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Cities Development Initiative for Asia

Basic Course on Public-Private Partnerships (PPP) for

Municipalities:

Training for Facilitators

Trainer’s Materials

17-20 July 2012 in Bangkok, Thailand

CDIA

© The Cities Development Initiative for Asia (CDIA)

CDIA is a multi-donor Programme established in 2007 to assist medium sized Asian cities to bridge the gap between their development plans and the implementation of their infrastructure investments. CDIA uses a demand driven approach to support the identification and development of urban investment projects in the framework of existing city development plans that emphasize with focus on environmental improvement, pro-poor development, good governance, and climate change.

All rights reserved.

Basic Course on Public-Private Partnerships (PPP) for

Municipalities: Training for Facilitators

Trainer’s Materials

© Cities Development Initiative for Asia (CDIA)

July 2012

Disclaimer This document is part of a training course on Municipal Public Private Partnerships, and has been developed for pedagogical purposes only. Its use or citation in any other context without the prior written authorization from CDIA is not permitted. Information from several reputable sources was used in the elaboration of this document to serve as examples for illustration of concepts or as case studies. However, CDIA cannot guarantee the accuracy of the information provided by those sources. The views expressed in this document are solely those of the authors and do not necessarily reflect the position or policy of the CDIA Funding Agencies.

CDIA’s Short PPP Training for Facilitators i

TABLE OF CONTENTS

TABLE OF CONTENTS ......................................................................................................................................... I

TABLE OF FIGURES ........................................................................................................................................... II

TABLE OF BOXES .............................................................................................................................................III

FOREWORD ..................................................................................................................................................... 2

1 WHAT IS AND WHAT IS NOT A PPP ........................................................................................................... 6

2 WHAT IS IMPORTANT............................................................................................................................... 8

3 URBAN DEVELOPMENT AND BROADER DEVELOPMENT GOALS ............................................................. 10

4 PPPS ARE PARTNERSHIP PROJECTS ........................................................................................................ 14

5 THE PPP STAKEHOLDERS ........................................................................................................................ 16

6 BENEFITS AND DOWNSIDES ................................................................................................................... 18

6.1 Infrastructure Challenges ......................................................................................................................... 19

7 THE IMPORTANCE OF BANKABILITY ....................................................................................................... 24

8 VALUE FOR MONEY ................................................................................................................................ 26

8.1 Quantitative value for money assessment ............................................................................................... 27

8.2 Qualitative value for money assessment.................................................................................................. 28

9 MAKING PROJECTS ATTRACTIVE ............................................................................................................ 30

10 TYPES OF URBAN PPP PROJECTS......................................................................................................... 36

10.1 Types of PPPs ............................................................................................................................................ 36

10.2 Sectors where PPPs can be applied .......................................................................................................... 37 10.2.1 Urban Transport ..................................................................................................................... 38 10.2.2 Public utilities ......................................................................................................................... 41 10.2.3 Public Services and Social and Public Infrastructures ............................................................ 44

11 IDENTIFYING PPP PROJECTS ............................................................................................................... 50

11.1 Project ideas ............................................................................................................................................. 51

11.2 Project selection ....................................................................................................................................... 51

12 WHAT IS NEEDED TO UNDERTAKE A PPP ............................................................................................ 52

13 LEGAL CONSIDERATIONS .................................................................................................................... 54

13.1 Civil law ..................................................................................................................................................... 55

13.2 Common law ............................................................................................................................................. 56

14 RISK MANAGEMENT ........................................................................................................................... 60

14.1 Risk identification ..................................................................................................................................... 60 14.1.1 Project Risk ............................................................................................................................. 60 14.1.2 Country-specific risks ............................................................................................................. 61 14.1.3 Municipal risk ......................................................................................................................... 62

14.2 Risk management ..................................................................................................................................... 62 14.2.1 Risk Qualification .................................................................................................................... 63 14.2.2 Risk Mitigation ........................................................................................................................ 64 14.2.3 Risk allocation ......................................................................................................................... 66

15 THE SPONSORS ................................................................................................................................... 72

15.1 Identification of projects .......................................................................................................................... 74

15.2 Consortia formation ................................................................................................................................. 74

CDIA’s Short PPP Training for Facilitators ii

15.3 Offer preparation...................................................................................................................................... 75

16 PROJECT FUNDING ............................................................................................................................. 76

16.1 SPV’s financial structure ........................................................................................................................... 76

16.2 Financing structure ................................................................................................................................... 77

17 LENDERS ............................................................................................................................................. 82

17.1 Loan characteristics .................................................................................................................................. 82

17.2 Project Finance ......................................................................................................................................... 83

17.3 Project Finance’s risk management .......................................................................................................... 84

18 THE PROJECT CYCLE ............................................................................................................................ 88

18.1 The project cycle stages ............................................................................................................................ 89

18.2 Project logistics ......................................................................................................................................... 90

18.3 Project team and governance structure ................................................................................................... 91

18.4 External advisors....................................................................................................................................... 91

18.5 Project plan and time-table ...................................................................................................................... 91

18.6 Project preparation .................................................................................................................................. 91 18.6.1 Pre-Feasibility Study ............................................................................................................... 92 18.6.2 Feasibility study ...................................................................................................................... 92 18.6.3 Tendering documents ............................................................................................................ 92

18.7 Project procurement ................................................................................................................................ 92 18.7.1 Prequalification of bidders ..................................................................................................... 93 18.7.2 Requests for Proposal (RFPs) ................................................................................................. 93 18.7.3 Bid evaluation ......................................................................................................................... 94

18.8 Project follow-up ...................................................................................................................................... 94

18.9 Project ending ........................................................................................................................................... 95

TABLE OF FIGURES

Figure 1. PPP Stakeholders ................................................................................................................... 16

Figure 2. Relationship between stakeholders ....................................................................................... 17

Figure 3. Source: PPP Reference Guide. World Bank Institute and PPIAF ............................................ 19

Figure 4: Project Finance vs Corporate Finance.................................................................................... 25

Figure 5. Value for Money .................................................................................................................... 27

Figure 6: PPP readiness in Asia-Pacific: ................................................................................................. 55

Figure 7: Civil Law and Common Law main features ............................................................................ 55

Figure 8: Different laws can affect PPP projects .................................................................................. 56

Figure 9: Risk evaluation matrix ............................................................................................................ 63

Figure 10: Risk allocation in an urban tunnel........................................................................................ 67

Figure 11: Risk allocation in a housing project ..................................................................................... 68

Figure 12: Cash Flow and Project Finance I .......................................................................................... 83

Figure 13: Cash Flow and Project Finance II ......................................................................................... 83

Figure 14: Stages of a PPP project ........................................................................................................ 89

CDIA’s Short PPP Training for Facilitators iii

TABLE OF BOXES

Box 1: Is this a PPP agreement? ............................................................................................................ 7

Box 2: How can PPP help urban development? .................................................................................... 11

Box 3: How can PPP be a successful partnership? ................................................................................ 15

Box 4: Parking in Medolang: Who are the stake-holders? ................................................................... 18

Box 5: Is PPP a good solution? .............................................................................................................. 20

Box 6: SPV's characteristics ................................................................................................................... 25

Box 7: Example of bankability and capital structure. Alandur Sewerage Project ................................. 26

Box 8: Is PPP procurement superior to the PSC? .................................................................................. 28

Box 9: Are the benefits-costs easy to measure? ................................................................................... 29

Box 10: Parking in Medolang: Making the project attractive ............................................................... 31

Box 11: Mass Rapid Transit: Bangkok Skytrain. Thailand ..................................................................... 39

Box 12: Infrastructure: Kuala Lumpur Smart Tunnel, Malaysia ............................................................ 40

Box 13: Alandur Sewerage System, India.............................................................................................. 42

Box 14: Water Supply Metro Manila, Philippines ................................................................................ 43

Box 15: Please try to identify ................................................................................................................ 46

Box 16: How does project analysis answer the following questions? .................................................. 52

Box 17: Making a PPP come true ......................................................................................................... 53

Box 18: Regulation by the law or by the contract................................................................................. 56

Box 19: UNESCAP principles in risk management ................................................................................. 62

Box 20: Risk qualification in a Subway PPP project .............................................................................. 64

Box 21: Asian Development Bank (ADB) Credit Enhancement Products .............................................. 65

Box 22: Infrastructure Debt Fund (IIDF) ................................................................................................ 65

Box 23: Risk mitigation measures ......................................................................................................... 66

Box 24: Risk sharing .............................................................................................................................. 67

Box 25: Risk allocation .......................................................................................................................... 68

Box 26: What are the sponsors’ tasks? ................................................................................................. 73

Box 27: Consortium formation ............................................................................................................. 75

Box 28: SPV’s characteristics ................................................................................................................. 76

Box 29: Capital structure: Who comes last? ......................................................................................... 77

Box 30: What is more expensive? ......................................................................................................... 78

Box 31: What are the main stages in a project cycle? .......................................................................... 88

Box 32: PPP development and implementation process according to PPIAF (World Bank) ................ 89

Box 33: How does the project cycle in your country differ? ................................................................. 90

Box 34: Prequalification of bidders in social housing ........................................................................... 93

Box 35: Follow-up of the social housing PPP project ............................................................................ 94

CDIA’s Short PPP Training for Facilitators 1


FOREWORD

PURPOSE, TARGET AUDIENCE, AND KEY MESSAGES

CDIA’s PPP Guidelines for Municipalities has received all kinds of compliments and positive recognition among its users and peer organizations for its clarity and simplicity. However, our goal was not only to make it easy to read and understand, but also make it an instrument for readers to learn how to deal with the opportunities that PPPs can bring to small and medium size cities in Asia in a safe and sound manner.

The training was designed to complement the Guidelines providing more than just words and additional readings but also practical and real-situation exercises for participants to have a drill on the concepts.

This training was not designed for PPP practitioners or people who will devote their careers entirely to the development of PPP projects, but for those that have not been exposed to this contractual scheme before or those with little knowledge of it. It was designed for city officials at the municipal level with different concerns and anxieties in the implementation of this model from the ones that were traditionally using PPP.

The objective of this training for facilitators is to present as it would be presented to its final users. In this way they can see themselves in the role of final participants evaluating the effectiveness that this training can bring to their particular context.

ORGANIZATION OF THIS GUIDEBOOK

Following the structure of CDIA’s PPP Guidelines for Municipalities, the training is divided in different sessions covering three parts:

In “Basis”, the fundamentals of the PPP model, including definitions and key principles, are described in a practical manner. It provides guided questions and exercises for participants to understand and get familiarized with the concepts, and their translation to the circumstances of the local governments.

In “Approach”, insights on how local governments can go about deciding whether or not to pursue a PPP approach are provided. A review is given on how a PPP scheme is different from a traditional publicly-financed project. It also describes the different positions of each individual player participating in the process.

In “Process”, the training provides a complement to the Guideline and an introduction to what the real process of engaging in a project under a PPP scheme entails.

B A S I S A P P R O A C H P R O C E S S

SECTION 1

PART 1

B A S I S


SESSION 1

BASIS I


Trainer general instructions

This session is an introduction to PPPs and the course. Main ideas that should be delivered to participants are: • Not all procurement involving a private partner is a PPP • PPP procurement involves financing from the private sector as well as risk sharing between the local authorities and the private partner • To make a successful PPP there are many necessary ingredients – all participants must obtain something • Even though PPP transfers many duties to the private partner, local authorities remain at all times responsible for the project, the services provided and its outcome • PPP procurement can be very helpful to local authorities as an urban development tool – stretching public funds, bringing private sector efficiency…

Public Private Partnership (PPP) is not a new concept, but as old as the need for infrastructures. Public Authorities have traditionally engaged with the private sector to develop public services and infrastructures using typical supply contracts or other forms of procurement instruments that share budgetary funding as a common characteristic. PPP procurements, in turn, demand from private participants not only their managing and implementation abilities but also their financing capacity. Public infrastructures, in general, require a significant investment and subsequently long-term agreements to make them commercially viable. That makes PPP contracts far more complex than traditional procurement contracts, demanding from the participants’ additional experience and capacities.

1 WHAT IS AND WHAT IS NOT A PPP

Trainer suggested readings

• “CDIA PPP Guide for Municipalities,” City Development Initiative Asia, June 2010. Section 1: Introduction to Public Private Partnerships (PPP) (page 4) • “Public-Private Partnership Handbook”, ADB, 2008. Section 1: Public Private Partnerships (PPPs) – An Overview (page 1) • “Public-Private Partnerships Reference Guide, Version 1.0”, PPIAF, 2012 Key Definitions: What is a PPP? (page 11) Section 1.2.1: PPP Contract Types (page 36)

PPP are long term contracts between a Public Authority and a private partner to provide a public infrastructure or service in which the private partner bears significant financial and management responsibility. PPP contracts share the following features:

Risks are shared between the public and private participants

Risks are allocated through contracts between the partners and/or the specific legislation, if any

The private partner is expected to finance and/or operate a public infrastructure or to provide a public service

The private partner expects to recover his investment and to obtain a reasonable return


The Public Authority retains property, service responsibility and the right to terminate the contract

The Public Authority is expected to assure that the PPP contract provides the best possible return on the investment made amongst all the available procurement alternatives

The PPP concept encompasses many different procurement alternatives itself, depending on what its role is (duties, responsibilities, rights…). Consider, for instance, the following examples:

A toll road that must be built from scratch: the private sponsor has to finance, design, build and operate the infrastructure.

A toll road that is already built but needs an upgrade: the design and construction aspects are less relevant than on the previous example.

A toll road that has already been built and upgraded by the Local Authorities, who decide to lease it to the private sector for a certain period of time: the private sponsor needs only to finance and operate the infrastructure.

PPPs are usually not limited to obtaining financing from the private sector – some responsibilities (as well as the associated risks) are, in many cases, transferred as well. The following contractual agreements between the public and private sectors are, in most cases, not considered PPP contracts:

Service contracts, regardless the payment mechanisms, where the private partner assumes no operating responsibilities

Management contracts, where the private partner assumes no financial risk

Divestiture or privatization of public assets, where property is transferred

Assignment of management to a publicly owned enterprise, where there is no private partner assuming operational and financial risks.

Trainer instructions Box 1

The first box is a very easy one, but is important in order to introduce some basic concepts (risk transfer, collaboration, private and public active participation). It is suggested that the box is solved collectively during the session, one question at a time. To make the session more participative, the trainer can ask for a volunteer to provide an answer and provide the reasons. Other participants can then give their opinions.

Take your time to explain each answer and resolve all doubts; the course can be speeded up later.

Box 1: Is this a PPP agreement?

In your local town, there is a Public Bureau in charge of water supply on exclusive terms. In accordance with your legislation, the local government could allow private companies to supply water.

The water supply infrastructure requires significant investment and better management, and your local government is evaluating different alternatives. Please provide some advice pointing out whether the following alternatives are a form of PPP or not:


Transforming the Water Supply Bureau into a state-owned company that will borrow money from the banks and provide the service on a commercial basis.

