ASSIGNMENTON

INFRASTRUCTURE DEVELOPMENT(PGPM-14)

By

MD IRSHAD ALAM(Registration No: 214-05-31-50011-2163)

SUBMITTED TOSCHOOL OF DISTANCE EDUCATIONNATIONAL INSTITUTE OF CONSTRUCTIONMANAGEMENT AND RESEARCH CENTRE25/1 BALEWADI, N.I.A POST OFFICEPUNE 411045.

ASSIGNMENT TITLE

Public Private Partnerships refers to arrangements, typically medium to long term, between the public and private sectors whereby some of the services that fall under the responsibilities of the public sector are provided by the private sector, with clear agreement on shared objectives for delivery of public infrastructure and/ or public services. A PPP is generally a contract or agreement to outline the responsibilities of each party and clearly allocate risk. In a BOT arrangement, the private sector designs and builds the infrastructure, finances its construction and owns, operates and maintains it over a period, often as long as 20 or 30 years. This period is referred to as the "concession" period. Such projects provide for the infrastructure to be transferred to the government at the end of the concession period. There are a number of major parties to any BOT project, all of whom have particular reasons to be involved in the project. The contractual arrangements between those parties, and the allocation of risks, can be complex. Explain in detail structuring of BOT projects.

1. Introduction1.1 Introduction1.2 Need1.3 Aim OF Present Study1.4 Research Objective1.5 Scope1.6 Methodology1.7 Literature Review1.8 Contribution of the Current Study to the Existing Literature

2. Infrastructure Project: Development Thought BOT Model2.1 Introduction2.2 Types of Infrastructure2.2.1 Economic Infrastructure2.2.2 Social Infrastructure2.3 Need of Infrastructure2.4 Development of Infrastructure2.4.1 Public Sector Projects2.4.2 Private Sector Project2.4.3 Public Private Joint Venture2.5 Public Private Partnership2.5.1 Definition2.5.2 Types of contracts in PPP2.5.2.1 Service Contracts2.5.2.2 Management contracts2.5.2.3 Lease Contract2.5.2.4 Concession Contracts2.5.2.5 Build Operate & Transfer2.6 Build Operate & Transfer2.6.1 Definition2.6.2 Variants of BOT2.6.3 Stages of BOT2.6.4 Major participants in BOT projects2.6.5 Main agreements in BOT projects2.6.6 Advantages and Disadvantages of BOT projects2.7 Financing of BOT projects2.7.1 Project financing2.7.2 Parties involved in financing2.7.3 Instruments used in project financing2.8 Conclusion

3. Risk Involved in BOT Model for Road Projects3.1 Introduction3.2 Risk identification in BOT for infrastructure projects3.3 Types of risks3.4 Allocation of risks3.5 Risk mitigation3.6 Risk mitigation techniques3.6.1 Contractual solution for Project Company3.6.2 Government support3.6.3 Insurance3.6.3.1 Political risk insurance3.6.3.2 Force majeure risk insurance 3.7 Conclusion

LIST OF ABBREVATIONS

BOTBuild Operate Transfer

BOOTBuild Own Operate Transfer

BOOBuild Own & Operate

BRTBuild Rent & Transfer

BOOSTBuild Own Operate Subsidize & Transfer

BLTBuild Lease & Transfer

BTOBuild Transfer & Operate

PPPPublic Private Partnership

GDP

Gross Domestic Product

SPVSpecial Purpose Vehicle

OPICOverseas Private Investment Corporation

MIGAMultilateral Investment Guarantee Agency (World Bank)

PRI

Political Risk Insurance

MCAModel Concession Agreement

SERV

Swiss Export Risk Insurance

1. INTRODUCTION

1.1 IntroductionInfrastructure represents the wheels of economic activity. People demand infrastructure facilities not only for direct utilization but also for raising their productivity. It contributes to economic growth both by increasing productivity and by providing amenities which enhance the quality of life. There is a strong association between the availability of infrastructure facilities such as telecommunications, power, roads & access to safe water and per capita GDP. Adequate quantity & reliability of infrastructure are key factors in the ability of countries to compete in international trade, even in traditional commodities. In the post-World War II era around 1945, most infrastructure projects in developing countries have been built under the direct supervision of the government itself, or of a government agency. But In early 1980s government started to find the alternative ways to finance these projects because of the following reasons :1. With continued population and economic growth in many developing countries, the need for additional infrastructure continues to grow. 2. The growing third World debt crisis has meant that developing countries have had less borrowing capacity and fewer budgetary resources of their own to finance the projects that are needed. 3. Limited resources of government & government agencies. Government agencies are looking for creative ways to promote additional projects by encouraging private sector enterprise, apart from shifting a portion of burden of the infrastructure development, including financial arrangements to the infrastructure development. Beginning in the late 1970s and early 1980s, some of the major international contracting firms and some of the more sophisticated developing countries began to explore the possibility of promoting privately owned and operated infrastructure projects financed under a concession type arrangement. One of the variant under this category is BOT (Built, Operate & Transfer).Other variants include: BOOT (Build, Own, Operate and Transfer); BOO (Build, Own and Operate, i.e., without any obligation to transfer); BRT (Build, Rent and Transfer); BOOST (Build, Own, Operate, Subsidize and Transfer). BOT (Build- Operate- Transfer): Build-Operate-Transfer (BOT) is a form of project financing, wherein a private entity receives a concession from the private or public sector to finance, design, construct, and operate a facility for a specified period, often as long as 20 or 30 years. After the concession period ends, ownership is transferred back to the granting entity. During the concession the project proponent is allowed to charge the users of the facility appropriate tolls, fees, rentals, and charges stated in the concession contract. This enables the project proponent to recover its investment, operating and maintenance expenses in the projects. 1.2 Need of Study: Infrastructure projects need massive investment, have long gestation period, yield small and in some cases negative returns, Thus entry of private sector in infrastructure financing and development must be well conceived. As more & more infrastructure projects in developing countries are developed on the basis of BOT model, therefore its various financial & contractual aspects must be analysed in detail. 1.3 Aim of Present Study: To establish procedural guidelines & framework for the financial & contractual aspects for the realization of BOT model for Highway projects. 1.4 Research Objective: To study the BOT model in Public- Private Partnership mode of development in Road projects. What are the various risks involved in the BOT model for Road projects & how these risks are incorporated in Concession agreement and financial analysis of projects? To develop standard model for contractual & financial analysis of BOT Road projects.1.5 Scope: Brief introduction of infrastructure projects & its need. Development of infrastructure projects through BOT & its main differences from conventional model. To study the evaluation of BOT model in Highway projects To study the various risks involved in the BOT model of Highway projects and what are various risk mitigation techniques. To study the contractual aspects of BOT Highway projects and how various risks are incorporated in the concession agreement. To study the financial aspects of BOT Highway projects and how to analyze the financial viability of projects while incorporating various risks involved in the project. To develop standard models for the Contractual & financial analysis of Road projects to be develop on BOT basis. 1.6 Methodology: Present study explores case studies available in India and some other developing country in which BOT contracts have been used in various Highway sector. The study mainly covers the important issues related to financial & contractual aspects of concerned projects.

