6.4 Project Study and Design Sections "The Study"

The project study and design shall include at least the following sections:

a. Detailed Study of Need

The detailed study of need aims at identifying the gabs in public services, and analysing their type and volume in details, considering the suitability of the proposed project to meet that need, and identifying the project's best parameters to meet that need.

The gabs mean any failure in provision of public service in terms of:

• The provided service Quality;

• The provided service Quantity; and/ or

• The service non-existence or non-provision of at all.

Naturally, the Federal Entity concerned with the project shall provide a detailed explanation of the now existing gaps and deficiencies when proposing the joint project. This explanation shall constitute part of the file submitted to the Financial and Economic Committee, stating "high level" initial details about them. To ensure verifying the data set out in the Federal Entity file, the Technical Bureau and the project consultants, who assist the Project Committee and the work team in preparing this study, shall carry out a comprehensive analysis of the need as follows:

First: Project Suitability to State Strategic Objectives

The Federal Entity vision and the desired services shall be studied from the State perspective and polices for the sector development as well as the Federal Entity strategic objectives and priorities. The proposed project shall be analyzed in terms of its conformity with these priorities and its contribution in executing the sector policy by studying and analysing the following main aspects:

• The project scale and its impact on State budget.

• The expected outcomes of the service provision.

• The expected schedule for service provision commencement.

• Level of demand for the service and citizens need for it.

Second: Readiness for launching and keeping up with the project

The work team ability to proceed with the project shall be ensured if the project is approved by the Financial and Economic Committee and the Cabinet, and its implementation shall be supervised throughout its period. Thus, the readiness shall be evaluated at two levels.

The first level relates to the competency of the team launching the project up to the contract-awarding phase. It shall be ensured that contracting with all required consultants is completed and that the Project Committee members and the work team are aware of the sector conditions and ready to allocate the required time to the project. The second level of readiness shall be evaluated later as it relates to the post-awarding phase, where the Federal Entity readiness to allocate a work team for following up the project implementation shall be ensured. The readiness evaluation scope shall extend to cover the general financial aspects. Coordination shall be carried out with the Ministry to make sure that state budget can cover the financial liabilities resulted from the project.

Third: Project Parameters suitable for Bridging the Existing Gaps

After ensuring the project alignment with the strategic objectives of the Federal Entity and readiness to launch the project, follow up its implementation and meet the financial liabilities, the proposed project outputs, the minimum required specifications and the related performance evaluation indicators should be identified. An initial list of the public and private properties, where appropriate, which the project needs and the partnership pattern expected to be approved shall be developed.

b. Technical and Practical Implementation Viability Study

This study includes analysing the technical aspects of the joint project in terms of obtaining the required outputs as reached in the above-mentioned study of need, and identifying the criteria of operation, used technology and maintenance. The study also includes reviewing the outlines of the project's potential engineering designs and their implementation viability by comparing them with the approved constructional standards and measures in the state and their conformity with the relevant laws.

On the other hand, the site shall be technically studied by carrying out a terrain analysis through the topographic studies and an analysis of the soil nature and its underground components by studying the technical geography (or what so called geotechnical study).

c. Legal Study

This study is based on an analysis of the legislative, organizational and contractual framework for the joint project. The purpose of this study is to consider the potential legal structures of the project based on the international best practices of the similar projects, and to recommend the best legal framework in terms of conformity with the applicable laws and regulations in the state. This study is the essence of the legal consultant duties, who shall carry out a detailed review of all related legislations and their effect on the project, any regulatory requirements relating to the project, and the required permits and the method of obtaining it and their impact on the project schedule. The study shall cover the taxes (if applicable) that will be imposed on the project company. If the legal consultant found any conflict between the applicable laws and the international practices in a manner that may affect the investors' attractiveness, it shall suggest the legislative amendments, which would put the project on a par with similar global projects.

