Filip drapak ppp in financial crises english


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The Impact of the Financial Crisis on Public Private Partnerships

Filip Drapak, Senior PPP Specialist, World Bank

Public Private Partnerships have been an innovative technique to fund large government projects. How the financial crisis has changed this approach will be the subject of this discussion.

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Filip drapak ppp in financial crises english

  1. 1. PPP and Financial crises 2008-2010 Filip Drapak World Bank Institute May 2010
  2. 2. 1
  3. 3. Content of presentation  Financial crises and infrastructure  Impact on PPP  Regional and global impact  Governance  Finance  Guarantees  Procurement  Development institutions and PPPs 2
  4. 4. Government response in terms of issues 1) Liquidity: (a) direct lending in form of parallel financing (EIB, funding facilities in France and Germany) (b) role of lender of last resort (TIFU in UK used for Manchester waste project) (c) policy measures enabling solutions to liquidity issues (DFC, short term financing of long term projects) 2) Capital allocation: (a) Debt guarantees (France, Spain, Portugal, Slovakia) (b) Underpinning (France, Germany, Poland) (c) Indirect guarantees (Sub-sovereign guarantees, Loan Guarantee for Ten T projects…) 3) De-risking of projects measures (a) swapping payment mechanisms (b) braking the projects up in several tranches (c) support guarantees on particular risks (d) structuring/ROE support (supplementary income, funding contribution optimization) 3
  5. 5. Policy and Governance implications  Procurement has to be more flexible, shorter and financial market risk sensitive Market flexibility and procurement flexibility Procuring authorities are suffering from the higher financing costs and bank fees, as well as greater transaction costs from procedures and negotiations that are taking longer to conclude. One risk is that final bids that were thought to have committed financing are reopened as debt continues to be re-priced. It’s no longer realistic to insist on committed financing at the bid stage – most lenders require price flex, or indeed market flex clauses (in which most terms, not just pricing, can be adjusted). This makes it impossible to conclude the financial evaluation of private partner proposals until much later in the process, and sometimes not even until days before financial close. This creates significant headaches for procuring authorities. How can a preferred bidder be selected if the financial proposal is not known with great certainty? How can competitive tension be maintained in final lending negotiations until well after preferred bidder selection? Should government share the pricing risk to which the preferred bidder is currently exposed? In one current UK social infrastructure P3, the c. $150M debt package has been re-priced twice since April this year, and closing has been delayed. CCPPP, 2009 4
  6. 6. Policy and Governance implications: introducing DFC  As one of potential policy measures to improve the financing of PPP projects UK government used so called DFC (Debt Funding Competition) What is a DFC? A DFC is an initiative that has been employed in the UK a number of times since 2000 and has been championed by the UK HM Treasury as a mechanism for government to induce competition and thereby obtain more favorable debt funding terms. When using a DFC, government selects a preferred bidder and that preferred bidder, in consultation with government, then goes to the debt market seeking the best price for the debt funding for the project. The objective for the UK government was to increase the competitiveness of the lending market with a view to reducing the overall cost of the project.1 We are now in a very different market where the primary focus of the DFC would be to source sufficient debt funders willing to lend to the project. David Lester and Chris Keane, 2009 5
  7. 7. Policy and Governance implications: introducing new institutions and guarantee support mechanisms  The solutions often suggest new institutions, from US discussion regarding the Infrastructure bank, ideas of setting up national guarantee instruments to the discussion on a new role of multilateral and development institutions. How to mitigate the impact of the financial crisis on PPPs2009 The French Institute for PPP (IGD - Institute de la Gestion Déléguée) released in November its proposals to mitigate the impact of the financial crisis on PPPs in France. IGD suggests to address the issue of lack of liquidity through the delinking of the duration of contracts and the duration of loans that would allow the short-term financing of projects and its long- term refinancing when market conditions will be more favorable, and the creation of a special public vehicle that would be entitled to collect and provide long-term resources to support banks activities. IGD also proposes to reduce the impact on costs through a special state warranty on local authorities’ projects, and calls for a broader public support through investment subsidies when construction periods are important. Pierre Van de Vyver, 2009 6
