NMIMS University Mumbai

1. Business Environment – Infrastructure NMIMS UniversityMumbai Dipankar De Mumbai

2. Agenda • What do we mean by ‘Infrastructure’? • Regulation of Infrastructure • Basics of regulation • India’s regulatory system: Issues and options • Financing of Infrastructure • Investment required • Approach for infrastructure financing • Models of infrastructure financing • Sources for financing infrastructure • Risks in Infrastructure financing • Special reference: Power sector

3. Infrastructure financing

4. Nature of infrastructure projects & challenges • Infrastructure projects are complex, capital intensive, long-gestation projects that have multiple and often unique risks to financiers. • Infrastructure projects are characterised by non-recourse or limited recourse financing; i.e. lenders can only be repaid from the revenues generated by projects. • Two things make it more challenging – High capital costs + Low operating costs Initial financing costs high in proportion of total costs Multi-party involvement Project sponsors, banks, international lending institutions, govt. agencies Complex & varied mix of financial & contractual arrangements

5. Project finance • Project finance is a method of raising long term debt financing for major projects through ‘financial engineering’, based on lending against the cash flow generated by the project alone. • Project finance is not the same thing as ‘financing projects’, because projects may be financed in many different ways. • Project finance is a seamless web that affects all aspects of a project’s development and contractual arrangements. • Project finance differs from a corporate loan, which is primarily lent against a company’s balance sheet and projections extrapolating from its past cash flow and profit record, and assumes that the co. will remain in business for indefinite period and so can keep renewing its loans.

6. Simplified project finance structure Investors Lenders Equity Project finance Debt Contractor Operator Finance Construction Contract Operation & Maintenance Contract Project Company Support Agreement Input Supply Contract Off-take Contract Concession Agreement or Licensee or Input Supplier Govt. or other public-sector authority Offtaker

7. Project finance structure • Project Contracts include – • A Project Agreement, which may be either an Offtake Contract or a Concession Agreement • Offtake Contract, under which the product produced by the project will be sold on a long-term pricing formula (e.g. a power purchase agreement) • Concession Agreement, which gives the Project company/ SPV the right to construct the project and earn revenues from it by providing a service either to the public sector (e.g. public building) or directly to the general public (a toll road) • A turn-key Engineering, Procurement, & Construction (EPC) Contract • An Input Supply Contract • Operation and Maintenance (O&M) Contract • A Government support Agreement

8. Models in infrastructure financing

9. BOO (Build-Own-Operate) Model • An infrastructure project is financed, constructed, owned and operated by a private sector entity and the government does not have any rights on the assets. • The project is wholly undertaken & completed by private individual / business entity by obtaining institutional finances on their own. • The firm would have exclusive ownership rights on such assets. • Very rare kind of model in India.

10. BOOT (Build-Own-Operate-Transfer) Model • An infrastructure project is financed, constructed, owned and operated by a private sector entity. • However, the right of the private party is only for a specified period as laid down in the contract and at the expiry of the contract period, the assets are to be transferred. • The private entity need to have its own arrangements for financing the project; and ownership is permitted till such time, the firm recovers its costs and agreed portion of profits.

11. BT (Build-Transfer) Model • The infrastructure project is financed by the government and is constructed by the private sector entity. • The ownership of the asset is transferred soon on completion of the construction of the project. The cost of construction with the margin of profit is agreed upon between the government and the construction firm. • Upon completion of the project, the government becomes the absolute owner of the assets, with all rights transferred as per terms of BT model.

12. BLT (Build-Lease-Transfer) Model • The private sector entity finances, constructs the infrastructure project • Upon completion, the asset is leased by government to the private party for a specified period and upon expiry of the lease term, government becomes the owner of the asset. • This model operates when the cost of the project is very huge or when the government cannot make suitable allocations for the project for any reason • The lease agreement acts as an incentive for the firm to recover costs and profit by collecting user charges or cess or toll on the assets from the public

13. BOT (Build-Operate-Transfer) Model • The infrastructure project is financed by the government and is constructed by the private sector entity • After completion, the private entity is authorised to operate facility, on behalf of the government; however, the ownership lies with the government.

14. Sources for financing infrastructure

15. Sources • Equity • Debt • External sources and • Other innovative sources

16. External sources • International developers either independently or having collaboration with domestic developers, equipment suppliers in collaboration with domestic or international developers, • Dedicated infrastructure funds, • International commercial banks – key source; lending based on detail project risk appraisal. However, limited in no. and constrained by exposure & country-wise limitations; loans for 7-10 years maturity – syndication needed • Export credit agencies – provide direct finance, interest rate subsidies & also guarantee the commercial credit • International bond markets – though costlier than syndicated loans, but offers typically longer maturities ranging from 10 - 30 yrs or more; fastest growing source • Multilateral agencies such as IFC, ADB, IBRD

17. Innovative instruments • Mezzanine Finance • Quasi-equity • Subordinated Debt • Variable rate bonds • Risk-adjusted bond • Cash Flow-adjusted bond • Deep Discount Bond • Take-out Financing

18. Mezzanine debt financing • Mezzanine debt is a hybrid instrument placed in between debt and equity. • It is a subordinated to secured debt, but is superior to equity in hierarchy of creditors • Mezzanine debt, when introduced at a given level of equity in project financing, is considered helpful in improving the quality of the superior debt, and hence its marketability. • It is generally provided by third parties, usually non-bank investors, in cases where there is a gap between the amount that senior lenders are willing to provide and the total debt requirements of the project, or in lieu of part of the equity to produce more competitive pricing for project company’s product/ service • E.g. Asian Infrastructure Mezzanine Capital Fund sponsored by the Prudential Capital Insurance Company

19. Take-out financing • Take-out financing is a method of providing finance for longer duration projects (say of 15 years) by banks by sanctioning medium term loans (say 5-7 years). • It is understanding that the loan will be taken out of books of the financing bank within pre-fixed period, by another institution thus preventing any possible asset-liability mismatch. After taking out the loans from the banks, the institution could off-load them to another bank or keep it. • This method is an off-balance sheeting funding (due to capital adequacy pressures) • Benefits - This ensures that the project gets long-term funding though various participants. • Takeout financing involved securitising infrastructure advances in favour of long-term financiers.

