ASSIGNMENT ON INFRASTRUCTURE DEVELOPMENT(PGPM 14)

Assignment

                        public private partnership refers to arrangements, typically medium to long term, between the public and private sectors whereby some of the services that fall under the responsibilities of the public sector are provided by the private sector, with clear agreement on shared objectives for delivery of public infrastructure and public services. A PPP is generally a contract or agreement to outline the responsibilities of each party and clearly allocate risk. In a BOT arrangement, the private sector designs and builds the infrastructure, finances its construction and owns, operates and maintains it over a period, often as long as 20 or 30 years. This period is referred to as the “concession” period. Such projects provide for the infrastructure to be transferred to the government at the end of the concession period. There are a number of major parties to any BOT project, all of whom have particular reasons to be involved in the project. The contractual arrangements between those parties, and the allocation of risks, can be complex. Explain in detail structuring of BOT projects.

BOT projects are public infrastructure projects which employ a particular form of structured financing.

The involvement of the private sector in the development of infrastructure by way of BOT projects, alternatively called BOO (build-own-operate) or BOT (build-own-operate-transfer) is proving to be a challenging exercise. The lead time of a project is very long, and associated up-front costs are significant. Further, there are a number of complex issues which have yet to be resolved by any of the infrastructure projects settled to date.

Such projects are complex by virtue of the number of parties involved and the corresponding number of contracts, which must all interlock. Furthermore, each party is dependent upon the performance of not only its counterpart, but also the performance of all parties to the project.

BOT projects are generally structured on a project basis requiring all parties to share the risks of the project. Project risk sharing is necessary because the sponsor, a joint venture of one sort or another, will have a limited worth being substantially less than the aggregate net worth of the equity parties.

The developing countries see BOT as a way of reducing public sector borrowings, and at the same time promoting direct foreign investments in their country’s infrastructure or industrial projects.

The examples of the BOT projects are power stations, Toll roads, Toll bridges and even pipeline system for oil and gas. Over the last ten years, there has been an accelerating global trend towards the execution of major infrastructure projects on a privatized basis, it using infrastructure in its broadest sense to encompass civil engineering, energy, telecommunications, process and resources projects. A number of concession based legal structures have been rediscovered or redeveloped as part of this trend, among which the BOT model is the best known.

These changes have been driven by a combination of ideological and economic factors, most prominent among which are the decline of orthodox socialist economic theories and the inability of many countries to finance necessary infrastructure development out of government funds.

The trend towards privatized infrastructure is now well established across a broad range of countries from the emerging economies of Asia to the newly reformed systems within the former soviet bloc and established market economies of Western Europe and North and South America. Within this broad movement towards the private procurement of infrastructure, a number of more specific developments area apparent.

Increasingly, contractors are being asked to assume greater risk by taking equity in the projects, arrange finance for owner and even collect toll fees or operate plants to pay for the project loans. Indeed, it is the commercial and financial considerations rather than the technical elements that are likely to be determinants in a successful proposal for a BOT project. The major objectives of the BOT scheme include:

i.          Development of infrastructure with financing from outside the budget allocation, thereby promoting economic development without recourse to increase in sovereign debt to the Government.

ii.       Risk transfer to private sector and better risk management, by exploring the innovativeness and efficiency of the private sector.

iii.     Creation of new equity, by stimulation of investor interest BOT infrastructure projects.

iv.     Establishment of comparative benchmark, to enable the government to measure and hopeful enhance the efficiency of management of similar projects implemented by government agencies.

Implementation of BOT projects gives rise to a number of issues, which call for detailed consideration in order to ensure the success of BOT projects. While all these issues are important, the overriding consideration should be that a project selected for implementation under the BOT scheme is should when subjected to an economic analysis and that the project is ‘bankable’ with adequate potential returns for the investors. The contractual arrangements should incorporate innovative approaches to protect the public interest yet capitalizing on the private sector initiative, resources and energies.

BOT  is defined as the granting of a concession by the government to a private promoter, known as concessionaire, who is responsible for financing, constructing, operating and maintaining the facility over the concession period before finally transferring the fully operational facility to the government at no cost. In general terms, under the BOT model in common usage worldwide, a government or government entity enters into an agreement with a private sector company under which the company agrees to finance, design and build a facility at its own cost, and is given a concession, usually for a fixed period, to operate that facility and collect tolls or other revenues from its operation before transferring the facility back to the government at the end of the concession period. The intension is that the company is to receive sufficient revenues during the operational phase to service its debt incurred in designing and building the facility; to cover its working capital and maintenance costs; to repay its equity investors; and hopefully, also provide a responsible profit for its investors. In some situations there may be no eventual transfer back to government, full privatization.

