Public-private Partnership in Infrastructure Finance

7/30/2019 Public-private Partnership in Infrastructure Finance

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Topic: public-private partnership in infrastructure finance

Yerra subbarayudu


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AGENDA

Introduction Public sector undertaking Private member undertaking Public-private partnership Advantages of a public-private partnership Infrastructure Finance Characteristics of infrastructure finance Main financing mechanisms for infrastructure projects Types of risk capital required Disadvantages Conclusion


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PUBLIC-PRIVATE PARTNERSHIP IN

INFRASTRUCTURE FINANCE

INTRODUCTION:-

The use of Public-Private Partnerships (PPPs) to replace

and complement the public provision of infrastructure has become common in

recent years. Projects that require large upfront investments, such as highways,

light rails, bridges, seaports and airports, water and sewage, hospitals and schools

are now often provided via PPPs.

A Public-private partnership bundles investment and service provision of

infrastructure into a single long-term contract. A group of private investors

finances and manages the construction of the project, then maintains and operates

the facilities for a long period of usually 20 to 30 years and, at the end of the

contract, transfers the assets to the government. During the operation of the project,

the private partner receives a stream of payments as compensation. These

payments cover both the initial investment the so-called capital expense and

operation and maintenance expenses. Depending on the project and type of

infrastructure, these revenues are obtained from user fees (as in a toll road), or

from payments by the government s procuring authority.


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PUBLIC SECTOR UNDERTAKING:-

Is a legal entity created by a government to

undertake c ommercial a ctivities on behalf of an owner government. Their legal

status varies from being a part of government into stock companies with a state as

a regular stockholder. And the development of the infrastructure or any other

development taken up by the governments are done through the public sector

companies

In past the entire development of the infrastructure financing

is done by the government itself and as the change in traditional approach thegovernment of India had established Indian infrastructure finance company ltd.

which regulates the infrastructure financing, funding for recognized projects and

signing public-private partnerships for sustained economic development and

improving the living standards of the population

PRIVATE MEMBER UNDERTAKING:-

The company established or acquired and

maintained by a private member other than government holding where there can be

one or more people being the shareholders and the company can remain private or

can list it in any of the stock market to become public company.

In India they are some key players in the

infrastructure financing along with the state owned companies like L&T Infra,

IDFC and others which are operating under public-private partnership in recent

years and there importance has grown significantly in this field
http://en.wikipedia.org/wiki/Governmenthttp://en.wikipedia.org/wiki/Commercehttp://en.wikipedia.org/wiki/Commercehttp://en.wikipedia.org/wiki/Government


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PUBLIC-PRIVATE PARTNERSHIP :-

Public private partnership (PPP) describes

a government service or private business venture which is funded and operated

through a partnership of government and one or more sector companies . It involves

a contract between a public sector authority and a private party, in which the

private party provides a public service or project and assumes substantial financial,

technical and operational risk in the project. In some types of PPP, the cost of

using the service is borne exclusively by the users of the service and not by the

taxpayer.

The G overnment of India d efines a PPP as "a

partnership between a public sector entity (sponsoring authority) and a private

sector entity (a legal entity in which 51% or more of equity is with the private

partner/s) for the creation and/or management of infrastructure for public purpose

for a specified period of time (concession period) on commercial terms and in

which the private partner has been procured through a transparent and open

procurement system."

ADVANTAGES OF A PUBLIC-PRIVATE PARTNERSHIP:-

The advantages of Public Private Partnerships (PPP s) include the following:

Speedy, efficient and cost effective delivery of projects Value for money for the taxpayer through optimal risk transfer and risk

management
http://en.wikipedia.org/wiki/Public_sectorhttp://en.wikipedia.org/wiki/Government_of_Indiahttp://en.wikipedia.org/wiki/Government_of_Indiahttp://en.wikipedia.org/wiki/Public_sector


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Efficiencies from integrating design and construction of public infrastructure

with financing, operation and maintenance/upgrading

Creation of added value through synergies between public authorities and

private sector companies, in particular, through the integration and crosstransfer of public and private sector skills, knowledge and expertise

