Tim C. Meaney DZ BANK AG Hong Kong Project Finance

1. PPP Project Financing The Role of Direct Agreements in a PPP Project 30th September 2005 Tim C. Meaney DZ BANK AG Hong Kong Project Finance

2. 2 1 3 7 8 4 6 5 DZ BANK Hong Kong Branch - 30 September, 2005 Agenda The Role of Direct Agreements in a PPP Project • What is a Direct Agreement? • Structural Presentation of a Direct Agreement • Purposes of Direct Agreements • Benefits of Direct Agreements • Who Provides Direct Agreements • Issues with Direct Agreements • Conclusions • Contact Information

3. DZ BANK Hong Kong Branch - 30 September, 2005 1) What is a Direct Agreement? • An agreement between individual Project Parties each of which is a contracting party with the PPP Concession Company (the “SPV”) and the Senior Lenders to the SPV. • The objective of the Direct Agreements is to establish certain legal rights which apply when the relevant contract is threatened with termination - typically by the action or inaction of the SPV. • The Direct Agreement does not transfer obligations to Lenders unless Lenders exercise their rights.

4. DZ BANK Hong Kong Branch - 30 September, 2005 2) Structural Presentation of a Direct Agreement • PPP Project - Typical Transaction Structure (simple form) Government Authority Provision of Services Service Fee Payment Fixed Time / Fixed Price D+C Contract Sub-contractors D+C Contractor PPP Project Company (special purpose vehicle or “SPV”) Insurers Construction Costs Operation Fee Services Provider Sub-contractors PPP Services 5% - 10% 90% -95% Equity Debt Investors LENDERS

5. DZ BANK Hong Kong Branch - 30 September, 2005 2) Structural Presentation of a Direct Agreement (cont.) • PPP Project - Typical Transaction Structure (simple form) • Location of Primary Direct Agreements: Government Authority Sub-contractors D+C Contractor Insurers PPP Project Company (“SPV”) Services Provider Sub-contractors Equity Debt Investors LENDERS

6. DZ BANK Hong Kong Branch - 30 September, 2005 3) Purposes of Direct Agreements • The purpose of a Direct Agreement is to provide rights to Lenders which may permit the prevention of termination of key project contracts executed between the SPV and other Project Parties without Senior Lenders having the opportunity to consider whether to preserve the contracts by “stepping in” and curing the underlying termination event where the SPV has failed or elected not to do so. • The rationale for Lenders having such rights goes back to a fundamental principle in limited recourse or project financing:

7. DZ BANK Hong Kong Branch - 30 September, 2005 3) Purposes of Direct Agreements (cont.) • The Lenders‘ primary source of repayment within a limited recourse project financing are funds generated by the Project itself and directed through the SPV. • To the extent that the SPV has insufficient funds to repay the banks, then these banks may enforce and exercise their security interest over the SPV assets. The key assets of the SPV are not the physical assets but the contractual agreements which form the basis of the PPP Project arrangements. Hence the need for Direct Agreements.

8. DZ BANK Hong Kong Branch - 30 September, 2005 4) Benefits of Direct Agreements • The key benefit of a Direct Agreement is in providing Lenders with an opportunity to revive the Project after a default caused by the SPV under the relevant Project Contract which remains uncured. • How is this achieved? • The Direct Agreement grants Lenders “Step In” Rights i.e. the ability to “step in to the shoes of the SPV” to; • i) Cure the underlying Event of Default • ii) Manage the Project for the Duration of the “Step In” Period

9. DZ BANK Hong Kong Branch - 30 September, 2005 4) Benefits of Direct Agreements (cont.) • Step In is undertaken by a Receiver or a “Designated Party”. • Step In involves the assumption of joint and several liability with the SPV during the Step In Period. • Lenders seek to “cap” i.e. limit this liability

10. DZ BANK Hong Kong Branch - 30 September, 2005 5) Who Provides Direct Agreements? • Direct Agreements can be established with a range of contracted Project Parties. For the purposes of this Presentation the key parties for Lenders with whom the impact of the Direct Agreement will be discussed are: • 1) The EPC / D&C Contractor • 2) The O&M Contractor • 3) The Concession Granting Authority (the “Authority”)

11. DZ BANK Hong Kong Branch - 30 September, 2005 5) Who Provides Direct Agreements? (cont.) • 1) The EPC / D&C Contractor • The Direct Agreements executed with a EPC or D&C Contractor is designed to provide Senior Lenders with the opportunity to preserve the contract with the Contractor following a default / termination event occuring under the Contract caused by the SPV. • Lenders will be required to cure the relevant event. • The preservation of the underlying construction arrangements is a critical factor for Lenders since the SPV has no source of revenue until the PPP assets are completed and the service provision commenced.

12. DZ BANK Hong Kong Branch - 30 September, 2005 5) Who Provides Direct Agreements? (cont.) • A complexity can arise when the Contractor is also the (or a) key shareholders of the SPV. There may be a hostile relationship following a default by the SPV and the Lenders may be forced to allow the Contract to be terminated i.e. to elect not to exercise rights under the Direct Agreement. • Practically very difficult to replace Contractor since the PPP Concession commonly provides a Completion Date default provision which may prevent the Lenders with limited time to cure the underlying default event.