Yes No . The Water Supply Bureau is still owned by a Public Authority

Carrying out the investment with public funds and reaching an agreement with a private partner for the management of the water supply service.

Yes No This is an example of a management contract where the private partner assumes no financial risk. Some PPP guides may consider it a PPP if remuneration is subject to performance indicators. Transferred risks, however, are limited.

Transforming the Water Supply Bureau into a publicly and privately owned company (the shareholders being the local authority and a private partner selected by public tendering). The company will borrow money from the banks and provide the service on a commercial basis.

Yes No The private partner bears significant financial and operational risks a as part of a mix capital company.

Reaching an agreement with a private partner for the construction of the needed infrastructure and the management of the water supply service. Funds will be provided by the local government and by the private partner.

Yes No This is a typical PPP agreement. The existence of a certain level of public finance does not change this fact. The private partner still bears some financial risk as well as operational risk.

Selling the Water Supply Body to a private investor together with an allowance to supply water.

Yes No This is an example of a divesture. Privatizations are not considered PPP. The relationship between the Authority and the private investor after the sale is a normal Authority/private enterprise relationship.

The CDIA’s PPP Guide for Municipalities includes broader definitions of PPP and a list of relationships between the Public Authority and private partners that are not considered PPPs.

2 WHAT IS IMPORTANT

Trainer instructions

In this section we are going to present some basic topics that will be explained in detail in the course of the succeeding sessions. It is important that participants understand what is important and why. Participants can be asked to determine what elements they consider important in PPP procurement, although normally they will not be able to do it. It may be easier to have them help justify why the topics outlined by the trainer are important.


• “CDIA PPP Guide for Municipalities,” City Development Initiative Asia, June 2010. Section 2: What are the main principles of PPPs? (page 5) • “Public-Private Partnership Handbook”, ADB, 2008. Section 1: Public Private Partnerships (PPPs) – An Overview (page 1) Section 3.1: Requirements and expectations (page 11)


In a PPP agreement, the Public Authority transfers management and decision- making powers to the private partner during a normally long period of time, and the private partner bears significant risks and assumes long-term commitments. The Public Authority and the private sector need to build up a different type of association beyond the classical client-procurer relationship. They must become longtime partners sharing the risks and revenues of the project. When identifying, appraising and developing a PPP project, there are many things that must be taken into consideration. Some of them have to do with basic urban development needs, therefore:

PPP should help achieving public goals. PPP agreements are a powerful and efficient tool which local governments have at their disposal. But still only a tool. If the usage of PPP in a certain project does not help urban development, does not support broader development goals or does not answer to users’ and citizens’ needs better than normal procurement, then said project may not succeed.

There is a more or less formal procedure that helps in deciding whether PPP is the better procurement option for a certain project: Value for Money.

PPP requires private partners. PPP agreements need the participation of private parties. To ensure that participation, the local authority must identify the potential partners, arouse their interest and design attractive and balanced PPP projects that take their needs and worries into consideration.

PPP requires private funds. One of the main features of PPP contracts is that they aim to raise private funds for public needs. Private lenders analyze carefully any potential investment, especially large and risky investments such as those required by PPP projects.

In order to be financed, PPP projects must be bankable, meaning they are capable of providing sufficient profit to the potential lenders to appear as a good investment option. In order to attract both private partners and private funds, PPP projects must go through an efficient and consistent risks identification, allocation and mitigation process.

Public Authority keeps responsibility and liability. The Granting Authority maintains in, all cases, the responsibility for delivering the services under its authority, and should make sure that the project is properly carried on in its behalf. Furthermore, even if the private partner assumes the complete financial risk, the Public Authority usually maintains economic liability.

The Public Authority must carry out a constant and efficient supervision and monitoring of the private partner performance throughout the project. All these concepts will be explained in detail in the following chapters, with examples to make them more comprehensive.


3 URBAN DEVELOPMENT AND BROADER DEVELOPMENT GOALS


• “CDIA PPP Guide for Municipalities,” City Development Initiative Asia, June 2010. Section 3: Do PPPs support broader development goals? (page 9) • “Public-Private Partnership Handbook”, ADB, 2008. Section 1.2: Motivation for engaging in PPPs (page 3) • “Public-Private Partnerships Reference Guide, Version 1.0”, PPIAF, 2012 Section 1.1: Infrastructure challenges and how PPPs can help (page 15)

The CDIA’s PPP Guide for Municipalities describes, in its introduction, the infrastructure needs and the public services shortfalls common to most Asian cities. It also exposes the main reasons for local governments’ inefficiency in providing adequate urban services and infrastructures. The Guide also describes how PPP procurement, by means of their many potential advantages, can support broader development goals such as reducing poverty, improving living conditions and providing environmental improvements. It focuses on the positive environmental impact of financial, management and technical improvement provided by efficient PPP agreements. PPPs have experimented a continuous growth in the last decades as they seem to be an effective answer to some of these public sector’s difficulties. Some of the reasons for this success are that PPPs:

reduce public deficit and debt. Concessional PPP contracts allow investing with limited indebtedness and impact on public accounts.

reduce public risks and liabilities. PPP agreements transfer significant risks to private partners reducing risks and liabilities supported by the Authority.

use private efficiency. Incorporating market criteria into the procurement results in better managed projects.

stretch public funds further. Local Authorities can make the most out of limited funds by taking advantage of private financial capacity, as shown in Figure 5 of CDIA PPP Guide for Municipalities.

bring investments forward. Stretching public funds permits providing more and better services

are implemented faster. Contractors are incentivized to implement projects faster to bring revenues forward.

have costs that are more predictable. Projects have a turn-key approach. The project financial plan includes the whole life costing for the fixed period including upgrade requirements, thus costs are extremely predictable.

All in all, PPP procures powerful tools for local governments to face their increasing needs and to improve urban development. Among many others, the following goals can be achieved:

Reduce transportation costs and increase efficiency

Provide clean water and sanitation to more people at a lower cost

Improve the quality of public services and public equipment

Find original tailor-made solutions for urban development challenges


Carry out pro-poor actions by including them in wider projects

Reduce project environmental impact

Save budgetary funds for non-self-sufficient investments

Trainer instruction Box 2

It is suggested that the box be solved collectively during the session, one question at a time. To make the session more participative, the trainer can ask for a volunteer to give an answer and provide the reasons. Other participants may then share their opinions.

Box 2: How can PPP help urban development?

In the following situations, can PPP help?

The city government has limited funds (90) and faces large investment needs (300 for 3 different projects)

Yes No Stretched funds bring investment forward .The government can use funds in the project(s) that are needed and take advantage of additional funding through the private initiative.

The city government has no indebtedness capacity due to its public deficit.

Yes No Reduces public deficit and debt. PPP is a way of obtaining private finance. Besides, a project structured as a concessional PPP contract will not impact public accounts.

The city government believes the legal procurement procedure does not help selecting efficient bidders.

Yes No The government faces a problem that cannot be solved using PPP. It requires an improvement of the procurement procedure.

Facing a complicated tunnel project and having limited expertise, the city government fears the project will result in significant cost overruns.

Yes No Reduced public risks and liabilities & costs are more predictable. Through a PPP agreement, the city government can transfer construction risk to a private partner and have a more accurate cost prediction.

The city government cannot afford to solve the lack of proper water supply utilities in the poor areas of the city with public resources.

Yes No PPP allows carrying out pro-poor actions by, for instance, including them in a wider Water Supply project, taking advantage of private management efficiency.


SESSION 2

BASIS II



This session is focused on PPP basic issues. Main ideas that should be delivered to participants are: • PPPs are partnership projects and should be faced in a much more collaborative way than traditional public procurement projects. • There are many actors involved in a PPP project, and they should all be taken into account. • PPPs have potential benefits and downsides. We should try to take advantage of benefits and avoid downsides. Knowing them will help to determine if PPP procurement is the best option for a certain project.

4 PPPS ARE PARTNERSHIP PROJECTS


• “CDIA PPP Guide for Municipalities,” City Development Initiative Asia, June 2010. Section 2.1: The importance of the third “P” - Partnership (page 5) • “Public-Private Partnership Handbook”, ADB, 2008. Section 3.7: Clear Sector Strategy and Road Map (page 24) Section 3.8: Clear Government Commitment and a Designated Champion (page 26) • “Public-Private Partnerships in Housing and Urban Development”, United Nations Human

Settlements Program, 2011. Building strong relationships through Clear Communication (page 17)

PPP projects are based on collaboration between a public partner, who is responsible for the procurement of a certain infrastructure or public service, and a private partner, who is willing to play an active role in the procurement process by means of assuming some significant operational and financial responsibilities. PPP relationships require cooperative contracts. The public and private partners must work together all the way through the project, and that stretches over a long period of time. Given the long duration of PPP contracts, previously identified, or even unexpected risks, will eventually arise. The private sector and the Authority must work together to overcome the difficulties when they arise, doing it in a creative and flexible way. CDIA’s PPP Guide for Municipalities includes a typical tasks distribution between the public and private partner, but in truth there are limitless possibilities on the distribution of tasks and responsibilities. What should be always taken into consideration is that PPP projects involve several stakeholders with different objectives and capacities. The PPP agreement should try to involve all stakeholders, align their objectives with those of the project and provide a proper framework for a collaborative performance.


This box focuses on building up confidence between partners - a basic requirement in order to develop a successful PPP project. It is suggested that the box be solved collectively during the session, one question at a time. To make the session more participative, the trainer can ask for a volunteer to give an answer and provide the reasons. Other participants may then share their opinions.


Box 3: How can PPP be a successful partnership?

PPP agreements should take into consideration the main principles of collaborative agreements:

Mutual trust: Transparency and capacity

Commitment:

Solid long term PPP programs with wide politic support. Budgetary and fiscal commitment. Understanding of PPP projects

Dialogue:

Flexible contractual agreements that include provisions for unexpected situations

Constructive approach:

PPP permits imaginative and creative solutions. Take advantage of having private firms searching for the best possible one.

Win-win basis:

In a PPP project success is impossible to achieve alone. If the private partner does not do well, the project is a potential failure.


5 THE PPP STAKEHOLDERS


• “CDIA PPP Guide for Municipalities,” City Development Initiative Asia, June 2010. Who are the stakeholders in a PPP? (page 20) • “Public-Private Partnership Handbook”, ADB, 2008. Table 2: Role of Different Stakeholders in the PPP Process (page 21) Figure 3: The Range of Stakeholder Interests in PPPs (page 22) • “Public-Private Partnerships in Housing and Urban Development”, United Nations Human

Settlements Program, 2011. Relationships with lenders and other parties (page 8)

CDIA’s PPP Guide for Municipalities identifies the typical stakeholders involved in a PPP process:

Figure 1. PPP Stakeholders

Since no two PPPs are alike, other stakeholders may be involved as well: construction companies, service managers, insurance companies, labor unions… Some specific aspects to PPP procurement (the need to focus on partnership; the way market rules affect project feasibility; the often complicated bidding process; bidder selection criteria…) oblige to take all parties involved into consideration in all phases, starting from project identification. Broadly speaking, the main players in a PPP and their role are the following:

Local Authority (or Public entity): The entity responsible for the facility or service object of the agreement. Sometimes Public Authorities contribute to the project with assets (ie. providing parking space for trucks on a waste transportation concession) or funds (becoming share-holders in the concession)

Sponsors: usually private companies. It is common practice that sponsors gather in groups (consortia) – Several consortia then enter the bidding process and can leverage on the


strengths of the sponsors behind it. Once the project is awarded, they constitute what is called a Special Purpose Vehicle (SPV), a company for the only purpose of developing the project. Sponsors governs the SPV, provide its equity and receive the eventual dividends.

Financial Institutions: the lenders that provide enough funds to the SPV to face the investment, usually in the form of debt. Local authorities may also require funding from financial institutions in the event the project requires public financial support to achieve bankability.

Contractor: the specialized companies responsible for the construction and/or management of the project. Often they are also sponsors of the SPV.

Users: the final users of the facility or service.

National or Regional Government: Responsible for issuing regulations and laws that affect the PPP agreement. They may eventually have to approve the project or provide public funds.

Dealing with parties that have such different natures and pursue such different goals adds complexity to PPP agreements. However, all of those stakeholders are necessary in order to achieve success and a poor performance by any of them can result on the project failure. The following chart represents the relations between the main stakeholders in a typical PPP project.

Figure 2. Relationship between stakeholders

In the graph above all the depicted stakeholders are related to the Special Purpose Vehicle (SPV), which stands in the center. SPVs and their characteristics will be described in detail later on.


This box is the first one that refers to the “Parking in Medolang” case study. Consider if you should make a summary or let the participants review the information provided. Participants should name all possible stakeholders apart from the main ones, which we have already detailed. The objective is to realize how many stakeholders can be affected by a PPP project, how complex the relationships between them can be and how that affects the project.


Box 4: Parking in Medolang: Who are the stake-holders?

Please refer to the “Parking in Medolang” case study.

Can you identify the project’s stakeholders, assuming that a PPP is used for procurement? Focus specially in those that do not figure on the graph above.

Business owners close to the new parking

Granting authority

Concession company

Lenders

Construction companies

Business owners close to the new parking (construction phase and operation phase)

Other parking facilities owners in the area

People living nearby that may be affected by the public works or the noise…

6 BENEFITS AND DOWNSIDES


• “CDIA PPP Guide for Municipalities,” City Development Initiative Asia, June 2010. Section 4: Are there downsides to PPPs? (page 10) • “Public-Private Partnerships Reference Guide, Version 1.0”, PPIAF, 2012 Section 1.1: Infrastructure challenges and how PPPs can help (page 15) • “Public-Private Partnerships in Housing and Urban Development”, United Nations Human

Settlements Program, 2011. Chapter 3: The Advantages and Disadvantages of PPPs (page 3)

Most potential benefits of PPP have been already exposed so far in this document and on CDIA’s PPP Guide for Municipalities. The following figure summarizes challenges faced by local authorities when facing infrastructure procurement, how PPP procurement can help overcoming these challenges, and how traditional procurement deals with these challenges.


6.1 Infrastructure Challenges

Figure 3. Source: PPP Reference Guide. World Bank Institute and PPIAF

So, if PPP has so many potential advantages, are there any downsides to PPPs? We shall review some key aspects that make PPP procurement complex:

Mindset change in Local Authorities: with more traditional procurement alternatives Public Administrations act as “buyers” – hiring contractors to build a road for instance. When using a PPP scheme, the public sector needs to become a “seller”, that is, to convince sponsors of the attractiveness of the project – focusing on cash-flows and risks.

Additional studies: compared to traditional procurement, PPPs require extra-work on the Local Authorities side. Besides developing the project’s technical aspects, a study showing the business behind and its attractiveness needs to be carried out.

Complex implementation: Going from a PPP in paper to a real PPP is a complicated task. Even when an Administration knows what it wants, still it must ensure that nothing is left out, that risk allocation is efficient, that contracts reflect the risk allocation that was planned, and so on.

