6 Loan notes to the value of the land would be provided by the UDF to the prior owner of the

land (for example ONE or a Local Authority). The loan notes are required to be repaid in cash by

the UDF to the prior land owner, according to an agreed timetable, and with an agreed rate of

interest. This may be a fixed or variable interest rate. Repayments may be required at regular

intervals, or may be contingent on the cashflows/ profits available at UDF level.


the value at the point of transfer must be given to a UDF with a commitment to invest this

money in the LA region. There may be other 'reserved matters' that are required.

� The agreement with the Local Authority providing the match may also need to guarantee the

Local Authority a repayment in cash or equivalent stake in the Holding Fund or successor

vehicle to the higher of the value of the initial transfer value and the investment value at the

winding up of the UDF.

5.9 Set up Costs

An industry rule of thumb for the costs of setting up investment funds suggests 1-2% of fund

value. For a £40m fund, this would therefore equate to a rough estimate of up to £800k over say a

12-18 month period. Whilst this is a significant outlay, the following should be taken into account

when assessing any cost-benefit analysis:

� A large proportion of set up costs may be eligible under ERDF rules as part of project

development, and could therefore be recouped from the Holding Fund or UDF once

established. This means that for these cost items the challenge would be one of cash flow

rather than the need to secure additional funding. In the case of a HF, this cashflow problem

should not apply for the selection of UDFs, which may represent the majority of set up costs

involved.

� To provide best value JESSICA should be considered as a long term fund that recycles monies

through a number of investments. The set up costs should therefore be placed in the context

not of a single [£40m] fund, but of an investment vehicle(s) that can not only leverage

additional third party finance at the project level, but that over its life may be able to use its

initial capital two or three times without incurring any further set up costs. On this basis the

ratio of set up costs to investment would be £800k: £80-120m, or 0.75-1%.

The key cost items are likely to be:

� Legal and financial advice in setting up a Holding Fund if required. This should include work

on fund structure, ERDF grant applications to the PMC and all necessary approvals. However,

any further work required on pipeline projects, and development of Business cases in relation

to the selection of UDFs, could be carried out once the HF has been established, and thus

deducted directly from HF resources. It is important to note that a template Holding Fund

agreement is now in place and has been signed with both London and the North West. This

means that costs may be significantly lower and timescales quicker than in these areas.

� Fund Management costs payable to the Holding Fund Manager once the Holding Fund is set

up. We understand that if provided by the EIB these are likely to be within the limit of 2% of

fund value per annum for Holding Fund Management set by the regulations, charged on a

cost recovery basis, and within the context that the EIB operates on a not for profit basis.

These costs would be expected to cover the Holding Fund’s obligations and services as

discussed in section 5.3. If no Holding Fund is used, these costs would need to be paid by the

Managing Authority upfront.


� Legal, financial and project management support to new or existing vehicles which wish to be

considered as UDFs, and who may need to make corporate structural changes, and to prepare

UDF business plans.

The quantum of costs can vary significantly depending on a number of factors. Important

variables to note would include:

� How much appropriately skilled resource is available both within ONE and within existing

vehicles to support the development of business cases and work on the project

implementation, and hence reduce reliance on external advisors. The experience of ONE in

setting up a JEREMIE fund, and the development skills within the region’s delivery vehicles

should be advantageous in this regard, although Fund structuring and Fund Management are

different to economic development and pure property development.

� The length of time taken to establish the fund(s), including time required to securing key

information from the Commission and to resolve any potential issues with CPRG or other

approvals, which can increase costs.

� The sources of match funding; using land and property assets as ERDF match may require

additional resource to ensure compliance with regulations and appropriate due diligence. The

use of debt as match funding similarly would require due diligence and additional funding

agreements.

� The amount of effective knowledge sharing and lessons learned from advisors and from other

JESSICA funds that can be accessed and utilised by ONE and its partners to smooth the set up

process.

5.10 Procurement and Selection of UDFs

A key role of the Holding Fund, (or the Managing Authority if no Holding Fund is used), is to

allocate funds from the Holding Fund to UDFs. This process would be managed by the Holding

Fund and the costs of this included in the Holding Fund Management fee. The Commission has

indicated that a transparent procedure for the selection of financial engineering instruments

should be applied. This is often referred to as a ‘call for UDFs’; in the same way as a Managing

Authority might operate a call for grant applicants under normal European grant funding

procedures. There has been much debate as to whether a ‘call’ needs to comply with EU and

national public procurement legislation, or whether a direct award can be made to UDFs. The

Commission guidance note on Financial Engineering (COCOF 08/0002/03-EN) addresses this

point, and suggests that where no Holding Fund is used, the Managing Authority could make a

direct award of grant to a UDF without a procurement process being required. This is the route

that has been adopted in Wales, where the Welsh European Funding Office (WEFO) as the

Managing Authority has awarded a grant of ERDF to the Welsh UDF. The terms of this grant, as

defined in the funding agreement between WEFO and the UDF, allow the Managing authority to

specify certain terms and conditions with regards use of the funding, as potentially would be

defined in a contract if a procurement process was used. This includes a requirement to repay the

grant at wind up of the UDF to the Welsh Assembly Government.


If the contribution to the operational programme is not provided as grant a competitive process

must be followed. This would be the case if the Holding Fund was awarding ERDF monies

effectively via loan to a UDF via a funding agreement that then required repayment of ERDF to

the Holding Fund or successor body. The selection process as a baseline position should follow

OJEU rules, although it is important to note that if the EIB is appointed as Holding Fund

Manager, they are able to operate their own procurement process. This EIB process is currently

being used by a number of other Holding Funds to call for UDFs (e.g. London and the North

West).

The process is likely to include the following key steps:

Figure 6: Potential Selection process for UDFs

UDF selection criteria could include the following:

� Understanding of the policy context and strategic priorities of the NEOP

� Understanding of the requirements of ERDF and JESSICA

� Experience and track record of the organisation and team members in investing in

regeneration projects and managing public money


� Evidence of understanding of local projects and ability to evidence a project pipeline

� Ability to provide additional private sector leverage and co-finance

� Forecast financial returns to partners

� UDF forecast operating costs, and fund manager remuneration/ fee structure

As indicated in Figure 6, we would suggest that UDF business plans submitted as part of the

selection process are required to include the full content as set out in Article 43.2 of the legislative

provisions for JESSICA. This includes the following:

� The targeted market of enterprises or urban projects and the criteria, terms and conditions for

financing them

� The operational budget of the financial engineering instrument

� The ownership of the financial engineering instrument

� The co-financing partners or shareholders

� The by-laws of the financial engineering instrument

� The provisions on professionalism, competence and independence of the management

� The justification for, and intended use of the contribution for the Structural Funds

� The policy of the financial engineering instrument concerning exit from investments in

enterprises or urban projects

� The winding up provisions of the financial engineering instruments, including the

reutilisation of resources returned to the financial engineering instrument from investments

or left over after all the guarantees have been honoured, attributable to the contribution from

the operational programme.

5.11 Governance Arrangements

Governance arrangements at all levels are essential to ensure that the objectives of the Managing

Authority are met, and to ensure appropriate transparency and accountability in the use of public

sector monies. Governance arrangements are also an important part of control, and hence must

be considered in the context of classification of balance sheet treatment.

Holding Fund – The Holding Fund Manager would be responsible for establishing appropriate

governance arrangements and internal controls to safeguard the monies within the holding fund

and the processes undertaken to deploy these into UDFs. There is no requirement in the

regulations for any specific governance arrangements between the Holding fund and the

Managing Authority, but in both London and the North West a Holding Fund Investment

Committee/ advisory board structure has been established to over see the activities of the

Holding Fund. This generally includes representatives from the Managing Authority, and other

local stakeholders. The Northwest used an external recruitment process to source external,

independent experts for their Investment committee. This has a number of advantages including

transparency of appointments, and providing access to additional skills and expertise from the

private sector which may not be available in house. There may be costs associated with this route,


both in terms of the use of recruitment consultants (if required), and potentially fees/ expenses

paid to independent committee members for their time.

As noted above, the make up and control of any decision making body such as an Investment

Committee can have an impact on balance sheet treatment. As a general principle, in order to

avoid consolidation the Managing Authority should have less than 50% by number and voting

rights of representatives and direct appointments to the board. We would recommend that in

order to facilitate focussed decision making, the board included in the region of seven

individuals, including an independent Chair. We would also recommend the inclusion on this

board of representation from the private sector with experience in investment funds. The role of

the Investment Committee would likely include:

� Approving the Holding Fund investment strategy

� Approving UDF business plans and the apportionment of funds from the Holding Fund to

UDFs

� Receiving and scrutinising monitoring reports on the progress of the Holding Fund and of

individual UDFs

� Approving the strategy and use of any returns coming back to the Holding Fund for

reinvestment.

UDFs – Each UDF will need to put in place its own governance arrangements, and to

demonstrate the robustness and appropriateness of these as part of applications to the Holding

Fund (or to the Managing Authority if no Holding Fund is used), in order to secure JESSICA

funding. This is likely to include a Management Board, composed of representatives of the legal

partners/ owners of the UDF potentially also with external advisors. There may be a need for a

number of committees for specific functions, (e.g. Remuneration, Appointments, Health &

Safety), and of these an Audit Committee would in our view be an essential pre-requisite in order

to oversee the audit requirements associated with receipt and defrayal of ERDF funds.

6. JESSICA PROJECT PIPELINE

As part of assessing the feasibility of JESSICA in the North East, the Managing Authority is

rightly seeking comfort that there is a suitable pipeline of projects that may be funded through

any UDFs established. This is important in order to;

� Demonstrate value for money in use of funds and set up costs;

� demonstrate added value in terms of the opportunities to recycle funds and secure additional

leverage; and

� to minimise any risks that ERDF is not defrayed on eligible expenditure before programme

close (and hence be clawed back).

6.1 Case Study Projects

The brief for the study included four project case studies to be used as hypothetical examples to

test the feasibility of JESSICA in the region. These projects were proposed by the Steering Group

as providing a representative sample of priority projects across the region, including both a


geographical and sectoral spread. In line with the study methodology, the consultant team

undertook meetings with all the project sponsors, and requested supporting information both in

terms of financial analysis and delivery of outputs in order to assess how a JESSICA fund could

assist in taking forward these projects.

For the purposes of wider circulation and confidentiality, the project names and details have been

anonymised.

The brief posed the following questions with regards to the case study scenarios:

Strategic Fit

•Does the project contain eligible expenditure under JESSICA, ERDF and the NEOP?

•Does the project fit within an Integrated Plan for Sustainable Urban Development?

Market Demand

•What are the key issues effecting delivery on the site? Demonstrate the degree to which these examples reflect the conditions in the region and take into account existing urban development activity as well as anticipated opportunities.

Deliverabiility

•Propose and illustrate appropriate delivery mechanisms that could be established to drive projects forward. Suggest criteria to measure their performance, robustness and degree of applicability for other JESSICA projects in the region.

Financial Viability

•Illustrate for each case how positive IRR could be maintained through the development of each project. Provide a measure of the Economic Rate of Return (ERR) for each case. Comment upon the appropriateness of using the same methodology to assess other potential JESSICA projects in the region.

Our work with the case study project sponsors highlighted the following issues:

� Up to date financial information, in terms of development appraisals or other analysis is not

generally available at this time, and hence accurate financial modelling can not be undertaken

to forecast IRR/ ERR of case study projects. It is also difficult to undertake informed analysis

on the amount of ERDF eligible spend within projects, or to assess the quantum of potential

JESSICA investment in a project. (For the purposes of modelling, assumptions around

eligibility include £43m of eligible spend; see Appendix 2.)

� Furthermore, discussion with sponsors indicates that two of the four projects are currently

forecasting a significant funding gap that must be filled before the projects can proceed. This

is not unusual given the current national economic climate, the property market in the North

East and the nature of regeneration projects, which often require public sector intervention.

Approaches to tackle current deficits include re-masterplanning, variations in mix and

phasing, and seeking new or additional grant funding. However, if projects require gap

funding, this indicates that at this time they may not be immediately suitable for investment

through JESSICA. If these projects contain eligible expenditure it should be considered

whether they should rather apply for ERDF as grant as the best way to ensure that projects are


unblocked and strategic objectives achieved. Alternatively, once gaps are filled, JESSICA may

be able to assist in provision of development finance.

� The renewable energy project (Project B) is a strategic development of high importance within

the Managing Authority’s plans, but has always been envisaged as a grant funded project.

Some of the facilities on the site may have the potential to generate a return in the long term,

but very limited commercial modelling has been undertaken. Income generation is expected

to purely cover operating costs, but our understanding based on discussions with ONE is that

it is not anticipated that revenues from site leases or facility rental would be able to support or

repay a capital loans in the short term.