  8. 8. Financial crises and infrastructure: reactions in 2008 • The USA president-elect, Barack Obama has said that: “we can’t worry short term about the deficit. We’ve got to make sure that the economic stimulus plan is large enough to get the economy moving.” • The EU is discussing proposals from Britain and France for a major programme of additional infrastructure investment • The newly elected government in New Zealand has announced its intention to make tax cuts and increase infrastructure investment including : “the development of new roads and public transport, improve schools and roll out an ultra-fast broadband network.” • China, which is already spending as much as 14% of GDP on infrastructure, is “weighing plans to expand a massive stimulus package with higher spending on health and social programs” 7
  9. 9. Financial crises and infrastructure: reactions in 2008 • The government of India has announced $60billion increase in state spending, including an additional $4 billion on infrastructure projects. • Mexico says it plans to spend 6.5% of GDP on infrastructure in 2009, the highest rate ever recorded, with a deficit of 1.8% of GDP. • South Korea is creating 50,000 jobs by the end of 2009 by spending over $3bn on infrastructure. (David Hall, Economic crisis and public services) The [Korean] government announced a fiscal stimulus package in response to the financial crisis with more than 15 percent of the envisaged investment to be carried out through PPPs. The package is accompanied by measures to reduce financial burdens on PPPs, smooth interest rate changes, and shorten project implementation. The measures introduce: (i) lower equity capital requirements on concessionaires (5–10 percent); (ii) for large-scale projects, higher ceilings on guarantees provided by the Infrastructure Credit Guarantee Fund (50 percent); (iii) help in changing equity investors for some projects; (iv) compensation for the preparation of proposals to encourage more vigorous competition during bidding; (v) sharing of interest rate risks with concessionaires; (vi) compensation for the excess changes in base interest rates through grading of risks at the time of the concession agreement; and (vi) shorter periods for readjusting benchmark bond yields. IMF 8
  10. 10. Governance Stanford published research paper “Public Private Partnership Agencies, A Global Perspective” defines three types of PPP agencies: (a) Review Bodies; (b) Full service Agencies and (c) Centers of Excellence. While Review Bodies do have a more of a Regulatory function, Service Agencies do have Advisory role and Centers of Excellence have Capacity building mandate. Obviously these roles tend to be more structured and mixed up in different governance structures within the global landscape. Lets look at 3 case studies of 1) UK: the centralization 2) SA: the decentralization 3) Russia: the refocusing 9
  11. 11. Governance: the UK case There are two important policy measures stipulated by financial crises: recent establishment of TIFU and planned set up of Infrastructure UK within UK Treasury, which will consolidate regulatory and policy team, TIFU and PUK and exercise clear responsibility from developing and supporting delivery of an infrastructure strategy for the UK. Establishment of Infrastructure UK is however more result of long term development than impact of financial crises. 10
  12. 12. Governance: the SA case Financial crises and South Africa PPP Unit: The demerger of regulatory and advisory roles, greater independence on Treasury. SA context of financial crises did bring major change of government and while presidential support to PPPs remained strong, the government and line ministerial leadership in this field was very weak. Financial crises initiated some progress in terms of IPPs to respond to energy crises, set up of a hospital PPP program and strong support still for the transport related PPPs. Key driver at SA PPP governance is at the moment the separation of Advisory from Regulatory function when driving the deal flow, which is more natural development rather that financial crises impact. PPP Unit will move away from Treasury in to a new Government Component under the brand name of Partnerships SA, will be 100% government owned and will have mainly project development function. The regulatory function will be exercised by Director General NT. 11
  13. 13. Governance: the Russia case Very substantial impact had financial crises on Russia and its impact on PPP perception in Russia. Russian federal PPP Unit is located within Russian Development Bank the “Vnesheconombank” and led by Alexandr Bazhenov. The situation in Russia has changed dramatically. While prior financial crises Russia did look at PPPs as an important, but not essential tool, given rich surpluses in budgets, this has changed with financial crises and PPPs are now considered essential for the development. This is reflecting on status and role of PPP Centre within “Vnesheconombank”, giving the PPP unit mandates in capacity building, advisory of choice, and financing of PPPs. 12
