GLOBAL PPP il* World Bank N W K PPP Institute GET PPP public- rivate partnerships sdbLUTIONs July2010 Preserving the Integrity of the PPP Model in Victoria, Australia, during the Global Financial Crisis by Richard Foster, Assistant Director Partnerships Victoria CO g The state of Victoria, Australia, under the Partnerships Victoria in Schools project. The _ Partnerships Victoria policy, uses public- winning bidder, Axiom Education Victoria, private partnerships (PPPs) as an important reached financial close in December 2008. mechanism for meeting public service delivery Although long-term interest rate swaps were ( needs in many social and economic infra- available long-term debt funding was not. structure sectors. Since 2000, 21 PPPs have Axiom Education Victoria issued three- and reached financial close, representing some four-year debt and took on the risk created $A10.5 billion of investment-about10 percent by the need to refinance the debt during the of Victoria's total public investment program. project's life. The state agreed to a variation Typically, the private sector designs, builds, on its standard position regarding sharing of finances, and maintains or operates the infra- refinancing gains. The standard position is o structure and receives revenue consisting of that the state is entitled to a 50 percent share service payments made by the government of any refinancing gains, other than those for that are linked to the project company's perfor- scheduled refinancings that have already been mance and the availability of the infrastructure. priced into the service payments to be received As in many markets, in Australia the global by the project company. In the Partnerships *0 financial crisis substantially affected the cost Victoria in Schools Project, the state is entitled o and availability of financing for PPPs. Monoline to only a 50 percent share of gains earned by guarantors, who had played a key role in many Axiom Education Victoria from refinancings projects, were early casualties of the crisis, and following financial close that (a) increase the their exit required new projects to raise debt amount of debt beyond the level assumed (D from banks. Although the Australian banking in the financial model as at financial close or sector was not affected by the crisis as substan- (b) occur after Axiom Education Victoria has tially as in some countries, short-term funding secured long-term debt finance. costs and financing availability were significantly altered by a dramatic fall in liquidity. The Biosciences Research Centre Project: As the crisis unfolded, Victoria sought to Continuing Viability of PPPs with Minor maintain the integrity of its well-developed PPP changes in Risk Allocation model while meeting the changing situation in The next PPP project to reach financial close the financial markets. This approach required in Victoria was the $A287 million Biosciences limited and carefully considered changes in the Research Centre Project. The successful bidder, way a small number of finance-related risks were Plenary Research, raised $A225 million in debt allocated and managed in PPP projects. from three of Australia's four major banks and fixed its base interest rate for the project's life The Partnerships Victoria in Schools Project through interest rate swaps. However, to ensure The first Partnerships Victoria project to that the project was bankable, the state and reach financial close after the start of the the equity providers agreed to share in market global financial crisis was the $A255 million disruption risk, allowing the banks to increase Copyright f 2010 The International Bano for Reconstruction and Development. All rights reserved. 2 PPP Solutions | July 2010 their debt pricing in limited circumstances if two During the bidding process, interaction with or more banks' cost of funds is materially greater bidders and the financial markets indicated that than the relevant reference rate. This project was liquidity constraints in the Australian market the first Australian PPP in which the state agreed were likely to prevent a bidder from securing to share market disruption risk (box 1). The state the full amount of finance required for a project also agreed to share scheduled refinancing gains of this size. The project's capital cost was more and losses with Plenary Research. than 10 times the capital cost of the Partner- ships Victoria in Schools and the Biosciences The Victorian Desalination Project: The Research Centre projects. Because the desali- Government's Goal of Full Private Finance nation project had to be delivered within tight through a Temporary Syndication Guarantee timelines to secure Melbourne's water supply, it An ongoing drought in Victoria has highlighted could not be delayed by the bidders' process of the importance of water to the economy, obtaining finance. community, and environment. The Victorian In view of these project-specific features, the Desalination Project, with an estimated capital project team and the bidders recommended- cost of $A3.5 billion, will be the largest desali- and the state supported-the syndication nation plant in Australia, supplying 150 gigaliters of bank debt through a form of temporary of water per year. In 2009, the project was the guarantee at commercial rates. The bidders' largest PPP project in the world. lead bank arrangers would provide the project's Box 1: Market Disruption Risk Market disruption clauses aim to provide scope and that lenders may be able to mitigate the risk through flexibility for lenders to address any misalignment prudent management of funding sources, and the between the base rate that would apply to a loan and project company may be able to mitigate the risk by the lender's own cost of funds. Historically, lenders in refinancing if one of its lenders is affected by market Australia did not include market disruption clauses in disruption. However, the unit also recognized that it their Australian dollar loan agreements because the may be prudent for the state to share the risk if the market originally involved domestic banks lending out sharing mechanism met the following criteria: of their own (Australian dollar) funding base. However, as a result of the onset of the global 1. Market disruption should be narrowly defined to financial crisis, lenders in Australia began insisting ensure that the market disruption mechanism is on including market disruption clauses in all of their invoked only where genuine market disruption loan documentation, including project finance facil- occurs-not, for example, where a bank's cost ities. In PPP projects, a lender's ability to pass on an of funds has risen for other reasons, such as increase in its cost of funds is constrained by the cash concerns about the bank's financial position. flow available to the project company. The project 2. If market disruption occurs, the project company company's equity providers may be able to absorb a must be obliged first to seek to replace the modest increase in the lender's cost of funds. However, offending bank, typically through refinancing. more significant increases may result in a breach (in 3. If the offending bank cannot be replaced, the