Municipal borrowers explore the PPP option

  • 21 May 2008
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It has taken some time but at last parts of western Europe appear to be embracing the public-private partnership model that the UK developed almost two decades ago. Germany, Spain and France are beginning to the see the benefits of PPPs but the potential of central and eastern Europe is also encouraging.

Until very recently, the market for public-private partnerships (PPP) in Europe has been dominated by the UK.

According to PriceWaterhouseCoopers, between January 1994 and September 2005, PPP deals worth about Eu100bn closed in Europe, around two-thirds of which were in the UK, with Spain and Portugal accounting for a further 9%-10% each.

The UK’s dominance is now being diminished. "We recently had a partner meeting in Paris to discuss prospects for European PPP where we went through the outlook for the market on a country-by-country and sector-by-sector basis," says Anthony Fine, partner in the energy, infrastructure, project and asset finance group at White & Case in London. "The conclusion was that although the UK will remain the dominant market for the foreseeable future, we will see a lot more activity in western Europe and in a number of emerging markets."

That view is confirmed by other participants. "The UK model is at last establishing itself outside the UK as one of the preferred ways for municipals and local governments to look at procurement," says Nick Beretta, a director in the infrastructure advisory team at Deloitte in London and a former banker who worked at UBS and Mediocredito.

"This is part of the broader reform of public sector procurement practices which used to be driven purely by budgetary considerations, but is now being shaped by the pursuit of enhanced efficiencies and improvements in public sector risk management."

PPP-philes certainly have some wonderful data to back up their argument. A study published by the UK’s National Audit Office in 2003, for example, reported that 73% of non-private finance initiative construction projects came in over budget, while 70% were delivered late. By contrast, only 22% of PFI projects had exceeded their budget and 24% were delivered late.

Experience in other markets tells a similar story. According to a recent report published by Deloitte, "in the United States, the cost of completing construction for segments of the Denver E-470 toll road that used a PPP approach came in $189m below the original cost estimate of $597m.

Efficiencies aside, PPP has been seen as an attractive option for governments eager to keep infrastructure-related debt off balance sheet. For the time being, the Eurostat definition of PPP qualifying for off-balance sheet treatment is "any contractual agreement between a public authority and a private entity whereby the construction risk and the performance risk or demand risk is transferred to the private sector."

Eurostat’s treatment of PPP prompts mixed feelings among industry experts. "For those countries where Maastricht is an issue, PPP is certainly an attractive option because under Eurostat rules these deals are generally treated as being off-balance sheet," says Tim Stone, chairman of KPMG’s global infrastructure and projects group and a non-executive board member of the European Investment Bank. "But the UK Treasury has always rightly taken the view that PPP projects should be supported on value-for-money grounds."

It is a mistake to over-emphasise the importance of Maastricht as a motivating force for PPP. After all, PPP was enthusiastically embraced in regions as far removed from the Maastricht guidelines as Australia and Canada long before many EU countries warmed to the idea.


Western Europe warms to PPP

It is in the core markets of western Europe, however, that bankers and analysts are most optimistic about PPP. Philippe Tromp, managing director, Europe and Australia at Financial Security Assurance (FSA) in London, points to the example of France as a market that is warming to PPP.

"PPP started quite modestly in social infrastructure projects, but all of a sudden it has taken off," he says. "Major infrastructure projects such as high speed rail networks, which in the past would have been completely financed by the state or through state-owned companies like SNCF or RFF, are a very clear example of an area where France is moving towards concession financing with transfer of traffic risk to the private sector."

The potential of PPP in France was confirmed in an update published by Standard & Poor’s in its Infrastructure Finance Outlook for February/March 2008. This reports that since the Contrat de Partenariat Public Privé was introduced in France in 2004, 130 projects have been launched. This, says S&P, only amounts to about 12 contracts with a total investment value at the end of 2007 of Eu2.5bn, compared with signed projects worth Eu66bn in the UK. But as the report adds, President Sarkozy has "required the 2004 PPP contract format to be amended with the intention of reinvigorating growth and modernising public infrastructure through increased recourse to PPP."

Germany, too, is starting to find the PPP model appealing, with Finance Minister Peer Steinbrück having publicly declared that the country is aiming for 15% of its public investment to be supported by PPP structuring.

In 2006, the groundbreaking Eu300m Essen Proton Therapy Centre financing, led by Deutsche Bank and Fortis, reached financial close. This project provides for the design, construction, financing and maintenance of a proton therapy centre for the treatment of cancer. Law firm White & Case, which served as legal counsel to the banks leading the deal, says that the Proton financing was a first on a number of counts — such as the first German PPP with an investment over Eu100m.

