7.2.1. Sources of Funds
The two main types of funds raised by a project company, as in any corporate finance structure, are debt and equity.
Debt may be in the form of loans or bonds. Equity may be take the form of pure equity or capital shares, and quasi-equity products (junior or subordinated debt, mezzanine debt, and so on); these are senior to the equity shares, but subordinated to the (senior) debt or main debt.
There are multiple sources and sub-categories for both the main categories of funds. The main ones are explained on the following pages.
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TABLE 1.6: Sources of Funds and Fund Providers |
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Main Category/Instrument |
Fund Providers and Main Features |
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Equity |
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Capital shares |
Typically a contractor/industrial developer with an interest in construction and/or the O&M aspect of the asset.
Sometimes a financial investor (that is, not an industrial partner), usually as co-investor. These are typically infrastructure funds or other risk capital investors (in some cases, an institutional investor will directly invest in the project). (See the brief description, in the box 1.25 of the role of infrastructure funds and other financial investors).
On some occasions, the government may invest in equity shares in the SPV, acting as a financial partner, with the investment coming directly from the procuring authority, or through the structured funds of a trustee or by “strategic investment funds”.(see chapter 5.5)
In some highly sophisticated markets, retail investors are becoming common, entering into the project structure through Initial Public Offerings (IPOs).[82] |
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Junior or subordinated debt, mezzanine debt |
Typically provided by industrial developer/contractor shareholders for tax efficiency purposes.
May be provided by third party financial investors (including government on some occasions as described above) to provide higher protection, but still higher returns than conventional debt. |
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Debt (senior debt) |
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Loans – bridging loans/short-term or mini-terms, long-term loans |
Commercial banks and investment banks are the most usual debt providers. Others include the following.
It should be noted that MDBs and ECAs in particular, but also NDBs, may either provide finance or facilitate access to finance by means of guarantees (and sometimes credit risk insurance in the case of some ECAs).
The most conventional scheme for project loans (the loan subscribed by the SPV) is a long-term loan. However, the private partner may, in some projects, opt for short-term loans with the aim of refinancing it at term (or the private partner may be forced to do so, depending on the ability of the respective market to provide long-term loans from the outset).
Short-term loans or loans aimed to be refinanced are called mini-terms when they are structured under project finance (that is, on the basis of the project creditworthiness) rather than being a loan fully guaranteed by the sponsor (which is conventionally referred to as a bridge loan)[83]. |
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Bonds or project bonds[84] |
Bonds as an instrument for debt come primarily from “capital markets”, i.e. institutional investors (pension and annuation funds, insurance companies, and sovereign funds), wealthy and super-wealthy investors (directly or through “family offices”), through an IPO or through “direct placements”. In some markets and for some projects, the bonds may also raise funds from retail investors. Some emerging markets (such as Chile, México and more recently Perú, amongst others in Latin America) are relying increasingly on project bonds as a way to finance infrastructure, relying either on the local institutional investors or on international investors[85].
Also, some multilaterals and national agencies may act as buyers/investors to boost the infrastructure capital markets. |
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Other debt structures |
PPP projects may include other financing instruments and structures (especially in PPPs where the main Capex relates to equipment and supplies) such as leasing (operational or financial), supplier credits, supplier financing (when the supplier of equipment accepts a deferred payment, usually structured in promissory notes, that may be discounted with or without recourse – forfeiting – to a third party), or Islamic finance structures. |
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Note: Shadow lending is a term used to mean loans provided by “shadow banks” which includes all entities outside of the regulated banking system that perform the core banking function, and credit intermediation (taking money from savers and lending it to borrowers). Money market mutual funds that pool investors’ funds to purchase commercial paper (corporate IOUs) or mortgage-backed securities are also considered shadow banks (IMF, Finance & Development, http://www.imf.org/external/pubs/ft/fandd/2013/06/basics.htm).
