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PPP Introduction and Overview

17.4. Other Forms of Public Participation in the Financial Scheme or Intervening in Commercial Feasibility [97]

Grant financing (or pure co-financing) is not the only way to increase affordability and/or the commercial feasibility and bankability in PPP projects. There are other instruments (revolving, such as public loans or “co-lending”) and techniques (which may be referred to as de-risking or as credit enhancement[98]). The former may help to fill a gap in the availability of finance while the latter may increase the accessibility to market finance.

All of these forms of financial support are used in both developed and developing countries. They have an essential role in the case of EMDEs due to the usual scarcity or limitations in the availability of long-term finance.

The following headings explain both revolving public financial support and de-risking techniques respectively.

Box 1.27 includes a description of how Latin America has approached the challenge of long-term finance, and introduces some instruments and techniques which have been applied recently in the region.

7.4.1. Other Ways (revolving) to Fill Financial Market Deficiencies or Increase Affordability

Apart from grants, there are other more sophisticated ways to inject funds, support viability or to increase affordability. As opposed to grant financing, they may not be regarded as public financing (in the sense of public conventional financing, affecting the investment budget of the public sector), but it does mean that the government is acting like a market lender or investor.

As alternatives to grants, these schemes are revolving forms of support, that is, the finance will be repaid. Sometimes it is provided on market conditions at a market price, and in other cases it is provided on favourable terms, “soft conditions”, or “concessional conditions”. The latter case is usually a response to affordability difficulties, whereas funding at market conditions is usually a solution to fund availability (for example due to a financial crisis such the 2008–2010 global financial crisis) or market appetite.

Chapter 5.5 provides a deeper explanation of these financial structuring techniques, many of which may be summarized as follows.

  • Public long-term loans (soft or not soft): By a public/national financial agency, for example, BNDES in Brazil, the Treasury Infrastructure Funding Unit (TIFU) in the UK, Banobras in México – usually accompanying private lenders under market conditions), other institutions, or even a specific budget fund (Transportation Infrastructure Finance and Innovation Act [TIFIA] in US – always accompanying private lenders and accepting a subordination in guarantees and term). See chapter 5 for details;
  • Public subordinated debt: Usually on soft terms (for example, participative loans in Spain for unfeasible road toll projects). See chapter 5 for details for details;
  • Equity: Investment through specific public infrastructure funds or “strategic funds” such as Fonadin in México – usually at market conditions and managed independently by a management company; and
  • Ad-hoc public equity investment for the project: These can be proposed in the RFP. Some potential pitfalls of this approach are discussed below. Section 5.5.5 provides additional and more detailed information.

When the motivation is to increase affordability, as in the case of grants, governments should take care to avoid the risk of spoiling VfM as the co-financing can decrease the effectiveness of the risk transfer.

Government as an Equity Partner

Section 2 explained how there are PPP structures in which public and private parties participate jointly in the equity. In these cases, the public partner commonly holds the majority or a significant portion of the shares, and it either participates actively in the management of the project company or reserves certain control rights for itself on strategic decisions.

These structures may be given a variety of names, including joint ventures, mixed equity companies or institutionalized PPPs.

However, the public partner may also participate in the equity of the PPP company, acting only as a financial investor, in order to support the commercial feasibility of the PPP project (by decreasing the amount of equity to be invested by the private equity investor) or as a way to decrease the net cost (and improve affordability) by having access to a portion of the equity cash flows. These cases will not be regarded by this PPP Guide as joint ventures or institutional PPPs, but as a mere financial variation of a conventional PPP.

In some of these cases, the motivation for a government to act as a co-investor may be to increase its control of the project by enjoying direct access to the day-to-day management issues of the project-company and full access to the project information. This is done with the intention to transfer the full scope of risks and responsibilities to the private partner. This motivation should be considered with extreme caution, as it can deter potential investors worried about political interference. It also implies a risk that the government unduly intervenes in the private sector’s responsibilities and ability to manage the project, limiting the ability of the project to deliver efficiency gains[99].

