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Structuring and Drafting the Tender and Contract

54.6 Other Ways to Increase Financial Feasibility and Affordability [14]

Apart from providing public funds to partially compensate for construction, or through public debt or equity instruments, there are other indirect means by which the government can increase commercial feasibility and/or reduce the budgetary burden of the PPP. These can also be considered, in broad terms, as public financial structuring techniques which have implications in the contract drafting. They have been introduced in chapter 1, but further examples are presented here;

  • Contractual guarantees. This concept is inherently linked to risk allocation. An example is a minimum revenue guarantee in road PPPs, in which the government makes payments to the private party if revenue falls below certain levels (for example, in South Korea) or under more sophisticated schemes, such as the Chilean road PPP model. In this model, the term is extended until revenues meet an agreed NPV. In water projects (for example, waste water treatment projects [WWTP] or desalinization), as well as in energy PPPs (such as a power purchase agreement [PPA]), the public party may structure the contract on the basis of a take or pay approach, guaranteeing a minimum off-take or a minimum price for the plant being available. These guarantees facilitate access to project finance on better financial terms, that is, they help to decrease the financial gap or increase feasibility by lowering the WACC. Strictly speaking, contractual guarantees are more closely related to risk structuring matters than financial structuring;
  • Foreign exchange risk guarantees. One specific case of guarantees deserves special attention. In the case of EMDEs with under-developed local financial markets, there is likely to be a foreign exchange risk. This can be mitigated by foreign exchange risk guarantees in which the public party will assume the risk of devaluation and its impact on the project debt raised by the SPV in hard currency;
  • Explicit/financial guarantees or direct guarantees from the treasury (on a first call, unconditional and irrevocable basis). These guarantees are usually given to protect or guarantee the project debt. In some cases, the guarantee is only effective during the construction period (for example, in the UK). An example of this approach is the Mersey Gateway Bridge PPP in the UK[15];
  • Guarantees in respect of government counter-party risk (“guarantee funds”). These guarantees do not transfer a risk back to government, but provide security for government payment obligations under the PPP contract. The Indonesian Infrastructure Guarantee Fund is an example. Brazil also has the same instrument;
  • Guarantees of a portion of the service payments (that is, limiting the deductions due because of potential under-performance), which may evolve to fixed payments schemes, such as Cessions Dailly, are described below. The difference is that the fixed portion of the payment is not a separate payment stream, but the same payment mechanism in which there is a contractual commitment by the authority limiting the deductions from the payment to a certain percentage (for example, 20 percent). This is done without renouncing the ability to terminate the contract on the basis of default by the private partner. This is a usual adjustment in availability payment mechanisms in emerging markets, especially in markets in the early stages of the PPP maturity curve; and
  • Specific credit enhancement mechanisms. These are usually in the form of subordinated debt provided by an official agency (sometimes multilateral or supra-national, as in the case of the European Investment Bank’s (EIB) Project Bond Credit Enhancement (PBCE) mechanism), which are priced at market rates (clearly above senior debt price) with the aim of increasing the credit rating of the project and facilitating access for the project to capital markets (allowing the private partner to issue project bonds). Even when funding or protection is not coming from the state/government that is procuring the project, these mechanisms have to be considered in the financial structuring, as the availability for such support will impact commercial feasibility. However, unless the access to such support is already granted and committed, it should not be included in the financial model for affordability or feasibility purposes. As in the case of public agency loans, the government should prepare the access to these facilities if it wants to rely on their potential advantages and provide a level playing field for competition.

Another technique commonly used to de-risk projects and increase commercial feasibility is the de-composition of the payment mechanism, creating a tranche that is an irrevocable and unconditional payment obligation which is potentially transferable or can be sold to a financer. This scheme, which can also be regarded as form of a deferred grant financing, is common in France for large infrastructure PPPs such as high-speed rail (HSR) projects, and it is known there as "Cessions Dailly". This mechanism allows the private partner to transfer part (typically 70 percent) of its rights for payment from the public sector under the contract directly to its creditors, subject to public sector agreement. This transfer is permitted after the assets built by the private partner have been commissioned. Once transferred, these rights for payment are secured and are independent of the PPP contract. Even if the PPP contract is terminated, the public authority will have to pay the bank for its share of payment.

The main consequence of such a transfer is that the credit risk rating of the tranche of debt serviced by this part of payment under the PPP contract is increased to the level of credit rating of the public authority. This in turn reduces the project WACC and its overall costs.

This scheme is similar to the CRPAO also discussed in section 4.2.

 

[15] The project is financed by project bonds that enjoy the unconditional and irrevocable guarantee from the UK Treasury (HMT), based on which the project was granted with a provisional Aa1 rating by Moody’s in March 2014. See https://www.moodys.com/research/Moodys-assigns-a-PAa1-guaranteed-rating-....

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