When designing SGs, the Government will need to reflect on a number of fundamental features such as:
(i) whether the SG should produce its effects before the underlying PPP contract is terminated or once termination has occurred;
(ii) if calls are made under the SG, whether the Government will want to be a creditor of the PPP company and what level of seniority (ranking) the Government will wish to have for its claims compared to those of other lenders or equity investors;
(iii) which loss-sharing mechanism to apply. For partial SGs, the sharing of the financial losses between the Government and the guaranteed parties (e.g. the lenders) can take several forms. For instance, a pro rata basis will mean that the Government and the lenders will share losses on an equal footing according to agreed percentages. In a "first loss" SG, the Government will cover 100% of the losses until the maximum guaranteed amount has been exhausted. Lenders will only start incurring losses beyond this amount;
(iv) if calls are made under the SG, whether the payment obligations of the Government should be on an "accelerated" or an "instalment" basis.
Guidance: Designing the SG features adequately will drive their effectiveness. Regarding (i) above, a Government can use an SG to step into a distressed project before it fails. This would allow the Government to work with the lenders and the equity providers towards a satisfactory outcome for the PPP project. SG instruments that are triggered upon termination of the PPP contract (e.g. debt assumption undertakings) lack this important lever.
As for (ii), it is advisable to structure guarantee payments as loans rather than grants.
Deciding on the ranking of the claims and on the loss-sharing mechanism in (iii) will depend on the incentives the Government wishes to provide and on the negotiations with the senior lenders.
Finally, the "acceleration" issue raised in (iv) requires careful consideration. Lenders will generally wish to have the option to accelerate the SG, in particular where they are concerned with the credit standing of the Government entity providing the SG. Governments may want to resist acceleration, not least because of the need to raise a large capital sum at the point of termination.