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BOX 1.25: Infrastructure Funds and Financial Partners[86] For new projects in developing countries, the main equity provider is usually the contractor. Most of the construction groups have a dedicated arm or subsidiary to manage their PPP business and to invest equity in the SPVs for their projects. However, a pure financial investor (that is, one with no interest in the PPP project other than equity investment) may also be an equity partner. The most common kind of financial investor is an ”infrastructure fund”. Such funds are structured similarly to any other investment fund (for example, a private equity fund). These are funds in which a number of original investors contribute their money (acting as “limited partners” or LPs), and a “management company” is in charge of managing those funds, investing them on behalf of the LPs, and overseeing the assets during the life of the fund. The typical investor in a fund (LP) is an institutional investor (pension funds, sovereign funds, and insurance companies), but the LPs may also include family offices, high net worth individuals, and even banks. Some LPs are increasingly investing directly in the projects through their own platforms (but usually only in larger projects). Financial investors in PPPs and infrastructure, including infrastructure funds, are more interested in projects that are already operational (so as to avoid the construction risk and enjoy a more immediate access to the “yield”, that is, to the distributions from the project company). Their investment in the assets when they are in their operating period is also good for the developer industry, as this will help developers to recycle capital and have cash available to invest in new projects. However, participation of the investor industry in greenfield projects (newly tendered DBFOMs) should be promoted by governments so as to increase the capacity of the developer market in a particular PPP program. Specialized financial investors should be considered positively and approached by governments when promoting their PPP programs. Contracts should be carefully structured so as to facilitate the participation of this kind of equity investor (for example, to attract these investors the PPP contract should allow reasonable flexibility regarding equity share transfers). |
7.2.2. Introduction to Financial Structuring and Financial Strategy
Financial structuring (from the private sector/sponsor point of view) refers to the art of designing the mix of funds to be used to finance the project, especially with respect to how much debt to raise and with what repayment profile. This maximizes the private partner’s equity IRR (or for the same targeted IRR, to be more competitive in the price submitted in the bid).
It includes the analysis and decisions regarding debt instruments, when more than one is available (for example, loans versus bonds), and also the potential definition of different tranches or different loan agreements (for example, whether or not to raise subordinated debt which is more expensive but more flexible than the senior debt).
At a more defined level, financial structuring must also determine several factors: the order and timing of drawdowns, the repayment profile of the different sources of finance, and the required financial support (for example, parent guarantees, bank guarantees) from sponsors and key sub-contractors.
Equity funds are always committed (or underwritten) before bid submission. By definition, the submission of an offer requires a firm commitment by the bidder to invest the capital as requested in the Request for Proposal or as committed in the submitted financial plan.
Debt may be also committed before bid submission when the tender process requires it. This requirement is common in dialogue and other interactive processes[87], and in some processes that pre-select a shortlist of bidders. In open tender models, the common approach worldwide is to request “sufficient” evidence regarding the availability of the finance[88]. This is further discussed in section 7.3.
The prospective bidder will analyze the options and investigate the availability of different sources of finance during bid preparation (or in an earlier stage when conducting a preliminary assessment of the opportunity, before deciding to invest significant resources in assembling the proposal). The bidder will incorporate these options and approaches into a financial structure so as to define its financial base case.
Financial strategy is a term that may be confusing as it overlaps with financial structuring. For the purpose of this PPP Certification Guide, financial strategy refers to the decision as to how and when to approach funders, especially lenders (for example, when the financial package is not required to be fully committed at bid submission[89]). Financial strategy includes the analysis of two potential options regarding the debt raising and structuring.
- Short-term loans assuming the risk of refinancing the loan, usually after construction. These can also be called a bridging loan strategy or a mini-perm (when the short-term loan is arranged on a project finance basis). This provides access to the potential upside[90] of de-risking the project scheme after construction and a greater ability to switch between debt and capital markets, or to capture falls in general interest rates; and
- A long-term project finance loan from the outset. This introduces less flexibility related to interest rate swaps (the most extended scheme to minimize interest risks and usually a requirement by lenders), but offers higher certainty and less risk. When the project finance scheme relies on issuing bonds in the capital markets, the financial package implementation is more complex. Disintermediation or fundraising through capital markets is only an option for countries with active national institutional investors (pension funds, insurance companies) or with access to global institutional investors which will usually require a credit rating provided by a rating agency[91].
From the public sector standpoint, availability of finance is one of the key elements for the success of a PPP, and it is a pre-condition that must be met if the government is to move ahead with a PPP scheme.
As discussed in section 5.6 (#a, the financial challenge), in countries where there is no sufficient availability of finance (a minimum number of lenders and capacity to lend for the long term, for example, more than 10-year terms), PPPs may not work. In some limited circumstances, governments may help to fill the potential gap of availability (in terms of volume of debt accessible in the respective market) by providing a portion of the debt through a national bank or national agency (see next heading). Governments can also assume or share foreign exchange risks to facilitate access to cross border financing for projects. In other cases, financial support by Multilateral Development Banks is paramount.
