The Impact of the Financial Crisis on Public Private Partnerships
Filip Drapak, Senior PPP Specialist, World Bank
Public Private Partnerships have been an innovative technique to fund large government projects. How the financial crisis has changed this approach will be the subject of this discussion.
3. Content of presentation
Financial crises and infrastructure
Impact on PPP
Regional and global impact
Governance
Finance
Guarantees
Procurement
Development institutions and PPPs
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4. Government response in terms of issues
1) Liquidity:
(a) direct lending in form of parallel financing (EIB, funding facilities in France and
Germany)
(b) role of lender of last resort (TIFU in UK used for Manchester waste project)
(c) policy measures enabling solutions to liquidity issues (DFC, short term
financing of long term projects)
2) Capital allocation:
(a) Debt guarantees (France, Spain, Portugal, Slovakia)
(b) Underpinning (France, Germany, Poland)
(c) Indirect guarantees (Sub-sovereign guarantees, Loan Guarantee for Ten T
projects…)
3) De-risking of projects measures
(a) swapping payment mechanisms
(b) braking the projects up in several tranches
(c) support guarantees on particular risks
(d) structuring/ROE support (supplementary income, funding contribution
optimization)
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5. Policy and Governance implications
Procurement has to be more flexible, shorter and financial market risk sensitive
Market flexibility and procurement flexibility
Procuring authorities are suffering from the higher financing costs and bank
fees, as well as greater transaction costs from procedures and negotiations
that are taking longer to conclude. One risk is that final bids that were thought
to have committed financing are reopened as debt continues to be re-priced.
It’s no longer realistic to insist on committed financing at the bid stage – most
lenders require price flex, or indeed market flex clauses (in which most terms,
not just pricing, can be adjusted). This makes it impossible to conclude the
financial evaluation of private partner proposals until much later in the
process, and sometimes not even until days before financial close.
This creates significant headaches for procuring authorities. How can a
preferred bidder be selected if the financial proposal is not known with great
certainty? How can competitive tension be maintained in final lending
negotiations until well after preferred bidder selection? Should government
share the pricing risk to which the preferred bidder is currently exposed? In
one current UK social infrastructure P3, the c. $150M debt package has been
re-priced twice since April this year, and closing has been delayed.
CCPPP, 2009 4
6. Policy and Governance implications: introducing DFC
As one of potential policy measures to improve the financing of PPP
projects UK government used so called DFC (Debt Funding Competition)
What is a DFC?
A DFC is an initiative that has been employed in the UK a number of
times since 2000 and has been championed by the UK HM Treasury
as a mechanism for government to induce competition and thereby
obtain more favorable debt funding terms.
When using a DFC, government selects a preferred bidder and that
preferred bidder, in consultation with government, then goes to the
debt market seeking the best price for the debt funding for the
project.
The objective for the UK government was to increase the
competitiveness of the lending market with a view to reducing the
overall cost of the project.1 We are now in a very different market
where the primary focus of the DFC would be to source sufficient
debt funders willing to lend to the project.
David Lester and Chris Keane, 2009
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7. Policy and Governance implications: introducing new
institutions and guarantee support mechanisms
The solutions often suggest new institutions, from US discussion regarding
the Infrastructure bank, ideas of setting up national guarantee instruments to
the discussion on a new role of multilateral and development institutions.
How to mitigate the impact of the financial crisis on PPPs2009
The French Institute for PPP (IGD - Institute de la Gestion Déléguée)
released in November its proposals to mitigate the impact of the financial
crisis on PPPs in France. IGD suggests to address the issue of lack of
liquidity through the delinking of the duration of contracts and the duration
of loans that would allow the short-term financing of projects and its long-
term refinancing when market conditions will be more favorable, and the
creation of a special public vehicle that would be entitled to collect and
provide long-term resources to support banks activities.
IGD also proposes to reduce the impact on costs through a special state
warranty on local authorities’ projects, and calls for a broader public
support through investment subsidies when construction periods are
important.
Pierre Van de Vyver, 2009
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8. Financial crises and infrastructure: reactions in 2008
• The USA president-elect, Barack Obama has said that: “we can’t worry short term
about the deficit. We’ve got to make sure that the economic stimulus plan is large
enough to get the economy moving.”
