Description
Risk framework of project finance, risk analysis of power projects, risk analysis of toll road project, risk sharing in PPP projects, reforms in PPP sectors. PPP models in road sector.
Structured Project Finance
What is Project Finance
• Financing against cash flows and project assets to a Project SPV typically for a green-field activity or expansion into new markets • Financing generally comprises „construction? and „operating? period • Usually Project Financing is Non-recourse or Limited Recourse
Why Project Finance
• Ability to leverage without impacting Developer?s balance sheet • Risk Diversification – may lead to credit enhancement • Longer Tenors • Best model for Public Private Partnership financing • Greater transparency in project execution and operation • Tax benefits
Counterparties Analysed in Project Finance
• Governments and Related Institutions
– – – – Land & Other Preliminary conditions & approvals Concession Agreements Counter guarantees Tax Credits
• Sponsors
– Equity and Contingent Equity – Completion and Operation risk (where there is some role duplication) – Management
Counterparties (contd…)
• Off-takers
– – – – Financial Capability Diversification Criticality to Off-takers /Bargaining Power Contractual Arrangements
• Contractors
– – – – Performance Guarantees Liquidated damages (limited recourse to contractors) Role duplication/conflict of interest Cost escalations
Counterparties (contd…)
• Suppliers
– Criticality to Supplier/Bargaining Power – Diversification – Take or Pay contracts
• Operator
– Penalties for non performance – Experience and reputation
• Market Intermediaries
– Power traders, brokers, transporters, ware house managers
• Swap Providers, Insurers
Contractual Foundations of Project Finance
• Commercial Agreements
– – – – Stable predictable cash flows Adequate debt service Reduce inflation, FX and legal risk Commercial contracts are pass through and are matching in tenors
• Collateral Agreements
– – – – Step in rights Cash sweep Adequate covenants to limit risks Adequate insurance and other provisions (incl political cover) to ensure tangible assets retain value
Commercial Agreements
• Concession Agreement
– – – – – – – Confer BOT rights Long Tenor Includes Tariff guidelines Force Majeure Protection Compensation for change in policy, law, competition Dispute Resolution Obligations of Concessionaire including providing / facilitating approvals, land acquisition etc – Presence of Independent Regulator – Lender comfort in case of Concessionaire induced termination
Commercial Agreements
• Off-take & Supply Agreements
– – – – – – Fixed Costs reimbursement Take or Pay – guaranteed quantity Off-take / supply contact >= Debt maturity Pass through Full tenor hedges Penalties for non-supply
Commercial Agreements
• Construction Agreement
– – – – – Fixed Price, LSTK Liquidated damages for cost escalations Workman Insurance Equipment Warranties Clear de-lineation of responsibilities between developer and contractor – Mobilisation advance, Retention money – Activity Time chart, equipment order/procurement
Commercial Agreements
• Operation & Maintenance Agreement
– Tenor co-terminus with debt – Clear definition of performance, operating parameters and output quality – Clear parameters set out of operating costs, efficiency norms – Grace period for routine maintenance and un-anticipated breakdowns – Penalties for non-performance, incentives for efficiency improvement – Limited liability for non performance – Lender has step-in and substitution rights
Collateral Agreements
• Lending Agreements
– Cash sweep – Limit additional indebtedness, cash shortfall to be met through contingent equity – Dividend restrictions, permitted investments of surplus cash – Inter-creditor agreement – Arbitration – Clearly defined Events of Default, tighter covenants – Permitted Capex, Maintenance Reserve
Collateral Agreements • Security Agreements
– – – – – Mortgages of assets Assignment of all Project Contracts incl step-in rights Share Pledges Insurances Lien on Project Accounts and on surplus investments
Collateral Agreements • Reserve Accounts
– Cash flow Waterfall – DSRA (min 6 mths , can be higher if cash flows are volatile/uncertain) – Maintenance Reserve – O&M reserve – Pension, contingent expenses
Structure
Concessionaire/Offtaker
Concession/Offtake Agreement Third Party Legal and engineering financial due diligence Firms
Independent project Reports
O& M Contract Operator
Project SPV
Project Finance Lenders
EPC Contract
Contractor
Completion Guarantee / Contingent Equity Undertaking Equity
Sponsor
Weight-% Sponsor 20
Criticality 2 CP 20 7
Fin Strngth 40 8
Rep/TR 40 8 7.8
O&M Shipping Offtaker
10 5 10
Supplier of LNG
20
PMS Govt
5 10
EPC
20
Total
Risk Framework
• Market Risk
– – – – Demand reduction (economic down turn) Substitution Technology obsolescence Competition
• Construction/Completion Risk
– – – – – Site Acquisition/ Rehabilitation Sponsor / Management risk Contractor risk Cost Escalation / Time Overrun Risk Contingency / Force Majeure Risk
Risk Framework • Political Risk
– Change in regulation – Exchange Control – Change in laws, taxation
• Financial Closure Risk
– Equity committed without firm
• Counterparty Risk (suppliers, off-takers in case of concentration)
Risk Framework • Technology Risk
– Complex technology – New technology
• Interest Rate & FX Risk
– Increased cost of construction (higher IDC) – Adverse impact on debt servicing and free cash flows – Absence of fixed income market (long tenor bonds)
Risk Framework • Price Risk (Products & RMs)
– No pass through – Products or RMs are commodities
• Operational Risk
– Complex operations – In experienced developer/operator – Disruptions in inputs (raw material , water, power unavailability, transporter strike etc) – Equipment failure – Repeated maintenance shut downs – Overloading (excess utilisation)
Mitigants • Market Risk
– Traffic studies – Conservative demand growth and market share estimates as well stress analysis – Contracted off-take (min fixed quantity) – Developers experience in similar markets
Mitigants
• Construction/Completion Risk
– Monitoring by Independent Engineers – Land acquisition for main project as well as related infrastructure is facilitated by government – Completion Guarantees from Sponsors – Liquidated Damages , performance bonds/financial guarantees – Contingent Equity Guarantees from Sponsors to meet cost overruns – Construction Insurance
Mitigants • Political Risk
– Assess criticality of project to the people/state – Political risk cover – government is a stake-holder – Sovereign counter-guarantees
