Conceptual Framework for PPPs

Presentation to the Planning Board

May 2007

PV Ravi Infrastructure Development Corporation (Karnataka) Limited

Definition
A Public Private Partnership is an arrangement between a public (government) entity & a private (nongovernment) entity by which services that have traditionally been delivered by the public entity are provided by the private entity under a set of terms and conditions that are defined at the outset

Characteristics
The public entity should have the enabling authority to transfer its responsibility enabling legislative & policy framework, administrative order the instrument of transfer is through a contract There is usually a significant transfer of responsibility to the private entity and usually includes financial investment obligations For a payment to the private entity directly by users or by the public entity such that - a significant portion of project revenues and/ or the payments, are conditional on achieving pre-specified levels of performance The nature of the relationship is usually long-term
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Risk Sharing
A risk is defined as any factor, event or influence that could threaten the successful completion of a project in terms of time, cost or quality In a conventional BOQ based implementation : risks planning, design, construction, environmental & social, physical damage and financing are evaluated Commercial risks revenue or maintenance costs, quality, safety of users and general regulatory risks not critically evaluated this is critical though to a private investor PPP involves sharing of risks risk allocated to the party best suited to manage them
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Why PPPs?
Fiscal reasons - Inadequacy of resources leveraging on lower government funding Optimal transfer of risks to the entity best suited to manage the risks
Design, Financing, Construction, Operations and Maintenance all are commercially understood and manageable Change of scope, defective designs, time overrun, cost overruns, leakage of revenues, high maintenance costs Appropriate technology, innovative design solutions, project management, better collection practices, life cycle costing
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Transfer of responsibilities efficiency gain

Other Reasons
Enhanced bankability more rigorous project preparation Incentive to deliver whole life solution not just asset creation Focus shifts to service delivery integrated with construction, measurement of quality & payment linked to service delivery Acceleration of programme time-bound implementation Better overall management of public services transparency in prioritisation, selection and ongoing implementation
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PPP Options

Works & Management & Services Contracts Maintenance Contracts

Operation & Maintenance Concessions

Build Operate Transfer Concessions

Full Privatization

Low
Extent of private sector participation

High

Concessions
BOT - Build Operate Transfer

BOOT - Build Own Operate Transfer

BOO - Build Own Operate

BOOST - Build Own Operate Share Transfer

BOLT - Build Own Lease Transfer

DBFO - Design Build Finance Operate

OMT - Operate Maintain Transfer
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Types of PPPs
Financially free standing projects
Role of public sector - planning, licensing & statutory procedures; no financial support/ payment by government Revenues through levy of user charges by private sector Toll Roads and Bridges, Telecom services, Port projects

Projects where Government procures services

Private Sector paid a fee (tipping fee), tariff (shadow toll) or periodical charge (annuity) by Government for providing services; payment against performance no/partial demand risk transfer Risks associated with asset creation (including design) and O&M transferred to private sector Accountability to users for service - retained by Government Roads - annuity/ shadow tolls, power - under PPAs. In the UK prisons, education, health services, defence related services

Other Types - Joint ventures, Not-for-Profit vehicles

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Features of PPPs - 1
Genuine risk transfer
All risks pertaining to design, building, financing and operation transferred to the private entity Transfer of demand risk depends on the extent to which the private sector can influence usage

Output based Specifications

Contracts specify the service outputs required rather than asset configuration/mode of service delivery

Emphasis on type of service & performance standards

Private entity incentivised to deliver outputs using innovation in design, construction, operation and financing

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Features of PPPs - 2
Whole life asset performance
Private entity takes responsibility & assumes risk for the performance of the asset and delivery of service over a long term

Payment for Performance

Revenue/ Payment to private entity is subject to performance in relation to specific & quantified criteria enshrined in the contract

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Value for Money

Transfer of risks/ responsibilities under a PPP structure should result in better value for money for the user
Telecom sector mobile phone tariffs from Rs. 16/- per minute to Re.1/- or 50 paise per minute Tolls paid offset by savings in direct & indirect costs and value of time Annuity payments public sector comparator value for money

Efficiency gain
Savings in cost of project versus overrun Savings in operating costs Revenue maximization - leakages
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Basic Issues
Striking a balance between differing concerns & objectives of parties Legislative Back up Rights and obligations of parties Identification and allocation of risks Penalties and rewards which would ensure performance

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Broad Roles & Responsibilities

Government Agency
Providing Project Site/ Assets Environmental Clearances Supporting Infrastructure and Utilities Specific Obligations (e.g. dredging) Regulatory Functions Designing, Engineering, Financing Construction/ augmentation / upgradation Operation and Maintenance Payment and other obligations Transfer of assets at expiry of concession period