• The EU is discussing proposals from Britain
and France for a major programme of additional
infrastructure investment
• The newly elected government in New Zealand has announced its intention to make
tax cuts and increase infrastructure investment including : “the development of new
roads and public transport, improve schools and roll out an ultra-fast broadband
network.”
• China, which is already spending as much as 14% of GDP on infrastructure, is
“weighing plans to expand a massive stimulus package with higher spending on
health and social programs”
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9. Financial crises and infrastructure: reactions in 2008
• The government of India has announced $60billion increase in state spending,
including an additional $4 billion on infrastructure projects.
• Mexico says it plans to spend 6.5% of GDP on infrastructure in 2009, the highest
rate ever recorded, with a deficit of 1.8% of GDP.
• South Korea is creating 50,000 jobs by the end of 2009 by spending over $3bn on
infrastructure.
(David Hall, Economic crisis and public services)
The [Korean] government announced a fiscal stimulus package in response to the financial crisis with
more than 15 percent of the envisaged investment to be carried out through PPPs. The package is
accompanied by measures to reduce financial burdens on PPPs, smooth interest rate changes, and
shorten project implementation. The measures introduce: (i) lower equity capital requirements on
concessionaires (5–10 percent); (ii) for large-scale projects, higher ceilings on guarantees provided by
the Infrastructure Credit Guarantee Fund (50 percent); (iii) help in changing equity investors for some
projects; (iv) compensation for the preparation of proposals to encourage more vigorous competition
during bidding; (v) sharing of interest rate risks with concessionaires; (vi) compensation for the excess
changes in base interest rates through grading of risks at the time of the concession agreement; and (vi)
shorter periods for readjusting benchmark bond yields.
IMF
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10. Governance
Stanford published research paper “Public Private Partnership Agencies, A
Global Perspective” defines three types of PPP agencies:
(a) Review Bodies;
(b) Full service Agencies and
(c) Centers of Excellence.
While Review Bodies do have a more of a Regulatory function, Service Agencies
do have Advisory role and Centers of Excellence have Capacity building
mandate. Obviously these roles tend to be more structured and mixed up in
different governance structures within the global landscape.
Lets look at 3 case studies of
1) UK: the centralization
2) SA: the decentralization
3) Russia: the refocusing
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11. Governance: the UK case
There are two important policy measures stipulated by financial crises: recent
establishment of TIFU and planned set up of Infrastructure UK within UK
Treasury, which will consolidate regulatory and policy team, TIFU and PUK
and exercise clear responsibility from developing and supporting delivery of
an infrastructure strategy for the UK. Establishment of Infrastructure UK is
however more result of long term development than impact of financial crises.
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12. Governance: the SA case
Financial crises and South Africa PPP Unit:
The demerger of regulatory and advisory roles, greater independence on
Treasury. SA context of financial crises did bring major change of government
and while presidential support to PPPs remained strong, the government and
line ministerial leadership in this field was very weak. Financial crises
initiated some progress in terms of IPPs to respond to energy crises, set up
of a hospital PPP program and strong support still for the transport related
PPPs.
Key driver at SA PPP governance is at the moment the separation of Advisory
from Regulatory function when driving the deal flow, which is more natural
development rather that financial crises impact. PPP Unit will move away from
Treasury in to a new Government Component under the brand name of
Partnerships SA, will be 100% government owned and will have mainly
project development function. The regulatory function will be exercised by
Director General NT.
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13. Governance: the Russia case
Very substantial impact had financial crises on Russia and its impact on PPP
perception in Russia. Russian federal PPP Unit is located within Russian
Development Bank the “Vnesheconombank” and led by Alexandr Bazhenov.
The situation in Russia has changed
dramatically. While prior financial
crises Russia did look at PPPs as an
important, but not essential tool, given
rich surpluses in budgets, this has
changed with financial crises and
PPPs are now considered essential for
the development.
This is reflecting on status and role of
PPP Centre within
“Vnesheconombank”, giving the PPP
unit mandates in capacity building,
advisory of choice, and financing of
PPPs.