When preparing the legal study, attention shall be given to the main articles and provisions to be included in the PPP contract, so that the legal consultant shall put the outlines of the PPP contract. The legal consultant shall scrutinize the phases of the private partner selection, the consequent establishment of the project company and the possibility of the state involvement. It shall prepare any decrees relating to this phase such as the acquisition decrees and fee collection decrees in the name of the Federal Entity. This matter aims at identifying and anticipating any obstacles that may hinder or delay the selection procedures and work commencement in order to take them into consideration when evaluating the project implementation viability.

If the project relates to existing facilities and the Federal Entity seeks to enter into partnership with the private sector for developing, restoring, preparing, maintaining, rehabilitating or operating the same, the study then shall include any existing contracts related to the project, whether there they are employment, supply, lease or maintenance contracts, and identify whether those contracts will be assigned or transferred to the project company/private partner or will be terminated.

The joint project site may come first in the investors' considerations. After studying and evaluating the site technically within the study of the technical and practical implementation viability, the legal study shall highlight the ownership of the land on which the project will be established. This phase includes carrying out comprehensive investigations regarding the site ownership and any obstacles that may hinder its availability, and accurately identifying the expected schedule to acquire it. The Ministry/concerned Federal Entity shall coordinate with the concerned authorities in the local governments to make the arrangements required to acquire the land on which the project will be established according to the applicable procedures in this regard.

In some cases, the site provided by the Federal Entity to the project company shall not be limited to the land only, it may include also other assets such as existing facilities, fixtures and equipment. Accordingly, this point shall be taken into consideration when preparing the study.

d. Environmental Impact Assessment Study

Pursuant to Article No. 4 of the Federal Law No. 24 of 1999 on environment protection and development, as amended by Federal Law No. 20 of 2006 regarding "environmental impact assessment", it states that "without prejudice to the provisions of the above article, the agency shall, in coordination with the competent authorities and other relevant entities, conduct the environmental impact assessment of the project and the establishment to be licensed. No project or establishment shall start the activity before obtaining the license aforementioned in the previous article including environmental impact assessment."

When studying the environmental impact assessment of the joint project, it is necessary to ensure that the initial environmental examination and the environmental impact assessment studies are carried out for projects that may threaten the environment due to its scale, nature, impact or activities. The study shall include the sustainability standards and factors, the climate change and reduction of carbon emissions to support the green development projects.

The environmental impact assessment study is defined as a study aiming at identifying, estimating and evaluating the impacts of the proposed project on the environments, and identifying the measures of mitigating the negative impacts and increasing the positive impacts on the environment and natural resources. The study shall be carried out before deciding to approve or reject the project.

The environmental impact assessment study shall include many basic information, including, but not limited to, policies framework, legal and administrative frameworks for the project, description of the project surrounding environment, description of the project potential environmental impacts and analysis of the project alternatives, if any. The most important pivot in this study may be the one relating to the "Environmental Management Plan". Environmental Management Plan is defined as "a set of mitigation measures, monitoring and control means and institutional procedures taken during project establishment and operation and would remove or mitigate the negative environmental impacts to be at levels locally acceptable, if any, otherwise to be in compliance with the UN standards.

It is expected that the environmental impact assessment study in this early phase of the joint project study and design shall be limited to the project initial environmental examination. The environmental impact assessment study shall be carried out upon a request of Ministry of Environment and after obtaining the Cabinet approval for implementing the joint project. The responsibility for following up the environmental impact assessment may be transferred during the project implementation phase to the private partner. This study usually requires sufficient time for developing the baseline upon which the project environmental impact shall be assessed and the appropriate steps shall be taken to minimize its negatives, if any.

