CHAPTER 3 INTRODUCTION TO PPP THROUGH BOT PROJECTS

Those who danced were thought 10 be quae insane by those who could nor hear the music. attributed to Angela Monet
A discussed in chapter I. PPP structures ire ultimately flexible Instead of endeavouring lo dissect every possible PPP structure in this book, chapters 3- ! describe in detail "#$ pro%ects- In the context of "#$ pro%ects, the parties must understand, mitigate and allocate amongst themselves the key risks specific to PPP pro%ects. "#$, therefore, represents a convenient opportunity for a discussion of the key issues that arise in most PPP pro%ects, and &ill be used as such here. $he "#$ pro%ect places the responsibility for financing, constructing and operating the pro%ect on the private sector. $he host country grants a concession to the private company to build and operate the facility over a period of time. $he private company then uses the revenue from the operation of the facility lo service debt and provide the investors &ith a return 'here the host country is also the offtake purchaser, the pro%ect is likely to be treated as payment for a service rather than financing of infrastructure $his can keep the pro%ect off the host country(s books, and therefore not burden the country(s debt ratios or public sector borro&ing re)uirements. $he pro%ect company may obtain financing from a combination of private banks, multilateral or bilateral organisations, export credit agencies, bond financing, international financial organisations and other such entities, collectively kno&n as the *lenders*. $hough referred lo here by a single name, each lender &ill have its o&n interests and re)uirements and therefore lender issues &ill need to be managed carefully. +enders are careful to manage nsk and are concerned to restrict the lype of risks ihey take. 'here nsk is high, shareholders generally stand lo gain high rates of return on their investment &here the pro%ect performs &ell. ,o- so &ith lenders, &ho generally receive a fused margin irrespective of the actual rale of return of the pro%ect Any ruk that remains &ith the boiiu&o and is not other&ise managed
91

Privas Staor litvalmml la Infraitnicnirt

through shareholder support is borne by the lenders. $herefore, the lenders &ill be keen to take only a certain amount and type of risk.. "#$ pro%ects are highly complex, commercially driven pro%ects, re)uiring extensive documentation and negotiation. A "#$ pro%ect represents a serious investment of money and time by everyone involved- $he pro%ect company, and in turn the lenders, &ill undertake extensive and expensive technical, financial and legal due diligence exercises lo analyse risk allocation for a pro%ect. A reasonable and efficient contractual structure &ith commercially appropriate risk allocation &ill be a deciding factor in the bankability of the pro%ect and &hether the lenders &ill &ish to go for&ard &ith the pro%ect financing of infrastructure development $his chapter &ill introduce "#$ pro%ects, their advantages and disadvantages /section 3. 0, the commercial agreements involved and the general contractual structure used including direct agreements bet&een certain pro%ect parties /section 3.10. It &ill then discuss the parties involved in a pro%ect, their positions in the pro%ect and some of the mechanisms available to them /section 3.30. 2inally, section 3.3 &ill discuss the stages of negotiation and development of a typical pro%ect.

3.1

WHY BOT?

*"#$* means "uild-#perate-$ransfer. a term said to have been coined by $urgat #4a+ prime minister of $urkey in the 567s.* A "#$ pro%ect involves a grantor providing a private company &ith a concession to build and operate a pro%ect /often to support a public service0. $he private company operates the pro%ect for the term of the concession /the *concession period*0, receiving revenues in exchange for operation of the pro%ect. $he revenues are obtained from a single offtake purchaser, &ho purchases pro%ect output from the pro%ect company /this is different from a pure concession &here output is sold directly to consumers and end users0. $he amount of risk the lenders &ill be &illing to take is heavily market driven and is commonly considered &ithin the concept of *bankability*. &hich is discussed m further derail in chapter 3. +evy. "uild, #perate, $ransfer Paving the 'ay for $omorro&(s Infrastructure / 5580 at 3 7.

/Aro9. BOTPTB !O A "#$ pro%ect provides certain benefits lo ibe pro%ect company. $hese can include: ; off balance sheel financing, ; non- o< limited recourse financing9 ; higher leverage allo&ing each dollar of e)uity investment to mobili4e a larger amount of total investment /thus an investor can ck; more investment by leveraging debt09 ; effective risk allocation, improving cost efficiency and pro%ect robustness9 and ; potential tax benefits through leasing and other structures. Potential benefits for the grantor of the concession include: ; improved efficiency, closely managed costs and faster completion through private sector involvement9 - lo&er cost of offtake o&ing to improved technology and efficient operation from the private sector, "r infrastructure at no direct cost, o&ing +o pnvate sector financing, therefore no need for any other source of financing and limited impact on the grantor(s credit capacity or rating9 ; earlier completion, since the pro%ect &ill not have to compete for scarce public sector funds9 ; lo&er risk burden o&ing to allocation to the private scctot and. possibly, guarantees provided by the pro%ect participants9 ; involvement of experienced industry professionals and private financing organisations, ensuring exhaustive revie& of pro%ect feasibility9 ; involvement of international lenders, including multilateral organisations such as the International 2inance =orporation i I2(= i; > attraction of further foreign investment9 ; maintenance of public sector strategic control over the pro%ect /as compared to privatisation0 and transfer at the end of the concession period /&here relevant09
OqHtr 3 foeabcixm o PPP

M
Privatf Sector Invesmtrnl in Infrtua-ucturt

( the interests of ?be pro%ect company in long-term facility operation, generally resulting in high )uality construction9 ; Iransfer of the most up-to-date technology and kno&-ho&, including training of local personnel9( ! ; indirect development of related industries9 ; development of local capital markets9 and ( involvement of local lenders, subcontractors, suppliers and shareholders @o&ever, "#$ pro%ects may also involve certain disadvantages for the grantor, including: ( distortion of development priorities, as the host gov ernment is more likely to favour pro%ects &hich are financially viable rather than those &hich are necessarily appropriate for the economic and infrastructure needs of the country9 ; increased financing costs, assuming that the host government &ould have available to it more beneficial financing terms and costs than &ould the private entity9 (- considering the complexity of Ihe pro%ect, the need for supervision, and high development cost including the cost of the due diligence exercise and Ihe cost of risk management9 ; possible public or political resistance, in particular from labour unions and those un&illing to sacrifice any government control over infrastructure9 ; temptation of pubbc utilities lo lender only the most difficult, least financially viable pro%ects in order to satisfy political pressure to implement PPP &ithout sacrificing its o&n pro%ect pipeline: ; need to miAgale foreign exchange risk for "#$ pro%ects &hose debt is denominated lo some extent in foreign currency. y some loss of control of an other&ise public sector operation9 and ; possible loss of income stream from the sector in )uestion. 2or further discussion of transfer of kno&-ho&. see Anited ,ations Industrial Bevelopment #rganisation, Cuidelines for Infrastructure Bevelorment through "uild#perate-$rinsfer at D!-57 / 5580.

