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PPP Introduction and Overview

17.5. Other Considerations regarding the Project Company's Financial Structure that Influence the PPP Project-Contract.

In addition to basic concerns about ‘bankability’, governments have other points of concern regarding the private financial package that will influence the project contract structure. These have specific implications in the tender process regulations (RFP) and more especially in the contract drafting.

Some of these concerns relate to bankability in a more subtle manner beyond the need for an appropriate risk structure that is acceptable to lenders, and the need for sufficient revenue to cover debt service. It needs to be recognized that lenders will demand certain rights to enable them to influence the management of the private partner, especially in cases of under-performance or in situations where there is a risk of default (“lender´s rights”).

Other concerns for government include the need to balance the competing objectives of boosting access to more efficient financing on the one hand, and having a financially reliable and resilient private partner that is truly committed on the other. See “limiting leverage and requesting minimum equity” and “transfer of shares and changes in control” below. Another concern is to consider the potential for undue windfalls obtainable by means of re-structuring finance (see “refinancing gains” below).

There is also a tension between maintaining competition and managing financial close risks. As a result, the considerations as to how and when the private partner should conduct financial close are common. In some jurisdictions, the government allows financing negotiations to take place after the bid award or even after contract signature, whereas other jurisdictions require finance to be fully arranged at bid submission (see “Requiring the Financial Package Upfront ot Allowing for Post-Award Negotiations. Risk of Financial Close” below). More recently, some sophisticated markets have imposed carefully monitored “preferred bidder debt funding competitions”.

Lenders’ Rights

Beyond the need for a proper risk structure acceptable for lenders (and investors), lenders’ rights are a paramount consideration in a well-designed PPP. The main guarantee (and after construction, the sole guarantee) for lenders consists of the economic rights included in the project-contract, that is, the economic value of the business.

Both the legal framework and the contract should accommodate the ability for the private partner to pledge economic rights (revenues, shares, compensation) to lenders in the guarantee package of the loan agreements.

It is also good practice to allow lenders to “step in”, that is, to take control of the project contract if and when the sponsor/investor is seriously underperforming and the financial sustainability of the project company is in danger, but before the government may need to exercise its right to terminate the contract.

In some jurisdictions, lenders will only be allowed to suggest a remedy plan before the authority declares the project terminated. This includes the ability to suggest a new contractor to operate the asset instead the original private partner. However, this will only be possible (in many cases) under a public process to select the new partner and substitute the outgoing investor.

Limiting Leverage and Requiring Minimum Equity Commitments

As we have already seen, debt leverage provides efficiency to the financial structure (decreasing the weighted average cost of capital - WACC). Therefore, it increases affordability or decreases the overall payments to be made by the authority (in government-pays PPPs), or increases the NPV of the equity cash flows (in user-pays PPPs). However, excessive leverage may endanger the sustainability and solidness of the PPP project, increasing the risk that the SPV will become insolvent[103].

The public party also benefits from the sponsor/promoter being significantly at risk that is, being directly exposed in financial terms to project failure and to the performance of the project. To ensure there is sufficient equity at risk, governments often limit the level of debt in the contract and require a minimum equity commitment from the bidder/sponsor. For instance, in Spain it is common practice to require a minimum equity contribution from the sponsor of at least 15-20 percent, with the flexibility of reducing the amount and percentage two or three years after construction is completed and the project is in service or operation.

There are also jurisdictions that require a specific minimum level of equity involvement by the investor-contractor or any key partner. This is one who is bringing the capacity or experience to the project that forms the basis on which the consortium has been qualified (or shortlisted).

Transfer of Shares and Changes in Control

Another government concern will be about the legal ability of the owners of the PPP company (the original successful bidder) to sell their equity and move out of the project. There is a competing tension between the objective of commercial feasibility (the more easy it is to sell shares, the more liquid and attractive the investment) and the logic of avoiding opportunistic behaviors (such as bidding and winning, but then selling on the right to develop the project). The need to regulate transfers of shares is also linked with transparency and fairness of the procurement, as the proposed ownership of the PPP company is likely to have been considered in the evaluation of the bids.

