The smallest projects - those with a debt requirement of up to about $500 million - probably still can raise finance without direct government support, as has been shown by the Victorian and South Australian schools projects. However, one major problem that the government needs to address is banks' unwillingness to commit to debt terms for more than a limited period. The traditional Australian model of requiring underwritten commitments of finance for a period of 6 months or more is no longer possible5. Instead, governments will need to be willing to accept a lower level of commitment, protecting themselves by:
• requiring financiers to confirm their support for their bidder's proposal on the basis of an agreed term sheet and suite of project documentation
• requiring full transparency to any changes in financing terms after bid submission
• requiring bidders to confirm financing terms prior to the finalisation of the bid evaluation, whilst there is still competitive pressure
• reducing the period between bid submission and financial close, to minimise the risk of changes.
In current market conditions, projects run the risk of one or more bidders making exclusive arrangements with banks such that other bidders are unable to obtain sufficient financial support, reducing effective competition for the project. The government could take one or more of several measures to avoid this risk, as shown in Table 2, though they all have problems.
Table 2: Possible facilitation measures to maximise competition for debt finance | |
Measure | Comment |
Require only 25 percent of debt finance supporting a bid to be committed | • Still doesn’t prevent banks being tied-up • Only useful for smallest projects |
State clearly in bid documents that exclusive arrangements between bidders and financiers are prohibited | • Hard to enforce • Bidders will be reluctant to share information with non-exclusive financiers |
Government arranges stapled finance that is available to winning bidder | • Bidders may still try to arrange their own exclusive finance on better terms • Financiers’ terms depend on credit risk of individual proposals, so terms may be excessively conservative |
Hold a funding competition after the selection of the preferred bidder | • Will discourage consortia led by financiers, which have been major market participants to date • Possible loss of robustness of bids from lack of earlier involvement of lenders • Lenders’ terms depend on credit risk of individual bidder’s proposals, such that more expensive finance for a relatively uncreditworthy proposal could offset other cost advantages that it may have |
A solution, only while limited market capacity remains a problem, may be to run a funding competition but to:
• require bidders still to provide evidence of financial support in their bids
• give the winning bidder's lenders a preferred position, such as a right to match terms for 50 percent of the debt, to incentivise their early involvement in the bid.
In addition, governments could actively encourage bidders to explore alternative financing sources to the bank market. Bidders have become conservative in their approach to financing projects, partly because of governments' past insistence on underwritten finance supporting bids. (Another factor is the emergence of the 'Big Four' banks as bidders for PPP projects.) Governments should be prepared to take some risks on deliverability of finance to encourage alternatives to bank finance. For example, there are signs that some investors may again be willing to rely on guarantees from the remaining monoline insurers. However, without government encouragement, bidders and bond arrangers may be slow to pursue these solutions. The current capacity of the monoline-wrapped bond market is limited, but it may add up to $300 - 500 million to the capacity of the bank market.
Governments also could enable greater access to bond investors by providing direct support, as described further below, which again would require them to take some risks on finance deliverability.
__________________________________________________________________________________
5 Many countries do not require underwritten debt finance until financial close.