Public-private partnership opportunities
December 2010 | TALKINGPOINT | FINANCE & INVESTMENT
FW moderates a discussion between Julien Reidy at Hogan Lovells and De Buys Scott at KPMG, on public-private partnerships.
FW: To what extent have you seen an increase in PPP activity over the last 12 months?
Scott: In South Africa the World Cup soccer attracted strong preparatory attention in the 18 months prior. The biggest fear was what exactly would happen after the competition. Those fears have been completely laid to rest. Major tenders have been launched in South Africa in the passenger rail industry and water. The passenger rail tender will replace the entire passenger rolling stock fleet in the country and the water tender looks at strategy for the water industry. Never before have either of these industries been in the limelight as they are now. Major road refurbishment and expansion, ongoing base load primary power and an exciting launch of renewable energy to be provided by independent power providers were also brought public. Therefore, there has been an unprecedented surge in PPP activity during the last 12 months in South Africa.
Reidy: There is no doubt that PPP activity globally was dramatically affected following the collapse of Lehman Brothers in 2008 and the subsequent drying up of credit markets. The PPP infrastructure model was dependent on the availability of long term debt and in the 12 to 18 month period following the Lehman Brothers collapse, long term debt was either unavailable or was only available at a price that rendered the underlying project untenable on a PPP basis. A lot of projects were either put on hold, cancelled, or were procured under more traditional procurement methods during that period. There has been a marked increase in PPP activity over the last 12 months or so. In the Middle East, a number of water and energy projects have either closed or are in the process of being procured. In South East Asia, the closing of the Sports Hub PPP Project in Singapore represents a key milestone, and we are also seeing a lot of countries looking to update and implement new PPP laws, including recently Vietnam and Indonesia. Thailand is also looking at updating its PPP legislation presently. In the UK and Europe, there has been an increase in activity, although it is fair to say this is not yet at the levels seen pre credit-crunch.
FW: Which sectors seem to be attracting the interest of private investors – for example, energy and power, oil and gas, telecommunications, construction and housing, transportation, water, healthcare, education and defence? Have there been any recent government policies and incentives to promote PPP opportunities in particular sectors?
Reidy: Energy and power remains a key sector globally. In Asia, economic infrastructure projects – utility projects, waste and water, energy and power, roads and transport – are still the main focal point for PPP. There does not seem to be a huge push in Asia yet for the type of social infrastructure projects we are seeing in Europe. For example, there has been little or no push for PPPs in healthcare, education, social housing, and defence. Many governments in South East Asia are looking to update their PPP laws to promote projects and private sector investment. Vietnam and Indonesia have both enacted new legislation during the course of 2010 to aid PPP projects and develop private sector investment in infrastructure. Indonesia, in conjunction with multilaterals like the World Bank, has also set up an infrastructure guarantee fund to promote PPP investment in the country.
Scott: The current sectors attracting interest in South Africa are rail passenger transport, freight rail, the power sector, water and water tariff pricing, a major roads strategy review, and various health sector and nursing college and training facilities. Some of the historically tendered sectors and PPPs seem to be re-examined after having been indefinitely stalled, in some instances for years. An example is the provincial head office buildings in Tswane. A variety of new feasibility studies are also under way which bodes well for attracting private capital and a broad skills base over a wide stretch of industries.
FW: Have you noticed any trends or changes in procurement and bidding processes for PPP deals?
Scott: Procurement is getting more thorough and comprehensive. Certain requirements are being sought that were never asked before, for instance asking key individuals to sign declarations on availability as well as major projects that they are involved in. Clearly there is a trend moving towards tightening up on human resources. Bidding remains extremely short and tight in timeframes and in some instances the financial costing side is getting very competitive. The South African market is very active, attracting virtually all global and local advisers, financial and legal, and their presence has generally lifted all standards of procurement, both public and private. Advisers also need to be sharper and more professional as fees are under pressure. Generally said, the developed world of procurement and advisers has influenced the local markets positively and will increasingly continue to do so.
Reidy: In South East Asia, the main trend is that of governments looking to update existing PPP and procurement legislation in an effort to promote private sector investment. We have also seen some governments looking to decentralise infrastructure responsibility and look at ways of implementing infrastructure projects at the sub-sovereign level. One trend becoming apparent is the emergence of Chinese contractors and suppliers in PPP projects. We saw, for example, in the Salalah IWPP project in Oman, SEPCO III being the first major Chinese EPC contractor on a large IWPP in the Middle East.
FW: What legal and regulatory considerations do potential investors need to make when considering a PPP opportunity?
Scott: The track record of the target country is critical. The more PPPs completed or significantly in progress will indicate experience, progress made and lessons learned. These are all critical aspects in the regulatory and legal framework of any country’s PPP environment. In addition it is necessary to understand how the PPP framework was achieved and on what model has it been based. It is important that a tried and tested precedent and PPP framework is selected. The supporting legal framework needs to be in place as well, including the existence of standardised documentation, timeframes and approval processes. Investor and funder confidence will be optimal in an environment where established and reliable frameworks prevail.
