Government Support in Financing PPPs

Full Description

Funded products

The government may decide to provide direct support for the project for example through subsidies/grants,
equity investment and/or debt. These mechanisms are particularly useful where the project does not in its
own merit achieve bankability, financial viability or is otherwise subject to specific risks that the private
investors or lenders are not well placed to manage. In developing countries where private finance is most
needed, these constraints may necessitate more government support than would be required in more
developed countries. Funded support involves the government committing financial support to a project, such
as:

direct support – in cash or in-kind (e.g. to defray construction costs, to procure land, to provide assets,
to compensate for bid costs or to support major maintenance);

waiving fees, costs and other payments which would otherwise have to be paid by the project company
to a public sector entity (e.g. authorising tax holidays or a waiver of tax liability);

providing financing for the project in the form of loans (including mezzanine debt) or equity
investment (or in the form of viability gap funding); and

funding shadow tariffs for roads and topping up tariffs to be paid by some or all consumers (in
particular, those least able to pay) say in water and electricity projects to reduce the demand risk borne
by the project company[1].

Few PPP projects are viable without some form of government technical or financial support. Efficient
financing of PPP projects can involve the use of government support, to ensure that the government bears
risks which it can manage better than private investors and to supplement projects which are economically
but not financially viable.

Contingent Products

The government may choose to provide contingent mechanisms, i.e. where the government is not providing
funding, but is instead taking on certain contingent liabilities, for example providing:

guarantees, including guarantees of debt, exchange rates, convertibility of local currency, offtake
purchaser obligations, tariff collection, the level of tariffs permitted, the level of demand for services,
termination compensation, etc.;

indemnities, e.g. against non-payment by state entities, for revenue shortfall, or cost overruns;

insurance;
 hedging of project risk, e.g. adverse weather, currency exchange rates, interest rates or commodity
pricing; or

contingent debt, such as take-out financing (where the project can only obtain short tenor debt, the
government promises to make debt available at a given interest rate at a certain date in the future) or
revenue support (where the government promises to lend money to the project company to make up for
revenue short-falls, enough to satisfy debt-service obligations).

For example, on the Zagreb-Macelj toll road, the government provided in-kind support in the form of land
and contingent debt drawn down whenever revenues were insufficient to cover debt service. Thus, lenders
were protected, but the risk remained with the equity holders.

The government will want to manage the provision of government support, and in particular any contingent
liabilities created through such support mechanisms. Governments seek a balance between supporting private
infrastructure investment and fiscal prudence.[2] Striking this balance right will help the government make
careful decisions about when to provide public-money support and manage the government liabilities that
arise from such public-money support, while still being aggressive in encouraging infrastructure investment.
Government assessment of projects receiving such support is doubly important given the tendency of lenders
to e less vigilant in their due diligence when government support is available, since this reduces lender risk
and exposure.

Governments actively managing fiscal risk exposure face challenges associated with gathering information,
creating opportunities for dialogue, analyzing the available information, setting government policy and
creating and enforcing appropriate incentives for those involved. Given the complexity of these tasks, it is
becoming more popular for governments, and in particular ministries of finance, to create specialist teams to
manage fiscal risk arising from contingent liabilities, in particular those associated with PPP. This is often
achieved through debt management departments, which are already responsible for risk analysis and
management. The government may also consider creating a separate fund to provide guarantees, allowing the
government to regulate better this function and ring fence the associated government liabilities. For more, see
Management of Government Risk.

Financial Intermediaries

The government may wish to use its support to mobilize private financing (in particular from local financial
markets), where that financing would not otherwise be available for infrastructure projects. The government
may want to mobilize local financial capacity for infrastructure investment, to mitigate foreign exchange risk
(where debt is denominated in a currency different than revenues), to replace retreating or expensive foreign
investment (for example, in the event of a financial crisis) and/or to provide new opportunities in local
financial markets. But local financial markets may not have the experience, or risk management functions,
needed to lend to some sub-sovereign entities or to private companies on a limited recourse basis.