• Financial Closure Risk
– Equity Commitments (Letters of Credit backing Equity commitments)
Mitigants
• Counter-party Risk
– – – – Diversified buyers/suppliers Credit analysis of off-takers in case of concentration Credit Insurance/CDS on off-taker defaults Revolving Letters of Credit from Off-takers
• Technology Risk
– Adopt proven technology – Look for developers experienced with the proposed technology
Mitigants
• Interest Rate & FX Risk
– Try and match currency of sales with that of loans – Hedging to the max extent possible – Diverse funding source including long tenor fixed coupon bonds
• Price Risk (Products & RMs)
– Fixed price contracts – Pass through contracts – Conservative assumptions and sensitivity analysis to achieve correct debt sizing
Mitigants • Operational Risk
– O&M contracts with penalties – Experienced developer and/or Operator – Sensitivity on operating costs and output norms – Back ups/ inventory planning and storage capacity for key inputs to avoid disruptions
Risk Analysis – Power Projects
Risks Weak financial state of SEBs/discoms which are the main off-takers in most projects ? ? ? ? ? ? ? ? Mitigants Power sector reforms have picked up pace and financials of many state discoms have improved Limit exposure to top 10 SEBs Criticality of project to the state and merit order ranking on tariff For mega projects risk spread across several SEBs as off-takers Significant demand supply gap Already identified land with survey reports on extent of rehabilitation and opposition expected State governments active participation Conservative assumptions on project completion timelines and costs to arrive at debt sizing
Land Acquisition / Rehabilitation
Constraints on fuel supply and quality
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? ?
Acquisition of land and Environmental clearances for the coal land (in case of captive mining) would be a pre-requisite for loan sanctions In case of coal being purchased or imported, long term supply contracts or linkages need to be established.. Also critical infrastructure incl coal handling , rail connectivity and coal washeries etc is critical For gas based projects firm supply contracts with penalties for non supply would be a precondition.
Contingent equity undertakings from sponsor for cost runs based on sensitivities on DSCR as a result of project cost escalations. EPC contracts would have covenants covering Liquidated damages Performance bonds/guarantees In cases where the sponsor is executing the project through various small contracts for supply and construction, a construction completion guarantee from Sponsor isbe taken
Inability to achieve pass through of costs overruns
? ? ? ?
Risk Analysis – Power Projects
Risks Environmental risks – due to fly ash disposal, change in emissions norms Risk of the project being noncompetitive in merit order Operating Risk arising out of poor equipment performance or breakdown FX and Interest rate Risk Other Risks including Force Majeure ? Mitigants The project would need to conform to Equator Principles and the same will be certified and monitored by a reputed agency Credit analysis and due-diligence would involve detailed benchmarking exercise with respect to merit order of the proposed project to establish the tariff competitiveness of the project vis-à-vis other projects in the region Coal based thermal power plants and even hydro and wind power plants have proven technology and are not complex operations Insist on a maintenance reserve account which would be funded annually through the cash flows waterfall to ensure that major maintenance can be carried out every 3-5 years if necessary. FX and interest rate sensitivities would be part of credit analysis Appropriate hedging for these risks Insurance cover with banks as loss payee
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Risk Analysis – Toll Road Project
Risks
Concession period / Concession Termination Risk ? ? ? Construction / completion Risk arising due to difficulty in land acquisitions and environmental clearances there by leading to cost escalations ?
Mitigants
Concession Agreement (CA) should provide for extension of concession period in case traffic is below projections In the event of termination, the CA should provide for a compulsory buy-out by the Government/ Concessionaire Political force majeure and defaults by the Government should be adequately compensated by the Concessionaire. Handing over possession of the required land and obtaining of environmental clearances to be conditions precedent which are satisfied by the Government/ Concessionaire before financial close R&R and Environmental issues CA defines the scope of the project with precision in order to enable the Concessionaire to determine his costs and obligations To mitigate impact of cost escalations, there should be contingent equity undertakings from sponsors for cost over runs. Sensitivity analysis to involve project delays and impact on debt servicing EPC contracts to have liquidated damages and completion guarantee of sponsor
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Risk Analysis – Toll Road Project
Risks
Traffic risk due to ? competition or poor ? hinterland connectivity ? ? ? ? Regulatory / Tariff risk due to tariff setting by a government body Operating Risk arising due to poor maintenance because of operator?s Inexperience ? ? ? ? ?
Mitigants
Independent traffic forecasts using reputed and experienced surveyors and data collectors High share of commercial traffic Limited alternatives – material time saving if toll road used Concession Agreement provides for compensation if alternate route is sanctioned by the authorities Real Estate and other development around toll road leading to other revenue streams Strong industrial and population growth is catchment area Tariff mechanism to be clearly defined in CA Indexation of the tariffs to inflation is critical In case of issues in tariff revision due to public opposition or political inability, Concessionaire to be compensated O&M contract with a reputed operator or presence of a experienced operator in the consortium is a strong mitigant Concession Agreement to provide for an assignment and substitution rights in case of poor O&M
Risk Analysis – Toll Road Project
Risks
Financial closure risk ? due to tight time limit laid out by the ? Concession Agreement Political Risk due to changes in Govt policy with regard to tariff settings, prescribed minimum wages etc FX and Interest rate risk Other Risks including Force Majeure ?