Local Authorities capacities: The mindset change and the “business case” above mentioned require special capabilities, which are not always present on the Public Sector. Is there an expert on risk allocation in the office? Does anyone know how to put that optimal risk allocation in the contract? Who can tell the correct price for this infrastructure and this level of risk? Do we have contacts in the market to test our ideas?

In short, PPPs are essentially more complex than traditional procurement. The potential benefits are great, but PPP projects which aren’t well prepared may attract an inefficient or opportunistic private partner, and turn potential advantages into effective disadvantages: construction cost over-runs, delays, poor service for the user… PPP procurement, as any other powerful tool, is dangerous if poorly used. Many PPP contracts end up in disputes, re-negotiation, exorbitant revenues or bankruptcy. Let us expose some basic recommendations to keep in mind when developing a PPP project:

Insufficient funds

Poor planning and project selection

Inefficient management

Inadequate maintenance

Additional sources of funding and financing

Improving project and service delivery

Improving maintenance

How PPPs can Help

What’s wrong with infrastructure?

Increasing fiscal resources

Improving public decision-making

Improving governance

Improving regulation

Non-PPP Alternatives or Complements

Low coverage, low quality, low reliability

Better infrastructure performance

Private sector analysis and innovation


Be informed. Every city is different and every project needs a tailor made solution, but positive experiences in other cities are always a good starting point. Do not try to be too innovative at once if you lack the experience.

Be pragmatic. PPP is no magic wand. Do not forget that a society has a limited payment capacity. Make the most out of it.

Be moderate. PPP schemes where too much risk is transferred (or kept) or too much private funds are attracted (or too few) will probably not work.

Get involved. Do not expect the private partner to do your job. Supervision and monitoring is essential for achieving success.


The objective of this box is to show that project analysis is important to take advantage of potential PPP benefits and avoid PPP downsides. It is suggested that the box be solved collectively during the session, one question at a time. To make the session more participative, the trainer can ask for a volunteer to give an answer and provide the reasons. Other participants may then share their opinions.

Box 5: Is PPP a good solution?

In the following situations, is PPP a good solution?

The city government needs funds for a project but wants to carry out project management directly during both construction and operation

Yes No Only seeking private funding

The city government has repeatedly failed to tender good quality projects even with help from private consultants.

Yes No PPP can help in developing better projects: the specialized private partners can usually provide better solutions and comprehensive projects

The city government needs funds for a project but there are no potential private partners that can manage project risks better than the authority.

Yes No A PPP awarded to a mixed capital company can be a good solution, as the concession company would have both the managing ability from the authority and the private finance.

Private parties are reluctant to bear significant risks and demand wider government guarantees.

Yes No If the PPP contract does not transfer significant risks to the private partner, the potential benefits of PPP will not be reached.

The city government is facing reelection and the main opposite candidate has rejected the usage of PPP.

Yes No The potential private participants may be reluctant to bid for a project that does not have wider political support.


SESSION 3

BASIS III



This session is also focused on PPP basic issues. Main ideas that should be delivered to participants are: • BANKABILITY: Project’s revenues and cost structure must be enough to convince lenders to finance the project. • VALUE FOR MONEY: In order to be used, PPP procurement should be superior to other procurement alternatives. A Qualitative assessments is relatively easy to carry out, intuitive and, in most cases, sufficient. • MAKING PROJECTS ATTRACTIVE: A bankable project that provides Value for Money cannot be developed if private partners do not participate. Projects must be structured in order to arouse stakeholders’ interest. In some cases that will require consultation.

7 THE IMPORTANCE OF BANKABILITY


• “Public-Private Partnership Handbook”, ADB, 2008. Section 6.4.1 Project Financing (page 56) • “Public-Private Partnerships Reference Guide, Version 1.0”, PPIAF, 2012 Section 1.3.2.1 Bankability (page 48) • “The Guide to Guidance”. EPEC, 2011 Section 1.2.3 Bankability (page 11)

PPP schemes are an interesting and useful solution for solving one of urban development main challenges: overcoming the lack of finance by opening to private participation and financing. But where does the money that the private sector brings come from? There are two main categories, which together make the “capital structure” of the SPV:

Equity: These are the funds that belong to sponsors, and that they decide to allocate into the SPV.

Debt: The funds that sponsors have are usually not enough to cover all the investments and initial costs. They need to convince external financiers (usually banks) to give a loan to the SPV.

When granting a loan, banks need guarantees in order to make sure it will be repaid. In PPPs, banks would require as a guarantee the cash flow generated by the project alone, plus the fact that when money comes into the SPV they are paid before the SPV’s shareholders. This scheme is known as “Project Finance”, since the project is the only guarantee banks rely on to be re-paid. If the project goes wrong, banks cannot turn to the SPV’s sponsors to get their money back. The following figure shows the difference between project finance and corporate finance


Figure 4: Project Finance vs Corporate Finance

So, if lenders will rely on the project alone to be repaid, they will want proof that the project is very robust, that it is a good business, which even if things do not go as well as initially forecasted, they will still get their dues.

Box 6: SPV's characteristics

Special Purpose Vehicles are companies with a set of very particular characteristics:

They can only pursue the objective they’ve been initially set-up for (for example the financing, construction, operations and maintenance of a road).

They are created after the PPP contract has been awarded –and thus have no previous track-record

In their capital structure lenders have usually much more weight than sponsors (ratios of 60%-40% or even 80%-20% are not uncommon).

SPVs are insulated from their parent companies: They are not for example affected by the bankruptcy of the parent company, or the parent company is not responsible for the SPV’s debt.

A project is “bankable” when, thanks to analysis and studies, it is capable of convincing lenders to make a loan to the SPV. Lenders take several aspects into consideration when analyzing projects, aspects related with the expected return (that depends on future cash flows) and the project risks. Lenders will study every aspect of the project to make sure it is a safe bet. They will then make a decision of whether or not they want to put money into it, how much should they charge (that is, what should be the interest rate) and how much money are they willing to lend. Project preparation is crucial to help a project be bankable: a realistic operative, economic and financial plan, a balanced risk allocation, and above all the certainty (bear in mind that nothing is 100% sure) that the cash flows will be enough to re-pay lenders, even should some contingencies arise. It should be pointed out that lenders’ expectations can be very volatile – this means that a project that is bankable at one point in time may suddenly become un-bankable because lenders are no longer sure they will get their money back and ask for more guarantees (this can happen for instance if a similar PPP in the region goes bankrupt and lenders experience losses). These additional guarantees can sometimes be beyond those offered by the SPV in traditional “Project Finance” schemes – guarantees that the lenders will put more money into the SPV under certain circumstances, or that the public sector will pay them back if the project fails for instance.


Box 7: Example of bankability and capital structure. Alandur Sewerage Project

The Alandur Sewerage Project was the first sewerage system and waste water treatment facility developed in India as a PPP project.

This project managed to obtain a loan from private sector financial institutions amounting to 59% of the capital needs – the project was thus bankable.

The project’s capital structure was the following:

Equity 12%

Term loan 59%

Public contribution 29%

Said Public contribution refers to one-time deposits in the form of connection charges collected from the citizens prior to the construction.

It should be noted that lenders are paid BEFORE sponsors, thus reducing effectively the risk they assume.

8 VALUE FOR MONEY


• “CDIA PPP Guide for Municipalities,” City Development Initiative Asia, June 2010. Section 2.3 “Value for money” – the many advantages of PPPs (page 7) • “Public-Private Partnerships Reference Guide, Version 1.0”, PPIAF, 2012 Section 3.2.3 Assessing Value for Money (page 138) • “The Guide to Guidance”. EPEC, 2011 Section 1.2.4 Value for money analysis (page 12)

In order to decide if a project should be developed as a PPP, the local authority should first find out if the infrastructure project itself is sound. Value for money is a practical way of deciding whether a project should be procured by means of a PPP agreement or using a different type of procurement agreement In any way, it does not replace the project pre-feasibility and feasibility studies that should be carried out simultaneously if they are considered necessary1. Obtaining Value for Money in a certain project means achieving the optimal combination of benefits and costs when delivering the expected facility or service, once we have stated that said investment has a positive impact in the city development.

1 For more information about feasibility analysis for urban development projects please refer to CDIA Pre-

Feasibility Study Guidelines and CDIA City Infrastructure Investment Programming & Prioritisation Toolkit. Obviously the procurement alternative affects the feasibility study. Feasibility and Value for Money analysis are usually developed simultaneously following an interactive methodology.


CDIA’s PPP Guide for Municipalities includes a very intuitive definition of the concept base on comparing the potential advantages provided by PPP procurement and those linked to traditional direct procurement.

Figure 5. Value for Money

This definition helps understanding how Value for Money can be analyzed, that is by comparing the advantages provide by each possible procurement alternative. Also it must not be forgotten that usually there is not a single PPP procurement option but several ones. Thus Value for Money analysis can also help finding out which PPP procurement option suits a certain project better. Most of the advantages provided by both PPP procurement and direct procurement are difficult to measure in a way they can be compare with each other. There are several approaches to measuring and compare Value for Money. All of them are either quantitative assessment, qualitative assessment or a mixture of both. 8.1 Quantitative value for money assessment

The most common and widely used tool for Value for Money quantitative analysis is the Public Sector Comparator (PSC)2. The PSC is based on comparing the fiscal cost of the PPP procurement option with that of the traditional public procurement option. In some regards PPP procurement is superior to the PSC, and in others not.


The objective of this box is to point out in which aspects PPP procurement is more economically efficient than traditional procurement alternatives, and the complexity of PSC analysis. After solving the box, ask participants if they think they could efficiently measure the costs detailed when analyzing a potential PPP project.

2 PSC was originally developed in the United Kingdom for the assessment of the Private Finance Initiative

program in the early 1990s.


Box 8: Is PPP procurement superior to the PSC?

For the following cost items in a project, is PPP procurement cheaper than the PSC?

Transaction cost

Yes No PPP procurement involves additional preparation and effort (external advisors…)

Investment cost

Yes No The private partner will tend to minimize investment needs and will not be able to take advantage of project mistakes and deficiencies.

Operating cost

Yes No The concession company will take operation costs into consideration when designing the infrastructure in a more efficient way than the authority or a private designer.

Overseeing by the Authority

Yes No Supervision needs to be more efficient in PPP projects, as they tend to transfer wider management and decision making responsibilities.

Maintenance cost

Yes No As in operating costs

Financing cost

Yes No Since the private partners are bearing more risks, they will also demand a higher remuneration which will result in higher financing costs.

In some occasions, there will be no public procurement option for a project. That is the case if the city has public indebtedness constrains. In other cases PPP procurement may have previously proved to be a more (or less) efficient way of procurement for a certain type of services in a certain type of cities, such as public waste management. In those cases there may be no real need to carry out a complex quantitative value for money assessment. This type of analysis requires specific expertise on a Public Administration or its consultants, which is not always available. Quantitative value for money analysis are extremely complex, costly and of dubious efficiency. Thus, they may not always be needed or worth the cost. 8.2 Qualitative value for money assessment

Besides the financial benefits that quantitative Value for Money Analysis tries to reflect, a PPP project can provide important benefits and costs that are hard to measure.


The objective of this box is to understand what kind of benefits and costs are analyzed in a quantitative value for money analysis.


Projects may provide other benefits and suffer other costs as seen in the box below. The box should be considered a non-exhaustive list.

Box 9: Are the benefits-costs easy to measure?

Identify in the following chart, for the proposed infrastructure, the financial and non-financial benefits and costs (regardless of procurement alternative).

Source: EPEC, “The non-financial benefits of PPPs”.

Are those benefits and costs easy or hard to quantify?

Amongst the most important non-financial benefits of PPP procurement are the following: Accelerated delivery: Projects can be brought forward in time when using a PPP procurement alternative. The reasons behind are:

- Transfer of construction risk to the private sector: When the construction risk is correctly transferred to the private sector, construction delays are usually assumed by the SPV’s sponsors – “no service – no payment”.

- Non-reliance on public funding: Since PPPs are financed thanks to private sector funding they do not need to wait for an opening in the public budget.

- Enhanced delivery: This refers to the enhanced quality of the infrastructure and associated services delivered. There are three reasons why PPP procurement can enhance procurement:

- Applied life-cycle approach and assured maintenance: The project is analyzed in a wide time-frame, encompassing the construction and the operation and maintenance phases. This helps to better assess the real cost of the project and prepare for it.

- Transfer of operation and maintenance risk: PPP projects usually involved a clear definition of expected quality standards to be delivered by the private sector, ways to measure them, and the penalties (or bonuses) to be applied in case they are not reached (or surpassed).

Financial benefits

Financial costs Non-financial benefits Non-financial costs

Roads Toll revenues Capital and maintenance

costs

Time savings Reduced accident

costs

Noise and pollution from

generated traffic Light rail

Fare-box revenues

Capital and maintenance

costs

Reduced commuter time

Congestion during

construction Prisons

Reduced revenue costs


costs

Less overcrowding No rioting

Improved security

Local property prices

Schools Energy cost

savings


costs

Improved educational outcomes

Increased congestion

around schools


- Strict governance structure: As compared to more traditional procurement alternatives, PPP projects have not only the Local Authorities but at least the sponsors and the lenders to keep an eye on the project. This can result in better management.

- Wider-social impacts: The benefits associated with PPP procurement can affect non-users as well as users of the infrastructure and related services. Some examples are the increased capacities developed by Local Authorities to implement these complex projects, the development of business opportunities for domestic companies, public funds are stretched further allowing other projects to be carried out…

These benefits are difficult to quantify but can be very important nevertheless. Qualitative value for money assessments can be very helpful pointing out these benefits. Qualitative value for money assessment can thus be an alternative or a complement to quantitative analysis.

9 MAKING PROJECTS ATTRACTIVE


• “CDIA PPP Guide for Municipalities,” City Development Initiative Asia, June 2010. Section 6.2 How would potential investors view the project? (page 14) • “Public-Private Partnership Handbook”, ADB, 2008. Section 3.6 Stakeholder Consultation (page 20) Section 6.7 Stakeholder Involvement (page 67) • “Public-Private Partnerships Reference Guide, Version 1.0”, PPIAF, 2012 Section 3.2.2 Assessing Commercial Viability (page 137)

Successful PPP urban development projects rely, to a large extent, in the ability of local authorities to develop an attractive project. Private sponsors cannot be forced to participate on a certain PPP, but rather must be persuade. If enough qualified private companies are willing to participate in the project as sponsors and financiers, the project can face the tendering and execution phases with confidence: It is easier to select the desired bidder among a large amount of qualified tenderers. A competitive tendering process usually results on lower project costs and a more robust agreement. Project supervision and monitoring tasks are normally eased and less problematic with the right sponsors and financiers. But what must the local authority or city government do in order to develop attractive projects? Let’s try to step into the private sponsor’s shoes and focus on some of the key elements they may consider, and what the Local Authorities can do to help:

Cost of analyzing the opportunity: For a private company to study a PPP project and to enter the bidding process can have very important costs. The Local Authorities should do their best to lower these costs as much as possible, preparing and facilitating relevant information, presented in a professional way and mistake free. Also, potential bidders must be certain that if they present a good offer they have possibilities of winning (they will not be “cheated out”).


