One of the most obvious trends in the project finance market at a global level is the shift from entirely private initiatives to projects involving the public administration. PPPs account for 25% of the total loans granted in Europe and Central Asia/Asia Pacific. Distribution among the different sectors of transportation and infrastructure make up nearly 80% of the total during the period from 2003 to 2006. UK, Italy, Spain and France are the markets that account for the largest portion of the total project finance market in Europe, thanks to well established laws that specifically regulate its use, in particular in the context of PPPs. Then what would the private sector investors and international fund providers generally be looking for considering involvement in a PPP project.
A large fraction of project finance initiatives are run by the private sector on the basis of concession contracts. PPP arrangements are based on medium to long-term contracts between a public sector contracting authority and a private sector provider for the delivery of specified public services. At the core of all well- functioning PPPs is a carefully structured contract that is both affordable and bankable. As we are concerned as to the bankability of a project, the tendency would be to look into the traditional benchmarks of a positive net present value (NPV) and an acceptable internal rate of return (IRR) to the private sector. However, if the PPP project itself is sufficiently well structured and the project environment provides sufficient incentive, the majority of projects can be considered bankable. Therefore it becomes imperative that private sector concerns are improved by strong government support and political buy-in.
This is intrinsically a difficult task, as demonstrated by the costly experience of Turkey, where badly-structured BOT power deals have been estimated to cost the country up to USD 7 billion a year. The unfortunate experience with PPPs in Turkey highlights that the key benefits from PPPs relative to conventional procurement will only be realised if the public sector is able to rise to the challenge of appropriate contract design and monitoring, and if private sector performance is spurred by the disciplines of transparency and competition where feasible.
Bankability is determined by how the project is defined and the constraints that are imposed, or the incentives that are provided, in respect of the implementation through the concession contract or regulations. The process of selecting bankable projects consists of selecting projects that can be given a serious chance of success with sufficient incentives through Government support and regulations, while keeping these incentives within acceptable limits and in line with risk transfer objectives.
Financial risks emerge when the main motivation behind the government's decision to undertake a PPP is not primarily related to achieving value-for-money (VfM). When PPPs are used to bypass normal expenditure controls and to move public liabilities and debt off budget and off the balance sheet of the government, they typically entail hidden and often higher costs in achieving the public policy purpose. Achieving VfM requires appropriate risk sharing between public and private partners in PPPs. For instance the main risks confronting road PPP projects are:
Revenue risk.
These are defined as risks associated with insufficient traffic levels, and on roads with tolls, when toll rates are too low to generate expected revenues. The treatment of traffic and revenue risk ranges from full private sector assumption of the risk to government provided minimum traffic and revenue guarantees.
Financial risk.
It is defined as the risk that project cash flows may fall short of the level needed to repay the loans and capital invested in the project. The private sector is generally responsible for financial risk, although in some cases governments may provide debt guarantees, equity guarantees, and other types of financial guarantees. Governments may also provide cash grants, equity, or subordinated loans, which improve the expected rate of return on private capital invested.
Exchange rate risk.
It is a major issue for toll roads financed on international capital markets, since exchange rates largely determine whether domestic income suffices to repay loans denominated in foreign currency. Projects can avoid this risk by tapping local capital markets for funding. The exchange rate risk is often mitigated by indexing the toll rates to local inflation. For projects involving foreign capital, the private sector generally assumes the exchange rate and inconvertibility risk, although in some cases, political risk insurance may be available to cover inconvertibility.
Political risk.
Concerns government actions that could impair the ability to generate earnings. Examples include cancelling the concession unilaterally; imposing new taxes or regulations that seriously reduce the value of the project from the viewpoint of investors; refusing to accept the tolls agreed in the concession contract; prohibiting investors from taking revenue out of the country; and not allowing a fair solution to contract disputes by a neutral judicial organization. Governments generally bear the responsibility of such risk when fair and time.
The private sector investor or project finance partner would generally be satisfied with political stability and 'buy-in' by all political stakeholders, continuous high level political support, as well as reliable & enforceable risk sharing procurement contracts with adequate return.
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