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Legal and Related Challenges of Funding

Infrastructure Projects in Emerging Economies

Opuiyo OforiokumaCEO/Managing Director

Perchstone & GraeysAnnual Law Seminar

Lagos, 25th April 2008

Challenges in Meeting Public Sector Financing Needs: Financing Key PPP Projects

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About Lekki Concession Company

LCC’s mission is to provide high quality road infrastructure and related services along the Lekki Peninsular of Lagos, Nigeria, and to be recognized as the pioneer for change in the way road infrastructure is delivered throughout Nigeria

Lagos Infrastructure Project (LIP), the first PPP Toll Road Concession in Nigeria, is already in the process of execution

LCC is an initiative of the ARM Group, which has a broad-based ambition to develop major infrastructure projects throughout Nigeria and West Africa

ARM Group is a leading player in the Nigerian asset management sector, with approximately NGN147 Billion under management

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About Our Project

Scope

Public-Private Partnership with Lagos State, to design, build, finance and operate:

Phase I - Lekki Epe Expressway (49.4 km)

Phase II - Coastal Road (20km) plus option to do the Southern Bypass

Funding

Financed by the Concessionaire, LCC, on a limited-recourse basis. Estimated project cost during construction is $300 Million

Toll

Concessionaire will collect tolls and charges on the Concession Roads to recoup cost of investments

Concession Period

30 years

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Typical Emerging Market Financing Challenges Viewed as high risk; hence, difficult to attract capital to them at all, or at

reasonable cost – there is global competition for investment funds

General lack of local understanding of the various infrastructure models and what they entail – affects both public and private sectors, and civil society at large

Lack of skills and experience in key areas, eg, deal development/packaging, project structuring/financing, and major project management/execution

Under-developed financial/banking sector, lacking experience in project financing of major infrastructure transactions

Lack of enabling legislation and/or non-existent/weak regulatory institutions

Political instability and/or lack of continuity

Economic instability and/or poor track record of management

Corruption, lack of transparent procurement processes, and lack of adherence to the rule of Law

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Typical Stages in Infrastructure Development & Delivery

DEVELOPMENTDEVELOPMENT PPP PROCUREMENT NEGOTIATION & AWARD

PPP PROCUREMENT NEGOTIATION & AWARD

DEAL STRUCTURING &

FINANCING

DEAL STRUCTURING &

FINANCING

PROJECT EXECUTION

PROJECT EXECUTION

Opportunity identification

Opportunity evaluation (feasibility studies, EIA/Social Impact studies, due diligence, etc)

Review/establish regulatory framework

Determine PPP Model to use

Procurement process (can be open tender or negotiated)

Bidding and selection of PPP Partner

Agree and negotiate final PPP contractual terms

Develop capital structure

Arrange financing (equity, debt, etc)

Financial close

Construction programme

Operation & Maintenance

Service Delivery

Asset transfer at end

LEGISLATIVE / REGULATORY FRAMEWORKLEGISLATIVE / REGULATORY FRAMEWORK

The 1st two stages are sometimes combined or reversed, especially in negotiated deals

The process to financial close has been known to take years, especially in emerging economies where little or no track record exists

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General Overview of The PPP Model PPPs involve collaboration between the Public Sector and the Private Sector

- Usually for the construction and/or management of a specific asset or a group of assets

- Helps to assign risk to the partner best equipped to deal with it

- Helps to secure specialist skills and experience not readily available in the Public Sector, for public interest projects

- Enables Public Sector funds to be used for other programs, where private sector financing is part of the PPP package

Various Models of PPP exist

- Service contracts, Operations & Maintenance Contracts, etc

- Concessions – transfers the rights to develop and operate defined assets, within a defined area, over a defined term

- Other PPP models include PFI, BOT, BOOT, DBFO, DBF, etc

- They should not be confused with “privatization”, which involves a transfer of ownership of the assets (eg, through the sale of shares)

PPPs are common in asset intensive and/or Utility type industries, eg, Roads, Water, Power, Airports

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Balancing Project Risks & Returns is Key

Project returns must be commensurate with the risks involved otherwise knowledgeable investors will be unwilling to participate in the project

