1 / 9

Corporate Governance Issues in Infrastructure Finance

Corporate Governance Issues in Infrastructure Finance. World Economic Forum - Financing for Development Workshop Tuesday - Wednesday, March15 -16, 2005 Hong Kong. Infrastructure Finance vs Corporate Finance.

elma
Download Presentation

Corporate Governance Issues in Infrastructure Finance

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. Corporate Governance Issuesin Infrastructure Finance World Economic Forum - Financing for Development Workshop Tuesday - Wednesday, March15 -16, 2005 Hong Kong J. Robert Sheppard, Jr. projfin@bellsouth.net

  2. Infrastructure Finance vs Corporate Finance • Typically, most corporate governance issues concern publicly-held corporations, but most infrastructure projects are financed using: • Special purpose, project-financed entities • Subsidiaries of foreign corporations • Joint ventures between major corporate partners • Corporations that finance new investments using their own balance sheet may engage in a wide variety of businesses, but infrastructure firms are typically limited to one line of business • Corporations that finance new investments using their own balance sheet offer products or services that vary across a wide spectrum of price and features/quality, but infrastructure firms typically offer products or services that are: • Regulated so as to reduce possible pricing strategies • Standardized with respect to features and quality J. Robert Sheppard, Jr. projfin@bellsouth.net

  3. Infrastructure Finance vs Corporate Finance • Decisions regarding new investments are hidden from public view when new projects are financed using the corporation’s balance sheet: • Project costs may not be disclosed • Rates of return for individual projects are unlikely to be disclosed • Decisions regarding new infrastructure investments can and should be made publicly • Standards for service are public • Regulatory regime is a governmental activity • Competitive bidding processes can be widely used • Operating period inputs for infrastructure can sometimes be benchmarked to publicly-available indices • Conventional, broadly available technology for most infrastructure services permits meaningful comparisons of cost among different countries and time periods J. Robert Sheppard, Jr. projfin@bellsouth.net

  4. Non-Transparent Costs of Infrastructure Finance • Risk premium for fixed-price construction contract that includes performance guarantees • Typical form of contract used to arrange non-recourse financing for privately-financed infrastructure projects • May be necessary for projects sponsored or owned by host-country governmental units • Risk premium for infrastructure project financing • Project-financed entities command a premium compared to corporate borrowers issuing comparably-rated debt of the same tenor • Host-country lenders may require a larger risk premium for non-recourse financings than lenders in US or European markets • Country-risk premium applied for financing arranged in international markets • Tenor of project financing is one of the most significant factors affecting cost of service • Available tenors may vary significantly depending upon financing approach • Where financing is arranged by private supplier of infrastructure services, public knowledge of financing arrangements may be very limited • Revised project economics following a restructuring occasioned by financial distress • It is important to distinguish between increased project costs based on risks borne by third-parties and increased project costs resulting from above-market equity returns J. Robert Sheppard, Jr. projfin@bellsouth.net

  5. Regulatory Regime Considerations • Risk allocation, objectivity of service standards, and tariff adjustment mechanisms can significantly affect: • Required returns of infrastructure equity investors • Risk premium demanded by domestic and international lenders • Risk allocation and specification of standards of service: • What risks are private investors required to bear? • Are these risks controlled by the private investor? • Can they be hedged, insured or otherwise transferred to a third-party? • What penalties are applied for a failure to meet required standards? • Are penalties financial only or do they threaten loss of a concession or franchise? • Do the penalties adversely affect only equity returns or do they also threaten the interests of project lenders? • Tariff adjustments: • What index or indices are used? • Can anticipated changes be borne by the public? Renegotiation risk? • Ability of tariff adjustment mechanism to reflect changes in project costs? • Existence of hedging, insurance or other risk-transfer mechanisms to cover mismatch risks? • Frequency of tariff adjustments? • Certainty, fairness, objectivity of adjustment process? J. Robert Sheppard, Jr. projfin@bellsouth.net

  6. Infrastructure Process Design Considerations • Sequencing of projects can significantly affect success of a development program • Sizing individual projects is important – promote modest size, not mega projects • Average size of international projects has always been significantly larger than for US projects – size increases project-specific risks in situations where country risk is already a concern • Modest-sized projects offer a number of advantages: • Spread risk among a larger number of equity investors • Provide more comparable projects for cost and operational comparisons • Easier to audit • Can more readily enable the host-country to build a track record of success • Use competitive bidding but understand its limitations • A successful track record is the most important factor in reducing the risk premium demanded by equity investors and project lenders J. Robert Sheppard, Jr. projfin@bellsouth.net

  7. Competitive Bidding Considerations • Appropriate design of bidding process requires a legal, financial, and engineering consultants • Risks to be borne by contractor, including price and performance guarantees, must be an explicitly-designed component of the RFP • Alternative risk allocation structures may facilitate identification of additional costs incurred by transfer of certain risks to the contractor • Alternative risk allocation structures can also lower expected project costs • Ensure competitive bidding or benchmarking of all major project components • Avoidance of new technology is easy in most infrastructure projects and will promote a broader market of bidders and verifiable cost estimates, as well as reduce project risks • Benchmark standards for costs to be borne by the public, such as fuel costs • Eliminate cross-subsidy opportunities, e.g., contractors that are also fuel suppliers, etc. • Structure tariff adjustment mechanisms that facilitate long-term financing and that ensure that an appropriate portion of benefits from cheaper or longer-term financing are passed through to the public • Understand that negotiations with the winning bidder will unavoidable resemble sole-source procurement in many respect J. Robert Sheppard, Jr. projfin@bellsouth.net

  8. Success Means…. Aside from adequate service at an affordable price, attributes of success will include: • Declining returns required by equity investors and project lenders – with returns being driven down by a track record of successful projects • The corollary of this attribute is that later projects will make earlier projects appear to have above market costs – even though these earlier projects – at their pricing – were a necessary step in reaching the more attractive later projects • Equity investors who want to re-invest in the host country • Capital markets issues to finance infrastructure projects that maintain investment-grade ratings on a long-term basis • Capital markets debt issued by infrastructure project should be significantly de-linked from the host country’s sovereign rating and should not automatically be downgraded to below investment-grade in the event of an economic crisis that does not directly affect the project • A successful result, not necessarily a pretty process • The history of international infrastructure development includes: • Large public subsidies and many bankruptcies for US railroads in the 19th century • The US nuclear power industry in the 1960s and 1970s • Overbuilding and financial distress in US merchant power and telecommunications in the 1990s • Developing countries can do better but it’s important to ask: “Compared to what?” J. Robert Sheppard, Jr. projfin@bellsouth.net

  9. Recommendations for Action • Design a regulatory regime that can survive macroeconomic stress and that will not require renegotiation of project economics after commencement of operations • Require competition, but structure each competitive process to reveal the premium that the public must pay for risk assumption by third parties • Understand the impact of financing costs and tenors on tariffs paid by the public and attempt to reduce the required risk premium and to facilitate long-term financing • Build a track record of successful projects to drive down the returns required by project sponsors as well as local and international lenders J. Robert Sheppard, Jr. projfin@bellsouth.net

More Related