Mitigants
Financial closure would be a key condition precedent for such projects In case of any bridge finance for expenditure, pending financial closure, support of a strong corporate guarantee of an operating company within the sponsor group will be key. The CA usually puts the onus of political risk on the Concessionaire CA to provide for extension of the concession period in the event of a lower than expected growth in traffic or inability to keep toll rates as per original envisaged levels due to political resistance
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Hedging as well as sensitivity analysis to determine breakeven USD/INR and interest rates where DSCR becomes < 1. Debt sizing will be done accordingly. Insurance cover where lenders are loss payee
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Iran Pakistan India Pipeline (D/E 70:30)
Risks
Completion ? ? ? ? ? ? ? ? ? ? ? ? ? ? ?
Mitigants
Security Fee to Pakistan during construction Involve Pakistan Oil Corporation as Stakeholder Construction Guarantees from respective Govt. Award Separate Construction Contracts Political Risk Insurance Involve Multilateral Organizations Take pipeline underground International O&M contractor Business Disruption Insurance Sovereign Guarantee A trapdoor agreement Single canalizing agent on off taker side (IOCL) Single supplier agent on supplier side Measurement of both supply & offtake throughput Payments dollar denominated
Financial Closure Disruption/Operation
Supply & Offtake Financial Viability
Dispute/Arbitration
Financial Modeling
• Project Cost Analysis
– Define complete scope of project incl all related infrastructure – Item-wise/Contract wise cost details – Debt Equity – Project expenditure details spread over construction period (atleast quarterly preferably monthly) – Build escalation in costs over time periods
Financial Modeling
• Base Case Assumptions for Operating Period
– – – – – – Quantity, price for output and inputs , exchange rates, capacity utilisation , demand growth estimate WC cycle
Financial Modeling
• P&L, Cashflow, Balance sheet, debt repayment schedules • Ratios
– DSCR – LLCR (PV of future free cashflows discounted @ interest rate)/ Principal Outstanding) – Interest Coverage – Asset Coverage – Reserve Cover Ratio = (balance reserves/outstanding principal)
Financial Modeling
• EBITDA should be after
– – – – – – – All production related variable and fixed costs After bad debt provisions Interest on trade creditors Royalty , technical knowhow fees and related payments All marketing expenses (without any amortisation) Insurance premiums Maintenance Tax Incremental WC Non discretionary capex Maintenance reserve provisions All interest incl that on WC
•
Free Cashflow for senior debt servicing = EBITDA less
– – – – –
Financial Modeling
• Stress Case Analysis
– – – – – Price/Tariff sensitivity Demand/Traffic sensitivity Cost/Margin sensitivity Interest Rate and FX rate sensitivity Cost Overrun, time overrun sensitivity
Public Private Partnership • Types of PPP
– Service Contracts – Management Contracts – Lease Contracts – BOT – Concessions – JVs
PPPs contd..
• Service Contracts
– Shorter Duration (1-3 yrs) – Multiple contracts for various activities – Useful when its important to keep entity public but infuse efficiencies in certain operations – Need monitoring – Easier to sell politically – Cant be useful to attract capital investment
PPPs contd..
• Management Contracts
– Ownership is public but most functions transferred incl management and operations – Performance targets clearly defined in terms of improvement of the utility (hospital, bus terminal etc) – Incentives linked to performance – Capital Investment (asset replacement or expansion) remains with the Public Sector – Tariff setting is also responsibility of Public Sector – Brings focus on profitability all across – Good starting point before complete privatisation – Possibility of mis-use/abuse to inflate performance should be checked through independent monitoring
PPPs contd..
• Lease Contracts
– Operator provides service at own expenses and is allowed to charge a fee – Duration is upto 10 years – All losses to the head of the operator but so also the upside of profits – Fixed lease payments irrespective of revenue achievement – Drives efficiency but can also lead to neglect on maintenance expenditure to improve profitability during lease period.
PPPs contd..
• Concession Agreements/ BOT
– Private sector responsible for operation, maintenance, collection, management, financing etc – Normally concession is for existing asset and may involve capacity addition to it or just pure operation – Private Operator also responsible for capital investments (e.g. distribution concessions link tariff hikes to capital investment for improvement of distribution network) – Tenor of concession is 25-30 yrs
PPPs contd..
• Concession Agreements/ BOT
– May involve viability gap financing from the Government to assist in capital investment – BOT is a specialised concession where a new infrastructure asset is created under the Concession and the builder has the right to operate and charge fee for the same to users
Risk Sharing in PPP projects in India
Construction Risk Risk Participant Operation Risk Revenue Risk Market Risk Interest Rate Risk Regulatory Risk
Equity holder Lender Govt* EPC contractor
No No Partial Yes
Yes No No No
Yes No Partial No
Yes No Partial No
Yes Yes No No
Yes No Yes No
* Govt shares risk through compensation clauses in the Concession Agreement
Degree of Risks in PPP Projects in India
Construction Project Road Port Airport High High High
Operation
Market
Interest Rate
Payment
Regulatory
low Medium High
Project Specific Medium High
Project Specific
Medium Low Low
Medium Medium Medium
Project Specific
Project Specific Project Specific
Power
Medium
Low
Low
High
High
Reforms in PPP Sectors
Roads
– – – – – Model concession agreement for toll highways has been published. The National Highways Act, 1956, has been amended to attract private investment in road development, maintenance, and operation. A comprehensive national maritime policy is being formulated to establish the vision and strategy for the sector until FY2024. Private sector participation including foreign direct investment in ports is being encouraged. Establishment of tariff authority for major ports to regulate port tariffs. Major airports are being built or upgraded through PPPs. The process of building 35 smaller city airports using PPPs has been initiated. 100% equity ownership by non-resident Indians is permitted in airports. The Airports Authority of India Act has been amended to provide a legal framework for airport privatization. A new civil aviation policy has been tabled in the parliament proposing foreign direct investment of up to 74% in domestic carriers.