Therefore, though BOT projects, a government relocates the risks and rewards in the development of large infrastructure projects to the private sector. BOT is effectively a means of financing the construction of infrastructure and has been referred to as financial engineering.

The five phase of a typical BOT project are pre-investment, implementation, construction, operation and transfer. The roles and responsibilities of the project sponsors at each phase of the project can be as follows:

i.          As consultants to carry out the feasibility study during pre-investment phase and engineering design during the implementation phase.

ii.       As project sponsors to negotiate favorable concession agreements from the government and as project promoters to raise equity and borrow loans during the implementation phase.

iii.     As contractors to built the facility, usually on a fixed price turnkey basis, during the construction phase.

iv.     As operator and owner of the facility, using the project revenues to retire the loans during the operation phase.

Thus the project sponsors usually have to play number of roles in a BOT project. Sometimes this leads to conflict of interest and place them in a paradoxical position.

CHARACTERISTIC OF BOT PROJECTS

Compare to other industrial and commercial developments, there is usually a longer construction period in a BOT project. A long construction period combined with the need to capitalize interest until completion results in high financing costs. The end product will usually have a long usable life, generally measured in tens or even hundreds of years (e.g. a tunnel) and commonly will have relatively low operation and maintenance costs.

Often the investors have a relatively large exposure to project risks. It has been said that a BOT project may be regarded as a high-risk construction project followed by a low risk utility project.

As a result of the long construction period and high financing costs, returns to the investors on the project are very susceptible to delay in the completion of the project. This will influence the form of the construction contract used, with emphasis usually being placed on speed of construction to contain financial incentives for early completion by the contractor. Special features of BOT projects:

i.          The BOT scheme is a very complex and risky exercise, both for the government and the private sector.

ii.       It carries high financing costs compared to public sector funding.

iii.     It involves some trade-offs between the society and private profits.

In a BOT arrangement, the private sector designs and builds the infrastructure, finances its construction and owns, operates and maintains it over a period, often as long as 20 or 30 years. This period is sometimes referred to as the "concession" period.

Traditionally, such projects provide for the infrastructure to be transferred to the government at the end of the concession period.

Most project finance structures are complex. The risks in the project are spread between the various parties; each risk is usually assumed by the party which can most efficiently and cost-effectively control or handle it.

BOT is a type of project financing. The hallmarks of project financing are:

i.           The lenders to the project look primarily at the earnings of the project as the source from which loan repayments will be made. Their credit assessment is based on the project, not on the credit worthiness of the borrowing entity.

ii.       The security taken by the lenders is largely confined to the project assets. As such, project financing is often referred to as "limited recourse" financing because lenders are given only a limited recourse against the borrower.

Once the project's risks are identified, the likelihood of their occurrence assessed and their impact on the project determined, the sponsor must allocate those risks. Briefly, its options are to absorb the risk, lay off the risk with third parties, such as insurers, or allocate the risk among contractors and lenders. The sponsor will be acting, more often than not, on behalf of a sponsor at a time when the equity participants are unknown. Nevertheless, each of the participants in the project must be satisfied with the risk allocation, the creditworthiness of the risk taker and the reward that flows to the party taking the risk. In this respect, each party takes a quasi equity risk in the project.

CONTRACTUAL STRUCTURE OF BOT PROJECTS

There are a number of major parties to any BOT project, all of whom have particular reasons to be involved in the project. The contractual arrangements between those parties, and the allocation of risks, can be complex.

The chart below shows the contractual structure of a typical BOT Project or Concession, including the lending agreements, the shareholder's agreement between the Project company shareholders and the subcontracts of the operating contract and the construction contract, which will typically be between the Project Company and a member of the project company consortium.

Each project will involve some variation of this contractual structure depending on its particular requirements: not all BOT projects will require a guaranteed supply of input, therefore a fuel/ input supply agreement may not be necessary. The payment stream may be in part or completely through tariffs from the general public, rather than from an off take purchaser. This model is useful in considering the parties to a BOT project and their functions, as well as some of the particular considerations commonly encountered in such projects.

THE MAIN PARTIES IN THE BOT MODEL AND CERTAIN OF THEIR FUNCTIONS ARE AS FOLLOWS:

1.             GOVERNMENT

A government department or statutory authority is a pivotal party. It will:

• grant to the sponsor the "concession", that is the right to build, own and operate the facility,
• grant a long term lease of or sell the site to the sponsor
• Often acquire most or all of the service provided by the facility.