The environmental requirements shall not be limited to compliance with the environmental legislations and to obtaining the approval of the environmental authorities, but they shall include the necessity to comply with the global measures in some cases based on the funders or guarantors request.

e. Study of Social Consequences

This study includes identifying the joint project social impacts on the relevant societies and residential communities surrounding it and assessing any consequent negative impacts. The study also analyzes the project impact on other ongoing or planned development works in the area. The project impact on the State Emiratization policies and programs relating to protecting the federal government interests and national objectives shall be studied. Therefore, the study shall include, but not limited to, indicators for the job emiratization in the private partner or a list of the jobs to be emiratized to ensure that the emiratization process is not stumbled, while raising the service quality and reducing the cost for the federal government.

f. Financial Study

The first step in the financial study is to evaluate the expected costs and revenues of the joint project in order to build the financial model based on them, and to identify the financial integrity of the joint project within various assumptions. The financial study shall include the following sections:

Expected Cost Study

This study shall include studying the capital costs, maintenance costs and the operational costs.

The capital costs include, but not limited to, the costs of design, raw materials, building and construction, machines, fixtures and equipment. The capital costs also include the labor and management costs in the construction phase, including the financial, legal and technical services and the project management, as well as any costs relating to compliance with the legislative and regulatory rules and limitation of risks relating to the construction phase.

The operational costs are associated with the operation phase in the joint project life cycle. These costs aim at ensuring the work organisation to procure the service, and include the labor expenses (including wages, salaries, employees dues, due pensions, insurance subscriptions, employees training and development, annual leaves, traveling, and any expected costs to lay off the excess employees), the raw materials, consumables, direct management costs and insurance. Any costs relating to minimizing risks in the operation phase and complying with the legislative and regulatory rules shall be calculated.

Project revenues

According to the project nature, we shall distinguish between two forms of the potential partnership. The first form is known as "Government Pays", in which the private partner provides the service to users free of charge in exchange for obtaing payments form the Federal Entity. The alternative form is known as "User Pays", in which the service is provided in exchange for fees to be paid by the users. In both forms, Federal Entity is one who will pay the private partner. When the Federal Entity assigns the private partner/the project company to collect fees, it shall do that task in the name and for the account of the government. Therefore, such money shall not subject to retention, deduction or set off because it belongs to the public sector.

The revenue prospective varies depending on the concerned entity. For the Federal Entity, the project revenues consist of the fees collected from the users and depend on the imposed fees and the level of demand for the service. It shall be noted that the Federal Entity is the one that shall identify the fees without any intervention by the private partner. As for the level of demand for the service, it is difficult to estimate it accurately, especially if that service was not available before and thus there is no historical information explaining the pattern of consumption. Therefore, this matter may require involving specialised consultants to carry out field tests and market study. The expected project revenues depend on the approved assumptions in terms of the project ability to issue invoices and collect fees and the fee suitability to the consumers' ability to pay.

For the private partner, the revenues consist of the dues and payments it receives from the Federal Entity for carrying out the works assigned thereto under the PPP contract. The private partner dues and payments structure often depends on two main components:

First: Fixed component for the service and project availability (availability based fee), where the Federal Entity regularly pays fixed amounts to the partner after ensuring that the service is provided at the level, quality and standards agreed upon in the PPP contract.

Second: Variable component depending on the amount of the provided service or the production quantity (Output based fee) or demand for service. Thus, the partner payments shall be, to some extent, associated with the project revenues through the variable component (output based fee). It shall be noted that the importance of this variable component in the private partner payments relatively reflects how the demand risks are distributed between the Federal Entity and the private partner. For example, if the project company payments depend only on the project and the service availability, i.e. on the fixed element (availability-based fee), the Federal Entity shall solely bear the responsibility for all demand risks. In such case, the contract shall be a management contract or a management and operation contract.

Third: Incentives and rewards: These incentives and rewards will be paid to the private partner if it provides distinguished services in terms of its efficiency, quality and exceeds the agreed standards of quality and performance or reducing the operation costs.

On the other hand, the dues and payments structure shall include fines and penalties to be imposed on the private partner if it fails to provide the service with the agreed quantity or quality. In addition, there shall be clear provisions ensuring the government right to review the prices and to make changes in the services and their relationship with the payment mechanism and the amended price.