Seaports
Airports
– – – – – –
Reforms in PPP sectors
Urban Infrastructure
– A model municipal law has been developed to help states and urban local bodies enact reform legislation and to facilitate the development and disposal of excess land. – The Urban Land (Ceiling and Regulation) Act, 1976 has been repealed. – Waste Management Privatisation by Municipalities
Railways
– Innovative pricing structures are being adopted for attracting new customers. – PPP-type initiatives are being considered for increasing capacity through the proposed dedicated freight corridors.
Power
– The Electricity Act, 2003 and the National Electricity Policy, 2005 have been designed to facilitate competition, reduce technical and commercial losses, and provide remunerative returns on investments. – The Central Electricity Regulatory Commission and 18 state electricity regulatory commissions have been established to regulate tariffs
Financing Sources for PPP projects
Equity • Domestic
– Domestic developers (independently or in collaboration with international developers) – Public utilities (taking minority holdings) – Other institutional investors (likely to be limited)
•
International
– – – – – International developers (independently or with domestic developers) Equipment suppliers (in collaboration with domestic or international developers) Dedicated infrastructure funds Other international equity investors Multilateral agencies
Debt • Domestic
– Domestic commercial banks (3–5 year tenor) – Domestic term lending institutions (7–10 year tenor) – Domestic bond markets (7–10 year tenor) – Specialized infrastructure financing institutions
•
International
– International commercial banks (7–10 year tenor) – Export credit agencies (7–10 year tenor) – International bond markets (10–30 year tenor) – Multilateral agencies (over 20 year tenor)
PPP Models in Road Sector
Build Operate transfer (BOT) - Toll • Private developer builds, operates and maintains the road stretch for the concession period. • Developer recovers investments by way of user charges. • Traffic and willingness to pay risk is borne by the developer Build Operate Transfer (BOT) - Annuity • Developer builds, operates and maintains the road stretch for the concession period . • Developer receives fixed payments semi-annually (“Annuity”) for the operation period from the government. • Developer is selected on the basis of lowest annuity quoted. • Traffic and willingness to pay risk transferred to government which retains the right to toll the road.
Road Sector PPP
PPP Models in Road Sector
Toll securitization: • Government builds the road and offers to private developer to operate and maintain the road stretch for the concession period. • Developer makes upfront payment to Government for taking over the road. • Traffic and willingness to pay risk is transferred to developer
Operations and Maintenance (O&M) Concessions: • Developer only operates and maintains the road stretch for the concession period • Shorter concession periods 5-10 years. • O&M contracts are fee based concession and the entire traffic risk is borne by the government
PPP Models in Road Sector
Design Build Finance operate (DBFO): • In DBFO detailed designing is also at the discretion of the concessionaire in addition to finance, build and operate. • DBFO schemes
– – – improve the design efficiency, reduce the cost of construction and reduce time to commence operations.
Shadow based Tolling: • Private developer develops and operates the toll road. • Developer receives payments from the government based on the actual/base usage of traffic on the road. • Traffic risk is borne by the developer • Willingness to pay risk borne by the government
Issues in Road Sector in India
• Inadequate pace of road infrastructure development • Lack of traffic data • Liquidity Crunch for Private Players • Lack of coordination between concerned agencies • Lack of speedy Dispute Resolution between NHAI and contractors
Issues in Road Sector in India
• Low level of private sector participation in state, rural and district roads • Inadequate funding of maintenance • Lack of Quality Monitoring by NHAI during operations period • Inaccurate estimation of Project Cost • Lack of easy access to debt funding
Model Concession Agreement
• • 1st stage – technical bidding
– bidders evaluated on the basis of cumulative experience score of the bidders – and total cost of the projects successfully executed in the past.
2nd stage – financial bidding
– bidders evaluated on financial criteria like networth, cash accruals, equity commitment, etc. – Bidder quoting minimum grant / maximum revenue sharing is allotted the project.
• •
MCA has facilitated private sector participation by clearly stating the revenue and risk sharing mechanisms. The main features of MCA are
• clearly states the rights and obligation of NHAI and bidders • rights of the Lenders, • risk sharing mechanisms.
– Concession Period
– Project specific; normally 20 years (likely to go upto 25-30 years in current scenario) – At the end of 8 years, concessionaire given the option to convert 4-lane road to 6-lane road – If concessionaire does not exercise the option, then new operator appointed on completion of concession period of 12 years – Provision for variation in concession period vis-à-vis traffic levels:
Model Concession Agreement
Bankability Issues
• • • • Concessionaire?s 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
– Concessionaire EoD : 90% Debt Due, however onus for due diligence
Supporting Provisions
• • • • Dispute Resolution Mechanism Re-negotiation in good faith Termination as a last resort Preferential treatment in re-bidding
Material Risks
• Completion
– within budgeted costs and time,
•
• •
revenue risks
– demand/ traffic and tariff risks
O&M risks. Financial Risks:
– Is financing plan is robust enough to withstand the impact of adverse factors – Is The project is subject to interest rate, liquidity (tenor of borrowing) or currency risks
•
Environmental and Social Risks –Identified in an independent EIA/ SIA study done as part of project evaluation.
– Need to ensure that Project is insulated from the risks of land acquisition, environmental advocacy and social issues –R&R issues, compensation claims etc –so that implementation is not hampered – Public consultations are duly held –issues such as access in road projects are dealt with early in the development cycle
doc_152986637.pptx
Risk framework of project finance, risk analysis of power projects, risk analysis of toll road project, risk sharing in PPP projects, reforms in PPP sectors. PPP models in road sector.