Concessionaire

In exchange the concessionaire has the right to receive revenue tolls or annuity or any other mechanism
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Other Key Elements

Bankability Issues
Concessionaires ability to assign rights Lenders step-in rights Charge on project assets and enforceability Critical Events and consequences Force Majeure Events of Default Remedial process incase of default/ events leading to termination Protection of debt in the event of termination

Supporting Provisions
Dispute Resolution Mechanism Re-negotiation in good faith Termination as a last resort Preferential treatment in re-bidding
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What a PPP is not & what it is

PPP is not privatisation or disinvestment PPP is not about borrowing money from the private sector. PPP is more about creating a structure
in which greater value for money is achieved for services

through private sector innovation and management skills

delivering significant improvement in service efficiency levels

This means that the public sector

no longer builds roads, it purchases miles of maintained highway no longer builds prisons, it buys custodial services no longer operates ports but provides port services through world class operators No longer builds power plants but purchases power
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Partnership in Practice
Partners not adversaries background of mistrust Project should be the focus win-win for both the parties Independent agencies Independent Engineer - useful

during both implementation and operations

Government retains ultimate responsibility uses the private sector to deliver infrastructure services of

specified standard
Private Financing can significantly leverage public funds
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Basic Features
Conventional financing is asset based debt provided is usually a percentage of project cost linked to the value of asset cover Project Financing is cash flow based - on the estimated cash flows that are generated by the project
A financing structure that relies on future cash flows of a project as the primary source of its servicing & repayment, with only the project assets, rights and interests being the security

There is little or no recourse to the sponsors Usually large projects - investments are huge & costs of non-completion/ unsuccessful operations - affect many Little tangible security All stakeholders would, therefore, like to see it succeed
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Project Appraisal
An elaborate project appraisal process analysis of risks and specification of return expectations (pricing) from investing in the project Cash flow projections based on technical, market and financial analysis

Risk mitigated through project contracts and financing agreements or consciously taken after evaluation
Structured financing to meet the characteristics of the project Security and documentation - elaborate Project monitoring and compliance
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Typical Funding Sources

Equity Capital
Core capital provided by the promoters (developers / contractors) Minority stakes may be taken by financial investors / funds

Preference Capital
Can be used if suitable changes made to the CA

Senior Secured Debt

Normally in the form of rupee term loans/ debentures from Indian banks/ institutions Capital market instruments may be possible after CoD; not too popular yet A variant could be debt with 2nd charge

Subordinated Debt
Typically with far lesser rights May even be unsecured

Challenge is to evaluate how additional resources can be channelised into the sector - insurance funds, pension funds
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Key Project Contracts

Concession Agreement Project Site Licence Agreement Shareholder/ JV Agreement Substitution Agreement / Direct Agreement State Support Agreement EPC Contract O&M Contract Trust and Retention Agreement
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Main Provisions
Concession Agreement
Terms and conditions of undertaking the project Obligations of the parties Tenor of the contract Default provisions and remedies Provision for substitution Force Majeure provisions and remedies Termination and compensation payments

State Support Agreement

Support during implementation Protection from a competing facility
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Other Key Contracts

EPC Contract
Price Overrun Time Overrun LDs and Bonus provisions Performance security Standards and Specifications Operating Standards Costs Quality of Service Penal provisions

O&M Contract

TRA Agreement
Trapping of all the project cashflows Prioritization of Cash flows
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Financial Analysis
Elaborate Financial Model capturing these risks base case analysis Establishes breakeven levels of traffic/ tariffs Assessment under various scenarios sensitivity analysis
Demand / Traffic Tariff / Tolls Inflation Maintenance Costs Debt Equity Ratio cash flow impact & level of promoters funds Internal Rate of Return (project/ equity)

Financial Ratios

Debt Service Coverage Ratio

Loan Life Ratio Project Life Ratio
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Financing Documents
Facility Agreement
Financial Terms Project Risk Mitigating Conditionalities General Conditions

Inter-Creditor Agreements Security Documentation

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Basic Structure
NHAI

Concession Agreement Financing Agreements

Annuity

JV Partner

Lenders
Debt

Project SPV

Equity

Shhldrs Agmnt

EPC Agmnt

Main Sponsor

LE

Contractor

Indep Eng

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Transaction Structure
Sponsors Advisers Invt. Bankers, Technical & Legal Advisers Financial Investors Equity / Sub-Debt Users Off-take Contracts TRA/Escrow Agreement EPC Contract Debt Substitution Agreement EPC Contractor Equity Concession / Licence Agreement Government Advisers Invt. Bankers, Technical & Legal Advisers