Note: Risks shown are not an exhaustive list

Economic Risks eg, unstable FX rates,

high inflation

Political Risks eg, political instability,

lack of continuity Legal Risks eg, lack of respect for contract, ineffective judiciary, absence of

key legislation, litigation culture

Financial Risks eg, loan tenors too

short, loan rates too high, onerous loan conditions, lack of insurance cover

Revenue Risks eg, rigid price controls,

uncertainty over volumes

Technical & Operating Risks

eg, unfamiliar environment, lack of experience & skills, technology failure

Regulatory Risks eg, lack of transparency,

weak institutions, rigidity/overzealousness,

highly politicized

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Effective Regulation Requires Balance

CONCESSIONAIRE

POLITICAL/REGULATORY DRIVERS

eg, provision of essential infrastructure, standards,

government policy

CUSTOMER DRIVERS

eg, affordability, value for money, quality and consistency of service

COMMERCIAL / INVESTMENT

DRIVERSeg, return on

investment, risk management

Regulation typically covers economic (eg, price-setting, ROI), and technical/operational matters (eg, performance standards, investment programmes)

The drivers, however, do not always pull in the same direction, at the same time, in the same way, and with the same amount of force

Regulation should be transparent, fair, balanced and apolitical

Interests of the key stakeholders should be balanced over the long-term

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D e v C o n s t r O & M

P r o j e c t R i s k P r o f i l e

F in /C om

C o llec tio n

T ra ff ic

E n g

T ra n s fe r

Understanding Project Risk is Critical

TYPICAL BOT PROJECT

Risk is an indication/measure of uncertainty and unpredictability

Identifying, managing and/or eliminating risk is critical in any project – this is a skilled exercise, supported by thorough due diligence

A fundamental element of structuring and executing infrastructure projects is the allocation of risk to the parties best able to deal with them – normally done through contract

Various instruments, eg, insurance, interest rate/currency hedges, etc, can be purchased to help lay-off risk to 3rd parties willing to underwrite them

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Conceptual Project Financing Structure

Concessionaire

Equity Investors

LendersInsurance

Revenues from Operations

Investors & other Providers of

Capital

Risk Management & Protection

Project support, eg, Bonds & Guarantees

Key consideration is how risk is distributed across the financing structure (“recourse”)

Financing agreements will document the roles and relationships across the structure

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Contractual Framework: Lekki Toll Road Concession

Sponsors

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Project Credibility & Bankability

Experienced Concession

& Project Manager Turnkey D&C Contractor + Maintenance

Financial StructureTechnical and Engineering

Govt. Support & Commitment +

Enabling Legislation (2004 Lagos Roads

Law)

Legal & Regulatory Expertise

Committed Sponsors

Financial Advisors& Arrangers

(robust financial model)

* Debt/Equity Mix* Tenor* Currency

* Feasibility* EIA/SIA Studies* Tolling Strategy* Surveys* Design

In developed economy environments, well researched and structured projects, backed by credible, experienced players, are usually easier to finance

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Key Project Financing Considerations Efficient project financing utilizes a mix of financing sources to achieve the optimum

balance between equity investors, lenders and other providers of capital – Share Capital, Loans, Mezzanine Finance, Grants, etc

Long loan tenors (15 years or more ideally) are key to the financing of major infrastructure

The cost of long term financing must be reasonable and commensurate with the risk of the relevant project – providers of finance need to understand how to properly price risk so as not to overburden the project

Concessionary financing from governments, multi-lateral agencies, and other similar institutions can help to significantly bring down the cost of financing and improve project economics and bankability

There should be adequate security for both lenders and investors, however, this does not mean “asking for everything plus the kitchen sink”

Where the market exists, and it is cost effective to do so, it is advisable to hedge against some risks, eg, currency fluctuation (where foreign currency financing is used) and interest rates (where they are floating)

Flexibility to repay loans early at zero or minimal exit cost, will facilitate refinancing later on (eg, through a bond issue) when the project risk profile has diminished and returns are stable

Take out appropriate insurance cover if you can get it – “a stitch in time saves nine”

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