In all cases, the private partner dues expected throughout the project period shall ensure recovering the total costs necessary to meet the required output specifications. The financial model aims at verifying this matter based on the current net value of the cash flows, and thus identifying the joint project implementation viability in terms of attracting financing and the investors' interest.

Financial Model

This model aims at measuring the joint project financial viability (credit validity and eligibility), financial sustainability and financing sources. The financial model focuses on the calculating the current net value of the cash flows and the internal return rate of the project throughout its period based on the total expected cost and the private partner payments. A suggested structure for the project shall be designed, which explains the relationship between the Federal Entity, the private partner and/or the single purpose vehicle established by the investor especially for implementing the project, the lenders, shareholders, suppliers, subcontractors and other stakeholders.

This suggested project structure shall include the financing structure, the appropriate returns for the shareholders rights, the debt finance costs and its main conditions (including, for example, debt service coverage ratios, if any). The development of the best capital structure for the project is an essential part of this analysis, as it directly affects the ability of the project financing.

The revenues overestimation and complacency in cost estimation are the most common deficiencies when preparing the financial model. Therefore, we shall depend on actual assumptions, as they are the main elements of the financial model and affect the cash flows at various levels according to their nature. The assumptions shall be explained in details due to their significant impact on the conclusions in relation to the financial sustainability of the joint project.

We mention here for example the growth variable in demand that affects the project revenues and the private partner payments in the event that they are linked with the production quantity through the variable element (output based fee). The other variables affecting the cost elements include the inflation rate that affects the labor and raw material cost or the assumption of the equipment and fixtures consumption rate, which is reflected on the cost of some assets replacement and the maintenance cost.

The assumptions followed during preparing the financial model shall be in line with the way of distributing risks between the Federal Entity and the private partner. This matter constitutes the core of the joint projects. The most important assumption in the financial model relates to the finance, its structure between debt, capital and its cost, i.e. the deduction ratio rate used to calculate the current net value of the cash flows. The deduction ratio shall be calculated based on the appropriate the government bonds return (to be selected at the evaluation time and based on the project period), plus an appropriate risk margin to identified by the project consultants.

The financing structure is an essential element as it directly affects the financing viability. The financing viability and the investor interest to participate in the joint project capital depend on the calculation of the current net value of the cash flows. The internal return rat (IRR), which shall exceed the required hurdle rate, shall be calculated. The current net value of the project shall not be less than zero, taking into consideration the deduction ratio approved by the investor.

Calculation of some financial ratios shall assist in evaluating the financial institution readiness to fund the joint project. We recall, for example, the annual ratio of debt service coverage that evaluates the private partner/project company ability to serve the debt from its annual cash flow. This ratio shall be calculated based on the net operational income of the project over the year divided by the project debt service over the year. Another example is the loan life coverage ratio, which represents the number of years required to cover the loan and depends on similar calculation. This ratio is considered on the basis of the whole loan period, i.e. the expected operational cash flow divided by the existing debt in the calculation date.

The financial model shall be sufficiently flexible to accommodate modification of the main variables and to analyse the financial model sensitivity based on them, where the impact of these variables on the current net value of the project and IRR shall be measured.

The following are some variables that may be important in considering the sensitivity:

• Project period.

• Inflation rate

• Construction cost

• Total operational costs

• Demand for service level

• Finance conditions

Accordingly and for various scenarios based on various assumptions of the main variables, the financial results of the financial model - whether at the level of IRR or the current net value of the cash flows or through calculating some financial ratios - shall explain the joint project viability to attract financing from financial institutions and the potential investors interest to participate in the capital. The financial model also helps in evaluating the need to guarantees and financial support to promote the joint project credit worthiness .