To overcome these constraints, the government may want to consider the intermediation of debt from
commercial financial markets, creating an intermediary sufficiently skilled and resourced to mitigate the risks
that the financial markets associate with lending to infrastructure projects. To achieve this, the government
may want to use a separate mechanism (the “intermediary”) to support such activities without creating undue
risk for the local financial market, for example, by:

using the intermediary’s good credit rating to borrow from the private debt market (e.g. providing a
vehicle for institutional investors who could not invest directly in projects) then lend these funds to
individual entities or projects as local currency private financing of the right tenor, terms and price for
 the development of creditworthy, strategic infrastructure projects;

providing financial products and services to enhance the credit of the project and thereby mobilize
additional private financing, for example by providing the riskiest tranche of debt, providing specialist
expertise needed to act as lead financier on complex or structured lending, syndication, credit
enhancement, and specialist advisory functions; and/or

providing support to finance or reduce the cost or improve the terms of private finance for key utilities.
These entities may need first to learn gradually the ways of the private financial markets, and the
financial markets may need to get comfortable with lending to infrastructure operators. This
mechanism can help slowly graduate such sub-national entities or state owned enterprises from
reliance on public finance to interaction with the private financial markets.

Current best practice indicates that such intermediaries should be private financial institutions with
commercially oriented private sector governance. Intermediaries meant to create space in an existing
financial market must have commercial incentives aligned to this goal, with appropriately skilled and
experienced staff, and a credit position sufficiently strong to mobilize financing from the market. Existing
private financial institutions with appropriate skills and capacity can help to perform this function. However,
private entities often suffer from conflicts of interest (e.g. holding positions in the market such that their
interests are not aligned with the role of intermediary) or would be constrained from taking positions in the
market due to its role as intermediary (crowding out vital market capacity). The government may therefore
want to create a new private entity to play this role.

Examples of financial intermediaries developed by Governments are:

India:

India’s Infrastructure Development Finance Company (IDFC)

IDFC was set up in 1997 by the Government of India along with various Indian banks and financial
institutions and IFIs. IDFC’s task was to connect projects and financial institutions to financial markets and
by so doing develop and nurture the creation of a long-term debt market. It offered loans, equity/quasi equity,
advisory, asset management and syndication services and earned fee based income from advisory services,
loan syndication, and asset management capitalize on its established knowledge base and credibility in the
market. IDFC also developed a project development arm, taking early positions in some project vehicles. By
bringing projects through feasibility, structuring, and presentation to bidders, it generated
success/development fees from the winning bidders.

The agency invested significant efforts in its early years in policy and regulatory framework changes to
facilitate private investment in infrastructure. More bankable infrastructure projects subsequently emerged.
IDFC has successfully leveraged the fact that the Government holds an equity stake – without compromising
on its commercial orientation.

IDFC began operations with a strong capital base of approx US$400 million. Growth was initially slower
than expected. After 6 years of operations, IDFC had a loan portfolio of around US$550 million and growth
accelerated. After 8 years, an IPO in July 2005 introduced new equity and allowed early investors to realize
their gains. An additional US$525 million equity was raised through an institutional placement in 2007, by
which time, the Indian government’s stake had fallen to 22 %. Other major shareholders now include
Khazanah, Barclays and various Indian institutions.

India Infrastructure Finance Company Limited (IIFCL)

The Company renders financial assistance through:

Direct lending to eligible projects

Refinance to banks and FIs for loans with tenor of five years or more

Any other method approved by Government of India

Tamil Nadu Urban Development Fund (TNUDF)

An example of a subnational financing intermediary is the Tamil Nadu Urban Development Fund (TNUDF),
which attracts private finance for on-lending to local governments for infrastructure projects, and encourages
private-sector co-financing of such projects. The TNUDF is answerable to private and public shareholders,
moving investment decisions away from the normal state decision-making process. However, TNUDF has
not mobilized private investment in the manner anticipated, due mainly to the abundant public, subsidized
funding available, making private finance too expensive and therefore less attractive.[3]

See also IFC SmartLessons, an awards program to share lessons learned by the International Financial
Corporation (IFC) during development-oriented advisory services and investment operations.