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14. Key financial issues of PPP in financial crises
PPP economics have changed
Lack of funding on both equity and debt side
Lack of interest of investors and operators
“The monoline wrapped bond market, which has been the financial structure
of choice for large PFI projects over the past 10 years, is now effectively
closed to new transactions. This has increased reliance on the banking
market.
The combination of capital adequacy requirements, reduced liquidity and
higher funding costs has increased the strain on the project finance banking
model. While the banks’ views of the PFI risk profile have not changed
materially, funding availability is limited and credit margins have moved up.”
Andy Rose, Executive Director, PUK
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15. PPP economics have changed
Economic cycle has to be taken in to the account
“Equity price bubble busts every 13 years on average,
last for 2 ½ years and are associated with GDP losses
of 4 percent of GDP. Housing price busts are less
frequent, but lasted nearly twice as long and were
associated with output losses that were less twice as
large…”
World Economic Outlook
Risk management and mitigation implication
(a) Country risk
(b) On project risk
(c) Refinancing risk
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16. PPP economics have changed
Implications for the VfM
(a) Projects less likely to achieve VfM
- Increased cost of equity
- Increased role of equity and proportion of equity financing
- Increased cost of debt (offset by lower interest rates?)
(b) Fiscal space implications to VfM
(c) Some governments more rigorous on VfM and can be more keen on
litigation
Ernst & Young’s P3 team in the UK infrastructure reports that the
average margin for availability payment-based P3s, increased from
82bps to 94bps between May and August 2008. Volume based
payment P3 projects had average margins of 155bps in August
2008, which is increase of 50bps since credit crunch.
Ernst&Young’s UK infrastructure report
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17. PPP economics have changed
VfM might be lost at the current market, this can however be offset by fiscal
and macro economical benefits of PPP
PPP lifecycle cost PSC: public model
VfM lost
equity
debt
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18. PPP economics have changed
is there evidence for change in economics of PPP?
Global project finance 2007/2008
51.3
Equity financing
74.4
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Bond financing
5.7
2007
2008
212.1
Loan borrowing
234.9
Global project 278.4
finance 315
0 50 100 150 200 250 300 350
USD billion Project finance 2009
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19. PPP economics have changed
is there evidence for change in economics of PPP?
Change in 2008 in %
60
45
40
20 11
0 Loan borrowing
%
Loan borrowing Bond financing Equity financing Bond financing
-20 Equity financing
-40
-60
-62
-80 Project finance 2009
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21. Global PPP in 2007-2009
Volume of PPPs have stagnated in 2008 on the 2007 level with growth mainly
generated in North America region (203% growth), however the 4Q 2008 volume fell
38% (in comparison to 4Q 2007 volume). 2009 total volume fell by 18% to USD 55 bn
with 4Q of 2009 up 9% via 4Q of 2008.
Global PPP in 2008
PPP volume 2007-2009 and
4Q % change India
Midle East anhd North Africa 4.5
alone
20%
Asia 11.3
2010
North America 8.4
Spain 4.6
Portugal
USD 3.4 bn
Portugal 6.4
UK 10.9 UK USD 8.2 bn
Global PPP 67
2010
0 20 40 60 volume80
of USD
Project finance 2009/2010 USD billion 55 bn
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22. PPP economics have changed, but not the perception
of the usefulness of PPPs
“Greater emphasis also needs to be made towards the social economic
benefits delivered to a country or region which could mean adopting a more
visionary approach to PPP models to include agglomeration benefits. Failure
to do so will mean that PPP projects may never get off the ground on a pure
cost benefit basis.”
EC Harris, Is PPP dead and buried?
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23. Using guarantees to support PPPs
During the current financial crisis, the banks have not been forthcoming with loans for PPPs, or they require
additional security in the form of guarantees of their loans. The only party that can provide such a guarantee
on the market today is the government. A few examples of this kind of guarantee:
-The French government has been "allowed to guarantee loans on priority projects implemented through PPPs
entered into before 31 December 2010, up to a global ceiling of €10bn."
