Financial issues can also prompt Governments to use SGs. Some examples are set out below.
- Leveraging additional sources of finance from the private sector - SGs are often used to attract funding for PPP programmes or projects, in particular for large-scale investments. Putting together lending packages for PPP projects may be constrained by limited financial capacity rather than a PPP-specific problem. By improving the credit quality of a loan, an SG may increase the amounts banks are willing to lend to a given project.
- Reducing the cost of capital and improving value for money - Occasionally, the stated objective of SGs is to reduce in the cost of capital of PPP projects (and hence improve the value for money). It is assumed that this will be achieved by: (i) reducing the cost of debt (which often represents a high proportion of the funding for a project); and (ii) enabling financial gearing to be increased (expensive equity is replaced by cheaper debt).
- Addressing instability in the financial markets - SGs have been proposed in order to (i) increase liquidity by lowering the credit risk borne by lenders and (ii) improve funding conditions by encouraging lower pricing and longer debt tenors. This was particularly the case during the recent credit crisis, when a number of European governments set up SG schemes to overcome blockages in the debt markets. Without SGs, the debt market disruptions would have discouraged private sector participation, reduced value for money or stopped/slowed down the delivery of individual PPP projects or programmes. The French guarantee scheme adopted in early 2009 (see Annex, paragraph 1) is a typical example of an SG measure aimed at tackling the financial crisis.
- Getting the asset built without public sector spending upfront - Governments may be tempted to use SGs to help attract the private sector to finance new projects whilst not making any public fund disbursement at the outset (e.g. capital contributions) for having the asset available. SGs are also perceived as better alternatives to direct grant finance as they have more of a market flavour.
- Tapping new sources of funds from the private sector - SGs can be used to encourage new sources of funding for PPPs, such as the capital markets. Capital markets can be a valuable alternative to conventional bank finance for PPPs. They offer an additional source of liquidity, and in some circumstances attractive pricing and long tenors. However, the requirements of capital market investors (e.g. minimum credit quality, simple investor decision-making procedures) may be incompatible with what is required of lenders in PPP transactions. SGs can help bridge this gap. For instance, Governments can use an SG to achieve a target bond rating or facilitate bond issuance. Box 1 below describes two proposals that show how SGs may enable PPP projects to access the capital markets.
| Box 1 - SGs for tapping the capital markets 1. The proposed EU 2020 Project Bond Initiative The Europe 2020 Project Bond Initiative is currently under development. The objective would be to attract additional private sector financing through the capital markets for individual large-scale infrastructure projects. The Initiative would provide credit support for senior debt in these projects. This support could be in the form of either (i) a subordinated debt tranche or (ii) a guarantee mechanism along the lines of the EIB / European Commission Loan Guarantee Instrument for Trans-European Transport Network Projects (see Box 2). This EU-supported credit enhancement of senior debt would allow PPP companies to source senior debt through bonds placed in the capital markets, possibly resulting in reduced funding costs and/or longer maturities. In the guarantee model, an EIB-issued guarantee would be called if the project were unable to generate sufficient cash to service its debt for any reason. It would also apply during the construction period to meet funding shortfalls and thus ensure that the project reaches the operating period. To ensure that the bonds remain at a rating level attractive to investors in most scenarios, it is anticipated that the credit support would amount to a maximum of 20% of the total bond funding of an individual project. For further information on the EU 2020 Project Bond Initiative, please visit: http://ec.europa.eu/economy_finance/consultation/index_en.htm. 2. The French "Fonds Commun de Titrisation PPP" ("FCT PPP") The FCT PPP is an initiative currently being developed by the French authorities. The aim of the initiative is to set up a fund (a "Fonds Commun de Titrisation") which would issue long-term bonds to finance PPP projects. The bonds would be issued on a project-by-project basis. For each project, bonds would be issued at or around financial close. The bond holders would not, however, be exposed to project risk during construction as the financing for the project construction would remain with banks. The bonds would refinance the banks once the project has reached satisfactory completion. The bonds would be backed by the portion of the service charge (payable by the public contracting authority under the PPP contract) that is not at risk of performance under the "cession de créances" mechanism (see Box 3). The risk for the bondholders would therefore essentially be that of the sovereign public contracting authority for the specific PPP contracts. This mechanism is expected to bring long-term funding from institutional investors to individual PPP projects. |