It is common practice to prohibit the transfer of shares without the prior authorization by the authority when such a transfer results in a change of control (that is, the project company ceases to be controlled by the party that was selected in the tender process). Many contracts strictly prohibit such changes during the construction phase (unless exceptional circumstances occur, such as insolvency of the shareholders), but do permit transfers (provided government is notified) when they do not represent a change in control and do not materially affect the credit and capacity standing of the project company[104].

When authorization is required, this will be subject to requirements in the contract. These requirements may set out the grounds on which the authority, acting reasonably, may refuse authorization. The private partner may need to satisfy the authority that the change in control will not adversely affect its credit standing and technical capacity. In some jurisdictions, it is a sufficient condition that the incoming controlling shareholder meets the pass/fail requirements in the original request for qualification (RFQ).

Authorities shall be aware of the need to bring flexibility to the following:

  • Changes in the ownership of the company so as to provide liquidity to the original investors.
  • Easing the conditions for transfer of shares without requesting previous authorization, unless there is a change in control (at least until after construction).

In this context, they should be very clear on conditions to be met for authorization to be granted.

Refinancing Gains

In some jurisdictions, contracts include provisions for sharing certain refinancing gains. This may occur if there is re-negotiation of the debt terms (usually after some years of operations) or the substitution of the existing pool of banks and current loan agreement by another new agreement with more favorable terms.

Typically, the private partner must share with the public partner a percentage of the increase in the equity IRR resulting from the refinancing[105]. See chapter 8 for further information on sharing of refinancing gains.

Requiring the Financial Package Upfront or Allowing for Post-Award Negotiations. Risk of Financial Close.

Assuming that the local financial market has, in general terms, enough capacity to finance the project (both in terms of volume and length of term), governments have a choice as to whether or not that financing is required at the time of bid submission.

The procuring authority is logically concerned about the ability of the project and sponsor to raise the necessary funding in the form of debt, especially when the project has a high risk profile. However, to request that the financial package be arranged at bid submission or before contract signature may affect competition if there is insufficient capacity in the financial market to fully finance each bid.

According to the European PPP Expertise Centre (EPEC)[106], “in difficult financial market conditions (for example, reduced liquidity), fully committed financing packages may be difficult to obtain at the time of bidding. This may mean that the financing agreements will not be concluded immediately once the PPP contract is signed”. Also, “in the past, PPP financings for major transactions were usually provided through ‘syndication’ arrangements, whereby a small number of banks underwrote the financing of the project and ‘re-sold’ it to a syndicate of banks after financial close. Most PPP projects are now funded through ‘club deals’: each bank assuming it will hold its stake of project debt to maturity. In some cases, these club arrangements can only be concluded after the appointment of the preferred bidder (the so-called ‘post preferred bidder book-building'), under which the full lending group is assembled using lenders that may have supported unsuccessful bidders”.

Requiring the financial package upfront also necessitates a longer time for bid submission. This is to permit the proper structuring and time for due diligence to be handled by the banks in advance of the bid deadline. Therefore, this approach is more common when the procurement route is based on a previous shortlisting (which by definition narrows the potential problem of lack of availability of lenders).

There is not a valid universal approach to this matter as it depends on the financial market of each country, as well as on the procurement route followed. In general terms, globally speaking, there are two types.

  • Markets in which competitive dialogue (chapter 5.8.3) and other interactive or negotiated process is standard, and the financial package is usually (but not always) arranged up front; and
  • Markets more accustomed to, or only procuring under, a one stage approach (open tender with no shortlist). Here, the financial arrangements may be postponed until after commercial close or contract signature.

Good practice: In a market where there are signs of a scarcity of lenders or bank lending capacity to back more than a reasonable number of bidders (for example, three bidders), and the government is pursuing an open tender approach (that is, without a shortlist), it is good practice not to require bidders to provide financial arrangements at bid submission. However, the RFP should require reasonable evidence of availability of funding (that is, indicative letters from banks).

