CV 4201 Civil Engineering Management

Lecture 6: Overview of Project Finance

& Concepts of the BOT Contractual
Approach for Privately-financed
Infrastructure Projects
 Overview of project finance
• DEFINITION / CHARACTERISTICS
– The financing of a new project where
the lender looks to the cashflow and
earnings of the project alone for
repayment of the loan and to the project
assets as collateral
– Financing structure is often with as little
recourse to shareholders or the sponsor
as possible, but is rarely totally non-
recourse
 Overview of project finance
• DEFINITION / CHARACTERISTICS (contd)
– Historical origins in mining and oil and gas
exploration
– Nothing more than financing of a large
project, but involves extensive contractual
documents to allocated risks
Conventional Structure of Project
CUSTOMERS

Net Revenues

Guaranteed
Financing Capital
CORPORATE EQUITY
BANKS
BORROWER SOURCES

Construction &
Operations
Project
Development
Development

OTHER CONTRACTING/
CONTRACTORS OPERATING/CONSULTING
PARTIES
 Project Financing Contractual
Structure
CUSTOMERS OR
OFFTAKERS OR
GOVERNMENT
AGENCY
CORPORATE
SHAREHOLDER Sales Agreement
A

Shareholders PROJECT Limited

BANKS
Agreement COMPANY Recourse
Loan Agreement
CORPORATE
SHAREHOLDER
Operating Agreement
B Turnkey
Engineering Consultancy
Construction
etc.
Contract
TURNKEY OTHER
CONTRACTOR PARTIES
 What is BOT?
• The build-operate-transfer (BOT) model
entails a concession company
(concessionaire) providing the finance,
design, construction, operation and
maintenance of an asset for a fixed period
(concession period), at the end of which the
asset is transferred in good condition and
free of charge to the client (host
government).
• Concession period is typically around 30
years for transport infrastructure projects, or
 BOT arrangement
Build * design
* manage project implementation
* carry out procurement
* construct
* finance

Operate * manage and operate plant

* carry out maintenance etc
* deliver product/ service
* receive delivery payment

Transfer * hand over plant in operating condition at

the
end of the contract period
 Types of engineering contracts
• Fixed price contracts
– Lump sum contracts
– Package deal ( All-in, Turnkey, Design and build)
contracts
– Bill of Quantities contracts
– Schedule of Rates contracts
• Cost Remibursement (Prime Cost, Cost Plus )
Contracts
– Cost plus fixed percentage contracts
– Cost plus fixed fee contracts
– Target incentive contracts
– Guaranteed maximum cost contracts
– Management contracts
• There is now world-wide interests in BOT
schemes
• Malaysia has made BOT schemes as
major component of its privatization
strategy
• Examples of infrastructure projects that
have been privatised as a BOT basis are:
– Power plants
– Water supply and sewage treatment
plants
– Toll roads
– Tunnels and bridges
Countries where BOT projects are
in place include:
• Developing
countries • Developed
• Malaysia countries
• Indonesia • Australia
• Philippines • U.K.
• Hungary • U.S.A.
• China • Canada
• Pakistan • Hong Kong
• India • Korea
• Singapore?
 S.T.
22/03/2001
 SingSpring wins tender
„ 20-yr contract

„ 78 cents/m
3

„ Current world’s

cheapest at 90 cents/m3
(Israel, Ashkelon)
„ Under BOO contract

„ RO process

„ Set up cost $250 million

„ 30 million gallons of

fresh water by 2005

Source: The Straits Times, 20 Jan 03

 Government

Concession
Agreement

Raw Supply Concession Offtake Users of

Material Contract Company Contract Product
Supplier
Loan Construction
Agreement Contract
Banks Contractors
Shareholders Operation
Agreement Contract

