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Financing Infrastructure Projects An Analysis of Issues and Cases… Presentation Structure Project Finance Transactions Issues in Infrastructure Finance Case Studies 2 IDFC : A Summary Who We Are… We Weare areaaspecialty specialtyfinancial financialinstitution institutionfocused focusedonly onlyon oninfrastructure infrastructurefunding funding Established by the GoI in 1997 Lead private capital to commercially viable infrastructure projects; promote public-private partnerships Bring innovation to private financing in Indian infrastructure Provide policy advice to encourage private financing in infrastructure With Withaabalance balancesheet sheetsize sizeininexcess excessof ofRs. Rs.17,000 17,000Crore, Crore,and andNIL NILNPAs, NPAs,IDFC IDFCranks ranksamongst amongstthe the largest financial institutions focused on financing Indian infrastructure largest financial institutions focused on financing Indian infrastructure 4 Project Finance Transactions ‘Financing a Project’ Project Finance doesn’t mean ‘financing a project’! 6 ‘Financing a Project’ …2 How does Joe Blo Inc. finance a chemical factory? Debt Repayment Joe Blo Inc. Lenders Equity Debt Equity Returns ChemFac 7 ‘Financing a Project’ …3 Such financing is also called: – Balance Sheet Financing, or – Recourse Financing Here the project ‘Lenders’ have a low level of due-diligence on the project itself, but a high level of due diligence on Joe Blo Inc.! 8 ‘Project Finance’ How does Joe Blo Inc. finance an airport? Joe Blo Inc. Other Equity Investors Lenders Equity Debt Repayment Equity Returns Other Lenders/ Bondholders Debt Airport 9 Project Finance Defined “Raising of funds to finance an economically separable capital investment project in which the providers of funds look primarily to cash flow from the project to service their debt and provide returns on their equity” 10 Emergence of Project Financing: Appropriate techniques for projects with high capital requirements and a complex risk profile Payouts are based only on the projects’ own assets and cash flows stream Creditors rely on the ability of the project for repayment of related debt obligations, nonrecourse debt Multi-source financing: syndicated commercial banks, bonds, ECAs, multilaterals 11 Why Project Finance? Isolate ‘Risk’ Project ‘Transparency’ Greater ‘Leverage’ Control/ Ownership issues 12 Characteristics of Project Finance Complex contractual arrangements Limited or non-recourse financing Risk management strategies and techniques Changing perceptions, new innovations 13 Demand Supply Gap Annual investment needs in Urban Infrastructure alone are about Rs. 400 billion* as against an availability of Rs. 50 billion, (excluding new mass transit and township development projects) *give or take a few hundred billion! 14 Equity Sponsor/ Corporate Equity Funds Financial Institutions Multi-lateral Institutions World Bank, IFC Public 15 Debt Banks FIs Debt Funds Multilateral Institutions World Bank, ADB, IADB Export Credit Agencies (ECA) Public 16 Principles of Risk Management Allocate project-specific risks to parties best able to bear them Control performance risks through incentive contracts Use market-hedging instruments (derivatives) for covering market-wide risks (interest and exchange rate fluctuations) 17 Risk Management 18 Risk Management 19 20 Oh What A Web! Concession Agreement State Support Agreement Government & Project SPV Government & Project SPV SHA Equity Investors Loan Agreements DLA/ Substitution Lenders & Project SPV Lenders, Government Equity Investment Agreements With Pvt Equity Investors Inter-Creditor Agreements Inter-se the Lenders Pledges & Hypothecations Lenders & Promoters Construction/O&M Contracts Project SPV, Promoters, Site Lease Agreement Project SPV & Land Owner Project SPV & Contractors/ Operators Bank Guarantees etc TRA Agreement Trustee Bank, SPV, Lenders 21 Issues in Infrastructure Finance Service Provision Options Infrastructure Services Status Quo: Govt creates assets & provides services Privatization: Private Sector creates assets & provides services PPP/ PFPI Commercialization : Govt creates assets & hands over to Pvt Sector to provide services 23 How Much Time Did They Take? Airports: Started in 1998-99 Bidder identified in 2001 SHA in 2002 Concession/ FC in 2005 24 How Much Time…(2) (Industrial) Water Supply: Started in 1995-96 Bidder identified in 1997 Concession in 2003 FC in 2004 25 How Much Time…(3) Commercial Complex: Started in May 2002 Bidder identified in June 2004 Government approval June 2005 Concession/ FC just now… SEZ: Started in 2002 Bidder identified in 2003 Approvals not yet in place… 26 How Much Time…(4) Industrial Roads Started in 2002 Bidder identified in 2005 Concession/ FC just now… 27 How Much Time…(5) How many large (> Rs. 500 Cr) projects have reached financial closure, and work commenced Last 8-10 years of PPP 4 Airports 1 Water supply project Number of Road (NHAI/ MORTH only) Number of Telecom/ Power Projects And how many are completed In round figures – none Except in Roads, Telecom, Power 28 Why are the projects delayed? Possible Reasons? Finance Inadequate Project Development Hasten to bid? Approval structures/ processes not being in place Plug-and-play approach? Social/ Environmental reasons LAND 29 Then why PPP? PPP Projects Take more time, more effort, and