The Value of Public-Private Partnerships How Risk Transfer and Performance Security Influence a Deal Aaron Toppston Director, Aon Infrastructure Solutions Baker & McKenzie International is a Swiss Verein with member law firms around the world. In accordance with the common terminology used in professional service organizations, reference to a partner means a person who is a partner, or equivalent, in such a law firm. Similarly, reference to an office means an office of any such law firm.
Public Private Partnerships (P3s) are significantly different from traditional infrastructure procurement Traditional Design-Bid-Build Procurement Public Private Partnership Architect Government Design request Building design Equity APD contract & routine payments Financing, construction & operation of asset for 30 yrs Debt Debt Government Concessionaire Construction contract & lump sum payment Construction and 2 yr warranty Contractor may contribute equity and act as concessionaire Contractor DB Contractor O&M Contractor 2
Many governments evaluate P3 projects based on Value for Money $107 12 $100 20 7 15 17 60 62 14 Ancillary Cost Retained Risk Financing Cost Base Cost Example VfM = $7 Traditional P3 Risk transfer drives Value for Money Infrastructure Ontario Assessing Value for Money 3
However, not all risks should be transferred to the private sector Risk Classification Typical Party Examples Responsible Strategic & Macro Environment Government Environmental approvals Right-of-way acquisition Force majeure events (e.g. California earthquake) Financial & Lifecycle Concessionaire / Revenue (e.g. toll risk)* Risks Equity Holders Inflation Refinancing Meeting operating standards Design & Design-Build JV Workmanship Construction ti Design Construction budget Construction schedule / completion 4 * Applies to revenue risk deals only. In availability payment, concessionaire takes counterparty credit risk / risk of government payment
Proper risk mitigation improves the Concessionaire s ability to deliver projects on-time, on-budget and repay its debt Concessionaire is responsible for obtaining and repaying all debt Concessionaire Debt By transferring risk to the DB and O&M contractors, the concessionaire reduces its risk exposure Risk transfer DB Contractor (CJV) Risk transfer O&M Contractor However, debt holders and rating agencies closely examine how the DB and O&M contractors mitigate risk Effective risk mitigation helps to keep the project on budget and on schedule, improving confidence in project debt repayment 75%+ of projects delivered through P3 procurement are on-time, on-budget vs. 30% for traditional delivery 1 1) United Kingdom National Audit Office (via the OECD Journal on Budgeting) 5
Debt makes up a significant portion of project finance 10-40% Equity Concessionaires, private equity, hedge funds, pensions Pensions, life insurance companies, other institutional investors 60-90% Debt Graphic concept from Weber and Alfen. Infrastructure as an Asset Class. Wiley Finance Publishing. 6
P3 financing is significantly different than traditional municipal financing for infrastructure projects Traditional Municipal Financing Public Private Partnerships Who Repays Debt Taxpayers Taxpayers for availability projects and users for toll projects Recourse to Payment Impact of construction and operational risks General obligation to government; government responsible to make good on debts Lower; government responsible for performance during lifecycle and must repay debt regardless of project performance Only obligation is to project revenues; no government guarantee Higher; concessionaire responsible for performance during lifecycle and earns revenue based on project performance Perceived Risk of Lower; few defaults historically Higher; especially during Default construction period 7
Rating agencies, debt syndicators, and end debt evaluate project risk through select criteria Credit Factor ILLUSTRATIVE Risk Free Rate Toll or Availability Payment Availability Payer Rating Credit Spread Project Risk Profile Contractor Risk Profile Contractor Supports Summary of DBRS, S&P, and Moody s Project Finance / PPP Rating Models 8
Performance security and other risk solutions are of top concern for lenders Solution Detail Liquidity Risk Controls Contractor best practices & sound contracts n/a Insurance Performance Bond Parental Guarantee Letter of Credit Cash Reserves Provides protection against hazards and liabilities that can cause catastrophic losses Provides core performance support in case of significant solvency or performance failure by contractor Guarantees performance of obligations under project contracts by ultimate parent of contractors Provides liquidity during construction phase for minor performance failures by contractor Offers cushion in project schedule and budget, and to fill minor gaps in operating revenues if a toll risk project Less liquid More liquid ILLUSTRATIVE 9