20. Process of take-out financing • The original lender participates in a long term project (say 15-20 years) by granting a medium term loan (of say 5-7). • On completion of the pre-decided period, this loan is taken over by another institution subject to fulfillment of the conditions stipulated in the original arrangement • Original lender receives the payment from the 2nd lender who has taken over the loan Most of the commercial banks, now in India, prefer entering into take-out arrangements with long-term financial institutions such as the IDFC (Infrastructure Development Finance Company), IIFC (India Infrastructure Finance Company), Power Finance Corporation, Rural Electrification Corporation, Hudco and the Life Insurance Corporation.

21. Investment needs for infrastructure

22. Rough estimate of investment needed for infrastructure: 2001-02 to 2010-11

23. Sector-wise investment needed for infrastructure: 2001-02 to 2010-11

24. Financing sources Rs. 5,500 bn financing gap!!

25. Overall financing gap in infrastructure: 2001-02 to 2010-11 Rs Billion

26. Public-Private-Partnership • Public Private Partnership (PPP) means partnership between a public sector entity (Sponsoring authority) and a private sector entity (a legal entity in which 51% or more of equity is with the private partner/s) for the creation and/or management of infrastructure for public purpose for a specified period of time (concession period) on commercial terms and in which the private partner has been procured through a transparent and open procurement system. • Public Private Partnership (PPP) Project means a project based on a contract or concession agreement, between a Government or statutory entity on the one side and a private sector company on the other side, for delivering an infrastructure service on payment of user charges

27. Why PPP? • Limitations of government resources and capacity to meet infrastructure gap • Need for new financing and institutional mechanisms • Since neither the public sector nor the private sector can meet the financial requirements for infrastructure in isolation, the PPP model has come to represent a logical, viable, and necessary option for them to work together. • Benefits and strengths • PPPs primarily represent value for money in public procurement and efficient operation. PPPs deliver efficiency gains and enhanced impact of the investments. • The efficient use of resources, availability of modern technology, better project design and implementation, and improved operations combine to deliver efficiency and effectiveness gains which are not readily produced in a public sector project.

28. Why PPP? • It leads to faster implementation, reduced lifecycle costs, and optimal risk allocation. • Private management also increases accountability and incentivizes performance and maintenance of required service standards. • PPPs result in improved delivery of public services and promote public sector reforms. • Access to project finance • PPPs allow governments to overcome their budgetary and borrowing constraints and raise finance for high-priority public infrastructure projects. • PPP projects also leverage available public capital by converting capital expenditure into flow-of-service payments. • Rigorous risk appraisal and optimum allocation • There is increasing reluctance in both the public and private sectors to absorb all the costs and assume all the risks of building and operating these assets alone. • Since the private sector assumes the risk of nonperformance of assets and realizes its returns if the assets perform, the PPP process involves a full-scale risk appraisal. This results in better cost estimation and better investment decisions.

29. PPP & GOI initiatives • PPPs offer a number of advantages in terms of enhancing the ability to take a larger shelf of infrastructure investments, introducing specialised expertise and cost reducing technology as well as bring in efficiencies in operation and maintenance. • To address the financing needs of these projects, various steps have been taken like setting up of India Infrastructure Finance Company (IIFC) and launching of a new Scheme to meet Viability Gap Funding (VGF) of PPP projects • Viability Gap Funding or Grant means a grant one-time or deferred, provided under this Scheme with the objective of making a project commercially viable.

30. Viability Gap Funding • The total Viability Gap Funding under the Scheme shall not exceed 20% of the total project cost. If the Govt. or statutory entity that owns the project may, if it so decides, provide additional grants out of its budget up to further 20% of the total project cost. • VGF is normally in the form of a capital grant at the stage of project construction. • The PPP project should be from one of the following sectors: • Roads and bridges, railways, seaports, airports, inland waterways, Power, Urban transport, water supply, sewerage, solid waste management and other physical infrastructure in urban areas, Infrastructure projects in Special Economic Zones, International convention centers and other tourism infrastructure projects

31. IIFC & VGF • India Infrastructure Finance Company Limited (IIFCL) has been set-up with the specific mandate to play a catalytic role in the infrastructure sector by providing long-term debt for financing infrastructure projects in India, either directly or through refinance. • IIFCL raises funds both from the domestic as well as external markets on the strength of government guarantees. • The IIFCL caters for the burgeoning financing gap in long-term financing of infrastructure projects in the public, private, or PPP sector. Total lending by IIFCL not to exceed 20% of total project cost.

32. PPP Projects - Process ManagementSupport Provided by Ministry of Finance, Department of Economic Affairs

33. Key constraints to private financing of infrastructure • The absence of sufficiently developed financial sector • Fiscal barriers • Red tape and procedural inefficiencies contributing to project delays and discouraging private investment • Absence of adequate regulation, that exacerbates risks and uncertainties for investors

34. Financial sector constraints • Raising adequate equity, as it involves greatest operational, financial and market risk. • Shallow capital market and weakness in corporate governance (primarily minority shareholder protection right) • Limited Mezzanine financing • Under-developed debt markets, as it requires long-term debt.

35. Infrastructure financing risks

36. Categories of risks There are at least seven categories of risks that characterise most infrastructure projects –

37. Thank you.