Investors Operator

Typical Contractual Structure for BOT Project

Flow of Funds During BOT Project Operation
Concession&
Contractual
Agreements

Project
Company
Build facility
Tolls
Operator
Revenues paid into
escrow account
Profit Escrow
Repatriation Account
Return
on Debt Royalty O&M
equity service & taxes costs
Equity Commercial Government O&M
Investors Lenders Operator
 Sources of Project Finance
Funding
• International Commercial Banks
• Export Credit Agencies
• International Capital Markets
• Domestic Commercial Banks
• Leasing Companies
Which projects easiest to finance?
• Hard currency generating
• High capital equipment import value
(export credit cover)
• High domestic priority (e.g. power in SE
Asia)
• Assured offtake
• Proven technology
• Countries with legal, tax, accounting
framework
 “Financiability”Comparison
Types of project in order of “financiability”:
- export refineries/ petrochemicals
- Power & water supply projects with
government guaranteed offtake
- Telecomms with international
revenues
- Road
- Rail
 Where in Asia? – Main Project
Finance Markets in Asian Region

• Malaysia: earliest and most developed,

slowed rapidly, but moving again
• Indonesia: took off rapidly after
troubled start but at a halt now
• Philippines: recent arrival, impressive
current record
• Thailand: early start but disappointing
record
Where in Asia? – Main Project Finance
Markets in Asian Region

• China: slow start, picked up speed and

advancing rapidly
• Vietnam: need is great but
infrastructure lacking
• India: huge market but mixed message
• Korea: private participations in
infrastructure deals
• Others: limited potential (e.g. Pakistan,
Laos and Myanmar
 CV 4201 Civil Engineering
Management
• Lecture 7: Management of Key
Project
Risks & Foreign Exchange
Risks
 The Key Project Risks
Risk Construction
mitigation
is the key Operation
to Project
Finance Technology / Environmental
Supply - Feedstock
Demand - Offtake
Political
Economic
Force Majeure
 The Key Project Risks
Construction
Risks
– Delay Probably the
– Sub-performance most important
– Site Problems
risk
– Shipping Problems
– Contractor Bankruptcy / Breach of Contract….

Mitigants
– Fixed Price, Lump Sum, Turnkey Contract
– Contractor Penalties for Delay and Failure to Perform
– Parent Company Guarantees
– Insurance
– Shareholder Support
 The Key Project Risks
Operation
Risks
– Incompetent Operators Cause Project
Failure / Damage
– Operating Costs Increase Out of Control
Mitigants
– Fixed Price Operating Contract
– Operator with Track Record
– Operator Penalties for Failure to Perform &
Insurances
 The Key Project Risks
Technology /
Risks Environmental
– Failure of Technology
– Environmental Discharge
– Social Displacement
Mitigants
– Use of Proven Technology
– Modern, Environmentally Clean Technology
– Independent Study on Environmental and Social
Impact
 The Key Project Risks
Supply - Feedstock
• Risks
– Cost Increases
– Disruption of Supply
– Transportation
– Quality Failure
– “Reserve Risk”
• Mitigants
– Long-term Fixed Price Supply-or-Pay Contracts (Supply /
Transport)
– Alternative Sources
– Right to Reject Sub-standard Material
 The Key Project Risks
Demand -
• Risks
Offtake
– Demand Forecasts Incorrect
– Market Disruptions
– Unanticipated Competition
– Transportation Disruption
• Mitigants
– Long-term, Fixed Price, Take-or-Pay
Contracts (Purchase / Transport)
– Shareholder Support
 The Key Project Risks
• Risks Political
– Expropriation
– Change of Law
– Change of Tax Regime
– Political Intervention
• Mitigants
– High Profile Projects
– Political Risk Insurance
– Government Guarantees / Compensation
Agreements
– Insurance
 The Key Project Risks
Economic
• Risks
– Currency Devaluation
– Interest Rate Increases
– Market Dislocation
• Mitigants
– Match Currencies of Costs / Revenues / Financing
– Currency Hedging
– Fixed Interest Rate Debt
– Structure that Provides for Sufficient Cashflows Even
in Downside Scenarios
 The Key Project Risks
Force Majeure
• Risks
– Natural Calamities (flood, fire,
earthquake…)
– Political Calamities (war, civil unrest,
strikes…)
– Man-made Calamities (explosion,
sabotage…)
• Mitigants
– Insurance
– Government Undertakings
 Lecture 8: Management of
Foreign Exchange Risks & Case Study of
BOT Project
 S.T.
10/07/97
 S.T.
12/07/97
 Foreign Exchange (Currency) Risk
• Risk results from the mismatch between
the revenue currency and payment
obligations for
– Taxes (usually in local currency)
– Operating expenses (could be in hard
currency)
– Dividend payments & profit repatriation
(mainly hard currency)
 Techniques to Mitigate Forex Risk
1. Access to hard currency
a) Currency matching through contractual
arrangement
eg. 1) An American contractor arranges for
reimbursement of costs to the contractor in the
currency of expenditures, with the balance in local
currency.
eg. 2) A UK contractor pricing its overseas contracts in
sterling pounds, effectively passing all forex risks to
the client.
eg. 3) Choose one strong foreign currency for imported
materials, equipment and subcontracts and one
local currency for local expenditures.
 1. Access to hard currency (contd)