Cha ut 1 Inn-ah!iio" IB PPP I.rmg. #O$ ProfrcO

$he sponsors /or developers0 may also bear certain risks, including: - condition of ihe local market9 ; failure or degradation of local infrastructure9 ; pro%ect cost ovenuns9 . tec boo logical advances rendering the pro%ect inefficient or unusable: ; regulation by local authorities inconsistent &ith pro%ect agreements, for example regulation of pricing9 ;; failure or &ithdra&al of local partners9 ; failure or &ithdra&al of shareholders9 y possible expropriation by the site country government, either direct or creeping, of pro%ect assets9 ; loss of po&er by Ihe political elements supporting the pro%ect9 ; re)uirement for use of untested technologies9 . repeal of host government support or refusal by the host government logo through &ith the pro%ect9 ; competition from parallel or alternative infrastructure9 ; political or popular resistance lo the pro%ect, its development, its developers or host government support thereof9 ; increase in financing costs9 ; currency convertibility, transferability and exchange risk9 ; changes in la& or taxation that affect the cost or viability of the pro%ect9 and government bankruptcy or collapse of the local economic system. Although critics in a number of developed countries have begun to )uestion &hether the "#$ pro%ect presents significant advantages in comparison lo more traditional forms of procurement, this techni)ue is being used in an increasing number of ma%or mftastri%cture pro%ects &orld&ide, in particular the AE, 2rance, Australia, Fouth Africa and =hile. $he most sophisticated market for "#$ is the Anited Eingdom, &hich has adopted it as a solution to its infrastructure needs and public sector borro&ing restrictions through the implementation of Private 2inance

9t
Prinne Sector tmtimcnl in Infra%fvcl&t

Initiative /P2I0, no& called Public Privale partnerships or /PPP0. P2 pro%ects have included the construction /or refurbishment0 and operation of pro%ects of all different kinds, including rail&ays, prisons, hospitals and military facilities

3.

BOT PROJECT AGREEMENTS

In a typical "#$ pro%ect the public sector grantor grants the right to a private company to develop and operate &hat &ould traditionally be a public sector pro%ect. $his private company, or pro%ect company, obtains financing for the pro%ect, and procures the design and construction of the &orks and operates the facility during the concession period. $hus the pro%ect company must have, or obtain access lo. resources sufficient to satisfy these obligations. Pro%ect company shareholders &ill often include companies &ith construction andGor operation en peri enee, and &ith input supply and offtake purchase capabilities. It is essential to include shareholders &ith experience in the management of the appropriate type of pro%ects, such as &orking &ith diverse IAEH multicultural partners, given the particular risks specific lo these aspects ufa "#$ pro%ect. $he pro%ect company &ill then co-ordinate the construction and operation of the pro%ect in accordance &ith Ihe re)uirements of the concession agreement. $he operation of the facility &ill generate revenues from an offtake purchaser &ho compensates the pro%ect company for delivery of the pro%ect output or provision of the pro%ect service. $he revenues generated from the operation phase arc intended to cover operating costs, maintenance, repayment of debt principal /&hich represents a significant portion of development and construction costs0, financing costs /including interest and fees0, and a return for the shareholders. $he lenders &ill be providing non-recourse or limited recourse financing and &ill, therefore, bear any residual risk along &ith the pro%ect company and its shareholders. In order to minimise such residual risk /as the lenders &ill only &ant, as far as possible, lo bear a limited portion of the commercial risk of the pro%ect0 the lenders &ill insist on passing the pro%ect company risk to the other pro%ect participants... $he level of commercial risk the lendeis &ill be &il ling to bear depends on the bankability of the pro%ect - a very fluid concept &hich is discussed further in chapter 3

Oie lrr J

!t. "#W e...$..$ #O$ Protrili

$he chart belo& sho&s the contractual sBuctule of a typical "#$ pro%ect. 2igure 3.1% =ontraeluai Ftructure for a "#$ Pro%ect
&e'(er) Sr*rc+o,o- N S+i'% +o,(er). A/ree-e't I &e'(i'/ S+*re+o,(i'/ Co'cc)),o'

A
/.ranlAt
O0er*tio' mt' ( )* t1 rircri.r Pro2ect
ConiLjin

7
O!!i*3c P4rrr4-r 5 A/ree-e't O!,t*3r P4rc+*)er Co!iJrJ'ic,io!6 Co'tr*i Co') tr4e i io' Co'tr*e toi

>lipid
S400,7 A/iec2Tic'i I'04t S400,ier

Iach pro%ect &ill involve some variation of this contractual structure depending on its particular re)uirements. 2or example, not all BOT pro%ects &ill re)uire a guaranteed supply of input, therefore an input supply agreement may not be necessary Fimilarly, the payment stream may not originate from an offtake purchaser, instead, the grantor may purchase output through the concession agreement, or the pro%ect company may sell output to the market. $he structure demonstrated above and discussed in this book should therefore be considered as a template 10 be adapted to the needs of each particular pro%ect. =hapters 18-1 discuss specific issues that &ill influence the variants used in certain industries. 3. .1 2inancing agreement $he financing agreement /this term normally covers numerous separate agreements0 contains the terms and conditions pursuant to &hich the lenders agree to lend funds to the pro%ect company. $he lenders to ihe pro%ect may include commercial banks, export credit agencies, bondholders, and multilateral and bilateral lending institutions. $his relationship is of particular importance in the

