Presentation to the Planning Board May 2007

1. Conceptual Framework for PPPs Presentation to the Planning Board May 2007 PV Ravi Infrastructure Development Corporation (Karnataka) Limited

2. Definition • A Public Private Partnership is an arrangement between a public (government) entity & a private (non-government) entity by which services that have traditionally been delivered by the public entity are provided by the private entity under a set of terms and conditions that are defined at the outset

3. Characteristics • The public entity should have the enabling authority to transfer its responsibility – enabling legislative & policy framework, administrative order – the instrument of transfer is through a contract • There is usually a significant transfer of responsibility to the private entity – and usually includes financial investment obligations • For a payment to the private entity – directly by users or by the public entity such that - a significant portion of project revenues and/ or the payments, are conditional on achieving pre-specified levels of performance • The nature of the relationship is usually long-term

4. Risk Sharing • A risk is defined as any factor, event or influence that could threaten the successful completion of a project in terms of time, cost or quality • In a conventional BOQ based implementation : risks – planning, design, construction, environmental & social, physical damage and financing are evaluated • Commercial risks – revenue or maintenance costs, quality, safety of users and general regulatory risks – not critically evaluated – this is critical though to a private investor • PPP involves sharing of risks – risk allocated to the party best suited to manage them

5. Why PPPs? • Fiscal reasons - Inadequacy of resources – leveraging on lower government funding • Optimal transfer of risks – to the entity best suited to manage the risks • Design, Financing, Construction, Operations and Maintenance – all are commercially understood and manageable • Change of scope, defective designs, time overrun, cost overruns, leakage of revenues, high maintenance costs • Transfer of responsibilities – efficiency gain • Appropriate technology, innovative design solutions, project management, better collection practices, life cycle costing

6. Other Reasons • Enhanced bankability – more rigorous project preparation • Incentive to deliver whole life solution – not just asset creation • Focus shifts to service delivery – integrated with construction, measurement of quality & payment linked to service delivery • Acceleration of programme – time-bound implementation • Better overall management of public services – transparency in prioritisation, selection and ongoing implementation

7. Build Operate Transfer Concessions Management & Maintenance Contracts Works & Services Contracts Operation & Maintenance Concessions Full Privatization High Low Extent of private sector participation PPP Options

8. Concessions • BOT - Build Operate Transfer • BOOT - Build Own Operate Transfer • BOO - Build Own Operate • BOOST - Build Own Operate Share Transfer • BOLT - Build Own Lease Transfer • DBFO - Design Build Finance Operate • OMT - Operate Maintain Transfer

9. Types of PPPs • Financially free standing projects • Role of public sector - planning, licensing & statutory procedures; no financial support/ payment by government • Revenues through levy of user charges by private sector • Toll Roads and Bridges, Telecom services, Port projects • Projects where Government procures services • Private Sector paid a fee (tipping fee), tariff (shadow toll) or periodical charge (annuity) by Government for providing services; payment against performance – no/partial demand risk transfer • Risks associated with asset creation (including design) and O&M transferred to private sector • Accountability to users for service - retained by Government • Roads - annuity/ shadow tolls, power - under PPAs. In the UK -prisons, education, health services, defence related services • Other Types - Joint ventures, Not-for-Profit vehicles

10. Features of PPPs - 1 • Genuine risk transfer • All risks pertaining to design, building, financing and operation transferred to the private entity • Transfer of demand risk depends on the extent to which the private sector can influence usage • Output based Specifications • Contracts specify the service outputs required rather than asset configuration/mode of service delivery • Emphasis on type of service & performance standards • Private entity incentivised to deliver outputs using innovation in design, construction, operation and financing

11. Features of PPPs - 2 • Whole life asset performance • Private entity takes responsibility & assumes risk for the performance of the asset and delivery of service over a long term • Payment for Performance • Revenue/ Payment to private entity is subject to performance in relation to specific & quantified criteria enshrined in the contract

12. Value for Money • Transfer of risks/ responsibilities under a PPP structure should result in better value for money for the user • Telecom sector – mobile phone tariffs from Rs. 16/- per minute to Re.1/- or 50 paise per minute • Tolls paid – offset by savings in direct & indirect costs and value of time • Annuity payments – public sector comparator – value for money • Efficiency gain • Savings in cost of project versus overrun • Savings in operating costs • Revenue maximization - leakages

13. Basic Issues • Striking a balance between differing concerns & objectives of parties • Legislative Back up • Rights and obligations of parties • Identification and allocation of risks • Penalties and rewards which would ensure performance

14. Broad Roles & Responsibilities • Government Agency • Providing Project Site/ Assets • Environmental Clearances • Supporting Infrastructure and Utilities • Specific Obligations (e.g. dredging) • Regulatory Functions • Concessionaire • Designing, Engineering, Financing • Construction/ augmentation / upgradation • Operation and Maintenance • Payment and other obligations • Transfer of assets at expiry of concession period • In exchange the concessionaire has the right to receive revenue – tolls or annuity or any other mechanism