b) Financing a ventures which produces

exportable products so that revenues
received could be in hard or convertible
currency.
c) Finance a venture whose users could pay in
hard currency
eg. 1) toll roads in Guangdong Province,
china where HK$ could be charged.
eg. 2) toll roads in Czech Republic, near
German border, where DM could be charged.
eg. 3) hotels and airports
 2. Indexing the Revenue Stream
(or Currency Adjustment)
• Adjust the amount of revenue (tariff/tolls) earned
in local currency against a benchmark hard
currency so that the real value of the revenue, in
hard currency, stays the same.
Therefore, if exchange rate of local currency
decreases, tariffs/tolls would be increased to
mark up for the loss ie. investor/contractor will
receive the same hard currency equivalent (from
the govt), regardless of the exchange rate.
 3. Government Support &
Guarantees
• Central Govt. approval for the project
• Host govt. provides support by fixing in
advance the forex rate. This might take the
form of a floor exchange rate, allowing the
sponsors to calculate in advance the
“worst case scenario”.
• Govt. guarantees of foreign exchange
convertibility and availability by the central
bank.
• Remittance guarantees required for
conversion and transfer of foreign
currency.
 4. Indirect Govt. Support
Govt. could support revenues to sponsors
by foregoing or deferring taxes, lease
rentals, concession fees, etc.
5. Conventional Hedging Techniques
• Currency -- forwards contract, futures, options
-- currency swaps
• Conventional techniques of currency hedging are
only available with limited maturity. Quoting from
two bankers:
– “forward currency contract and options are rarely
available for Eastern European currencies above a few
months.”
– “large infrastracture projects of this kind (I.e. privately
financed) tend to be too long term for the usual hedging
instruments to be of much use.”
5. Conventional Hedging Techniques

• Interest rate swaps

• Such currency hedging and interest swap

techniques, therefore, can assist in
“smoothing out” minor and short-lived
variations in exchange rates, rather than be
used as a specific long-term tool.
 6. Other Measures by contractors
1. Negotiate with the client for large advance
payment and smaller retentions of money,
through this may be hard to do
sometimes.
2. Negotiate with the client for shorter time
lapse between valuation and receipt of
interim payments.
3. Negotiate with subcontractors and
suppliers for longer credit terms for items
and contracts denominated in foreign
currencies.
6. Other Measures by contractors (contd)

4. Unbalance the tender i.e. bid at

disproportionately higher prices for early
work items such as excavation and
foundation work.
5. Over-measure the amount of work
completed in the early months of the
projects
 Case Study: Malaysia-Singapore
Second Crossing

• RM1,400 million Financing

• 2 Km Crossing + 35.5 Km Expressway
• DMG Financial Adviser to United
Engineers
• Associated Township
• Financing Signed in January 1995
 Project Concept
1. Construction of Bridge and Expressways
2. Collection of Tolls for 30 years
3. State Government to acquire and
alienate land
4. Development of New Town with
provision of primary infrastructure
 Project Description
• BRIDGE:
– 2 km long
– Dual 3-Lane Carriageways
– 1.7 km in Malaysian Waters
• CIQ COMPLEX:
– Customs Offices
– Immigration Offices
– Quarantine and Warehousing Facilities
 Project Description (cont’d)
• EXPRESSWAYS:
– 44 km in length
– Second Crossing Expressway connect to
N/S Expressway and Senai Airport
– Johore Bahru Parkway connect to Johor
Bahru
• NEW TOWN:
– 10,000 Hectares to be developed over 25
years
 Chronology
1989 July UEM Preliminary Proposal
submitted to Federal Government
1989 September Letter of Exclusivity sent to UEM
1990 March Detailed Proposal Presented
1990 November Letter of Intent Issued
1991 September MOU executed with State
Government
 Chronology

