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Public Private Partnerships: Financing Aspects of PPPs. ALAIN TERRAILLON European Investment Bank. « Concessions and Public- Private Partnerships  » Ankara, 10-11 March 2008. Overview. Introduction What are PPPs What is project finance Risk allocation Financial structures for PPPs

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Public Private Partnerships:

Financing Aspects of PPPs


European Investment Bank

« Concessions and Public-PrivatePartnerships »Ankara, 10-11 March 2008

  • Introduction
    • What are PPPs
    • What is project finance
    • Risk allocation
  • Financial structures for PPPs
    • Role of equity, debt, mezzanine and subcontractor finance
  • Issues for Senior Lenders
    • How do Senior Lenders look at risk in PPP transactions?
  • Issues for the Public Sector
    • Why finance is important for the public sector counterpart

What are PPPs?

  • Delivering public infrastructure through procuring services rather than capital assets
    • Public sector defines service requirement
    • Private sector designs, finances, builds, operates, (usually transfers) the asset
  • Mainly private (not public) financing
    • Fiscal environment & EMU
    • Does not exclude public component (e.g. from Structural / Cohesion Funds)
  • Improve the efficiency and quality of public services
    • Accelerating investment in infrastructure
    • Achieving private sector efficiencies
features of ppps
Features of PPPs
  • Contracts for services, not procurement of assets
  • Output, not input, specifications
  • Payments related to service delivery
  • Whole life approach to design, build and operation
  • Private sector funding to underpin risk transfer
  • Project Finance for all but smallest projects
project finance
Project Finance
  • Project Finance is specialised form of finance based on:
  • A ‘stand alone’ project
  • A Special Purpose Company (SPC) as the borrower
  • High ratio of debt to equity (‘gearing’)
  • Lending based on project cash flows (not balance sheet)
  • Lenders rely on project contracts, not physical assets, as project security
  • Non recourse finance (ie no claim on investors)
  • Finite project life (ie debt to be repaid at project close, in contrast to corporate debt which can be ‘rolled over’)

Pops and Value forMoney

In principle, PPPs can improve VFM by:

  • Facilitating and incentivising on time and on budget project implementation
    • No service / no pay
    • Incentives to cost control
  • Optimisation of capital & maintenance spends over project life
  • Innovation in design and financing structures
  • Improving management of operational risks

Optimal risk allocation  reduced cost of risk

Reduced cost of risk  better Value for Money

structuring ppp transactions
Structuring PPP transactions
  • Alignment of risk, incentive and reward is the key to value for money in PPP transactions
    • Improved management of risks reduces overall cost of project
    • This reduced cost secures value for money
  • Correct risk transfer also critical to securing affordability
    • Risks are being priced that were previously left unpriced
    • Pricing impact on current defined budgets (not future undefined budgets)
  • Private funders play lead role in taking on, allocating and managing PPP project risks
which risks
Which risks?
  • Meeting service delivery standards
        • For example: if the project design is unable to meet service need, private sector must pay costs of rectifying
which risks1
Which risks?
  • Meeting service delivery standards
        • For example: if the project design is unable to meet service need, private sector must pay costs of rectifying
  • Cost overrun during construction
        • For example: unstable ground conditions requiring additional foundations would be a private risk
  • On time completion
        • For example: if facility is delivered late due to ground conditions, no payments until availability
  • Underlying and future costs of service delivery
        • For example: latent defects risk in an existing building
  • Physical damage to a building
  • Market risks in some projects

UK Education PPP

Local authority


Equity providers

Ministry of Education

Educational services

Catering, cleaning,

Security, energy etc






Borrower / Concessionaire

(the SPC)






Senior Loan







Direct agreements


Welsh DBFO Road - A55project










Equity /




Senior loan

Borrower / Concessionaire


Senior /

Junior Loan








joint venture



financial structuring
Financial structuring
  • Senior debt
  • Mezzanine debt
  • Equity
  • Sub-contractor finance
financial structuring1
Financial structuring

Senior debt

  • Typically 80-90% of capital requirement
  • Interest and repayment in priority to all other capital
  • Seeks to minimise risk of unremedied failure of PPP contractor:
    • Disciplined approach to due diligence
    • Pass through of risks
    • Entitlement and incentive to step in to remedy significant failings
  • Priced accordingly
financial structuring2
Financial structuring

Sources of senior debt

  • Bank debt
  • Debt raised in capital markets
    • With a financial guarantee (‘wrap’) from a monoline insurer (monoline takes risk)
    • Without a guarantee but rated by a rating agency (investors take risk)
  • European Investment Bank
    • With or without a guarantee / wrap
financial structuring3
Financial structuring