Uncertainties: Uncertainties are aspects of the project that are not defined, or situations and events that may have a very negative impact on the project but that are difficult to quantify (as opposed to risk, which can be measured and priced). Local Authorities should make the project uncertainty-free.

Risk allocation: Can the sponsors manage effectively the risks that Local Authorities want to assign them? If not, they will either refuse to bid, or put such a high price to the project that it may not be affordable for the Local Authorities or users.

Remuneration: Sponsors are willing to participate into a PPP to make money. The higher the risks they assume, the more money they will demand. If too little compensation is offered by Local Authorities, then most likely they will not be interested.

Bankability: Even if all the above requirements are met, sponsors still need to convince lenders to give them money. The project must be attractive not only to sponsors, but to lenders as well (as described in a previous chapter).


The objective of this box is to make participants conscious of the many different problems a project can face in order to attract private interest and to teach them how to face said problems in a constructive way.

Participants may realize that problems often have to do with the efficiency and capacity of the public administration and the lack of commitment of the involved or affected stakeholders. The exercise can lead to a discussion, preferably related to said topic.

Box 10: Parking in Medolang: Making the project attractive

Please refer to the “Parking in Medolang” case study.

After adopting the decision to use a PPP as a procurement alternative for the parking, the following issues have been identified:

Medolang Municipal Government has a reputation for awarding contracts to four local contractors, without a transparent tendering process.

Establishing a public, transparent and non-discriminatory procedure is crucial. Involving a Multilateral agency to ensure the tendering is fair could be a strong guarantee for potential bidders.

The parking lies on terrains that belong to the Local Authorities, but which are currently occupied by a public school.

Having clear plans about where will the public school be transferred, when and how is the project going to be financed seems necessary. Public commitment from local authorities is a plus.

There are elections coming up in two years, and the opposition party has shown its discontent with this project.

The opposition party needs to be boarded into the project. Consult with them to understand their issues and how the project could be modified to find a solution.

There was an earthquake five years ago that destroyed several buildings.

Local authorities need to assume force-majeure risks, or else require the concession company to insure against this risk and include the cost of said insurance in the PPPs financial plan.


Some neighbors, which will be affected by the project in several ways, are very well organized. In the past they’ve organized many public acts and manifestations, even forcing the city major to reconsider some of the decisions already taken

Have these citizens manifest their concerns about the project in the public consultation stage. Have a meeting with them to point out the project’s advantages.

How can these issues be overcome to make the project attractive?


PART 2

A P P R O A C H


SESSION 4

APPROACH I



This session is devoted to showing examples of PPP projects. It should not be consider as an exhaustive list of sectors and projects in which PPP can be applied. The objective is to pass on to participants the idea that PPP is a flexible procurement option that can be used for almost any kind of PPP project, not just for the ones listed here. Some other important ideas are: • Similar projects in similar countries are always a useful reference, but each project is unique, especially when we are talking about PPP projects. It is not recommended to copy project structure due to the complexity of PPP procurement. • If you are not a PPP expert, do not try to be too innovative at the beginning. It is recommended to start to use PPP with simple projects that have already worked in the country or the region, and to develop them in a similar way, taking local circumstances into consideration. • Similar projects have common features and you should know them. Reviewing successful projects is useful, but reviewing unsuccessful projects can be even more useful, as similar projects tend to fail due to the same kind of problems. • There are some types of risks that private partners fear the most, such as expropriation or demand risk. Even experienced administration fail to manage such risks correctly so you must be especially careful with projects involving these kinds of risks, such as urban transport projects.

10 TYPES OF URBAN PPP PROJECTS


• “CDIA PPP Guide for Municipalities,” City Development Initiative Asia, June 2010. Section 5: In what sectors can PPPs be applied? (page 12) • “Public-Private Partnership Handbook”, ADB, 2008. Section 1: Specific Pro-Poor Activities in PPPs (page 81) • “Public-Private Partnerships in Housing and Urban Development”, United Nations Human

Settlements Program, 2011. Chapter 11: Patterns in applying the PPP model to housing and urban development

(page 22) • “Cities PPPs”, Handshake #4, International Finance Corporation, 2012. Public Transport (page 40) and Urban water (page 54)

PPPs are a very powerful and flexible procurement alternative. As such, there are many different types of PPPs which can, in turn, be applied to many sectors.

In this chapter we shall explore these two aspects.

10.1 Types of PPPs

PPP contracts were originally applied in projects where users paid tariffs or tolls generating enough return for the investments made. This is the case of a toll road.

Later on, they were applied in projects where the Public Authority assumed payment obligations on behalf of the users, known as “shadow toll”. This was due to the fact that sometimes citizens have a limited payment capacity, but the project generates benefits to society that justify the public resources that are allocated (such is the case, for instance, of many public transportation systems like subways).


In both cases payments are linked to the usage of the infrastructure or service provided and revenues are determined by the usage, which is related to the performance of the private partner as operator.

PFI is another kind of PPP contractual scheme3, where the Public Authority assumes repayment obligations based on prefixed project milestones and/or performance standards. This allows extending the scope of PPP agreements to a wider range of sectors (like public buildings to host administrative offices).

In summary, and just to illustrate the flexibility of PPP procurement, we’ve pointed out the different types of PPPs one can have considering:

If sponsors assume demand risk, or are paid a fixed amount (minus penalties) depending on the quality of services provided.

If sponsors are paid by the citizens or Local Authorities

10.2 Sectors where PPPs can be applied

Almost any urban infrastructure project could be developed under a PPP modality in a more or less creative way; legal restrictions being the ultimate boundary.

Each urban infrastructure sector has, however, its own characteristics, opportunities and challenges. PPPs are easier to implement in some sectors than in others, depending on social, economic and financial parameters. For instance, the PPP will need to clearly define in a simple way, easy to verify, some quality parameters – this can be easily done in a road project, but is much more complex in a hospital project.

Broadly speaking, PPPs can be categorized in three different sectors: Transportation, Utilities and Services. As a reference we enclose a table with different kinds of projects for which PPPs have been used within each sector category:

Transportation Utilities Services

Roads & Bridges

Rails (urban and non-urban)

Ferries

Bus Rapid Transit

Transport hubs and terminals

Ports

Airports

Water treatment and distribution

Sewage system and wastewater treatment

Solid waste treatment

Power generation and distribution

Central heating and cooling systems

Hospitals and jails

City government offices

Sports facilities and auditoriums

Police and fire stations

Libraries

Schools and University dormitories

We will review these sectors and their characteristics in the following chapters, with a special focus on the urban environment.

3 Private Finance Initiative (PFI) developed initially by the governments of Australia and United Kingdom in the

1990s.


10.2.1 Urban Transport

In developed countries, PPPs have emerged as an effective tool for the construction, expansion, maintenance and operation of transport infrastructures. Especially in those where users’ payments can offset a significant part of the cost of provision.

Urban transport projects cover very different types of infrastructures, from relatively simple bus line projects to complex and expensive metro lines, so they have less common features than other types of projects. That said, urban transport projects have some common particularities:

They require significant investments, which need long-term PPP agreements to recover said investment.

Demand risk is always one of the key elements in the feasibility of the project, therefore, of great importance.

Measuring the quality of the operation and maintenance provided by the private partner is fairly easy and transparent

Pro-poor differential rate settings and cross subsidies require more sophisticated payment methods.

Several transport projects have been successfully developed in Asia in the last decade under PPP agreements.

TRANSPORT 425

• East Asia and Pacific 123

• Europe and Central Asia 31

• Middle East and North Africa 17

• South Asia 254

Concessions and Greenfield projects with private investment 2001-2011

Source: World Bank PPI Database


Box 11: Mass Rapid Transit: Bangkok Skytrain. Thailand

Background

In 1992 Bangkok had 9 million citizens and chronic congestion problems.

There was no PPP regulation and no financial capacity.

Several MRT had been projected and never developed.

There were no public funds, just land.

The project

The local government decided to launch an MRT project as a PPP contract.

No feasibility studies were made as they were not mandatory at the time – just capacity, area and undefined technology.

The awarded bidder was a very experienced project developer that changed the project with a long term scope.

Demand was one-quarter as forecasted.

The project’s outcome was a great success for users and a disappointment for sponsors and lenders4.

4 “Success and failure in urban transport infrastructure projects”, Allport R.; 2008


Box 12: Infrastructure: Kuala Lumpur Smart Tunnel, Malaysia

Background

Annual flooding problems in an urban area with heavy traffic.

Extremely complex location due to the proximity to the Klang and Gombak rivers.

A possible solution is a mixed used tunnel: a tunnel to divert and store the storm water that allows traffic flow when empty.

The local government had public funds but lacked the capacity to develop the project.

The project

The project was launched as a PPP contract for the construction and 40 years management of the tunnel.

The government kept the construction delay risk and transmitted the construction cost overrun risk, which it was not able to manage.

Urban transport is a key development issue where private participation can provide a positive impact. Local governments should be careful when allocating risks, because default projects mean big economic and political losses for the authority and that can make a mark that will turn down the participation of private parties in future projects for long periods of time.

Some other recommendations and findings are the following:

Main lesson to learn is that each type of urban transport project is different.

Transport projects require significant investment, so they also require experienced parties, both on the private and on the public side.

Default is often related to demand risk. Demand studies are especially important. Mitigation measures should be considered carefully.

High quality private design and management capacities, a creative scope and effective collaboration are helpful in order to achieve success.


10.2.2 Public utilities

Public utilities are one of the main urban development challenges of Asian cities. Water supply, sanitation, solid waste treatment and power supply are basic needs that are often insufficiently covered: in many cities there are water and electricity shortages, or the sewage system doesn’t cover entire parts of the city. The rapid growth experienced in the past has often aggravated these problems, and local governments frequently lack the funds to face the investment requirements.

Public utilities are excellent candidates for PPP agreements: they collect fees from users (who are already used to paying), the quality of the service provided is easy to measure, project size is reasonable (not too big or small)… Thus they are among the most common forms of infrastructures build and operate under PPP schemes at a city level. A significant number of PPP public utilities projects have been developed in the region over the last decade.

WATER AND SEWERAGE 347




• South Asia 7

ENERGY 646




• South Asia 214

TELECOMMUNICATIONS 99




• South Asia 31

Concessions and Greenfield projects with private investment 2001-2011

Source: World Bank PPI Database

Public utilities main common features are the following:

They tend to be natural monopolies, that is, there isn’t room for more than one profitable provider in the market. So instead of competition “in the market”, they are well suited for competition “for the market” (that is, a PPP project)

The average project size is well suited for a PPP project (neither too big nor too small, circumstances that present problems to be discussed later on)

There usually exists a “payment for the service” culture, which can help finance the project partially (or totally in some cases)


PPP schemes can support pro-poor differential rate settings and cross subsidies

The potential impact of management improvements is very significant

The impact of inefficient public supervision can be especially negative

Public utilities often face resilience to paying. For instance, added value of an improved sewerage or a wastewater treatment plant is not easily discerned, so users tend to reject payment of direct fees for said services.

Box 13: Alandur Sewerage System, India

Background

Alandur is part of Chenai urban area, and had 130.000 residents in 1997.

The CMWSSB was responsible for all water and sanitation services

Only one fifth of the population had a sewerage connection. Some of the rest were connected to septic tanks

The sewage overflow accumulated as stagnant water in the south-eastern corner of the town, creating a ground for mosquitoes and diseases.

The local government had a significant lack of resources

The project

The local Authority launched a PPP contract for the construction and management of a sewage system and treatment plant.

The state PPP unit assisted in the development of the project

Citizens paid connections fees in advance to finance the project

The concession company could not reject any connection request in the covered area


Participants are not expected to give the right answer, but to think how they can apply what they have learnt. What can we do to avoid typical downsides of this kind of projects?


Box 14: Water Supply Metro Manila, Philippines

Background

Metro Manila, one of Asian largest cities, had 11 million residents in 1997.

The MWSS was responsible for all water and sanitation services

Over a third of the population, mainly poor, lacked water supply connections

Vendors sold low quality water charging 7.4 times the official price

The local government did not have the financial capacity nor the flexibility needed to provide a universal service

The local Authority launched two PPP contracts for the construction and management of the east and west water systems.

Questions

Water supply being a natural monopoly, how can you minimize risk of bad performance by the concession companies?

Link revenues and penalties to project objectives (making new connections and expanding the network, serving poor areas of the city…)

Carry out a transparent tendering process

Do you think user payments may be enough to return the needed investment?

Probably yes: there is willingness to pay and tariff margin (some users are paying 7.4 times the official price)

Does the project need and can it support pro-poor covenants? Which covenants can you propose?

It needs pro-poor covenants, as the poor are the ones that have no access to water supply

Pro-poor covenants that were introduced in the real contract:

Flexible technical standards in narrow roads;

1 standpipe / 475 people in poor areas;

Free household connection in poor areas;

Deferred payment of the connection fee


Asian cities have implemented public utilities by means of PPP agreements with varying degrees of success. As we have repeatedly stated, each project is different. But there are some common recommendations widely valid when developing public utilities PPP projects.

Advocate a transparent process. Non transparent tendering processes are particularly dangerous, as most contracts award exclusivity.

Be realistic about the project and the expectations. Project objectives should be realistic and cautiously ambitious. Sometimes a project can be broken down into several steps, and each step can be treated as a specific project.

Avoid, whenever possible, the temptation of using extremely long contracts. Short term projects are not only possible but especially adequate for public utilities, as they limit risks for all stakeholders.

Make the accountability a key element of the project. An efficient performance monitoring is absolutely mandatory. Public utility projects being natural monopolies, users will not have an alternative should there be any problems with the related service. Choosing suitable performance indicators and building up “incentives to perform” can make the difference.

Include active pro-poor covenants that encourage the private partner to provide universal access. A public utilities project s failure is usually related to a deficient pro-poor performance. Differential rate settings and cross subsidies can help, but are generally insufficient.

10.2.3 Public Services and Social and Public Infrastructures

The definition of what is and what is not a public service differs in every country. Justice, education and public order are generally considered public services. Health is a public service in many countries but not in others.

Local legislations limit the usage of PPP contracts for public services. In most cases, limitations affect the management of services that imply exercise of authority, such as course of justice or public order. In other cases, transferring the management of any public services is not permitted. In those countries, PPPs are only applicable to the management of public service facilities and other public buildings, and tend to include the delivery of non-core services such as food, cleaning and transport.

All around the world there are examples of public services and public service facilities provided by means of PPP agreements. Potential benefits of PPP schemes are significant but so are some of the downsides. All this services have some common features that affect the way PPP schemes can be applied.