77
Pri"+"t Stout atvenmr m Av'urAirr

"#$ context as the lenders &ill generally be responsible for the financing of a substantial portion of the pro%ect As a result of this funding, the lenders &ill often have a substantial influence /directly or indirectly0 on the drafting of the agreements involved in the "#$ pro%ect, in order to ensure that the pro%ect is bankable.* $he nsk management mechanisms commonly found m the financing agreement &ill usually include security and account arrangements * 'here more than one lender is involved, there &ill be interr%ieditor arrangements amongst the lenders to manage sharing of security and setting out priority and decision-making.* 3.1.1 Fhareholders( agreement $he shareholders( agreement governs the relationship bet&een the shareholders &ithin the pro%ect company. $he shareholders( agreement may involve several documents, for example a sponsor(s agreement for the rxe-financial close phase, a %oint venture agreement and articles of association or incorporation or &hatever constitutional documents exist for the pro%ect company as &ell as shareholder loan, stand-by credit, stand-by e)uity and other similar documentation. $he shareholders( agreement &ill cover topics such as the business of the pro%ect company, conditions precedent to its creation, the issue of ne& shares, the transfer of shares, the allocation of pro%ect costs and the management of the pro%ect company including decision-making and voting. Fuch an agreement &ill often also include a non-competition clause, providing that the shareholders may not enter into activities directly or indirectly in competition &ith the pro%ect company. 3.1 J =oncession agreement Ander the concession agreement /also kno&n as the *implementation agreement*0, the grantor grants a concession /a scries of rights0 to the pro%ect company to build and operate mfiastructure for a preKleirmined period, the concession period. $he concession agreement may also set out the legal and tax regimes applicable to the pro%ect, including the environmental obligations of the pro%ect company. $he terms of the concession &ill need lo satisfy the re)uirements of all of the pro%ect participants, including die lenders. In practice, the concession agreement, the Fee chapter 3 for further discuui#B of bankability Fee section 1.3 for further discussion of security arrangements and secnon 1.D.1 for further discussion of account arrangements Fee section 1.6. 7 on intercreditor issues.

=kfiff 3 hum,clnm lu PPP itrov)- #O$ Prof !#

191

offtake purchase agreemcnl and.or the input supply agreement /to the extent each is needed0 can be combined in one agreement. 3. .: #fftake purchase agreement $he offtake purchase agreement secures the pro%ect payment stream. It obliges the offtake purchaser to procure a certain amount of pro%ect output or pay for an amount of pro%ect service /under certain formulations such as *take-or-pay* or *payment for availability*, &hether or not it is used0 over a given time. $he offtake purchaser &ill be looking for a guaranteed long-term output from the pro%ect. $he offtake purchase agreement may provide sanctions if the pro%ect company fails to deliver output as promised, in particular if the construction of the pro%ect is not finished &ithin the time for completion or does not perform as re)uired &hen completed. $he obligation to purchase output may re)uire that the offtake purchaser maintains sufficient facilities lo receive the output delivered or use the service provided. $he credit risk associated &ith the offtake purchaser &ill be of particular concern to the pro%ect company and the lenders. $he offtake purchaser may be re)uired to provide credit enhancement such as escro& accounts, revolving bank guarantees or staieGfederal guarantees for its payment obligations. An offtake purchase agreement may, of course, be unnecessary in some pro%ects, such as hospitals, tunnels, road&ays and bridges, &here no physical offtake is produced. In such cases it is often the grantor of the concession &ho &ill pay the pro%ect company for use of the pro%ect or the pro%ect company may collect tariffs directly from consumers. $herefore, the offtake purchase agreement may be one and the same as the concession agreement. 3. .; Input supply agreement $he input supply agreement obliges an input supplier to debver lo the pro%ect company a specified )uantity of input necessary lo the operation of the pro%ect, at a certain level of )uality $his agreement allocates certain elements of the market risk associated &ith the price and availability of the input $he input supply agreement &ill only be needed &here some supply of input is necessary for operation of the facility. Input may be a misnomer for certain pro%ects &here the re)uired service is effectively an offtake arrangement. 2or example, in &aste &ater treatment pro%ects the pro%ect company &ill need to subcontract for the removal and disposal of

PnvaH Salar Imalmtf. at lufivtrvaurr

sludge oi in hospital pro%ects for the removal of medical &aste. $his type of agreement &ill re)uire many of the same conditions and raise similar issues to other input supply agreements. 3.1.8 =onstruction contract $he construction phase of the "#$ pro%ect is generally governed by a turnkey construction contract, sometimes also kno&n as a *design and build* or an *IP= /engineering, procurement and construction0 contract. $he lenders, &ho are seeking certainty of exposure, re)uire a construction contract that establishes a fixed lumpsum price and a set time for completion and places the ma%ority /and in some cases substantially all0 of the construction risk on the construction contractor. 3.1.D #peration and ma in le nance agreement $he pro%ect company &ill &ant to ensure proper operation of the &orks during the concession period and &ill therefore enter into an operation and maintenance agreement &ith the opera lor of the facility $he operator(s obligations should mirror those set out in the concession agreement, the offtake purchase agreement, and those re)uired to ensure continued and efficient operation of the pro%ect, 3.1.6 Birect agreements $he lenders and the grantor may enter into direct agreements &ith the pro%ect participants to cover issues such as security over pro%ect assets, secondment of personnel, accommodation and costs. Fimilarly, these direct agreements may consider the management of kno&-bo& bet&een the pro%ect participants and the pro%ect company including transfer, duration, licensing rights, exclusivity, distributorship, and the supply of spare parts, goods or ra& materials. Birect agreements may contain collateral &arranties in favour of the lenders and the grantor and &ill set out step-in rights, nouce re)uirements, cure periods and other issues intended lo maintain the continuity of the pro%ect &here the pro%ect company defaults andGor falls a&ay.* 2igure 3.1 identifies some of the many direct agreements that may exist in a "#$ pro%ect. 2or example, the direct agreement bet&een the construction contractor and the grantor, giving the grantor access lo &arranties of the construction &orks in the event of pro%ect termination. 2or further discussion of direct agreements and collateral &arranties, see section 1.E 6. Fee also chapter 15 of Fcriven. Pmchard and Befmoo /eds0. A =ontractual Cuide to La%or =onstruction Pro%ects / 5550.

Griiroa'iion lo PPP /AriLg. #O$ Pro%ects 73 2igure 3.1: Birect Agreements Fnareho@tss
C-a ur 3

tKstructiori =ontractor 33 PARTIES IN<O&<ED IN A BOT PROJECT A number of parties &ill be involved in a "#$ pro%ect Iach may have different interests, levels of sophistication and available resources 3.3.1 +enders $he profile of a lender group can range from pro%ect to pro%ect, and may include a combination of private sector commercial lenders together &ith export credit agencies, and bilateral and multilateral finance organisations.( 2unding is sometimes provided by pro%ect bonds, sold on the capital markets..3 sovereign &ealth funds and other financial K 8M-KK* Fee section 3.3.3 for further discussion of muln-lateraJ organi4ations. Fee section 1 6.1 on pro%ect bonds. Fee section .3 on financial intermediaries.

