PPPs are generally (in developed countries and EMDEs with a certain degree of financial market development) financed in the local currency[13].
National agencies (national development banks [NDBs] and other national financial institutions) may play a significant role in lending to projects, especially in countries with a lesser degree of financial development (that is, with a potential insufficiency of debt market mechanisms to finance the project).
In some cases, private lenders may not have the capacity to fully underwrite project loans for larger projects. In such instances, a public development bank or public financial agency may help to fill the loan market gap, providing part of the loan (for example, the Banobras in México, and Instituto de Credito Oficial (ICO) in Spain). The most conventional approach is when these agencies act as “co-lenders”, lending on the same conditions as the banking community and subject to their leadership.
In other cases, the financial agency may provide the cornerstone piece of the financial structure (that is, the financing may not be achieved on the terms considered without the involvement of the agency). This is the case for many projects in Brazil with the Brazilian Development Bank (BNDES) lending on favourable or out of the market conditions (for example, loans at longer terms than those provided by the commercial lenders). It may also be the case when the public debt instrument provides special advantages or comfort to the private sector project financiers. For example, under the Transportation Infrastructure Finance and Innovation Act (TIFIA) scheme in the US, the government provides up to 30 percent of the project finance on subordinated terms, thereby increasing the rating of the project and making it more attractive for commercial lenders and/or bond holders).
The use of these mechanisms should be carefully considered, as systematic financing by public agencies may produce a crowding out effect because the banking industry may be unable to compete on the same terms with the public lenders. In addition, through public sector lending (even from a public independent financial agency), the government is indirectly retaining a part of the project risks that the PPP contract has transferred to the private partner.
Strictly speaking, the presence of these agencies does not constitute financial structuring of the contract (that is, structuring the payments to the private partner), as these funds are not from the respective department promoting and procuring the project. However, if the loan conditions are more favourable than those provided by the market, these structures indirectly affect the payment profile of the project and increase affordability.
When the government is relying on public agency loans, it should ensure that the financing is available. Therefore, some preparatory work must be done before tender launch. If the participation of the financial agency is necessary for the feasibility and affordability of the project, it should be available for any bidder. Therefore, the project should be assessed in advance by the financial agency and its requirements for capacity and eligibility should be clear and accessible to all interested parties. They should also be consistent with the qualifications criteria of the tender package.
Box 5.8 explains some examples of national (TIFIA and BNDES) and multilateral public financial agency loans (European Investment Bank [EIB] loans within the European Union [EU]). Chapter zero described the role of other MDBs through A/B loans as well as export credit agency (ECA) financing (see chapter 1.7.2.3).
Public subordinated loans as a support mechanism
In addition to loans provided by financial agencies, loans may also be provided by the very department or procurement agency in charge of the procurement process and contract. The contract may provide for such a loan, on favourable conditions and subordinated terms, to compensate for part of the works.
For example, this is the case in Spain for a number of user-pays toll roads. It is used to fill the feasibility gap in those projects as an alternative to direct and pure (non-revolving) co-financing. The next sub-section describes the particularities of user-pays non-feasible projects.
Like grants, soft loans (on favourable or below-market conditions, in terms of tenor or price) may also be used to reduce the weighted average cost of capital of a project. This then reduces the long-term burden committed in the payment mechanism (in government-pays PPPs), or decreases the feasibility gap (in user-pays PPPs). But unlike a grant, a loan can leave the public debt records unaffected. This is only possible if the loan will not be treated as a public investment in terms of budget or fiscal treatment.
Soft loans, especially when provided by the procuring authority, will have clear implications in the drafting of the contract. The contract should clearly state how to deal with inter-creditor issues (that is, the relationship between the government lending agency and the private sector lenders). A soft loan provided by the procuring authority is usually a subordinated loan (but senior to the equity provided by the investor). It is also common that the soft loan is in the form of a participative loan (for example, as in Spain), that is, the government receives part of the upside of the project in exchange for the below-market conditions (see box 5.8). Remuneration and rights to receive distributions have to be clearly described in the contract.
[13] The situation in which a country needs to rely on cross-border financing is much different. When a country does not have a minimum financial capacity (so as to provide loans in local currency on reasonable terms), it has to rely on cross-border financing. When this is the case, foreign exchange (forex) issues may arise. Multilateral Development Banks (MDBs) have a more relevant role to play in these projects. This has been discussed in chapter 0.5.6.
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