15. Other Key Elements • Bankability Issues • Concessionaire’s ability to assign rights • Lenders’ step-in rights • Charge on project assets and enforceability • Critical Events and consequences • Force Majeure • Events of Default • Remedial process incase of default/ events leading to termination • Protection of debt in the event of termination • Supporting Provisions • Dispute Resolution Mechanism • Re-negotiation in good faith • Termination as a last resort • Preferential treatment in re-bidding

16. What a PPP is not & what it is • PPP is not privatisation or disinvestment • PPP is not about borrowing money from the private sector. • PPP is more about creating a structure • in which greater value for money is achieved for services • through private sector innovation and management skills • delivering significant improvement in service efficiency levels • This means that the public sector • no longer builds roads, it purchases miles of maintained highway • no longer builds prisons, it buys custodial services • no longer operates ports but provides port services through world class operators • No longer builds power plants but purchases power

17. Partnership in Practice • Partners not adversaries – background of mistrust • Project should be the focus – “win-win” for both the parties • Independent agencies – Independent Engineer - useful during both implementation and operations • Government retains ultimate responsibility – uses the private sector to deliver infrastructure services of specified standard • Private Financing – can significantly leverage public funds

18. Basic Features • Conventional financing is asset based – debt provided is usually a percentage of project cost linked to the value of asset cover • Project Financing is cash flow based - on the estimated cash flows that are generated by the project • “A financing structure that relies on future cash flows of a project as the primary source of its servicing & repayment, with only the project assets, rights and interests being the security” • There is little or no recourse to the sponsors • Usually large projects - investments are huge & costs of non-completion/ unsuccessful operations - affect many • Little tangible security • All stakeholders would, therefore, like to see it succeed

19. Project Appraisal • An elaborate project appraisal process – analysis of risks and specification of return expectations (pricing) from investing in the project • Cash flow projections based on technical, market and financial analysis • Risk mitigated through project contracts and financing agreements or consciously taken after evaluation • Structured financing – to meet the characteristics of the project • Security and documentation - elaborate • Project monitoring and compliance

20. Typical Funding Sources • Equity Capital • Core capital provided by the promoters (developers / contractors) • Minority stakes may be taken by financial investors / funds • Preference Capital • Can be used if suitable changes made to the CA • Senior Secured Debt • Normally in the form of rupee term loans/ debentures from Indian banks/ institutions • Capital market instruments – may be possible after CoD; not too popular yet • A variant could be debt with 2nd charge • Subordinated Debt • Typically with far lesser rights • May even be unsecured • Challenge is to evaluate how additional resources can be channelised into the sector - insurance funds, pension funds

21. Key Project Contracts • Concession Agreement • Project Site Licence Agreement • Shareholder/ JV Agreement • Substitution Agreement / Direct Agreement • State Support Agreement • EPC Contract • O&M Contract • Trust and Retention Agreement

22. Main Provisions • Concession Agreement • Terms and conditions of undertaking the project • Obligations of the parties • Tenor of the contract • Default provisions and remedies • Provision for substitution • Force Majeure provisions and remedies • Termination and compensation payments • State Support Agreement • Support during implementation • Protection from a competing facility

23. Other Key Contracts • EPC Contract • Price Overrun • Time Overrun • LDs and Bonus provisions • Performance security • Standards and Specifications • O&M Contract • Operating Standards • Costs • Quality of Service • Penal provisions • TRA Agreement • Trapping of all the project cashflows • Prioritization of Cash flows

24. Financial Analysis • Elaborate Financial Model capturing these risks – base case analysis • Establishes breakeven levels of traffic/ tariffs • Assessment under various scenarios – sensitivity analysis • Demand / Traffic • Tariff / Tolls • Inflation • Maintenance Costs • Financial Ratios • Debt Equity Ratio – cash flow impact & level of promoters’ funds • Internal Rate of Return (project/ equity) • Debt Service Coverage Ratio • Loan Life Ratio • Project Life Ratio

25. Financing Documents • Facility Agreement • Financial Terms • Project Risk Mitigating Conditionalities • General Conditions • Inter-Creditor Agreements • Security Documentation

26. NHAI Concession Agreement Annuity JV Partner Financing Agreements Shhldr’s Agmnt Lenders Project SPV Equity Debt EPC Agmnt O&M Agmnt Main Sponsor Indep Eng LE Contractor Basic Structure

27. Advisers Sponsors Invt. Bankers, Technical & Legal Advisers Advisers Invt. Bankers, Technical & Legal Advisers Equity Concession / Licence Agreement Financial Investors Insurance Companies Equity / Sub-Debt Insurance Policies Users Off-take Contracts O&M Contract O&M Operator TRA/Escrow Agreement TRA Agent EPC Contract Debt Substitution Agreement EPC Contractor Lenders Transaction Structure Government Project SPV

