cda –washington – october 1 rst, 2004 improving sub-sovereign projects risk approach cda –...
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CDA –Washington – October 1rst, 2004
Improving sub-sovereign projectsImproving sub-sovereign projects
Risk approach Risk approach
CDA – Washington – October 1CDA – Washington – October 1rstrst, 2004, 2004
page 2 CDA –Washington – October 1rst, 2004
Foreword
Access to basic services (water and sanitation, energy, transport, habitat, waste disposal and health) are affected by three major trends:
Urbanization: more than 50 % of the world population is now living in urban areas; 60 % by 2030 according to UN - Habitat
Decentralization is considered as a key element in improving the quality and cost efficiency of basic service
Private Sector Participation (PSP) has been advocated in order to ensure good quality services as cost effectively as possible
These trends however have to overcome various hurdles:
If decentralization of local services is widespread and considered as a core element in improving the quality and cost efficiency of local infrastructures and services, it has not always been accompanied by clear and predictable sources of local government revenues;
The PSP as a mean of achieving public service efficiency can be developed only if specific legal, political, economic and social conditions are met
Last but not least, financial institutions (especially international) are either prohibited or reluctant to take a direct (or indirect) sub-sovereign risk;
page 3 CDA –Washington – October 1rst, 2004
Table of contents
From Veolia Environnement experiences, the sub-sovereign project risk approach can be improved by:
1rst step: Making the sub-sovereign risk approach “more readable”
2nd step: Bringing more financial discipline by involving private management practices
3rd step: Developing access to local long term financial sources
page 4 CDA –Washington – October 1rst, 2004
Part I
Making the sub-sovereign risk approach “more readable”
page 5 CDA –Washington – October 1rst, 2004
Difficulties to assess sub-sovereign risks (1)
Two main obstacles which make sub-sovereign risk difficult to assess:
Revenues predictability: Decentralization of responsibilities has not always been accompanied by
commensurate fiscal allocations: Most local governments rely heavily on central government tax sharing arrangements
and transfer for the bulk of their revenues
3 Consequences: Revenues often provide only for operating costs but not for capital investments Revenues do not have multi-years predictability and therefore are not suitable for long
term planning and financial commitments Uncertainties reduce the ability of local officials to make investments decisions
(One additional consequence: many municipalities are supplementing their revenues with sales of assets to finance capital investments)
page 6 CDA –Washington – October 1rst, 2004
Difficulties to assess sub-sovereign risks (2)
Measurements of public service performance:Public service accounting rules which:
Are traditionally based on yearly budgetary concept:Receipts and expenditures are entered as a function of changes in cash positionRecognition of revenues and expenses is not linked to the provision of services or
transfer of goods
Therefore it is difficult to measure the performance of public service
Are traditionally characterised by the absence of balance sheet concept:No distinction between expenses and fixed assetsNo recognition of commitments received or given
Therefore no true image of the public service assets base (and therefore no provisioning for assets obsolescence)
Conclusion: Public services provided through sub-sovereign budgetary framework very seldom benefit from cost recovery, adequate cost management and services standard approach.
page 7 CDA –Washington – October 1rst, 2004
Difficulties to assess sub-sovereign risk… (3) Revenues unpredictability and public and public accounting rules (may) explain
the historical reluctance (and the prohibition) of Multilateral development Banks and Commercial banks to take a direct sub-sovereign risk.
However, the World Bank and IFC have jointly established a “Municipal Fund” for investments in “well run” sub-sovereign operations. The Municipal Fund has completed 25 transactions in 12 countries.
“Well run” sub-sovereign operations roughly mean investment grade rated entities which are for the time being mainly concentrated in North-America and Western Europe.
Moreover, the European Bank for Reconstruction and Development (EBRD) which is not prohibited by its Charter to lend to sub-sovereign entities shows a very significant evolution of its central Europe and Russia infrastructure portfolio:
Risk portfolio: 1997 2003Sovereign: 82 % 37 %
Municipal: 16 % 36 %Private: 2 % 27 %
page 8 CDA –Washington – October 1rst, 2004
… which has led to promote two main forms of PSP
“Ring fencing” the management, the assets, the cash flows (revenues), by transforming the public service into a sub-sovereign owned operating utility under laws and corporate accountancy rules,
allows a:
More precise evaluation by the lenders (and the private sector) ) of
The sustainability and predictability of revenues
The assets base and amortization rules
The provisions for unpaid customer receivables
Commitments given and received
The real cost of services rendered
Such difficulties explain also an approach followed by many countries (like Popular Republic of China) to transform a sub-sovereign budgetary framework into an operating utility company
page 9 CDA –Washington – October 1rst, 2004
Part II
Bringing more financial discipline by involving private sector’s management practices
page 10 CDA –Washington – October 1rst, 2004
Financial discipline
If “corporatizing” the sub-sovereign public service allows a better evaluation of the revenues predictability and real costs of services rendered it may not provide the (financial) discipline used (traditionally) by private sector’s management practices
Such financial discipline is provided by: Project finance approach:
Whereby the risk is evaluated an the basis of predictable future cashflows which should cover the operating cost, the debt service and the operator’s remuneration
This approach is used to:- Build new assets
- Without being supported by budgetary ressources - With a direct or limited recourse on the private operator
