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Conceptual Framework for PPPsConceptual Framework for PPPs

Presentation to the Planning Board

May 2007

PV RaviInfrastructure Development Corporation (Karnataka) Limited

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Definition

A Public Private Partnership is an arrangement between a public (government) entity & a private (non-government) entity by which services that have traditionally been delivered by the public entity are provided by the private entity under a set of terms and conditions that are defined at the outset

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Characteristics

The public entity should have the enabling authority to transfer its responsibility – enabling legislative & policy framework, administrative order – the instrument of transfer is through a contract

There is usually a significant transfer of responsibility to the private entity – and usually includes financial investment obligations

For a payment to the private entity – directly by users or by the public entity such that - a significant portion of project revenues and/ or the payments, are conditional on achieving pre-specified levels of performance

The nature of the relationship is usually long-term

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Risk Sharing

A risk is defined as any factor, event or influence that could threaten the successful completion of a project in terms of time, cost or quality

In a conventional BOQ based implementation : risks – planning, design, construction, environmental & social, physical damage and financing are evaluated

Commercial risks – revenue or maintenance costs, quality, safety of users and general regulatory risks – not critically evaluated – this is critical though to a private investor

PPP involves sharing of risks – risk allocated to the party best suited to manage them

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Why PPPs?

Fiscal reasons - Inadequacy of resources – leveraging on lower government funding

Optimal transfer of risks – to the entity best suited to manage the risks Design, Financing, Construction, Operations and

Maintenance – all are commercially understood and manageable

Change of scope, defective designs, time overrun, cost overruns, leakage of revenues, high maintenance costs

Transfer of responsibilities – efficiency gain Appropriate technology, innovative design solutions,

project management, better collection practices, life cycle costing

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Other Reasons Enhanced bankability – more rigorous project

preparation Incentive to deliver whole life solution – not

just asset creation Focus shifts to service delivery – integrated

with construction, measurement of quality & payment linked to service delivery

Acceleration of programme – time-bound implementation

Better overall management of public services – transparency in prioritisation, selection and ongoing implementation

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PPP Options

Full Privatization

Works & Services

Contracts

Management &

Maintenance Contracts

Operation & Maintenance Concessions

Build Operate Transfer

Concessions

Low High

Extent of private sector participation

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Concessions

BOT - Build Operate Transfer

BOOT - Build Own Operate Transfer

BOO - Build Own Operate

BOOST - Build Own Operate Share Transfer

BOLT - Build Own Lease Transfer

DBFO - Design Build Finance Operate

OMT - Operate Maintain Transfer

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Types of PPPs

Financially free standing projects Role of public sector - planning, licensing & statutory

procedures; no financial support/ payment by government Revenues through levy of user charges by private sector Toll Roads and Bridges, Telecom services, Port projects

Projects where Government procures services Private Sector paid a fee (tipping fee), tariff (shadow toll) or

periodical charge (annuity) by Government for providing services; payment against performance – no/partial demand risk transfer

Risks associated with asset creation (including design) and O&M transferred to private sector

Accountability to users for service - retained by Government Roads - annuity/ shadow tolls, power - under PPAs. In the UK -

prisons, education, health services, defence related services

Other Types - Joint ventures, Not-for-Profit vehicles

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Features of PPPs - 1 Genuine risk transfer

All risks pertaining to design, building, financing and operation transferred to the private entity

Transfer of demand risk depends on the extent to which the private sector can influence usage

Output based Specifications Contracts specify the service outputs required rather

than asset configuration/mode of service delivery Emphasis on type of service & performance standards Private entity incentivised to deliver outputs using

innovation in design, construction, operation and financing

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Features of PPPs - 2

Whole life asset performance Private entity takes responsibility &

assumes risk for the performance of the asset and delivery of service over a long term

Payment for Performance Revenue/ Payment to private entity is

subject to performance in relation to specific & quantified criteria enshrined in the contract

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Value for Money

Transfer of risks/ responsibilities under a PPP structure should result in better value for money for the user Telecom sector – mobile phone tariffs from

Rs. 16/- per minute to Re.1/- or 50 paise per minute

Tolls paid – offset by savings in direct & indirect costs and value of time

Annuity payments – public sector comparator – value for money

Efficiency gain Savings in cost of project versus overrun Savings in operating costs Revenue maximization - leakages

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Basic Issues

Striking a balance between differing concerns & objectives of parties

Legislative Back upRights and obligations of partiesIdentification and allocation of risksPenalties and rewards which would

ensure performance

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Broad Roles & Responsibilities Government Agency

Providing Project Site/ Assets Environmental Clearances Supporting Infrastructure and Utilities Specific Obligations (e.g. dredging) Regulatory Functions

Concessionaire Designing, Engineering, Financing Construction/ augmentation / upgradation Operation and Maintenance Payment and other obligations Transfer of assets at expiry of concession period