However to illustrate how JESSICA could be used within the region, DTZ have produced

estimates in order to allow some hypothetical modelling to be undertaken. These estimates

combine available information with DTZ’s market assessment and local knowledge in order to

produce summary development appraisals for each of the four case study projects.

These estimates have not been agreed with case study project sponsors, and are not

intended to reflect an accurate or realistic representation of the financial position of these

projects. The modelling undertaken is for illustration only. No investment decisions

should be made on the basis of this analysis.

A summary of the information available, inputs and assumptions used and key considerations

on each of the four projects is included as Appendix 2.

6.2 Alternative pipeline projects

It is important to note that just because the case study projects may not all be ideal JESSICA

projects, does not mean that JESSICA in the region is not viable. The advantages of the model

are such, particularly in terms of the ability to recycle funds for re-use in wider regeneration

projects, that innovative approaches should be considered whereby JESSICA can be used to

free up other sources of funding (e.g. limited RDA and Local Authority resources), and where

a focus on the first investment may be on timing and certainty of defrayal and financial

viability potentially above strategic fit. This means that is likely that the Managing Authority,

potentially assisted by any Holding Fund, would need to conduct detailed review and due

diligence on other potential projects for JESSICA investment as part of next steps.

� ONE Capital Programme – there are a large number of other regeneration projects across the

region which ONE has considered for funding through its other resources. We have

undertaken with ONE a high level review of these, taking into account whether or not there

may be eligible spend, and any potential to substitute capital funding already committed

through the Single Programme with an ERDF JESSICA investment, which would support

JESSICA feasibility and also free up Single Programme monies for other uses. Financial

analysis of these projects is outside the scope of this study, but our high level review suggests

that the following may be worth further investigation as part of next steps.

Darlington Business Incubator – this project is part of the broader Central Park project. The

project will result in the creation of a Business Incubator at Yarm Road, Darlington (Central Park)

which will provide management services, ensuring a business incubation process consistent with


the relevant BSSP product specification. Detailed Feasibility will include confirming the need for

the project. The intention is for Darlington Borough Council (DBC) to develop an incubator

building in this key location adjacent the main line railway station. Upon completion an

incubator operator will manage the facility by way of an agreement/lease of this building. The

identified site is already partly in the ownership of DBC and ONE – the project will comprise the

acquisition of the remaining plots to provide the site (for which values have been agreed with all

land owners), undertake necessary highway works to access the site from Yarm Road,

procurement of the construction of the building and the creation of a rental guarantee in the first

two years in order to support sustainability. It is possible that this rental guarantee could

potentially be funded through JESSICA (state aid approvals allowing.)

Middlehaven - Middlehaven is a major regeneration area between Middlesbrough Town Centre

and the River Tees. A key regeneration site within the HCA’s national portfolio, the project

presents a major opportunity to re-connect the Town Centre of Middlesbrough with the riverside

and re-position Middlesbrough’s role as a sub-regional centre for the Tees Valley city region. The

site suffers major constraints in terms of poor quality environment, low value riverside uses, and

connectivity barriers to the town centre, but the scale of the site comprising 80 hectares, and the

previous investment in reclaiming the dock area, offers the potential to create a distinctive new

riverside quarter for the town. Middlehaven represents a key ‘flagship’ project for Tees Valley

Regeneration (TVR). A Development Framework has been created by David Lock Associated,

and a significant public sector funding package has been secured including ONE, the HCA, the

Council and ERDF from the previous programme period. Development has subsequently

commenced on Phase 1 of the site with Terrace Hill progressing a first phase of approximately

15,600m2 of commercial and ancillary leisure development on the south eastern edge of the

Middlesbrough Dock. One NorthEast has invested additional funds to commence the acquisition

process in the Central Industrial Area and also to deliver elements of key infrastructure. It is

possible that a case could be made for eligibility depending on the specific uses for the

commercial space, and any potential linkage with Innovation Connectors. If so, either a loan to

the developer, or the provision of JESSICA equity leading to a reduced requirement for developer

loan, could potentially increase the viability of the project.

� Current ERDF grant applications – there are a number of projects that are already in various

stages of business case development for applications to ONE for ERDF grant. As such, these

projects should include eligible expenditure, and should be deliverable within the programme

timeframe. We have reviewed the list provided by ONE of these projects to see if in any of

these it may be possible to substitute grant for investment and hence provide a quick win in

terms of establishing JESSICA and defraying funds. From our review and discussion with

ONE staff it appears however that all these projects have a genuine need for grant funding

rather than development finance.

� Private Sector Projects – informal market intelligence indicates that there are a number of

stalled private sector led projects in the North East, which may be ‘oven-ready’ but have

stalled due to issues in securing development finance. From our discussions with ONE and

DTZ, we would suggest the following could be potential JESSICA projects. We would

recommend a detailed soft market testing exercise with potential project sponsors as part of

next steps to assess demand, increase awareness and establish the strength of a potential

pipeline.


[PROJECT LIST REMOVED DUE TO COMMERCIAL SENSITIVITIES]

6.3 Investment Criteria for project selection

UDFs may come forward with an established portfolio of projects that they intend to fund, or

alternatively may have investigated a project pipeline but not yet have selected projects. In either

case, those projects should meet a set of investment criteria established by the UDF. We would

suggest investment selection focuses on three key areas:

Figure 7: Indicative Investment Selection Criteria


7. RISKS & MITIGATIONS

As with any major new initiative or major investment, there are a number of risks in the development and operation of JESSICA which ONE

should consider as part of its decision making process.

Table 5: Risks & Mitigations

Ref Issue Risk Mitigation

1. Timing of delivery of outputs – under an

ERDF grant regime all outputs delivered

through use of ERDF funds must be reported

to the Commission by programme close (31

December 2015.) Before outputs can be

delivered under JESSICA, the following have

to happen:

� Set up Holding Fund (if required,)

� Select UDFs

� UDFs make investments in projects

� Projects use funds to support regeneration

� Projects deliver outputs.

Given the long term nature of urban

regeneration projects and the time needed to

establish a JESSICA it may be difficult for

projects to deliver outputs by the end of 2015.

This issue was also recently raised by the

LDA.

The Commission has indicated verbally that

If outputs are not delivered by 2015, there is a

risk that the Commission seeks repayment of

ERDF from the UDF/ Managing authority

through clawback provisions.

There is an additional implication that if outputs

must be delivered by project investments by

2015, then all ERDF must also have been

defrayed by projects by 2015.

Seek written confirmation from the

Commission as this is an important

consideration in assessing the feasibility

of JESSICA.

Consider liaising through DCLG to put a

UK wide request to the Commission for

clarification on this issue.

Mitigate risks by including forecast

timing of spend and delivery of outputs

as part of the assessment criteria for

selecting UDFs and investment projects;

and look for a small number ‘oven

ready’ projects that can deliver spend

and outputs by the deadline.



for JESSICA it may not be necessary for

outputs to be delivered by 2015, but this is a

live issue and is also linked to ongoing work

on audit requirements (see below.)

2. Audit requirements at project level –

Although the regulations indicate that the

‘beneficiary’ of the ERDF funding is the UDF,

the Commission are currently indicating

(through correspondence with the Welsh

European Funding Office) that if the monies

passed from a UDF to a regeneration scheme

are related to a specifically defined activity,

(as would be the case for JESSICA

investments which will fund specific eligible

activity as part of an overall project), then

the audit trail and full audit requirements

must extend to the project level. This is still

under review at the Commission and we

understand there is a desire to ensure audit

can focus on the fund not project level where

possible.

There is a risk that this additional administrative

burden means that JESSICA becomes less

attractive to some potential borrowers when

compared to other sources of finance.

Furthermore, there may be a risk of clawback if

auditors at project level find errors, lost

documentation, or disagree with judgements

made with regards to eligible expenditure. Any

such errors may be extrapolated across the

portfolio of investments made by a UDF.

Requirements for document retention,

auditor access and inspection are

standard throughout the public and

private sectors, and those that are

familiar with receipt of ERDF grant will

already have experience with the

standards required. It should be noted

also that audit fees are eligible

expenditure.

Build in audit requirements in to

agreements with UDFs and between

UDFs and projects.

Continue discussions with DG Regio on

the interpretation and implementation of

audit requirements.

3. State aid clearance – Our analysis indicates

that some of the areas where JESSICA may

have the most benefit to the area are those

where either a ‘soft loan’ is required, or

where investment through equity or rental

guarantee is most appropriate. Currently, all

The current guidelines for risk capital focus on

SMEs, and are not suitable for calculating aid

given through equity and guarantees through a

mechanism such as JESSICA. It is also not clear

what the Commission view is on loans not on

market terms; for example if full security

We understand that CLG may take

forward a proposal to undertake

research on potential precedents and

mechanisms for quantifying state aid

through JESSICA, which could be used

as the basis for a UK state aid



of these interventions would require state aid

approval from the Commission.

arrangements are not required. Without state

aid approval these financial products should not

be utilised by JESSICA in the North East. There

is a risk that approval is not secured in time to

allow these products to be used in advance of

the 2015 deadline.

notification. We would recommend that

as part of next steps discussions with

CLG are continued in this regard.

In the interim, there is precedent (in

Wales and the North West) for a no-aid

position being developed on JESSICA

UDFs providing loans on commercial

terms (set in line with Commission

guidance.) The fund could therefore

commence as a loan fund, and add other

products to its offer as time progresses

and the state aid position is clarified. For

this reason initial products that would

benefit from loan may be the most

suitable for the early pipeline.

4. Robustness of project pipeline – ONE needs

to consider how much certainty it seeks as to

the projects that could be funded through

JESSICA before making a decision to proceed

or before setting up a Holding Fund.

If there is not a suitable pipeline of projects that

contain eligible spend and meet the investment

criteria for JESSICA then there is a risk that

funds will not be defrayed by 2015 and are lost

to the North East.

Initial work indicates that there is

market demand, and that there are a

number of potential projects that could

be funded through this mechanism. We

would recommend further detailed

work and due diligence on a shortlist of

potential projects as part of next steps.

This could potentially be funded

through the ERDF Technical Assistance

programme. Work could also be aligned

with development work on possible



UDFs.

5. Balance sheet treatment – As a complex

investment vehicle holding assets but also

potentially taking on debt or being exposed

to project level liabilities, balance sheet

treatment of both Holding Funds, UDFs and

UDF interest in projects will need careful

review.

In the current funding climate, any vehicle

which brings debt or exposure to liabilities on to

the public sector balance sheet is highly unlikely

to secure the necessary approvals.

A Holding Fund managed by the EIB

can be off balance sheet for the

Managing Authority as long as it does

not have majority control (e.g. Through

representation on an Investment

Committee). UDFs which are private

sector owned or majority private sector

would also be off the public balance

sheet.

6. Securing approvals – Approvals to proceed

with JESSICA in the North East would be

needed from PEG, PMC, and DCLG Central

Projects Review Group (CPRG). This

involves an options appraisal and business

case submission based on the Treasury ‘5

case’ model. Should ONE wish to be

involved directly in the establishment of

UDFs, then this would also need Section 5.2c

consent.7

Approvals not received, or take time to secure

which causes delay in implementation timetable

and requires additional resource to resolve.

Both the North West and London have

received CPRG approval for their

Holding Funds, which indicates that

both DCLG and HM Treasury are

familiar with these models. ONE should

continue dialogue with CPRG, and seek

to learn from the lessons of colleagues in

putting together the necessary business

cases. Key issues are likely to be balance

sheet treatment as discussed above.

7 Guidance note on the exercise of the Secretary of State for Trade & Industry’s powers under section 5 of the Regional Development Agencies Act

1998, and as amended by the Greater London Authority Act 1999.



7. Uncertainty over future role of RDAs –

some of the policies that may be introduced

by the new Conservative-Liberal Democrat

UK coalition government may include a

dismantling or change in role/ structure of

Regional Development Agencies (RDAs)

such as ONE.

There may be unwillingness from the ONE to

enter into a vehicle such as JESSICA when

future funding and institutional arrangements

are uncertain.

The success of the fund could be impacted by

changes in ownership and structure caused by

any changes to the role of the RDA.

The Conservatives have indicated that

there may be a continuing role for RDAs

in locations such as the North East. Any

changes in any case may take up to 12

months to develop before

implementation. Under any government,

there will still be an obligation under the

terms of the European Funding to

deliver the NEOP, and JESSICA will still

be a tool open to Managing Authorities.

Any JESSICA funds in the North East

should be structured so that ownership

interests and contracts can be

transferred/ novated to any successor

bodies of ONE if required.


8. CONCLUSION AND NEXT STEPS

The key conclusions and recommendations from this study are as follows:

� A review of the property and development funding market confirms that there is market

failure in the North East with regards to the provision of development finance and that this

could in part be addressed through JESSICA.

� Three of the case study projects submitted as part of the brief could benefit from JESSICA

investment alongside public sector grant, and a package of funding that includes JESSICA

could help unblock stalled projects. Other public and private sector projects could also benefit

from access to JESSICA, and subject to further review, could provide the necessary pipeline.