NeedAim & ObjectivesAnalysisDevelop Contractual & Financial Analysis ModelInputs fromNHAIIL & FSPrivate FirmsInputs fromBooksJournalsSeminarsNHAI & Most websitesInfrastructure, meaning types, characteristics & other aspects.Privatization of infrastructure.BOT concepts& applications.Risk management in BOT road project.Financial & Contractual aspects of Road projects on BOT

Figure1.1: Flowchart for Methodology

1.7 Literature ReviewVarious researchers have examined the various risks involved in the BOT model for infrastructure projects and methods to incorporate the risks involved in concession agreement and financial analysis of projects. Some of the studies done in this field are as follows:i. K. N. Vaid (1997) carried out various characteristics of Infrastructure projects, its impact on communities and various reforming options. Infrastructure services- including the power, transport, telecommunications, and provisions of water and safe disposal of waste- are central activities of households and economic production. Infrastructure failures quickly and radically reduce communities quality of life and productivity. Conversely improving infrastructure services enhances welfare and fosters economic growth.

ii. R. Bharadwaj (1997) proposed the devise into three parts. First part discussing the present state of infrastructure in India, Second part discussed with the projected growth of infrastructure need and the third part look into the investment need for infrastructure development.

iii. Tercia Arambam (1999) studies the various factors involved in the analysis of BOT model for infrastructure projects. The work has been divided into two parts, one is privatization of infrastructure projects & other one is BOT concepts & issues.

iv. Ajeet K Chaudhry (2001) studied the key issues involved in the development of Indian road sector. He concluded various sections discussing the problems in Indian road traffic, NHDP & Toll & Annuity model for project development.

v. Kulwinder Singh Rao (2004) carried out the various procurement methods involved in the development of Indian road sector. He concluded into two major parts; first part discussing the PPP in Indian road sector and other part discussing the selection procedure and bid evaluation criteria.

vi. Sudong Ye and Yisheng Liu (2008) proposed that the infrastructure development can be abstracted into development patterns. Based on the findings, they investigated possible task allocations between public and private sector to build a development decision tree of infrastructure projects.

vii. Sudong Ye and Yisheng Liu (2008) studied the finance approach, the debt service payment relies solely on project cash flows and the assets of the toll road projects. They evaluated, quantified and identified the major financial risks associated with project- financed toll road projects.

viii. Young Hoon Kwak (2008) studied a detailed overview of Asian concession market, 87 concession projects awarded between 1985 and 1998 covering 12 Asian countries were examined . The concession agreement is one of the infrastructure privatization models. In Asia, the rise of concession projects began in the 1980s, and the number of such projects continues to grow. 1.8 Contribution of the Current Study to the Existing Literature The BOT scheme to financing infrastructure projects has many potential advantages and is a viable alternative to the traditional approach using sovereign borrowings or budgetary resources. BOT projects involve a number of elements, such as host government, the Project Company, lenders, contractors, suppliers, purchasers and so on. All of which must come together for a successful project. The application of the BOT scheme in Indian infrastructure development is being carried out stage by stage. There are two broad categories of risk for BOT projects: country risks and specific project risks. The former associated with the political, economic and legal environment and over which the project sponsors have little or no control. The later to some extent could be controllable by the project sponsors. A few researches of risk management associated with Indias BOT projects focused on a particular sector. Different researchers appear to have different points of view on risk identification because they have approached the topic from different angles. A particular risk should be borne by the party most suited to deal with it, in terms of control or influence and costs, but it has never been easy to obtain an optimal allocation of risks. Risk Management is a critical success factor of BOT projects.

2. INFRASTRUCTURE PROJECT

2.1 IntroductionInfrastructure assets are the physical structures used to provide essential services to a society. These tangible assets can be viewed as the backbone of an economy. It is the foundation on which the economic, social & political structure of the society rests and its importance for overall development of the country cannot be over-emphasized. It mainly includes transport, Railway, Energy sector, Water & sanitation etc. Due to its importance to a countrys economic and social development, government institutions historically have provided infrastructure. 2.2 Types of Infrastructure: Infrastructure can be classified into two categories: 1) Economic infrastructure 2) Social infrastructure Infrastructure Sectors

Economic InfrastructureSocial Infrastructure

TransportToll roadsBridgesSeaportsAirportsRails

Energy & Utility Distribution Storage Electricity Distribution GenerationCommunications Cable Networks Satellite SystemsHealthcare facilitiesEducation facilitiesSocial HousingJudicial andcorrectional facilities

Figure 2.1: Types of Infrastructure2.2.1 Economic Infrastructure: Economic infrastructure consists of assets and services such as transport, utilities and communications. Private agents can easily provide these goods efficiently. For example toll roads.2.2.2 Social Infrastructure:Social infrastructure consists of assets and services that are provided either as a free or subsidized good. Examples are education and health care. Infrastructure and related services have significant implications for achieving sustainable development objectives, as infrastructure services underpin many aspects of economic and social activity. As a consequence, infrastructure failure can have a widespread impact across the community. Without reliable power, well- connected utilities and a modern transport network a countrys economy is not able to develop successfully in the long term. 2.3 Need of Infrastructure: Infrastructure represents the wheels of economic activity. People demand infrastructure facilities not only for direct utilization but also for raising their productivity. It contributes to economic growth by increasing productivity and facilitating amenities which enhance the quality of life.Population growth and rapid urbanization have placed enormous pressure on existing infrastructure stocks in developed and developing countries. The provision of new infrastructure and the maintenance of existing infrastructure thus present a daunting challenge to governments worldwide. 2.4 Development of Infrastructure: Initially infrastructure expenditure in developing countries has been funded directly from fiscal budgets. However, several factors such as macroeconomic instability and growing investment requirements have shown that public financing is volatile and, in many countries, rarely meets crucial infrastructure expenditure requirements in a timely and adequate manner. Private sector organizations on the other hand, have a large pool of sources from which they can seek funding, ranging from equity investors to capital markets and banks. In addition, they can seek funding from both local and international financial markets. Governments may not have access to, or the capacity to access, all these sources of funding. As a result, private sector involvement in infrastructure provision has been widely considered and implemented as a preferred method of financing infrastructure provision. This collaboration between public and private sectors is crucial in order to increase the sources of funding available for infrastructure and reduce the pressure on fiscal budgets. Like any other project infrastructure projects also have a life cycle with some variations. In general a project life has following stages 1. Identification of need 2. Development of solutions to meet the needs (i.e. design facilities) 3. Financing of the facilities 4. The Construction of facilities 5. Operation of facilities 6. Decommission of facilities

From an idea to physical facility, a certain amount of capital is required for its design & construction. Once the physical facility is put into operation after its completion, the project can produce products/ services, which may be sold for revenues to recover capital investment in addition to socio economic benefits.