They support competition in the market, that is, there could be more than one profitable provider in a certain market (as opposed to many public utilities, in which investments and fixed costs allow for only one operator in the market)

Projects usually require the availability of payment mechanisms publicly funded. Project direct revenues are usually irrelevant

Management improvements potential impact is significant

Monitoring complexity is low in some cases (administrative building) and complex in others (Hospital).


Box 1: Public Building: Iloilo Market, Philippines

Background

Iloilo City is the capital of Iloilo Province, Philippines, with a population of 0,5 million inhabitants (2007 census).

Recent urban decay in the inner city.

Revitalization plan for the area -> catalyst for building owners to upgrade their buildings.

Main public actions: Pedestrianization of “Calle Real”, appointment of “Aldeguer Street” into a street market, development of the “City Central Market”

The City Central Market project

Project included:

o Restoration of the building’s façade and rehabilitation of the historic two story art-deco Central Market building

o construction of three new commercial buildings behind the existing historic Central Market front building

o the construction of a parking building

o rehabilitation of the wet market facility

o introduction of internal roads within the complex

Project cost: 20 Million USD

Iloilo lacked the financial capacity to undertake the project

The private sector was engaged with the help of CDIA, using a PPP scheme

Urban projects being implemented under a PPP schemes for the development of public services has been less common in Asian cities than other types of PPP projects. The local and international experiences developed so far have the following recommendations:

Improve Value for Money Analysis: Project failure is seldom, but the expected value for money is often not achieved. An accurate Value for Money analysis is the only way to solve this issue.


Ensure critical size for the project through bundling: Transaction costs are often a key issue in modest size facilities. Bundling several projects into one is a common solution in those cases.

Include incentives to perform: Competition in the market must be complemented by other type of incentives to perform

Performance indicators should be kept simple while being able to control quality standards and service sustainability.


This box is a summary of the contents delivered during the session.

It is suggested that the box be solved collectively during the session, one question at a time. To make the session more participative, the trainer can ask for a volunteer to give an answer and provide the reasons. Other participants may then share their opinions.

Participants may provide different answers from the ones provided below, but these are the most important ones.

Box 15: Please try to identify

Local parameters that affect the kind of projects that can be developed as PPP

Lack of payment willingness, Social rejection…

National or regional parameters that affect the kind of projects that can be developed as PPP

Project characteristics that can increase the complexity of PPP schemes

Sectors and types of projects in which the above circumstances are more likely to appear


SESSION 5

APPROACH II



This session is focused on the preliminary aspects of the development of PPP projects: project identification, institutional framework and legal framework. The level of complexity increases, and some participants may have problems understanding certain “collateral concepts”. Keep in mind the course objective and try to keep explanations as direct as possible, simplifying concepts when needed in order to transmit the basic ideas.

11 IDENTIFYING PPP PROJECTS


PROJECT IDENTIFICATION is normally carried out by Local Authorities with limited external advice; therefore this is an important lesson. The course describes the basic aspects of project identification, but trainers should focus on those aspects that are specific to PPP project identification: bankability, opportunities for risk allocation, project size...

The exercise at the end of the lesson is very useful, so expose the basic ideas and give participants time to participate in the resolution of the exercise.


• “CDIA PPP Guide for Municipalities,” City Development Initiative Asia, June 2010. Section 6: How can potential PPP projects be identified? (page 13) • “Public-Private Partnerships Reference Guide, Version 1.0”, PPIAF, 2012 Section 3.1: Identifying PPP Projects (page 124) • “The Guide to Guidance”. EPEC, 2011 Section 1.1: Project selection and definition (page 9)

The process of identifying potential PPP projects can be divided in two main steps:

steps will be developed in the following sub-chapters.

Manage PPP Transaction

Manage PPP Contract

Structu

re P

PP

Ap

pra

ise P

PP

Design PPP Contract

Structure: Identify risks Allocate risks and responsibilitiesAppraise: Project feasibility Commercial viability of PPP Whether PPP will provide value for money Whether PPP is fiscally responsible

Decide procurement strategy Market PPP Qualify bidders Manage bid process Reach financial close

Establish contract management institutions Monitor and manage PPP delivery and risk Deal with change

Key Commercial

Terms

Draft PPP Contract

Final PPP Contract

Business case

Progress toward PPP contract

Progress toward Investment decision

Final decision

Stage

Approval

To proceed with transaction

To sign contract

De

alin

g with

Un

solicite

d P

rop

osa

ls

Approval

Define performance requirements Define payment mechanisms Create adjustment mechanisms Provide for termination Establish dispute resolution mechanisms

Identify PPP Project

Originate project ideas Screen candidate projects for PPP potential Prioritize potential PPPs for development

PPP Concept“Strategic” or

“outline” business case

Approval

To proceed with business case


Source: PPP Reference Guide. World Bank Institute and PPIAF and CDIA

11.1 Project ideas

PPP project ideas have the following typical origins:

Public planning. Many PPP project ideas originate as part of the municipal infrastructure planning process. In some countries any project that requires significant public investment must be analyzed to establish the best procurement option, including PPP procurement.

Strategic financial approach. Some governments believe a top-down approach is more efficient in some cases. Many PPP project ideas involving previously existing infrastructures are part of public expenditure reduction policies.

Private initiative. Many legal frameworks provide ways in which private investors may originate project ideas.

An interesting source of PPP ideas are previous successful experiences. When trying to determine if a PPP is well suited for a project in a certain sector, it is helpful to look for past successful experiences elsewhere, and the number and size of PPP projects that managed to go forward. This will allow to determine if the sector is well suited for PPPs and to recover useful information for the preparation of the project.

It should be noted, however, that each PPP project is unique. What worked for one project may not work for another. Avoid thinking that projects can be transferred from one city to another. Learning on others’ experience is necessary, but copying from others is not possible, as different projects will comprise many different circumstances altogether.

11.2 Project selection

Project ideas must be carefully analyzed to find out if they are suitable for its development as PPPs. The selection of potential PPP projects among the proposed ones is usually done as part of the municipal budget planning, as PPP and budgetary planning are closely related.

The selection process has two main objectives that were already mentioned when describing the value for money assessment: Analyzing project feasibility in a preliminary way and determining whether PPP procurement creates value for money.

The pre-feasibility study (PFS), also named Outline Business Case, usually includes technical, socio-economic, environmental, and financial feasibility analysis, and should focus both on project viability and project attractiveness to potential private partners.


This box is especially useful, so do not hesitate to take the time it needs to solve it properly. Participants must understand what each step is about and if they need to fulfill it or not (for example if the project plausibility is beyond any doubt, they do not need to expend many resources in the socio economic pre-feasibility study - and should focus on financial aspects instead).

Participants may work in groups. Planning and identification procedures may differ significantly from one place to another. Participants’ local experience may be helpful.


Box 16: How does project analysis answer the following questions?

Is the project reasonable?

Technical analysis and socio economic pre-viability

Are there enough resources to repay the investment?

Financial pre- feasibility study: Analysis of project revenues, payments by the users, availability fees from the Local Authority or both.

Is the project bankable?

Financial pre- feasibility study: Analysis of revenues versus expenditures taking local financial conditions into account

Guarantees, maximum penalties that can be applied…

Are there enough opportunities for risk transfer?

Risk analysis and preliminary risk allocation proposal.

Market tests

Does the project scale justify transaction cost?

Value for Money preliminary analysis

When screening projects, the authority has to find the appropriate balance between carrying out an efficient analysis and keeping costs reasonable. In this regard, there is a logical difference between approved projects that may be procured as PPP and projects that would either be developed as a PPP or be ruled out. In the first case, feasibility study should be carried out irrespective of the procurement option, and the information it provides is extremely helpful for Value for Money assessment. So, the more detail reached, the better.

In the second case pre-feasibility should be kept as simple as possible, taking into account that expenses can be useless. The study should focus on the financial aspects and ensure the project is potentially bankable before going into further detail.

12 WHAT IS NEEDED TO UNDERTAKE A PPP


PPP procurement requires a more efficient INSTITUTIONAL FRAMEWORK than other procurement options. Participants must understand that if their local government is not capable of providing a solid and adequate framework, it will be much harder to develop successful PPP projects. Having what is needed is the first step they should undertake.


• “CDIA PPP Guide for Municipalities,” City Development Initiative Asia, June 2010. Section 7: What changes are needed to undertake a PPP? (page 16) • “Public-Private Partnership Handbook”, ADB, 2008. Section 3.4: Institutional Structures and Capacity (page 14) Section 6.3: Institutional Structures and Capacity Building (page 53) • “Public-Private Partnerships Reference Guide, Version 1.0”, PPIAF, 2012


Section 2.1.3: Implementing Principles (page 74) • “Public-Private Partnerships in Housing and Urban Development”, United Nations Human

Settlements Program, 2011. Chapter 9: PPP organizational & administrative effectiveness (page 17)

Local governments traditionally use budgetary funding procurement alternatives for the provision of public services and infrastructures. But few municipalities have PPP experience, and even fewer have positive background experiences.

Dealing with PPP projects is far more complicated than dealing with standard projects. We have been finding out why. In order to develop projects of such a complexity local governments may have to conduct significant changes, akin with CDIA’s PPP Guide for Municipalities key elements of success from a local government standpoint.

Authority’s willingness is essential to succeed. Policy makers may have to cope with pressure against the project at some time and can be tempted to delay or abandon the project if it gets stuck. Changes in the administration can influence the course of the projects, especially if they are not truly committed with the PPP scope. Also, PPP projects require committing considerable human and economic resources, preparation and tendering processes tend to last longer and projects often demand payment by the users which is not easily understood by their constituents.

Authority’s capacity. The development of PPP projects comprises many steps, and involves experts in a variety of fields (finance, procurement law, risk management, public accounts, specific technical fields…). Most municipal government will not have the needed means available within their administration. Complementing the authority capacity is, by all means, necessary.

Reliable feasibility study. When private parties consider entering in a PPP project in a city with little or no PPP experience, soundness of the studies and projections is a key issue. A weak technical or financial proposal will probably result in tender failure, or worse yet, a contract failure. Demand and financial projections, however, are difficult to review and have a massive impact in the result of the project. Participants usually find out projections were inconsistent when it is already too late.

Solid legal and regulatory base. Laws, regulations and the PPP contract rule the relationships between the public and the private partners before and after the transaction. Laws and regulations are beyond the control of the local government, but a good contract with creative scope can offset inconveniences.

Transparent procurement. The procurement process should remain public, objective and non-discriminatory in order to encourage private participation and to settle the appropriate basis for the project.


This box is will help to review the section’s main concepts.

Once they have identified the needed measures, ask them if they believe their local government fulfills that specific requirement, or even better, ask if any of the local governments they know has been able to change their institutional framework so it now fulfills that requirement. Positive experiences can be especially useful in this regard.

Box 17: Making a PPP come true

Identify measures or initiatives that can help with a PPP project, and related with the following aspects:


Authority’s willingness

Public commitments made by the highest ranking politicians

Convincing the opposing political party that the project is needed

Allocating resources to develop the project (studies for preparation stage, subsidies for operation …)

Authority’s capacity

Asking for technical assistance from Multilaterals

Hiring experts (technical, legal, economic…)

Tendering process

Publicity: Advertising the tender process in the media

Transparency: Using a fair process with clear stages and objective selection criteria, describing the process in the project’s documentation, making all relevant project documentation available to interested bidders

Non-discrimination: Treating domestic and international firms the same way – not imposing qualification requirements that do not bring value to the project, not giving more information to certain companies…

13 LEGAL CONSIDERATIONS


LEGAL FRAMEWORK is country specific, so trainers should focus on transmitting the basic concepts. Participants should be able to understand their legal framework, mainly if they have a specific PPP law or other relevant legislation. They should also understand the implications.

If PPPs are not regulated by law, then they need to regulate everything in the contract, which means structuring will be more complex and they will need more assistance.

In turn, if they have laws regulating PPP procurement in some way, they have to know their limitations and understand that regulation by the law may provide certainty in exchange for flexibility.

PPP projects in common law countries cannot be developed as PPP projects in civil law countries: each legal system has its own strengths and downsides that must be taken into account during project structuring.


• “CDIA PPP Guide for Municipalities,” City Development Initiative Asia, June 2010. Section 7.2: How important is a sound legal, institutional and regulatory framework?

(page 17) • “Public-Private Partnership Handbook”, ADB, 2008. Section 3.3: Legal, Regulatory, and Policy Frameworks (page 13)


• “Public-Private Partnerships Reference Guide, Version 1.0”, PPIAF, 2012 Section 2.5: PPP Legal and Regulatory Framework (page 114)

CDIA’s PPP Guide for Municipalities includes an assessment of the importance of the institutional and regulatory framework. It concludes with a clear statement: An efficient institutional and legal PPP framework eases the development of PPP projects, but is not essential. Local authorities can develop successful PPP projects in countries with immature or incomplete framework.

Figure 6: PPP readiness in Asia-Pacific: Source: The 2011 Infrascope. Economist intelligence Unit and ADB

Each country has its own regulatory and institutional PPP framework, which lies beyond municipal government’s means. Said framework will depend on the country’s legal model, which will probably be either civil law or common law type, as those are the two main legal models worldwide.

Figure 7: Civil Law and Common Law main features

The same kind of PPP project (like a water treatment facility, for instance) may need completely different arrangements under Civil Law and Common Law. This is another reason why trying to replicate the exactly same project from elsewhere is likely to fail.

13.1 Civil law

Civil law countries have a set of legal rules that regulate the main aspects of any public project, from expropriation to procurement. In many cases rules will come from different legislative levels, mainly national and regional but sometimes also local (local tax regulations for instance).

Civil Law Common Law

Legislative

powerParliament Parliament and courts

Principles of

law

• Legal rules

• Main principles of law

• Customs (not always)

• Basic principles of law

• Legal regulations

• Jurisprudence

Modification

of the legal

framework

Occasional

Via the promulgation of

regulations

Continuous

Via the jurisprudential

interpretation of the law


Figure 8: Different laws can affect PPP projects

The legal provisions and procedures needed for the development of PPP projects can be complex, numerous, unclear and/or scattered over different instruments. In such conditions it can be hard to master the legal framework and all aspects involved, but once the legal frame is under control projects gain soundness.

If PPP procurement is regulated by law, projects will have to adapt to it. A PPP law will usually regulate to some extent at least the following items:

PPP structure

Basic risk allocation

Procedures (identification, approval, tendering and implementation)

13.2 Common law

Common law countries may have some regulations affecting PPP projects, for instance, accounting or tax regulations, but they do not need a law to enable the use of PPP5. In such countries, the contract will have to rule almost every aspect of the relationship between the participants in the project, making in practice project apprising more complicated, yet possible.

In common law countries with significant PPP experience they ease the lack of specific regulatory framework with the support of PPP units, which provide guidelines, and standardized model contracts.


This box should help participants to understand the implications of having a legal framework.