N
Private Set tor lnvtstmrru i' Infrastructure

As s general premise. /ie lenders &ill only &ant ?o tike those risks &hich are measurable and measured. $he lenders &ill not be in the operation, construction or insurance business and therefore &ill not &ant lo bear risks &ith &hich they are unfamiliar and &hich are more appropriately borne by other parties. $he lenders &ill also &ant to have certainty as to financial exposure. $he lenders may be involved in most of the important phases of the &orks, including the drafting of the pro%ect documents and certification of completion. $hey &ill generally maintain their revie& po&ers over the pro%ect &ith tbc assistance of an independent engineer. $he lenders may re)uire that direct agreements be entered into bet&een themselves and each of the pro%ect panic ipants.* 33." t. ran tor and host government $he "#$ pro%ect discussed here is based on the provision of a concession by a national or local government, a government agency or some regulatory authority /referred to here as the *grantor*0 $he grantor &ill generally be responsible for the interface bet&een the pro%ect and the government authorities of the host country . $his may include: ; rights of access9 ; protection from nationalisation or expropriation9 ; protection from changes in la&, regulations and lax9 and ; foreign exchange availability and convertibility issues. $he grantor &ill need to have the authority lo provide the concession. #ltra $ires activities /those acts &hich are outside Ihe scope of the grantor(s legal mandate0 by a government authority can render the concession void and available legal remedies are not Akely to compensate the sponsors satisfaclorily. It may be necessary lo pass legislation or even a constitutional amendment before the concession as let by ihe grantor can be considered valid. $he host government and the national andGor local government /to the extent they are nol party to the concession agreement0 may also play an important role in Ointei and Price /17780 supra note 87. 2or further discussion, see section 1.6. II and .D. .

2or further disc union, sec secnons 1 6

, 3.1.6 uid ! 59 and chapter it of Ftriven. Prilchard and Belmon / 5550 supra @Le 57.

Cha lrr 3 !B%.&. . .. IB f P f .-..-.,.,>P BOT Prafrcu

I us providing guarantees and generally ensuring thai ?he pro%ect commences and is completed successfully through its more or less active support. $he host government &ill also play an important role during pro%ect operation, in relation to regulatory re)uirements and taxationGtariff restrictions. 'here the host government is not a party lo, and is therefore not legally bound by. the concession agreement, the pro%ect participants &ill need to ensure continued support from the host government, &hich generally involves taking into consideration the interests of the host government. 2or its part, the host government may prefer lo limit its involvement in the pro%ect and minimise any risk it may have to bear. As far as possible, the pro%ect participants should ensure that the pro%ect and any pro%ect activities continue to be consistent &ith the host government(s interests..vD

3.3.".1

'ost go$ernment inieresis

Pro%ect sponsors &ill need to be acutely a&are of Ihe interests of the host government in relation to the infrastructure pro%ect in particular and foreign investment generally @ost government interests &ill include: ; perceived public or national interest: ; public control of the pro%ect during ihe concession to ensure protection of public interests and improved public perception of the host government9 ; public safety including environmental and social impact, ; response of the relevant constituency /often related to tariff restrictions and levels of environmental impact and public nuisance09 - rrimirnising the need for in%ection of public funds, investment, guarantees and assistance9 ; attracting foreign investment9 ; minimising public nsk &hile maximising pubbc control9 ; smooth and efficient transfer of the pro%ect /if applicable0 at tbe end of the concession period in good mechanical condition &ith no need for replacement of ma%or parts or coairprncnl. and $his issue 5 discussed further in chanters ! and 8

19= $r. i$. I-ti'0' minfrastnu$itrt y *ttr*cti'/ >e'e!it) !or 0o,itic*, 0er)o'*,itie) or 0*rtie) i' 0o?er @t+i) ?i,, r*'/e !ro- re-*i'i'/ co')i)te't ?it+ -*2orit7 0*rt7 0o,ic7 to o,( !*)+io'e( re'tA)ee3i'/B.

3.3."."

'ost go$ernment in$ol$ement

T+e +o)t /oCer'-e't ?i,, o!te' >e i'Co,Ce( i' t+e *)0ect) o! t+e 0ro2ect (e)cri>e( >e,o?.D T+e)e i))4e) -*7 >e (e!i'e( i' t+e ,e/*, !r*-e?or3 0roCi(e( !or BOT 0ro2ect) 4'(er ,oc*, ,*?. A'7 e1i)ti'/ !r*-e?or3 ?i,, (e!i'e ,o )o-e e1te't t+e /r*'tor.) *00ro*c+ to t+e 0ro2ect *'( t+e ri)3)".o>,i/*tio') t+e /r*'tor c*' 4'(ert*3e..# T+e +o)t /oCer'-e't.) ro,e ?i,, *,)o (e0e'( ,*r/e,7 o' t+e 0o)itio' o! t+e /oCer'-e't i' t+e 0ro2ect *'( t+e 'ee( !or re,eC*'t )400ort i' or(er to *ttr*ct t+e 'ece))*r7 0riC*te i'Ce)t-e't i' i'!r*)tr4ct4re (eCe,o0-e't

(a) *b)

n$itation to render +is, sharing

T+e /r*'tor -*7 i'Co,Ce i+e +o)t /oCer'-e't or >e i')tr4cte( >7 t+e +o)t /oCer'-e't$ i' t+e ori/i'*, 0ro-otio' o! t+e 0ro2ect$ i(e'ti!7i'/ t+e 'ee( !or t+e 0ro2ect *'( (e!i'i'/ it) reE4ire-e't). T+e +o)t /oCer'-e't -*7 *,)o >e i')tr4-e't*, i' c+oo)i'/ t+e )4cce))!4, >i((er). T+e 0ro2ect co-0*'7 ?i,, *)3 I+e /r*'tor to >e*r cert*i' ri)3). I' -*'7 c*)e) t+e i'te'tio' i) 'ot )o -4c+ !or t+e /r*'tor to co-0e')*te t+e 0ro2ect co-0*'7 !or t+e occ4rre'ce o! I+e ri)3$ >4t r*t+er !or t+e /r*'tor ,o 0,*ce 0re))4re o' t+e +o)t /oCer'-e't to *Coi( )4c+ ri)3)$ or !or t+e +o)t /oCer'-e't t+ro4/+ it) re,*tio')+i0 ?it+ t+e /r*'tor$ to >e * 0ri-*r7 o>,i/or i' re,*tio' to )4c+ ri)3). T+e +o)t /oCer'-e't -*7 t+ere!ore >e c*,,e( o' ?+ere )4c+ ri)3) *'Ae or *re ,i3e,7 ,o *')e