Pre-DevelopmentDesignConstructionOperation of completed facilityCapitalsSources of fundsRevenuesEndStart

Socio-economic benefitsFigure 2.2: Development Pattern and Cash Flow of Infrastructure Project (Source: JCEM, Feb 08)Hence, the development of infrastructure project involves two components: 1. Allocation of responsibilities of design, build and operation of project. 2. Finance & use of project revenue.As project passes from one phase to the next there are various time points to make decision on task allocations. Key decisions include a decision that who is responsible for financing the project, followed by decisions on who is responsible for the design, construction, and operation of the project. On the basis of above the development of infrastructure projects can be done three ways: 1. Public sector 2. Private sector 3. Public private joint venture

2.4.1 Public Sector Projects: If whole of the project is developed by the public sector including the finance, design, construction & operation, then it is called as public sector projects. 2.4.2 Private Sector Projects: If whole of the project is developed by the private sector including the finance, design, construction & operation, then it is called as private sector projects.

2.4.3 Public private joint venture:In Public private joint venture, a project is jointly developed by public and private sectors. In this mode, the public & private sectors collaborate to combine their strengths and capabilities and agree on a sensible allocation of risks between them.

Management & Maintenance ContractsOperation & Maintenance ConcessionsBuild Operate Transfer ConcessionsFull PrivatizationWorks & Services ContractsPublic Private Partnership

Low HighFigure 2.3: Extent of private sector participation (Source: JCEM, Feb 08)2.5 Public Private Partnership: Privatization is a process in which the delivery of goods and services, usually administered by the government, is shifted to the private sector. Privatization can be divided into primarily three areas: 1. The selling of governmental holdings (i.e., British Airways and British Telecom). 2. The subcontracting of government services to private undertakers (i.e., US Postal Service, park maintenance).3. The subcontracting of financing and developing public facilities (i.e., Channel Tunnel). Public Private Partnership comes under this category.Under a public-private partnership approach, a cooperation between government and private parties is achieved where the government works together with the private sector to provide for public requirements. However, the differences between privatization and public private partnerships are difficult to detect, depending on the level of government participation. Complete privatization has no government participation. 2.5.1 Definition: Private financing and operations of public infrastructures- often also called Public- Private Partnerships or PPPs. PPP is a partnership between the Public sector and the Private sector for the purposes of delivering a project or a service traditionally being provided by the public sector. A host of terms exists to define such partnerships like Private Finance Initiative (PFI as it called in UK), Privatization, Delegated management, Concessions (as generically known in Europe) etc. Given the current economic sate of many developing countries and in order for the government to maintain adequate investments in infrastructure, an enormous burden is placed on public finances. Developing countries spend around US $200 billion in a year on infrastructure investment, of which more than 90% is government- sponsored. Current estimate point to financing needs of about 5.5% of GDP for all developing countries- for both new investment and maintenance expenditures. The financing needs in low income countries can potentially be as high as 7% of GDP. These figures translate into a requirement of US $ 465 billion annually by the developing countries with the demand split almost down the middle between new investments & maintenance. PPP structure enable leveraging of additional sources of funding of infrastructure. These can help to bridge the gap between the forever increasing financial demands for infrastructure especially transports infrastructure and financial shortfall in available public funds. Thus, PPP can help to implement development projects without to having to wait for future government budgetary supports for funding. Key roles of private sector in PPP: There are four key roles for the private sector in PPP scheme 1. To provide additional capital. 2. To provide alternative management and implementation skills. 3. To provide value added to the consumer and the public at large. 4. To provide better identification of needs and optimal use of resources.

Advantages of PPP: 1. Source of additional funding to meet the supply demand gap for funding of new infrastructure.2. Enhance governments capacity to develop integrated solutions.3. Facilitate creative and innovative approaches.4. Reduce the cost to implement the project.5. Reduce the time to implement the project.6. Transfer certain risks to the private project partner and better risk allocation.7. Acceleration of infrastructure provision.8. Reduce whole life costs.9. Better incentives to perform.10. Generation of additional revenues.

However, while PPPs can present a number of advantages, it must be remembered that these schemes are also complex to design, implement and manage.

Table 2.1 Potential advantages of using PPPFinancial AdvantagesEconomic and Social AdvantagesPolitical Advantages

Easing of budgetary constraintsStreamlined construction schedule and reliable projectA new role for the public authority

Optimal allocation and transfer of risk to the private sectorModernization of the economy and improvement of servicesAllocation and not abdication

Realistic evaluation and control of costs implementationAccess to financial markets, combined with the development of local financial marketsProject stability

They are by no means the only or the preferred option and should only be considered if it can be demonstrated that they will achieve additional value compared with other approaches, if there is an effective implementation structure and if the objectives of all parties can be met within the partnership.2.5.2 Types of Contract in PPP:When a decision is made to involve the private sector in the provision of infrastructure, there are various options or procurement routes that can be followed. It is important to consider these various options for private sector participation because the procurement route followed defines which party (public vs. private) will be responsible for various crucial aspects such as the financing of the project. The various options for private sector participation in infrastructure provision are: 1. Service contract 2. Management contract 3. Lease contract 4. Concession contract 5. Built, Operate & Transfer (BOT)

2.5.2.1 Service Contract: The Service Contract is an institutional arrangement whereby a private company is contracted to provide a clearly defined technical task (i.e. a mains rehabilitation exercise, design engineering) or administrative task (i.e. payment collection) for the public sector.

2.5.2.2 Management Contract: With this option, the private sector is paid a fee for operating and maintaining a government - owned business and making management decisions. In service contract the customer remains legally clients of the public sector. 2.5.2.3 Lease Contract: Under the lease option, the private sector leases facilities and is responsible for operation and maintenance in exchange for payments. Public sector doesnt pay any free to the private player (on in contrary, it may receive some) and private partners profits are solely dependent on its own profit. 2.5.2.4 Concession Contract: Under concessions, the private sector finances the project and also has full responsibility for operations and maintenance. The government owns the asset and all full use rights must revert to the government after the specified period of time. 2.5.2.5 Build, Operate & Transfer:

Direct Private UtilityMunicipal UtilityPublic Water PCL ConcessionBOTLease ContractManagement ContractService ContractPublic PrivateOwnershipPublic PrivateManagementThese are similar to concessions but they are normally used for new Greenfield projects. The private sector receives a fee for the service from the users.

Figure 2.4 Types of contract in PPPTable 2.2 Comparative Analysis of Contracts in PPPOptionAsset OwnershipOperations and MaintenanceCapital InvestmentCommercial RiskDuration

Service ContractPublicPublic and PrivatePublicPublic1-2 years

Management ContractPublicPrivatePublicPublic3-5 years

LeasePublicPrivatePublicShared8-15 years

ConcessionPublicPrivatePrivatePrivate25-30 years

Build Operate TransferPrivate and PublicPrivatePrivatePrivate20-30 years

2.6 Build, Operate & Transfer: Build Operate Transfer enables direct private sector investment in large scale projects such as water plants, sewage plants, transport, power plants, etc, and is a relatively new approach to infrastructure development. The theory of BOT is quite simple: Build: A private company/consortium agrees with a government to invest in a public infrastructure project. The company then secures their own financing to construct the project. Operate: The private developer then owns, maintains and manages the facility for an agreed concessionary period (e.g. 20 years, depending on the detail project) and recoups their investment through charges or tolls (e.g. treated fee). Transfer: After the concessionary period the company transfers ownership and operation of the facility to the government or another relevant authority. 2.6.1 Definition: In the BOT approach, a private party or concessionaire retains a concession for a fixed period from a public party; called principal (client), for the development and operation of a public facility. The development consists of the financing, design and construction of the facility, managing and maintaining the facility adequately, and making it sufficiently profitable. The concessionaire secures return of investment by operating the facility and, during the concession period, the concessionaire acts as owner. At the end of the concession period, the concessionaire transfers the ownership of the facility free of liens to the principal at no cost. BOT is a new approach to the infrastructure development. The host government identifies the infrastructure projects that must be constructed and chooses the investors (private companies) from domestic or international society by inviting public bidding and permits the winner to build a project company. The government signs the agreement with the project company. The government grants investment companies operational concession within a period of time and permits them to construct and administrate certain public infrastructure by financing and authorizes them to pay off loans, reclaim investment and make a profit through charges from users or selling products. At the expiration of the concession period, the infrastructure shall be transferred to the government without any expense. In such a legal relation, one subject is the local government and another is the investment enterprise. Their mutual rights, obligations and all relations are established by BOT Investment Contracts. The investment, construction and operation of the BOT projects are constituted by a series of contracts.

