Tools to Mitigate Risks in Tools to Mitigate Risks in Highway PPPsHighway PPPs

Ellis J. JuanInfrastructure Economics & Finance Department (IEF)

Workshop, PPP in Highways, April 3rd , 2006

Mobilizing Private Capital and Mobilizing Private Capital and Management into Infrastructure Management into Infrastructure DevelopmentDevelopment

IEF, April 2005 2

PC (project completion)

InvestmentInvestment

DebtDebt

EquityEquity

Toll Road PPP : Cash Flow Toll Road PPP : Cash Flow FluctuationsFluctuations (Proxy (Proxy for risk)for risk)

Basic StructureBasic Structure : :

Capital Markets:Capital Markets: Long-Term Financing Long-Term Financing

Cash FlowsCash Flows

US$US$

YearsYears

Repayment of Debt is based on project cash-flows (non-recourse to sponsors) Relatively high initial investments Need for longer debt tenors to justify IRR to sponsors

Repayment of Debt is based on project cash-flows (non-recourse to sponsors) Relatively high initial investments Need for longer debt tenors to justify IRR to sponsors

IEF, April 2005 3

PC (project completion)

Investment

Debt

Equity

Basic StructureBasic Structure : :

Capital Markets:Capital Markets: Long-Term Financing Long-Term Financing

Cash Flows (e)Cash Flows (e)

US$US$

YearsYears

Cash Flows Cash Flows realreal

Risk Mitigation products : Minimize cash flows Risk Mitigation products : Minimize cash flows downward fluctuations (ability to repay principal + downward fluctuations (ability to repay principal + interest)interest)

Key driver: Cash Flow predictability

Toll Road PPP : Cash Flow Toll Road PPP : Cash Flow FluctuationsFluctuations (Proxy for risk (Proxy for risk))

IEF, April 2005 4

Toll Road PPPs : Risk AssessmentToll Road PPPs : Risk Assessment

Completion Risk (engineering & construction cost / time cost control)

Operational Performance Risk (technical & operational know-how)

Environmental Risk (future liabilities, project delays, costs overruns)

Credit Risk (project leverage)

Inflation, interest rate and exchange exchange rate fluctuations rate fluctuations

Political Risk (expropriation, political violence, currency convertibility & transfer)

Regulatory RisksRegulatory Risks. (Government’s default on contractual obligations, i.e., pricing formulas, right of way – land acquisition risk, construction of alternate road, etc. )

Legal Environment (rule of lawrule of law, i.e., judicial system, regulatory procedures and arbitration)

Project Specific Risks (non-Project Specific Risks (non-sovereignsovereign

Country (Economy wide) Risks Country (Economy wide) Risks (sovereign)(sovereign)

Demand (traffic) Risk

Pricing Risk (regulated and non-regulated)

Environmental (past liabilities) Risk

IEF, April 2005 5

Key Stakeholders in the Risk Assessment and Risk Allocation of Toll Roads PPP Finance

Toll Road PPP Finance : Risk StructuringToll Road PPP Finance : Risk Structuring

ProjectCompanyProject

Company

ShareholdersShareholders

Lenders /BondholdersLenders /

Bondholders

OperatorOperator

Construction Contractor

Construction Contractor

GrantingAuthorityGrantingAuthority

Services PurchaserServices Purchaser

Shareholder’s Agreement

Concession Agreement

Purchase Agreement (e.g., shadow toll – government entity)

End-users

Traffic Demand

Construction Contracts

Operation & Maintenance Agreement (O&M)

Authority Right of WayAuthority

Right of WayLand acquisition and further transfer to PPP

IEF, April 2005 6

Toll Road PPP Finance : Risk StructuringToll Road PPP Finance : Risk Structuring

ProjectCompanyProject

Company

ShareholdersShareholders

Lenders /BondholdersLenders /

Bondholders

OperatorOperator

Construction Contractor

Construction Contractor

GrantingAuthorityGrantingAuthority

Services PurchaserServices Purchaser

Shareholder’s Agreement

Concession Agreement

Purchase Agreement (e.g., shadow toll – government entity)

End-users

Traffic Demand

Construction Contracts

Operation & Maintenance Agreement (O&M)

Regulatory RisksRegulatory Risks

Regulatory & Demand Regulatory & Demand RisksRisks

Completion Completion RisksRisks

Performance Performance RisksRisks

FX Risks and FX Risks and Refinancing Refinancing Risks Risks

Political and Macroeconomic Risks Political and Macroeconomic Risks

Authority Right of WayAuthority

Right of Way

Regulatory RisksRegulatory Risks

Land acquisition and further transfer to PPP

IEF, April 2005 7

Toll Road PPP Finance : Risk Mitigation Toll Road PPP Finance : Risk Mitigation

Non-sovereign Sovereign

Completion Risk

Performance Risk

Environmental Risk

Demand Risk

Political Risk

Regulatory Risk (inc.

Land Acquisitio

n Risk)

Macroeconomic Risk

Cost overruns and delays.

Revenue generation and operational costs increase

Hidden liabilities

Revenue generation

Expropriation, transfer, convertibility Cease of revenue generation

Revenue generation. Tariff Adjustment; Right of Way, Termination payment

Revenue generation. Devaluation / inflation impact of cash flows

High Low Low High Low High High

EPC Contract and performance bonds

Performance based contracts

Environmental Assessment

Traffic Minimum Revenue Guarantees / VPN ConcessionPartial Credit Guarantees

Political Risk Insurance

Concession Contract Partial Risk Guarantees

Local currency financing

Private Private Private Private/Public

Private /Public

Public N.D.