In exchange the concessionaire has the right to receive revenue – tolls or annuity or any other mechanism

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Other Key Elements Bankability Issues

Concessionaire’s ability to assign rights Lenders’ step-in rights Charge on project assets and enforceability Critical Events and consequences

Force MajeureEvents of Default

Remedial process incase of default/ events leading to termination

Protection of debt in the event of termination

Supporting Provisions Dispute Resolution Mechanism Re-negotiation in good faith Termination as a last resort Preferential treatment in re-bidding

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What a PPP is not & what it is

PPP is not privatisation or disinvestment PPP is not about borrowing money from the private

sector. PPP is more about creating a structure

in which greater value for money is achieved for services through private sector innovation and management skills delivering significant improvement in service efficiency levels

This means that the public sector no longer builds roads, it purchases miles of maintained

highway no longer builds prisons, it buys custodial services no longer operates ports but provides port services through

world class operators No longer builds power plants but purchases power

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Partnership in Practice

Partners not adversaries – background of mistrust

Project should be the focus – “win-win” for both

the parties

Independent agencies – Independent Engineer -

useful during both implementation and operations

Government retains ultimate responsibility – uses

the private sector to deliver infrastructure

services of specified standard

Private Financing – can significantly leverage

public funds

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Basic Features Conventional financing is asset based – debt provided is

usually a percentage of project cost linked to the value of asset cover

Project Financing is cash flow based - on the estimated cash flows that are generated by the project “A financing structure that relies on future cash flows of a

project as the primary source of its servicing & repayment, with only the project assets, rights and interests being the security”

There is little or no recourse to the sponsors Usually large projects - investments are huge & costs of

non-completion/ unsuccessful operations - affect many Little tangible security All stakeholders would, therefore, like to see it succeed

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Project Appraisal

An elaborate project appraisal process – analysis of risks and specification of return expectations (pricing) from investing in the project

Cash flow projections based on technical, market and financial analysis

Risk mitigated through project contracts and financing agreements or consciously taken after evaluation

Structured financing – to meet the characteristics of the project

Security and documentation - elaborate

Project monitoring and compliance

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Typical Funding Sources Equity Capital

Core capital provided by the promoters (developers / contractors) Minority stakes may be taken by financial investors / funds

Preference Capital Can be used if suitable changes made to the CA

Senior Secured Debt Normally in the form of rupee term loans/ debentures from Indian

banks/ institutions Capital market instruments – may be possible after CoD; not too

popular yet A variant could be debt with 2nd charge

Subordinated Debt Typically with far lesser rights May even be unsecured

Challenge is to evaluate how additional resources can be channelised into the sector - insurance funds, pension funds

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Key Project Contracts

Concession Agreement Project Site Licence Agreement Shareholder/ JV Agreement Substitution Agreement / Direct

Agreement State Support Agreement EPC Contract O&M Contract Trust and Retention Agreement

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Main Provisions Concession Agreement

Terms and conditions of undertaking the project Obligations of the parties Tenor of the contract Default provisions and remedies Provision for substitution Force Majeure provisions and remedies Termination and compensation payments

State Support Agreement Support during implementation Protection from a competing facility

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Other Key Contracts EPC Contract

Price Overrun Time Overrun LDs and Bonus provisions Performance security Standards and Specifications

O&M Contract Operating Standards Costs Quality of Service Penal provisions

TRA Agreement Trapping of all the project cashflows Prioritization of Cash flows

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Financial Analysis Elaborate Financial Model capturing these risks – base case

analysis Establishes breakeven levels of traffic/ tariffs Assessment under various scenarios – sensitivity analysis

Demand / Traffic Tariff / Tolls Inflation Maintenance Costs

Financial Ratios

Debt Equity Ratio – cash flow impact & level of promoters’

funds

Internal Rate of Return (project/ equity)

Debt Service Coverage Ratio

Loan Life Ratio

Project Life Ratio

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Financing Documents

Facility Agreement Financial Terms Project Risk Mitigating

Conditionalities General Conditions

Inter-Creditor Agreements Security Documentation

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Basic Structure

Project SPV

NHAI

Lenders

Contractor

JV Partner

Main Sponsor

Indep EngLE

Debt

Financing Agreements

Equity

EPC Agmnt

O&M Agmnt

Annuity

Shhldr’s Agmnt

Concession

Agreement

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Transaction Structure

Government

Project SPV

Invt. Bankers,Technical & Legal

Advisers

Advisers

Invt. Bankers,Technical & Legal

Advisers

Advisers

UsersOff-take Contracts

InsuranceCompanies

Insurance Policies

EPC Contractor

EPC ContractTRA

Agent

TRA/Escrow Agreement

Concession / Licence Agreement

O&M Operator

O&M Contract

Sponsors

Equity

FinancialInvestors

Equity /Sub-Debt

Lenders

Debt SubstitutionAgreement

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Implementation Structures

Existing Assets Full Divestiture – UK – Telecom, Steel, Electricity, Ports,

Water, Airlines, Airports; so far in India – Modern Foods, BALCO, Hotels

Asset Sales/ Leases – airports in Australia BOT/ ROMT Concessions – roads, tourism facilities, berths in

ports Management contracts – water assets, ports in Philippines

New Assets Implementation by government – followed by OMT

concessions – Mumbai-Pune expressway, Ports in Rotterdam, hospitals

Implementation through SPVs – Moradabad bypass or port connectivity projects or dedicated freight corridor for railways