� JESSICA is not a ‘golden bullet’ – it is an investment mechanism not grant and needs to be

seen as alternative or addition to other sources of development finance rather than as a gap

funding mechanism. Awareness raising and work with stakeholders will be required in order

to ensure any JESSICA is positioned in this context and to manage expectations.

� There is likely to be scope within the NEOP to fund a JESSICA initiative under Priority 1.1

with regards to Innovation Connectors, although further work would be required to put

together a strategic case to support this and to establish whether there is a portfolio of projects

containing sufficient eligible spend. If additional funds within Priority 2.1 could be secured

then this would increase the number of projects containing potential eligible expenditure.

� A fund of £20m ERDF (based on the potential amount identified in Priority 1.1) plus £20m

match funding provided through a mixed package of funding sources would provide a fund

of sufficient size to be feasible. If land assets are to be used as match funding, further

consideration would be required as to the controls put in place to protect the interests of those

parties providing land.

� In order to secure ‘quick wins’, minimise the risks of not defraying funding, and ensure value

for money in set up and operating costs, it is likely that if progressed a North East JESSICA

fund could look to fund one or two UDFs rather than a larger number. It is suggested that the

use of a Holding Fund, potentially using the expertise and advantages of the EIB, would be

beneficial.

� There is an appetite from partners to fully investigate the opportunity presented by JESSICA

in the region, particularly given the ability to re-use any recycled funds for wider regeneration

uses (our interpretation of the regulations is that this would include mixed use development

and housing that would not be eligible under the first cycle of investment.)

8.1 Further work required

In order to address the risks identified and demonstrate the full case for JESSICA we would

recommend that ONE and its partners take forward a number of work-streams over the coming

period. ONE may prefer that the bulk of these activities are undertaken before the Holding Fund

is established, although work on projects and UDFs in particular could be undertaken through

the Holding Fund Manager.


Technical Assistance ERDF monies under Priority 3 could be available to support further

development of a JESSICA mechanism and hence to fund the use of external financial, property

and legal advisors in the delivery of these work-streams.

Figure 8: Suggested JESSICA North East Implementation Work-streams

Workstream1: Projects

Workstream2: UDFs

Workstream3: Match Funding

Workstream4:

Structuring, Approvals &

Legals

Produce project shortlist. Undertake detailed analysis, modelling and due diligence on potential projects to be funded through JESSICA.

Undertake soft market testing and stakeholder engagement to identify and develop potential UDFs

Carry out detailed review of land and property assets available to provide match funding at Holding Fund and UDF level.

Produce final business case, secure approvals, draw up Holding Fund agreement.


8.2 Implementation Timetable

The following table sets out key milestone dates for a project plan to take forward the

implementation of JESSICA in the North East.

Table 6: Indicative implementation timetable

Ref Task Date

1. Presentation of JESSICA Feasibility Study Final Report by ONE to

PEG and PMC

May 2010

2. Further work undertaken on Workstreams 1-4 as set out above. June - July 2010

3. Preparation of full JESSICA business case for submission to PMC,

PEG and CPRG.

August 2010

4. Sign Holding Fund agreement, transfer match funding to Holding

Fund, draw down of ERDF.

October 2010

5. Holding Fund Manager establishes Investment Committee, agrees

selection criteria and process for UDFs, draws up funding

agreements with UDFs, and calls for UDFs.

September – November

2010

6. Selection of UDFs and allocation of ERDF (and match if not provided

by UDFs) to UDFs

January 2011

7. UDFs established, set up governance, reporting and monitoring

procedures, and bring forward first projects

January – June 2011

8. UDFs make first loan investments in urban regeneration projects. June 2011 – December

2015

9. ERDF defrayed by UDFs and outputs delivered December 2015

10. Second cycle of investments made by UDFs 2014 – 2020 (for

example, based on a

range of investments

with different pay back

periods).

11. Potential wind up of UDFs at end of life, monies remaining within

the UDF shared between UDF partners or returned to the Managing

Authority, for continued support of urban regeneration projects.

2022 – 2025 (for

example, based on a 12 -

15 year life for UDFs.)


APPENDIX 1: MARKET REVIEW

This report section is structured so as to examine in turn the five key issues which we have

identified as impacting upon the commercial development market and which may hinder new

development in both the short and long term. High level commentary is also provided on key

factors in the retail and residential markets. This list of issues is not exhaustive but is considered

to represent the major factors having impact upon the office and industrial market sectors. Where

possible we have sought to identify where a JESSICA fund may address some of the issues

identified.

The information below has been collated from a combination of statistical analysis and

qualitative research using key stakeholders within the market and while every effort has been

made to provide a robust overview of market dynamics it must be remembered that this is a

complex field with a considerable number of influences and as such any projections as to future

conditions must be taken as a guide only.

Issue 1: The Underlying Economic Climate

At the beginning of 2010 initial indications are that the country has emerged from recession

following six successive quarters of decline in economic growth. This represented one of the

worst periods of economic decline in the UK since the Second World War and has impacted upon

virtually every sector of the economy, and in every region of the country.

The recession had begun as a result of a rapid decline in inter-bank lending brought about as the

solvency of major financial institutions was called into question. The economy suffered a sharp

shock from this loss of credit and began to contract as demand for goods reduced. The

combination of a decline in demand, falling asset values and rising commodity prices throughout

2008 led to many companies suffering. In 2008 we saw market collapse above and beyond that

seen in previous recessions, particularly in the financial sector, and significant government

intervention in the US and UK to sure up bank balance sheets.

However, governmental action does appear to have stemmed the unprecedented potential for

failure of the ‘institutional’ companies, leading to a return to more conventional recessional

behaviour in the markets. It has also left governments around the world with massive national

debts and exposure to some of the more toxic assets that these failing companies possessed.

While debt-financed government spending appears to have brought the economy in line with

more conventional recessionary behaviour, the additional debt needed to do this will impact

fiscal policy for years to come. The current deficit in public finances is unsustainable in anything

other than the short term. With falling revenues from tax receipts and an increasing cost in both

spending and servicing the debt accrued, this deficit will eventually have to be paid for by either

tax rises or public spending cuts in both the medium and long term. The approach to be taken by

the new coalition government is still uncertain, although either tax increases and reductions in

public spending are likely to impact on any future economic growth. An additional potential

problem can be identified as a result of the UK policy, now suspended, of Quantitative Easing as

it is likely to increase inflation, which will in turn drive up interest rates. This will push up the

cost of capital for borrowers.


Such economic uncertainty makes forecasting of any kind extremely difficult. The DTZ view is

that the majority of economic indicators will not return to growth until 2012, although it is worth

noting that such forecasting has remained fluid as major unexpected events unfold.

While this uncertainty remains, activity within property markets will remain subdued as

occupiers take a more cautious approach to expansion and relocation and developers,

constrained by limited availability of finance and concerned by occupational demand for finished

product, will avoid all but prime development opportunities.

Issue 2: Physical Barriers to Development

In this section it is worth considering briefly the key physical barriers to development which

place a constraint on the opportunities for urban expansion within the key North East city areas

of Newcastle-Gateshead, Sunderland, Darlington and Middlesbrough, and also highlights

different tensions in each area.

In each of these urban centres a relatively compact city core has been created as a result of

physical barriers (typically a river, major highway or public open space). Within Newcastle,

Sunderland and Darlington this is coupled with fairly dense level of development made up of a

high proportion of historic, and sometimes listed, buildings.

As a result, much of the existing urban core provides commercial accommodation made up of

relatively small and irregular floor plates which, while suitable for most small to medium sized

enterprises, can be difficult to accommodate larger corporate organisations. While a limited

number of schemes have sought to address this issue, the majority of large modern premises

(those in excess of 4,645 sq m) have had to be delivered in out of town business parks, most

notable Quorum and Cobolt Business Parks in North Tyneside which together have 71,533 sq m

of vacant accommodation Within Newcastle the limited large-scale development opportunities

acted as a catalyst for the physical regeneration of the Quayside over the last 15 years, most

notably in schemes such as St Ann’s Warf (5,425 sq m), Keel Row House (2,787 sq m) and Trinity

Gardens (14,632 sq m) This has provided an opportunity for the two settlements of Newcastle

and Gateshead to work closer together and, as development opportunities have become limited

on the northern side of the River Tyne, developers have looked to opportunities within

Gateshead.

Initially development on the southern bank of the Tyne focused on leisure and cultural uses

along with residential property however latterly the Local Authority and developers have turned

their attentions to commercial opportunities with the possibility of providing large modern office

premises. The first such developments have included Baltic Place (12,170 sq m) and the first

phase of Baltic Business Quarter (4,180 sq m).

A similar picture has emerged in Sunderland where a relatively compact city core is bordered by

the River Wear and steep topography to the north, residential suburbs to the south and west and

the North Sea coast to the east. As a result, few major development sites have been able to come

forward in recent years, with the majority of commercial development taking place in outlying

locations close to major transport hubs. The most significant opportunity for the development in

the city centre, remains vacant.


Whilst Middlesbrough has not been constrained by the same historic core as the other major

urban centres, the A66 which bounds the centre has proved a barrier for expansion. Historically,

the focus for development in this part of the region has proved to be proximity to the arterial

route of the A19.

Issue 3: The Supply/Demand Imbalance

The economic downturn experienced over the last three years has undoubtedly created a short

term imbalance in supply and demand as requirements for new accommodation have all but

disappeared and the availability of space has increased.

Within the office market the largest market centre is Newcastle upon Tyne which, as the graph

below shows, has seen availability of accommodation grow significantly in recent years for all

grades of accommodation.

Figure 9: Office Availability

-

100,000

200,000

300,000

400,000

500,000

600,000

700,000

800,000

900,000

1,000,000

Q4

2005

Q1

2006

Q2

2006

Q3

2006

Q4

2006

Q1

2007

Q2

2007

Q3

2007

Q4

2007

Q1

2008

Q2

2008

Q3

2008

Q4

2008

Q1

2009

Q2

2009

Q3

2009

Q4

2009

sq ft (000s)

Grade A Grade B Grade C Source: DTZ Research Figure 9 shows that total office availability, which includes both new accommodation as well as

space returning to the market following tenant vacation, has increased by around 50% over the

last 4 years. In a non-recessionary market, demand for accommodation would normally restrict

this increase in availability but as the above indicates the recessionary conditions which began to

be experienced from Q2 2007 have reduced the level of demand and therefore allowed office

availability to increase.

Contributing to this increase in availability has been the development of a number of major new

schemes including:


Table 7: New scheme development

Scheme Location Developer Size Year

Completed

Baltic Place Gateshead Quayside Robertson

Group/C&N

11,150 sq m 2009

Wellbar Central Newcastle City Centre Siddiqui Family 11,150 sq m 2010

Downing Plaza Newcastle City Centre Downing

Developments

18,580 sq m 2011

Coopers Studios Newcastle City Centre Hanro 1,486 sq m 2009

West One Newcastle Quayside Mandale 4,180 sq m 2009

East Quay 5 Newcastle Quayside Argon 3,250 sq m 2008

In addition, to the above a further 55,740 sq m [Source: Promis 2010] of accommodation has

planning consent across the wider Newcastle-Gateshead conurbation however in each scheme

the developers have commented that they will not progress the schemes without a pre-let in

place.

As a result of the economic decline this increase in availability has been mirrored by a decrease in

annual take up as businesses of all sizes take a more cautious approach to office relocations and

expansion. Take up as illustrated in Figure 10 below reflects the total amount of accommodation

being leased in a single year, including both business relocations and start ups. New build figures

represent only brand new schemes being completed in a particular year and does not include

older accommodation or refurbishments.


Figure 10: New Build Supply versus Take-Up

0

50

100

150

200

250

300

350

01 02 03 04 05 06 07 08 09 10 11 12 13 14

sq ft (000s)

Take-Up New Supply

Source: DTZ Research

As the above shows, for all but one year since 2003 take up has typically outstripped supply

which has forced prime rents upwards. In recent months this pattern has begun to change and as

some of the schemes mentioned above reach practical completion over the next 18 months an

oversupply is likely to become apparent.

This picture of the office market in Newcastle is not unique and while the office markets within

Sunderland, Darlington and Middlesbrough are less well established a similar pattern is also

emerging.

This pattern suggests that over the short term the economic crises has resulted in a reduction in

demand for office accommodation and this coupled with an increase in availability of both new

build and existing accommodation will put pressure on rental growth and may result in future

schemes not being economically viable in the short term. As a result there may be opportunity

for public sector intervention to bridge this gap in the short term.

In the industrial market agents have experienced a significant drop in enquiries as a result of the

downturn in economic conditions with the greatest falls being seen for accommodation in excess

of 4,645 sq m.

