2.3  Sub-sovereign Creditworthiness Guarantees

Sub-sovereign creditworthiness SGs are used to enhance the creditworthiness of non central government grantors of PPP contracts. With such SGs, the quality of the payment obligations of the sub-sovereign entity becomes equal to that of the central government guarantor.

Sub-sovereign guarantees may vary in form, but they are often structured as direct undertakings by the central government to the lenders to PPP projects. These undertakings require the central government to intervene if the sub-sovereign defaults on its obligations towards the PPP company. This intervention may vary from making payments on behalf of the sub-sovereign entity to undertaking to ensure that the sub-sovereign will be put in a position to meet its obligations. In some cases, the central government may try to achieve this through non-contractual means, such as "comfort letters" or "letters of intent". In other cases, the lenders will insist on formal contractual commitments.

The credit enhancement brought about by sub-sovereign SGs can improve the terms of the financing for the PPP company. The debt pricing should indeed reduce with the credit rating improvement. This can therefore improve the value for money of the underlying PPP projects although this has implications for the fiscal situation of the sovereign guarantor (see section 3.3).

The Italian "Fondo di Garanzia per le Opere Pubbliche" is a good example of an attempt to formally credit enhance the financial obligations of sub-sovereign entities (see Annex, paragraph 3). In contrast, the UK PPP hospitals programme of the 1990s is an example of soft sub-sovereign support. At the outset of the programme, potential lenders collectively expressed concerns about the ability of hospital trusts ("NHS Trusts") to meet their financial obligations as they fell due. The "National Health Service (Residual Liabilities) Act" passed in 1996 gave the lenders certain protections, but these fell well short of a commitment that Government would stand behind the debts of NHS Trusts. The UK Government was unwilling to make such a contractual commitment. Eventually, the Secretary of State for Health issued a letter of explanation to lenders. This indicated that it was "untenable", given the statutory responsibilities of the Secretary of State for Health, that the Government would stand by in circumstances where an NHS Trust was unable to meet its obligations (and thus be unable to meet its commitments under a PPP contract) and do nothing. This letter explained the powers and duties of the Secretary of State but stopped short of giving comfort to a specific group of lenders. It proved sufficient for lenders to lend to the PFI programme. By 2001/2002, lenders had become more comfortable with PFI in health and dropped their requirement for this letter of explanation, despite there being no change in legislation.

In this section 2, we have reviewed the three main categories of what can straightforwardly be defined as SGs. Governments sometimes also use debt instruments to support PPPs. Being loans (i.e. the Government lends to PPP projects alongside existing lenders to address market failures or specific project risks), these instruments are not considered as SGs per se. Box 4 provides two examples of Government debt instruments used in PPPs. To avoid accounting and other regulatory issues (see section 3.3 below), debt instruments often work on a commercial, "gap filling" basis alongside other commercial lenders until market conditions become more favourable, or the project circumstances change.