  14. 14. Key financial issues of PPP in financial crises  PPP economics have changed  Lack of funding on both equity and debt side  Lack of interest of investors and operators “The monoline wrapped bond market, which has been the financial structure of choice for large PFI projects over the past 10 years, is now effectively closed to new transactions. This has increased reliance on the banking market. The combination of capital adequacy requirements, reduced liquidity and higher funding costs has increased the strain on the project finance banking model. While the banks’ views of the PFI risk profile have not changed materially, funding availability is limited and credit margins have moved up.” Andy Rose, Executive Director, PUK 13
  15. 15. PPP economics have changed  Economic cycle has to be taken in to the account “Equity price bubble busts every 13 years on average, last for 2 ½ years and are associated with GDP losses of 4 percent of GDP. Housing price busts are less frequent, but lasted nearly twice as long and were associated with output losses that were less twice as large…” World Economic Outlook  Risk management and mitigation implication (a) Country risk (b) On project risk (c) Refinancing risk 14
  16. 16. PPP economics have changed  Implications for the VfM (a) Projects less likely to achieve VfM - Increased cost of equity - Increased role of equity and proportion of equity financing - Increased cost of debt (offset by lower interest rates?) (b) Fiscal space implications to VfM (c) Some governments more rigorous on VfM and can be more keen on litigation Ernst & Young’s P3 team in the UK infrastructure reports that the average margin for availability payment-based P3s, increased from 82bps to 94bps between May and August 2008. Volume based payment P3 projects had average margins of 155bps in August 2008, which is increase of 50bps since credit crunch. Ernst&Young’s UK infrastructure report 15
  17. 17. PPP economics have changed  VfM might be lost at the current market, this can however be offset by fiscal and macro economical benefits of PPP PPP lifecycle cost PSC: public model VfM lost equity debt 16
  18. 18. PPP economics have changed  is there evidence for change in economics of PPP? Global project finance 2007/2008 51.3 Equity financing 74.4 15 Bond financing 5.7 2007 2008 212.1 Loan borrowing 234.9 Global project 278.4 finance 315 0 50 100 150 200 250 300 350 USD billion Project finance 2009 17
  19. 19. PPP economics have changed  is there evidence for change in economics of PPP? Change in 2008 in % 60 45 40 20 11 0 Loan borrowing % Loan borrowing Bond financing Equity financing Bond financing -20 Equity financing -40 -60 -62 -80 Project finance 2009 18
  20. 20. European PPP market in 2008-2009 (EPEC) 19
  21. 21. Global PPP in 2007-2009  Volume of PPPs have stagnated in 2008 on the 2007 level with growth mainly generated in North America region (203% growth), however the 4Q 2008 volume fell 38% (in comparison to 4Q 2007 volume). 2009 total volume fell by 18% to USD 55 bn with 4Q of 2009 up 9% via 4Q of 2008. Global PPP in 2008 PPP volume 2007-2009 and 4Q % change India Midle East anhd North Africa 4.5 alone 20% Asia 11.3 2010 North America 8.4 Spain 4.6 Portugal USD 3.4 bn Portugal 6.4 UK 10.9 UK USD 8.2 bn Global PPP 67 2010 0 20 40 60 volume80 of USD Project finance 2009/2010 USD billion 55 bn 20
  22. 22. PPP economics have changed, but not the perception of the usefulness of PPPs “Greater emphasis also needs to be made towards the social economic benefits delivered to a country or region which could mean adopting a more visionary approach to PPP models to include agglomeration benefits. Failure to do so will mean that PPP projects may never get off the ground on a pure cost benefit basis.” EC Harris, Is PPP dead and buried? 21
  23. 23. Using guarantees to support PPPs During the current financial crisis, the banks have not been forthcoming with loans for PPPs, or they require additional security in the form of guarantees of their loans. The only party that can provide such a guarantee on the market today is the government. A few examples of this kind of guarantee: -The French government has been "allowed to guarantee loans on priority projects implemented through PPPs entered into before 31 December 2010, up to a global ceiling of €10bn." -The Spanish ministry of infrastructure initiated special financial guarantees for PPP projects (mainly for high speed trains) for an estimated amount of 15.000 M€ -In Australia, the main problem is the unavailability of long tenor debt, with recent projects being financed using 5-year mini-perm