Module 5 Financial Implications of Port Reform

1. Module 5 Financial Implications of Port Reform

2. Financial Implications for Port Reform • Part A : Public-Private Partnerships in Ports : risk analysis, sharing and management • Risk Management • Contractual Risks • Approach of the different partners to risk and risk management • Concluding thoughts • Part B : Principles of Financial Modeling, Engineering and Analysis • Measuring economic profitability from the perspective of the Concessioning authority • Rating risk from the perspective of the concession holder • Financial project engineering • Financial modeling of the project • Construction of the financial model • Characteristics of the port operator Module 5

3. Fundamental risks carried by the terminal operator • Cost risks : risk of exceeding initial cost estimates for the construction or operation of the project • Revenue risks, or commercial risk : depending on traffic and revenue yields Module 5

4. Characteristics of the port operator • and associated risks • National environment (legal, economic, social and political aspects) : country risks • Industrial and commercial dimension : project risks and commercial/traffic risks • Vertical partnership with the concessioning authority : contractual risks • Horizontal partnerships with numerous players (customers, ship-owners, shippers…) : additional commercial risk • Long-term commitment : need for a clear and stable legal arrangement between the operator and the concessioning authority Module 5

5. Financial Implications for Port Reform • Part A : Public-Private Partnerships in Ports : risk analysis, sharing and management • Contractual Risks • Approach of the different partners to risk and risk management • Concluding thoughts • Part B : Principles of Financial Modeling, Engineering and Analysis • Measuring economic profitability from the perspective of the Concessioning authority • Rating risk from the perspective of the concession holder • Financial project engineering • Financial modeling of the project • Construction of the financial model • Characteristics of the port operator • Risk Management Module 5

6. Risk Management : Overview Major steps • Risk identification • Sharing of risks with public authorities • Sharing of risks with partners • Reduction of exposure to residual risk • Reduction or limitation of the consequences of residual risks • Adjustment of the expected rate of return according to the degree of residual risk Important principles • Properly allocate risks • Not make the operator carry risks that the public sector could carry at a lower cost Module 5

7. Country Risks (1/3) Legal risk : Mitigation : • lack of precision in the legislation • possibility of change in the legislation • thorough legal analysis • guarantee of legal stability • contract revision clauses • environmental study Monetary risk : Mitigation : • exchange rate fluctuations • non-convertibility of the local currency into foreign currencies • non-transferability • Payment of expenses in local currencies • Hedging products • Guarantees from the government and the Central Bank • Off-shore account Module 5

8. Country Risks (2/3) Economic risk : Mitigation : • Macro-economic factors • Market survey Political risk : Mitigation : • Expropriations • Nationalizations • Non-compliance with the contract • Inefficiency of administrative authorities • International arbitration • Inclusion of multilateral organizations among the shareholders/ lenders • Recourse to export credit agencies • Insurance cover Module 5

9. Country Risks (3/3) Interference risk : Mitigation : Direct intervention of the Public Authority in the management of the project • Contract clause limiting government authority intervention • Contract provisions allowing renegotiations Force majeure : Mitigation : • Natural risks • Industrial risks • Internal socio-political risks • Risks of war or armed conflict • Contract clauses : suspension of reciprocal obligations of the parties Module 5

10. Project Risks (1/3) Construction risks • Causes : design errors, inadequate assessment of local conditions, poor management of the job site, poor coordination of the parties • Consequences : unforeseen cost increases or delays in completion • Mitigation measures : involvement of the operator in the design, transfer of risks to the construction company, careful selection of the construction company Hand-over risks • Occur when the operator takes over the management of existing infrastructure • Mitigation measures : clause of the contract safeguarding the concessionaire against pre-existing conditions. Module 5

11. Project Risks (2/3) Operating risks : countermeasures • Non performance risk : selection of an operator with recognized experience in port and terminal management • Operating costs overruns risks : use of a fixed-price contract between the master concessionaire and the operator. Procurement risks • Cause : non-availability of critical goods and services and unforeseen increases in the cost of external resources necessary for the project • Solution : the operator can produce the critical resource himself or sign a long-term purchase contract with its producer, with a “put or pay” clause. Module 5