If the equity investment gives the government the right to be represented on the board of the SPV, this will be a potential source of conflicts. Therefore, it is desirable that the investment is managed by a specific body or unit rather than by the procurement agency itself[100].

Governments should acknowledge that the investment of equity means that it is taking back more risk than if it invests an equivalent amount as debt.

Chapter 5.4.5 further explains the implications and features of a PPP structure with equity participation by the government.

7.4.2. De-risking Approaches, Credit Enhancement and Other Risk Mitigation Techniques

The government has to pay attention to commercial feasibility right from the inception of the project (preparation and structuring), including bankability. An unfeasible project will not become feasible just by injecting public finance into the mix. The risk structure/allocation needs to be acceptable to the private sector (both investors and lenders).

However, there may be specific situations where a significant number of risks (or some risks with significant potential impact) may not be absorbed by the private sector, but the government still considers that PPP is a valuable option. There may also be projects tendered in the context of difficult financial market situations such as a bank crisis, or when a government wants to boost the development of a market (for example, capital markets in emerging economies). In these circumstances, the government may design a de-risked scheme to facilitate debt raising.

Examples of de-risking approaches include the following.

  • Direct guarantees to the lenders (unconditional and irrevocable), which are provided by National Development Banks (NDBs) (for example, Banobras in México) or directly by the treasury (for example, in the UK, during construction, assuming the possibility that project construction risks might materialize);
  • Guaranteed portion of service payments (that is, limiting the deductions due because of potential under performance, for example, by 20 percent);
  • Fixed deferred payments, unconditional and irrevocable (like in what does High Speed Rail (HSR) PPPs in France and Spain, or like the CRPAO in Perú), which have been discussed in the previous heading may be considered either co-financing by means of deferred grant financing or a de-risking technique;
  • “Guarantee funds” to provide security for government payment obligations under the PPP contract;
  • Escrow accounts and trustee structures (for example, payments from a water authority for a water plant that are backed by a portion of the tariff paid by final users, which is reserved and allocated in specific accounts managed by a trustee); and
  • Contingent or contractual guarantees aimed to protect the project company (for example, minimum traffic guarantees in user-pays road projects) or lenders (for example, guaranteeing all or a certain percentage of the outstanding debt in case of early termination, including termination by default of the private partner. This is sometimes referred to as “debt underpinning” – World Bank - Farquharson, Torres de Mästle, and Yescombe, with Encinas 2011).

In the context of insufficient availability of local finance, when it is necessary to mitigate Forex risk so as to help projects to access cross-border finance, specific guarantees or mechanisms to mitigate such risk become necessary. This may be solved using contractual guarantees (for example, in user-pays schemes allowing for a revision of the tariff according to currency exchange movements, or being treated as a compensation event giving the right to receive direct compensation for part or all of the loss suffered by a devaluation beyond an exchange rate threshold). Alternatively, it may be handled through direct guarantees from the government to the lenders, or even by using a hard currency to make the payments in government-pays PPPs. This has been explained in Chapter 5, where in section 5.6 plus chapter 5.4.6 provides additional examples on this kind of mechanism.

Additionally, direct letters to lenders may be considered a kind of soft guarantee aimed to give additional and “direct” comfort. For example, lenders may seek confirmation from the procuring authority that there have been no challenges to the award of the contract.

Credit Enhancement

There are some instruments to provide public finance (in revolving mode) that may not necessarily provide soft terms and that may decrease the average cost of capital of the project directly. Instead, or in addition, these instruments are structured mainly to provide a higher protection to lenders, thus increasing the credit rating of the debt. This may be the case of the Transportation Infrastructure Finance and Innovation Act (TIFIA) loans in the US (chapter 5 provides a sample/case study about the TIFIA), or more recently the Project Bonds Credit Enhancement (PBCE) mechanism structured by the EU commission and managed by the EIB to provide credit enhancement, specifically to projects financed through capital markets by means of project bonds.