Structured Project Finance
What is Project Finance
• Financing against cash flows and project assets to a Project SPV typically for a green-field activity or expansion into new markets • Financing generally comprises „construction? and „operating? period • Usually Project Financing is Non-recourse or Limited Recourse
Why Project Finance
• Ability to leverage without impacting Developer?s balance sheet • Risk Diversification – may lead to credit enhancement • Longer Tenors • Best model for Public Private Partnership financing • Greater transparency in project execution and operation • Tax benefits
Counterparties Analysed in Project Finance
• Governments and Related Institutions
– – – – Land & Other Preliminary conditions & approvals Concession Agreements Counter guarantees Tax Credits
• Sponsors
– Equity and Contingent Equity – Completion and Operation risk (where there is some role duplication) – Management
Counterparties (contd…)
• Off-takers
– – – – Financial Capability Diversification Criticality to Off-takers /Bargaining Power Contractual Arrangements
• Contractors
– – – – Performance Guarantees Liquidated damages (limited recourse to contractors) Role duplication/conflict of interest Cost escalations
Counterparties (contd…)
• Suppliers
– Criticality to Supplier/Bargaining Power – Diversification – Take or Pay contracts
• Operator
– Penalties for non performance – Experience and reputation
• Market Intermediaries
– Power traders, brokers, transporters, ware house managers
• Swap Providers, Insurers
Contractual Foundations of Project Finance
• Commercial Agreements
– – – – Stable predictable cash flows Adequate debt service Reduce inflation, FX and legal risk Commercial contracts are pass through and are matching in tenors
• Collateral Agreements
– – – – Step in rights Cash sweep Adequate covenants to limit risks Adequate insurance and other provisions (incl political cover) to ensure tangible assets retain value
Commercial Agreements
• Concession Agreement
– – – – – – – Confer BOT rights Long Tenor Includes Tariff guidelines Force Majeure Protection Compensation for change in policy, law, competition Dispute Resolution Obligations of Concessionaire including providing / facilitating approvals, land acquisition etc – Presence of Independent Regulator – Lender comfort in case of Concessionaire induced termination
Commercial Agreements
• Off-take & Supply Agreements
– – – – – – Fixed Costs reimbursement Take or Pay – guaranteed quantity Off-take / supply contact >= Debt maturity Pass through Full tenor hedges Penalties for non-supply
Commercial Agreements
• Construction Agreement
– – – – – Fixed Price, LSTK Liquidated damages for cost escalations Workman Insurance Equipment Warranties Clear de-lineation of responsibilities between developer and contractor – Mobilisation advance, Retention money – Activity Time chart, equipment order/procurement
Commercial Agreements
• Operation & Maintenance Agreement
– Tenor co-terminus with debt – Clear definition of performance, operating parameters and output quality – Clear parameters set out of operating costs, efficiency norms – Grace period for routine maintenance and un-anticipated breakdowns – Penalties for non-performance, incentives for efficiency improvement – Limited liability for non performance – Lender has step-in and substitution rights
Collateral Agreements
• Lending Agreements
– Cash sweep – Limit additional indebtedness, cash shortfall to be met through contingent equity – Dividend restrictions, permitted investments of surplus cash – Inter-creditor agreement – Arbitration – Clearly defined Events of Default, tighter covenants – Permitted Capex, Maintenance Reserve
Collateral Agreements • Security Agreements
– – – – – Mortgages of assets Assignment of all Project Contracts incl step-in rights Share Pledges Insurances Lien on Project Accounts and on surplus investments
Collateral Agreements • Reserve Accounts
– Cash flow Waterfall – DSRA (min 6 mths , can be higher if cash flows are volatile/uncertain) – Maintenance Reserve – O&M reserve – Pension, contingent expenses
Structure
Concessionaire/Offtaker
Concession/Offtake Agreement Third Party Legal and engineering financial due diligence Firms
Independent project Reports
O& M Contract Operator
Project SPV
Project Finance Lenders
EPC Contract
Contractor
Completion Guarantee / Contingent Equity Undertaking Equity
Sponsor
Weight-% Sponsor 20
Criticality 2 CP 20 7
Fin Strngth 40 8
Rep/TR 40 8 7.8
O&M Shipping Offtaker
10 5 10
Supplier of LNG
20
PMS Govt
5 10
EPC
20
Total
Risk Framework
• Market Risk
– – – – Demand reduction (economic down turn) Substitution Technology obsolescence Competition
• Construction/Completion Risk
– – – – – Site Acquisition/ Rehabilitation Sponsor / Management risk Contractor risk Cost Escalation / Time Overrun Risk Contingency / Force Majeure Risk
Risk Framework • Political Risk
– Change in regulation – Exchange Control – Change in laws, taxation
• Financial Closure Risk
– Equity committed without firm
• Counterparty Risk (suppliers, off-takers in case of concentration)
Risk Framework • Technology Risk
– Complex technology – New technology
• Interest Rate & FX Risk
– Increased cost of construction (higher IDC) – Adverse impact on debt servicing and free cash flows – Absence of fixed income market (long tenor bonds)
Risk Framework • Price Risk (Products & RMs)
– No pass through – Products or RMs are commodities
• Operational Risk
– Complex operations – In experienced developer/operator – Disruptions in inputs (raw material , water, power unavailability, transporter strike etc) – Equipment failure – Repeated maintenance shut downs – Overloading (excess utilisation)
Mitigants • Market Risk
– Traffic studies – Conservative demand growth and market share estimates as well stress analysis – Contracted off-take (min fixed quantity) – Developers experience in similar markets
Mitigants
• Construction/Completion Risk
– Monitoring by Independent Engineers – Land acquisition for main project as well as related infrastructure is facilitated by government – Completion Guarantees from Sponsors – Liquidated Damages , performance bonds/financial guarantees – Contingent Equity Guarantees from Sponsors to meet cost overruns – Construction Insurance
Mitigants • Political Risk
– Assess criticality of project to the people/state – Political risk cover – government is a stake-holder – Sovereign counter-guarantees
• Financial Closure Risk