1991 Septembe MOU executed with State

r Government
1992 November Execution of Tripartite Agreement
between UEM, Federal and State
governments
1993 Negotiations of Concession
Agreement and Development
Agreement
1993 April Development Agreement
executed with State Government
 Chronology (cont’d)
1993 July Concession Agreement executed
with Federal Government
1994 May Novation of Concession
Agreement to Linkedua
1994 March Inter-Government Agreement
executed
1994 September Execution of Cost Sharing
Agreement
 Chronology (cont’d)

1994 December Novation of Development

Agreement to PROLINK
1995 January Ground Breaking Ceremony
1995 January Signature of RM1 billion loan
agreements for Linkedua
1997 November Projected Opening of Bridge and
Expressways
 Project Agreements
1. CONCESSOIN AGREEMENT
– Construction of Expressways and Malaysian side of Bridge
– Collect Tolls
2. DEVELOPMENT AGREEMENT
– Acquisition of Land
– Provision of Primary Infrastructure
3. INTER_GOVERNMENT AGREEMENT
– Facilitates co-ordination of Design and Construction of the
Bridge between Malaysian and Singapore Governments
4. COST SHARING AGREEMENT
– Sharing of Costs of Construction of Bridge and
Expressways between Concession Company and
Development Company
 Key Issues in Structuring
a Bankable Concession
• No government capital contribution or toll
revenue support
• Termination provisions provide support for
debt repayment and equity return
• Government to compensate for imposition of
tolls outside agreed regime
• Cost sharing support from development
company
• Land acquisition process
• Projected toll revenue
 Agreements for Construction
• 13 separate packages
• Conditions of contract more onerous
than FIDIC
¾Weather
¾Ground Conditions
¾Lump sum/ remeasured with a cap
¾Control of progress with damages/
performance bond
• Monitoring by PL as project manager
 Traffic Revenue Projections:
MVA Study
• Historic Data
• Land use development
• GDP growth
• Future transport infrastructure
• Relative monetary and temporal costs of
travel
• Relative capacity of alternative transport
facilities
• Projected tolls
 Financing
• Gearing Constrained by:
¾Toll Revenue Profile
¾Need for annual debt service coverage
• 70:30 Debt: Equity Ratio
• Equity:
¾Ordinary shares
¾Redeemable convertible subordinated
• Debt:
¾15-year non-recourse project finance
facilities
 Security
• Debenture
• Charge over escrow account and debt
service
• Reserve account
• Assignment of project agreements
• Covenants including maintenance of debt
service coverage ratios
 Project Economics
• Gearing constrained by toll revenue profile
• Loan life abridged analysis period
• Need for annual debt service coverage
 Risk Analysis
RISK MITIGANTS
1. Land Acquisition Development Agreement
Concession Extension
2. Cost Overruns Pre-Assessment
Conditions of Contract
Experienced Contractors
Project Monitoring
Government Bears Costs of
Variations Requested
3. Delays Performance
Bonds/Damages
4. Toll Revenue Independent Traffic Forecast
Pre Agreed Toll Escalation
 Risk Analysis (cont’d)

RISK MITIGANTS
5. Operating Approved Maintenance
Risks Experienced Staff
6. Interest RatesPart of debt is Fixed
Interest
7. Force Majeure Insurance
Concession Extension
8. Termination Government Redemption
Obligations
 2000 and beyond…
• Where is the projected traffic
revenue?
• Where is the subsidy from the land
sales?
• Negotiations with
Lenders/Government
¾reschedule debt?
¾take out by Asset Management
Company?
Thank You!