BOT Concessions – commonest form – roads, ports,

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Isn’t Private Infrastructure Expensive?

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Isn’t Private Infrastructure Expensive?

Additions to Cost BenefitsRisk Premium Lower Cost From Efficiency

Example

Public Entity Private Entity

ROI 8% WACC 13.7% (Debt @ 11% 70: 30 Equity @

20%)

Cost 105.3 Cost 100

Required RequiredReturn 113.7 Return 113.7

A 5.3% cost overrun (increase in actual project cost) in the public sector is enough to overcome the private sector disadvantage of higher financing cost!

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Isn’t Private Infrastructure Expensive?

Additions to Cost BenefitsRisk Premium Lower Cost From Efficiency

Example

Public Entity Private Entity

ROI 8% WACC 13.7% (Debt @ 11% 70: 30 Equity

@ 20%)

Cost 100 Cost 95

Required RequiredReturn 108 Return 108

A 5% reduction in project cost (efficiency) by the private sector is enough to overcome the higher financing cost!

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Key question What should be the framework to induce the

private entity make the investments needed to provide efficient service to the end user? Investments decided by the investor or driven by

the market, i.e. the consumer Private entity has a stronger case for state support

if it makes investments determined by the State Demand risk – how much passed on?

Extricate the public entity from making commercial decisions on individual projects, wherever possible

Public entity’s role from being a planner, financier & manager to facilitator & regulator

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The Right BalanceThe Investor wants

Monopoly rights

Full pricing freedom

State support for social obligations/ viability considerations

The Investor needs

Initial risk mitigation support - can be pre-defined

Stable environment -

regulatory and policy framework

State support for social obligations/ viability considerations – can be transparently determined

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Some Indian Examples - 1 Roads

BOT Concessions for toll roads and bridges (NHAI, state governments) (OMT Concessions in future)

Annuity payment based concessions – highways, urban roads (NHAI/ state governments)

Solid Waste Management Engineered landfills – tipping fee linked payments

(Bangalore, Trivandrum) SW Collection and Transportation (MCD/ NDMC)

Port Concessions Major Ports – container berths (JNPT, Chennai, Kochi,

Tuticorin, Vizag, Kandla); bulk cargo berths (Marmagao, Haldia, Ennore, New Mangalore)

Minor Ports –Pipavav, Mundra, Kakinada

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Some Indian Examples - 2

Water Supply and Sanitation – Bulk water supply systems in Tirupur and Vizag

Tourism Facilities – hotels, tourist facilities, PWD rest houses – Karnataka & Kerala

Bus Terminals/ Parking Facilities Bus terminals – Dehra Dun, Amritsar, Jullundur Parking + commercial complexes – NDMC/

DDA/ MCD/ Bangalore

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International Experience - 1

Toll Roads (Chile, Mexico, Hungary, Poland); Ports (Argentina, Philippines, Sri Lanka)

Airports (Australia, Greece, Germany) Roads in UK under DBFO program Private Finance Initiative of UK – diverse areas

Dorset Police Service - $ 40 million contract for refurbishment of police stations, construction of a divisional headquarters building, maintenance, janitorial & waste management services

Nottinghamshire, Police Fleet Management Contract - ($ 180 million over 25 years) – driver slots - usage of a vehicle for a 24 hour period

Durham & Dunstead Hospital Project, Durham – 30 year, $ 155 million hospital services contract – to construct and operate health care facilities + ancillary services

Stoke-On-Trent Grouped Schools Project – a $ 250 million project involving 122 schools – refurbishment and maintenance contract

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International Experience - 2

Louis Trichardt Maximum Security Prison Project, South Africa – a $ 270 million project – largest prison facility (also UK and Australia)

Full fledged water concessions in Argentina (Buenos Aires) and Philippines (Manila); Management contract for water supply & sanitation in Johannesburg, South Africa

Rural Pay Phones, Peru – against payment of a subsidy – based on a system of monitoring of service standards

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On the Table in Karnataka

Airport Rail Link Core Ring Road Airport Expressway BMRDA Townships Minor airports Tourism Properties IMTC (Kempegowda) Mega Convention Center, Bangalore Bypass roads Truck terminals …