– Equity Commitments (Letters of Credit backing Equity commitments)
Mitigants
• Counter-party Risk
– – – – Diversified buyers/suppliers Credit analysis of off-takers in case of concentration Credit Insurance/CDS on off-taker defaults Revolving Letters of Credit from Off-takers
• Technology Risk
– Adopt proven technology – Look for developers experienced with the proposed technology
Mitigants
• Interest Rate & FX Risk
– Try and match currency of sales with that of loans – Hedging to the max extent possible – Diverse funding source including long tenor fixed coupon bonds
• Price Risk (Products & RMs)
– Fixed price contracts – Pass through contracts – Conservative assumptions and sensitivity analysis to achieve correct debt sizing
Mitigants • Operational Risk
– O&M contracts with penalties – Experienced developer and/or Operator – Sensitivity on operating costs and output norms – Back ups/ inventory planning and storage capacity for key inputs to avoid disruptions
Risk Analysis – Power Projects
Risks Weak financial state of SEBs/discoms which are the main off-takers in most projects ? ? ? ? ? ? ? ? Mitigants Power sector reforms have picked up pace and financials of many state discoms have improved Limit exposure to top 10 SEBs Criticality of project to the state and merit order ranking on tariff For mega projects risk spread across several SEBs as off-takers Significant demand supply gap Already identified land with survey reports on extent of rehabilitation and opposition expected State governments active participation Conservative assumptions on project completion timelines and costs to arrive at debt sizing
Land Acquisition / Rehabilitation
Constraints on fuel supply and quality
?
? ?
Acquisition of land and Environmental clearances for the coal land (in case of captive mining) would be a pre-requisite for loan sanctions In case of coal being purchased or imported, long term supply contracts or linkages need to be established.. Also critical infrastructure incl coal handling , rail connectivity and coal washeries etc is critical For gas based projects firm supply contracts with penalties for non supply would be a precondition.
Contingent equity undertakings from sponsor for cost runs based on sensitivities on DSCR as a result of project cost escalations. EPC contracts would have covenants covering Liquidated damages Performance bonds/guarantees In cases where the sponsor is executing the project through various small contracts for supply and construction, a construction completion guarantee from Sponsor isbe taken
Inability to achieve pass through of costs overruns
? ? ? ?
Risk Analysis – Power Projects
Risks Environmental risks – due to fly ash disposal, change in emissions norms Risk of the project being noncompetitive in merit order Operating Risk arising out of poor equipment performance or breakdown FX and Interest rate Risk Other Risks including Force Majeure ? Mitigants The project would need to conform to Equator Principles and the same will be certified and monitored by a reputed agency Credit analysis and due-diligence would involve detailed benchmarking exercise with respect to merit order of the proposed project to establish the tariff competitiveness of the project vis-à-vis other projects in the region Coal based thermal power plants and even hydro and wind power plants have proven technology and are not complex operations Insist on a maintenance reserve account which would be funded annually through the cash flows waterfall to ensure that major maintenance can be carried out every 3-5 years if necessary. FX and interest rate sensitivities would be part of credit analysis Appropriate hedging for these risks Insurance cover with banks as loss payee
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? ? ?
Risk Analysis – Toll Road Project
Risks
Concession period / Concession Termination Risk ? ? ? Construction / completion Risk arising due to difficulty in land acquisitions and environmental clearances there by leading to cost escalations ?
Mitigants
Concession Agreement (CA) should provide for extension of concession period in case traffic is below projections In the event of termination, the CA should provide for a compulsory buy-out by the Government/ Concessionaire Political force majeure and defaults by the Government should be adequately compensated by the Concessionaire. Handing over possession of the required land and obtaining of environmental clearances to be conditions precedent which are satisfied by the Government/ Concessionaire before financial close R&R and Environmental issues CA defines the scope of the project with precision in order to enable the Concessionaire to determine his costs and obligations To mitigate impact of cost escalations, there should be contingent equity undertakings from sponsors for cost over runs. Sensitivity analysis to involve project delays and impact on debt servicing EPC contracts to have liquidated damages and completion guarantee of sponsor
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Risk Analysis – Toll Road Project
Risks
Traffic risk due to ? competition or poor ? hinterland connectivity ? ? ? ? Regulatory / Tariff risk due to tariff setting by a government body Operating Risk arising due to poor maintenance because of operator?s Inexperience ? ? ? ? ?
Mitigants
Independent traffic forecasts using reputed and experienced surveyors and data collectors High share of commercial traffic Limited alternatives – material time saving if toll road used Concession Agreement provides for compensation if alternate route is sanctioned by the authorities Real Estate and other development around toll road leading to other revenue streams Strong industrial and population growth is catchment area Tariff mechanism to be clearly defined in CA Indexation of the tariffs to inflation is critical In case of issues in tariff revision due to public opposition or political inability, Concessionaire to be compensated O&M contract with a reputed operator or presence of a experienced operator in the consortium is a strong mitigant Concession Agreement to provide for an assignment and substitution rights in case of poor O&M
Risk Analysis – Toll Road Project
Risks
Financial closure risk ? due to tight time limit laid out by the ? Concession Agreement Political Risk due to changes in Govt policy with regard to tariff settings, prescribed minimum wages etc FX and Interest rate risk Other Risks including Force Majeure ?