GovernProject IdentifyingProject PackingInviting Public BiddingBOT financingBiddingInvestmentOperating ConcessionalProject Design anCcbbCCCCCConstruction ConstructionProject OperationMake a ProfitTransfer the ProjectAccept the Project

Figure 2.5: The BOT Concept

The key characteristic of BOT is private financing. In BOT, the government subcontracts the entire development process, including the associated risks, to the private entity. One of these risks is financing, which must be obtained by the concessionaire, who is ultimately responsible for all aspects of the project.

2.6.2 Variants of BOT: Build-Operate-Transfer (BOT) is a generic term taking different forms. The other major types are Build Operate Own (BOO), Build Transfer Operate (BTO), and Build Lease Transfer (BLT). Build-Operate-Transfer (BOT): The private sector is responsible for design, finance, construction, operation and maintenance of the facility. The title of ownership is retained by the concession company during the concession period. The facility is transferred to the government at the end of concession period Build-Operate-Own (BOO): The private sector is responsible for design, finance, construction, operation and maintenance of the facility. Here the title of the ownership remains with the concessionaire. There is no transfer of ownership to government. Build-Transfer-Operate (BTO): The private sector constructs the facility and transfer the ownership to the government. The concessionaire operates the facility by taking a contract to operate the facility. Build-Lease-Transfer (BLT): The private sector constructs the facility and leases the facility o the government. The facility will be transferred to government at the end of concession period.Project DeliveryConcession period

B.O.T.buildoperatebuild

B.O.Obuildownoperate

B.T.Obuildtransferoperate

B.L.T.buildleasetransfer

Figure 2.6: Analysis of variants of BOT2.6.3 Stages of BOT Projects: The length of the concession period is determined in the concession agreement between concessionaire and principal. Within the concession period, the concessionaire must be able to recover investments for all funding parties. Six stages are identified during the concession period. After the preliminary study, usually conducted by the government, a consortium is chosen following a specific selection procedure. After the selection, the concessionaire starts the implementation of the project by forming the team, executing studies, obtaining permits, and proceeding with design development. Once the design is approved, construction begins. Upon completion of construction, the facility opens for use and the repayment of the facility is covered by the incoming revenues. After a predetermined concession period, the facility transfers to the principal and then state agencies will own and operate the facility. Six stages of BOT projects are: 1. Preliminary study 2. Selection process 3. Project implementation 4. Construction 5. Operation 6. Transfer 2.6.3.1 Preliminary study: The preliminary study usually takes place prior to the involvement of the concessionaire. This stage is executed by, or on behalf of, the principal. Feasibility studies are necessary to prove the forecasted success of the project, in order to attract private funding. Alternatively, a private party may identify a need and initiate the BOT project and in such a case, the preliminary study is conducted by the private entity with limited government involvement. 2.6.3.2 Selection process: The selection process depends on who initiates the project. In a public selection process where the initiative is coming from the public sector (government), a request for qualification is distributed. After receiving applications, the government selects a few consortia to submit proposals (request for proposals) and from these a concessionaire is chosen. During this process, the consortia will group interested parties as required for the efficient and adequate execution of the project. Alternatively, in a speculative selection process, the private sector initiates the project and contacts the appropriate government agency for approval. The project is granted after proper negotiations. 2.6.3.3 Project implementation: After the selection stage and the foundation of the concessionaire, the proposal is finalized. Together with all the involved parties, the concessionaire develops a detailed program and preliminary design, and applies for permits. This process can be shortened if a government agency is actively participating. Once permits are issued, the final concession agreement is signed. During the project implementation stage, in addition to the interests of the involved parties, the interests of the external parties also require attention. The influential power of politics, the opposition, and environmental agencies are significant factors and, if not taken into account, may hinder or even dissolve the project. 2.6.3.4 Construction Once the necessary permits are obtained, construction begins. Often BOT projects are fast track projects where the design is not complete when construction starts. This is feasible because of congruent financial interests within the members of the consortium and the pressing need to complete construction and start collecting revenues. Less controversial designs allow a quicker construction period with fewer uncertainties. 2.6.3.5 Operation During the operation stage, the facility is operated and maintained by the operator who is paid by the concessionaire. The concessionaire, as the owner of the facility during the operation period, is obligated to operate the facility in a manner that adequately services the public user. The concessionaire is also responsible for maintaining the facility in working condition. Both the concession and operation agreements specify the condition of the facility at the time of transfer to the principal.2.6.3.6 Transfer The facility is transferred to the principal, usually at no cost. Transfer time is determined in the concession agreement. After transfer, the principal is the sole owner of the facility and can choose to operate and maintain the facility directly or hire an independent operator. If the principal is the government, it may choose after transfer not to charge the final users anymore. In essence, the facility at that time will have become public, and its maintenance and operation can be funded by indirect taxation. 2.6.4 Major Participants in BOT Projects: Five Major participants are identified in every project. Very simply, the principal grants the concession to the concessionaire. The concessionaire, usually a consortium of companies, undertakes the financing and development of the project. Financing is obtained from sponsors and lenders. The contractor builds the facility and the operator runs the facility. Responsibility for Project

Public Sector Role Private Sector Role

Development Construction Ramp-up Maturity Start of Construction TimeFigure 2.7: Role of Public Private Partnership in BOT projects

There are basically five major participants in BOT project: 1. Host government 2. Concessionaire 3. Investors 4. Contractor 5. Operator 2.6.4.1 Host Government: In a BOT project, the principal is usually a government agency, a local or federal government body that recognizes the need for a public facility but is unable to financially support the project. The government agency is thus forced to look for alternative options. 2.6.4.2 Concessionaire: After the identification of the need for the facility, the government, following a due process, will grant a concession to the concessionaire. The concessionaire is usually a consortium and takes the responsibility of developing (designing, financing and constructing), maintaining and operating the facility, on behalf of the principal. The concessionaire is the owner of the facility during the concession period and realizes profits on the initial investment through the usage of the facility. 2.6.4.3 Investors Financing is supplied by the private sector and the investors include both shareholders and lenders. The shareholders invest money in exchange for equity, and lenders support the concessionaire during negotiations with the principal with promises for loans to be available during the development of the project. Lenders may include banks, insurance companies and bond holders. 2.6.4.4 Contractor The concessionaire commissions a contractor with the construction of the facility. In most cases, the contractor is part of the concessionaires consortium and involvement is favored by all concerned parties. During the early stages of the process the contractors involvement assures the consortium of the most effective and efficient design and execution of the project. Ultimately, the contractor is responsible for the construction of the project and for hiring subcontractors, suppliers and consultants. 2.6.4.5 Operator The operator is also in the concessionaires service and manages the operational stage of the facility. Similar to the contractor, the operator is usually part of the concessionaires consortium, because of the critical role in the revenue stream. In addition, the importance of operating knowledge for programming, financing, design and construction is required.