Risks

Cash Flow effect

Impact

Risk Mitigation Instrument

Provider

IEF, April 2005 8

Demand and Tariff Risk: Rolling GuaranteeDemand and Tariff Risk: Rolling Guarantee

Rolling Guarantee

• A partial credit enhancement product providing a guarantee of a specified number of interest and/or principal payments, on a rolling forward basis – i.e. the guarantee rolls forward to the next installment date automatically (if no claim has taken place) or upon payment by the issuer of a previous claim -- so that the guarantee covers a rising share of remaining debt service.

• For a toll road project where investors perceive a potential risk associated with a variation in the debt service coverage due to slow traffic, delays on tariff adjustments or both at some point within the overall bond tenor, or are uneasy about a period of heavy investments (i.e., rehabilitation), the rolling guarantee will smooth out the repayment profile and reduce investor concerns about potential timing/cash flow issues.

IEF, April 2005 9

Debt / Service

Coverage Ratio

1.51.5

1.01.0

Outstanding Principal

Years

N N + I

Rolling Guarantee

DSCRDSCR

Demand and Tariff Risk: Rolling GuaranteeDemand and Tariff Risk: Rolling Guarantee

N + 2

IEF, April 2005 10

Demand and Tariff Risk: PCG + MonolinerDemand and Tariff Risk: PCG + Monoliner

Traffic MinimumRevenue Guarantee(Granting Authority)

Traffic MinimumRevenue Guarantee(Granting Authority)

Layer of Lower Credit Risk Quality

(PCG)

Layer of Lower Credit Risk Quality

(PCG)

Partial Credit Partial Credit Guarantee Guarantee MLAMLA

(a portion of the credit loss on the transaction, -- debt service)

Future Flows Securitization of Tolls

Mitigation of the lower credit risk quality and improving the transaction rating attracts participation of Monoline Monoline Insurers to provide a Insurers to provide a “wrap”“wrap” on the whole transaction, improving further the transaction credit rating.

BBB Credit Rating

AAA Credit Rating

IEF, April 2005 11

Financial MarketsFinancial Markets

Risk Mitigation Providers Risk Mitigation Providers

Multilateral Development Banks and Donors (Aid, lending and guarantees) Export Credit Agencies (ECAs) Private Insurance & Guarantors

Political Risk Insurance Financial Guarantee providers (i.e., monoliners, specialized risk support) Derivatives

Cross-border Debt MarketsCross-border Debt Markets Global Financial Markets Driven by risk & return balance Highly sensitive to political –economic

volatility (i.e., financial crisis 1997-2001) Bank markets : have not quite return to

developing countries infrastructure finance Capital markets : depth and liquidity. Risk

& return oriented (new participants). Volatile.

Local Currency Debt MarketsLocal Currency Debt Markets Domestic savings capacities Bank Markets. Short-term nature. Depth

and liquidity dependent upon financial sector reform and competition.

Capital markets. Depth and liquidity dependent upon social and safety net reform (pensions, insurance, etc.) and adequate securities regulatory framework

IEF, April 2005 12

WBG: Risk Mitigation Framework

SovereignRisks

Investors / Financial Institutions

Non – SovereignRisks

IFC

• Partial Credit Guarantees

• Hedging Products

• Risk sharing facility

• Securitization

• Investment Guarantee

MIGA IBRD / IDA

• IBRD / IDA Partial Risk Guarantees

• IBRD Enclave Guarantee

• Partial Credit Guarantee

• Policy Based Guarantee

World Bank Risk Mitigation Instruments

IEF, April 2005 13

IFC MIGA IBRD/IDA

Products Partial Credit GuaranteesHedges for clients (interest rate, currency and commodity swaps)

Non-commercial political risk insurance

PRG – IBRD & IDAPCG & PBG – IBRD Only

Clients Private sector investors, lenders for private sector projects

Private sector investors, lenders for private projects

Private lenders for public projects

Loans Yes Yes Yes

Equity (Quasi-Equity)

Yes Yes No

Coverage (Risk) Full and timely payment of principal and/or interest up to a specified amount - IFC covers all risks that may result in non-payment of a client’s obligations.

•Currency convertibility and transferability•Expropriation •War and Civil Disturbance (incl. terrorism and sabotage)•Breach of Contract

Government contractualObligations including:• Currency convertibility and

transferability• Expropriation• Political Violence• Breach of Contract • Regulatory • Subsidy payment (e.g. OBA)

Guaranteed Percentage

Determined on a case by case basis (credit risk driven).

Debt: up to 95% Equity: up to 90%

Up to 100% of a tranche

Comparison of World Bank Group Risk Mitigation Instruments

IEF, April 2005 14

Comparison of World Bank Group Risk Mitigation Instruments [Contd.]

IFC MIGA IBRD/IDA

Eligibility Must be a member country Must be a member country Must be a member country

Tenors Market based but IFC’s involvement can lengthen tenors

Up to 15 years (20 years in some cases)

Market based

Limits Based on client’s needs Project: up to $110mm (net)Country: up to $420mm (net)

Based on project and country needs and CAS allocation.

Priority Areas of Focus All IFC recipient member countries.Providing long-term local currency financing and development of domestic capital markets.

•  Africa•  IDA eligible countries•  South-South investments•  SMEs

• Infrastructure• IDA eligible countries

Government Counter Guarantee

No No (through the MIGA Convention)

Yes – for IDA in the event borrower is not the sovereign,

a sovereign guarantee may not be required.

Public Sector Projects No No Yes

Areas of Collaboration Joint project preparation, environmental analysis, Board processing, etc.