Mitigants
Financial closure would be a key condition precedent for such projects In case of any bridge finance for expenditure, pending financial closure, support of a strong corporate guarantee of an operating company within the sponsor group will be key. The CA usually puts the onus of political risk on the Concessionaire CA to provide for extension of the concession period in the event of a lower than expected growth in traffic or inability to keep toll rates as per original envisaged levels due to political resistance
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Hedging as well as sensitivity analysis to determine breakeven USD/INR and interest rates where DSCR becomes < 1. Debt sizing will be done accordingly. Insurance cover where lenders are loss payee
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Iran Pakistan India Pipeline (D/E 70:30)
Risks
Completion ? ? ? ? ? ? ? ? ? ? ? ? ? ? ?
Mitigants
Security Fee to Pakistan during construction Involve Pakistan Oil Corporation as Stakeholder Construction Guarantees from respective Govt. Award Separate Construction Contracts Political Risk Insurance Involve Multilateral Organizations Take pipeline underground International O&M contractor Business Disruption Insurance Sovereign Guarantee A trapdoor agreement Single canalizing agent on off taker side (IOCL) Single supplier agent on supplier side Measurement of both supply & offtake throughput Payments dollar denominated
Financial Closure Disruption/Operation
Supply & Offtake Financial Viability
Dispute/Arbitration
Financial Modeling
• Project Cost Analysis
– Define complete scope of project incl all related infrastructure – Item-wise/Contract wise cost details – Debt Equity – Project expenditure details spread over construction period (atleast quarterly preferably monthly) – Build escalation in costs over time periods
Financial Modeling
• Base Case Assumptions for Operating Period
– – – – – – Quantity, price for output and inputs , exchange rates, capacity utilisation , demand growth estimate WC cycle
Financial Modeling
• P&L, Cashflow, Balance sheet, debt repayment schedules • Ratios
– DSCR – LLCR (PV of future free cashflows discounted @ interest rate)/ Principal Outstanding) – Interest Coverage – Asset Coverage – Reserve Cover Ratio = (balance reserves/outstanding principal)
Financial Modeling
• EBITDA should be after
– – – – – – – All production related variable and fixed costs After bad debt provisions Interest on trade creditors Royalty , technical knowhow fees and related payments All marketing expenses (without any amortisation) Insurance premiums Maintenance Tax Incremental WC Non discretionary capex Maintenance reserve provisions All interest incl that on WC
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Free Cashflow for senior debt servicing = EBITDA less
– – – – –
Financial Modeling
• Stress Case Analysis
– – – – – Price/Tariff sensitivity Demand/Traffic sensitivity Cost/Margin sensitivity Interest Rate and FX rate sensitivity Cost Overrun, time overrun sensitivity
Public Private Partnership • Types of PPP
– Service Contracts – Management Contracts – Lease Contracts – BOT – Concessions – JVs
PPPs contd..
• Service Contracts
– Shorter Duration (1-3 yrs) – Multiple contracts for various activities – Useful when its important to keep entity public but infuse efficiencies in certain operations – Need monitoring – Easier to sell politically – Cant be useful to attract capital investment
PPPs contd..
• Management Contracts
– Ownership is public but most functions transferred incl management and operations – Performance targets clearly defined in terms of improvement of the utility (hospital, bus terminal etc) – Incentives linked to performance – Capital Investment (asset replacement or expansion) remains with the Public Sector – Tariff setting is also responsibility of Public Sector – Brings focus on profitability all across – Good starting point before complete privatisation – Possibility of mis-use/abuse to inflate performance should be checked through independent monitoring
PPPs contd..
• Lease Contracts
– Operator provides service at own expenses and is allowed to charge a fee – Duration is upto 10 years – All losses to the head of the operator but so also the upside of profits – Fixed lease payments irrespective of revenue achievement – Drives efficiency but can also lead to neglect on maintenance expenditure to improve profitability during lease period.
PPPs contd..
• Concession Agreements/ BOT
– Private sector responsible for operation, maintenance, collection, management, financing etc – Normally concession is for existing asset and may involve capacity addition to it or just pure operation – Private Operator also responsible for capital investments (e.g. distribution concessions link tariff hikes to capital investment for improvement of distribution network) – Tenor of concession is 25-30 yrs
PPPs contd..
• Concession Agreements/ BOT
– May involve viability gap financing from the Government to assist in capital investment – BOT is a specialised concession where a new infrastructure asset is created under the Concession and the builder has the right to operate and charge fee for the same to users
Risk Sharing in PPP projects in India
Construction Risk Risk Participant Operation Risk Revenue Risk Market Risk Interest Rate Risk Regulatory Risk
Equity holder Lender Govt* EPC contractor
No No Partial Yes
Yes No No No
Yes No Partial No
Yes No Partial No
Yes Yes No No
Yes No Yes No
* Govt shares risk through compensation clauses in the Concession Agreement
Degree of Risks in PPP Projects in India
Construction Project Road Port Airport High High High
Operation
Market
Interest Rate
Payment
Regulatory
low Medium High
Project Specific Medium High
Project Specific
Medium Low Low
Medium Medium Medium
Project Specific
Project Specific Project Specific
Power
Medium
Low
Low
High
High
Reforms in PPP Sectors
Roads
– – – – – Model concession agreement for toll highways has been published. The National Highways Act, 1956, has been amended to attract private investment in road development, maintenance, and operation. A comprehensive national maritime policy is being formulated to establish the vision and strategy for the sector until FY2024. Private sector participation including foreign direct investment in ports is being encouraged. Establishment of tariff authority for major ports to regulate port tariffs. Major airports are being built or upgraded through PPPs. The process of building 35 smaller city airports using PPPs has been initiated. 100% equity ownership by non-resident Indians is permitted in airports. The Airports Authority of India Act has been amended to provide a legal framework for airport privatization. A new civil aviation policy has been tabled in the parliament proposing foreign direct investment of up to 74% in domestic carriers.