Table 2.3 Participates & their Primary GoalPARTYPRIMARY GOAL

GovernmentRealization (Serving the public need) with preferably no risk.

ConcessionaireGet the concession granted, make profit.

Sponsor/Share holderMake profits, having a high ROI in relation to the risks taken.

LenderHaving a safe and profitable investment for a long term.

ContractorGetting the project, realizing the facility according to the clients need.

OperatorOperating the facility as efficiently and effectively as possible.

Contractor/UserEconomically feasible to use the facility.

2.6.5 Main Agreements in BOT Projects: A BOT project has following agreements Concession agreement Loan agreement Shareholders agreement Construction contract Supply contract (Equipment/Material/Fuel supply contract) Off-take agreement O & M agreement2.6.5.1 Concession Agreement: The concession agreement is between the government and the concessionaire. The concession agreement is regarded as the "heart" of a BOT project as it determines the commercial viability and profitability. A concession agreement includes the following: The concession period The construction duration Toll/tariff structure with toll/tariff revision provisions Rights and obligations of both parities Government guarantees: The host government offers guarantees to the project promoters (concessionaire) like supporting loans, guarantees of minimum operating income etc.

Concession CompanyGovernmentConcession AgreementOff take ContractConstruction ContractShareholders AgreementLoan AgreementSupply ContractInvestorsBanksRaw Material SupplierOperatorUsers of ProductContractorsOperation Contract

Figure 2.8: BOT project agreement2.6.5.2 Loan Agreement: The loan agreement is between the lenders (i.e. Banks) and the concessionaire. The Banks provide the much necessary debt to the concessionaire. Bank debt is the primary source of financing for a BOT infrastructure project. 2.6.5.3 Shareholder Agreement: The shareholder agreement is between the equity investors and the concessionaire. 2.6.5.4 Construction Contract: The construction contract is between the contractor and the concessionaire. The contract is usually let under fixed price turnkey contract. 2.6.5.5 Supply Contract (Equipment/Material): An agreement between the supplier and the concessionaire. The supplier in a supply contract is often government agency that supplies raw material such as coal to power plant and oil. 2.6.5.6 Off- take Agreement: An agreement between the government and the concessionaire to purchase minimum quantity of services such as electricity, water at fixed price for fixed term.

2.6.5.7 Operation and Maintenance Contract (O & M Contract): An agreement between the concession company and the operator. The operation phase plays a very important role in the success of BOT project as is success is tied to its revenue generating ability. The operation phase of build-operate-transfer projects presents the great management challenge and demands the highest level of attention. 2.6.6 Advantages & Disadvantages of BOT Project: 2.6.6.1 Advantages: 1. Key advantages of privatization are as follows. The private firms are more efficient, hence project or service can be delivered at lower cost. Private firms are more innovative in selection of design and operation phases of a project or service. 2. The private sector invests directly in the development of infrastructure, thereby reducing public debt, balancing the budget deficit, and reduced role of public sector. 3. BOT projects create business opportunities for the local private sector, create employment avenues as well as attract substantial foreign direct investment. 4. BOT projects help in facilitating transfer of technology by introducing international contracts in the host countries. 2.6.6.2 Disadvantages: 1. Transaction costs are high, they amount to 5-10% of total project cost 2. Not suitable for smaller projects. Victorian Government of Australia has suggested that projects with a value of less than Australian dollar $15m are unlikely to gain benefits from BOT delivery method. 3. The success of BOT project depends upon successful raising of necessary finance. Various costs such as cost of construction, equipment, maintenance should be committed during the life of the project. 4. BOT projects are successful only when substantial revenues are generated during the operation phase.2.7 Financing of BOT projects: One of the primary features of BOT is private financing which infers the concessionaire is fully responsible for acquiring the necessary funds to develop and operate the facility. The concessionaire will raise the required funding in debt and equity. The return of investment is realized during the operational stage of the facility.

Cash Flow Product Implementation and ConstructionOperation

Concession Period

Figure 2.9: Cash flow over concession period

2.7.1 Project Financing:

LenderGovernment(Borrower)Project

Loan repayment secured by ablity of Government invests borrowed governemnt to repayfunds in project

Figure 2.10: Corporate financing approach

The term project financing refers to the financing of an economic unit in which a lender looks initially to the cash flows and earning of that economic unit as the source of funds from which a loan will be repaid and to the assets of the economic unit as collateral for the loan. Project financing is an old technique. It was developed in the United States 35 years ago because the borrowers could only offer underground oil reserves as a security. A new technique was created for that purpose where the bankers would lend on the future revenues to be earned from the sale of the oil for only security. The major idea in project financing is that the bank directly shares the project risks with the company. The company is not a debtor of the bank; the project is the debtor. The bank is repaid from the project cash flows and has the project itself as security.

LenderProjectSponsor (s)

Lender has no or limited recourse to other sponsor assets

Figure 2.11: Project financing approach

On the basis of security for the landing, project financing can be divided into two categories.1. Non recourse Financing2. Limited recourse Financing

Non recourse Financing:

The financing is said to be non- recourse if the lenders are repaid only from the cash flow generated by the project or, in the event of complete failure from the value of the project asset.

Limited recourse Financing:

The financing is said to be limited recourse when the project sponsors/government provide undertakings that obligate them to supplement the projects cash flow under certain, limited circumstances.

The ultimate goal in project financing is to arrange a borrowing for a project which will benefit the sponsor and at the same time be completely non-recourse to the sponsor, in no way affecting its credit standing or balance sheet. Project financing is sometimes called off balance sheet financing. Lenders look to forecasted cash flows as collateral for the loan, extensive feasibility and engineering studies are necessary so that the cash flow projections can be relied upon.

2.7.2 Parties Involved in Project Financing:

Mainly five parties are involved with project financing1. Sponsors & Investors2. Lenders3. Government4. Contractors (Construction/ Operating Company)5. Suppliers & Customers

2.7.2.1 Sponsors & investors:

Single sponsor or group of sponsors take a controlling stake in the equity of the company. They are generally involved in the construction and management of the project.

2.7.2.2 Lenders:

A large fraction of the substantial investment needed is usually raised in the form of debt from commercial banks, international financing institutions & bilateral government lenders.

2.7.2.3 Government:

The host government may be providing a part of financing, either as debt, equity of on a standby basis. It or one of its agencies may be purchasing the output of the project or providing the financial guaranties as to revenue. Equity participation by the host government may be useful and may help the host government to feel that the project is being negotiated fairly with the full disclosure.

