SGs are often granted through provisions of the PPP contract between the Government and the PPP company rather than as separate Government undertakings to lenders and/or investors. The typical PPP contract SGs are set out below.
- Revenue or usage guarantees - These SG mechanisms are common in transport PPPs. Under these SGs, the Government, as PPP contract grantor, guarantees the PPP company a certain level of usage (e.g. traffic level in a toll road project) or revenues (e.g. if traffic revenues fall below a certain level, the Government makes up the shortfall). These SGs offer less protection than outright loan guarantees as (i) the primary beneficiary of the guarantee is the PPP company and not the lenders and (ii) should the PPP company's costs not be managed properly, there would still be a risk of payment default on the loan because of insufficient cash flow1.
- Guaranteed minimum service charges - Under these mechanisms, the Government guarantees that the service charge it has undertaken to pay on a regular basis to the PPP company during the operational phase of the PPP contract will not fall below a certain threshold, irrespective of the performance of the PPP company. The PPP company's lenders usually secure this Government commitment to ensure that their debt, or a portion of it, is de facto guaranteed even if the PPP company performs poorly or if the PPP contract is terminated. The French "cession de créances" and the German "Forfaitierungsmodell" presented in Box 3 are variants of this form of SGs.
- Change of law/regulation undertakings - In countries with a regulatory framework which is not yet fully developed, the Government may need to provide contractual commitments, or protection, in respect of future regulatory policy. This may also be true for public procuring authorities without an established track record. Policy risks can be allocated to the Government via the provisions of the PPP contract, provided that the contract is binding upon the Government and cannot be changed unilaterally2.
- Termination payments - Termination payments are a feature of many PPP contracts. They often cater for the legal principle that there should be no "unjust enrichment" when a contract ends. SGs can be found in PPP contract provisions that deal with the compensation owed to the PPP company when the PPP contract is terminated prematurely following default of the PPP company. Standard termination provisions normally provide for Government payments that reflect the value of the terminated contract or of the assets that are handed back to the Government. There are SGs where the contract provisions go beyond this norm and, for instance, ensure that the lenders will be paid the full amount or a pre-agreed proportion of their outstanding debt. The PPP contracts granted in the early 2000s for the maintenance and renewal of the London Underground are an example of this (see Annex, paragraph 2). Even where termination provisions ensure that the PPP company will be paid by reference to senior debt outstanding these SGs are less straightforward for lenders than outright loan guarantees. This is because (i) the primary beneficiary of the guarantee is the PPP company and not the lenders and (ii) the lenders have to wait until the PPP contract is terminated before being repaid, which can be a complex and lengthy process.
| Box 3 - Guaranteed minimum service charges 1. The French "cession de créances" A "cession de créances" is an assignment of receivables in which a creditor transfers the benefit of certain receivables directly to its banks. The "cessions" are regulated under the "Loi Dailly" of 1981, which was aimed at providing a clear framework for simplified commercial mortgaging techniques. Under the "Loi Dailly", a creditor may raise money from its bank by transferring the benefit of amounts due to it. These amounts are collated on a "bordereau Dailly", which in turn serves as security for the loan. One of the advantages of the mechanism is its bankruptcy remoteness. In the event of bankruptcy, a liquidator cannot reintegrate the funds subject to the "cession" into the common debt for the benefit of all creditors. The principal aim of the "cession" is to secure a portion of the debt repayment to the banks. To avoid bearing a performance risk, the bank has to ask for the "cession" to be "accepted": by accepting a "cession", the debtor undertakes to pay the amounts due under the assigned receivables whatever happens under the underlying contract. This acceptance creates a very strong direct payment obligation from the public procuring authority to the bank. The "cessions" and the acceptance mechanism have been used for the financing of French PPPs. The public authority granting the PPP contract (and hence liable for a stream of service charge payments to the PPP company over the life of the contract) can decide in advance to accept the transfer of the benefit of a portion of those payments to the lenders, under certain conditions provided for in the PPP contract. The main conditions under which this acceptance becomes valid are that (i) construction must be complete and the project in operation and (ii) only a portion of the part of the service charge corresponding to the investment and financing costs can be transferred. A law of 2008 caps this portion at 80% of the investment and financing element of the payment. The benefit of the transfer then becomes irrevocable, irrespective of whether the services under the PPP contract are being rendered or not. The economic rationale of this system is that the loans backed by the "cession Dailly" will be considered as public borrowing by the lenders and as such will attract low interest payments, resulting in a lower service charge for the authority. The system has proved to be efficient in optimising the cost of financing PPPs, without significantly limiting the risk transfer. 2. The German "Forfaitierungsmodell" Germany makes extensive use of the "forfeiting" model at the municipal level. In this model, the public contracting authorities and the lenders enter into a side agreement. Under this agreement the public authority waives its right to reduce or suspend the payment of the element of the service charge that covers the debt service in the event of poor performance or non-performance by the PPP company. In certain cases, the "forfeiting" covers only 80 to 95% of the debt service obligations (as in the case of the "cession de créances" in France), leaving the "non-forfeited" portion of the debt exposed to project risk. Typically, "forfeiting" is only applied post project completion, with the lenders assuming project risk during the construction phase. As a result, lenders treat the proportion of debt subject to "forfeiting" post completion as a public sector risk and price it accordingly. |
- Debt assumption undertakings - Some Governments (for example Turkey - see Annex, paragraph 7) have used, or are planning to use, debt assumption undertakings to provide guarantees to the lenders in some of their PPP projects. These PPP contract undertakings require the Government to assume the debt obligations of the PPP company should the PPP contract be terminated. Often, this is achieved through novation of the financing agreements to the Government upon termination. In simple terms this means that the Government becomes the borrower, replacing the PPP company. Whether this is acceptable to the lenders will depend on the credit status of the Government entity that will assume the debt service obligations.
- Residual value payments - Residual value provisions are sometimes used in PPP contracts whose duration does not allow the PPP company to fully amortise its debt or remunerate investors. In these cases, the Government undertakes to pay the PPP company, upon contract expiry, a pre-defined amount which generally reflects the residual value of the underlying asset. Residual value provisions are used for instance in the Italian motorway sector, where a number of concessions granted some time ago have a short remaining life but significant investment requirements.
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1 The cash flow is the difference between the revenues of the PPP company and its operation, maintenance and tax costs.
2 Policy risk is also often allocated by law, particularly in civil law countries (e.g. impartial arbitration, regulatory independence).