28. Implementation Structures • Existing Assets • Full Divestiture – UK – Telecom, Steel, Electricity, Ports, Water, Airlines, Airports; so far in India – Modern Foods, BALCO, Hotels • Asset Sales/ Leases – airports in Australia • BOT/ ROMT Concessions – roads, tourism facilities, berths in ports • Management contracts – water assets, ports in Philippines • New Assets • Implementation by government – followed by OMT concessions – Mumbai-Pune expressway, Ports in Rotterdam, hospitals • Implementation through SPVs – Moradabad bypass or port connectivity projects or dedicated freight corridor for railways • BOT Concessions – commonest form – roads, ports,

29. Isn’t Private Infrastructure Expensive?

30. Isn’t Private Infrastructure Expensive? Additions to Cost Benefits Risk Premium Lower Cost From Efficiency Example Public Entity Private Entity ROI 8% WACC 13.7% (Debt @ 11% 70: 30 Equity @ 20%) Cost 105.3 Cost 100 Required Required Return 113.7 Return 113.7 • A 5.3% cost overrun (increase in actual project cost) in the public sector is enough to overcome the private sector disadvantage of higher financing cost!

31. Isn’t Private Infrastructure Expensive? Additions to Cost Benefits Risk Premium Lower Cost From Efficiency Example Public Entity Private Entity ROI 8% WACC 13.7% (Debt @ 11% 70: 30 Equity @ 20%) Cost 100 Cost 95 Required Required Return 108 Return 108 • A 5% reduction in project cost (efficiency) by the private sector is enough to overcome the higher financing cost!

32. Key question • What should be the framework to induce the private entity make the investments needed to provide efficient service to the end user? • Investments decided by the investor or driven by the market, i.e. the consumer • Private entity has a stronger case for state support if it makes investments determined by the State • Demand risk – how much passed on? • Extricate the public entity from making commercial decisions on individual projects, wherever possible • Public entity’s role from being a planner, financier & manager to facilitator & regulator

33. The Investor wants Monopoly rights Full pricing freedom State support for social obligations/ viability considerations The Investor needs Initial risk mitigation support - can be pre-defined Stable environment - regulatory and policy framework State support for social obligations/ viability considerations – can be transparently determined The Right Balance

34. Some Indian Examples - 1 • Roads • BOT Concessions for toll roads and bridges (NHAI, state governments) (OMT Concessions in future) • Annuity payment based concessions – highways, urban roads (NHAI/ state governments) • Solid Waste Management • Engineered landfills – tipping fee linked payments (Bangalore, Trivandrum) • SW Collection and Transportation (MCD/ NDMC) • Port Concessions • Major Ports – container berths (JNPT, Chennai, Kochi, Tuticorin, Vizag, Kandla); bulk cargo berths (Marmagao, Haldia, Ennore, New Mangalore) • Minor Ports –Pipavav, Mundra, Kakinada

35. Some Indian Examples - 2 • Water Supply and Sanitation – Bulk water supply systems in Tirupur and Vizag • Tourism Facilities – hotels, tourist facilities, PWD rest houses – Karnataka & Kerala • Bus Terminals/ Parking Facilities • Bus terminals – Dehra Dun, Amritsar, Jullundur • Parking + commercial complexes – NDMC/ DDA/ MCD/ Bangalore

36. International Experience - 1 • Toll Roads (Chile, Mexico, Hungary, Poland); Ports (Argentina, Philippines, Sri Lanka) • Airports (Australia, Greece, Germany) • Roads in UK under DBFO program • Private Finance Initiative of UK – diverse areas • Dorset Police Service - $ 40 million contract for refurbishment of police stations, construction of a divisional headquarters building, maintenance, janitorial & waste management services • Nottinghamshire, Police Fleet Management Contract - ($ 180 million over 25 years) – driver slots - usage of a vehicle for a 24 hour period • Durham & Dunstead Hospital Project, Durham – 30 year, $ 155 million hospital services contract – to construct and operate health care facilities + ancillary services • Stoke-On-Trent Grouped Schools Project – a $ 250 million project involving 122 schools – refurbishment and maintenance contract

37. International Experience - 2 • Louis Trichardt Maximum Security Prison Project, South Africa – a $ 270 million project – largest prison facility (also UK and Australia) • Full fledged water concessions in Argentina (Buenos Aires) and Philippines (Manila); Management contract for water supply & sanitation in Johannesburg, South Africa • Rural Pay Phones, Peru – against payment of a subsidy – based on a system of monitoring of service standards

38. On the Table in Karnataka • Airport Rail Link • Core Ring Road • Airport Expressway • BMRDA Townships • Minor airports • Tourism Properties • IMTC (Kempegowda) • Mega Convention Center, Bangalore • Bypass roads • Truck terminals • …