Seaports
Airports
– – – – – –
Reforms in PPP sectors
Urban Infrastructure
– A model municipal law has been developed to help states and urban local bodies enact reform legislation and to facilitate the development and disposal of excess land. – The Urban Land (Ceiling and Regulation) Act, 1976 has been repealed. – Waste Management Privatisation by Municipalities
Railways
– Innovative pricing structures are being adopted for attracting new customers. – PPP-type initiatives are being considered for increasing capacity through the proposed dedicated freight corridors.
Power
– The Electricity Act, 2003 and the National Electricity Policy, 2005 have been designed to facilitate competition, reduce technical and commercial losses, and provide remunerative returns on investments. – The Central Electricity Regulatory Commission and 18 state electricity regulatory commissions have been established to regulate tariffs
Financing Sources for PPP projects
Equity • Domestic
– Domestic developers (independently or in collaboration with international developers) – Public utilities (taking minority holdings) – Other institutional investors (likely to be limited)
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International
– – – – – International developers (independently or with domestic developers) Equipment suppliers (in collaboration with domestic or international developers) Dedicated infrastructure funds Other international equity investors Multilateral agencies
Debt • Domestic
– Domestic commercial banks (3–5 year tenor) – Domestic term lending institutions (7–10 year tenor) – Domestic bond markets (7–10 year tenor) – Specialized infrastructure financing institutions
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International
– International commercial banks (7–10 year tenor) – Export credit agencies (7–10 year tenor) – International bond markets (10–30 year tenor) – Multilateral agencies (over 20 year tenor)
PPP Models in Road Sector
Build Operate transfer (BOT) - Toll • Private developer builds, operates and maintains the road stretch for the concession period. • Developer recovers investments by way of user charges. • Traffic and willingness to pay risk is borne by the developer Build Operate Transfer (BOT) - Annuity • Developer builds, operates and maintains the road stretch for the concession period . • Developer receives fixed payments semi-annually (“Annuity”) for the operation period from the government. • Developer is selected on the basis of lowest annuity quoted. • Traffic and willingness to pay risk transferred to government which retains the right to toll the road.
Road Sector PPP
PPP Models in Road Sector
Toll securitization: • Government builds the road and offers to private developer to operate and maintain the road stretch for the concession period. • Developer makes upfront payment to Government for taking over the road. • Traffic and willingness to pay risk is transferred to developer
Operations and Maintenance (O&M) Concessions: • Developer only operates and maintains the road stretch for the concession period • Shorter concession periods 5-10 years. • O&M contracts are fee based concession and the entire traffic risk is borne by the government
PPP Models in Road Sector
Design Build Finance operate (DBFO): • In DBFO detailed designing is also at the discretion of the concessionaire in addition to finance, build and operate. • DBFO schemes
– – – improve the design efficiency, reduce the cost of construction and reduce time to commence operations.
Shadow based Tolling: • Private developer develops and operates the toll road. • Developer receives payments from the government based on the actual/base usage of traffic on the road. • Traffic risk is borne by the developer • Willingness to pay risk borne by the government
Issues in Road Sector in India
• Inadequate pace of road infrastructure development • Lack of traffic data • Liquidity Crunch for Private Players • Lack of coordination between concerned agencies • Lack of speedy Dispute Resolution between NHAI and contractors
Issues in Road Sector in India
• Low level of private sector participation in state, rural and district roads • Inadequate funding of maintenance • Lack of Quality Monitoring by NHAI during operations period • Inaccurate estimation of Project Cost • Lack of easy access to debt funding
Model Concession Agreement
• • 1st stage – technical bidding
– bidders evaluated on the basis of cumulative experience score of the bidders – and total cost of the projects successfully executed in the past.
2nd stage – financial bidding
– bidders evaluated on financial criteria like networth, cash accruals, equity commitment, etc. – Bidder quoting minimum grant / maximum revenue sharing is allotted the project.
• •
MCA has facilitated private sector participation by clearly stating the revenue and risk sharing mechanisms. The main features of MCA are
• clearly states the rights and obligation of NHAI and bidders • rights of the Lenders, • risk sharing mechanisms.
– Concession Period
– Project specific; normally 20 years (likely to go upto 25-30 years in current scenario) – At the end of 8 years, concessionaire given the option to convert 4-lane road to 6-lane road – If concessionaire does not exercise the option, then new operator appointed on completion of concession period of 12 years – Provision for variation in concession period vis-à-vis traffic levels:
Model Concession Agreement
Bankability Issues
• • • • Concessionaire?s 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
– Concessionaire EoD : 90% Debt Due, however onus for due diligence
Supporting Provisions
• • • • Dispute Resolution Mechanism Re-negotiation in good faith Termination as a last resort Preferential treatment in re-bidding
Material Risks
• Completion
– within budgeted costs and time,
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revenue risks
– demand/ traffic and tariff risks
O&M risks. Financial Risks:
– Is financing plan is robust enough to withstand the impact of adverse factors – Is The project is subject to interest rate, liquidity (tenor of borrowing) or currency risks
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Environmental and Social Risks –Identified in an independent EIA/ SIA study done as part of project evaluation.
– Need to ensure that Project is insulated from the risks of land acquisition, environmental advocacy and social issues –R&R issues, compensation claims etc –so that implementation is not hampered – Public consultations are duly held –issues such as access in road projects are dealt with early in the development cycle
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