Alleviation of capacity constraints and bottlenecks in the economy through

higher productivity of labor and capital resources in the delivery of projects

Competition and greater construction capacity (including the participation of

overseas firms, especially in joint ventures and partnering arrangements)

Accountability for the provision and delivery of quality public services through

an performance incentive management/regulatory regime

Innovation and diversity in the provision of public services Effective utilization of state assets to the benefit of all users of public services

INFRASTRUCTURE :-

Is basic physical and organizational structures needed

for the operation of a society or enterprise , or the services and facilities necessary

for an economy to function. It can be generally defined as the set of interconnected

structural elements that provide framework supporting an entire structure of

development. It is an important term for judging a country or region's

development. They include:

Telecommunications (Wi-Fi, WiMax, Broadband, GSM and CDMA etc.)
http://en.wikipedia.org/wiki/Societyhttp://en.wikipedia.org/wiki/Businesshttp://en.wikipedia.org/wiki/Economyhttp://en.wikipedia.org/wiki/Economyhttp://en.wikipedia.org/wiki/Businesshttp://en.wikipedia.org/wiki/Society


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Social infrastructure (hospitals, modern prisons, courts, museums, schools and

Council and Government Housing)

Energy (Renewable energy i.e. solar and wind, power generation, distribution,

transmission and supply) Transportation (light rail systems, bridges, tunnels and under-ground/over-

ground high speed trains, toll roads etc.)

Water (Water supply, dams for irrigation, water, liquid and solid treatment

plants, sewerage etc.)

FINANCE:-

There is a need for large and continuing amounts of investment in

almost all areas of infrastructure the key issue is, while the need exists, it gets

difficult for the projects to get nanced. In the past the government has been the

sole nancier of these projects and has often taken responsibility for

implementation, operations and maintenance as well. There is a gradualrecognition that this may not be best way to execute/ nance these projects. And the

public-private partnership came into existence

CHARACTERISTICS OF INFRASTRUCTURE

FINANCE:-

Infrastructure projects differ in some very signi cant ways from

manufacturing projects and expansion and modernization projects undertaken by

companies.


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1. Longer Maturity:

Infrastructure nance tends to have maturities between 5 years to

40 years. This re ects both the length of the construction period and the life of the

underlying asset that is created. A hydro-electric power project for example may

take as long as 5 years to construct but once constructed could have a life of as

long as 100 years, or longer.

2. Larger Amounts:

While there could be several exceptions to this rule, a meaningful

sized infrastructure project could cost a great deal of money involved in it and thisis a kind of characteristics which might or may not have much risk involved in it

for example a kilometer of laying a highway road or construction of a power plant

involves a huge amount

3. Higher Risk:

Since large amounts are typically invested for long periods of time

it is not surprising that the underlying risks are also quite high. The risks arise from

a variety of factors including demand uncertainty, environmental surprises,

technological obsolescence (in some industries such as telecommunications) and

very importantly, political and policy related uncertainties.

4. Fixed and Low (but positive) Real Returns:

Given the importance of theseinvestments and the cascading effect higher pricing here could have on the rest of

the economy, annual returns here are often near zero in real terms. However, once

again as in the case of demand, while real returns could be near zero they are

unlikely to be negative for extended periods of time (which need not be the case


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for manufactured goods.) Returns here need to be measured in real terms because

often the revenue streams of the project are a function of the underlying rate of

in ation

MAIN FINANCING MECHANISMS FOR

INFRASTRUCTURE PROJECTS:-

A number of financing mechanisms are available for infrastructure projects and for

Public-private partnership projects in particular.

1. Government Funding:

The Government may choose to fund some or all of the capital

investment in a project and look to the private sector to bring expertise and

efficiency. This is generally the case in a so-called Design Build Operate projectwhere the operator is paid a lump sum(s) for completed stages of construction and

will then receive an operating fee to cover operation and maintenance of the

project. Another example would be where the Government chooses to source the

civil works for the project through traditional procurement and then bring in a

private operator to operate and maintain the facilities or provide the service. Even

where Government s prefer that financing is raised by the private sector,

increasingly Governments are recognizing that there are some aspects of the

project or some risks in a project that it may be easier or sensible for the

Government to take.