2.7.2.4 Contractors (Construction / Operating Company):

The main contractor of the plant will often hold a stake in the equity of the project company

2.7.2.5 Suppliers and Customers:

Once the project facility has been built and becomes operational, the project company will need to purchase the supplies it requires and sell the products and services it provides. The government is often the sole customer for some infrastructure projects.

ContractorsSuppliersOther InvestorsGovernmentLendersProjectCompanyProject SponsorsCustomers.

Figure 2.12: Parties involved in project financing

2.7.3 Instruments Used in Project Financing: The choice of financial instruments available to a borrower varies with the type of project financing involved. In terms of structuring levels of debt and equity in projects, it is suggested to use as much debt as the project cash flows permits in order to have high return for the shareholders. There are three general categories of capital and loans used in a project financing: 1. Equity 2. Subordinated debt 3. Senior debt.

2.7.3.1 Equity: The equity investment in a project financing represents the risk capital. Equity investors are the last in priority for repayment; however the upside potential is significant. Lenders look to the equity investment as providing a margin of safety. They have two primary motivations for requiring equity investments in projects which they finance. 1. Lenders do not want the investors to be in a position to walk away easily from the project. 2. The more burden the debt service puts on the cash flow of the project, the greater the lenders' risk. The greatest risk is assumed by equity investors as they are paid last, once all short and long term obligations are met, though, due to the great risk the equity partners assume, a higher return of investment is expected. 2.7.3.2 Subordinated debt Subordinated loans are senior to equity capital but junior to senior debt and secured debt. Subordinated debt has the advantage of being fixed rate, long term, insecure and be considered as equity. A subordinated loan is often used by a sponsor to provide capital to a project which will support senior borrowings from third party lenders. The sponsor may be the owner of the project, or government interested in getting the project built. Sources for subordinated debt include finance companies, risk capital companies, and risk portfolio managers of insurance companies. Subordinated lenders are cash flow lenders. They are unsecured. Subordinated lenders are sensitive to the capabilities of the management of the project to production and market share while servicing debt. 2.7.3.3 Senior debt: Senior debt constitutes the largest portion of the financing. Most borrowings from commercial banks for a project financing are in the form of senior debt. The senior lenders will want a cushion to support their senior debt, may be in the form of subordinated debt of equity. Sometimes host government commit to make subordinated loans available on a standby basis over a certain period of time to provide for senior debt service when & if the project company cash flow is insufficient for such purpose. Some of the main sources of debt financing are multinational agencies, the World Bank, and various regional development banks. The equity to debt ratio is determined by the principal and depends on the financial capacity of the equity partners and their ability to secure long term loans. The debt to equity ratio is usually established at 1 to 4 (20% equity, 80% debt). Due to the higher risks assumed by the sponsors (consortium), a comparably higher return on investments (ROI) compensates the risks. Average ROIs in the studied cases were 15-20% for equity and 8-10% for debt. 2.8 Conclusion: Present Chapter has elaborated about the various development models of infrastructure projects, the concept of Public- Private Partnership and what are the various procurement systems for the development of Infrastructure projects in Public- Private Partnership. Furthermore, difference between BOT and other develop models has been considered. Chapter also provides a depth analysis of various stages involved in the development of BOT projects, major participants, various agreement & various instruments used for financing of Infrastructure projects.3. RISK INVOLVED IN BOT MODEL ROAD PROJECTS

3.1 Introduction:

In any construction project, risks are unavoidable. A risk is defined as any factor, event or influence that threatens the successful completion of a project in terms of time, cost or quality. Any project has a number of identifiable risks. Some are reasonably within the control of one or more of the parties to the project. Others may not be within any party's reasonable control, but may be insurable, at a cost. Still others may not be insurable. The conventional wisdom in project financing generally is that each risk should be assumed by the party within whose control the risk most lies. When making decisions regarding the choice of procurement approach as we move towards fully private, more risk is transferred to the private sector and vice versa.

Every BOT project carries some risk. The challenge is to identify the risks, allocate risk to the party best able to handle it & reduce uncertainty/ risk to an acceptable level. This is called risk management.

Risk Review & MonitorRisk MitigationRisk AllocationRisk AssessmentsRisk Identification

Figure 4.1: Steps in Risk management3.2 Risk Identification in BOT Infrastructure Projects:In BOT Infrastructure projects project participants are exposed to various kinds of risks. As a nature it involves dealing with many parties, huge amount of money, and long period of time, therefore it is said to be very risky.One main cause that leads to project failure is the inappropriate allocation of risks to the various parties in the project. Risk management starts by the identification of various types of risk that could be encountered in a project. In order to identify the risks it is essential to understand what each risk consists of and the reasons for project failure.Reasons for Project Failure are: Delay in completion, with consequential increase in the interest expense on construction financing and delay in the contemplated revenue flow. Capital cost overrun. Technical failure. Financial failure of the contractor Government interference. Uninsured casualty losses. Loss of competitive position in the market place. Financial insolvency of the host government.3.3 Type of Risks:BOT projects undergo significant change in their risk profile as they move from the High risk pre- completion to the low risk post- completion stage. While permitting risks and risks, associated with timely completion of the project dominate the pre- completion period, the primary risk in the post completion period pertains to the ability of the stretch to attract the necessary amount of traffic, and also for commuters to pay the requisite amount of tolls. Pre-Construction Construction Operation

Risk

Project development phase / TimeFigure 3.2: Risk profile in various phases

In BOT project, Project Company is responsible for financing, development, and operation of project. In highway project, Project Company particularly has to face with some major risks.

These risks include:

1. Pre-construction risk: Right-of-way acquisition, environmental compliances.

2. Construction: Design changes, unforeseen geological, delays, cost overruns.

3. Traffic and revenue: Low traffic demands, low toll rates.

4. Performance & operating risk: Failure to operate & maintain the project.

5. Inflation risk: Inflation based on WPI.

6. Currency: Exchange rate fluctuations, inconvertibility.

7. Political: Termination of project, breaches of concession agreement and high tax.

8. Force majeure: Floods, earthquakes and war.

3.3.1 Pre- Construction risk:

It mainly includes delay in land acquisition & environmental compliances. The administrative departments concerned with the project should take the responsibility for obtaining the land acquisition & various clearances for the project. Shifting/ removal of utilities such as trees, telephone lines, sewage lines, etc., are another critical factor. There is a need for simplifying and streamlining administrative procedures and setting up single window clearances.

Awareness for expeditious approvals by various state and local government bodies need to percolate to ground level as well.

3.3.2 Construction risk:

There may be unexpected developments during the construction period which can involve time & cost over runs for the project or even shortfall in the achievement of the technical standards laid down for the given project. The reputation of project contractor consultant as well as the history of road construction in the state is important elements. Normally, the sponsor would sign a fixed price, firm date, turnkey construction contract with the contractor that includes: Completion & performance guarantees Liquidated damages for delays Bonus for early completion.

The price of the turnkey project is, of course, increased by a risk factor to compensate the contractor for taking this risk. Construction risk is assumed secondarily by the project company, and indirectly by its equity investors, since their equity will be eroded to the degree that costs are increased due to delays or cost overruns which are not covered by damages from the contractors.