But even in cases where the financial market is sufficiently capable of absorbing significant debt levels, there will be projects that will not be accepted by the lending market because the risk profile (even when properly structured) may not be acceptable, or there may occasionally be projects that are so large that they exceed the size of the financial market. This is explained in sections 7.3 and 7.4.
Financial structuring and strategy is the responsibility of the private investor. Therefore, the government should not create restrictions as to where the private investor should raise the finance from (for example, by insisting on local banks), or what instruments or structure should be negotiated, other than setting up maximum leverage, or insisting on a lending competition (when appropriate) – see section 7.5.
Appendix 6A includes a deeper description of financial structuring and the fundraising process.
7.2.3. The Role of the Multilateral Development Banks (MDBs)[92]
When dealing with PPPs in EMDE countries, a significant role is played by MDBs, such as the World Bank Group (usually under the International Finance Corporation, IFC), the Inter-American Development Bank (directly or through the Inter-American Investment Corporation, IIC), the Asian Development Bank (ADB), the European Bank for Reconstruction and Development (EBRD), the European Investment Bank (EIB[93]), the African Bank for Development (AfDB) and the Islamic Development Bank (IsDB). Other agencies with a more regional focus are the CAF Bank for the Andean region or the Banco Centroamericano de Integración Económica (BCIE) for Central America, among others.
MDBs provide financing for projects (PPP and other public or private projects) — most frequently in hard currency — for long terms. These are usually longer terms than commercial lenders who may not offer sufficient length or amount to the project finance structure. The presence of these institutions provides protection to the commercial lenders under A/B loan structures due to the preferred creditor status of most of the MDBs. An A loan is one provided by the MDB, and the B loan is a commercial loan syndicated to the commercial lenders which is protected indirectly by a cross-default clause. The presence of the MDB may be paramount for those international commercial banks assuming project risks in an emerging market and agreeing to provide cross-border finance.
In addition, an MDB may provide guarantee facilities (partial risk and partial guarantees), or specific guarantees against political risks both to the commercial banks and investors (for example, the Multilateral Investment Guarantee Agency [MIGA], as part of the World Bank Group, provides such guarantees). Examples of partial guarantees are numerous.
One interesting example is the participation by the IDB in the IIRSA project in Perú. IIRSA Amazonas Norte is a 960 kilometer (km) network of toll roads located in northern Peru, which link the Amazonian region in the eastern interior of the country with its Pacific coast. The project was financed with a project bond issued under 144-A for an amount of $224 million, based on Recognition Certificates of the Annual Payment for Work (CRPAOs) committed to by the government, which also had a partial guarantee by IDB for $60 million. This example is interesting as it illustrates how MDBs may support the development of sophisticated financial solutions in EMDE countries.
More recently, these institutions have begun developing their own infrastructure funds (IFC launched in 2011 a $1 billion infrastructure fund[94]) or are providing funds to privately managed infrastructure funds as another LP.
However, the support of MDBs in the PPP context goes beyond the finance provision, and includes the following:
- Support in identification and selection of projects;
- Support in PPP structuring, acting as advisors to governments or providing funding for hiring advisors to obtain a better structure and design for the PPP; and
- Policy advice to strengthen the policy and PPP framework.
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BOX 1.26: Bilateral Financial Support: The Role of ECAs MDBs are not the only international players in the financing of international projects. Most countries (developed and some developing) have established “Export Credit Agencies” (ECAs). These are financial (or insurance) institutions that provide financial support to projects developed by their national companies abroad. This support is more usual in export contracts, providing financial facilities to the foreign buyer, public or private. However, ECAs also play a role in project finance structures, including PPP projects. Their participation is obviously linked to the participation of a bidder from the ECA’s country, which may be in the form of finance to the project, but is most frequently the provision of guarantees (to the lenders to the project and also, in some cases, to the equity investors). Some country’s ECAs provide both forms of support, and some others provide only guarantees or insurance against credit risks (including political risk). Some notable examples are the Export-Import Bank (EXIM) and the Overseas Private Investment Corporation (OPIC) (US), CESCE (Spain), Hermes (Germany), SACE (Italy), the Japan Bank for International Cooperation (JBIC) (Japan), and the Export-Import Bank of Korea (KEXIM) (Republic of Korea). The provision of that support is subject to the conditions settled by the “OECD Consensus” whose aim is to regulate the conditions to avoid the financial dumping competition among countries by controlling the potential subsidization of the financing. |
7.2.3. Islamic Finance Particularities
In Islamic countries, financing has a series of particularities that relate to religion. Banks and lenders in general have to operate in accordance with Sharia (the Islamic law). Sharia law influences the types of investments that are permissible and influences the way in which a financial transaction is handled. For example, interest payments are not permitted, but there may be a legitimate bank profit based on the bank sharing the profit and loss of the enterprise to which it is lending.
