This document outlines best practices for structuring public-private partnership (PPP) and concession contracts. Key points include: 1. Using output-based contracts focused on performance rather than investment obligations to incentivize efficiency. 2. Requiring adequate insurance, performance bonds, and credit ratings to ensure compliance. 3. Protecting financiers and monitoring concessionaire finances through revenue assignment, financial disclosure, and notification of non-compliance. 4. Establishing clear risk matrices and sharing arrangements based on ability to control risks and potential for externalization. 5. Including provisions for default management, mediation, termination, and credit enhancement of government payments.

1. Best practices on PPP and concession contracts structuringMauricio Portugal RibeiroAug 2010

2. Contents1. IntroductionOutput based contractsInsurance and performance bondProtection of financers and monitoring of concessionaire financial conditionsRisk sharing arrangementsDefault and conflict management toolsTermination and early termination of contractsCredit enhancement of the Government and backstop facilities to Government payments

3. Introduction and disclaimerDifficulties to consolidate best practicesThis presentations is based on our opinion on what is best practiceAll of the contract features recommended in this presentation were already used in concession contracts, but they are not yet “bullet proof” from a legal standpoint Administrative lawyers still debate whether it is possible to use some of themThe Courts have not yet analyzed many of them

4. Output based contractsContracts focused as much as possible on service performance obligations (not on investment obligations):Focus on service output has two consequences:Room to produce efficiency gains, as decisions on inputs are left to the private partnerChange the traditional public sector activity of supervision of contractAdequate connection between performance indicators and payment systemGov paymentTariff chargingFor the case of non-compliance of the service indicators by the private partner, shiftfrom the imposition of fines by the Governmentto non payment by the Government

5. Output based contractsExample from road sectorPavement and infrastructure indicatorsIGGIRIStructural numberCapacity indicatorsExpansion of capacity obligations triggered by traffic thresholdsService performance indicatorsEmergency Rescue and accident cleaning time obligationsMonitoring obligationSafety obligationsSocial and environmental obligationsFull compliance with the Equator Principles and with IFC Social StandardsInvestment obligations remain for some aspectsGuardrailsHuman CrossingsSome of the monitoring systems

6. Insurance and performance bondsInsuranceCoverage and limits are defined in the contract, by specialist based on assets values and availability of coverages in the insurance marketRequirement of insurers investment grade credit rating Performance bondTo produce contract compliance incentives in a context in which applying fines is not easyRequired minimum coverage and value are established in the contract for each year based on the estimated investments for that year In the cases in which the assets are transferred back to the Government at the end of the contract, requirement of higher coverage values in the last years of the contract so as to create incentives to keep the assets in the proper conditionsRequirement of investment grade credit rating of performance bond providers

7. Protection of financers and monitoring of the concessionaire financial conditionsProtection to financersConcessionaire can assign revenues streams and other rights to the financersGovernment paymentsTariff paymentsProtected debt (principal, interest and fees) in any case of early termination of the contractStep in rightsMonitoring of the concessionaire’s financial conditions by the GovernmentSPC’s accounting have to comply with the local GAP for listed companies (although there is no requirement to list the SPC)Concessionaire have to deliver all its financial contracts to the GovernmentConcessionaire have to deliver quarterly financial statements and disclosure all financial information to the GovernmentFinancers have the obligation to notify the Government of the non-compliance with any covenant or provision of the financing contractThe Government have to notify the financers of any non compliance of the concessionaire with the concession contract

8. Risk sharing arrangementsClear risk matrix that in compliance with local best practicesSome risks are allocated by the law (vg. creation of new taxes)Most of the risks are allocated by the contractRisk sharing criteriaCriteria 1Who is able to (at the lowest possible cost) decrease the expected loss or increase the expected gains of a given situation? Criteria 2Risks should not be attributed to agents that are able to externalize lossesGovernments may transfer burden to tax payers, and for this reason the risk of loss does not produce the right incentivesCriteria 3Risks should be attributed to the Government ifIf there is no insurance coverage for that risk in the marketInsurance market are underdevelopment or premiums are too high

9. Risk Matrix ExampleRisk matrix was extracted from the Pontal Project, in Petrolina, taken from the model developed by the IFC – International Finance Corporation

10. Contract financial equilibrium protectionNeed of financial equilibrium protectionOffset the regulator powersCompensation of risks that are allocated by the contract to the other concessionaire BenchmarkingMain concern in Brazil is to define a methodology that does not change or distort the risk matrixDue to the asymmetries of information, traditional rate of return regulation has many times distorted the risk matrix of concession contractsThe tendency is to use a methodology that is connected with the risk matrix and that uses as a reference the marginal impacts in the cash flows of events that have caused the disequilibrium of the contractUse, when possible, market costsDefine a formula in the contract to calculate the discount rateProcedures for contract reviewAnnual price adjustments against inflation Ordinary revisions (periodically, each 2-5 years, etc.)Extraordinary revisions

11. Default and conflict management toolsStep in rights of the GovernmentFor cases that involve safety of the users and of the environmentFor cases that risk the continuity of the service provisionStep in rights of financiersIn both cases breach of the financing agreements or of the concession contractMediation and arbitration for all matters between the Gov and the concessionaire to avoid going to the JudiciaryTermination and Early Termination of ContractsIn the case in which assets are transferred to the GovernmentObligation to pay to the concessionaire of all non-depreciated or non-amortized assetsPayment should be previous to the transfer of the assetsContract should foresee clearly which assets will be transferred to the GovernmentContract should foresee procedure and methodology to account for amortization/depreciation of assets that will be transferred back to the GovernmentEarly termination of contractsIn all cases, protection of the debt paymentProtection of the investors (equity holders) in the case of early termination because of nationalization or expropriation of assets, and in the case of termination for non compliance with the contract by the Government

12. Credit enhancement of the Government and back stop facilities to Gov paymentsRating of PPP contract payment obligation of the Federal, State and Local Governments are very lowBecause of the different legal frameworks that controls the treasury bonds payments and the contract payments of the Government, the bonds rating is very different from the contract payments ratingAlthough the Federal Government bonds and some of the States bonds are investment grade, their PPP contract debts are not Federal and States Governments have created backstop facilities

13. Some backstop facilities were created in the PPP law but has never been used

14. We generally include in the scope of our mandates to reform the law and help the Government to set a guarantee structure adequate to the projectMain challengesDevelop and consolidate new financial equilibrium model and methodology

15. From a legal standpoint, consolidate:The protections to financers specially in the case of early termination of contractsThe possibility of requiring minimum credit rating level from the insurers and performance guarantee providersThat payment for non depreciated assets of the concessionaire can be done before transferring of them to the GovernmentThat the backstop facilities structures to do the credit enhancement of the Government payment are valid