Box 18: Regulation by the law or by the contract Advantages Disadvantages

5 Some common law countries do adopt PPP laws or at least policy drafts to address inconsistencies between

the proposed PPP policy and existing laws.

Private contract law

Companylaw

Taxlaw

Laborlaw

Competitionlaw

Consumer protection law

Insolvencylaw

Infrastructures sector law

Propertylaw

Foreign investment law

Intellectual property law

Environmental law

Public procurement law

Acquisitionlaw

National

Level

Regional

Level

Local

Level


Law and contract Project soundness

Certainty for the private participants

Simpler project structuring

Lack of flexibility

Mainly contract Flexibility

Adaptability

More complex project structuring that requires more expertise and consumes more time and resources


SESSION 6

APPROACH III



The last session of the day is devoted to risk management and will introduce some complex concepts. Take your time to explain what is meant by “risk”. You may want to mention the difference between risk and uncertainty. Risks are things that can happen, their effects are more or less predictable and, therefore, they can be managed. Uncertainties are aspects of the project that are not defined, such as a project where the dispute settlement procedure is not clearly defined. Their effects are unpredictable and are very difficult to manage.


• “CDIA PPP Guide for Municipalities,” City Development Initiative Asia, June 2010. Section 2.2: PPP is about sharing (and mitigating) risks (page 5) • “Public-Private Partnerships Reference Guide, Version 1.0”, PPIAF, 2012 Section 3.3: Structuring PPP Projects (page 152) • “The Guide to Guidance”. EPEC, 2011 1.2.2: Risk allocation (page 11)

14 RISK MANAGEMENT

Risks are inherent to all projects. In PPPs, the risks are distributed between the public sector and the private sector through the contract and the specific regulatory framework. In this chapter we shall review the following issues:

Risk identification: What are the different types of risks that can be present in a PPP?

Risk management: Once we know what the main risks are, what do we do about them?

14.1 Risk identification


This part of the session is relatively easy. You should involve participants in the identification and description of potentials risks. For instance, you can ask them what kind of project risks they think there are and when they mention one of the important ones, ask for a definition.

Broadly speaking, risks borne by a project can be divided into those which are particular to the specific project (construction, demand… usually known as “project risk”), those that arise from the geographical national setting in which the project is located (macroeconomic, natural catastrophes… usually known as “country risk”), and finally those related to the local area where the project is located (default of local authorities… we shall call these risks “municipal risks”). In this chapter we will go through the specifics of these three risks.

14.1.1 Project Risk

Any PPP project carries numerous risks, amongst which the most notable ones are: Design Risk: This occurs when mistakes are discovered in the design of public infrastructure or facilities that require subsequent modifications (with the added costs in time and money associated). Construction Risk: Includes risks associated with time delays, non-compliance with legal and performance established standards, additional building costs, increments of supplies costs, technical defects and negative external effects.


Demand Risk: This risk arises from the usage of incorrect demand projections or the fluctuation of demand due to factors unrelated to their own actions. Such factors can be variations in the economic cycle, changing market trends, new direct sources of competition or obsolescence. Operation performance Risk: Those associated to the performance of the service to be rendered. They can happen due to lack of performance of the operator or other causes, This is a breach of the contract that may imply penalties on the operator or deductions on revenues if the private party is paid on performance. Any of them leads to reduction of revenues that will affect the overall business. Financing Risk: The risks associated to the funding arrangements of the project including, but not limited to, arranging the necessary funding, refinancing, interest rates fluctuations, etc. that endanger the repayment of the financial obligations.

14.1.2 Country-specific risks

Investments in PPPs are intimately linked to their location, from physical, economic, political, legal, financial and social viewpoints. Country-specific risks are associated to a country’s geographic, social, economic, financial, legal and political situation. Political and regulatory risk: actions by government bodies or by public authorities that can negatively affect a project’s viability or profitability or that can limit or prevent recovery of the invested capital or obtained benefits. For example, regulatory changes, lack of fulfillment of obligation, partial legal decisions or currency exchange restrictions. Risk of expropriation: total or partial expropriation or nationalization of the asset or termination of the contract, without justified cause and/or in exchange for insufficient compensation. Environmental and Geographic risk: the physical environment and its regulation are responsible for part of the country risk borne. Laws and regulations can impose environmental liabilities and constraints on a project. Public and Private IFIs as well as some domestic commercial banks that have adopted the Equator Principles, will expect projects to meet minimum environmental and social requirements that may exceed those set out in applicable laws and regulations. Natural phenomena as earthquakes, floods, landslides, volcanic eruptions, extreme temperatures are also part of this risk. Social risk: the risk of local stakeholders opposing the project or instability of any kind can cause lower earnings or jeopardize the conditions under which the PPP project was framed. Economic-financial risk: economic policy decisions and their consequences on the country’s economy and financial system affect the results of the project and its viability. The main economic-financial type risks are:

Sub-sovereign risk: risk of the Local Authorities defaulting, and thus not being able to make any payments agreed upon with the PPP Company.

Local economic risk: degradation of the local economy, with a decrease in local consumption, population loss or shrinking demand.

Sovereign risk: risk of country entering in default.

Economic risk: instability of the macroeconomic situation, decreasing consumption capacity or shrinking demand.


Financial risk: worsening of financial conditions with a negative impact on credits for financing or refinancing a project. Very important in PPP projects owing to long maturity periods and the need for regular investments.

Exchange rate risk: devaluations that decrease the value of the part of the investment made in foreign currency. With regard to concessions, this regularly affects the capital provided by investors and, in some cases, debt acquired in international markets.

14.1.3 Municipal risk

Urban projects are affected as well by “Municipal risk”. This is risk due to the fact that the project is located in an urban environment and dependent on a local public authority. This risk may manifest itself in several ways. A few examples:

Risk of local authorities defaulting: This happens when local authorities do not pay the concession company the sums agreed upon in the PPP contract, due to the lack of public resources. The SPV may not have access to sovereign guarantees, making the situation critical.

Risk of change of government and project reversal: If elections take place and the new government didn’t support the PPP project, the new public authorities may decide to break the PPP contract without proper compensation to the SPV’s shareholders and lenders.

Risk of non-deliverance of municipal permits and licenses: The local authorities may find it hard to fulfill their obligations and provide the SPV with the necessary permits and licenses to carry out its obligations.

Municipal risk can be very acute, since bilateral investment agreements and other instruments designed to mitigate risks may be difficult to activate. 14.2 Risk management


The main objectives of RISK MANAGEMENT must be clearly stated: risk must be measured, allocated and mitigated, if possible. Throughout the session remind participants what is being done and ask them if they think we can achieve the risk management objectives with the proposed instruments. Repeat the main objectives as often as necessary so everybody understands them.

In this sub-chapter we shall focus on how to deal with risks in a PPP project.

Box 19: UNESCAP principles in risk management

Some general principles that might be considered in risk management are the following6:

Eliminate or reduce to the extent possible the chances of a risk to occur. For example, when possible, borrow in local currency to avoid exchange rate risk.

Allocate risks to the party that is best equipped to manage them most cost effectively. For example, political and regulatory risks are more appropriate for the public sector, while construction and operating risks are more suited to the private sector. The commercial risks are generally allocated to the private sector. But deviations can be considered on the basis of valid reasons - for example, sharing of commercial risks may be considered to attract private investors in an untested PPP market.

6 A guidebook on PPPs in infrastructure, UNESCAP, 2011


Consider insurance (if available) to deal with risks which neither party is able to manage but still can maintain value for money in the project.

When neither party is in a position to effectively manage a risk, it may be kept unallocated with an indication in the contract how the risk may be shared between the parties or assumed by a party in the event of its occurrence. In case of a concession contract, it may also be transferred to the end-users by way of charging higher tariffs.

Now that we know what are the main risks associated with our project, what’s next? Usually, the next steps are the following:

Risk qualification: How important is this risk?

Risk mitigation: What can I do to make this risk less important, or to eliminate it altogether?

Risk allocation: Should this risk arise, who should pay the consequences? Let’s explore these steps.

14.2.1 Risk Qualification

Different techniques ranging from rule of thumb (based on past experiences) to sophisticated simulation models are available for the assessment of different risks in a project. A risk has two key features: the probability of the risk occurring and its potential impact on the project, represented by its impact on the expected cash flow. These features tend to be represented using a risk evaluation matrix.

Figure 9: Risk evaluation matrix


This box shows how we can carry out a very simple risk qualification matrix that only requires specific technical knowledge. This kind of assessment may be enough for a preliminary risk allocation.


Box 20: Risk qualification in a Subway PPP project

Imagine you work on the risk management of a Subway PPP project. It will go underground, through the city center (it is a very ancient city). For the following risks that you’ve already identified, try to determine the probability they materialize and the impact they would have in the project (High, Medium, Low).

Risk Probability Impact Risk assessment

Design Low Medium Medium-Low

Construction Medium Medium Medium

Demand Medium High Medium-High

Operation Low Low Low

Maintenance Low Medium Medium-Low

Land aquisition Medium Medium Medium

Archaeological Low Medium Medium-Low

14.2.2 Risk Mitigation

There are three basic types of instruments to help reduce the exposure to a certain type of risk: Formal agreements (e.g. MoU, LoA, official contracts etc.) between the parties Insurance offered by third parties Credit Enhancement Guarantees (CEG) from IFIs and domestic organizations Agreements between the parties These are agreements that transfer risk from one party to another, without involving insurance companies. It is usual that SPVs sign “back-to-back” contracts with their suppliers, transferring significant amounts of risk to them. An example would be the contract signed between the SPV and the contractor in charge of the public works: any unjustified over-cost or delays is likely to be assumed by the contractor and not the SPV (even though the SPV will be held responsible by the Local Authorities should this risk arise). Some country risks may be mitigated through agreements signed between the countries of origin and destination of the investment. For a Local Authority it could be useful to check if these agreements are in place – it would make it easier to seduce sponsors and lenders from certain countries. Insurance Private insurance companies also offer policies that mitigate some aspects of country risk – though the cost can be very significant. Some insurance policies that may be available are the following:


Exchange rate insurance policies: they normally cover devaluation contingencies of the local currency under a certain threshold.

Natural disasters insurance: these can be of many different types, for example compulsory earthquake insurance for public work concession contracts in Chile.

Credit Enhancement Guarantees (CEG) from IFIs and domestic organizations International Financial Institutions (IFIs) and domestic organizations in some countries may provide risk-sharing and management tools at the local level for PPP projects.

Box 21: Asian Development Bank (ADB) Credit Enhancement Products

The Asian Development Bank (ADB) has the following Credit Enhancement Products (CEP):

Political Risk Guarantee: ADB guarantees to commercial co-financiers payment of all or part of the project’s debt service against specific political risks (confiscation, expropriation, nationalization, political violence, breach of contract…)

Partial Credit Guarantee: ADB provides comprehensive coverage to commercial co-financiers of all commercial and political risks for a specified portion of a borrower’s debt service obligation.

Guarantor or Record Scheme: ADB is the “lender-of-record”, since the loan made by ADB and the commercial co-financiers is made in ADB’s name. The complementary loan enjoys the same privileges and immunities as those applicable to ADB’s direct loan (exemption from restrictions on currency conversion, withholding tax, special debt provisioning …).

Some countries, such as Indonesia and India, have established funds that can act as PPP financiers or guarantors, effectively decreasing the private sector’s risk exposure to the project.

Box 22: Infrastructure Debt Fund (IIDF)

In March 2012, the Government of India launched a USD2bn infrastructure debt fund.

The fund was set up jointly with some private sector commercial banks, and has been mandated to invest in infrastructure.

To attract offshore funds into IIDF, the finance minister had announced the reduction of withholding tax on interest payments on borrowings by the IIDFs from 20% to 5%. Income of the IIDFs has also been exempted from income tax.


Participants are not expected to give the exact answers, but to give reasonable ones. Let them work in groups to encourage discussions. The other participants can give their opinion about the mitigation measures proposed. You may have to review some concepts if you notice they are not clearly understood, especially the basic ones.


Box 23: Risk mitigation measures

Propose measures to mitigate the following risks (independently if the risk will be kept by Local Authorities or the Private Sponsor).

RISK COVERAGE

Invoicing and collecting Contract enforcement

MFI Insurance

Construction/equipment costs

Limit cost bearing

Turnkey contract

Guarantees

Land costs Legal framework regulating risk

taking

Operation costs

Contract at a fixed price

Revenue linked to standard costs

Guarantees

Interest rate

Exchange insurances, subsidies or rate

revision

Coverage: swaps, caps, collar

Exchange rate

Exchange insurances, subsidies or rate

revision

Legal framework, Terms of the

contract

Force majeure

Private insurance (with limitations)

Terms of the contract (they cover

specific risks)

Legal framework MFI Insurance

14.2.3 Risk allocation

Bottom line is that PPPs are about public service delivery. Therefore, the allocation of risks between the granting Authority and the private party is a key element of this collaboration and an essential success factor. It is a common and dangerous tendency to pass all risks to a single party, normally the private sector, since these transferred risks will be valued and priced accordingly. The larger the risk the larger the revenue and profit that will be expected to compensate that risk. So, mastering the transfer of risks is meant to enhance the viability of the projects.



RISK SHARING is an important concept. Participants must understand that when a risk’s potential impact is too big, it may be better to share the risk (i.e. demand risk if demand is prone to uncertainties). Risk sharing can contribute to making the project feasible.

Box 24: Risk sharing

Risks need not be entirely assumed by one party, as there are mechanisms to distribute a determined risk between two parties.

Imagine a toll road. What mechanism could be implemented so demand-risk is shared between the Granting Authority and the private party.

• Minimum demand guarantees. If the real demand drops under a certain stated minimum, the Authority will compensate the SPV for the shortfall of revenues.

• Minimum income guarantees. The authority guarantees the SPV a minimum level of income, which at the end has a similar effect as the minimum demand guarantees.

• Minimum demand guarantees are normally compensated by a profit sharing system in order to ensure contract balance. If the real demand exceeds a certain stated maximum, the SPV will share profits with the authority or devote revenues in excess of the maximum to the infrastructure improvement.

The rule of thumb is that each risk should be borne by the party best able to manage it, which will demand the least revenue for assuming it: It will manage the risk in a cost effective way. For example, political and regulatory risks are more appropriate to the public sector while construction and operating risks are more suited to the private sector. The chart below describes risk assignment for an urban tunnel project:

Figure 10: Risk allocation in an urban tunnel

The following graph reflects the risk distribution chosen on a PPP social housing project.

- POLITICAL

- FORCE MAJEURE

- OTHERS

RISK

ALLOCATION

STATE

- COMMERCIAL

- CONSTRUCTION

SHAREHOLDERS

- CONSTRUCTION

- TECHNOLOGY

CONSTRUCTOR

- MARKET

USERS

- FINANCIAL

- CONSTRUCTION

- COMMERCIAL

BANKS

- COUNTRY RISK

-NATURAL DISASTERS

- LEGAL LIABILITY

- ACCIDENTS

-INTEREST RATE

INSURANCE CO.