Appendix B to this chapter provides information on this special subject.
[82] See section 3.4. (Tapping the Retail Investor) in Paving the Way: Maximizing the Value of Private Finance in Infrastructure (WEF, 2010), page 69.
[83] Mini-terms may be referred to as “soft” or “hard”. In a soft mini-term, when the date for full repayment is reached without a refinancing having occurred, the loan will be extended under a “full cash sweep” mechanism (that is, all the available cash flow after costs is applied to loan amortizations until the full amortization of the loan). In a hard mini-term, such flexibility is not contemplated. Therefore, the borrower is in default if a refinancing has not occurred on or before the date for full repayment of the original loan.
[84] A bond is a tradeable debt investment in which an investor loans money to the private partner for a defined period of time at a variable or fixed interest rate for the development of a project. In a bond financing, the debtor issues the debt which is acquired by one or more investors (including retail investors when the issuance of the debt to capture funds is in the form of an IPO). Bond finance is also referred to as a form of “disintermediation”, meaning that there is no intermediary (such as a bank) between the borrower and the end investor.
[85] The more significant case, with a decent history going back to the end of the past century, is Chile. One of the most paradigmatic project cases is the highway “Costanera Norte” where the structure included a credit wrap from IDB, co-guaranteeing the debt with the monoline insurer Ambac. These and other features regarding project bonds and the role of institutional investors are covered in the paper Mejores Prácticas en el financiamiento de Asociaciones PúblicoPrivadas en America Latina (Best Practice in PPP Finance in Latin America) which reproduces the outcome of a Conference held in May 2011 in Washington and is commissioned by World Bank Institute, PPIAF with the support of the Government of Spain and BBVA.
[87] Section 10 (“Overview of the PPP process cycle”) in this Chapter provides an introduction to different tender processes, and Appendix A to Section 3 describe this matter in further detail.
[88] Not requiring bidders to arrange financial packages in advance to bid submission is also appropriate in markets with a small number of financial institutions available to fund the project on a long-term basis. In these circumstances, government may prefer to provide flexibility to the awardee to secure lenders after being nominated preferred bidder, at which time it will have access to all of the available lenders in the market.
[89] In that context, a bidder may select the lenders in advance (appointing a mandated lead arranger, or even obtaining full debt commitments) or may base its financial bid on indicative letters of support from different banks, with no exclusivity arrangements, so as to open the loan to competition after award. Section 7.5 explains these issues in further detail. Appendix 1 to Section 5 analyses the overall issue of bid preparation and fund raising.
[90] The upside of refinancing may be partially captured by mechanisms for sharing refinancing gains. See Guidance Note: Calculation of the Authority’s Share of a Refinancing Gain (HM Treasury UK, 2008).
[91] Project bond financing is a common option for countries with well-developed capital markets, but it is more commonly applied as a re-financing solution (through “bridge to bonds” loans), not as a financing mechanism for construction. It provides access to wider resources for long-term finance, usually enjoying longer debt terms, but it is a less flexible financial solution (as funds often may not be drawn down progressively). Recently however, in highly-developed countries and sophisticated markets, deferred drawdowns are becoming practicable. Readers can find additional discussion on project bonds as an alternative for project debt in appendix 6A. For information on the credit ratings process and methodology applied by the credit rating agencies, see the respective credit rating web pages.
[92] These and other roles of MDBs are discussed in Investment Financing in the Wake of the Crisis: The Role of Multilateral Development Banks (Chelsky and others, 2013). See also Paving the way (WEF 2010) section 2.3, and Multilateral Banks: building skills and markets” page 41 and following.
[93] EIB is clearly an International Financial Institution (IFI) but is also regarded by some practitioners as an MDB. EIB includes lending to projects in EMDE countries in its strategy and portfolio, however the bulk of its operations remain within the scope of the EU.
[94] The fund was closed in 2013 with the participation of 11 investors: IFC and a Singapore sovereign wealth fund; GIC (Government of Singapore Investment Corporation, the Singapore sovereign fund) as anchor investors; and 9 sovereign and pension fund investors from Asia, the Middle East, Europe and North America. See IFC Global Infrastructure Fund Completes $1.2 Billion Fundraising at http://ifcext.ifc.org/ifcext/Pressroom/IFCPressRoom.nsf
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