are also – prima-facie – more cost BUT Shortage of budgetary funds Improvement in levels of service to users Innovation in designs, project management and implementation of projects Long-term operations and maintenance of assets Focus on service to users – not just asset creation 30 Are Funds an Issue? Yes and No YES Project Development Funds Equity Debt in Urban Infra (water, city roads, metro transport projects, sanitation, solid waste) NO Commercial debt (sectors other than mentioned above) 31 Inadequate Project Development Hasten to set up project/ bid Bidders/ lenders then start asking for data/ studies Thin slice method to get all the DPRs done Re(negotiation) of project and contract parameters along the way 32 Approval Process/ Structures Once the bidder is identified: Land, Environmental Clearances Cabinet approvals Searching for consensus Legislative/ legal amendments required Searching for sources of Government funds/ equity/ grants User unwillingness to pay 33 Approval Process/ Structures… (2) Since there are no replicable frameworks Each project is a “stand-alone” experiment Rarely is precedent used. Bangalore and Hyderabad airports are rare instances of projects using precedent Infra Acts/ Polices have enough flexibility to… Enable frequent by-pass of their intent! Transparency conditions are applied regardless of whether they are regular “Contracts” or BOT Projects 34 Key Lessons - Roads Bypasses on national highways and river bridges have demonstrated reasonable success Common sense approach to traffic forecasting along with statistical analysis Emphasis on getting base year traffic right Small state highway projects have also done well in states such as Maharashtra, MP Developed by local promoter groups with a strong ‘ears to the ground’ philosophy Certain large projects such have not been able to generate the expected numbers in the early years High project cost, competing routes, service roads, higher growth rate expectations being the primary reasons 35 Key Lessons - Telecom Limited mobility not sustainable leading to migration to full mobility. Mass-market model for the sector (based on high penetration and low ARPUs). Consolidation in the sector. 36 Key Lessons - Power It is essential to first fix the ‘leaky bucket’ Competitiveness of tariff essential to ensure viability of a generation project. Retail tariffs to ultimately mirror the cost of supply. Factors to attract private sector participation in the sector: Regulatory confidence longer term regulatory tariff regime (“No Moving Goal Post”) Legal and Administration support Government to disconnect consumers Government credit risk mitigation appropriate mechanism for delivery of subsidy to be developed Credible business plan to meet transition period funding requirements past unfunded liabilities to be taken over by Government Credible base line data freedom and support from 37 Key Lessons - Urban It is essential to first fix the ‘leaky bucket’ User charge regime has to come into place - tariffs to ultimately mirror the cost of supply Subsidy to be explicit Large governance issues to be addressed Factors to attract private sector participation in the sector: Regulators to be in place Ring-fenced ULB revenues Legal and Administration support Government to disconnect consumers Government credit risk mitigation appropriate mechanism for delivery of subsidy to be developed Credible base line data freedom and support from 38 Way Forward…? Not to rush into a Project bid/ implement approach Get frameworks/ approvals/ funds in place before doing so Capacity building and reform should go ahead Now there is enough project experience/ expertise to set up a “precedent” basis Adequate project preparation Funding required to do so Not too many “money bags” waiting to invest into infrastructure… 39 Way Forward… Small Number Of Profitable Projects BOT Larger Number Of Marginally Profitable Projects Govt. ‘Leveraged’ Privatisation (2) Unprofitable, But Imperative Projects Budgetary Allocation Maintenance Works Dedicated Funds (Road Fund) 40 Concept of PFPI Traditional Approach Asset creation funded through government borrowings Service provision and maintenance of assets by public sector PFI Approach Asset creation funded by private finance Service provision and maintenance of assets by private sector Fundamental Tenets Value for Money Risk Transfer to Private Sector 41 What PFPI is not .. What it is (1) PFPI is not privatisation or disinvestment PFPI is not about borrowing money from the private sector PFPI is more about creating a structure in which greater value for money is achieved for services through private sector innovation and management skills delivering significant improvement in service efficiency levels 42 What PFPI is not .. What it is (2) This means that Government no longer builds roads, it purchases miles of maintained highway no longer builds hospitals, it buys health services no longer buys computers and software, but pays for managed IT services 43 Case Studies Experiences in Project Finance An Airport Project EU grant Airport Development Fund 18% Total Cost, 2.1 Mio Euro HERMESsecured loan 10% 15% 35 percent 6% 2% Equity capital Subordinated loan 65 percent approx. 