PPP Development Stage – Financing (Investments)
12.2 What are the key processes?
The main indicator of the effectiveness of the financial operation
is a profitability of business. The key issue for the private sector
in this respect is that tools be provided for clear analysis and
planning of financial and investment activities in future periods.
Thus, to compare pros and cons, the private sector should have
the ability to perform a complete evaluation of the business and
so must have access to operational and financial activities of
The key processes of financing PPP include:
- 1. Defining investment options
- 2. Business valuation
- 3. Bankability assessment
- 4. Investment management
1. Defining investment options
Partners should agree on the main applicable and available
forms of financing and choose the most effective one. This
process is usually governed by legislation and general practice
and requires a careful and detailed investigation of each form.
A. Subsidised finance
National governments, international donors and specialised
financing institutes (for example, the International Financing
Institutions and local development banks) usually provide
grants and subsidised loans to local authorities for financing
the capital costs of wastewater collection treatment facilities.
The following types of subsidised financing (or soft financing)
can be distinguished:
- direct investment subsidies as a grant;
- subsidised loans through:
– interest subsidy or
– credit risk guarantee;
- subordinated loans (longer repayment period, higher risks); and
- Tax allocations, typically though deductions against taxable income to
the private industry to enable companies to comply with new pollution
Through grants and subsidised loans, lower tariffs for cost recovery
can be maintained. However, direct grants do not provide for incentives
to improve efficiency and may discourage pollution abatement. As
a direct grant is usually expressed as a percentage of total costs,
wealthier areas (large cities) tend to benefit relatively more.
The same is true in the case of subsidised loans. The subsidised
finance can be provided by:
Local special financial intermediaries
In many countries special purpose government-owned development
banks or financial intermediaries have been established
to respond to the needs for medium- to long-term project financing.
Governments may also manage environmental funds that provide
loans and grants to municipalities for environmental investments.
Such funds could come from revolving funds and/or from multi- and
International Financial Institutions (IFIs)
IFIs may provide low-cost sanitation project finance. As highly
creditworthy institutions, their key function is to channel
financing from the international capital market to recipient
developing countries. They provide this financing on, mostly, favourable
terms (for example, low-interest margins or long repayment
periods), and in many cases accept the recipient country’s credit
risks. Constraints for utilising IFI loans are that in many cases
IFIs require a public sector guarantee and that the loans are
denominated in a foreign currency, exposing the projects to a
B. Market financing
Local governments’ access to long-term (international)
capital markets and equity financing is limited by a perceived
lack of creditworthiness and limited confidence in the capacity
of local governments to repay debts.
Commercial banks are not usually very interested in long-term
lending for sanitation and wastewater treatment projects.
They would require a public sector guarantee, which might
not be available. This makes international commercial lending
even more difficult. Several mechanisms for securing bank loans
exist – for example,
contracts and documentation to assure lenders that their
funds will be used to support the project in the way intended;
or a mortgage on available land and fixed assets.
Municipal bonds for infrastructure guarantee full repayment
in the case of default through the levying of additional
taxes, and thus are only available to governments. Revenue
bonds are secured by the revenues of the project and, given
the higher risk, typically offer slightly higher interest rates
than governmental bonds.
The most creditworthy countries might issue an international
bond (backed up by a sovereign guarantee). The critical requisites
for developing a countries’ access to this international
bond market are: having a good name with respect to governance;
a sound municipal fiscal policy; and adequate collateral or other
means of securing risk (for example, royalties from state assets,
tax revenues or loan guarantees) to cover foreign exchange and
other risks involved.
C. Attracting private capital
An innovative finance instruments to attract financing sources
is a project pool structure whereby lender’s and investor’s
risks are spread over a number of projects. The primary source
of repayment is not a single’s project cash flow, but the
performance of a number of projects. The aim of this pooling
structure is to gain access to long-term private financing.
A fund financed from various sources can be set up to finance
project costs. Subsequent repayments from the projects
are then used to replenish the fund to permit funding of other
investments. The large, diversified pool of borrowers is attractive
to lenders because risks of debt payment are spread. In the sanitation
sector, revolving funds are usually created with extensive
government or donor involvement. Households and communities can
also apply revolving funds to finance on-site and local sewerage
Over the past few years, infrastructure equity funds have provided
a means by which developers can raise financing for infrastructure
projects in emerging markets. Such funds allow developers
to leverage their contributions with those of investors and
thus to spread their capital. For investors, equity funds mitigate
project and country risk by creating a portfolio of projects
under one company.