In this size range demand to date has principally come from the manufacturing sector, which has

been severely affected by the economic downturn, and the distribution sector which has been

driven by the retail markets which have themselves suffered in the downturn.

At smaller unit sizes (predominantly under 465 sq m concern had been expressed that the small

and medium sized occupier, who typically occupied this type of accommodation, would be most

affected by economic decline. In reality, however, activity has remained relatively stable at this

level. While lenders to these companies were expected to withdraw funding where businesses

were at risk, instead they have sought to manage the situation. The concern going forward will


be that as banks own businesses have stabilised, they will take a less flexible approach to their

lending portfolio.

Looking at supply, developers have been quicker to react within the industrial sector to the

economic situation, resulting in a significant drop off in the completion of new accommodation.

At present, DTZ research estimates that only 46,450 sq m (500,000 sq ft) was completed in 2009

compared to a long term average of approximately 92,900 sq m (1,000,000 sq ft) per annum.

Where buildings have been brought forward they have often been subject to a pre-let or been

constructed on a ‘design and build’ contract (typically on a fixed price contract let for the costs of

construction plus a predetermined profit margin, as opposed to the developer taking

development risk on the sales revenues generated by the project. This is therefore a lower risk

model for developers, whereby they can expect lower returns but are not exposed to risks of

voids/ delays in securing tenants/ sales).

In terms of secondary stock, where this has been returning to the market we are increasingly

seeing demolition being pursued by landlords. In particular, their concern has been that with

limited demand, holding costs on vacant property can be high, particularly with the removal of

vacant rate relief. Landlords have therefore taken the option of demolition and will look to

redevelop as the market returns or consider alternative uses such as residential.

A further issue to be considered is the legacy of the Enterprise Zones. We are yet to understand

the full implications of significant buildings programmes which have been undertaken within

Enterprise Zone sites and which have resulted in vast amounts of accommodation being

constructed in a handful of strategic out of town sites.

Within the North East, Enterprise Zone sites such as Quorum, (139,350 sq m of accommodation),

Cobolt, (209,025 sq m) or Dawdon Business Park, (46,450 sq m), have dominated commercial

property development for almost 20 years with such sites benefiting from a number of

advantages over traditional development opportunities. In particular such status allows:

� Exemption from development land tax

� Exemption from rates on industrial and commercial property

� 100% allowances for corporation and income tax purposes for capital expenditure on

industrial and commercial buildings

� A greatly simplified planning regime, whereby developments that conform with the

published scheme for each zone will not require individual planning permission

In the office market these Enterprise Zone locations have often been able to provide the large

floor plates unavailable in CBD locations and with the tax exempt status has enabled these parks

to successfully attract many national companies, (particularly in low skilled support functions

such as call centres) which can be selective in the areas in which they locate. There has also been

significant demand in the North East from central government relocations.

The two largest out of town parks, Cobalt and Quorum, are both situated in North Tyneside and

as a result of their former Enterprise Zone Status, (which provides tax exempt status for

investment in these schemes,) both have undergone a programme of significant development and

currently have a combined 71,533 sq m of vacant accommodation with a further 39,018 m2to be

constructed.


As a result of this and the massive incentives (typically in excess of 5 years rent free on a 15 year

lease) available to new occupiers, these schemes are likely to satisfy the majority of company

requirements coming forward in the short to medium term.

Outside of Enterprise Zones, there remain a number of developments with significant capacity

for new development, including Great North Park, Newcastle; Newburn Riverside, Newcastle;

Rainton Bridge, Sunderland; Morton Palms, Darlington; Northumberland Park, North Tyneside;

North Shore, Stockton; Middlehaven, Middlesbrough; Lingfield Point, Darlington; Durham Gate,

Spennymoor and Wynyard Business Park, Billingham.

In each of the above the developers have shown reluctance to progress further development

while schemes with Enterprise Zone Status still have vacant accommodation as they are unable to

compete with the significant incentives available in such schemes.

Retail

In respect of the retail sector the decline in consumer spending resulting from the recessionary

market conditions has meant that many retail businesses have suffered a decline in turnover and

as a result put many businesses at risk of administration. Most retail chief executives expect this

situation to continue for at least another 12-18 months.

As a result most retailers have placed on hold programmes of expansion and indeed in some

cases have sought to downsize accommodation or remove themselves from less profitable

locations. As a result demand for retail accommodation is low and many retail units which have

become vacant have remained so for some time.

Because of this few new retail schemes have been commenced in recent years unless substantial

pre-lets of accommodation could be put in place.

One of the few retail sectors which has shown signs of activity has been food retail which is

dominated by the ‘Big 4’ of Tesco, Morrison’s, Asda and Sainsbury’s. These retailers now have a

range of store formats from large out of town premises (typically around 6,968 sq m) to

neighbourhood stores (which are typically 465 sq m) and have actively pursued new site

acquisitions, often paying values substantially above those seen for office or industrial use.

Moving forward it is expected that trading conditions will remain challenging for some time in

the retail sector and as a result demand for accommodation is likely to remain low. As a result

we do not expect to see significant speculative development to be undertaken, unless aimed at

the food sector, for at least another 12 months.

Residential

Turning attention to the residential sector and the economic decline seen over recent years has

similarly impacted on transactional activity with the number of transactions declining markedly.

The Land Registry record that the total volume of sales in the North East fell 60% between 2007

and 2009 from 59,501 per annum to just 23,728.


Key factors which have caused this decline have been the increase in redundancies, or at least the

threat of redundancy, and restrictions on the availability of mortgage finance.

As the recession has bitten the public has become more cautious in its spending as concerns over

job losses have risen and as a result those who may have previously been investigating buying a

new home have put those plans on hold until such time as the economy stabilised.

For those that chose to pursue a new house purchase, many have been further restricted by the

availability of mortgage finance. The majority of Banks responded to the credit crunch by

removing most mortgage products from the market and those that were still available were

subject to higher loan-to-value ratios and increased fees. As a result there was insufficient credit

available for most house purchasers and many transactions were unable to complete.

With this drop in demand house prices began to fall and developers, responding to this drop, put

on hold new development and ceased construction on ongoing schemes. As a result the number

of house completions has also dropped in recent years with the Department for Communities

and Local Government recording that house completions in the North East dropped from a peak

of 8,850 per annum in 2007 to 4,330 in 2009.

With no houses being constructed, and transactions falling, many house-builders have seen

financial difficulty and while the largest firms have been able to raise additional capital from

investors to see them through the recession, many smaller firms have been faced with

liquidation.

To stimulate house building the government has had to resort to investment support with the

most notable programme being the recent Kickstart initiative which allocated £400million of

funding for direct investment in stalled housing schemes. It will be some time before we can tell

if such investment has been a success.

Moving forward as the economy recovers we expect a gradual increase in demand for residential

property however the greatest barrier to this growth, and one which is likely to require central

government support, is the availability of mortgage finance with the expectation being that bank

restrictions on mortgage finance will remain for some time still and alternative government back

schemes, like HomeBuy Direct, will be required.

Issue 4: Value and its Impact on the Development Process

An impact of the recent market downturn has been the increase in vacancy rates for commercial

property across the region and as demand has also reduced landlords has been forced to reassess

rental levels and the incentives being offered to attract new occupiers.

The graph below shows the growth in prime office rents, (ie. rents for high specification office

accommodation within the core office locations) rents seen in the region over recent years and the

significant fall experienced more latterly. This reflects the best rents achievable across the North

East and are most likely to be seen within Newcastle, Gateshead and North Tyneside. As

markets within Sunderland, County Durham and Tees Valley are less established, accurate data

to break down this information to these sub-markets is unavailable. Moving forward DTZ have

predicted rents may slowly return to levels seen in recent years however in the short term


developers have expressed concern at the potential revenue returns, particularly for schemes

which were conceived at a time when economic predictions were felt to be far more optimistic.

Figure 11: Prime North East Office Rents

10.00

12.00

14.00

16.00

18.00

20.00

22.00

24.00

01 02 03 04 05 06 07 08 09 10 11 12 13 14

£ per sq ft per year

Figure 12: Prime North East Industrial Rents


As well as rental compression developers have also had to contend with increased letting voids

which have presented them with high holding costs, particularly as a result of the recent revision

to vacant rates liabilities. In part as a result of this, few developers have stated they would

consider speculative schemes in future and as a result will require at least 50% of accommodation

to be pre-let prior to any start on site.


Combined with the fall in rental values has been an outward shift in yields as the majority of

investors have retracted from the market as they become more risk averse and the availability of

credit has all but disappeared.

DTZ research shows that prime office yields in the region, (those yields being achieved for

modern office accommodation let on leases with in excess of 10 years remaining and to tenants of

strong financial standing), have declined by 200bps (basis points) over the last 2 years and while

recent signs of recovery have seen a modest improvement of 75bps, yields remain some way

from the level seen during the previous peak. For developments therefore which were conceived

prior to 06/07, developers will have seen the predicted values of their scheme when it is complete

fall by as much as 30% which in many instances will have made schemes unviable or if viable, a

less attractive funding proposition for lenders.

Figure 13: Prime Office Yields

2

3

4

5

6

7

8

9

01 02 03 04 05 06 07 08 09 10 11 12 13 14

%


The industrial market has in many respects fared worse than the office sector. Figure 14 shows

how between 2006 and 2008 yields increased by 250bps (basis points) reaching 8.5% for prime

units and significantly higher for non-prime assets, reflecting increased risk in the market. Of the

few deals that have taken place, investors have focused their attention of prime premises with

strong covenants and long unexpired lease terms. The difficulties in the industrial market have

been more acute in the disposal of non-prime assets where investors have viewed non-prime

assets with extreme caution, particular where the covenant strength of the tenant has been called

into question.


Figure 14: Prime Industrial Yields


As the above shows the changes in rents and yields in both the office and industrial sectors seen

over recent months has meant that the financial return from new developments has reduced and

in some cases made schemes unviable. As a result developers have had to place on hold plans to

bring schemes forward over the short term at least. In addition as the viability of some schemes

has been questioned the funders of such projects have begun to reassess their own involvement

and this may lead to them to withholding future finance. In these situations there may be an

opportunity for alternate funding to be brought forward, such as through JESSICA and thus

enable development while the market recovers.


APPENDIX 2: CASE STUDY PROJECT SUMMARIES

9. APPROACH TO HYPOTHETICAL FINANCIAL MODELLING

Financial modelling of JESSICA intervention in each of the case study projects has been

undertaken for the purpose of providing illustrative examples of JESSICA investment only. This

exercise is not intended to reflect the current reality of the projects but to provide a high level

illustration based on the limited information available. As such the assumptions and outputs of

the modelling exercise should be treated as indicative only and should not be relied upon for the

purpose of assessing the financial viability or standing of a JESSICA fund or funds or specific

projects.

Where detailed financial information has not been made available by project sponsors, the

modelling has been based on development appraisals prepared by DTZ for the purpose of

illustration only. It is recognised that the appraisals prepared by DTZ are based on limited

information and as such are likely to differ from those developed by the project sponsors.

Summary outputs of the DTZ case study development appraisals are included in the following

sections. These development appraisals have been used to identify pre-financing cash flows only.

Using these cash flows, separate detailed funding calculations for each of the projects have been

undertaken as part of the wider financial modelling work.

Based on the current projections, each of the case study projects are identified as having a gap

funding requirement. For each of the case studies, JESSICA investment, alongside other third

party sources of finance has been profiled on the assumption that the project will be made viable

by way of grant funding or otherwise.

9.1 Assumptions on JESSICA financial products

For the purpose of the study an illustrative mix of JESSICA funding options are presented, the

details of which are included in respect of each scheme below. The investment assumptions are

illustrative only and may not suit future project requirements once plans are more developed.

The modelling focuses in three cases on the provision of debt and one investment via equity.

Guarantees have not been used in these examples, as the information available indicates that the

projects need actual cash input rather than an underwriting of rental incomes. Included in the

narrative however is an indication of where alternative approaches (potentially requiring state

aid approvals) may be of benefit to the schemes.


The specific projects in this report are referred to as following in the financial modelling:

Table 8: Project information summary

Project JESSICA Investment JESSICA Base Case

£ Amount

Project A Mezzanine debt £7m

Project B Equity £7m

Project C Senior debt £4m

Project D Senior debt £25m

Within the JESSICA senior and mezzanine debt investments, three different scenarios have been

produced for projects A and C to illustrate the impact of different interest rates on project

viability.

1. Base case – the base case uses an approximation of ‘commercial terms’, broadly reflecting

rates that were available to some similar projects pre –credit crunch, but increased to

reflect the fact that banks are currently reluctant to engage in financing urban

regeneration projects. This has been taken as 7.5% for senior debt and 12% for mezzanine

debt. In the current market, bank finance for these projects as modelled would be

difficult to secure. However, as the market recovers, and if ongoing work on projects can

improve viability, private finance may become available, or, JESSICA could step in at

these rates. Depending on the HF investment strategy, the business plan of the UDF and

its desire to secure returns, this may be a preferred pricing approach.

