4.2.2 Conclude financing agreements

TEN-T PPPs are normally financed in whole or part through project finance arrangements. Where possible, public authorities should seek to secure a fully committed financing package along with their bids. In this case, concluding the financing agreements could take place shortly after, or simultaneously with, signing the PPP contract.

However, in current market conditions (notably during any period of reduced liquidity in the financial markets), it is unlikely that fully committed financing can be provided at the time of bidding. In this event, it is unlikely that the entire package of financing agreements needed for the project can be concluded immediately after the PPP contract is signed.

Prior to the current crisis, PPP financing for major project financed transactions was usually provided via syndication arrangements whereby a single bank, or small number of banks, would take all project debt, then "re-sell" it to a syndicate of banks.

In practice, most current projects are funded by "clubs" of banks which assume they will hold project debt to maturity (i.e. it will not be sold down, or syndicated). In some cases, these club arrangements can only be concluded after appointment of the preferred bidder - so called post preferred bidder "book-building" (see below).

The strength of financier commitment which can be obtained at the time of bidding will depend on the particular project and market. Bidders should at least show a reasonably deliverable financing plan in their proposals - i.e. it should be demonstrated that the debt, equity and grant providers have reviewed and accepted the broad design of the PPP and the major contractual provisions, including the proposed risk allocation. For many projects this commitment will be conditional to some extent since financiers will generally not complete their detailed due diligence until after the PPP contract has been signed.

Sometimes lenders will insist on changes to the PPP contract after they carry out their review and detailed due diligence. There may be limits, however, to how much the public authority can change the PPP contract at that point in response to lenders' requests without going against good procurement principles. Normally, most lenders will also want to see full draft subcontracts and ensure that major subcontracts (e.g. turnkey construction contract and operating and maintenance contract) are pre-agreed and subcontractors are committed to fixed price contracts before they sign the financing agreements.

In some larger PPPs, the public authority has played an active role in ensuring competitive financing terms by requiring a debt funding competition, particularly in the UK. Under this method, the preferred bidder is required to carry out a competition, overseen by the public authority, for third-party debt in order to obtain the best financing terms, and the public authority takes the benefit (in whole or in part) gained by any improvement in financing terms. This method requires intensive involvement of capable financial advisers, and it may not be suitable for projects or in markets where financial innovation is expected to play a significant role in the competitive position of bidders. Moreover, it may not be suitable in conditions of limited financial liquidity. <1>

In these circumstances, the private sector may need to engage in post preferred bidder "book-building". <2>

A large number of financing agreements are needed for a project financed PPP deal. These agreements have three basic purposes:

□ First, they are designed to protect the interests of senior lenders vis a vis sub contractors and other providers of finance (for example, equity investors). In particular, senior lenders wish to ensure that considering the total financial risks taken on the private sector, those borne by their borrower (the PPP company) are minimised. In practice this means that to the greatest possible extent, risks taken by the private sector are 'passed down' to sub-contractors (rather than remaining with a thinly capitalised PPP company);

□ Second, the agreements need to clearly establish that the servicing of senior of debt takes priority over returns to all other forms of finance -indeed, this is what makes senior debt 'senior'; and

□ Third, the suite of financing agreements is designed to ensure that, should things go wrong to the extent that lenders' debt investment is at risk, lenders have the powers to take the actions they deem necessary to protect their investment.

The third point is crucial, and goes to the heart of the benefits that PPP can deliver for the public authority. A well designed PPP aligns the interests of lenders and the public authority in that both require a successful project to meet their objectives. Lenders are incentivised - and empowered - to ensure that problems with the project are addressed in a timely manner. Only in this way can they be certain that their investment is assured. For this reason, the public authority should be able to rely on lenders' incentives to deal effectively with problems in both construction and operation that would threaten the project's performance. This is a major source of risk transfer from public to private sector in PPP projects <3> (see the Annex Project Finance).

Some of the typical financing agreements to be prepared and concluded are:

□ senior loan agreements (agreements between lenders and the PPP company setting out the rights and obligations of each party regarding the senior debt);

□ common terms agreement (an agreement among all the financing parties and the PPP company that sets out the terms that are common to all the financing instruments and the relation between them - including definitions, conditions, order of drawdowns, project accounts, voting powers for waivers and amendments, etc.; a common terms agreement greatly clarifies and simplifies the multi-sourcing of finance for a PPP);

□ where subordinated or mezzanine debt is used in the financing structure, subordinated loan agreements may be provided by the project sponsors or third party investors, or both;

□ shareholder agreement as part of the constitutive documents of the PPP company;

□ direct agreement (allowing the senior lender to take over the project -"step in" - under certain circumstances specified in the tender documents);

□ accounts agreement (involving a bank to control the cash flowing to and from the PPP company, to make sure that it is used in the way that has been agreed and that the PPP company's shareholders cannot siphon out cash if disaster is looming);

□ shareholder funds and subordination agreement (to ensure subordination to the senior lenders' interests);

□ security agreements (share pledge; charge over accounts; movables pledge; receivables pledge, etc.);

□ sub-contracts for construction, operations and other services;

□ parent company guarantees and other forms of credit enhancement; and

□ Legal opinions from the lender's legal advisors on the enforceability of contracts.

These agreements often contain many cross-references and therefore will generally have to be prepared as a unified package<4>

Enforceability of contracts is a key issue for lenders in their due diligence investigations. This includes the issue of the vires, or powers, of the public authority to enter into transactions. This issue is likely to be considerably more complex in cross border transactions where lenders will need to be assured that mechanisms are in place to ensure enforceability against public authorities in multiple jurisdictions. The issues of the liability attaching to Authority A on Authority B's default will also be important.