A public-private partnership (PPP) project will involve financing from various sources, in some combination of equity and debt. The ratios of these different contributions will depend on negotiations between the lenders and the shareholders. This section looks at the main sources of financing and the agreement in the financing puzzle that governs the relationship between the different investors, the inter-creditor agreement.
Equity Contributions
Project sponsors are the investors in the project company that are likely to be providing expertise and some of the services to the project company (such as construction or operations services). Sponsor funding is generally through equity contributions in the project company through share capital and other shareholder funds.
Equity holds the lowest priority of the funding contributions in a project, therefore the other contributors (such as lenders) will have the right to project assets and revenues before the equity contributors can obtain any return; or, on termination or insolvency, any repayment. Equity contributions bear the highest risk and therefore potentially receive the highest returns.
Sponsor support may include:
- Shortfall guarantees, where the banks, after enforcing all other security rights, experience a shortfall;
- Buy-down undertakings, a promise to prepay project debt to ensure specified ratios, in certain circumstances;
- Price guarantees, to ensure pricing of off take;
- Market price purchase guarantees, to purchase a minimum quantity of product at market price over a set period;
- Tax loss purchases, where a shareholder agrees to purchase certain tax losses from the project company;
- Technical support, extended warranties and maintenance arrangements; and
- Contingent equity or subordinated debt commitments to cover construction or other price overruns.
Debt Contributions
Debt can be obtained from many sources, including commercial lenders, institutional investors, export credit agencies, bilateral or multilateral organisations, bondholders and sometimes the host country government. Unlike equity contributions, debt contributions have the highest priority amongst the invested funds (e.g. senior debt must be serviced before any other payments are made). Repayment of debt is generally tied to a fixed or floating rate of interest and a programme of periodic payments. The source of debt will have an important influence on the nature of the debt provided. This section will focus on some of the characteristics of project debt.
Bank Guarantees/ Letter of Credit/ Performance Guarantees
Bank guarantees form an important part of project financing, allowing counter-parties immediate access to payment without the cost of locking up cash. Such guarantees may be “on demand” or only payable once the default is proven in court, adjudication or arbitration. A bank issuing a guarantee, letter of credit or performance bond will fix the amount and obtain a counter indemnity from the customer, possibly secured against fixed or floating charges or cash deposits. The issuer will be entitled to convert the counter indemnity payments into loans or demand immediate repayment. The issuers will enter into the intercreditor agreement to ensure sharing of rights over project assets.
Bond/Capital Markets Financing
Bond financing allows the borrower to access debt directly from individuals and institutions, rather than using commercial lenders as intermediaries. The issuer (the borrower) sells the bonds to the investors. The lead manager helps the issuer to market the bonds. A trustee holds rights and acts on behalf of the investors, stopping any one investor from independently declaring a default.
Rating agencies will assess the riskiness of the project, and assign a credit rating to the bonds which will signal to bond purchasers the attractiveness of the investment and the price they should pay. Bond financing generally provides lower borrowing costs, if the credit rating for the project is sufficiently strong. Rating agencies may be consulted when structuring the project to maximise the credit rating for the project.
Mezzanine/Subordinated Contributions
Located somewhere between equity and debt, mezzanine contributions are accorded lower priority than senior debt but higher priority than equity. Examples of mezzanine contributions are subordinated loans and preference shares. Use of mezzanine contributions (which can also be characterised as quasi-equity) will allow the project company to maintain greater levels of debt to equity ratio in the project, although at a higher cost than senior debt. Subordination involves a lender agreeing not to be paid until another lender to the same borrower has been paid, whether in relation to specific project revenues or in the event of insolvency. Subordination can be achieved either by contract or through corporate structuring (where the subordinated lender provides debt to a holding company, which only has access to project revenues or assets once the lenders to the subsidiary company have been satisfied). Contractual subordination may create challenges in some jurisdictions, where subordinated lenders holding funds on trust for senior creditors is not enforceable. Mezzanine financing for project financed transactions can be obtained from shareholders, commercial lenders, institutional investors and bilateral and multilateral organisations.
Inter-creditor Agreement
An inter-creditor agreement will often be entered into by the lenders in order to address key issues between the different sources of financing. Inter-creditor issues include:
- Order of drawdown of funds;
- Coordinating maturity of loans;
- Order of allocation of debt service payments;
- Subordination;
- Holding and acting on security rights;
- Management of drawdowns, insurance funds and technical advisers;
- Exercise of discretions;
- Voting on decisions, e.g. variations of lending agreements, waiver of requirements, accelerate loan, enforce security, terminate hedging arrangements; and
- Management of payments.