Project Development Funds

In the UK, arguably one of the most efficient PPP market in the world, advisory costs during project
development average 2.6 per cent of project capital costs. Advisory costs in lesser developed PPP markets
run even higher. The large amount of upfront costs for procuring PPP projects, in particular the cost of
specialist transaction advisers often meets with strong resistance from government budgeting and expenditure
control. But quality advisory services are key to successful PPP development, and can save millions in the
long-run. Therefore, funding, budgeting and expenditure mechanisms for project development are important
to a successful PPP program, enabling and encouraging government agencies to spend the amounts needed
for high quality project development.

The government may wish to develop a more or less independent project development fund (PDF), designed
to provide funding to grantors for the cost of advisers and other project development requirements. The PDF
may be involved in the standardization of methodology or documentation, its dissemination and monitoring
of the implementation of good practices. It should provide support for the early phases of project selection,
feasibility studies and design of the financial and commercial structure for the project, through to financial
close and possibly thereafter, to ensure a properly implemented project. The PDF might focus on specific
sectors or projects in a region or nationally, but needs to have a broad scope to address the different forms of
PPP to respond to sector needs. The PDF may provide grant funding, require reimbursement (for example,
through a fee charged to the successful bidder at financial close) with or without interest, or obtain some
other form of compensation (for example, an equity interest in the project), or some combination thereof, to
create a revolving fund. The compensation mechanisms can be used to incentivize the PDF to support certain
types of projects.
Below are some of the project development funds/ facilities developed by governments:

South Africa Project Development Facility

Africa’s Project Development Facility (PDF) is a single-function trading entity, created within the National
Treasury in accordance with the Public Finance Management Act. Its primary function is to support
governmental entities with the transaction costs of PPP procurement. The PDF collaborates with the
Department of Provincial and Local Government’s Municipal Service Partnerships Unit, provides funding for
the preparation of feasibility studies and procurement of service providers, and may consider funding the
costs of procuring the project officer. Support from the PDF can only be acquired if the project receives
support from the National Treasury’s PPP Unit.

The PDF recovers its disbursed funds either in part or in full as a success fee payable by the successful bidder
at the financial close of the project. The risk of the project not reaching financial close is taken by the PDF in
all cases other than an institutional default.

India

Project Development Fund of IL & FS

India Project Development Fund (IPDF) was introduced by IL&FS towards funding project development
expenses of large infrastructure projects, primarily in surface transport, ports, water and power infrastructure.
IPDF meets all project development costs and takes on the development risk upto financial closure.

IPDF is the first private equity fund in India for project development funding covering:

Project Design & Techno-Financial Feasibility

Environmental, Social & Market Studies

Establishing Contractual Framework

European Union Funds

European Union (EU) Funds are an important element of European infrastructure finance. The European
Commission makes funds available to EU Member States under either the European Regional Development
Fund, the European Social Fund or the Cohesion Fund. Incorporating EU Funds into a public-private
partnership (PPP) structure poses some challenges. The materials below provide guidance on how to combine
private finance in a PPP structure with EU funds:

Combining Cohesion and Structural Funds with PPPs in EPEC PPP Guide, European Expertise Centre
(EPEC)

Poznan Waste-to-Energy Project, Poland Using EU Funds in PPPs Case Study, European PPP
Expertise Centre (EPEC), June 2012
 EU Funds in PPPs - Project Stocktake and Case Studies, European PPP Expertise Centre (EPEC), June
2012

Using EU Funds in PPPs - explaining the how and starting the discussion on the future, European PPP
Expertise Centre (EPEC), May 2011

[1] Some of this is supported by output based aid – for more on this, see www.gpoba.org which is a facility
that supports output based solutions

[2] For further discussion of this issue, see Irwin, Government Guarantees: Allocating and Valuing Risk in
Privately Financed Infrastructure Projects (World Bank, 2007)

[3] Krishnan, “Tamil Nadu Urban Development Fund: Public-Private partnership in an infrastructure finance
intermediary” (World Bank, 2007).

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