2. ‘Reference rate case’ - As part of the state aid regime, the Commission uses a

methodology to calculate ‘reference rates’ and an appropriate margin as an

approximation of current commercial terms across different Member states. This is

discussed in section 3.4 of the report. Loans provided at or in excess of the reference rate

are deemed not to provide aid to projects. State aid is a specialist area and JESSICA

project sponsors should seek expert legal advice. From an initial review of the reference

rate guidelines there are different interpretations possible as to how the reference rate

would be calculated in each case. However, the lowest reference rate compliant senior

loan could be 2.16% (taken as the UK reference rate of 1.16% plus the lowest possible

margin of 1%.) A scenario at 2.5% for senior debt and 7.5% for mezzanine has therefore

been modelled for two of the four projects to illustrate the impact on viability of a lower

rate of interest. Further work would be required (on the credit rating and collateral

available) before a UDF could take a view as to whether such a rate could be provided on

a no aid basis.


3. JESSICA State Aid case – In order to illustrate the maximum benefit to these

regeneration projects, a third scenario has been modelled setting out an interest free loan.

This would require state aid approval. One way of calculating the amount of state aid

could be the difference in interest due between the reference rate and the interest rate

applied. It should be queried also whether a 0% interest rate would be considered as a

loan product under the regulations.

In reducing financing rates for the reference rate and state aid cases, this allows a reduction in the

amount of grant required to make the projects financially viable. This means that less cash is

going in to the project upfront, and hence slightly increases the senior debt drawdown required.

The saving in interest on the JESSICA loan is therefore partly offset against increased senior debt

costs, due to the increased gearing, but there is still an important net benefit to the projects.

These scenarios are summarised in the table below:

Table 9: Summary of interest rate assumptions for JESSICA Investment

Case Senior Debt Interest Rate Mezzanine Debt Interest Rate

Base Case 7.5% 12%

‘Reference Rate’ 2.5% 7.5%

JESSICA Aid 0% 0%


10. PROJECT ASSESSMENT AGAINST INVESTMENT CRITERIA

The table below sets out a high level assessment on the basis of work undertaken and the

available information, using a ‘traffic light’ approach. This indicates our appraisal of the four case

study projects against the JESSICA investment criteria suggested in section 6.3 in the main body

of the report. Supporting detail, and potential actions to improve the status of each project, are

given in the following sections. Using this tool a green status suggests a good fit with criteria,

amber that some issues remain, and red that there are significant issues that would need to be

addressed or that securing a fit with the criteria is unlikely.

The financial challenges faced by these projects in the current market is evident. However the

modelling undertaken still indicates how JESSICA may be of use in providing finance.

Table 10: Summary assessment against proposed investment criteria

Project Financial Viability Strategic Fit & Eligibility Deliverability

Project A Some gap funding

required, but project

could support a soft

loan.

Potential for some eligible

spend with changes/

restrictions on office

space, and potential for

link to Innovation

Connectors.

Development agreement in

place; key issue to

overcome is securing

finance.

Project B Purely grant funded

project that unlikely to

be able to support a

repayable investment on

commercial terms.

High priority Innovation

Connector; spend on

infrastructure and R&D

facilities.

A number of projects on

the site are programmed

for delivery within the next

few years. Project

management arrangements

in place.

Project C Significant gap funding

requirement on current

masterplan and

estimates.

Potential for some eligible

spend with changes/

restrictions on office

space, and potential for

LCEA Innovation

Connector.

Phase 1 due to complete

2011, but key issues on

land acquisition ongoing.

Project D Significant gap funding

requirement on current

masterplan and

estimates.

High priority Innovation

Connector; spend on

infrastructure and R&D

facilities

Project management and

procurement arrangements

commenced.


11. FINANCIAL PERFORMANCE AT PROJECT LEVEL

Table 11 sets out the cash flows for each project using the base case interest rates. It can be seen

that projects B and D have significant negative cash flows before the costs of financing and

developer profit. This analysis illustrates the grant funding requirement for each project, which it

has been assumed is filled by public sector intervention. For project B an investment of JESSICA

equity has been assumed in the place of grant.

For the purposes of the financial modelling, a developer profit requirement has been assumed for

each of the projects (excluding Project B8) as follows:

� The total requirement for developer profit has been calculated as 15% of the total

development cost (excluding financing costs)9 for each project.

� The model restricts the payment of developer profit until all other borrowing has been repaid.

This includes both Senior and Mezzanine loan principal, interest and fee payments.

� Where applicable, any other returns payable to the developer (including but not limited to

interest on developer loans and development management fees) are in addition to the

assumed developer profit requirement of 15% of development costs as referred to above10.

Table 12 sets out the financing requirements and draw down of third party and JESSICA

investment across the life of the projects using the base case interest rates.

8 Due to the nature of the Project B, and the likelihood that the project sponsors will manage the

future works internally, no developer profit has been assumed for this project. A margin on

construction costs (or contractor profit) has been assumed in the cost of the works. JESSICA

equity investment has also been provided at 0% return, which may have state aid implications.

9 Total project expenditure in Table 11.

10 To put this into context of common practice in the UK, developers receive developer profit and

management fees as a reward for project promotion and managing the development process.

Developers sometimes also independently obtain a return on mezzanine they bring.


Table 11: Project cash flow summary

HEADLINE SUMMARY (£'000s) - BASE CASE PROJECTSProject A B C D

Total project revenue 128,951 7,507 137,683 306,230

Total project expenditure (including RLV payment where applicable) but excluding DV profit and cost of finance

(102,367) (13,925) (136,024) (330,428)

Net cash flow (before financing, grant & developer profit) 26,584 (6,418) 1,659 (24,198)

Project surplus / (deficit) - before financing, grant & developer profit 26,584 (6,418) 1,659 (24,198)

Financing costsSenior debt (6,656) 0 (995) (3,724)Mezz debt (4,854) 0 (563) 0JESSICA loan (4,854) 0 (597) (3,724)

Total (16,364) 0 (2,155) (7,448)

Developer profit (Equity return) (15,355) 0 (20,404) (49,505)

Project surplus / (deficit) before grant (5,135) (6,418) (20,900) (81,151)

Grant funding required (after financing costs) 113,603 5,135 6,418 20,900 81,151

1. If the project is independently viable such that it can afford to bear a land payment

(rather than requiring grant as set out in the bottom row of the table) then this cost to the

project is included within the ‘total expenditure including RLV payment’ line. Note that

in the base case analysis no projects are independently viable and therefore no such land

payments are included.

2. The economics of project B are such that the most efficient form of funding is for JESSICA

to insert equity without requiring a return. In consequence there is no developer profit

(as this is represented by a return on equity).

3. For project A, JESSICA mezzanine debt is provided pari passu with private sector

mezzanine.

4. For projects C and D, JESSICA senior debt is provided pari passu with private sector

senior debt.


Table 12: Project financing summary

FINANCING SUMMARY (£'000s) - BASE CASE PROJECTSProject A B C D

Total drawdownSenior debt 22,492 0 6,730 25,196Mezz debt 7,057 0 2,773 0JESSICA 7,057 6,692 4,038 25,196Equity 28 0 13 24,000

Total 131,272 36,634 6,692 13,554 74,392

GearingSenior debt 61.40% 0.00% 49.65% 33.87%Mezz debt 19.26% 0.00% 20.46% 0.00%JESSICA 19.26% 0.00% 29.79% 33.87%Equity* 0.08% 100.00% 0.09% 32.26%

Arrangement feesSenior debt 2.00% n/a 2.00% 2.00%Mezz debt 2.00% n/a 2.00% n/aJESSICA 2.00% 0.00% 2.00% 2.00%

Arrangement feesSenior debt (341) 0 (135) (245)Mezz debt (108) 0 (55) 0JESSICA (108) 0 (81) (245)

Total (557) 0 (271) (491)

Commitment feesSenior debt 1.50% n/a 1.50% 1.50%Mezz debt 1.50% n/a 1.50% n/aJESSICA 1.50% 0.00% 1.50% 1.50%

Commitment feesSenior debt (1,474) 0 (227) (1,690)Mezz debt (279) 0 (94) 0JESSICA (279) 0 (136) (1,690)

Total (2,032) 0 (456) (3,381)

Interest chargeSenior debt 7.50% n/a 7.50% 7.50%Mezz debt 12.00% n/a 12.00% n/aJESSICA 12.00% 0.00% 7.50% 7.50%

Interest chargeSenior debt (4,841) 0 (634) (1,788)Mezz debt (4,467) 0 (413) 0JESSICA (4,467) 0 (380) (1,788)

Total (13,775) 0 (1,428) (3,577)

Total cost of financeSenior debt (6,656) 0 (995) (3,724)Mezz debt (4,854) 0 (563) 0JESSICA (4,854) 0 (597) (3,724)Total (25,967) (16,364) 0 (2,155) (7,448)

* - Project B Equity is a JESSICA Investment. In all other cases equity is provided by third parties.


12. FINANCIAL PERFORMANCE AT UDF LEVEL

Two different scenarios have been modelled using outputs from the four case study projects in a

portfolio approach in order to illustrate the impact of different UDF structures:

� Single UDF investing in all four case study projects

� Two UDFs investing on a sectoral basis; one focusing on innovation connector projects under

priority 1.1 of the NEOP, and the other focusing on mixed use development under priority 2.1

of the NEOP.

In both scenarios the following assumptions have been used:

� UDF fund management fees have been assumed at 2% per annum of investment value; the

costs included below represent a total fee over a 10 year period.

� No set up costs have been included, as these have been assumed as an upfront cost rather than

included in operational performance. Section 5.9 of the report includes a discussion of the

potential type and quantum of set up costs for a Holding Fund and UDF. It should be noted

that UDF set up costs could be covered through the activities of the HF and be part of these

fees depending on the timing of HF set up.

� Holding Fund management fees are also not included in this analysis of UDF level financial

performance, but are discussed in section 5.3 of the report. It has been assumed that monies

are provided to the UDFs on a loan or equity basis but with the HF not seeking a return on its

investment during the life of the UDF. Based on the indicative timetable in section 8.2 of the

main report, a holding fund may be operating for circa 6 months before funds are drawn

down into the UDF.

� Table 13 summarises the impact of these structures on UDF returns. For the purposes of this

analysis projects A and C have been included on the JESSICA aid case. On the base case the

UDF returns would be higher.

12.1 Single UDF

The hypothetical scenarios here include a total of £41m of JESSICA investment against presumed

eligible expenditure across four case study projects. When consolidated as a portfolio of

investments funded by a single UDF, this equates to a fund level IRR (ie. before netting off

management fees) of 5.96%, although due to challenges around the financial viability of projects,

there is also a gap funding requirement which on these estimates totals £114m, (although of this

£81m relates to project D). This gap funding requirement would need to be secured before the

UDF could make investments.

On this basis, a single UDF would be financially viable as it returns a positive IRR at fund level,

although, as expected, this return is significantly below that which would be attractive to private

sector investors. As a public sector fund intended to bring forward regeneration projects

however, it suggests that JESSICA could benefit the region. Should state aid approval be secured,


the JESSICA mechanism could provide cheaper finance– whilst this would decrease the returns at

UDF level, it would increase the number of projects that could be successfully funded.

12.2 Two Sectoral UDFs

An alternative scenario would be to fund these four projects through two separate UDFs

operating on sectoral lines. For the purposes of this report, this has been based on one focusing

on innovation connector projects (Projects B and D) under priority 1.1 of the NEOP, and the other

focusing on mixed use development under priority 2.1 of the NEOP (UDF 2). This sectoral split

would have administrative advantages in terms of funding each UDF from a different priority of

the programme, and would also allow a degree of specialisation at UDF level. Based on this split,

UDF 1 produces a fund level IRR of 5.18%, and UDF 2 an IRR of 7.32%.


Table 13: Financial performance at UDF level

£000 UDF 1 UDF 2 Single UDF

A (JESSICA Aid Case) Investment amount (6,181) (6,181)

Return 8,690 8,690

Profit / (loss) 2,509 2,509

Investment IRR 6.77% 6.77%

B (JESSICA Base case)

Investment amount (6,692) (6,692)

Return 6,692 6,692

Profit / (loss) 0 0


C (JESSICA Aid Case)


Return 2,916 2,916

Profit / (loss) 378 378


D (JESSICA Base case)


Return 28,920 28,920

Profit / (loss) 3,724 3,724


TOTAL

Investment amount (31,888) (8,718) (40,606)

Return 35,612 11,605 47,217

Profit / (loss) 3,724 2,887 6,612

Blended IRR on investments 5.18% 7.32% 5.96%

UDF

Investment amount (£40 ERDF & Match + Recycled Funds) (31,888) (8,718) (40,606)

Return 35,612 11,605 47,217

Management fees (2% of NAV p.a. over life of fund) (1,523) (833) (2,356)

Profit / (loss) 2,201 2,055 4,256

UDF IRR 3.01% 5.14% 3.78%

The following sections set out individual development appraisals and financing analysis for each

of the case study projects.