(c)

Attracting in$estment

O'ce t+e +o)t /oCer'-e't +*) (eci(e( ,o /o !or?*r( ?it+ * 0ro2ect it ?i,, ?*'t to *ttr*ct t+e 'ece))*r7 !orei/' i'Ce)t-e't I' or(er to *ttr*ct t+e >e)t E4*,it7 *t t+e ,e*)t (irect co)t$ t+e +o), co4'tr7 -*7 0roCi(e )o-e i'ce'tiCe) ,o t+e 0ro2ect co-0*'7$ )4c+ *) ,*1 >e'e!it) @i'c,4(i'/ t*1 +o,i(*7)$ t+e 4)e o! t*1 +*Ce') or cre*tiCe 4)e o! t*1 cre(it)B$ *))i)t*'ce i' 0roc4ri'/ ,*'($ re,*1*tio' o! ,e/*, reE4ire-e't) @)4c+ *) ,ice')i'/ *'( ot+er *(-i'i)tr*tiCe 0roce(4re)B$ /r*'t)$ (e>t See )ectio') 3. .3 *'( F.8 o' /oCer'-e't i'Co,Ce-e't GG Hor !4rt+er (i)c4))io' o! >o,t /oCer'-e't ,e/*, re/i-e)$ )ee UNIDO . 1GG=B )40r* 'ote F; *i:1A8 .

Cha Hr 3

"?ooWIi? n; ' ibvu)ti #O$ Pro-ten

198

financing, improved tariffs on utilities and other services or fuel, ne& or improved infrastructure, use of pro%ect resources for non-pro%ect related purposes, or involvement in bids for further pro%ects in the host country.
012 Potil!ai mar-etin)

$he pro%ect company may need assistance in *selling* the pro%ect lo the public and lo any relevant government organisations. $he host government is generally in a good position to advise or assist in conveying to the relevant parties the benefits of the pro%ect.
0e2 Sellin) of )overnment olicy

As the pro%ect &ill involve a traditionally public seclor seivice. govetnmenl policy &ill have a direct relation to the success of the pro%ect, including issues such as the setting of tariff re)uirements, environmental, service, health and safety restrictions, la&s on taking of security and lenders nghts. exchange and convertibility of currency matters and taxation $ins may include passing legislation to facilitate the implementation of "#$ pro%ects.
0f2 Provision of information basic lo the feasibility of the ro%ect

$he site &ill be located &ithin the territory of the host government and &ill often involve land either &ithin the host country or provided by the host government. In either case, the host government mighl have a certain amount of information about the site9 geographical, archaeological, bydrokigical and meteorological information useful for the development phase of the pro%ect.
f)2 3ocumentation

$he host govemmenl may provide draft documentation for use in the pro%ect, in particular concession agreements and offtake purchase agreements.
0h2 (ssistance &ith finance

$he host government &ill often provide some finance andGor assist in obtaining financing, insurance and.ur guarantees from local lenders, multilateral agencies, international organisations or export credit agencies

Pmnte Sector Mc2'?'r i' Inf&iovc$trr

( ) -uarantees
$he pro%ect company may need guarantees from the host government concerning various aspects of the pro%ect, possibly including: ; the offtake purchaser(s and the input supplier(. obligations. . availability, transferahility and convertibility of local currency9 and .> other such risks thai the pro%ect company and grantor cannot manage efficiently. 3JJ Lultilateral, bilateral and eiport credil agencies $hese mlernational. often political, entities are fre)uently involved in "#$ pro%ects and can have an important impact on the nsk allocation and financing used in a pro%ect. Although each of these entities can play different roles and have differing re)uirements for getting involved in pro%ect financing, they have been grouped together for ease of reference. 'hen involved in such pro%ects, these agencies &ill place strict re)uirements on the pro%ect structure and lending arrangements, in particular in relation to envuonmenlal and social safeguards0. +enders anxious lo benefit from such involvement /and the potential mitigation of political risk0 &ill make it a prionty to ensure that these re)uirements are satisfied.

3.3.3.1

Multilateral agencies (M.As) and bilateral agencies (B.As)

L+As represent a grouping of nations, and are o&ned and funded by their members. $heir purpose &ill often be set out in charier documentation and may include fostering transition to market economies, alleviating poverty, suppurung the development of ne& markets, and providing commercial banks and companies &ith support and incentives to enter certain markets. Fome L+As are mandated to finance pro%ects in specific geographical regions, such as the inler-Aroerican Bevelopment "ank /+AB"0 and the African Bevelopment "ank /AfB"0. Iach L+A &ill have its o&n slightly different approach to pro%ects. L+As can participate in pro%ects through e)uity investments /usually )uite small0, by providing guarantees or insurance, or by providing loans. An L+A can provide financing from its o&n funds or act as a conduit for funding from commercial banks. As a representative of Feveral countries, the L+A &ill &ant lo encourage e)uality of treatment, transparency and free trade bet&een its member countries. $herefore.