13. DZ BANK Hong Kong Branch - 30 September, 2005 5) Who Provides Direct Agreements? (cont.) • For certain PPP Projects there may also be a desire to establish Direct Agreements with key EPC / D&C Sub-Contractors. Primary focus here would be key equipment suppliers. This may also be slightly more critical where the SPV shareholder and the EPC Contractor are related parties.

14. DZ BANK Hong Kong Branch - 30 September, 2005 5) Who Provides Direct Agreements? (cont.) • 2) The O&M Contractor: • The O&M Contract Direct Agreement provides Lenders with a right (but not an obligation) to cure an Event of Default. • O&M is critical in the context of PPP since PPP at it‘s heart involves the provision of services. • O&M Contractor should provide notice of termination to Lenders. Otherwise ineffective. The same applies to the EPC / D&C Direct Agreement. • The O&M Direct Agreement will permit the Lenders to “Step In” to the Contract between the SPV and the O&M Contractor.

15. DZ BANK Hong Kong Branch - 30 September, 2005 5) Who Provides Direct Agreements? (cont.) • 3) The Concession Granting Authority (the “Authority”): • Commonly a Direct Agreement or Tripartite Agreement. Tripartite Agreement to the extent that the SPV also is a counterparty to the Agreement. • The Authority Direct Agreement is the key Direct Agreement in the contract of a PPP Project. The SPV has no source of revenue other than that receivable under the Concession Agreement. As such the need for preservation of the Contract is critical. • The importance of the Authority Direct Agreement is influenced by the consequences of the underlying SPV Default Termination regime within the Concession;

16. DZ BANK Hong Kong Branch - 30 September, 2005 5) Who Provides Direct Agreements? (cont.) • If termination of the Concession by the Authority for SPV Default results in transfer of the assets to the Authority and a termination sum being payable to ensure repayment of debt, then Lenders are in a position of some comfort. • If termination of the Concession by the Authority results in no transfer of the assets to the Authority and no payment of a termination sum to the Lenders, then the impact and importance of this Direct Agreement is substantially heightened.

17. DZ BANK Hong Kong Branch - 30 September, 2005 5) Who Provides Direct Agreements? (cont.) • In the latter case, Lenders will wish to ensure that the Authority Direct Agreement provides a sufficient basis for a preservation or revival of the PPP Project. This may involve: • Foreclosure on the Project Assets • Appointment of a Receiver • Termination of the Construction Contract and appointment of a replacement contractor • Termination of the O&M Contract and appointment of a replacement contractor • Rescheduling of the Project Debt • The exercise of the above remedies should not provide additional termination rights to the Authority

18. DZ BANK Hong Kong Branch - 30 September, 2005 5) Who Provides Direct Agreements? (cont.) • Target of the Lenders under a Direct Agreement is to minimize the interference and disruption to the Project and to consider the steps which are to be taken to preserve the Project and the underlying Concession.

19. DZ BANK Hong Kong Branch - 30 September, 2005 6) Issues with Direct Agreements • Importance of achieveing a “balanced” Direct Agreement • Imbalanced Direct Agreement will limit the effectiveness of the Step In arrangements and limit the ability to preserve the Project. • The following comments focus on the Authority Direct Agreement / Tripartite Agreement. • Identified issues: • Tripartite Agreement should not be the only remedy for Lenders • Election Periods and Cure Periods should be reasonable

20. DZ BANK Hong Kong Branch - 30 September, 2005 6) Issues with Direct Agreements (cont.) • Transfer of liability should be defined and “reasonable” e.g. Lenders representative should only be liable for identified defaults causing the termination event and Step In plus obligations during Step In Period. • Unreasonable Step In Criteria should be avoided. • Direct Agreements should not in themselves create Lender obligations unless the election to Step In is taken.

21. DZ BANK Hong Kong Branch - 30 September, 2005 7) Conclusions • In considering the formulation of Authority Direct Agreement (which an appear as a bid document) it is vital for the Authority to receive appropriately experienced advice. This is a general comment regarding the proposed bid documentation. • Inexperienced advice leads to unbalanced documentation which could render the underlying transaction “unbankable” in its current form. • Poor bid documents unnecessarily delay the closing process may add cost and create an unhelpful atmosphere during negotiations.

22. DZ BANK Hong Kong Branch - 30 September, 2005 7) Conclusions (cont.) • The Authority Direct Agreement is not the only source of remedy for Lenders. The financing agreements must also be acknowledged. • The Direct Agreement will remain an essential ingredient to the PPP (and other) infrastructure financing arrangements and as such should be given due consideration.

23. DZ BANK Hong Kong Branch - 30 September, 2005 Contact Information: For further information please contact: Mr. Tim C. Meaney Head of Project Finance DZ BANK AG Deutsche Zentral-Genossenschaftsbank Hong Kong Branch 9th Floor, Tower II, Admiralty Centre 18 Harcourt Road, Hong Kong Direct Tel.: +852 2864-3990 Direct Fax: +852 2864-3174 Email: tim.meaney@dzbank.de Website: www.hongkong.dzbank.de