13. PROJECT A

13.1 Project Overview

A scheme comprising 30ha of land immediately to the west of a large town centre, the site has

already seen the development of a College. The remainder of the site will be developed in line

with principles set out in the masterplan, with 28,000m2 business space, 600 homes, a 4* hotel

and ancillary retail/bars/restaurants.

An economic appraisal was completed in 2005 which led directly to public sector funding of

£15.9m being secured for the project. This public sector funding has now been virtually all spent

or committed on infrastructure preparation for development and selected early acquisitions.

13.2 Strategic Fit and Eligibility

On the basis of the masterplan and proposed site mix, the potentially eligible elements of the

project would appear to be land acquisition, infrastructure works or construction related to the

business space being delivered on the site. This would align with Priority 2.1 in the NEOP,

‘Cultivating and Sustaining Enterprise’, on the basis that this includes the creation of premises for

business incubation, particularly if those are based on brownfield land. To be eligible it would be

necessary for the developer to ringfence some of the business space for business incubation use;

this could be possible as long as the financials for the rest of the project can be made to work (as

business incubator space is often let at a discount and therefore generates less return than offices

let on commercial rates.)

However, work undertaken as part of this report has indicated that there may be limited

uncommitted funds available under priority 2.1. The other element of the NEOP which may be

suitable for JESSICA is Priority 1.1; Innovation Connectors. This development is not a designated

Innovation Connector, but as discussed in the body of the report, it may be possible to form a

case to align this project with one of the existing Innovation Connectors. This would require

agreement from the current Innovation Connector Partnership members, and for a strategic case

to be made setting out how this development, building on the R&D and training initiatives

already provided by the College on the site, could support digital media or materials technology.

This again would be likely to require some change in the mix/ uses designated in the masterplan,

to ensure areas of office space were ringfenced to support these particular uses, which may have

additional implications for financial viability.

13.3 Delivery Mechanism and Key Issues

Options for this project may include one or a combination of the following in order to close the

funding gap:

� change to the development mix or phasing to reduce upfront costs or increase values;

� seeking additional public sector grant;

� seeking a reduced developer return (profit); and/or

� improving the terms of finance; as for example may be possible through JESSICA.


13.4 Potential for JESSICA Funding

We are advised that limited financial information is available for the scheme at present due to a

recent review of the masterplan and development appraisal for the site. Estimates have instead

been used to create an illustrative development appraisal for the project, (see Table 15) and to

consider how JESSICA could be used to help overcome the identified barriers to delivery.

A preferential senior debt loan or equity investment in the scheme may well be attractive to the

developer consortium as a means for improving viability. However, as previously noted, further

discussion is required with the Commission around the issue of State Aid in order to assess the

potential for such investments to be offered, and how any aid would be quantified. This has been

discussed in section 3.4 of the main body of this report and further discussion of this matter is a

suggested next step.

Should the necessary level of finance for the scheme prove to be unavailable in the private sector,

either as a result of restricted credit or lack of appetite for schemes of this nature, JESSICA may

provide a valid substitute source of funding. We would suggest that the project sponsor embarks

on an informal dialogue with lenders to ensure sufficient appetite for the scheme and address the

need for alternatives as necessary.

The assumptions used in hypothetical modelling are as follows:

� A developer profit target of 15% of development cost (excluding. finance) has been ,

based on industry standard benchmarks.

� As an illustrative example only, we have assumed that the developer is able to secure

senior debt required of circa £22m, but that there is a financing requirement for equity or

mezzanine debt. Mezzanine debt is currently rarely available for regeneration projects,

and this is therefore somewhere where a JESSICA investment could assist in taking

forward the project. For modelling purposes, and to illustrate the impact of this sort of

finance, an equivalent JESSICA mezzanine loan for 19% of the total borrowing

requirement has been modelled.

� The JESSICA loan base case has been modelled on commercial terms- as a comparator for

rates provided by the private sector to projects with similar risk profiles (which would

place it on a no-aid basis), assuming an all-in interest rate of 12% arrangement fees of 2%

and commitment fees of 1.5%.

� The total loan made available via JESSICA under this illustrative scenario is c. £7.1m.

� The loan acts as a revolving facility (whereby the loan may be drawn and repaid in part

or in full as required over the term) over several phases of the project and is repayable

over a period of 10 years.

� It is assumed that the loan is defrayed on eligible expenditure under priority 2.1, and as

such could be spent against land acquisition, infrastructure or office construction as long

as part of the office space was used for business incubation/ SME/ R&D. An allocation of

these costs would be required for eligibility purposes, whereby the proportion of the

building including an eligible end use was also applied to calculate an eligible portion of


other related costs. For example, if 25% of an office building was used for business

incubation activities, it could be argued that 25% of the total construction costs, 25% of

the supporting infrastructure and 25% of required land acquisition for the project was

also eligible.

In order to reduce the gap funding requirement, the following could be considered:

� Substitute JESSICA equity investment for some of the gap funding; this would however

require state aid approval, particularly as the scheme may not be in a position to repay

the capital or provide a return based on current analysis11.

� Increase the loan provided to the scheme through JESSICA and provide on non-

commercial terms (which may require state aid approval). For example, an increase in the

size of the JESSICA loan to £15m loan provided on a reduced 7.5% interest rate would

decrease the grant funding requirement by c. £2.25m. This would be the simplest way to

completely eliminate the gap – on a 0% interest loan gap funding requirement reduces to

£1.3m, and the illustrative numbers suggest that the loan could still be repaid in full and

hence available to be recycled for future projects. Table 14 shows the impact on required

gap funding for each interest rate case.

Change the mix on the scheme, to increase the profit making elements, for example a higher

percentage of residential (although this may reduce the portion of the project eligible under the

OP for support, as housing is not eligible for ERDF).

Negotiate a lower developer’s return; if the scheme targeted a 12% developers profit instead of

15%, the gap funding requirement would decrease by c. £0.9m. This could potentially be

achieved by the public sector underwriting some of the returns.

Table 14 shows the financing breakdown under each scenario, and the net saving to the project

that could be generated through using a reduced interest rate.

Table 14: Project A - Financing summary

11 There are a number of existing State Aid notified schemes in the UK, which allow for the

provision of Gap Funding to regeneration schemes.


PROJECT 'A' FINANCING SUMMARY (£'000s)

Funding Scenario Base Case Reference Rate JESSICA - Aid

Total drawdownSenior debt 22,492 23,553 25,468Mezz debt 7,057 6,634 6,181JESSICA loan (mezz debt) 7,057 6,634 6,181Equity 28 29 31

Total 36,634 36,849 37,860

GearingSenior debt 61.40% 63.92% 67.27%Mezz debt 19.26% 18.00% 16.33%JESSICA loan (mezz debt) 19.26% 18.00% 16.33%Equity 0.08% 0.08% 0.08%

Arrangement feesSenior debt 2.00% 2.00% 2.00%Mezz debt 2.00% 2.00% 2.00%JESSICA loan (mezz debt) 2.00% 2.00% 0.00%

Arrangement feesSenior debt (341) (360) (395)Mezz debt (108) (112) (113)JESSICA loan (mezz debt) (108) (112) 0

Total (557) (583) (508)

Commitment feesSenior debt 1.50% 1.50% 1.50%Mezz debt 1.50% 1.50% 1.50%JESSICA loan (mezz debt) 1.50% 1.50% 0.00%

Commitment feesSenior debt (1,474) (1,525) (1,595)Mezz debt (279) (295) (297)JESSICA loan (mezz debt) (279) (295) 0

Total (2,032) (2,115) (1,893)

Interest chargeSenior debt 7.50% 7.50% 7.50%Mezz debt 12.00% 12.00% 12.00%JESSICA loan (mezz debt) 12.00% 7.50% 0.00%

Interest chargeSenior debt (4,841) (5,269) (6,164)Mezz debt (4,467) (4,542) (4,608)JESSICA loan (mezz debt) (4,467) (2,839) 0

Total (13,775) (12,649) (10,772)

Total cost of financeSenior debt (6,656) (7,155) (8,154)Mezz debt (4,854) (4,948) (5,018)JESSICA loan (mezz debt) (4,854) (3,245) 0Total (16,364) (15,347) (13,173)

Total saving through JESSICA 1,017 3,191

Table 15: Project A - Hypothetical Development Appraisal outputs


Project A

Development Income

Sales Valuation m2 Average Rate m2

(£'s)

Gross Revenue (£'s)

Housing Sales 55,350 1,626 90,000,000

Rental area summary m2 Rate m2 (£'s)

Gross MRV (£'s) Yield Investment value (£'s)

Offices (B1) 22,500 135 3,037,500 8.50% 27,977,450Offices (SME) 2,700 135 364,500 9.00% 4,050,000Hotel 3,000 150 450,000 6.50% 6,923,077

38,950,528

Gross Revenue 128,950,528

Development costs (£'s)

Acquisition costs (8,000,000)Construction costs (76,689,638)

Professional fees (7,303,775)Marketing & Letting costs (1,237,675)Purchaser's costs (2,239,655)Disposal fees (2,395,756)

Miscellaneous fees (4,500,000)Finance costs (16,363,726)Developer profit (15,354,985)

Total development costs (134,085,210)

Residual Land Value (RLV) / (Gap funding requiremen t) (5,134,683)


14. PROJECT B


A renewable energy project in Northumberland which is now leading the way in exploiting the

economic potential of offshore wind and wave power by providing world-class testing and

verification facilities, Research and Development (R&D) expertise, engineering support and

supply chain development. The historic and future development of the site is at present heavily

reliant on grant funding, as the key projects have not been designed as commercial ventures

intended to cover initial costs. For this reason, JESSICA is less likely to be suitable but is included

here in any case to illustrate potential scenarios. The key elements of the project include:

� Project Fujin - It includes the development of the worlds largest (15MW) Drive Train/Nacelle

Test Facility (with support from the Energy Technologies Institute (ETI), a UK public-private

partnership supporting the development of clean energy technologies). This project would

establish Project B as the UK’s national centre for offshore wind development.

� Blade test 2 - Development of a 100m Wind Turbine Blade Test Facility.

� Project Nautilus - Development to house test equipment for marine renewable technology.

Whilst a significant proportion of public sector funding has already been allocated to the projects

identified above, some funding has yet to be secured for the infrastructure upgrades required to

support these developments. Infrastructure requirements (which could potentially be supported

through JESSICA) include the following:

� Electricity - Of particular significance, the completion of Project Fujin will need to be

supported by an upgrade to the local electricity supply. This is likely to require investment in

a primary substation.

� Quay improvements - The transportation strategy for the site requires the movement of

drivetrain/nacelle components weighing in excess of 100 tonnes and provision for the

transportation of 100m wind turbine blades to and from the test facilities.

� Other infrastructure - In addition to the above, the site requires further supportive works in

the form of demolition, road construction and landscaping.


These projects are a designated Innovation Connector within the NEOP, and the majority of the

construction and infrastructure works should therefore be eligible under the NEOP. It is a

priority project for ONE, and aligns with both the RES and RSS. The site is on the edge of a town,

and therefore should also be deemed within an urban area (as all JESSICA projects must be urban

regeneration projects.) There is therefore a very strong strategic fit with the objectives of the

NEOP and there should be minimal issues with regards eligibility. The project is already due to

receive ERDF grant, but could potentially receive ERDF investment through JESSICA alongside if

other considerations (state aid, ability to secure repayment of investment) can be met.



ONE are in the process of appointing a project manager to take forward the development of the

site with funding to be provided by ONE and other delivery partners. The project manager will

be responsible for commissioning and managing architects, engineers and construction contracts.

Specific delivery structures have not yet been agreed, but it is expected that construction

contracts will be let directly by ONE.

This project has never been conceived as a property development opportunity, rather as a public

sector supported initiative to develop a cutting edge facility and establish the region as a hub for

renewable energy R&D. Financial analysis to date has therefore focussed on an assessment of

costs and securing grant funding rather than seeking commercial finance or looking for any

return on investment. It appears that there are likely to be some revenue generating opportunities

on the site, both in terms of rental payments and charges to users for lease of facilities but to date

these have been envisaged as covering operating costs rather than being sufficient to service a

loan.

14.4 Potential for JESSICA Funding

Based on the information made available to date, high level modelling has been undertaken in

order to illustrate the potential for JESSICA funding to be utilised to contribute to the

development of site infrastructure. This element of the site has been selected on the basis that this

is where there is a key financing need at present. The assumptions used in hypothetical

modelling are as follows:

� As an illustrative example only, a speculative equity stake in the project equating to 50% of

the total infrastructure cost (assumed as c £14m) has been modelled. Equity has been used for

two reasons: a) so as to demonstrate the potential of equity under JESSICA as part of

hypothetical modelling, b) as the project may not produce sufficient revenue to service a loan.

