Many observers recognize the positive incentives that arise from relying on private financing in the form of equity. This has led some to ask whether P3s can be executed without private debt financing, thereby presumably maintaining the same performance incentives but without the incremental cost of private debt financing relative to public debt financing. In practice, this would mean having public financing replace some or all of the private debt, since it would be much more expensive to have equity replace the private debt in its entirety.
In a limited way, this type of financing-known as the "wide equity" model9-has already started to happen. It began with the first signs of the credit crisis in 2007, when bond markets seized up, and continued with the full-blown credit crisis in 2008, when the cost of credit soared and credit availability collapsed. As a result, governments have in some cases made greater upfront contributions to the project financing-usually through payments at key delivery milestones-to reduce the private financing requirements to more manageable levels and thereby facilitate the financial close.10
These kinds of responses to the credit crisis have nevertheless retained a significant role for private debt financing, without which it would not be possible to have the kinds of penalty clauses for delays and non-performance issues that have characterized the second wave of P3s. Moreover, the prospect of totally replacing private debt with public debt financing, coupled with the continued participation of private equity, raises significant issues. In this case, the public sector would act both as an owner and as a debt provider on a project. In addition to the potential conflict between the two roles, 11 this kind of financial structure could also make it more difficult to attract equity providers, who may have concerns about potential opportunistic behaviour on the part of the public sector partner.
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9 Under this type of financing model, private equity provides a higher share of the total private financing required for the project, usually with the public sector owner making greater contributions during the early stages of the project.
10 In several Canadian jurisdictions, P3 projects included significant public sector funding contributions from both provincial and federal governments well before the first signs of the credit crisis in 2007. In some cases, public sector contributions make up a large share of the total P3 project funding (e.g., regional health district funding in British Columbia makes up 40 per cent of the total funding for hospital projects).
11 This alone would suggest that a public lender may behave quite differently from a private lender, because it would not have the same incentives to perform due diligence and monitor the delivery of the project. Additional contract provisions outlining the rights of each party could minimize this conflict.