The “bankability” of such project financing:Derives from the operator’s expertise to build a long term business plan based on
hypothesis which are judged realistic by the lendersOn the other hand, the lenders, especially international institutions, are very
reluctant, (if not prohibited), to take an “early termination risk” (which means being faced to take a direct sub-sovereign risk)
page 11 CDA –Washington – October 1rst, 2004
The concession route: synthetical financial model
External financial sources
Internal financial sources
Financial costs: Debt service Equity remuneration
Debt: Public – Private Foreign - Local
Capex: New assets
OPEX Operational expenses Maintenance
Funding sourcesBy
Financing needs
Debts are consolidated on the operator’s balance
sheet
- Private
- Public / Private
- Public
Lenders
OBA Grants Subsidies
Equity:
Consumers Cashflows: Volume x tariff (affordability)
page 12 CDA –Washington – October 1rst, 2004
Municipality
Consumers(Volume &
tariff)
Private operator
Management Company
Water assets Company
100%
Lenders
Concession agreement:
Funding catalyst
Lease contract(fees)
The lease contract
page 13 CDA –Washington – October 1rst, 2004
Combining lease contract and new assets financing
Three remarks:
The private operator can participate to the financing of new assets which it will operate by paying in advance the present value of X years of an additional lease fee
Lenders may pledge Lease (1) and (2)
Lenders may benefit from a “Municipal Support Agreement”
Municipality Private Operator
Water Assets Cy
Existing assets
New assets
100%
Consumers (Volume x Tariff)
Lease (fee)
contract (1)
Prepayment of the PV of X years of
Lease fee (2)
Lenders for new assets
« Municipal support Agreement »
Grants and subsidies
page 14 CDA –Washington – October 1rst, 2004
Staff (operational)
COSTS % TOTAL
• Equipment sophistication• Network length
VARIATIONS DEPEND ON
Direct operational costs• Raw water ressources• Treatment process
Maintenance• Maintenance budget permanence• Age and nature of process and network• Management
(Capex) : Amortization and debt service
• Accounting principals• Financing structure
General administration
• General policy, management
Taxes
20 % to 30 %
10 % to 20 %
10 % to 25 %
15 % to 25 %
• Training level• Management
• Energy consumption (pumps)• Management
30 % to 40 %
Whatever the form taken by the PSP agreement, Whatever the form taken by the PSP agreement, one common denominator: Mastering the cost structureone common denominator: Mastering the cost structure
page 15 CDA –Washington – October 1rst, 2004
Part III
Developing access to local long term financing
page 16 CDA –Washington – October 1rst, 2004
Developing access to local long term financing…
Contributes to enhance private operator’s development policy regarding sub-sovereign infrastructures project by
Eliminating the foreign exchange exposure (matching the currency denominating revenues and debts)
Eliminating the sovereign risk factor from the (local banks) risk analysis (which is not the case for International Banks) – Examples: Jordan, Israel, China, Colombia, Morocco
Accepting a sub-sovereign risk factor: “early termination” Examples: Morocco, Colombia,
Being less expensive: front end fees, legal fess,…
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The financing sources
Access to local long term financing may be limited (maturity) or impossible. However, from Veolia Environnement experiences, there are more possibilities than usually mentioned by financial advisors:
Existence of an institutional investors market (insurance companies, pension funds) which has to buy assets generating long term and predictable revenuesi.e.: Colombia, Mexico, Chile, Israel, Morocco
Acceptance of the “transformation concept” at the banking system level:the banking system may accept that there is a certain proportion of their short term deposits which being stable enough allows long term lending. i.e.: Jordan, Morocco, Africa Franc Monetary Zone.
Such environment supposes in addition: The capacity, at the local banking level, not only to accept a funding risk but also a
long term credit risk Moreover, to develop the capacity to share between several institutions the risk
(syndication technique). Such capacity building is crucial and one of the IFI’s roles should be also to contribute to its enhancement.
page 18 CDA –Washington – October 1rst, 2004
Such an approach has been extensively used by Veolia Environnement (Veolia Water)
Raised with banking sector (Water sector alone) China: 10 projects – Amount raised: CV of US$ 500 millions South Korea: 4 projects (3 industrial outsourcing) – Amount raised: CV of US$ 300 million Morocco: 3 projects – Amount raised: CV of US$ 330 million Israel: 1 project – Amount raised: CV of US$ 100 million Czech Republic: 1 project – Amount raised: CV of US$ 200 million Jordan: 1 project – Amount raised: CV of US$ 50 million
Raised with institutional investors (in addition or not to bank lending) China: 3 projects – Financial partner - CV of US$ 100 million Morocco: 3 projects – Financial partner - CV of US$ 75 million Israel: 1 project (private placement) - CV of US$ 100 million Colombia: 1 project (Lend issue) - CV of US$ 40 million
Remarks: Most of the financing raised are on a limited or non recourse basis Most have a maturity exceeding 10 years
page 19 CDA –Washington – October 1rst, 2004
Conclusion
page 20 CDA –Washington – October 1rst, 2004
The Veolia Environnement experiences derived from its global activities: Total turnover (at June 30, 2004): euro 12 billion
Breakdown by division: Water: 39 %Waste: 25 %Energy services: 21 %Transportation: 15 %
Breakdown by revenues: France: 55 %Rest of Europe: 29 %North America: 8 %Asia Pacific: 4 %ROW: 4 %
Conclusion (1)
Its clientele: Municipal outsourcing: 70 %Industrial outsourcing: 30%
page 21 CDA –Washington – October 1rst, 2004
Conclusion (2)
From these experiences, three comments:
Yes, the sub-sovereign risk approach is manageable
Yes, access to local financing is more feasible than usually thought (by international financial institutions and consultants)
A more global approach should aim at: Improving capacity building at the sub-sovereign levels
Developing, at the local financial levels, a better understanding of long term funding and long term credit risk
CDA –Washington – October 1rst, 2004
Thank you for your attentionThank you for your attention