Combining utilities may enlarge the scope for economies of
scale, but also ensures larger balance sheets. Furthermore,
the wide diversification of projects increases credit strength
to attract long-term private financing. In the UK, multi-utilities
provide the whole range of utility services – electricity
generation and distribution, water supply, sanitation services,
but also gas distribution and telecommunication.
2. Business valuation
Every initiative starts from the evaluation of the entire business
in order to receive a comprehensive picture of the current
stage and to consider participation forms and further development.
Such an evaluation demands from the public sector guarantees
of financial, operational and accounting transparency of
the business. As a result of evaluation, the private sector
should be aware of all the strengths, weaknesses, opportunities
and threats (SWOT analyses) and be sure of the feasibility
of its financial or other benefits.
The main criteria for the PPP investment must be the economic
and social benefits that will improve the welfare of society.
Because of positive externalities, the economic and social
benefits often outweigh financial profitability; however,
the private sector can only fund projects that are financially
profitable. Public-private partnerships must therefore be financially
viable. Cost-benefit analysis (CBA), the best-known
tool of economic feasibility analysis, deals with aggregate
economic efficiency; however, it does not focus directly on who
pays the bills. It is a tool for identifying the option that
best conforms to the economic goal of maximising benefits net
of costs for society as a whole.
3. Bankability assessment
The PPP assessment should include an assessment of the “bankability” of
any project that will be part or wholly financed by the private
sector. This specifically relates to projects that are expected
to be procured and managed under Design, Build, Operate and
Finance or Concession contracts.
In general, providers of finance for infrastructure projects
will look favourably on projects with the following characteristics:
- Contractual balance: where there is a commercial incentive
for all parties to complete the transaction and deliver
the project throughout its life.
- Bankable cash flows: projects with characteristics that
make them an attractive proposition for debt providers,
possibly lowering the projects cost of financing.
- Security of cash flows: providers will have a preference
for availability based payment mechanisms. They may be
satisfied in some sectors by usage based payments underpinned
by market testing of demand related revenues, or when the
project involves an increase in existing capacity, where
the level of demand is already known.
- Opportunity to innovate: projects where technical innovation
is introduced can significantly reduce a component
of the whole-life cost of the asset.
- Synergies: may be important where the equity provider
is also the operator of complementary facilities.
- Opportunities for financial engineering: which increase
the overall return on equity.
- Appropriate risk transfer: appropriate allocation of
risk between the public and private sector, and between
parties best able to manage the risks, should result
in optimal project pricing.
- Repayment cushion: a reliable net revenue stream in excess
of capital and interest repayment requirements (supported
by sufficient equity/guarantees and loan reserve accounts)
to provide sufficient funds to service debt.
- Sponsor credit: strong performance bonds or completion
guarantees given by the PPP Contractors during the construction
and operation phase, and any mitigation used to enhance
the creditworthiness of the Contractors.
- Vires/legislative framework: very clear legal powers
of the public sector body to enter into the contract
and to pay on termination.
- Technical complexity: a project solution that is based
on proven technology, ease of replacing the operator
and minimal complicating factors such as planning, licensing
or environmental constraints.
- Residual interests: good alternative use value of the
assets, and ease of access for the lender to utilise
- Compensation on termination: the contractual basis for
termination does not provide either party with an incentive
to terminate; however, if the project is aborted a formula
exists for the lenders to step in to solve the problems
or be compensated, and the public sector can meet break
costs on termination.
The conclusions of the bankability assessment will help
to establish the suitability of projects for Design,
Build, Finance and Operate and Concession contracts.
In addition, it will help to identify those issues that
need to be addressed prior to commencing a procurement,
or that need to be reflected in contract documentation.
4. Investment management
The main purpose of investment management is to provide a programme
of further investment development of the company; that programme’s
implementation is expected from successful public and private
participation. All partners should have to commit resources (financial,
human and capital) to increase their interest in seeing the partnership
succeed. The programme should comprise all potential benefits
and opportunities that can be brought from the partnership; hence
performance of the programme of investment requires a careful
and competent approach.