Reidy: Rule of law and sanctity of contract are crucial for attracting foreign investment for a PPP project. The level of ‘political risk’ is a key factor. In emerging jurisdictions there is a reliance on multilateral involvement – such as the ADB, World Bank/IFC and JBIC – and political risk coverage. There needs to be transparency of procurement to properly attract foreign investment in emerging PPP markets. The most common obstacles we see is inadequate legal and regulatory frameworks, lack of feasibility work and resources or capacity at government level. There are also often unrealistic expectations at government level and this manifests itself in unbankable risk allocation arrangements and stop-start approaches to infrastructure procurement.
FW: In your opinion, how should a private investor approach the task of structuring the deal and arranging finance to ensure they optimise the deal? Are there any common pitfalls here that can jeopardise the process of creating long-term value?
Reidy: When long term debt markets collapsed during the credit crunch, the PPP projects that did proceed usually had some form of government financing assistance. In Victoria, Australia, the huge desalination PPP project received government based underwriting and refinancing protection. In the UK, the Manchester Waste PPP project received government co-lending support, and such co-lending was also mooted for the M25 project in London. Other European projects saw far greater EIB financing support. In Singapore, it has been reported that the Sports Hub PPP project received some limited form of refinancing protection, due to the initial financing loan tenor being shorter than the underlying project term. The private sector is no doubt assisting governments to some degree in establishing the form of assistance or protection necessary where governments elected to proceed with a particular project using a PPP model notwithstanding funding difficulties. Now that long term debt is available again, albeit at higher pricing than pre credit crunch times, there is perhaps less need on the public sector side to look to provide co-lending or similar support. Deals have been and will, at least in the near future, continue to be structured on a club financing basis and there has not yet been a return globally to the underwriting we have seen for PPP deals previously.
Scott: Value creation is inter alia a function of the most appropriate funding structure. Maximise the available safe and free cash flow with the maximum debt being incurred and serviced with the resultant equity contribution minimised. Equity is the most expensive form of funding and should be treated accordingly. Financial institutions invariably prefer more equity than others to cover their debt exposure. Experienced financial practitioners will be able to structure such a capital debt structure. The next major area is in assuming risk. The inherent concept of any PPP is to try to pass as much risk as possible to the private party whom, naturally, should resist that as far as possible. Any form of lesser risk acceptance or sharing of risk carrying all alone is an improvement. Lastly, a properly prepared PPP model with proper cash flow debt covenants and proper reserving, and which projects an acceptable IRR from inception should be monitored very strictly thereafter for deviation and to understand why this is occurring. Often proper post completion project monitoring can save significant costs as well as yield unexpected revenues, hence increased returns.
FW: How important is it for PPP investors to understand and evaluate their contractual obligations under the deal? Are you seeing an increase in disputes arising from PPP arrangements, where one party fails to meet their obligations?
Scott: It is very important for investors to understand and evaluate their obligations. It is the essence of a very detailed process designed to enhance share risks after proper debate on each risk item as to who best influences such a risk. By default all parties should participate quite rigorously in this process and should have a relatively well-defined understanding of the partnership. I believe there are far less disputes in PPPs relative to ordinary partnerships simply because of the absolute rigor of the process. We have seen no increases in publicly known possible disputes under PPP arrangements.
Reidy: One of the key reasons PPP has proven to be so successful in terms of delivery post financial close for a project is the level of due diligence that takes place by all participants – government, sponsors/equity participants, lenders, subcontractors – prior to achieving financial close. Experienced PPP investors and lenders have detailed risk analysis tools and use trusted experienced advisers to assist them in structuring deals, evaluating and addressing risk allocation, arranging adequate finance and finalising transactions. Unlike more traditional construction projects, where there perhaps has been an increase in disputes during the credit crunch, we have not witnessed any marked increase in disputes from PPP projects globally.
FW: What risk management strategies would you recommend to investors in PPP deals?
Reidy: Experienced PPP investors and lenders already have detailed risk management techniques, strategies and tools to address risk in projects. When looking at emerging PPP markets, such investors look to appoint experienced international PPP advisers to assist them in conjunction with good locally based advisors.
Scott: Risk management strategies start with any private investor. Ensure that you have PPP-experienced staff and advisers involved. The topic is very technical and complicated, and unless your interests are looked after by properly qualified advisers then the risk of encountering an unbalanced and risk loaded deal against you is significant. As a private party you should also try to do some homework, for instance, benchmarking against previous deals if possible. Do not simply accept the answer if it seems illogical. Rigorous project management post operating date against forecasts and expectations, together with thorough sourcing of explanations for deviations, are also good prudent policies.
Julien Reidy is of counsel in Hogan Lovells’ Singapore office. Mr Reidy has extensive experience advising both public and private sector participants on PPP and infrastructure projects in South East Asia, the Middle East and Europe. In the South East Asian region, he has recently advised on the multibillion dollar redevelopment of Singapore’s National Stadium on a PPP basis, the flagship project under the Singapore government’s PPP initiative. He can be contacted on +65 6302 2555 or by email: firstname.lastname@example.org.
De Buys Scott, is a partner and head of the Global Infrastructure and Projects Group at KPMG. He has wide-ranging experience advising on PPP and infrastructure projects in South Africa and also offers advice on Islamic finance investment opportunities. Mr Scott can be contacted on +27 11 647 8982 or by email: email@example.com.
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De Buys Scott