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22| pfi | Middle East Report 2010 Infrastructure

Bidders should be required to demon- strate significant financing commit- ments.

Unrealistic or over-ambitious risk-sharing expecta- tions on behalf of government procurers will eventual- ly prove counterproductive by negatively impacting on developer appetite for the project and thereby reducing the quality of, and competitive tension within, the devel- oper pool.

Furthermore, developers and operators will need remuneration commensurate with the risk by way of increased returns on equity, while financiers may demand additional reserves and increased financing costs – ulti- mately contributing to higher tariff expectations. In the worst case, unrealistic risk-sharing can quash commer- cial interest altogether and/or render a project unbank- able. The ensuing negative perception that the procurer is uncommitted can prove lasting beyond a single proj- ect and set the PPP ambitions back measurably. Third, governments should focus on a robust and transparent tendering process that strikes a balance between sufficient detail to allow a level quantitative and qualitative comparison across bids (considering legal, tech- nical and financial elements) but without being overly pre- scriptive and thus constraining “positive ingenuity”. A well-articulated RFP-package, supported by a suite of financial model bid forms, can aid significantly in this respect.

Fourth, any PPP structure should properly incentivise private sector developers to deliver operational excellence and service consistency over the life of the underlying asset. Procurers should implement clearly defined bonus and deduction regimes against realistic performance benchmarks, as well as rights to review such during the concession period. This will ensure best efforts from private sector devel- opers to optimise operations and maintenance of the proj- ect asset as deviations from the base case will directly affect equity returns. It will also improve the condition of the asset at the end of the concession period, which ultimately increases the asset’s post-concession longevi- ty and therefore residual value efficiencies. Fifth, bidders should be required to demonstrate sig- nificant financing commitments in support of their bids. This mitigates financing risks such as changes in material terms and conditions, or prolonged delays in clos- ing or in the worst case, failure to close, post-selection of a “preferred bidder”.

Procurers and their advisers, therefore, need to care- fully evaluate the robustness of financing proposals with respect to conditionality (soft vs. hard underwriting, market flex, material adverse effect, etc), dependency on refinancing during the concession period, experience of the financiers with regional project finance practice, and the level of engagement from Export Credit Agencies (ECAs), at the time of bid submission.

Regional practice varies widely from no minimum commitment to fully underwritten commitments and

while, prima facie, a fully underwritten, unconditional financing may sound like the obvious solution, such has to be weighed against unnecessarily constraining liq- uidity for a broad competitor pool. No party benefits if one or two bidders lock-up the financing market. We believe a mid-point where 50% of total financing required is committed at bid submission strikes a sensible balance for all stakeholders. Finally, MENA governments should consider whether they want to take direct equity stakes in the project com- panies. Such investments ensure a continuing level of sov- ereign ownership and ostensibly “control” in the project – an important political consideration in many MENA jurisdictions.

Direct equity stakes also create an alignment of inter- ests with private sector developers, thereby contributing to the perception of a “fair deal for all” and underscor- ing what should be a collaborative approach between pro- curers and developers. Government equity stakes can also improve the bankability of infrastructure projects, as com- mercial lenders view such commitments as a mitigant to political risks.

Opening the vault

While PPP models continue to increase in popularity among MENA governments, the question remains whether, in a comparatively liquidity constrained mar- ket, infrastructure projects will be able to capture a suf- ficiently large proportion of liquidity going forward. A snapshot of the current financing market may help to answer this question:

Judging by the volume of closed project finance trans- actions, bank liquidity for regional transactions in the first three-quarters of 2010 has recovered to more than dou- ble the levels in 2009, though it is still well below pre-liq- uidity crunch levels. Average financing amounts per project have stayed remarkably resilient and large proj- ect financings continue to achieve financial close, albeit at higher debt margins. Finally, credit enhancements from ECAs have become key drivers, and often determining success factors, in a number of post-crunch project financings.

Financiers forced to “triage” their balance sheets will naturally gravitate towards projects offering the best risk- return proposition. The generally lower perceived risk inherent in many PPPs implies that infrastructure proj- ects will be well positioned to benefit from the liquidity pick-up in the commercial bank market. Moreover, given that these projects often entail significant civil works, they are well placed to benefit from local currency liquidity from the domestic bank market in order to supplement the traditional international and regional bank financing. The next natural evolution, true capital market liquidity, will come in time, and will initially target brown-field assets providing a conduit for banks to redeploy capital

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