� It should be noted that the format of the investment provided under this scenario is highly

speculative. Repayment of the JESSICA equity investment relies on the availability of as yet

unsecured revenue streams becoming available. For modelling purposes, the assumption has

been made the current £400k p.a. lease payment could be redirected to repay the upfront

investment. The lease payment has been indexed at 2.5% annual to provide an indicative

uplift over the term.

� It is noted that an investment of this type does not reflect commercial terms available in the

private market (i.e. an investment as modelled here which targets just repayment of the

investment amount only and not a further return), however in the interests of achieving wider

social outcomes as a priority over financial returns, such an investment may be a desirable

alternative.

� The ability of a UDF to offer an investment of this type in the context of State Aid

requirements is yet to be determined and would require further consultation with the

Commission.

� Full repayment of the investment is made over a 15 year term.

The following outputs have been generated based on the assumptions above.


Table 16: Project B - Summary outputs from hypothetical modelling

Outputs Value

Project IRR before financing and developer

profit

0.00%

Gap funding assumed £6.4m

Equity investment through JESSICA £6.7 m

Total returns to UDF on JESSICA equity

investment

£6.7 m

Profit/ loss on JESSICA investment £0m

Fund IRR (return to UDF on JESSICA loan

provided)

0%

From the information provided and discussion with ONE and the project sponsor, it does not

appear that this project is the most suitable project for JESSICA at this time. There are current and

likely to be future streams of grant funding to support this type of initiative.

Utilisation of lease revenue – the potential to divert the lease income currently received by ONE

in order to service a JESSICA investment should be reviewed, taking into account the

implications of diverting this revenue away from its existing uses.

� Incremental financing – A number of projects are identified as being revenue

generating. However, there is some uncertainty as to how any future operating surpluses

(if any) arising from the new testing facilities could be utilised for the purpose of

supporting a JESSICA loan. A review of operating budgets for proposed facilities should

be undertaken to assess whether these developments may be in part self supporting

(where there are limitations on the level of grant funding available).


Table 17: Project B - Hypothetical development appraisal ouptuts

Project B

Development Income (Rental Income) 7,506,983


Demolition/Roads/Landscaping (3,000,000)Construction costs - Port Upgrade (2,500,000)Construction costs - Primay Substation (7,000,001)Construction costs - Contingency (475,001)

Professional fees (950,000)Finance costs (0)




15. PROJECT C


This project represents a major opportunity to redevelop a brownfield site of strategic importance

and create a new business quarter in a city centre. The site area extends to 10.44 hectares (25.8

acres) . The current proposals for mix on the site include;

� 71,100 sq m Grade A office space;

� 4,700 sq m retail/leisure space;

� 150 bedroom 3 or 4 star hotel;

� 80 bedroom (as a minimum) limited service hotel;

� Up to 600 residential units subject to a minimum of 320 as a base position;

� Public realm;

� Multi-storey car park (560 spaces).


The masterplan includes high quality office space and a retail offer12, neither of which would be

eligible under ERDF rules. Should some of the commercial space be used for SMEs or business

incubation, the construction costs of this, plus associated infrastructure and land acquisition

could be considered eligible under Priority 2.1, although it should be noted that the information

provided by ONE indicates that limited uncommitted capital funding under this priority is

currently available.

Furthermore, without public sector intervention developers advise it is extremely difficult if not

impossible to obtain traditional development funding for business incubator/ start up /

R&D Sector. If capable of being developed, the increased income risk of such a facility invariably

has an adverse effect on the yield, suppressing capital value and affecting viability. Public sector

rental guarantees can ameliorate the problem in the short term but inevitably the risk will fall

back on developer/funder /owner/investor, so does not fix the problem in this market. However,

in a scheme of this scale,, cross subsidy/incentive will be explored. If a high quality covenant on

12 It should be noted that the Welsh European Funding Office have agreed with the Commission

that elements of retail may be included as eligible expenditure as part of the Welsh UDF, on the

basis that retail is an essential element of mixed use town centre regeneration in the current

climate. Specific guidance on this is to be included in the Welsh eligibility rules, and is expected

to include provision for retail to be eligible as long as the costs make up less than 50% of the total

ERDF contribution to the project, and as long as the total amount of retail in the project is less

than 30,000m2.


one part of the site could be procured for the developer which enables them to deliver an

incubator type facility elsewhere within the scheme, this could potentially provide a solution.

15.3 Delivery Mechanism and key issues

The site is being promoted by an Urban Regeneration Company. The development is planned

over a 10 year period, commencing in autumn 2011 with phase 1 due to complete 2012.

However, the project has currently stalled and this timetable may now be delayed, although

partners are continuing to work hard to unblock barriers. The following appear to be key issues

affecting deliverability of the scheme at present:

� Upfront infrastructure costs (estimated at circa £10m. There could be potential for

JESSICA to assist in financing these costs under priority 2.1, as illustrated by the scenario

modelled below.

� Additional Gap funding requirement for the first commercial phase which it appears

likely would need to be filled by public sector grant.

� Ongoing land acquisition negotiations for the public sector to purchase the remainder of

the site.

� Planning issues

15.4 Potential for JESSICA Investment

The project sponsor has indicated that it is too early in the development cycle to establish

whether loan or rental guarantee interventions could be utilised. Development appraisals are

currently being reviewed, and were not able to be made available to the consultant team at the

time of the study in order to undertake detailed financial analysis.

Estimates have instead been used to create an illustrative development appraisal for the site, and

to consider how JESSICA could be used to help overcome the identified barriers to delivery. The

assumptions used in hypothetical modelling are as follows:

� A developer profit target of 15% of development cost (excluding finance) has been

assumed for the project, based on industry standard benchmarks.

� As an illustrative example only, a senior debt equivalent JESSICA loan for 30% of the

total borrowing requirement has been modelled.

� The JESSICA loan base case has been modelled on commercial terms- as a comparator for

rates provided by the private sector to projects with similar risk profiles (in order to

proceed on a no-aid basis), assuming an all-in interest rate of 7.5%, arrangement fees of

2% and commitment fees of 1.5%.

� The total loan made available via JESSICA under this illustrative scenario is £4.04m.

� The loan is repayable over a period of approximately 2.5 years (as senior debt is repaid

first).



such could be spent against land acquisition, infrastructure or office construction as

along as part of the office space was used for business incubation/ SME/ R&D.


� Substitute some grant gap funding for a JESSICA equity investment; however based on

indicative numbers it appears unlikely that this would generate a return of either

principal or profit.

Increase the loan provided to the scheme through JESSICA or provide on reference rate or non-

commercial terms (which would require state aid approval.) This is illustrated by the scenarios

in:

� Table 18 and Table 19. Because the loan can be paid back relatively quickly the impact of

reducing the interest rate (in terms of financing costs save) is less than for project A.

� Change the mix on the scheme, to increase the profit making elements, for example a

higher percentage of residential.

� Negotiate a lower developer’s return; if the scheme targeted a 12% developers profit

instead of 15%, the gap funding requirement would decrease by £3.3m. However,

discussions with the project sponsor suggest that this would be likely only if a high

quality pre-let could be secured. If this was possible, there could be a further opportunity

for JESSICA to provide a rental guarantee to support this.


Table 18 shows the impact on required gap funding for each interest rate cases.

Table 19 shows the financing breakdown under each scenario, and the net saving to the project

that could be generated through using a reduced interest rate.

Table 18: Project C - Cash flow summary

PROJECT 'C' SUMMARY (£'000s)


CASH FLOW SUMMARY

Total project revenue 137,683 137,683 137,683Total project expenditure (including RLV payment where applicable) (136,024) (136,024) (136,024)Net cash flow (before financing, grant & developer profit) 1,659 1,659 1,659

Project surplus / (deficit) - before financing, grant & developer profit 1,659 1,659 1,659

Financing costsSenior debt (995) (1,006) (1,013)Mezz debt (563) (577) (585)JESSICA loan (senior debt) (597) (346) 0

Total (2,155) (1,929) (1,599)

Developer profit (Equity return) (20,404) (20,404) (20,404)

Project surplus / (deficit) before grant (20,900) (20,674) (20,343)

Grant funding required (after financing costs) 20,900 20,674 20,343


Table 19: Project C - Financing Summary

PROJECT 'C' FINANCING SUMMARY (£'000s)


Total drawdownSenior debt 6,730 6,756 6,769Mezz debt 2,773 2,827 2,856JESSICA loan (senior debt) 4,038 4,054 4,061Equity 13 13 13

Total 13,554 13,650 13,699

GearingSenior debt 49.65% 49.50% 49.41%Mezz debt 20.46% 20.71% 20.85%JESSICA loan (senior debt) 29.79% 29.70% 29.65%Equity 0.09% 0.09% 0.10%

Arrangement feesSenior debt 2.00% 2.00% 2.00%Mezz debt 2.00% 2.00% 2.00%JESSICA loan (senior debt) 2.00% 2.00% 0.00%

Arrangement feesSenior debt (135) (135) (135)Mezz debt (55) (57) (57)JESSICA loan (senior debt) (81) (81) 0

Total (271) (273) (192)

Commitment feesSenior debt 1.50% 1.50% 1.50%Mezz debt 1.50% 1.50% 1.50%JESSICA loan (senior debt) 1.50% 1.50% 0.00%

Commitment feesSenior debt (227) (226) (225)Mezz debt (94) (95) (96)JESSICA loan (senior debt) (136) (135) 0

Total (456) (456) (321)

Interest chargeSenior debt 7.50% 7.50% 7.50%Mezz debt 12.00% 12.00% 12.00%JESSICA loan (senior debt) 7.50% 2.50% 0.00%

Interest chargeSenior debt (634) (646) (653)Mezz debt (413) (425) (432)JESSICA loan (senior debt) (380) (129) 0

Total (1,428) (1,200) (1,086)

Total cost of financeSenior debt (995) (1,006) (1,013)Mezz debt (563) (577) (585)JESSICA loan (senior debt) (597) (346) 0Total (2,155) (1,929) (1,599)

Total saving through JESSICA 226 556

Table 20: Project C - Hypothetical development appraisal outputs


Project C

Development Income

Sales Valuation m2 Average Rate m2

(£'s)

Gross Revenue (£'s)

Housing Sales 19,890 1,983 39,450,000

Rental area summary m2 Rate m2 (£'s)

Gross MRV (£'s)

Yield Investment value (£'s)

Offices (B1) 54,000 160 8,640,000 8.00% 64,520,014Offices (SME) 9,990 160 1,598,400 9.00% 15,551,190Hotel 1 4,500 167 750,015 6.50% 9,552,105Hotel 2 2,500 144 360,000 6.50% 3,923,461Retail 4,230 135 571,050 7.50% 4,685,960

98,232,730

Gross Revenue 137,682,730


Construction costs (113,764,140)Professional fees (10,834,680)Marketing & Letting costs (1,163,642)Purchaser's costs (5,648,382)Disposal fees (2,640,687)Miscellaneous fees (1,972,500)Finance costs (1,598,605)Developer profit (20,403,617)




16. PROJECT D


To ensure Newcastle becomes one of the premier locations in the world for science research and

commercialisation through the development of new approaches to university and business

collaboration. This is a city centre project being promoted by three public sector organisations.


This project is a designated Innovation Connector within the RES and NEOP, and is a strategic

priority for the region. Spend to support infrastructure on the site, and for R&D/ business

incubation units which is the key part of the first phase or works, would likely be eligible under

priority 1.1. The draft project programme indicates that if JESSICA was used as part of the first

phase of work it would be possible to defray JESSICA monies and deliver outputs within the

2015 timetable.


Partners are working to establish a new corporate JV vehicle to take the project forward. This

may be either a public partnership between the public sector land owners/funders, or a public-

private vehicle which would likely require an OJEU process to seek a development partner.

The partners have committed to a funding package that would contribute to preliminary

expenditure, enabling works, site acquisition infrastructure and delivery of first phase of works,

the majority of which is secured.

Phase 1 will include a marketing centre, space for the university and incubator units targeted at

small businesses within the science and innovation market. The intention is to link the space to

the wider science themes of the site, however there may be the possibility to broaden the scope of

uses in the early stages.

The current program for the project suggests a procurement process for contractors/ development

partners would be run in 2011, with start on site in 2012. Practical completion of Phase 1 and

associated infrastructure is forecast in 2013.

16.4 Potential for JESSICA Investment

An initial outline development appraisal has recently been completed by consultants for 1NG,

which includes an incubation facility and associated infrastructure. It should be noted that

outputs from the appraisal are high level and provide an illustrative picture only. The initial

work has identified a viability gap across the scheme as a whole, however further work is being

undertaken to refine the scheme and enhance overall value where possible. At present, the

scheme costs significantly exceed income.