3.3.3 Traffic & revenue risk:

In respect to toll roads, the project concessionaire has to deal with individual users and the traffic volume risks are expected to be borne by him. Risks associated with toll roads are primarily dependent on the following factors: The economic utility of the stretch: Projects, which serve a captive demand, for instance stretches, which connect to ports or city bypasses, which relieve congestion levels carry relatively lower levels of traffic risks.

The availability of alternate freeways and other competing modes of transport, to which traffic diversion could take place.

The composition of traffic along the stretch.

Sensitivity of various user segments towards payment of tolls.

Toll road projects are very sensitive to Traffic demand risk. In order to attract private company to invest, government may assume the risk to some degree by providing supports to project company.

3.3.4 Performance & operating risk:

Operating risk is the risk that the project will not conform to the required performance parameters over the period of the concession agreement. Typically, the performance parameters specified in the concession agreement are driving quality of the carriage way, safety standards, adherence to maintenance schedule, and availability standards as mentioned in the concession agreement. Non-compliance with the performance parameters can be an event of default and may impinge on the developers ability to collect tolls.

The risk that the project will not perform as expected will be covered by warranties from the consortium of construction contractors and equipment suppliers and by performance guarantees in an operating and maintenance contract. In each case, these risks are substantially within the control of the parties assuming them.

3.3.5 Inflation risk:

For the risk that arises out of inflation both equity investors & lenders will normally insist to government on some mechanism to protect themselves against inflation risk. This protection may be provided by price escalation clauses in the off-take agreement or by provisions in the concession agreement allowing the project company to increase tolls. For example toll road projects. Such price escalation clauses would attempt to take account of increased costs of the project due to inflation.

3.3.6 Currency risk:

There are two types of Currency risks; one is the Convertibility; i.e. the assurance that revenues generated in domestic currency can be converted into Foreign Exchange for making payments abroad or for the transfer of profits in case of foreign investments. The government would need to provide guarantee for such convertibility. The other risk is the Variation in the exchange rate. The government must provide guarantees against such risk.

3.3.7 Political risk:

Political risk is sometimes the most significant risk faced by foreign investors and lenders in developing countries because of the likelihood sudden political change. Such changes can jeopardize projects at a critical stage. Political risk is associated mostly with public sector projects. It includes the possibility that governments will not allow repatriation of funds, as well as regulatory or legislative changes that occur during project construction. Usually, political risks are difficult to control. Many developers involved in public sector transportation projects require the government to provide strong backing and expectations of high traffic flow.

Providing tax-exempt financing is a commitment that the government can make to help mitigate this risk in domestic projects. Organizations like the Overseas Private Investment Corporation (OPIC) provide expropriation insurance to alleviate foreign political risk. Other organizations also provide insurance against political risk such as the MIGA (World Bank).

3.3.8 Force majeure:

Force majeure risks represents the losses which are beyond control of the parties to the project arising from the events such as fire, flood, earthquake, war, riot & strikes, etc. some of the risks can be mitigated by covering them through insurance. For the rest they have to deal with as expected. The concession agreement should provide for extension of the concession of the concession period for such a situation or even termination if the circumstances so dictate.

3.4 Allocation of Risks:

From these eight types of risks, major groups that can generate enormous impact to project success are Traffic and revenue, Currency, Inflation & Political risks. These are called Country risks. Therefore, government normally provides support to these types of risks. Support schemes are explicitly written in the concession agreement between government and Project Company. Risks other than country risks are called Project specific risks. These are to some extent are controllable by the project sponsors.

Every BOT project carries some risk. These risk to be managed through proper appreciation of their impacts on various players and allocation to the parties who are best able to control them, i.e. deal with them at least cost.

Table 3.1: Country & Project risksProject specific risks

Risks other than country risks are called Project specific risks. These are to some extent are controllable by the project sponsors Construction Performance & operating risk

Country risks:

Risks which are associated with the political, economic and legal environment of the host country and over which the project sponsors generally have little or no control.

Government normally provides support to these types of risks. Pre-construction risk Traffic and revenue Politic Currency Inflation risk

Most of the risks that are present in BOT Road projects can be shared between Government & the project company. The challenge is to reduce the uncertainty to an acceptable level and allocate responsibility to the party best able to handle it.

Table 3.2 Risk allocation between various partiesRiskAllocation

CompanyGovernment

Pre- construction

Construction

Traffic & Revenue

Performance & Operating

Inflation

Currency

Political

Force Majeure

3.5 Risk Mitigation:

Risk response and mitigation is the action that is required to reduce or eliminate the potential impact of risk. There are two types of response to risk one is the immediate change or alteration to the project, which usually results in the elimination of the risk; the second is contingency plan that will only be implemented if risks identified should materialize.

Risk IdentificationSeek for risk-mitigating solutionsAppraise new or residual risksEvaluate or price risksRisk monitoring and control

Figure 3.3: Risk management processRisk management process

The options for responding to risk are risk avoidance, risk reduction, risk transfer, insurance, risk retention, each should be assessed as one or more will apply in every circumstance.

3.5.1 Risk Avoidance:

This method of mitigation involves the removal of the cause of the risk and therefore the risk itself. Ideally any approach involving avoidance is best implemented by the consideration and adoption of an alternative course of action. Other examples of risk avoidance include the use of exemption clauses in contracts, either to avoid certain risks or to avoid certain consequences flowing from the risks. Risk avoidance is most likely to take place where the level of risk is at a level where the project is potentially viable.

3.5.2 Risk Reduction:

This method adopts an approach whereby potential exposure to risks and their impact is alleviated. Methods of risks reduction may require some initial investment which should then reduce the likelihood of the risk occurring. Risk reduction occurs where the level of risk is unacceptable and alternative action is available.

Risk reduction exercises will always be worthwhile because they can lead to greater knowledge about the project and this reduced not only the potential impact of risks but also the level of uncertainty itself a major source of risk. However, risk reduction will result in an increase in the base cost (i.e. the estimate of all certain items) but should offer a significantly greater level of contingency required. It goes without saying that risk reduction should only be adopted where the resultant increase in costs is less than the potential loss that could be caused by the risk being mitigated.

3.5.3 Risk Retention

Once all the avenues for response and mitigation have been explored a number of risks will remain. This does not imply that these risks can be ignored; indeed it is these risks which will in most instances undergo detailed quantitative analysis in order to assess and calculate the overall contingency levels required. The aim of the previous responses is to reduce project uncertainty and in doing so increase the base estimate to reflect the more certain nature of the project. However, it does not imply that these retained risks can simply be ignored. Indeed, they should be subject to effective monitoring, control and management to ensure that they are within the contingency allowances set. It should be noted that this contingency should be made up of residual risks which are assessed to be of a low likelihood and low potential impact.

3.5.4 Risk transfer:

Risk transfer is the technique that plays a far greater role in infrastructure development projects and involves the complete or partial transfer of risks among the various parties involved in the implementation of the project. This is achieved through the web of documents that is formulated during the course of implementation of infrastructure projects. The documentation structure provides for the flow of risk transfers that are negotiated and agreed to in the course of development of an infrastructure project. For example, the construction risks would, typically, be transferred by the government to the private developer under the concession agreement. The private developer would then transfer all or most of the construction risks to the construction consortium under the construction contract. The construction consortium would distribute and transfer the risks among themselves or to various sub-contractors.