Under the PBCE tool, the EIB provides a subordinated loan or a guarantee which covers the first loss of the project (typically up to 20 percent of the capital cost). Therefore, this increases the rating of the project, allowing it to access capital markets under better terms — or even enabling it to access the markets at all.

BOX 1.27: Recent Practices regarding Financial Support to PPP Private Finance in Latin America

  • Institutional investors in the region (especially pension funds) could be bigger providers of financial support to PPPs than they are today if a number of constraining factors are solved or mitigated. These include the need for a more rigorous preparation process for the PPP projects themselves and the specific collaboration of the MDBs in promoting pension fund participation. Nevertheless, the de-risking approaches implemented in some countries have played a role in attracting institutional investors;
  • Some countries have developed “guarantee funds” (for example, Brazil), but their value is not clear compared to other mitigation techniques and they have not been properly promoted. An example is the FGP (Fondo Grarantidor de PPP) which was created in 2005 with $3 billion, and is managed by Banco do Brazil, which acts as trustee;
  • The use of financial guarantees has been limited, despite efforts in some countries. For instance, in 2008, Mexico put financial guarantee lines in place that acted as credit wraps (these were partial guarantees and payment guarantees to back the payment credit risk in PPPs promoted by states and local governments);
  • Contractual guarantees have been extensively used with good results in Chile, Colombia and Perú (a noteworthy case is the Chilean scheme for minimum revenue guarantee in real toll road PPPs);
  • México created a Strategic Investment Fund (SIF) called FONADIN, in 2008, on the basis of the former Infrastructure Investment Fund (FINFRA) and Highways PPP Trust (FARAC) (the latter being a budgetary fund only, intended to provide non-revolving finance). FONAFIN can provide non-revolving finance where agreed by the government, and it can be involved in equity (equity shares and junior debt) as well as provide guarantees[101]; and
  • In addition, some more sophisticated de-risking approaches have been successfully implemented, such as Recognition Certificates of the Annual Payment for Work (CRPAO) in Perú and Development Capital Certificates (CKD) in México — though this last was a response to a regulatory change intended to boost institutional investment projects, rather than as an instrument or de-risking scheme[102].

Source: The contents of this box are a free summary of the paper “Mejores Prácticas en el financiamiento de Asociaciones PúblicoPrivadas en America Latina” (Best Practice in PPP Finance in Latin America) (World Bank Institute, 2011).

 

 

[98] The distinction between de-risking and credit enhancement is really subtle, as a de-risking approach will favorably affect the credit rating and increase bankability. This PPP Guide defines credit enhancement as “instruments which are structured mainly to provide a higher degree of protection to lenders, thus increasing the credit rating of the debt”. Generally speaking, de-risking techniques are embedded in the contract and form part of the payment mechanism or the risk structure, while credit enhancements are explicit instruments which do not form part of the contract (or when mentioned usually create a commitment to the lenders but not to the private partner).  

[99] The presence of the procuring authority or government as a shareholder in the project company may have benefits for the management of the project (as it will give both parties the ability to handle, in advance, any disputes or controversies in the area of PPP company governance).  However, when the intention is to retain greater control over the private partner operations but enjoy the experience and capabilities of the private sector, or other strategic reasons (for example,  to help the public partner to gain experience in running the service in question in the future), rights of control should be clearly set out from the outset in the RFP documents. These rights should not divert materially from the usual step-in rights. The rights of the private partner should be clearly protected so as to avoid undue interference in the operations, including the implementation of back-to-back sub-contracts so as to transfer the material responsibilities and rights that are intended to be managed by the private partner.  

[100] Further reflections on this matter may be found in A New Approach to Public Private Partnerships: Consultation on the Terms of Public Sector Equity Participation in PF2 projects (HM Treasury 2012).

[101] http://www.fonadin.gob.mx/wb/fni/quienes_somos

[102] These legal structures are conceived to channel funds from institutional investors through trust structures that are to be listed in the stock market. See a paper from Deloitte for more information (in Spanish): http://www2.deloitte.com/content/dam/Deloitte/mx/Documents/bienes-raices...

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