Special Purpose Vehicle (SPV) For Infrastructure Projects Financing Through Public Private Partnerships (PPPs)

In managing and controlling the construction projects, there are two basic features which go hand in hand ‘project management’ and ‘project finance’. In general, most of the people especially engineers are aware of the project management aspects while they do not pay much attention to the project financing. As a result, most of the project failures and project delays arise due to the lack of the reliable financing which is the main blood stream in developing the infrastructure projects.

Project financing in the form of Public Private Partnership (PPP), Asset Backed Securitisation (ABS) are now becoming popular and in some cases a mandatory investment technique. Projects have traditionally relied upon project finance techniques with debt being made available by commercial banks often from financial institutions and/or multilateral financing agencies. But to accumulate loans, long term debt, subordinated or senior debt, equity, quasi-equity against the project is not an easy task. Alternatively, securitisation offers an attractive potential alternative for generating capital to finance the projects. More and more major infrastructure financing are now using securitisation in conjunction with more traditional project finance techniques. Such in the popularity of securitisation, the experts are estimating that it will only take 10 to 15 years for it to replace traditional bank-lending (Project Finance International). Therefore, in light of such estimates, it is imperative to have basic knowledge of public private partnership, securitisation role in the projects by parties involved especially engineers on it.

Typically, creating an SPV allows privately managed infrastructure projects, either at the stage of construction and/or operation, to enjoy most degree of isolation. In most cases the use of an SPV is a requirement imposed on the private agent by the public sector, the financiers, the guarantors or the contractors of the project. The special purpose vehicle (SPV) conceptually can be divided into two as in legal and financial view point. This research is limited to the legal and financial framework analysis of SPV in PPP projects. So, it can be described as special legal purpose vehicle and special financial purpose vehicle.

SPV varies depending on the legal and financial agreements with stakeholders in a project. Moreover, different infrastructure projects have different structure of SPV. For example, Power Purchase Agreement (PPA), telecommunication, gas and oil, mining or even water treatment projects the structure of SPV is quite different and unique. Therefore, no single SPV structure is suitable for all PPP projects.

In project financing, the special purpose vehicle, the consortium or project company what would be it named is the hub and the desired financing depends on its functionality, its linkage to varies participants involved in the project. Mr. Abu Naser Chowdhury conducted a research which objectives is to find the following:

- Comparison of various SPV models used in many worldwide projects to search for essential attributes which strengthen the development of the model
- Investigate the forces in SPV development process and potential solutions on legal and financial framework
- Propose a prototype SPV that can be adaptive for infrastructure projects – a guideline

Conclusions

Project finance transactions in public-private partnership projects are complex contractual arrangements among a number of different parties with different objectives. Such transactions can work only if the needs of the private and public sector can be met in an appropriate manner. Financing is the essential part for all these activities; a special purpose vehicle is formed for this issue. It is true that the financing of infrastructure project depends on the anticipated financial performance of the SPV. A proper financial structure needs to set by the special purpose vehicle not only for tapping funds from lending institutions but also for operation and service for the project itself.

The purpose of studying special purpose vehicle for infrastructure projects financing through public private partnerships is to (1) identify the financial components for the development of SPV (2) the legal framework requirements, and (3) finally, propose a guideline as a decision support tool for special purpose vehicle in infrastructure projects financing. The research is carried out by examining 12 worldwide public-private partnerships projects. The focus is to identify and evaluate various components of special purpose vehicle used in those projects. After that, four IPP and two desalination projects in Asia and Mediterranean Middle East are screened out for in-depth analysis on (1) financial sources and strategies (2) market conditions (3) securities and agreements (4) legal framework and support and (5) credit enhancement. The analysis is taken into the financial and legal issues related to project vehicle. A qualitative research is prepared where the data collection techniques are case studies.

From the analysis, the attributes of project vehicle for infrastructure project financing can be divided into five categories; (1) finance-ability (2) sources of funds (3) securities and agreements (4) sovereign support and (5) credit enhancement. All these five attributes are essentially important for financial and legal risk consideration too.