- EXECUTION

- OPERATION

OPERATOR

- COUNTRY RISK

- COMMERCIAL

GUARANTORS


Figure 11: Risk allocation in a housing project


RISK SHARING is an important concept. Participants must understand that when a risk’s potential impact is too big, it may be better to share the risk (i.e. demand risk if demand is prone to uncertainties). Risk sharing can contribute to making the project feasible.

Box 25: Risk allocation

Who should bear the following risks? Remember that a specific risk can be shared between the Granting Authority and the Sponsors, and that these, in turn, could transfer the risk to some third party (contractors, lenders…)

RISK PARTY THAT MANAGES RISK BEST

Design Granting Authority

Sponsors

Demand Granting Authority

Sponsors

Construction/equipment costs Constructor

Sponsors

Land costs Granting Authority

Operation costs Operator

Sponsors

Interest rate Granting Authority

Banks

Exchange rate Granting Authority

Banks

Force majeure Granting Authority

Insurance companies

Legal framework Granting Authority

Public Sector

Private sector

Construction

Demand

Availability

FinancingDesign

Changes by

granting authority

Changes by other

public authority

Force majeure

Unpredictable

risk


SESSION 7

APPROACH IV



This session is devoted to one of the main private participants in the projects: the SPONSORS. The objective of the session is for participants to place themselves in the position of the PPP sponsors and understand how they analyze PPP projects and what their more common worries and needs are. It should be understood that sponsors have an active role in project development since they are the ones that bring the rest of the private participants into the project. Arousing their interest is, therefore, essential. A useful exercise for Local Authorities when developing a PPP project is asking themselves the following questions and answering them from a sponsors’ perspective: • Would we be able to find out about this project? • Would we have enough information to understand and analyze the project? • Would we want to participate in the project? • Do we have the expected capacities and expertise? Do we need to form a consortium? • Would we accept the proposed risk allocation? The session should try to prepare participants to answer these questions.


• “CDIA PPP Guide for Municipalities,” City Development Initiative Asia, June 2010. Section 6.2: How would potential investors view the project? (page 14) • “Public-Private Partnerships Reference Guide, Version 1.0”, PPIAF, 2012 Section 1.3.1: Finance Structures for PPP (page 45) • “The Guide to Guidance”. EPEC, 2011 Annex 1: Project Finance (page 47) • “Linking cities to finance. Overcoming Bottlenecks to Financing Strategic Urban

Infrastructure Investments”. City Development Initiative Asia, 2011 Section 3: Alternative financing (page 30)

15 THE SPONSORS

The sponsors are the party that takes the entrepreneurial initiative of the PPP business. It is also the party that carries part of the risks in exchange for profit. It normally brings together private participants although sometimes public entities could associate or participate with them. The sponsors normally associate around Special Purpose Vehicle (SPV) companies which are the ones that execute the contracts.

Sponsors demonstrate their technical abilities and financial solvency in normally long and expensive tender processes. They contend with other bidders of similar credentials and their main motivation is merely economic. They compete for a business with expected profits that will be in line with the assumed risks. The larger the risk the bigger the expected profits

Sponsors, nowadays, come from a diversity of business backgrounds but the common denominator of all of them comes from the fact that they are able to mobilize resources (financial and technical) for the execution and/or performance of the services required.


After explaining who the sponsors are in a simple way, time should be spent with this box. Participants are faced with typical sponsors’ concerns and must try to find out how they can solve them.


For instance, as bidding costs are high investment capacity is limited and so are other resources, sponsors screen projects before taking a decision to bid. After each question has been answered you may ask participants how that affects the Authority (project marketing, attractive projects…)

Participants may work in groups.

Box 26: What are the sponsors’ tasks?

What would you expect the sponsors’ tasks to be and what do they consist on?

*Projects may overwhelm sponsors’ abilities, financial capacity or experience.

Sponsors select contracts that :

analyze PPP programs, frameworks and projects.

match their experience, abilities, expected remuneration and risk bearing capacity.

*Bidding costs are high and investment capacity is limited.

Select partners and form consortiums:

• Search for partners that complement their capacities (missing abilities or experience, financial capacity, local partners…)

• Large consortiums result in managing difficulties, such as lack of consensus. 2-3 partners are ideal, while 4-5 is the maximum recommended.

Sponsors expect to become the successful bidder.

Prepare bids:

• Perform an in-depth study of all of its issues (contract, technical specifications, due-diligence for the asset...)

• Offer the best possible price given the borne risk

Sponsors do not want to provide all the funds PPP projects require.

Seek financing:

• Seek for potentials financial sources, such as debt, bonds…

• Define the optimal financial structure

• Secure financing as much as it is required

Sponsors have to fulfill contractual commitments.

Comply with the commitments taken:

• During construction: cost and timeline commitments

• During operation: maintain availability and repay debt

• Any shortfall will affect the expected revenues and jeopardize the project


15.1 Identification of projects

Sponsors seek investment opportunities in which the potential revenue compensates the risks involved. The acquired risks come both from the project itself and from the environment that surrounds it.

Sponsors analyze potential projects to invest in taking into account:

Local risk: political, economic, financial , social, legal and geographic

Available risk mitigation mechanisms such as the ones provided by International Financial Institutions or possible partnerships with local developers

Company characteristics: physical presence, technical capabilities and appetite or aversion to risk

Project characteristics: risk allocation, demanded experience, local experience and potential competitors.

The main tool available to a company in order to identify projects is its Management Information System, mainly composed of:

The internal and external sales network.

Published information: official gazettes, journals, websites, etc.

Fairs and events

The information provided by the company’s clients.

15.2 Consortia formation

Establishing partnerships with suitable companies improves the chances that the bid presented gets awarded the contract, reducing risks at the same time. The main reasons are:

• Sharing bidding costs: The cost of bidding will be spread among some or all of the companies participating in the consortium sharing the often high transaction cost in this kind of procurement.

• Offering the required solvency to the granting Authority: companies with specific expertise that could not participate in certain tenders on their own can join hands offering enough guarantees to the granting Authority.

• Manage risks in a more efficient way: Risks are priced according to the ability of the company to manage them. Most companies will be able to excel in managing certain risks while others need to be handled by those who can manage them better. For this reason, a bid submitted by a consortium of companies with different types of expertise in handling different risks can be more competitive than one submitted by a company bidding on its own.

The formation of consortia between different firms/companies is essential when one company does not meet one or more of the requirements for the pre-qualification stage (usually EoI stage) by itself.

This collaboration facilitates competition between large and medium-sized or small companies, as the latter could not bid for certain works or services if they did not join forces with others.


This exercise is a relatively simple one that helps participants understand that many PPP projects cannot be developed by a single company, especially those that bundle different elements together. The local government should be conscious of that.

Participants can work alone. If the exercise leads to a discussion, it should not last long.


Box 27: Consortium formation

The Canadian Medical Company (CMC), a hospital management firm with large experience, is analyzing the possibility of bidding for a PPP hospital project to be developed in an Asian city.

What partners does the company need?

A local partner, since CMC has no local experience

A construction company, since CMC is a management firm

Which of the following companies match the CMC requirements better?

A local construction company specialized in commercial buildings with little hospital experience

A big German construction group with lots of hospital references

A medium size regional group specialized in hospital building management with local experience

A big regional medical company that runs two hospitals in the country

A local construction company specialized in commercial buildings with little hospital experience

• If the project is not very complicated and references are enough to fulfill the bidding requirements it can be the best option. It does not overlap with CMC value added (it’s small, it’s local, it can exit the consortium after construction) and the consortium will be easy to rule.

A big German construction group with lots of hospital references

• If necessary to fulfill the bidding requirements or due to the complexity of the project it can be an acceptable option. It is a big firm so it will demand more control but it will also be able to bear more risks.

A medium size regional group specialized in hospital building management with local experience

• It’s not a good option, since it overlaps with CMC’s capabilities and know-how.

A big regional medical company that runs two hospitals in the country

• It’s not a good option, since it overlaps with CMC’s capabilities and know-how.

Why?

15.3 Offer preparation

The offer preparation starts when the decision to bid is taken. Said decision involves a substantial commitment of corporate resources, involving high costs, only compensated if success is achieved.

The preparation of the offer, once the objectives are determined, will require establishing an implementation schedule and devote some resources to its development.

Potential sponsors expect the following from a Granting Authority, when preparing an offer:

Well prepared documentation: Relevant documents are easy to handle, with a clear structure, covering all relevant topics, and prepared in a professional way.

Awarding criteria: the criteria used by the Authority for its evaluation should be stated clearly and based, as much as possible, on objective criteria.


Clearly defined scope of services and supplies (studies, basic design, engineering, procurement, construction, delivery times of equipment and materials, implementation of the infrastructure, operation and maintenance, and training).

Feasible project: The hypothesis considered by local authorities regarding the project are realistic – investment costs, time-frames, demand, financing costs…

Balanced risk allocation: The risks that will be transferred to the sponsor are reasonable, and in line with the proposed remuneration.

Additional documentation that may be helpful to the sponsor: For instance, fiscal and taxation rules, relevant laws, development plans…

16 PROJECT FUNDING

Financing is one of the fundamental aspects in developing concession projects. The investment needed may be high, with long recovery periods and significant associated risk.

After being awarded a PPP project, sponsors establish a Special Purpose Vehicle (SPV). The function of the SPV is to isolate partners from project risks, so that in general, the maximum that partners can lose is their contribution to SPV equity.

This chapter describes the different financing sources available for PPP projects and the type of financing structure that tends to be used in this type of projects. The main criteria for employing one resource or another are also explained.

16.1 SPV’s financial structure

Box 28: SPV’s characteristics

Even though SPVs’ characteristics where described in session 3, we shall include them here again because of the importance they have on PPPs.

Special Purpose Vehicles are companies with a set of very particular characteristics:

They can only pursue the objective they’ve been initially set-up for (for example the financing, construction, operations and maintenance of a road)

They are created after the PPP contract has been awarded –and thus have no previous track-record

In their capital structure lenders have usually much more weight than sponsors (ratios of 60%-40% or even 80%-20% are not uncommon)

SPVs are insulated from their parent companies: They are not, for example, affected by the bankruptcy of the parent company, or the parent company is not responsible for the SPV’s debt

All the entities funding an SPV expect a return and will require certain guarantees. An SPV’s financial structure is composed of mainly four different streams, each one with specific characteristics.

Equity. Equity comprises the funds directly provided by the companies in the partnership to contribute to the investment needed to execute the project. The main characteristic of the equity is that the return expected by shareholders is higher than the rest of financial resources7. This is because it is the less available financial resource and the less likely to be recovered in case of business failure.

7 Equity holds last place in the priority order of liabilities. Company shareholders receive what remains after all

other creditors have been paid.


Debt. These are the funds given to the SPV for a certain period of time, and that must, therefore, be reimbursed along with the agreed interests. These are typically bank loans, but debt can take other forms like bonds. These do not entail company ownership, even though they require guarantees. Debt regularly used in PPP projects is the type without recourse from shareholders or with limited recourse8. This type of debt is typically referred to as “Project Finance”. This is a financing system where the guarantee of the payment is based on the project’s capacity to generate revenue.

Subordinated loans. These are shareholders’ loans to the SPV. These loans are paid at a fixed rate, independently of the profits generated, and their collection is subordinate to the rest of the payment obligations.


This exercise will help participants understand a basic concept in project finance: SENIORITY. The financier with the lower seniority is bearing a higher risk. Coming last means having fewer chances to get paid, so those who come last will demand a higher return.

Participants can work alone. The exercise may lead to a discussion that can be helpful. The trainer should state clearly that without seniority all lenders will bear the same risk.

Box 29: Capital structure: Who comes last?

Imagine an SPV that has been awarded a PPP contract to operate a public bus line.

Its capital structure has the three types of funding described above: Equity, Debt and Subordinated debt.

During the first year of the operational phase the SPV is not doing too well due mainly to the fact that there are less users than forecasted. Revenues cover operation and maintenance expenses, but

it is clear that there will not be enough money to repay all the people that financed the project.

Possibility one: split evenly among all four of them (Wrong)

Possibility two: split in proportion to the resources each of them has contributed (Wrong)

Possibility three: establish a certain order (Right). Which order?

• First: Debt

• Second: Subordinated loan

• Third: Equity

16.2 Financing structure

The optimum financing structure for a specific project is difficult to identify a priori but it can greatly influence the result of the project. The process of how to select the financial instruments is based on:

8 Recourse to shareholder is the possibility of requiring shareholders to pay part of the debt or associated costs

that the project cannot generate. The most common method is recourse to shareholders limited to the construction period.


the financier for every level of risk that offers the most competitive price; but each financier has limited capacity to take risks.

the bank debt that has the lowest interest rate; but banks can only take on moderate risks. Beyond those risks taken by the banks, project partners are the ones that can take on the greatest risk, but they demand high rates of return.

With these premises, a typical debt-equity ratio in a Project Finance varies between 80/20 to 60/40.

In any case, the indebtedness capacity for a specific project is limited by the banks’ willingness to assume risk on that project, which is also bound by the following elements:

- the maximum tenure (typically in Asia is between 7 to 10 years, and in some cases up to 20 years)

- the project’s estimated cash flows

- the debt coverage required


Participants can work alone. The exercise may lead to a discussion that can be helpful. The trainer should state clearly that without SENIORITY all lenders will bear the same risk.

Box 30: What is more expensive?

Consider the example of the toll road SPV and its financing sources: Debt, Equity and Subordinated loan.

Try to rank them from less expensive to more expensive. Keep in mind that the key issue is the risk they assume (the more risk, the more remuneration they will demand).

• Debt

• Subordinated loan

• Equity


SESSION 8

APPROACH V



This session is devoted to the other main private participant in the projects: the LENDER. The objective of the session is for participants to place themselves in the position of the potential lenders of PPP projects in order to understand how they analyze PPP projects and what their more common concerns and needs are. The trainer should transmit that a project won’t be feasible without lenders, that lenders are very conservative and inflexible in their demands. Knowing in advance the potential sources of finance and their characteristics can save a lot of time and resources during project appraisal. An important concept explained during this session is PROJECT FINANCE, a complicated concept. The trainer should not hesitate to advance as slowly as required, ask participants to repeat in their own words what was explained, use simple examples like the ones provided in the presentation and encourage participants to interrupt if they get lost.


• “Public-Private Partnerships Reference Guide, Version 1.0”, PPIAF, 2012 Section 1.3.1: Finance Structures for PPP (page 45) • “The Guide to Guidance”. EPEC, 2011 Annex 1: Project Finance (page 47)

17 LENDERS

PPP projects are financed using a mix of debt and equity, which is known as capital structure. Common equity is mainly provided by the partners of the Special Purpose Vehicle Company who is awarded the contract, the sponsors, to whom we have devoted the previous sessions.