  • Typically 10-20% of capital requirement
  • Shareholder loans that earn interest (‘subordinated debt’)
  • Share capital that receives a dividend
  • Primary risk taking tier – also seeks significant pass through of risks
  • Equity funders paid to take this risk
financial structuring4
Financial structuring


  • Typically 10-20% of capital requirement
  • Shareholder loans that earn interest (‘subordinated debt’)
  • Share capital that receives a dividend
  • Sources include contractors and (increasingly) institutional equity investors
  • Primary risk taking tier – also seeks significant pass through of risks
  • Equity funders paid to take this risk
financial structuring5
Financial structuring

Mezzanine debt

  • Lies between senior debt and equity in transfer of risks
  • Repayment affected by poor performance before senior debt
  • Return greater than senior debt
  • Usually provided by banks offering senior debt (ie prepared to accept a higher risk / return tranche)
financial structuring6
Financial structuring

Subcontractor finance

  • SPV (and lenders) need assurance that contractors can meet contingent obligations
    • Parent company guarantees
    • Letters of credit
    • Performance / surety bonds
  • Providers of guarantees etc have no recourse against SPV
implications for senior lenders
Implications for Senior Lenders
  • Minimisation of risks retained by the SPV
    • Gearing determines maximum value of risks that can be retained in the SPV
  • Acceptable project structure
    • Project agreement, sub contracts, financing agreements, security package, insurance
  • Acceptable financial structure
    • Sufficient liquidity
    • Reserve accounts (debt service, lifecycle etc)
    • Robust cashflows and acceptable ‘waterfall’
    • Adequate cover ratios
cover ratios
Cover ratios

Surplus cash senior lenders require to be retained to meet (potential) shortfalls in debt repayments

Loan life cover ratio:

NPV of cash flow available for debt service during the life of the debt

Debt principal outstanding

Annual debt service cover ratio:

Cash flow available for debt service

Debt service due in the period

how do lenders control cash
How do lenders control cash?

Using ratios

  • If ‘base case’ minimum LLCR is, say, 1.30 and ADSCR is 1.20
  • At, say, LLCR 1.15 and ADSCR 1.10 equity distributions stop (‘lock up’)
  • At, say, LLCR 1.10 and ADSCR 1.05 borrower is in default (‘default’)

Other factors

  • A range of other lock up and default circumstances (reserve accounts not funded, project agreement defaults, insolvency etc)
financial structuring7
Financial structuring


  • Inability of SPV to take financial losses means risks held by SPV must – to maximum extent possible – be insured
  • Borrowers contractually required to hold a range of insurances (construction, material damage, 3rd party liability, business interruption,etc)
  • Lenders engage insurance advisors, and implications of future insurance cost increases a major issue in negotiating deals
  • What happens if an insured risk becomes uninsurable?
risk and reward
Risk and reward
  • What happens when things go wrong?
  • Implications for the public sector

Where do the risks go?






