Session III: Managing Risk

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Session III Managing Risk
Tools to Mitigate Risks in Highway PPPs

• Cledan Mandri-Perrott
• Infrastructure Economics Finance Department
  (IEF)
• Workshop, PPP in Highways, Latvia May 9th 2006c

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Contents

• Risk principles
• Types of Risks
• Cash flow projections as a proxy for risk
• Risk Assessment
• Risk Structuring
• Risk Mitigation Instruments (Demand and Tariff
  Risk)
• Rolling Guarantee
• Partial Credit Guarantee

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Risk Principles

• Risk should be borne by the Party best placed to
  take on that risk
• Risk gets translated into cost i.e. the higher
  the risk the higher the cost
• Project Related Risks are those manageable by
  sponsors and lenders
• Non-Project Related Risks are those that are not
  manageable by sponsors and lenders

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Risk Assessment - 1

• Project Related Risks
• (relatively manageable by sponsors and lenders)
• Completion Risk (engineering construction cost
  / time cost control)
• Operational Performance Risk (technical
  operational know-how)
• Market Risk (Traffic)
• Financial Risk (Exchange Rate and Interest Rate
  Fluctuations)
• Environmental Risk (past and future liabilities,
  project delays, costs overruns)

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Risk Assessment - 2

• Non-Project Related Risks
• (non-manageable by sponsors and lenders)
• Political Risk (expropriation, political
  violence, currency convertibility transfer)
• Contractual Risk Regulatory Risks.
  (Governments default on contractual obligations,
  i.e., pricing formulas, right of way )
• Macroeconomics Environment -- Volatility Risk
  (changes in macro balance in relatively short
  periods, i.e., exchange rate, inflation, etc...)
• Legal Environment (rule of law, i.e., judicial
  system, regulatory procedures and arbitration)

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Transport PPP Cash Flow Fluctuations (Proxy
for risk)

• Repayment of Debt is based on project
  cash-flows (non-recourse to sponsors)
• Relatively high initial investments
• Need for longer debt tenors to justify IRR to
  sponsors

Basic Structure
US
Investment
Debt
Cash Flows
Equity
CC (Construction completion)
Years
Capital Markets Long-Term Financing
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Transport PPP Cash Flow Fluctuations (Proxy
for risk)
Risk Mitigation products Minimize cash flows
downward fluctuations (ability to repay principal
interest) Key driver Cash Flow predictability
Basic Structure
US
Investment
Cash Flows (e)
Debt
Real Cash Flows
Equity
PC (project completion)
Years
Capital Markets Long-Term Financing
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Transport PPPs Risk Assessment
Country (Economy wide) Risks (sovereign)
Project Specific Risks (non-sovereign

• Inflation, interest rate and exchange rate
  fluctuations
• Political Risk (expropriation, political
  violence, currency convertibility transfer)
• Regulatory Risks. (Governments default on
  contractual obligations, i.e., pricing formulas,
  right of way land acquisition risk,
  construction of alternate road, etc.
• Legal Environment (rule of law, i.e., judicial
  system, regulatory procedures and arbitration)

• Completion Risk (engineering construction cost
  / time cost control)
• Operational Performance Risk (technical
  operational know-how)
• Environmental Risk (future liabilities, project
  delays, costs overruns)
• Credit Risk (project leverage)

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Transport PPPs Risk Assessment
Project Specific Risks (non-sovereign)
Country (Economy wide) Risks (sovereign)
Demand (traffic) Risk Pricing Risk (regulated and
non-regulated) Environmental (past liabilities)
Risk
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Risk Structuring

• Key Stakeholders in the Risk Assessment and Risk
  Allocation of Toll Roads PPP Finance

Shareholders
Granting Authority
Lenders / Bondholders
Shareholders Agmt
Concession Agreement
Project Company
Operator
Services Purchaser
End-users Traffic Demand
Operation Maintenance Agreement (OM)
Purchase Agreement (e.g., shadow toll)
Construction Contracts
Construction Contractor
Authority Right of Way
Land acquisition and further transfer to PPP
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Risk Structuring
Political and Macroeconomic Risks
FX Risks and Refinancing Risks
Regulatory Risks
Shareholders
Granting Authority
Lenders / Bondholders
SHA
Concession Agreement
Regulatory Demand Risks
Project Company
Operator
Services Purchaser
End-users Traffic Demand
Operation Maintenance Agreement (OM)
Purchase Agreement (e.g., shadow toll
government entity)
Performance Risks
Construction Contracts
Construction Contractor
Authority Right of Way
Land acquisition and further transfer to PPP
Completion Risks
Regulatory Risks
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Risk Mitigation
Risks
Cash Flow effect
Impact
Risk Mitigation Instrument
Provider
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Demand and Tariff Risk Rolling Guarantee

• Rolling Guarantee
• A partial credit enhancement product
• provides guarantee of a specified number of
  interest and/or principal payments
• on a rolling forward basis i.e. the guarantee
  rolls forward to the next installment date
  automatically (if no claim has taken place) or
  upon payment by the issuer of a previous claim --
  so that the guarantee covers a rising share of
  remaining debt service.

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Demand and Tariff Risk Rolling Guarantee

• Rolling Guarantee when is it used?
• investors perceive a potential risk associated
  with a variation in the debt service coverage due
  to slow traffic, delays on tariff adjustments or
  both at some point within the overall bond tenor,
  or
• uneasy about a period of heavy investments (i.e.,
  rehabilitation),
• the rolling guarantee will smooth out the
  repayment profile and reduce investor concerns
  about potential timing/cash flow issues.

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Demand and Tariff Risk Rolling Guarantee
Outstanding Principal
Debt / Service Coverage Ratio
DSCR
1.5
1.0
Rolling Guarantee
Years
N
N I
N 2
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Partial Credit Guarantee
Future Flows Securitization of Tolls
Mitigation of the lower credit risk quality and
improving the transaction rating attracts
participation of Insurers to provide a wrap on
the whole transaction, improving further the
transaction credit rating.
Traffic Minimum Revenue Guarantee (Granting
Authority)
AAA Credit Rating
Partial Credit Guarantee MLA (a portion of the
credit loss on the transaction, -- debt service)
Layer of Lower Credit Risk Quality (PCG)
BBB Credit Rating
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Financial Markets

• Cross-border Debt Markets
• Global Financial Markets
• Driven by risk return balance
• Highly sensitive to political economic
  volatility (i.e., financial crisis 1997-2001)
• Bank markets have not quite return to
  developing countries infrastructure finance
• Capital markets depth and liquidity. Risk
  return oriented (new participants). Volatile.

• Local Currency Debt Markets
• Domestic savings capacities
• Bank Markets. Short-term nature. Depth and
  liquidity dependent upon financial sector reform
  and competition.
• Capital markets. Depth and liquidity dependent
  upon social and safety net reform (pensions,
  insurance, etc.) and adequate securities
  regulatory framework

• Risk Mitigation Providers

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Risk Mitigation Providers

• What is available in the market?
• Multilateral Development Banks and Donors (Aid,
  lending and guarantees)
• Export Credit Agencies (ECAs)
• Private Insurance Guarantors
• Political Risk Insurance
• Financial Guarantee providers (i.e., monoliners,
  specialized risk support)
• Derivatives

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WBG Risk Mitigation Framework
Sovereign Risks
Non Sovereign Risks
Investors / Financial Institutions
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Comparison of World Bank Group Risk Mitigation
Instruments
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Comparison of World Bank Group Risk Mitigation
Instruments - 2
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• Thank you!