structures. Governments have proved willing to share in the refinancing risk at the maturity of these financings. The State Government of Victoria has underwritten the senior debt syndication of its A$5 billion desalination project, in the expectation, that the bank club supporting the winning bidder will be able to sell down to members of the bank club that supported the losing bidder. -The Portuguese government is reportedly providing a Euro 800 mil. guarantee to the Litoral Centro highway concession and will also guarantee the Pinhol Interior concession project. - Kazakhstan used debt instruments guaranteed by the government to finance PPPs with the goal of “encouraging participation of pension funds in the system”. Currently, the law enables the government to provide guarantees both to the concessionaire for infrastructure bonds within the limits of the concession agreements and to loans attracted to finance concession projects. According to the professionals participating in the PPP process, the government’s accounting process in the fiscal budget will include subsidies or co-funding as state investments, while the guarantee will be considered as a public debt. 22
  24. 24. TIFU – the UK loan facility The UK, which has the largest PPP market so far, has decided to establish a The Infrastructure Finance Unit (TIFU) to lend to PFI/PPP projects to "ensure that infrastructure projects go forward as planned despite financial markets conditions and thereby support jobs and economy." This is generally a good idea, but at first it seemed that it would not be necessary. For a while, banks managed to form a club, or the European Investment Bank supported the project. However, margins continued to climb and banks could only deliver short-term financing in the form of mini-perms. For the time being, the bond market and credit risk insurance are dead, so finally TIFU found its first project to bail out in April 2009: "TIFU completed its first loan facility on 8 April 2009, providing a £120 million loan for the Greater Manchester Waste Disposal Authority’s PFI project alongside the European Investment Bank and a syndicate of commercial banks." This project was bailed out in the sense that the project could not secure financing without TIFU support, but it is a new development project so it's difficult to judge whether it meets the criteria I set out above. The second project to be bailed out was considered in May for the Wakefield waste treatment project. Finally, two years after the selection of a proffered bidder, the financing of £700 million was secured on a preliminary basis in June without TIFU assistance and is expected to close within several weeks. Bailing out PPPs might be controversial for taxpayers, but it remains the only practical option for the public sector. Hopefully, the financial crisis will subside soon and financial markets will come back to their traditionally aggressive and long term lending to PPPs. 23
  25. 25. Canada: Partnerships BC Funding contribution optimization 8% ARHCC 8% Okanagan Lake Bridge 8% Optimization based on Sea to Sky IHA 7.8% SMH balancing public funding 7.5% NCC SFPR 7.5% FSJ 7.3% 7.4% 7.4% contribution to achieve certain Diamond Centre Kicking 7.1% IRR Horse SOPF 7% 7% RJH 6.9% 6.5% Older Projects Current Projects 24
  26. 26. Australia: Credit Enhancement through Supplementary Income Good example of Credit Enhancement through supplemental income is the Airport Motorway Trust project in Australia. -The government issues an Infrastructure Bond at its cost of funds and lends the proceeds to the project company, which invests the proceeds at the market rate. -The difference between the cost of interest on the Infrastructure Bond and the interest income on the invested proceeds provides supplemental income to the project. - In the early years of operation, when Airport Motorway’s toll revenues barely provided over 1X debt service coverage, total coverage with supplemental interest income was 2X. -This allowed project debt to have a much higher rating and lower cost of capital than if it were secured only by toll revenue - The Infrastructure Bond carries a long-term maturity date, which gives the project cash flows ample time to ramp-up. The bond is retired from the invested proceeds. Thereafter, debt service is payable solely by project revenues. Fitch Ratings, William Streeter 25
  27. 27. Conclusions  Financial crises impact on the PPP market is not over yet, however recovery and optimism is quite strong  Smaller transactions and larger risk diversification are demanded by the financial market  Long maturities still available but costly  Bigger role for development banks and multilateral institutions  Governments should focus on building the pipelines of good projects, as there is permanently less good projects than there is funds available for them  Bond, wrapped or privately insured financing not really available yet, but number of solutions have emerged 26