Insurance Companies Insurance Policies

Project SPV

O&M Contract

O&M Operator

TRA Agent

Lenders

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Implementation Structures
Existing Assets
Full Divestiture UK Telecom, Steel, Electricity, Ports, Water, Airlines, Airports; so far in India Modern Foods, BALCO, Hotels Asset Sales/ Leases airports in Australia BOT/ ROMT Concessions roads, tourism facilities, berths in ports Management contracts water assets, ports in Philippines Implementation by government followed by OMT concessions Mumbai-Pune expressway, Ports in Rotterdam, hospitals Implementation through SPVs Moradabad bypass or port connectivity projects or dedicated freight corridor for railways BOT Concessions commonest form roads, ports,
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New Assets

Isnt Private Infrastructure Expensive?

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Isnt Private Infrastructure Expensive?

Additions to Cost
Risk Premium

Benefits
Lower Cost From Efficiency

Example
Public Entity
ROI 8%

Private Entity
WACC 13.7%

(Debt @ 11% 70: 30 Equity @ 20%)

Cost Required Return

105.3

Cost Required Return

100

113.7

113.7

A 5.3% cost overrun (increase in actual project cost) in the public sector is enough to overcome the private sector disadvantage of higher financing cost!
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Isnt Private Infrastructure Expensive?

Additions to Cost
Risk Premium

Benefits
Lower Cost From Efficiency

Example
Public Entity ROI 8% Private Entity WACC 13.7%

(Debt @ 11% 70: 30 Equity @ 20%)

Cost Required Return

100

Cost Required Return

95

108

108

A 5% reduction in project cost (efficiency) by the private sector is enough to overcome the higher financing cost!
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Key question
What should be the framework to induce the private entity make the investments needed to provide efficient service to the end user?
Investments decided by the investor or driven by the market, i.e. the consumer Private entity has a stronger case for state support if it makes investments determined by the State Demand risk how much passed on?

Extricate the public entity from making commercial decisions on individual projects, wherever possible Public entitys role from being a planner, financier & manager to facilitator & regulator
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The Right Balance

The Investor wants
Monopoly rights

The Investor needs

Initial risk mitigation support - can be predefined Stable environment regulatory and policy framework State support for social obligations/ viability considerations can be transparently determined
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Full pricing freedom

State support for social obligations/ viability considerations

Some Indian Examples - 1

Roads
BOT Concessions for toll roads and bridges (NHAI, state governments) (OMT Concessions in future) Annuity payment based concessions highways, urban roads (NHAI/ state governments)

Solid Waste Management

Engineered landfills tipping fee linked payments (Bangalore, Trivandrum) SW Collection and Transportation (MCD/ NDMC)

Port Concessions
Major Ports container berths (JNPT, Chennai, Kochi, Tuticorin, Vizag, Kandla); bulk cargo berths (Marmagao, Haldia, Ennore, New Mangalore) Minor Ports Pipavav, Mundra, Kakinada
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Some Indian Examples - 2

Water Supply and Sanitation Bulk water supply systems in Tirupur and Vizag Tourism Facilities hotels, tourist facilities, PWD rest houses Karnataka & Kerala Bus Terminals/ Parking Facilities
Bus terminals Dehra Dun, Amritsar, Jullundur Parking + commercial complexes NDMC/ DDA/ MCD/ Bangalore

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International Experience - 1
Toll Roads (Chile, Mexico, Hungary, Poland); Ports (Argentina, Philippines, Sri Lanka) Airports (Australia, Greece, Germany) Roads in UK under DBFO program Private Finance Initiative of UK diverse areas

Dorset Police Service - $ 40 million contract for refurbishment of police stations, construction of a divisional headquarters building, maintenance, janitorial & waste management services Nottinghamshire, Police Fleet Management Contract - ($ 180 million over 25 years) driver slots - usage of a vehicle for a 24 hour period Durham & Dunstead Hospital Project, Durham 30 year, $ 155 million hospital services contract to construct and operate health care facilities + ancillary services Stoke-On-Trent Grouped Schools Project a $ 250 million project involving 122 schools refurbishment and maintenance contract
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International Experience - 2
Louis Trichardt Maximum Security Prison Project, South Africa a $ 270 million project largest prison facility (also UK and Australia) Full fledged water concessions in Argentina (Buenos Aires) and Philippines (Manila); Management contract for water supply & sanitation in Johannesburg, South Africa

Rural Pay Phones, Peru against payment of a subsidy based on a system of monitoring of service standards
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On the Table in Karnataka

Airport Rail Link Core Ring Road Airport Expressway BMRDA Townships Minor airports Tourism Properties IMTC (Kempegowda) Mega Convention Center, Bangalore Bypass roads Truck terminals

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