12. Project Risks (3/3) Financial risks : countermeasures • Risks associated with raising the shareholders’ equity or obtaining loans : raise the initial trench, establish standby credit loans • Interest rate fluctuation risk : appropriate financial instruments (rate caps, rate swaps…) • Risk of failure from the government to make good on its subsidy payment : IFI guarantees Social risks • Main challenges : special status of dockworkers, seamen, etc. under national law, port workers redundancies • Mitigation : thorough preparation to insure that the local authorities can manage delicate social situations Module 5

13. Commercial or Traffic Risks • Origin : potential shortfalls in projected traffic and pricing constraints • Usual response : through the terms of the concession agreement, sharing of the risk between the operator and the Port Authority, both in terms of responsibility and consequences Module 5

14. Concessionaire Concessioning authority Freedom of action Protection of the user, public interest Regulation Costs Tax-payer User Regulatory Risks : General View Module 5

15. Regulatory Risks : Technical regulation • Regulation of investments : verification of the compliance with… • Functional definition of thresholds triggering new investment • Construction standards • Specifications relating to security or environmental protection • Regulation of maintenance : • Commercial risks are borne by the operator • Public service obligation is defined in the performance requirements of the concession contract • The concessioning authority may impose maintenance standards to make sure that it will get the assets back in good condition. • Regulation of performance : in case of weak competition • Performance standards can concern productivity, service and capacity • Although sometimes necessary, they are difficult to impose Module 5

16. Regulatory Risks : Economic and Financial Regulation • Scope of the authorized activity • Public service obligations (continuity of service, equal access and treatment for users) • Guarantees of non-competition can temporarily compensate for the imposition of strict regulation. • Ultimate objectives : market regulated by competition • Pricing controls are necessary when the operator provides an essential public service in a position of strong market dominance • Fees or subsidies are also a tool of regulation (positive or negative concessions) Module 5

17. To be avoided Regulatory Risks : Golden Share or Blocking Minority Advantages : • oversight of the concessioning authority from within • “right to know” about decisions of the concessionaire. Drawbacks : • Invalidation of risk sharing • Conflict of interest Module 5

18. Tariff is set freely Tariff policy Risk and Port Typology • Operator handling only his own traffic : economic regulation is not necessary, but standards of maintenance can be imposed. • Operator acting on behalf of a third party in a competitive situation : the traffic risk has is carried by the concessionaire. • Operator acting on behalf of a third party in a monopoly situation : the public service dimension requires a close economic oversight. Traffic risk and profit can be shared. • Transit or transshipment traffic : economic regulation is not required, but awarding the concession to the highest bidder will allow the Port Authority to maximize its profit. Module 5

19. Other Concessioning Authority Guarantees Guarantees from the Port Authority, to be included in the contract of concession : • Standards of facilities and performance of service in the port • Land transport modes • Quality of the intermodal service at the port Module 5

20. Financial Implications for Port Reform • Part A : Public-Private Partnerships in Ports : risk analysis, sharing and management • Approach of the different partners to risk and risk management • Concluding thoughts • Part B : Principles of Financial Modeling, Engineering and Analysis • Measuring economic profitability from the perspective of the Concessioning authority • Rating risk from the perspective of the concession holder • Financial project engineering • Financial modeling of the project • Construction of the financial model • Characteristics of the port operator • Risk Management • Contractual Risks Module 5

21. Contractual Risks (1/2) Contract Management risk : Clauses of the contract governing the possibility of changes or disputes about contract implementation usually include… • Revision clauses • Contract termination or renewal clauses • Early termination clauses • Procedures for settlement of disputes Module 5

22. Contractual Risks (2/2) Risks induced by indexation : • Significant deviation of real world conditions from the indexation formula • Divergence between the indexing conditions of different contracts signed by the Port Authority and the operator Credit risk : Financial commitments are efficiently honored through the use of bank bonds. Module 5