As opposed to “preferred bidder funding competitions” (explained below), in the conventional financial close process, the actual financial conditions negotiated at financial close (and therefore the conditions assumed at bid submission) are at the sole risk of the bidder. However, it is good practice to give relief to the private partner when an adverse and unexpected change in the financial market occurs (including the ability to withdraw the offer or renounce to the contract). It is also becoming standard and regarded as good practice that the risk of the volatility in the price conditions of the financing (those which do not relate to the credit standing of the PPP project as offered by the successful bidder) is retained by the authority or shared: this refers to the “interest base rate” movements between bid submission and financial close (see appendix 5A and Chapter 3.1)[107].

Preferred Bidder Debt Funding Competitions[108]

In contrast to the situation described (that is, when availability of finance is not an issue, but the financial market is highly competitive and PPPs are a well-known asset for lenders), governments may seek to further control and take part of (if not all) the risk and reward related to the financial conditions obtainable at financial close.

In those circumstances, and particularly in large PPP projects[109], the authority may seek to secure competitive financing terms by requiring the preferred bidder to conduct a debt funding competition (a competition among potential lenders in order to obtain the best financing terms possible). The authority will retain most or all of the benefits (and assume the related risks).

However, as stated by the EPEC guide, debt funding competitions may not be suitable for projects or in markets where financial innovation is expected to play a significant role in the competitive position of bidders. Moreover, it may not be suitable in conditions of limited financial liquidity.

BOX 1.28: Key Points regarding Financing in a Private Finance PPP Contract

  • Private finance is the financing provided by the private party (from its own funds or by raising funds from third party lenders) to finance all or part of the infrastructure development costs. The costs will be recouped by means of the revenue to be generated by the contract.
  • Like any business operator, the PPP project company will present a mix of funds in the form of equity and debt.
  • Though debt may be raised against corporate guarantees, the common practice is to structure the financial package on the basis of the project finance technique. Having debt funding in the mix of the project company’s financial structure under the project finance technique will release capital capacity for the equity investor to invest in other projects. It also decreases the cost of the overall mix of funds (lower WACC), which is the concept of leverage.
  • Project finance will usually be more expensive than corporate debt, but it provides a number of advantages both for the private and the public partners.
  • Under the project finance technique, the public party has to pay attention not only to feasibility but also bankability. Therefore, the project structure (of revenues and especially in terms of risks) has to match common lender requirements in addition to those requirements from the private party as an equity investor.
  • Bankability lies at the heart of project appraisal and preparation, which is explained in detail in chapter 4.
  • There are multiple sources of funds for equity and debt, including pure financial investors to provide equity, institutional investors, development banks, and commercial banks.
  • The public party (or the government in the general sense) may be a finance provider in many forms, including the provision of public financing in strict terms (grant financing), co-lending schemes, and equity, or it may support bankability in other ways (de-risking and credit enhancement).
  • The government may act as a finance provider in user-pays projects where the project is economically viable but there is a viability gap that is filled by public finance (with an alternative approach being to provide deferred support in the way of a hybrid payment mechanism).
  • The government may also act as a finance provider in all revenue regimes to mitigate financial market failures or imperfections, or simply to increase the affordability of the project in the long run.




[103] See “An Example of an Over-Leveraged PPP: Victoria Trams” in PPP Reference Guide V2 (World Bank 2014) page 55.

[104] Change in control should be defined clearly in the contract. There are different approaches in different jurisdictions and practices. Besides the effective control of the company, some PPP practices define a threshold for change in control other than 51 percent of the shares. For example, the contract may define a change in ownership of 20 percent of the shares to be a change in control.

[105] Further reading on refinancing matters may be found in Standardization of PF2 Contracts (HM Treasury 2012).

[106] Guide to Guidance (EPEC, 2012), “Conclude the Financing Arrangements”.

[107] The Application Note — Interest-Rate and Inflation Risks in PFI Contracts (HM treasury and Infrastructure UK, 2013) explains this issue and how to handle the neutralization of interest rate movements until financial close in its section 2.3.

[108] For a description of the approach suggested in the UK, see HM Treasury Preferred Bidder Debt Funding Competitions: Draft Outline Guidelines, August 2016.

[109] When a project is small, the costs of conducting the competition, including the cost of specialized advisors to oversight the process and additional time, may easily offset the benefits of the potential better financial conditions.

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