-The Spanish ministry of infrastructure initiated special financial guarantees for PPP projects (mainly for high
speed trains) for an estimated amount of 15.000 M€
-In Australia, the main problem is the unavailability of long tenor debt, with recent projects being financed
using 5-year mini-perm structures. Governments have proved willing to share in the refinancing risk at the
maturity of these financings. The State Government of Victoria has underwritten the senior debt syndication
of its A$5 billion desalination project, in the expectation, that the bank club supporting the winning bidder will
be able to sell down to members of the bank club that supported the losing bidder.
-The Portuguese government is reportedly providing a Euro 800 mil. guarantee to the Litoral Centro highway
concession and will also guarantee the Pinhol Interior concession project.
- Kazakhstan used debt instruments guaranteed by the government to finance PPPs with the goal of
“encouraging participation of pension funds in the system”. Currently, the law enables the government to
provide guarantees both to the concessionaire for infrastructure bonds within the limits of the concession
agreements and to loans attracted to finance concession projects. According to the professionals
participating in the PPP process, the government’s accounting process in the fiscal budget will include
subsidies or co-funding as state investments, while the guarantee will be considered as a public debt.
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24. TIFU – the UK loan facility
The UK, which has the largest PPP market so far, has decided to establish a The Infrastructure Finance Unit (TIFU)
to lend to PFI/PPP projects to "ensure that infrastructure projects go forward as planned despite financial markets
conditions and thereby support jobs and economy." This is generally a good idea, but at first it seemed that it
would not be necessary. For a while, banks managed to form a club, or the European Investment Bank supported
the project. However, margins continued to climb and banks could only deliver short-term financing in the form of
mini-perms.
For the time being, the bond market and credit risk insurance are dead, so finally TIFU found its first project to bail
out in April 2009: "TIFU completed its first loan facility on 8 April 2009, providing a £120 million loan for the
Greater Manchester Waste Disposal Authority’s PFI project alongside the European Investment Bank and a
syndicate of commercial banks." This project was bailed out in the sense that the project could not secure
financing without TIFU support, but it is a new development project so it's difficult to judge whether it meets
the criteria I set out above.
The second project to be bailed out was considered in May for the Wakefield waste treatment project. Finally, two
years after the selection of a proffered bidder, the financing of £700 million was secured on a preliminary basis in
June without TIFU assistance and is expected to close within several weeks. Bailing out PPPs might be
controversial for taxpayers, but it remains the only practical option for the public sector. Hopefully, the financial
crisis will subside soon and financial markets will come back to their traditionally aggressive and long term
lending to PPPs.
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25. Canada: Partnerships BC Funding contribution optimization
8%
ARHCC
8% Okanagan Lake Bridge
8% Optimization based on
Sea to Sky
IHA
7.8% SMH
balancing public funding
7.5% NCC SFPR 7.5%
FSJ
7.3%
7.4% 7.4% contribution to achieve certain
Diamond Centre
Kicking 7.1% IRR
Horse SOPF
7% 7% RJH
6.9%
6.5%
Older Projects Current Projects
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26. Australia: Credit Enhancement through Supplementary Income
Good example of Credit Enhancement through supplemental income is the Airport
Motorway Trust project in Australia.
-The government issues an Infrastructure Bond at its cost of funds and lends the
proceeds to the project company, which invests the proceeds at the market rate.
-The difference between the cost of interest on the Infrastructure Bond and the
interest income on the invested proceeds provides supplemental income to the
project.
- In the early years of operation, when Airport Motorway’s toll revenues barely
provided over 1X debt service coverage, total coverage with supplemental interest
income was 2X.
-This allowed project debt to have a much higher rating and lower cost of capital
than if it were secured only by toll revenue
- The Infrastructure Bond carries a long-term maturity date, which gives the project
cash flows ample time to ramp-up. The bond is retired from the invested proceeds.
Thereafter, debt service is payable solely by project revenues.
Fitch Ratings, William Streeter
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27. Conclusions
Financial crises impact on the PPP market is not over yet, however recovery
and optimism is quite strong
Smaller transactions and larger risk diversification are demanded by the
financial market
Long maturities still available but costly
Bigger role for development banks and multilateral institutions
Governments should focus on building the pipelines of good projects, as
there is permanently less good projects than there is funds available for them
Bond, wrapped or privately insured financing not really available yet, but
number of solutions have emerged
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