9.5 Other Financial-Related Provisions

Chapter 1 introduced a number of topics that are typical considerations for the public partner. These are related to the financial structure of the project contract and should be documented in the contract. See section 0.7.3, especially the following.

• The problem of leverage and requirements for minimum equity.
• Potential establishment of limits on changes in control and the regulation of share transfers.
• The rationale for imposing the sharing of refinancing gains[88].
• The relevance of lender´s rights provisions.

This section explains other (but not all) matters related to financial requirements, specifically: the regulation of performance guarantees, reserve funds for renewals and reinvestments, and insurance requirements.

Performance guarantees

While the whole financial package is considered to be at risk, it may be said that the main guarantee for the procuring authority is represented by the equity invested by the private partner; this capital is directly provided, and it is the first level of capital at risk of performance and compliance (with debt generally only being at risk if the equity has been exhausted).

However, it is common practice to require the private partner to provide and maintain a performance guarantee which is usually irrevocable and executable on demand (typically in the form of a bond or a letter of credit).

The use of such a guarantee is to fund any penalty accrued by the private partner as well as any other loss or cost necessary to re-establish operations or to rectify a breach. When the guarantee is executed (in full or partially), the private partner will have to renew the amount of the guarantee.

The guaranteed amount may vary depending on the country practice. In the majority of projects and countries, it usually ranges from 2 to 4 percent of the total Capex[89] estimated at the inception of the contract.

Typically the amount of the guarantee is higher during construction than during the operations period (for example, 4 percent during construction and 2 percent during operations).It is common for the amount of the guarantee to be increased yearly by the CPI or another general index.

Limits and regulations regarding reserve funds

As described in chapter 1, one of the essential features of a PPP is to transfer the responsibility and inherent risks of the life-cycle cost of the project. The private partner will have to plan the renewals and major maintenance works that will have to be made during the life of the contract. This requires financial planning, progressively allocating the funds to a specific reserve fund (the "renewal investment fund reserve") in advance of when they are needed to accomplish the renewal investments. The means to fund reserves is part of the financial plan provided at bid submission, and it is likely to be further adjusted at financial close.

It is good practice to establish limits and regulations as to when these reserve funds can be used. Typically, any use of these funds other than for renewal or major maintenance investment requires specific authorization from the procuring authority.

Insurance requirements

Both construction cost and life-cycle cost risks are transferred (potentially with exceptions) to the private partner. It will therefore be the first party responsible to absorb a loss due to accidents or any event that may affect the physical asset/project, including the costs necessary to re-establish its physical state to the specified state or to meet the specified service requirements.

However, it is common practice and essential that certain risks events are retained or are shared, especially those regarded as force majeure where the infrastructure is damaged resulting from wars, riots, and natural catastrophes.

Typically, the private partner is required to obtain and maintain insurance policies with respect to loss and damage due to accidents and force majeure events. These policies should cover the losses up to a minimum amount prescribed in the contract. The government is indirectly protected by the insurance package, as the amount received under the insurance policy will be deducted from the compensation payable by the government in respect of such an event.

In general terms, the government should not rely entirely on the ability of the private partner to self-insure certain risks, so the prescription for a minimum insurance package is common practice in all PPP contracts.

Insurance should cover not only losses due to physical damages (“all risks insurance”), but also losses due to third party claims (third party liability insurance) that may result from these events and losses due to delay in start-up or business interruption insurance.

The EPEC Guide to Guidance provides some additional information on this matter[90].