Cha ter 3 huraix nan to PPP throu)h #O$Pro2eeli

19G

L+ As &ill often re)uire thai lenders for the pro%ect can tracts be on an interr%aliorially competitive basis. t(adIT m; umbrella It is commonly believed that governments make greater effort to ensure lhal loans to multilateral- are repaid, even in difficult times. Participation of Ihe International 2inance =orporation @2=Q of the 'orld "ank is often referred lo as ihe * 2= umbrella* due to the probability of preferential treatment given to repayment of obligations to the 2= by governments looking to restructure indebtedness in hard times.*. 2or example. I"RB(s loans &ere not rescheduled during the Russian crisis in late 556G 555. Fome of the more active L+As in international pro%ect finance are the 2=. the Asian Bevelopment "ank /AB"0, the Iuropean "ank for Reconstruction and Bevelopment /I"RB0 and Ihe Iuropean Investment "ank /Il"0. $he I2=, the I"RB and certain other such orgaruutEnu generally refer lo themselves as *International 2inance Institutions* /I2Is0 rather than L+As. =ertain international organisations specialise in providing political risk coverage for pro%ects, such as the Lultilateral Investment Cuarantee Agency /LEiA0 of the 'orld "ank. Anlike the above-mentioned L+As, these organisations &ill not provide funding for the pro%ect. "+As /sometimes described as development finance institutions0 are similar to L+As in purpose and approach, but are funded by only one nation. $hey are generally mandated to provide support to specific developing countries, in the form of debt or e)uity investment. $hey are politically oriented, in that they cany oul the political &ill of their donor nation. Although usually "+A involvement is not limited to pro%ects involving investment by member country nationals, some "+As nave an origins clause re)uiring that pro%ects funded by the "+A may not be in direct competition &ith member country nationals. *S Fee generally 2emandes-Bu)ue. *=o-financing &ith I2=: Preferred =reditor Ftatus and Inter-=redilor Agreements* International "usiness +a&yer 377 / 5660: although eventi m Argentina in 177 -1771 may have altered perceptions.

119
Pnvam Strier tavunnrnl in Infr

PR#PAR=# An example of a "+A is PR#PAR=# /FociTtT de Promotion et de Participation pout la =ooperation Iconomi)ue F.A.0 of 2rance. PR#PAR=# is a development finance institution &hich specialises in providing long-term finance, by &ay of e)uity and debt firnding /including me44anine finance0 to the private sector in specific countries, including notably the African. =aribbean and Pacific 4ones. It &as incorporated as a soci't' anonyme of &hich the Agence 2ranUaise de BTveloppement /an agency of the 2rench Covernment0 is a ma%ority shareholder /&ith a 8D per cent, slake0 along &ith 3! private minority shareholders

3.3.3."

/01ort credit agencies (/2As)

An I=A is an agency attached lo a given country and can be an arm or a department of Ihe govemmenl of that country, lis general role is to encourage and assist foreign investment and the export of goods and services by its nationals Although traditionally government-run. certain of these agencies have been privatised. $he I=A can provide financing, insurance or guarantees for the goods and services exported by its source-country nationals. $his financing is often extensive, up to 6! per cen+ of the total price of the export $he more active I=As in "#$ pro%ects include the 2%tport-Import "ank of the Anited Ftales, I=CB of the Anited Eingdom, =#2A=I of 2rance, @ermes of Cermany, FA=@ of Italy and the Japan "ank for tatemational =ooperation /J"I=0. I=As may provide direct lending, or guarantee or insure repayment of commercial lender financing in case of political risk andGor commercial risk. $he political nsk borne by I=As &ill generally include political violence, &ar. hostilities, expropriation and currency transfer nsk. In certain cases. I=As provide extended risk cover such as change in la&, changes in taxation or breach of a government guarantee. 3J.: Pro%ect company $he sponsors &ill identify a pro%ect and pul together a bid in an effon to be a&arded the pro%ect. #nce selected, they &ill create a special purpose vehicle /FPO0 &hich &ill contracl &ith the grantor lo design, construct, operate, maintain and transfer the pro%ect. $he use of an FPO is likely lo enable the sponsors lo

C-a trr i Intro1uction lo PPP i-nmrh .n

Ill 2inance the pro%ect on a limited recourse basis. $he nationality of the pro%ect company can also have important tax implications. $he pro%ect company &ill generally include shareholder companies &hich specialise in one or several of the tasks &hich need to be performed under the concession agreement. $he pro%ect company should also include a party &ith experience in managing ma%or international infrastructure development pro%ects $he grantor may re)uire that Ihe pro%ect company includes local investors i' order lo improve transfer of technology, and provide %obs and tram trig lo local personnel. $he shareholder(s agreement &ill also include provisions related lo deadlock, excluding shareholders from decisions associated &ith a contract lo &hich thai shareholder is a counterparty, pre-emption rights in lespect of retiring shareholders and ho& to address default in shareholders, particularly in relation to their financing obligations. $he pro%ect company &ill need to decide ho& to distribute revenues to its members. $he shareholders &ill &ant lo distribute revenues as early as possible, &hile the lenders &ill &ant to delay revenue sharing to ensure that the shareholders remain committed to the operation of ihe pro%ect for the longest possible time and to retain control over amounts other&ise available for distribution. $he shareholders &ill also &ant to be able to divesl their shareholding as early as possible, since most of them &ill be coiruiiereia+ construction companies rather than financial investors, and are therefore not &ell suited to long-term shareholding. $he grantor, on Ihe other hand, &ill &ant the shareholders tied to the fortunes of the pro%ect company as long as possible, lo align then interests more &ith those of the grantor /a financially viable pro%ect over the long term0. $he shareholders and grantor &ill usually reach a compromise of divestment only a fe& years after completion of construction, and then only to shareholders experienced in the relevant industry. Fhareholders may also include specialist investment vehicles &hich provide e)uity financing to pro%ects, for example me44anine financing and venture capital funds. Fuch investors often &ish to perform their o&n due diligence exercise before providing financing. Fhareholders of the pro%ect company &ill often be both shareholder and subcontractor, for example the construction contractor or operator may also be a 2ur more det%i led discussion of rJ'ehoider agreements, see 'ood /177D0 supra nole D7.

ill Private Sector Irtveitmeitl lit trtfHatntcaat

shareholder. 'here this arises, they &ill be in a position of conflict of interest. $his conflict of interest &ill need to be managed amongst the shareholders, the grantor and the lenders, for example the shareholder should not be in a position to negotiate or influence the negotiation of the original contract or set prices. 'here the pro%ect company has a right of action against one of the subcontractors, the subcontractor shareholder may be barred from voting or receiving sensitive information on the issue. $his is an extremely difficult line to dra&, since in theory the shareholder should be removed from dec is ion-making and accessing inforraalion early in the process, &hen troubles &ith the subcontractor first begin A number of mechanisms exist lo help in this process, including the use of independent pro%ect managers or executives m the management of the pro%ect company and the use of independent experts to verity data and decisions. 3.3.; =onstruction contractor $he pro%ect company &ill enter into a construction contract &ith the construction contractor in order to divest its obligation lo the grantor to design, build, lest and commission ihe pro%ect. $his task is generally undertaken on a lumkey basis, placing completion and performance nsk on the construction contractor. $he construction contract &ill be. as far as possible, back-to-back &ith the concession agreement, and therefore any construction nsk placed on the pro%ect company by the concession agreement &ill, through the construction contract, flo& through to the construction contractor. $he construction contractor &ill generally subcontract certain or all of its construction obligations to other entities in order to share risk and revenues, sub%ect to any restrictions imposed by the concession agreement or the construction contract. 3 J .= #perator $he operator &ill operate and maintain the pro%ect over an extended period, often from completion of construction, or the fust completed section, until the end of the concession period. It &ill need to manage the input supply and offtake purchase, monitor testing of the pro%ect and ensure proper operation and maintenance. $he operator &ill also need to manage interfaces: ; &ith the construction contractor, &hen the tests on completion are performed and &hen the pro%ect is handed over to Ihe operator after completion9 r &ith the offtake purchaser, to ensure timely delivery9