when things go wrong
When things go wrong
  • Public sector defaults
  • No fault defaults (Force Majeure)
  • Private sector (concessionaire) defaults
public sector defaults
Public sector defaults
  • Vires
    • Can the public sector sign the contract?
  • The public sector covenant
    • Can the public sector be forced to pay?
    • Public sector defaults
  • Compensation on termination
    • Debt plus some remuneration of equity on public sector default
force majeure
Force Majeure
  • No fault reasons for termination
  • Public sector generally seeks to limit to prevent risk transfer from private to public
  • UK contract does not include all ‘Acts of God’ e.g. bad weather
    • War, civil war, armed conflict, terrorism;
    • Nuclear, chemical, biological contamination not caused by contractor
    • Pressure waves caused by devices travelling at supersonic speed
  • Equity and debt back (but no equity return) following force majeure termination
relief events
Relief Events
  • UK contracts defined as:
    • Fire, explosion, storm, flood, earthquake, riot
    • Failure of e.g. power companies to supply power
    • Accidental loss to the sites
    • Fuel shortages
    • General construction strikes (but not contractor specific strikes)
    • Archaeological finds
  • But only relief from termination – principle of no service, no pay remains
concessionaire default
Concessionaire default
  • Concessionaire default means failure to meet the terms of the concession contract
  • Termination of sub contractors (insolvency, poor performance, corruption etc)
    • Technical due diligence
    • Importance of liability caps
  • Step-in by senior lenders
    • Ability of lenders to act to save the project
    • Public sector relies on lenders to control the project
    • Importance of Direct Agreements and ability to replace the concessionaire
  • Compensation on concessionaire termination
replacing sub contractors
Replacing sub contractors
  • Sub contractors have a key role in taking risk in PPP projects
  • Lenders look for contractual right and practical options replacing non performing contractors
  • On termination, sub contractors typically required to pay termination damages
  • Lenders seek unlimited damages, contractors seek to limit these (for UK PPP construction contracts, cap of 50% of contract value typical)
  • Lenders seek to be assured that damages payable will be sufficient to meet additional costs with a new contractor
  • Lenders will regard geographically remote or highly specialised projects as particularly risky
compensation on termination
Compensation on termination
  • Extent of compensation for lenders depends on the cause of termination
  • Lenders will always require full compensation for termination for authority default or authority voluntary termination
  • UK PPPs: lenders fully compensated for Corrupt Gift and Force Majeure termination
  • Compensation for other concessionaire defaults based on either Market Value (retendering) or Fair Value (no retendering) methods
market value based compensation on termination
Market value based compensation on termination
  • A feature of UK schools and hospital PPPs
  • Applies unless there is no ‘liquid market’ in concessions (defined as at least two potential bidders)
  • On default by concessionaire, public authority ‘sells’ unexpired period of concession contract
  • Bidders determine what (capital) sum they will pay to buy future cashflows – bearing in mind they must deliver service to achieve these cashflows
  • Lenders’ compensation = bid capital sum
  • If no bids (or negative bids), compensation is zero
fair value based compensation on termination
Fair value based compensation on termination
  • Applies only where no liquid market
  • Present value of future cash-flow over concession minus present value of future costs minus rectification costs = lender compensation
  • In theory, fair value and market based compensation should be identical
  • In practice, lenders would always prefer greater certainty of fair value
conclusions what do senior lenders need
Conclusions: What do senior lenders need?
  • A clear public sector covenant
  • A good understanding of the risks taken on by the private sector
  • Limitation of the risks taken on by borrower
  • Sound insurance arrangements
  • A liquid market in sub-contracted services
  • Step-in rights
  • Appropriate compensation on termination
senior lenders the public sector s best friend
Senior Lenders: the public sector’s best friend!
  • Senior lender due diligence
    • Public sector gains some reassurance on deliverability from senior lender due diligence
  • Clear identity of interest with the public sector once project is underway
    • Good project performance key to lenders being repaid
  • Public sector looks to senior lenders to control the project and deal with problems
    • Lenders take controls and powers necessary to do this
    • Public sector should be wary of too ‘tight’ cover ratios and other financial parameters
issues for the public sector
Issues for the public sector
  • Public or private finance?
  • Senior debt: Bank or bonds?
  • Refinancing
  • Funding competitions
  • Innovations in the funding market
public or private finance
Public or private finance?
  • Options for national funding
    • Grants or loans?
  • Public funding:
    • upfront capital or on-going revenue?
    • budgetary resources and value for money
  • Private finance
    • Testing bankability
    • Testing affordability
    • Testing value for money (public sector comparator)
bank or bond
Bank or bond?
  • Bonds: a debt instrument that pays bondholder a rate of interest in return for bondholder paying principal amount to the Issuer on issue
  • Repayment according to a pre agreed repayment profile
  • Bonds issued by project companies, rated by Rating Agencies
  • Investment grade bond [minimum BBB- (S&P) / Baa3 (Moody’s)] converted to AAA via monoline wrap
  • May be floating, fixed or index linked
bank or bond1
Bank or bond?
  • Size: In the UK, public bond issues unlikely to be less than EUR 75 million
  • Maturities: traditionally bonds offer longer maturities (up to 40 years on some UK PPPs)
  • Flexibility: generally bank debt more flexible as (tradable) bond conditions fixed. Project variations more easily dealt with in bank finance (multiple bond holders)
  • Early redemption conditions: may be disadvantageous for bonds
  • PPP transactions typically refinanced to take advantage of better funding conditions at some stage
  • Usually post construction, when riskiest part of project is complete
  • May be refinance from bank debt to bonds, or increase in senior debt (i.e. reduction in equity reflecting lower risk profile)
  • Issues for public sector:
    • Should it seek a share of refinancing gain?
    • Implications of increased senior debt – potential increase of public sector contingent liability?


  • Revenue shortfall during ramp-up - stand-by-facility drawn to cover debt service;
  • If stand-by-facility can be repaid during the 5-year ramp-up, guarantee not called;
  • If revenues are insufficient to repay the stand-by-facility during the 5-year ramp up, the guarantee is called – guarantee is then repaid during project life from revenues left over after senior debt service.
conclusions implications for the public sector
Conclusions: Implications for the public sector
  • Realistic risk sharing expectations
  • Clear legal and institutional framework
  • Effective use of experienced advisors
  • But also need for new public sector skills – you cannot leave it to the lawyers!
  • Focused, dedicated and experienced public sector team – PPP Task Force
  • Transparent and competitive procurement
  • Recognition of lenders’ concerns