Before the Essen transaction, however, White & Case had also advised on a Eu350m Landkreis Offenbach schools facilities management project. "The provision of school teaching is the responsibility of the state and can not be privatised, but the maintenance of school buildings is an area that can be transferred to the private sector," says Antje Mattfeld, a partner at White & Case in Hamburg.

Public-private partnerships have has also made a successful breakthrough as a method of financing road developments in Germany, with the first project of its kind — the Eu230m widening of the A8 motorway between Augsburg and Munich — reaching financial close in April 2007.

More recently, in October 2007, the EIB announced that it was lending nearly Eu90m to support the construction and servicing of the A4 motorway in Thüringen, which is the first PPP project directly financed by the bank in Germany.


Spain, Russia see the light

In Spain, meanwhile, PPP is becoming an increasingly important mechanism for underpinning new and upgraded infrastructure. "At both the central and local government level there is a massive programme for investment in infrastructure," says Jesus Gonzalez Torrijos, director of infrastructure finance at BBVA in Madrid. "At the central government level the government has publicly announced that private finance should contribute 40% to the total infrastructure budget. And at the local government level, the contribution of PPP is increasing constantly."

"The other key development in Spain is that PPP is spreading to many more sectors," adds Torrijos. "Previously, PPP only played a significant role in road and light railway projects. Now we are starting to see PPP in areas like justice, defence, education, health, sport and leisure. So we are following the UK model where PPP has been applied to all sectors of the economy."

Russia has also identified PPP as a promising mechanism for rehabilitating its crumbling infrastructure.

The passing in July 2005 of the Law on Concession Agreements paved the way for the more widespread application of PPPs in Russia, with the $3bn St Petersburg Western High Speed Diameter ring road project generally seen as a key prototype for the financing mechanism. The first phase of this project is due to open by the end of 2008, with the entire construction scheduled for completion by 2011, after which the ring road will operate as a toll facility for 30 years.

The potential of Russia has not gone unnoticed among the world’s most prolific infrastructure investors. In August 2007, Macquarie Bank and Renaissance Capital announced an infrastructure advisory and fund management joint venture in Russia and other CIS countries.

At the time of the launch, Renaissance announced that "it is estimated that up to $200bn will be spent on infrastructure in Russia over the next five years or so, excluding the oil and gas sector. While the government will provide most of the funding, there is an expectation that the private sector will support this development with the additional funding required."

Perhaps. But some observers are dubious about the immediate prospects for private sector investment in the Russian infrastructure sector. "Russia has interesting potential, but it is hard to see private sector investors committing long term finance to the market yet," says Deloitte’s Beretta. "The view from the investor world is quite clear on Russia: it’s a great market with plenty of projects, but the recent progress in the domestic financial market is still at an early stage."


Caution in CEE

There is good reason to be cautious about the outlook for PPP in the more emerging regions of Europe, where there have been plenty of false dawns.

That track record makes a number of observers sceptical about the outlook for PPP deals in central Europe.

"With one or two exceptions, such as Hungary, many governments in central and eastern Europe don’t have the resources to execute widespread PPP programmes," says Michael Dinham, managing director of the infrastructure finance group at ING in London, which has advised on big-ticket infrastructure projects throughout the region. "Sometimes there are legislative obstacles, sometimes there are planning obstacles, and sometimes there are political obstacles created by politicians who still don’t like the idea of private sector involvement in infrastructure."

Bankers insist that in the grand scheme of things, short term conditions in the global banking system ought not to have a negative effect on the economics of PPP. "I don’t believe that the credit crunch is having or should have a material impact on the PPP market, which is all about the provision of essential public infrastructure," says Dinham. "These are long term projects of 30 years or more and because they serve such an important socio-economic function they should not be affected by short term fluctuations in the financial market."

Social necessity aside, Dinham says that from a practical perspective the current upheavals in the global financial system ought not to have a prohibitive effect on the financing costs of infrastructure projects. "If you take a typical PPP project anywhere in the world, and double the lending margins charged by financiers, the overall pricing impact for governments is still fairly marginal.

"Most PPPs are structured so that the government does not start making payments until the asset is delivered, which can be several years down the line. When the government does start making payments, a proportion covers the operating costs of the asset and a proportion covers the debt and equity finance.

"So the debt financing costs may be less than half of the total, and most of that will be principal repayment rather than interest. So if Euribor is 5% and the margin on the debt is 1%, which rises to, say, 1.5% in the credit crunch, the incremental cost impact for the project as a whole is still very low, perhaps only 1% or 2%."
  • 21 May 2008

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