Cha ter 4 Intro1uction lo PPP Ihroueh #O$ Pro%ects

113

- &ith the input supplier, lo ensure compliant provision of input9 and ; &ith the grantor for confirmation of performance levels and confirming proper maintenance and testing of the &orks at the end of the concession period, if the pro%ect is to be transferred back lo the grantor. $hese stages in the pro%ect are some of the most difficult to manage and &ill re)uire particular attention from the operator A further point of interest for the operator &ill be payment. $rie pro%ect company &ill &ant to tie the operator(s payment to the operator(s performance of the pro%ect. $he operator may not &ant to bear the risk of operation cost or actual output, and may prefer to be reimbursed for its costs and paid a fee for its services. In any case, the payment scheme should include penalty fees and incentive bonuses to encourage efficient operation of the pro%ect. 33.D #fftake purchaser In order to divert market risk a&ay from the pro%ect company and the lenders, an agreement may be made &ith a purchaser for the use of the pro%ect or the purchase of any output produced. $his offtake purchase agreement &ill re)uire the offtake purchaser to pay for a minimum amount of the pro%ect output or for all fixed costs no matter ho& much output it takes, and thereby create a secure payment stream &hich &ill be an important basis for financing. $he offtake purchaser may also be the grantor, or a govemmenl entity such as a public utility, in &hich case the offtake purchase agreement and the concession agreement may be one and the >tame document $he entity driving the "#$ pro%ect &ill often be die offtake purchaser. $he offtake purchaser may need to manage Ihe connection of the pro%ect to transmission or transportation facilities. #ften the pro%ect company &ill be responsible for connection to or building pan of such facilities. $he nsks associated &ith interconnection and offtake purchase pro%ect company interfaces &ill need to be managed sensibly to ensure the commercial and technical viability of the pro%ect $he offtake purchaser &ill &ant to obtain a certain minimum output at a given level of )uality and at a reasonable price $herefore, the offtake purchaser &ill maintain a strict testing schedule, imposing sanctions &here output or )uality is insufficient. $he offtake purchaser may also &ant to monitor maintenance of the pro%ect to ensure continued and efficient supply. $he standards and testing may be imposed by a third party, such as a regulator. $he costs associated &ith standards

11:
Pnv5 Setter htvamtnt in Inftaumcnirt

raised after the completion of corislniclion or any change in the lesling regime &ill need lo be addressed. Ixtensive reporting and communication protocols may need lo be defined to allo& the offtake purchaser to monitor and control Ihe operation of Ihe pro%ect in accordance &ith its needs, including periodicity of maintenance and scheduled shutdo&n of the pro%ect. 3.3.F Input supplier $he input supplier assumes the supply risk for an input necessary for operation of the pro%ect. $hus the pro%ect company is protected from the risk that the pro%ect &ill not reach its intended production level for lack of an essential input, such as fuel or ra& materials. $he input supplier ensures a minimum )uantity of input is delivered, at a minimum standard of )uality and at a set price. $he mechanism used to calculate this price can be extremely complex. It may pass input costs through to the offtake purchaser, resulting in a sensitive interface bet&een the input supplier and offtake purchaser $he input supplier may also need to provide uifrastructure to permit delivery of input, such as pipelines, pons or rail&ays #nly certain types of pro%ects &ill re)uire a form of input supply. #thers &ill rely on market availability of input or may not need input at all. Ftill others &ill re)uire a service rather than an input, such as the removal of sludge from a &ater treatment facility. 33.G Interfaces As can be noted from the discussion above and the chart opposite, a "#$ pro%ect re)uires the various pro%ect participants to &ork together to discharge their obligations and ensure the success of the pro%ect. 2igure 8. sho&s ho& the various parties involved &ill need to &ork together. $he solid lines indicate periods during &hich the pro%ect r%articipants may be involved concurrently on site activities and may be sharing pro%ect risk. $he pro%ect documents &ill need to allocate nsk appropriately in order lo avoid disruption of the pro%ect.

3.:

STAG&S OH DE<E&OPMENT AND NEGOTIATION OH A BOT PROJECT

A "#$ pro%ect is generally preparation intensive, re)uiring careful analysis and negotiation before the pro%ect is performed. $he most time-consuming elements include negotiating documentation and structuring the financing.

Cha ter J Intro1uction Hi PPP f-roita- #O$ Pro%erti

III @o&ever, given /he amount of money and risk involved, it behoves the grantor and the pro%ect company to allo& sufficient lime for this important development stage. Fimilarly, appropriate specialist advice should be obtained front legal, insurance and financial advisers, technical and operational experts, and parties experienced in operations in the host country, its customs, politics and market. $here are numerous mechanisms for selecting the pro%ect company, ibough they can generally be divided into three categories: open, semi-negotiated and fully negotiated. $he open tender procedure involves an extension of an invitation to tender a price against fixed specification and contract terms $his may be the case &here a concession agreement is offered &ith no opportunity lo negotiate. $he semi-negotiated approach allo&s short listed bidders to negotiate based on draft documentation, and lo provide proposed modifications in their bids. A fully negotiated process sees the preferred bidder selected based on its o&n abilities, &ith the pro%ect documentation negotiated, often after selection $he decision as lo ; the number of stages of bidding procedure lo apply, ; the extent lo &hich documentation is developed early in thai process. ; the extent to &hich bidders are able to propose modifications in tbeir bids, and ; ihe extern to &hich that documentation can be negotiated post a&ard. &ill depend very much on the si4e of Ihe pro%ect the amount of resource available to the grantor, the nature of the market /and the kind of competition thai can be mobili4ed0, and the perception of Ihe grantor as lo the relative merits of a more or less strict process. Fome say that a strict process focuses competition and therefore reduces cost and the time lo contract signature. #thers say that a less formal process allo&s rapid procurement and the flexibility needed to address pro%ect specific issues. @o&ever, efforts lo maximi4e transparency and competition &hile avoiding corrupt practices generally move legislators to impose processes closer to the open procedure then the fully negotiated one. 2igure 3J gives an indication of the time commitment necessary to put together a typical PPP pro%ect and ho& that time is divided bet&een several of the primary tasks. $his chart is only indicative, as each pro%ect &ill be different, and the nature of the financing and the site country &ill have a substantial impact on Ihe time investment re)uired for pro%ect development. Iach task can be significantly longer or shoner than indicated here.