Three important features of debt in PPP projects are the following:

- It’s a significant amount of the required investment resources (60% to 80%)

- It has priority in the receivables over the funds provided by the promoters of the project. The risk that is incurred is therefore less than the risk assumed by sponsors, and consequently, so is the remuneration.

- The guarantees offered to banks are often limited by the project and its future cash flows. Lenders have limited or no recourse to either equity sponsors or the public sector in case of cash flow shortfall.

In this chapter we will focus on the characteristics of loans, the different types of financial sources available for a PPP project, how to comply with some requirements imposed by lenders, and finally, Project Finance’s Risk management.

17.1 Loan characteristics

The main characteristics of loans are the following:

Tenure: meaning the date at which the outstanding amount is paid in full. PPP projects require long term debt in order to generate enough revenues to repay it.


Seniority: Different loans have varying service priority over the rest of the invested funds (as previously seen in the exercise). Among debt products, each one has a different seniority. Senior debt, usually lent by banks, has the highest priority, while subordinate debt has lower priority.

Interest rates: This is the remuneration demanded by lenders. It depends on the risk assumed by lenders, as well as the situation of the economy and the markets. Loans interest rates are normally stated as a floating rate formed by an indicator (the most commonly used is the LIBOR, London International Bank Offered Rate) and a certain margin or spread expressed in basis points, i.e. 200 bsp, or 2%. PPP companies tend to transfer interest rate risk turning floating rates into fixed rates. That way they have more predictable debt repayment obligations.

Repayment schedule: Each loan has its own repayment schedule that includes fees, interests and principal repayment. Schedule is normally related to the project cash flow. Lenders may provide a grace period; delaying payments (of the principal) until positive cash flow has been achieved.

17.2 Project Finance

The long term, tailor made financing based on the project cash flow is known as structured financing or Project Finance. It is the common way of financing PPP projects.

Project Finance is shaped according to the expected project cash flow. During the investment period, debt and equity are provided to handle the investment (capital expenditures or Capex) and the payment of the interests and fees generated during the period.

(800)

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1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

YearMill

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Total Cash Flow Funds + Debt

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Figure 12: Cash Flow and Project Finance I

The operating and maintenance expenses must be subtracted from the total cash flow to obtain what is known as free cash flow.

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Total revenue

Total investmentOperating expenses

Figure 13: Cash Flow and Project Finance II


During the operation period, the free cash flow is allocated to repaying the debt. Once debt is repaid, free cash flow is earmarked to remunerate the equity.

Debt service is defined as the debt repayment obligations formed by principal and financial expenditures, mainly interest and fees. Debt service must be adapted to the forecast free cash flow.

Financiers estimate the debt that a project can withstand by forecasting expected earnings and expenditures9, in a less optimistic way than sponsors, fixing the expected remuneration in accordance with the project risks, and considering that some ratios and conditions must be maintained.

17.3 Project Finance’s risk management

The viability of Project Finance depends on a suitable risk distribution between the different stakeholders participating in the project.

Remember that the main efficiency principle in risk allocation is that each risk should be assumed by the party that is best able to manage it. The party that can manage a risk best will demand the least revenue for assuming it.

Not all PPP projects can be financed under project finance conditions. Projects that entail high risk, such as Greenfield projects, are more difficult to finance than brownfield projects. Project characteristics that make them suitable to opt for Project finance are:

Predictability of project cash flow with some degree of stability

Reliability of project participants

9 Expenditures obligations faced, by order of priority, are.

• Operational expenditures (Opex) • Taxes • Interests, fees and repayment of debt principal • Reserve fund • Dividends.


PART 3

P R O C E S S E S


SESSION 9

PROCESS



This session is an introduction to the project development processes. A second course is intended to explain processes in detail, so concepts will be explained very lightly. This is meant to be a very collaborative session. On the one hand, public procurement varies from country to country. On the other, the PPP development process is a consequence of PPP features, so participants should be able to determine the needed steps.


• “CDIA PPP Guide for Municipalities,” City Development Initiative Asia, June 2010. Part 3: Processes (page 20) • “The Guide to Guidance”. EPEC, 2011 Section 2.1: Getting organized (page 16) Section 2.2: Before launching the tender (page 19)

18 THE PROJECT CYCLE

The “Basis” and “Approach” aspects of PPP procurement have been covered in the previous sessions. Now we will briefly discuss the PPP project cycle.

To begin with, we must not forget that these projects are after all infrastructure, public services or facilities projects: the PPP procurement shares many common aspects with traditional procurement alternatives.

Besides the usual procurement stages, PPP procurement involves additional ones. This additional work is aimed at presenting a solid business-case (Is PPP the best procurement alternative? What is the private company supposed to do? What risks will they assume? What will be their return? …).


Participants should first try to identify the stages of the project cycle. Once the stages are identified they should try to order them as a class assignment. The trainer should try to bring back concepts learned during the course whenever it is pertinent.

For instance, pre-feasibility should be carried-out at the beginning because structuring PPP projects is expensive and it should be stated if it is worth doing…

Box 31: What are the main stages in a project cycle?

Imagine you are preparing the procurement of a waste-management facility.

1) Identify and arrange in the proper order the different project cycle stages, assuming that a traditional procurement alternative is used.

2) Now try to do the same exercise supposing PPP procurement is used.

Answer

Please see the rest of the chapter. Note: There is no “correct single” answer, since public procurement may vary from country to country.


Before analyzing the PPP project cycle it should be noted that we shall study a “generic basic project cycle”, which may vary from one country to the next.

18.1 The project cycle stages

Before beginning to work on a project, it is convenient to organize the project’s logistics:

Set up a project team and establish the governance rules

Engage a team of advisors to complement the team project’s weaknesses

Establish a project plan and time-table

On the following graph there is a very simple scheme in which the different stages of a PPP project’s life cycle have been split, from the local authority’s perspective:

Figure 14: Stages of a PPP project

Each one of the phases above could be further split into other sub-phases. The project preparation phase, for instance, could have, besides the feasibility study, a public information procedure which is compulsory in many places.

Also, the PPP project doesn’t end with the procurement phase – it ends with the contract conclusion.

Box 32: PPP development and implementation process according to PPIAF (World Bank)

As a complete PPP project development scheme we include here the process as outlined by PPIAF (Public-Private Infrastructure Advisory Facility, part of the World Bank Group). This process develops in detail the steps above outlined, as well as some approval points along the process.

Project identification

Project preparation

Procurement Follow-up Project ending



The objective of this exercise is to understand the different stages detailed in the figure above by trying to find out if they are carried out by the participants’ local administration.

Box 33: How does the project cycle in your country differ?

Broadly speaking, try to determine how well-suited the scheme shown above is to PPP procurement in your country, and what the sub-stages are.

Since we already discussed project identification, we shall focus now on all the other steps. Special attention will be paid to the first steps.

18.2 Project logistics

Once the Local Authorities have identified and prioritized the projects to be developed through PPPs, and before starting actual work on the project, the project’s logistics should be organized:

Set up a project team and establish the governance rules

Engage a team of advisors to complement the team project’s weaknesses

Establish a project plan and time-table

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These aspects are explained on the following sub-chapters.

18.3 Project team and governance structure

The size and extra-effort make it advisable to set-up a team that will manage the project. The team members should have most of the required skills necessary (technical, financial, public procurement, understanding and relations with the private sector…).

It is also common practice to establish a governance system that relies on boards or committees. The most usual ones include:

A project board or steering committee: its members comprise the main local government stakeholders (and stakeholders from the regional or even national government if needed). The team leader is a senior officer from the Municipality. The committee is responsible for delivering the project.

A project management team: its members are comprised of public officials that bring the required skills to the project, as well as external advisors (as needed). The Project Director should be familiarized with both the public and private sector, and be ready to devote a considerable amount of time (probably full-time) and energy to the project. The project management team is responsible for managing the PPP project, and reports to the steering committee.

18.4 External advisors

It is important to have a strong team of expert advisors, in order to bring the necessary skills the management team would otherwise lack. The needed skills as well as a budget to hire these experts should be identified and allocated early in the project.

It may be useful to hire a high level consultant or request help from a Multilateral Agency (such as the Asian Development Bank, or institutions like CDIA) in order to assist in the planning of the external assistance that will be needed, prepare terms of reference, etc.

The external skills needed by the management team will evolve along with the project. The management team will have different needs during the feasibility stage (elaboration of various reports) than during the actual procurement phase (bid evaluation).

In particular during the procurement phase it might be advisable, depending on the local authority’s experience in PPPs, to hire a financial adviser, a technical adviser and a legal adviser. You can also rely on a consortium of consultants or on institutions like CDIA that will lead the process with the necessary pull of consultants

18.5 Project plan and time-table

The project management team, once formed, should begin by developing a detailed project plan. This plan should include a timetable for project preparation and procurement.

The project’s main milestones (as identified on the project cycle chapter: document development, stakeholder consultation, public authority approval …) should be established with a realistic approach.

18.6 Project preparation

The project preparation usually involves several stages: Pre-Feasibility Study, and Feasibility Study, along with whatever compulsory public information stages are necessary to expose the project to all interested stakeholders.


18.6.1 Pre-Feasibility Study

Pre-feasibility comes in the early stage of the project. It serves the purpose of identifying the project and its possibility to come under a PPP scheme. It also facilitates an early assessment of its feasibility and the way the project can be structured.

This Study includes the appraisal of social and environmental aspects of the different options and corresponding necessary corrective and protective measures, analysis of the pros, cons and costs of each option and the selection of the most recommended one.

It should be noted that this study must be undertaken independently of the procurement option that will be finally used.

18.6.2 Feasibility study

The Feasibility Study contains all the information on the pre-feasibility study, and a more accurate and refined detail and evaluation about:

Provisions on the assets use and profitability

A description of the risks associated

The amount of investment and financing to be made

In short, it must describe the business with enough detail to allow for its evaluation by both the public and private sector (remuneration, risk and investment level).

18.6.3 Tendering documents

Besides the feasibility study previously mentioned, PPPs require the elaboration of additional documents which embody all aspects concerning the future concession: the General Conditions (GC), which includes the contract agreement between public and private parties, and the Technical Specifications (TS) which describe the technical requirements that the awardee has to fulfill. Both are contractual documents and help in the implementation. Under civil law these specifications are complemented with the applicable laws; under common law they will constitute an essential part of the contract, and must be very detailed.

The GC shall include, among others, the requirements applicable to the tenders; the rates and penalties and rewards for the quality of services; economic financial and tax benefits and contributions that can be applied by the granting Authority or other Authorities; penalties and possibilities that may lead to confiscation or termination of the contract; and finally, the award criteria.

The TS shall contain information on the technical and functional specifications, description of services, quality standards and other technical issues related to the future concession.

18.7 Project procurement

The project procurement first requires proper project marketing.

It’s important to remember that a complete procurement process takes time and possibly the help of external advisors (such as CDIA experts). Rushing the process can be counterproductive.

Project procurement should take into account the national legal framework – usually involving publicity, transparency and no discrimination principles.

Main steps of project procurement are:


Prequalification of bidders

Request for proposals

Bids evaluation

Awarding

18.7.1 Prequalification of bidders

The goal of this stage is to allow only competent companies (from a technical, managerial and financial viewpoint) to participate on the bidding process.

Bidders who satisfy the prequalification criteria are selected as prequalified bidders and are allowed to present offers on the tendering stage.


The objective of this exercise is for participants to understand that prequalification must be adapted to project circumstances. Excluding potential bidders means reducing the competitiveness of the tendering process.

On the other hand, awarding the contract to an unprepared bidder is even worse as it can lead to the failure of the project. So BALANCE is the key concept that should be considered in this exercise.

Participants may solve this exercise in groups and they can give their opinion about the criteria proposed by other groups.

Box 34: Prequalification of bidders in social housing

Imagine you are preparing a social housing project, which will use a PPP as a procurement alternative.

The goal is to build two buildings of flats that will be rented to low income citizens. The concession company will finance (10 USD Million investment), construct and rent the apartments for a period of 20 years.

What prequalification criteria would you set for this project?

* Experience in construction of residential buildings (in the past three or five years, several projects – minimum two or three a year – of at least the same size as the planned investment)

* Experience in renting apartments (the sponsor’s revenues should be at least two or three times the expected revenues from the project)

18.7.2 Requests for Proposal (RFPs)

Pre-qualified bidders may proceed to the actual bidding stage of the process.

To make sure the bidding and selection processes go well, local authorities should pay special attention to their design and provide good quality information to potential bidders. Local investors will require less documentation because they are aware with first-hand knowledge of the context in which the investment will take place.


The main document to be produced by local authorities to rule the process is the request for proposal (RFP). This document is often only issued to prequalified bidders.

The RFP will include the GC, TS, FS and all other documents prepared for the bidding process.

18.7.3 Bid evaluation

The bid evaluation process should be a transparent, neutral process based on the common principles of good governance.

Bid evaluation is a time consuming task.

The criteria used for bid evaluation is usually related to the underlying business proposal. For example, in a bus transportation PPP the parameters used for bid evaluation could be related to the user fare proposed by the bidder, as well as the type of buses that will be provided and their technical characteristics (noise, pollution, comfort…).

As illustrated by the previous example, bid evaluation should take into account all aspects involved in the offer, and not just price.

18.8 Project follow-up

The Public Authority maintains responsibility for the quality of the service and the maintenance of the infrastructure. Therefore, it is compelled to carry out an active and efficient contract management throughout its life.

Efficient management needs a well designed and implemented monitoring based on the PPP project. That is achieved, among others, by linking payments and incentives upon service performance to ensure success.


Project follow-up should be as simple as possible without losing efficiency. As participants try to propose a follow-up program, they will realize the difficulty of the task.

Participants may solve this exercise in groups and give their opinion about the programs proposed by other groups.

Box 35: Follow-up of the social housing PPP project

Consider the PPP social-housing project described in the previous Box.

Can you design a simple follow-up program to ensure that the quality delivered by the concession company is according to specified standards?

A possibility could be a program with weekly, monthly, semi-annual and annual inspections.

Different items would be verified in each inspection, with increasing complexity in less frequent visits:

- Weekly inspection: Façade (broken windows,grafitis…), cleanliness of common areas

- Monthly inspection: Heating systems, illumination, electricity and water in common areas, security system. Review of tenants’ complains in complaint box.

- Yearly inspection: Structural verification, annual audited accounts, …


18.9 Project ending

The contract signed between the sponsors and the Local Authorities should include detailed provisions concerning the end or termination of the contract. Special attention should be paid to:

• The scenarios in which the contract may be terminated and the potential implications. For example, a PPP contract could be terminated if the SPV charged fees to users above the level agreed upon with the local authorities, forcing the public administration to step in and, maybe, assume the outstanding debt obligations.

• The payment (if any) that must be made by the public authority to the PPP Company

• The condition of the assets when they are handed over to the Local Authority

Depending on the circumstances, it must be noted that early termination should not alter the initial balance of the contract, as this might be considered an unlawful modification.

It should be recalled that responsibility for the underlying service remains at all times with the granting authority.

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