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2. Corporate or On-Balance Sheet Finance:

The private operator may accept to finance

some of the capital investment for the project and decide to fund the project

through corporate financing which would involve getting finance for the projectbased on the balance sheet of the private operator rather than the project

itself. This is typically the mechanism used in lower value projects where the cost

of the financing is not significant enough to warrant a project financing mechanism

or where the operator is so large that it chooses to fund the project from its own

balance sheet. The benefit of this is that the cost of funding will be the cost of

funding of the private operator itself and so is typically lower than the cost of

funding of project finance. It is also provably less complicated than project

finance. However, there is an opportunity cost attached to corporate financing

because the company will only be able to raise a limited level of finance against its

equity (debt to equity ratio) and the more it invests in one project then less that will

be available to fund or invest in other projects.

3. Project Finance:

One of the most common, and often most efficient, financing

arrangements for Public-private partnership projects is project financing , also

known as limited recourse or non-recourse financing. Project financing

normally takes the form of limited recourse lending to a specially created project

vehicle (special purpose vehicle or SPV ) which has the right to carry out the

construction and operation of the project. It is typically used in a new build orextensive refurbishment situation and so the SPV has no existing business. The

SPV will be dependent on revenue streams from the contractual arrangements and/

or from tariffs from end users which will only commence once construction has

been completed and the project is in operation. It is therefore a risky enterprise


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and before they agree to provide financing to the project the lenders will want to

carry out extensive due diligence on the potential viability of the project and a

detailed review of whether project risk allocation protects the project company

sufficiently. This is known commonly as verifying the project s bankability .

TYPES OF RISK CAPITAL REQUIRED:-

There are two types of risk capital that are deployed in any project:

1. Explicit Capital:

This is typically the equity that a developer or a sponsor commits

to the project. Here while the downside is unlimited (to the full extent of the

amount of money the sponsor has committed to the project), if the project does

well, there is no limit on the upside either. The sponsor seeks to conserve his

capital and maximize the returns on it by deploying unique and project speci c

skills and by managing the underlying risks associated with the project. Given alimited supply of capital, the promoter also tends to concentrate his energies and

capital in a small number of relatively lumpy investments so that he does not

spread himself and his resources too thinly. In a typical infrastructure project, the

developer puts together a consortium of capital providers who not only commit

capital to the overall project but also assume complete operational and nancial

responsibility for speci c risks (such as engineering, procurement and

construction; operations and maintenance; and fuel supply), thus, lowering the

capital requirements from the developer.


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2. Implicit Capital:

This is typically the risk capital that is committed by a lender to

the project. Loans have the characteristic that while the downside is unlimited (i.e.,

to the full extent of the amount lent - as in case of equity/explicit capital but with

the cushion of the explicit capital), the upside is limited to the rate of interest

charged on the loan. Secondly, the loans typically involve much larger amounts of

money relative to the equity investments. Given the fact that a typical lender raises

money from retail deposits (or bond holders) he needs to hold a reasonably high

amount of capital to assure his depositors that irrespective of the fate of the project,

he will be able to meet his obligations. Assuming that the desired rating aspiration

for the lender is AAA (i.e., the lender would like to assure its depositors of a near

zero default risk) an unsecured loan to a typical ten year infrastructure project

(rated, say A-, with an average maturity of six years) could require as much as 25%

tier 1 capital to be committed to it. Since the capital is required to cover the lender

against all the uncertainties surrounding a speci c project, the lender seeks to

reduce the amount of capital deployed by diversifying across projects (unlike thepromoter who seeks to specialize and concentrate his exposure) and by ensuring

that to the extent possible, the explicit capital (brought in by the promoter) is

suf cient to cover the risks beyond the worst-case scenarios. The lender seeks to

be compensated for this capital through the rate of interest charged on the project

loan. Given the relatively large amounts of funds required for each project and the

comparatively smaller number of such providers, lenders in the past have typically

not had the opportunity to suf ciently diversify their risks nor have they had a

suf cient amount of tier 1 capital. Not unexpectedly, having held signi cantly less

than the required amount of implicit capital, they have very quickly found


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themselves undercapitalized relative to the level of credit rating that they had

committed to their depositors and in some cases have even defaulted to them.