The government's co-operation is critical in large projects. It may be required to assist in obtaining the necessary approvals, authorizations and consents for the construction and operation of the project. It may also be required to provide comfort that the agency acquiring services from the facility will be in a position to honors its financial obligations.

The government agency is normally the primary party.

It will initiate the project, conduct the tendering process and evaluation of tenderers, and will grant the sponsor the concession, and where necessary, the off take agreement. The power of a government agency to enter into the documentation associated with an infrastructure project and perform its obligations there under, and the capacity in which that body enters the documents (agent of the Crown or otherwise) is a critical issue. This is examined in detail below.

Examples of the powers required by the authority in a typical BOT project are:

• To contract with another person for that person to carry out one or more of the authority's functions (e.g., the construction and operation of the relevant infrastructure);
• To make payments to that person in consideration of the services provided;
• To resume land and then make that land "available" to that person;
• To lease or sell land to that person together with providing easements and rights of way for access;
• To provide undertakings, indemnities or guarantees to financiers and others in relation to its or other persons' liabilities.

2.            LENDERS

The lenders usually comprise banks and certain other financial institutions who are empowered to lend money or extend credit under relevant legislation. Many considerations will determine the currency of the loans and whether the loans are made available by onshore of offshore lenders. Project expenditure will be largely in the local currency, although a sizeable proportion may be in foreign currencies. For example, many construction materials may be imported and paid for in foreign currency.

The lender is the party, usually a consortium of interested groups (typically including a construction group, an operator, a financing institution, and other various groups) which, in response to the invitation by the Government Department, prepares the proposal to construct, operate, and finance, the particular project.

The lender may take the form of a company, a partnership, a limited partnership, a unit trust or an unincorporated joint venture. The investors in the lender are often referred to as the "equity investors" or the "equity providers". It is not unusual for equity investment to be approximately 20% of the cost of the project. Equity funds are, however, expensive compared to the cost of debt. An equity investor may require a return of 20% to 25% in today's market to compensate it for assuming the major risks inherent in an infrastructure project. As a result it may be cost-efficient for equity to be much less than 20% of the project cost.

The lender may be a company, partnership, a limited partnership, a unit trust, an unincorporated joint venture or a combination of one or more.

3.            PROJECT COMPANY

The project company is usually a single purpose company and is the grantee of the concession. It is responsible for securing finance, procuring the design and construction of the project, the operation of the project during the concession period and the eventual transfer back to government. the project company is also responsible for serving debt incurred in the implementation of the project.

The construction company may also be one of the sponsors. It will take construction and completion risks, that is, the risk of completing the project on time, within budget and to specifications. These can be sizeable risks and the lenders will wish to see a construction company with a balance sheet of sufficient size and strength with access to capital that gives real substance to its completion guarantee.

Often the general design of the infrastructure is dictated by the experienced utility. The construction risk is then taken by the construction company. Further, depending upon the nature of the infrastructure, the commissioning risk is often allocated to the construction company. The sponsor will aim to require the construction company to enter into a fixed price fixed time construction contract.

4.            INVESTORS

There are generally two types of investor in the project company. One type is a project sponsor whose participation in the project is not restricted to their role as investor. Other project sponsor are long term investor whose only interest in the project is as an investment and who will often take little role in the management of the project company.

In a large project there is likely to be a syndicate of banks providing the debt funds to the sponsor. The banks will require a first security over the infrastructure created. The same or different banks will often provide a stand-by loan facility for any cost overruns not covered by the construction contract.

5.            CONSULTANTS

A wide variety of consultants will be involved in BOT projects including financial consultants, engineers and technical consultants, insurance advisers and legal advisors. Merchant banks acting as financial advisers play a large part in structuring BOT projects. The finance advisor should advisor adviser should of should of course be familiar with the host country and its capital market and financial institutions as well as having experience in the area of privatized infrastructure work generally.

BOT project, independent technical consultants are often employed to monitor the works. Often the independent consultants will be employed by the project company but will owe primary duties to the government.

Where the operation of the privatized facility is complex, it is preferable to sub contract the work to an operator with previous experience in the particular area of operations. The government, lenders and investors may prefer the operator to be one of the project sponsors and to be committed as a share holder to the project for a certain minimum period. The project company itself undertakes the operations of the facility.

Users supply the revenue for the project and in the case of bridges, tunnels and highways will often be the toll-paying public. Where the facility has a product, e.g. a power station, the users may be the host government, utility companies or other product purchasers. In these cases, off-take agreements are often negotiated as an essential element of the contractual structure of the overall project. These off-takes agreements will often be on a “take-and-pay” or “take-or-pay” basis.