It may be useful in this phase to test the market reaction regarding the assumptions adopted in preparing the financial model. This matter shall serve as an evaluation of the project reality and determinants. We can achieve this goal by holding workshops, lectures and field presentations and requesting evaluation notes from the potential investors. The transaction Advisor shall carry out this test in cooperation with the Technical Bureau team and the relevant Federal Entity under the supervision of the project committee.

Risk Matrix

A risk matrix shall be prepared for each project individually. This matrix identifies the joint project risks and their occurrence probability, and assesses their financial impacts, their mitigation methods and distribution on the party(s) who can manage them. The following is a guiding list of the most common risk categories to be taken into consideration in details when preparing the risk matrix.

The financial model reflects the risk distribution approach by two methods: by amending the deduction rate or by explaining the impact of these risks on each cost element. The second method may be preferred due to its focus on each cost risk and clarification of the financial impact of each risk. This method also ensures more accuracy as some risks have an impact in specific phases over project period and their impact may decrease or increase in the future during the project implementation. This matter would provide a realistic image of the project in terms of size, cost and safety, financing probability and continuity.

For more information on the risk distribution matrix, please refer to appendix (2).

g. Study of Impacts on Public Finances

The purpose of this study is to assess the joint project impacts on the state public finances, where it compares the project revenues that will be credited to public treasury, along with the cost the state will incur throughout the project life cycle.

Studying the project impact on public finances depends on calculating the expected net value of amounts incurred by the state after taking into consideration the revenues, if any, and the costs. The schedule of these payments shall be analysed, and they shall be compared with any other dues from the treasury, whether they are resulting from other joint projects or any other source.

As a general rule, these payments shall be within the limits of the financial endurance, i.e. they shall be within the limits of the Federal Entity budget and accepted by the public treasury in light of the government financial priorities.

If it is found that the government is not able to meet such financial liabilities, the Project Committee may amend the output specifications, without prejudice to the targeted benefits from the project, aiming to decrease the project costs on the general balance sheet.

• State revenues from the joint project

The joint project may generate revenues in the state treasury if it relates to the state main public utilities such as electricity, water, transportation, etc. by imposing fees on users for using the service provided by the joint project. These fees shall not be the followed rule in all joint projects as there are some project types that do not provide direct service for the user such as a tunnel construction project. Thus, some projects may not generate any revenues in the state treasury. As for the projects which generate revenues in the state treasury such as a power plant establishment project, it is not necessary to generate revenues sufficient to cover the costs incurred by the state. The state may also support the tariff imposed on users if it found that citizens or part of them are not able to bear it.

• Joint project cost for the state

The state costs in the joint projects are primarily consist of the payments it pays the private partner/project company for implementing the project. As we stated above, the project company is not entitled to deduct its payments from the collected fees if the state assigns it to the collection process. The reason behind this approach is that the private partner collects such fees for and in the name of the government, which in its turn pays the private partner/project company according to the provisions contained in the PPP contract. Therefore, the money collected by the project company shall not subject to attachment, deduction or set off because it falls under the scope of public funds. The other costs incurred by the state arise from the state financial support provided to the project. This support may be made by ensuring a minimum of demand and consequently a minimum of revenues. The support may be also in the form of capital support, where the state contributes in financing the project by soft loans it obtains from the creditors.

h. Information Verification and Financial Study Approval

The Project Committee shall verify that all information set out in the project study is accurate, confirmed and complete as much as possible. In order to do so, the committee may require the project consultants to provide the following:

• Report confirming the collected information reality and sources.

• Details, reality and appropriateness of the assumptions on which the financial model is prepared.

• Explanation of evaluation methodologies of various costs, including the financial assessment of risks.

• Documented confirmation that the financial study inputs are accurate and verified.

• Report confirming achievement of value for money principle for the proposed project, which includes "quality for cost" analysis, and ensuring that the contracting through partnership with the private sector is the ideal way comparing to the remaining methods of purchase.

• Confirmation of budget availability: This confirmation is necessary for meeting the financial liabilities relating to the project.