Based on the initial development appraisal, high level modelling has been undertaken in order to

illustrate the potential for JESSICA to contribute to the funding of the development. Although

JESSICA could support just phase 1 of the scheme, modelling has been undertaken on a whole


scheme basis in order to access revenue from later phases to repay the loan. The assumptions

used in hypothetical modelling are as follows:

� A developer profit target of 15% of development cost (excluding finance) has been

assumed for the project, based on industry standard benchmarks.

� A 26.5% uplift in revenue has been assumed in order to overcome a significant gap

funding requirement present in the initial appraisal. Note: this assumption has been used

for the purposes of creating an illustrative scenario. The true nature of any gap funding

requirement or RLV will not be known until further analysis has been completed. Both

the development appraisal and financing structure used for the purposes of this

modelling are illustrative only and as such subject to further refinement.

� As an illustrative example only, a senior debt equivalent JESSICA loan for 45% of the

total borrowing requirement has been modelled.

� The JESSICA loan has been modelled on commercial terms- as a comparator for rates

provided by the private sector to projects with similar risk profiles (in order to proceed

on a no-aid basis), assuming an all-in interest rate of 7.5%, arrangement fees of 2% and

commitment fees of 1.5%.

� The total loan made available via JESSICA under this illustrative scenario is c. £25.2m.

� The loan is repayable over a period of approximately 10 years.


such could be spent against land acquisition, infrastructure or construction of the

gateway building as along as the space was used for business incubation/ SME/ R&D.

The base case outputs from this modelling are shown in Table 11 and Table 12. No further

sensitivities have been run due to the size of the upfront gap funding required by the scheme,

which removes any need for further finance as the initial grant provided can itself be recycled to

provide finance for the schemes’ later phases.


� Substitute some grant gap funding for a JESSICA equity investment; however based on

indicative numbers it appears unlikely that this would generate a return of either

principal or profit.

� Change the mix on the scheme, to increase the profit making elements, for example a

higher percentage of residential.

� Change the phasing of the scheme, bringing forward those sub-elements that are viable.

� The illustrative modelling has been carried out using development appraisal information

provided for the entire master planning area. This early development appraisal is subject

to change. For example, it is likely that the site will be developed and financed in phases


as opposed to the single development illustrated above. This will alter the overall

viability position for the scheme and as such, the level of gap funding is likely to change.

Excerpts from the development appraisal were provided by consultants to 1NG, and hence the

full data can not be reproduced here.


17. APPENDIX 3: CASE STUDY OF POTENTIAL UDFS

In order to illustrate how UDFs in the North East might operate, a mini case study is presented

below which builds on the narrative in the body of the report, and sets out;

� how existing vehicles could be used as UDFs, including commentary on current functions and

capacity. 1NG has been used as an example. The choice of 1NG here should not be seen as a

recommendation that this vehicle is better placed than others to take forward a UDF;

� consideration as to the scope of activities, investment strategy, ways of functioning, longer

term roles, restructuring required, and recycling of funds should a UDF be established.

17.1 1NG - Background & Current functions

1NG is the city development company (CDC) for the Newcastle-Gateshead sub region. 1NG is an

independent, private sector led company which leads on the delivery of regeneration,

development and investment led projects in Newcastle Gateshead. It was established as a

Company Limited by Guarantee, (which is a common structure for this type of vehicle). A

company limited by guarantee does not have shareholders or ‘owners’, but is set up by Members

or ‘founding partners’), in this case ONE, Newcastle City Council and Gateshead Council. All

three Members provide equal funding towards the operating costs of the vehicle, and also sit on

the board. The board includes a mixture of public and private sector representatives, and is

chaired by Lord Faulkener. The three key priorities for 1NG in the next 12 months as stated on

the company website are:

� Deliver the strategic vision for Newcastle Gateshead through the development of the 1Plan

which is an economic masterplan.

� Develop and build the enabling physical and business infrastructure necessary to secure the

delivery of the key priority projects in Newcastle Gateshead.

� Build and engage with the private sector who are essential to the success of the key priority

projects.

Within this remit, the current functions of 1NG are linked to the facilitation of regeneration across

the area. This includes activities such as;

� Meeting with developers, investors, and stakeholders to promote the area, development

opportunities and understand potential barriers

� Procuring, commissioning and managing consultants, advisors, masterplanners and

developers/ contractors to take projects forward

� Structuring and establishing project delivery vehicles (for example an SPV is likely to be

established for the Science Central project)

The team includes professionals with significant experience in regeneration and development,

including skills relating to policy, property, finance and place making. 1NG does not own assets

or undertake direct development, although it can enter into construction contracts underwritten

by the covenant strength of its partners, for example it could procure a developer for a project in

Newcastle if the payment to the contractor was underwritten by Newcastle City Council.


17.2 How 1NG might take forward a UDF

1NG therefore already fulfils some of the functions of the UDF, as a vehicle that helps to deliver

urban regeneration, although crucially at present it is not an investment vehicle that takes a stake

in projects. There are a number of other factors also which align with the principles of JESSICA

and the critical success factors needed to establish a successful UDF:

� Science Central is a priority project for ONE and 1NG, and as an Innovation Connector

included in the NEOP contains a significant volume of eligible expenditure. Detailed financial

modeling is currently being undertaken, and 1NG expects will produce a viable scheme that

would benefit from loan or rental guarantee support of the type that could be provided by

JESSICA. As the sponsor for this project 1NG would be well placed to act as the UDF which

invests in a Science Central PPP.

� 1NG is currently working on the 1Plan, which as an economic masterplan which brings

together spatial planning with a holistic approach to job creation, economic sustainability and

environmental considerations could form a good basis for a UDF Investment Strategy and

project pipeline, and fulfil part of the requirement for an ‘Integrated Plan for Sustainable

Urban Development’.

� 1NG is currently investigating the opportunity for a ‘Development Enabling Initiative’; a pool

of funding to provide access to finance to unblock stalled private sector schemes. This

initiative, if taken forward, could have many similarities in terms of operation and objectives

with JESSICA, although would not be required to operate within the ERDF rules. There may

be synergies between establishing a UDF and 1NG’s plans to take forward a development

enabling initiative; in particular the two pots of funding could be administered through a

single UDF, in order to reduce overheads. This would also provide a pool of monies within

the UDF that could be used on ineligible expenditure, and hence broaden the range of projects

that could be supported.

� 1NG staff may have many of the skills and local knowledge needed to take forward a UDF.

� The company’s Memorandum and Articles of Association includes the powers that would be

necessary for 1NG to become or establish a UDF, including the power to establish subsidiaries

and to invest in regeneration projects as long as these activities are in line with the overall

public duty objectives ‘to assist, promote, encourage, develop and secure the regeneration to

the highest quality of the economic, social and physical environment within the City

Development Area’.

In practice, and in line with the analysis provided in section 5.4 of this report, a prime route for

1NG to consider would be to establish a separate subsidiary that operated as a UDF. To do this

would require the following:

� Undertake feasibility work for discussion with the 1NG board as to the advantages of

establishing a UDF, the strategic fit with the company’s objectives and the next steps.

� Prepare an outline business case (OBC) for board approval, including size and structure of

UDF to be established, potential project pipeline and resources. Given that ONE is a member

of 1NG, section 5 consent would be required before a subsidiary could be established (see

discussion of approvals processes in section 7).

� Submit a Business plan to the Holding Fund for draw down of monies into the UDF (or

directly to ONE in the case of no HF).


17.3 Investment Strategy and Operations

In this hypothetical case study, the following would be likely considerations for a 1NG UDF:

� Match funding – could be provided at UDF level by match provided by partners; for example

Newcastle City Council or Gateshead Council. Key considerations in the use of land as match

funding are set out in section 5.7.

� Investment Strategy – the 1PLAN could be adopted by the UDF as the key document within

the IPSUD, and the projects listed within the 1PLAN prioritised for UDF investment. It would

be likely that the 1NG UDF proposal was approved by the Holding Fund on the basis of a

detailed financial appraisal of an initial project or project portfolio for investment, in order to

provide comfort to the Holding Fund (or directly to ONE in the case of no HF) that ERDF and

match can be defrayed by 2015, for example Science Central. Due to state aid considerations, it

is likely that the UDF would operate initially only by providing loans, but the portfolio could

be expanded later.

� Restructuring – As part of establishing the UDF subsidiary, some limited restructuring may

be necessary within 1NG, in order to make best use of existing staff and resources. Current

staff could be seconded to work for the UDF, or new hires may be needed. The UDF as a

separate entity would need to establish its own systems, controls and operating procedures to

allow it to meet the ERDF monitoring and reporting requirements.

� Governance – The UDF as a separate legal entity would need its own board or management

committee. There is potential that this board could contain all or some of the same members as

the existing 1NG board, which would decrease time to set up a new board, and would allow

the UDF to take advantage of the existing knowledge and expertise of the main board. Any

potential conflicts of interest would need to be considered, but in theory as a subsidiary of the

1NG group there should not be direct conflict between the interests of the UDF and those of

the 1NG as the parent company.

� Recycling of Funds – the policy on recycling of funds may be set by the Holding Fund (or

directly to ONE in the case of no HF) as part of the JESSICA set up process. Funds such as

these tend to be established with a 12-15 year life span, to reflect the longer term nature of the

financing requirements of regeneration projects. Whilst funds are held by the UDF, it would

be able to reinvest any returns in line with its investment strategy. After the first cycle of

investment the UDF could invest in housing projects or other projects included within the

1PLAN. Wind up provisions included in the legal documentation of the UDF would set out

the intended use of resources at the end of the UDF life. This is likely to include a requirement

for UDFs to repay investment provided by the Holding Fund or successor body; for example a

vehicle established by ONE. All returns from the financial engineering instrument must be

reused for the benefit of urban development in line with the regulations.


17.4 TVR and Sunderland Arc as UDFs

Tees Valley Regeneration was a company limited by guarantee which was the Urban

Regeneration Company (URC) for the Tees Valley. URCs were established with a limited life and

remit, and TVR has now achieved its strategic objectives. As a consequence, on the 31st March

TVR ceased to operate as a company. All functions of TVR have transferred to Tees Valley

Unlimited (TVU), although all the services that were provided within TVR will continue under

the new structure but there will be a wider remit to fulfil the city-region aspirations. This change

was part of a move to consolidate the separate bodies involved in strategic economic

development activities across the Tees Valley Region. The other key entities brought together

with TVR to form TVU include Stockton Councils Joint Strategy Unit and Visit Tees Valley (a

tourism body). TVU is a business unit of Stockton Council and as such is not a separate entity for

legal purposes. This means that TVU does not itself now have powers to establish subsidiaries or

joint ventures which would be needed to set up a UDF. These powers do however reside with

Stockton Council as a unitary local authority, and it would therefore be the Local Authority

which would need to take forward a UDF. In this instance,

Sunderland Arc is an Urban Regeneration Company and is legally constituted as a company

limited by guarantee. It is therefore likely that it would be able to operate as UDFs along much

the same principles as 1NG in the example described above. Sunderland has an Economic

Masterplan which could act as an IPSUD,

The key issues to consider for these and other public sector bodies seeking to take forward UDFs

would be similar; in terms of provision of match funding, governance arrangements, project

pipeline, and access to skills and resources.

17.5 A Public-Private or Private sector led UDF

An alternative model that might work for the North East would be for a private sector led UDF to

come forward. This could, for example, be a new subsidiary set up by current private sector

partners in the area, potentially building on the models already established by ONE with

Langtree and UK Land. The advantages of this would be:

- Brings private sector skills and expertise to the operation of the UDF, including in fund

management and property development, which will already be present in these sorts of

organisations

- These (and other similar) organisations have an established track record of working in

partnership with the public sector, have existing relationships with ONE and are active

in the local area

- If private sector majority owned/ controlled the UDF could be off balance sheet for the

public sector

- Potential for synergies and efficiency savings by joining up the role of a UDF alongside

existing activities


- Private sector do not require the same approvals processes to establish new vehicles/

subsidiaries – although normal business planning and board approval would be needed,

establishing a wholly private UDF could be quicker than if RDA / public sector consents

required.

- A private sector led vehicle could have more credibility with private sector developers

and potential funders.

- UDF management fees are eligible expenditure, and therefore there is some certainty that

the fund operator can make a return on their UDF operating activities – although to be

attractive to a private sector partner it is likely that they would also look to secure a

significant share of any returns made.

In terms of practicalities, it would be likely that such a UDF would need to be selected

through a competitive process. It is possible that a public-private body could be formed,

potentially with ONE or one or a number of local authorities. This could assist in securing

match funding at the UDF level - as local authorities could bring land as match and hence

allow match at holding fund level to be ‘substituted’ (see section 5.8).

Documents

North East JESSICA Evaluation Study - ec.europa.eu · brief, Navigant’s proposal in response to the brief, and Inception report. The study has been The study has been undertaken