particular, the required debt service cover ratio) of the project company should bear the initial cost project company's loan covenants. Thus, banks and increase under the lender's market disruption sponsors bidding for PPP projects in Australia during clause. the crisis sought to pass the market disruption risk 4. If necessary, the government will meet the back to Victoria by asking it to agree to increase the increased cost above an agreed threshold, but PPP service payments to reflect the project company's it will require a right to be reimbursed by the increased loan service costs if a market disruption event project company (for example, from future free occurred, cash flow that would otherwise be available for The Partnerships Victoria Unit within Victoria's equity distributions or as a priority share of any Department of Treasury and Finance took the view future refinancing gains) Preserving the Integrity of the PPP Model in Victoria, Australia, during the Global Financial Crisis 3 remaining debt for a specified term. The state would guarantee the part of the debt that was to be syndicated (slightly under half the senior The onset of the global financial crisis led to a reduction debt) and would act as a lender of last resort if the debt were not complete old don in banks' risk appetites and, hence, their hold positions. within a specified period. Because Victoria Some foreign banks exited the Australian market, and aihi aA domesiced ratnpoiion. BcueVtofi thes great uncertainty arose as to how financial market condi- ations would evolve in the short to medium term. In view syndication guarantee was expected to enable of these factors, banks were no longer willing to under- bidders to access significantly greater volumes write loans on the assumption that they would be able to of funds than would be the case without the syndicate the loans following financial close. The risk that guarantee (see box 2). The government chose to use a sd t they would be unable to syndicate was too great for them The ovenmet coseto ue asynicaion to accept. For smaller projects, bidding consortia were guarantee rather than other forms of state still able to secure committed finance through a "club" support for these reasons: of banks, each agreeing to provide a proportion of the *required debt that was within their long-term hold limit. the guarantee in pace for oniy the initial However, for larger projects, even forming a sufficiently thre guarane in pacforol the initial. large club of banks could be difficult, if not impossible. three years of the project. A sndication uarantee is a means by which a * The support ensured that the project ~ wasgovernment with a strong credit rating can secure ose, albeit with assistance of a partial committed finance for a PPP when the required debt is government guarantee, and o pria not available on a club basis before financial close but strong incentive for the winning bidder is expected to be available after financial close in the secure fu private finance withngbdrato syndication market if the risk to the syndicating bank sere llngprivte fiae th og arne is mitigated. The government agrees to guarantee the for the longer-term debt. *part of the debt that is earmarked for syndication, but financiers ao n guarante e o (a) only while it is held by the initial lender. As a result, finniers fi drom thea losng bdder toine thes the initial lender will treat this portion of the loan as a winning bidder's team andj(b) ne ine credit exposure to the government, rather than as an to participate in the project once the successfuexposure to the project company. Hence, the lender's snu ceud r p ne ta d p op s l w r "hold" limit for its exposure to the project company will announced. * If the state did have to act as the lender not apply to this portion of the loan. Commercial incen- of last resort, it would be able to exit that tives are put in place to encourage the initial lender role by selling down the debt when market to syndicate the debt. Once syndication occurs, the conditionsgovernment guarantee falls away. If the initial lender is condiionsimprved,not successful in syndicating the debt within an agreed With the support of the syndication period, the government steps in as a lender of last resort guarantee, bidders for the Victorian Desali- on commercial terms (but only for that part of the debt nation Project could obtain committed finance intended for syndication). to meet the full cost of the project. On July 30, 2009, the AquaSure consortium was announced financial close. As a result, the project is now as the winning bidder. It reached financial completely privately financed for the longer close on September 2, 2009. More than half of term, and the state syndication guarantee is no the required debt was committed by 12 debt longer required. providers without state support. The remaining As was the case with the Biosciences $A1.7 billion was provided by banks with Research Centre Project, the state has elected support of the three-year syndication guarantee. to share in refinancing gains and losses and Following an international road show, 22 new market disruption risk under limited circum- debt providers committed 50 percent more stances associated with the Victorian Desali- syndicated debt than required for the project. nation Project. The state's syndication guarantee ended on November 16, 2009, just over two months after 4 PPP Solutions | July 2010 Figure 1. Credit margins for selected Australian PPPs 400 ce 01 January 2005 May 2006 October 2007 February 2009 July 2010 Financial close date Source: Department of Treasury and Finance (Victoria). Note: Bubble size reflects project cost. The Peninsula Link Project: Movement Back to stances, refinancing losses will be borne entirely Precrisis Risk Allocation by Southern Way. Victoria shares in any refinancing The successful financing of the Victorian Desali- gains, except to the extent that refinancing has nation Project has led to improvement in the already been assumed in calculating the availability financial market appetite for future Partnerships payments to be made by the state. This approach Victoria projects. This improved appetite was first represented a movement of risk allocation back to seen in the Peninsula Link Project, a $A849 million precrisis arrangements. road project being delivered under an availability Although risk allocation is moving toward payment model. precrisis principles, the cost of finance remains On January 15, 2010, Victoria awarded the significantly higher than before the crisis, Peninsula Link contract to the Southern Way presenting challenges for bidders seeking to consortium, with financial close occurring less provide value for money to the state. As figure 1 than one month later. Although market disruption shows, credit margins are considerably higher than risk is still shared by the state in limited circum- precrisis margins. The findSngs, interpretations, end Wonclus trn W _ub_§artnea of this note are the authors' own end shtod tGl e tBAL PPP A g h a y not be attributed to the World Bank, its aETWORKv a n Barrprsetd ora heement ofou risk all o ba to E,t s b U I N S Bad o h cutishyrprerss prnipe,thEo T ffiacerman