3.6 Risk Mitigation Techniques:Various Risk Mitigations Techniques are available and can be divided into three categories which are as follows:

1. Contractual solution for Project Company2. Government support3. Insurance

3.6.1 Contractual Solution for Project Company:

3.6.1.1 Turnkey Construction contract:

Completion, cost overrun and other risks typical of the construction phase are usually allocated to the construction contractor or contractors through a turnkey construction contract, whereby the contractor assumes full responsibility for the design and construction of the facility at a fixed price, within a specified completion date and according to particular performance specifications. The construction contractor is typically liable to pay liquidated damages or penalties for any late completion.

3.6.1.2 Performance Guarantee:

In addition, the contractor is also usually required to provide a guarantee of performance, such as a bank guarantee or a surety bond. Separate equipment suppliers are also usually required to provide guarantees in respect of the performance of their equipment. Guarantees of performance provided by contractors and equipment suppliers are often complemented by similar guarantees provided by the concessionaire to the benefit of the contracting authority.

3.6.1.3 Operation and Maintenance Contract:

Similarly, the project company typically mitigates its exposure to operation risks by entering into an operation and maintenance contract in which the operating company undertakes to achieve the required output and assumes the liability for the consequences of operational failures.

3.6.2 Government Support:

To minimize the above risks in BOT projects government provides some supports to the project company. There are mainly eight categories of government financial support given to Project Company:

3.6.2.1 Equity guarantees:

This kind of guarantee gives Project Company a right to sell the project to the government with a guaranteed minimum return on equity.

3.6.2.2 Debt guarantees:

Under this guarantee, government provides a full guarantee or a cash-flow deficiency guarantee for repayment of debt.

3.6.2.3 Exchange rate guarantees:

Fluctuation of currency can create significant impact on project which involved foreign capital. By the guarantee, government compensates the Project Company for increases in local cost of debt service due to exchange rate movements.

3.6.2.4 Grants and subordinated loans:

Government can help in enhancing project economics by providing non-repaying grants or subordinated loan. Subordinated loan will be repaid to government after the senior loan. At such time, project would normally be in the relieved financial stage.

3.6.2.5 Shadow tolls:

In this system, government, instead of users, pay a specific annual payment per vehicle corded on the road to Project Company. The shadow tolls can be made into several rates depending on demand volume.

3.6.2.6 Minimum traffic guarantee:

Government will compensate to Project Company in cash if traffic falls below a specified minimum level. This is the common type of support in BOT project. In some case, besides the minimum guarantee, the contract may specify ceiling traffic level too.

3.6.2.7 Concession extensions:

Government may give right to Project Company to extend the concession term if revenue falls below a specified level. This type of support give less financial exposure to government, but also give less efficiency in easing financial status of Project.

3.6.2.8 Revenue enhancements:

Government normally enhances project revenue by limiting competition, facilitating demands, or allowing development of ancillary facilities.

These eight types of government support have different features. Following figure shows impact in project financing and government financial exposure of each type of the supports and the government has benefit sharing from the excess volume too.

3.6.3 Insurance:

Insurance is a form of risk management primarily used to hedge against the risk of contingent loss. It is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for a premium, and can be thought of a guaranteed small loss to prevent a large, possibly devastating loss.

The term 'insurance' does not refer to the various warranties, liquidated damages, indemnities, etc. which may be offered by contractors, operators, host governments, or others. Rather, it means the contractual undertakings by third-party insurers to indemnify project participants for certain types of risk. Although insurance cannot create the blanket protection from risk that many project developers seem to feel it should, it is an essential part of any BOT project.

Some type of insurances used in BOT projects are:

1. Political risk insurance2. Force majeure risk insurance

3.6.3.1 Political Risk Insurance:

Multinational enterprises and banks face a number of risks when conducting business overseas. Some of these risks can be removed or mitigated by conducting due diligence on the parties involved and on the economic viability of the proposed business. Other risks are harder for investors or lenders to predict. These include some commercial risks and, noncommercial- or political - risks. Political Risk Insurance (PRI) is a tool for businesses to mitigate and manage risks arising from the adverse actions - or inactions - of governments.

As a risk mitigation tool, PRI helps provide a more stable environment for investments into developing countries, and to unlock better access to finance. Political risk insurance is generally provided by various multilateral agencies such as MIGA (Multilateral Investment Guarantee Agency) & OPIC (Overseas private Investment Corporation).

1. MIGA (Multilateral Investment Guarantee Agency):

The Multilateral Investment Guarantee Agency (MIGA) is a member of the World Bank Group. Its purpose is to promote foreign direct investment by providing political risk insurance (guarantees) to investors and lenders, and by helping emerging economies attract private investment. MIGA offers political risk insurance for projects in a broad range of sectors in 147 developing member countries, covering all regions of the world.

Political risks covered under MIGA are:

1. Currency inconvertibility & transfer restriction.2. Expropriation.3. War and civil disturbance.4. Breach of contract.Terms of coverage:

MIGA prices to risk, and premium rates are decided on a per project basis. MIGA provides coverage for up to 15 years (and possibly 20 years if justified by the nature of the project).

Amount of coverage:

For equity investments, MIGA may guarantee up to 90 percent of the investment, plus up to an additional 450 percent of the investment contribution to cover earnings attributable to and retained in the investment.For loans and loan guaranties, the agency generally offers up to 95 percent of the principal (or higher as determined on a case-by-case basis), plus up to an additional 135 percent of the principal to cover interest that accrues over the term of the loan.For technical assistance contracts and other contractual agreements, MIGA may insure up to 90 percent of the total value of payments due under the insured agreement (up to 95 percent in exceptional circumstances).

2. OPIC (Overseas private investment corporation):

The Overseas Private Investment Corporation (OPIC) is an agency of the United States Government established in 1971 that helps U.S. businesses invest overseas and promotes economic development in new and emerging markets.Through OPIC Political risk insurance is available only to U.S. investors, contractors, exporters and financial institutions involved in international transactions. Political risk insurance can cover currency inconvertibility, expropriation and political violence, and is available for investments in new ventures, expansions of existing enterprises, privatizations and acquisitions with positive developmental benefits.

Political risks covered under OPIC are:

1. Currency Inconvertibility2. Expropriation3. Political Violence4. Standalone Terrorism

3.6.3.2 Force Majeure Risk Insurance:

Force majeure risks represents the losses which are beyond control of the parties to the project arising from the events such as fire, flood, earthquake, war, riot & strikes, e.t.c. some of the Force majeure risks can be mitigated by covering them through insurance.

Some of the firms which provide insurance for Force majeure risks are:

1. New India Assurance2. SERV (Swiss Export Risk Insurance)3.7 Conclusion:

Road projects developed on BOT basis are exposed to various kinds of risks. As a nature it involves dealing with many parties, huge amount of money, and long period of time, therefore it is said to be very risky. This present Chapter elaborates the various risks involved, how these risks are allocated to various parties involved mainly in between concessionaire & how these risks are mitigated. Following Chapters contains the details of concession agreement & financial analysis of Road projects.