50% EIB loan 45 A Road Project 46 Case Study - Waste to Energy… 47 Case Studies - 12 Garbage to Gold Easy for any self-respecting alchemist?! Technically superior, but also more expensive Can the returns (financial or economic) justify the higher costs? Obviously cannot be termed as the costequivalent of a regular power plant 48 Case Study - The SWERF Project at Lucknow Project to generate about 5 MW of power from MSW Project to offer a MSW Management solution to the city About 1000 TPD; of this about 750-800 Tons lifted the same day Projected population of 25 lac in 2001 Present disposal practices are far from being sanitary Waste composition would be heterogeneous in most respects Project had its Award process satisfactory LoI issued on August 1996 thro’ competitive bidding Waste Supply Agreement in Feb 1997, PPA signed on July 1998, Land Lease agreement in March 1999, GoUP Guarantee in Feb 2000 Project enjoyed the commitment of its Stakeholders the LNN, UPPCL, MNES, local community, Pollution Control Board etc. 49 Case Study - Structuring The Project Financial closure achieved through tie-up of Equity (Rs 20.00 crs); Senior Debt (Rs 26.50 crs); Deferred Credit (Rs 11.50 crs);Capital Subsidy (Rs 15.00 crs) Contractual structure completed thro’ execution of Waste Supply Agreement by LNN Power Purchase Agreement with UPPCL Equipment Supply & Know-how provision agreements with Entec/ IUT/ Janbacher EPC arrangements with Jurong/ Jeevitha/ L&T O&M arrangements with Haustle Commercial tightness ensured thro’ provisions of Contracts - Defect Liability provisions, Financial G’tee backed performance, & LD’s Offtake agreement - LC’s and Government Guarantee 50 Thank You… 51 [...]...Emergence of Project Financing: Appropriate techniques for projects with high capital requirements and a complex risk profile Payouts are based only on the projects own assets and cash flows stream Creditors rely on the ability of the project for repayment of related debt obligations, nonrecourse debt Multi-source financing: syndicated commercial banks, bonds, ECAs,... Complex contractual arrangements Limited or non-recourse financing Risk management strategies and techniques Changing perceptions, new innovations 13 Demand Supply Gap Annual investment needs in Urban Infrastructure alone are about Rs 400 billion* as against an availability of Rs 50 billion, (excluding new mass transit and township development projects) *give or take a few hundred billion! 14 Equity... just now… 27 How Much Time…(5) How many large (> Rs 500 Cr) projects have reached financial closure, and work commenced Last 8-10 years of PPP 4 Airports 1 Water supply project Number of Road (NHAI/ MORTH only) Number of Telecom/ Power Projects And how many are completed In round figures – none Except in Roads, Telecom, Power 28 Why are the projects delayed? Possible Reasons? Finance Inadequate Project... Project SPV, Promoters, Site Lease Agreement Project SPV & Land Owner Project SPV & Contractors/ Operators Bank Guarantees etc TRA Agreement Trustee Bank, SPV, Lenders 21 Issues in Infrastructure Finance Service Provision Options Infrastructure Services Status Quo: Govt creates assets & provides services Privatization: Private Sector creates assets & provides services PPP/ PFPI Commercialization : Govt... being in place Plug-and-play approach? Social/ Environmental reasons LAND 29 Then why PPP? PPP Projects Take more time, more effort, and are also – prima-facie – more cost BUT Shortage of budgetary funds Improvement in levels of service to users Innovation in designs, project management and implementation of projects Long-term operations and maintenance of assets Focus on service to users – not just... “stand-alone” experiment Rarely is precedent used Bangalore and Hyderabad airports are rare instances of projects using precedent Infra Acts/ Polices have enough flexibility to… Enable frequent by-pass of their intent! Transparency conditions are applied regardless of whether they are regular “Contracts” or BOT Projects 34 Key Lessons - Roads Bypasses on national highways and river bridges have demonstrated... traffic forecasting along with statistical analysis Emphasis on getting base year traffic right Small state highway projects have also done well in states such as Maharashtra, MP Developed by local promoter groups with a strong ‘ears to the ground’ philosophy Certain large projects such have not been able to generate the expected numbers in the early years High project cost, competing routes,... maintenance of assets Focus on service to users – not just asset creation 30 Are Funds an Issue? Yes and No YES Project Development Funds Equity Debt in Urban Infra (water, city roads, metro transport projects, sanitation, solid waste) NO Commercial debt (sectors other than mentioned above) 31 Inadequate Project Development Hasten to set up project/ bid Bidders/ lenders then start asking for data/ studies ... viable infrastructure projects; promote public-private partnerships Bring innovation to private financing in Indian infrastructure Provide policy advice to encourage private financing in infrastructure. .. on financing Indian infrastructure largest financial institutions focused on financing Indian infrastructure Project Finance Transactions Financing a Project’ Project Finance doesn’t mean financing. .. into infrastructure 39 Way Forward… Small Number Of Profitable Projects BOT Larger Number Of Marginally Profitable Projects Govt ‘Leveraged’ Privatisation (2) Unprofitable, But Imperative Projects