=L r.; I I'IJ#IJ K6 PPP i!nmrli #O$ Pro7tra 2easibility revie&s &ill be undertaken in the early bid process for the pro%ect lo assess feasibility, availability of finance and profitability. $hey should be performed roughly in parallel, although each pro%ect &ill have different re)uirements. $he commitment letter is an undertaking by Ihe lenders concerning the proposed structure and financial feasibility. As indicated by this chart, pro%ect doctimenlation can involve a substantial investment of time. 1 2igure 3.3 sho&s the phases of a PPP pro%ect and the tasks to be performed during each of these phases. $he follo&ing chapters of this book &ill discuss in detail the commercial documents &hich create the contractual structure of the pro%ect. 2igure 3.3 outlines a roughly chronological list of the tasks 10 be performed in a PPP pro%ect, from identification of the pro%ect by the grantor /or the pro%ect company0 to the transfer procedure /if any0. @o&ever, a PPP pro%ect &ill involve many other essential elements, including a bid-tendering procedure and financing /discussed in chapters 1 and !0. $he identification phase / 0 involves the grantor or a promoter identifying the need for, and the possibility of using, a PPP pro%ect structure. #nce this need is identified, the grantor &ill revie& the proposal and make a decision as to its appropriateness. #nce a good pro%ect is selected, it can be prepared, through a feasibility study and development of pro%ect documentation that & ill define the risk allocation to be adopted /10. $he grantor &ill then start the tendering of Ihe pro%ect and receiving bids /30. $his &ill re)uire preparing a tendering procedure, often involving pre-)unification of bidders, drafting preliminary provisions for the pro%ect documents, and preparing the tendering procedures including bid evaluation criteria.** $he sponsors then prepare a bid based on the tender documents /30, and the grantor evaluates ihe bids received against its criteria, negotiates &ith those bidders &hich exemplify best the crileria re)uired, and a&ards the pro%ect to the preferred bidder /!0. +enders must complete then due diligence and agree Ihe pro%ect documents &ilh Ihe biddei and the grantor, financing is pul in place, insurance is arranged and the pro%ect documents are negotiated and drafted in final form /80. $he arranging of financing &ill occur lo some extent before pro%ect a&ard, in particular &hen Ihe grantor re)uires *Vinder&ntten(( bids /&here the lenders promise lo finance the pro%ect if the bid is accepted0.

1Fec also sections

.3- .D. Fee generally bid n 53- 359 &&&.&crfdbaiik.org: 2ederation Intemauonile des InginieursAC unveil. $endering Procedurei / 5530.

13 Prrvate Sector investment in Infrastructure

Buring the implemental ion phase /he facilities are designed and built in accordance &ith the pro%ect documents @8B. #nce appropriate performance levels are reached the operation phase &ill begin /FI. during &hich the facilities are operated and maintained as agreed. It is during the operation phase that the pro%ect paymenl stream is produced, pro%ect debt is repaid and the shareholders earn a return on their investment. At the end of the concession period the facilities are either transferred lo the granlor or re-let to another operator /50.

Hi/4re 3.:% P+*)e) o! * PPP Pro2ect

/ 0 Qdcn?i8calion Identify pro%ect Fire selection Perforin prelim mary feasibility study =oncept desigli Befine possible forms of financing Becis+n'i to proceed to tender process ; Ftrategic importai%ce of pro%eci ; 2orecast Iconomic IER O 2orces.- 2inancial RR ; Invironmental and sociaJ impact Assign pro%ect manager and learn

Cha ter 3 Imroaiicuon a #O$ Profeta

9 Il (21 Preparai ion Perform feasibility study ; +egal, firurciil and technical asses sment. Eey risk assessment. =onfirm PPP viability. Feleci cernimele ia I structures and financing sources, ; Identity govemmenl support, if any. ; InvirtKWmeriiaQ and social assessment Identify polenlial pro%ect parlictpantX(market pro%ect =onfirm politicalpublic buy-in =onsultation process lo obtain market and stakeholder feedback Lap out procurement procedure +and ac)uisi lion /if any0 Appoint financial, legal and technical advisers P0 $endering Befine pre-)uahfication and bid evaluation criteria Produce tender documerm /including pro%ect document-0 Pre)uiJification of bidden

/30

"id preparation

"idder due diligence Respond to re)uests for clinficuion Lodification of tender document0 funhet to comments "id nibmission

/!0

Hfltoetion

Perform bid evaluation Fe I ecl preferred bidden9 s0 ,egotiate any open issues on pro%ect documents 2urther selection /if necessary0 Pro%ect a&ard /ti0 2inancing /may be pan of /3Y bid preparatori and /!0 selection0 Arrange financing +ender due diligence ,egotiate pro%eel document. /inc I uding direct agreements, insurance a%rsngcrnents and financing agreements I)uity airangernents @edging arrangements Insurance arrangements =omnutment of financing 2ulfil or &aiver of all =Ps 2inancial close /D0 Implen&ntation 2orm pro%ect company I)uity contri biif%orii paid up Bra&do&n of debt Besign and construct facility =ommissioning and tests on completion Performance testing Lobili4e operator and input supplier #fftake interconnection

Cha "6 i Intro1ucilo" lo SO$ Pro7ecli

IH
(8)

#perai ion

=rperinori and maintenance - ddim ouipur Inspections and testing Repayment of debt Bistribution of return on ecruity $raiming of grantor personnel Periodic ma%or maintenance

(9)

Ind of concession

@andover procesO&c-rlti $ransfer assets or retender =ompensation /if any0