DISADVANTAGES:-

1. Tendering and negotiation:

Public private partnership contracts are typically much

more complicated than conventional procurement contracts. This is principally

because of the need to anticipate all possible contingencies that could arise in suchlong-term contractual relationships. Each party bidding for a project spends

considerable resources in designing and evaluating the project prior to submitting a

tender. In addition, there are typically very significant legal costs in contract

negotiation. Having several bidders do this involves a cost which can add up in

total to tens of millions. It has been estimated that total tendering costs equal

around 3% of total project costs as opposed to around 1% for conventional

procurement. The cost of both successful and unsuccessful bids is, in effect, built

into total project costs.

2. Contract re -negotiation:

Given the length of the relationships created by PPPs and the

difficulty in anticipating all contingencies, it is not unusual for aspects of the

contracts to be renegotiated at some stage. Wherever possible, provisions areincluded in the contract that spells out how variations are to be priced. But, given

the length of time spanned by the contract, it is almost inevitable that

circumstances will arise which cannot be foreseen.


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3. Performance enforcement:

One of the difficulties with performance specification in

the area of service delivery is that performance sometimes has dimensions which

are hard to formulate in a way that is suitable for an arms-length contract.

Examples include maintaining good customer relations, and not

creating public relations blunders which rebound on the government

4. Political acceptability:

Given the difficulty in estimating financial outcomes over such

long periods, there is a risk that the private sector party will either go bankrupt, or

make very large profits. Both outcomes can create political problems for the

government, causing it to intervene.

CONCLUSION:-

Infrastructure growth is a critical necessity to meet the growth

requirements of the country. Government led infrastructure nancing and

execution cannot meet these needs in an optimal manner and there is a need to

engage more investors for meeting these needs. And there is increase in the public-

private partnerships compared to the past and governments should take initiative in

making the procedures transparent and protect the interest of the public and the

private company involved in the partnership.


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SOURCES

1. http://ppp.worldbank.org/public-private-partnership/financing/mechanisms

2. http://cowles.econ.yale.edu/~engel/pubs/efg_eib.pdf 3. http://www.ccsenet.org/journal/index.php/ijbm 4. http://www.rpa.ie/en/rpa/ppp/Pages/AdvantagesofPPPs.aspx 5. http://www.ifmr.ac.in/pdf/workingpapers/21/SourcesInfraFin.

pdf 6. http://www.treasury.govt.nz/publications/research-

policy/ppp/2006/06-02/06.htm 7. http://www.iifcl.org/Content/sifty.aspx
http://ppp.worldbank.org/public-private-partnership/financing/mechanismshttp://ppp.worldbank.org/public-private-partnership/financing/mechanismshttp://ppp.worldbank.org/public-private-partnership/financing/mechanismshttp://www.ifmr.ac.in/pdf/workingpapers/21/SourcesInfraFin.pdfhttp://www.ifmr.ac.in/pdf/workingpapers/21/SourcesInfraFin.pdfhttp://www.treasury.govt.nz/publications/research-policy/ppp/2006/06-02/06.htmhttp://www.treasury.govt.nz/publications/research-policy/ppp/2006/06-02/06.htmhttp://www.treasury.govt.nz/publications/research-policy/ppp/2006/06-02/06.htmhttp://www.iifcl.org/Content/sifty.aspxhttp://www.treasury.govt.nz/publications/research-policy/ppp/2006/06-02/06.htmhttp://www.treasury.govt.nz/publications/research-policy/ppp/2006/06-02/06.htmhttp://www.ifmr.ac.in/pdf/workingpapers/21/SourcesInfraFin.pdfhttp://www.ifmr.ac.in/pdf/workingpapers/21/SourcesInfraFin.pdfhttp://www.rpa.ie/en/rpa/ppp/Pages/AdvantagesofPPPs.aspxhttp://www.ccsenet.org/journal/index.php/ijbmhttp://cowles.econ.yale.edu/~engel/pubs/efg_eib.pdfhttp://ppp.worldbank.org/public-private-partnership/financing/mechanismshttp://ppp.worldbank.org/public-private-partnership/financing/mechanisms

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