Finance-ability: It is vital to structure the financial attributes of special purpose vehicle. In this respect the foremost duty is to set and check the finance-ability attributes of the project. The structure is the ‘sell idea’ to attract funds from lending and financial institutions. The analysis reveals that Dabhol project had high financial and legal risks involved in it. In finance-ability category, the rigid ‘hell-or-high water’ agreement, foreign supply contract with absence of performance guarantee, high tariff rate and above all direct negotiation to achieve contract had made the project vehicle risky in all aspects. Paiton 1 project in Indonesia is also suffered in financial ground due to high tariff rate. This happened as the supply contract was costly, no performance guarantee provided by the supplier, had little experience in this business and not at all creditworthy. The Indonesian government did not provide counter guarantee for off-take thought it provided ‘comfort letter’ a sort of payment security.

Sources of funds: In question of sources of fund (if domestic capital market contribution is not significant) the sponsors must consider World Bank as the first and foremost option. The host government can take the world bank’s help for subordinated debt financing mechanism and ensuring partial credit guarantee and/or partial risk guarantee to attract other lending institutions in debt financing for the project. Export credit agencies, bilateral banks are in a better position to compel the government to meets its obligations to the project investors and lenders. The support of ECA is sometimes crucial in the project finance market. These agencies need to be selected carefully according to the risks and mitigation strategy set by the project vehicle because most of the ECAs engage in buying-off the host government which in terns charges high premium from the project.

Securities and Agreements: Securities and agreements need to be transparent, concrete and creditworthy. For developing countries particularly in Asia, the contract awarding process must be ‘competitive’, no matter what the situation exists. It has been found that two projects used direct negotiation as awarding contract were Dabhol and Paiton 1. The direct negotiation of achieving the contract had huge impact of mistrust to the project. Skikda desalination project in Algeria initiated in 2004 where the supplier contract, performance guarantee has not set yet. It is found that the project attracted foreign investors, EPC contractors from Spain, achieved MIGA guarantee but payment security like escrow account and host government payment guarantee has not finalized.

Sovereign Support: Government should step in and provide guarantees to the investors in terms of payment guarantee, comfort letter etc. The performance guarantee and counter guarantee to the central bank for foreign exchange availability and transfer. It is found that in HUBCO project, Pakistan government had extended its sovereign support for successful financial structure of SPV regarding to fund accumulation, guarantees to payment and performance even foreign exchange by the central bank of Pakistan.

Credit Enhancement: Sponsors’ contingency equity support played a big role in credit enhancement in Paiton 1 project, Indonesia. This not only attracted financing by private offshore and export credit agencies but also this helped at the time of restructuring debt mechanism. The subordinated debt mechanism was also acted as credit enhancement in HUBCO and Ashkelon project which was set by these two projects on different mechanism.

Finally, it is found that improper setup of SPV in Dabhol project made Indian Government to renege the project, Paiton 1 in Indonesia to restructure the debt financing repayment after a difficult settlement among the stakeholders. At the end, a prototype SPV is proposed as a decision support tool to the experts, government entities, sponsors and lending institutions which helps as guideline.

Recommendations for the Prototype SPV

The prototype special purpose vehicle has been structured on considering financial and legal attributes. Based on findings from the information of diverse situations, the SPV is been structured on finance-ability, sources of fund, securities and agreements, sovereign support and credit enhancement areas. The applicability of the SPV structure will depend on selecting the attributes suitable on that particular condition of the situation exists. The proposed guideline will help the policy maker of the government sector, project sponsors to foresee the essential attributes governing the financial and legal aspects at the time of structuring the SPV framework.

His thesis abstract is copied and posted.

ABSTRACT

The development of special purpose vehicle (SPV) is essential for successful financial closeout of public-private partnership (PPP) projects. The financing of infrastructure projects depends on the anticipated financial performance of the SPV. Ambitious and improper setup of SPV causes suffering to project, forces restructuring debt mechanism and even bankruptcy to giant companies. Concerted efforts from the government and private sectors, as well as political, legal and financial issues need to deal with for smooth mechanism of SPV. These issues have been identified and evaluated from twelve worldwide infrastructure projects. It is found that different projects used different SPV structure. An Attempted has taken to identify the attributes governing the setup of SPV in those cases. Furthermore, six cases out of twelve in Asia and Mediterranean Middle East are screened out for in-depth analysis on financial strategies, legal framework, contract, securities for the SPV framework. The findings are based on a variety of diverse situations.
Finally, a SPV structure for infrastructure projects in general has been developed, addressing key issues in five areas: (1) finance-ability; (2) sources of funds; (3) securities and agreements; (4) sovereign support; and (5) credit enhancement. The research findings should enable public as well as private sector clients to establish more efficient SPV with respect to financial framework for infrastructure projects.