23. Financial Implications for Port Reform • Part A : Public-Private Partnerships in Ports : risk analysis, sharing and management • Concluding thoughts • Part B : Principles of Financial Modeling, Engineering and Analysis • Measuring economic profitability from the perspective of the Concessioning authority • Rating risk from the perspective of the concession holder • Financial project engineering • Financial modeling of the project • Construction of the financial model • Characteristics of the port operator • Risk Management • Contractual Risks • Approach of the different partners to risk and risk management Module 5

24. Concessioning Authority Major issues : • Capacity of the operator to comply with the terms of the contract (financial objectives, reliability) • Degree of commitment of the shareholders • Commercial positioning of the operator • Transfer of technology and participation of national players International Financial Institutions can play the dual role of lenders and advisors to the concessioning authority. Module 5

25. Objectives : Shareholders : • All shareholders • Constructor, equipment supplier • Operator • Customer, shipper or ship-owner • Financial investor • Project internal rate of return, investment coverage ratio, return on equity • Return on the construction phase and through the upstream services provided • Return on the facility management services provided • High quality of service, reasonable rates • Life sustainability of the project Project Sponsors Module 5

26. Lenders Imposable constraints : • Debt coverage ratios • Minimum equity investment on the part of the sponsors • Replacement of equity participation by subordinate debt • Earmarking of cash flow surpluses for debt repayment • Guarantees on the part of the sponsors • Comfort letters or commitments by the concessioning authority, domiciliation of revenue or debt, assignment of debt, technical and financial performance bonds Module 5

27. Financial Implications for Port Reform • Part A : Public-Private Partnerships in Ports : risk analysis, sharing and management • Part B : Principles of Financial Modeling, Engineering and Analysis • Measuring economic profitability from the perspective of the Concessioning authority • Rating risk from the perspective of the concession holder • Financial project engineering • Financial modeling of the project • Construction of the financial model • Characteristics of the port operator • Risk Management • Contractual Risks • Approach of the different partners to risk and risk management • Concluding thoughts Module 5

28. Oversight Authority Fair competition Public service dimension Proper protection of the interests of users Commercial activity Concluding Thoughts Port Authority Module 5

29. Financial Implications for Port Reform • Part A : Public-Private Partnerships in Ports : risk analysis, sharing and management • Part B : Principles of Financial Modeling, Engineering and Analysis • Rating risk from the perspective of the concession holder • Financial project engineering • Financial modeling of the project • Construction of the financial model • Characteristics of the port operator • Risk Management • Contractual Risks • Approach of the different partners to risk and risk management • Concluding thoughts • Measuring economic profitability from the perspective of the Concessioning authority Module 5

30. Differential Cost/Benefit Analysis • Principle : comparison of a solution with a proposed project with a reference solution • Methodology : • Assessment of economic benefits and costs • The various costs and benefits must be considered net of all taxes Module 5

31. Commonly Used Economic Profitability Indicators • Socio-economic discounted profit or Net Present Value (NPV) : must be positive • Internal Rate of Return or Economic IRR : must be higher than the discount rate of the national economy, and the highest possible • Sensitivity studies Module 5

32. Investment costs • Maintenance and operation equipment • Induced infrastructure costs • Costs related to transferring traffic from one transport route to another • Possible effects of the project on town planning • Environmental and safety impacts • Increase in national added value (job creation, increase in company profits) • Increase in real income for consumers and in profits for companies (price reduction) Assessing the “economic costs” of the project • Assessment of “market” economic costs • Assessment of “non-market” economic costs • Assessment of “positive externalities” of the project Module 5

33. Financial Implications for Port Reform • Part A : Public-Private Partnerships in Ports : risk analysis, sharing and management • Part B : Principles of Financial Modeling, Engineering and Analysis • Financial project engineering • Financial modeling of the project • Construction of the financial model • Characteristics of the port operator • Risk Management • Contractual Risks • Approach of the different partners to risk and risk management • Concluding thoughts • Measuring economic profitability from the perspective of the Concessioning authority • Rating risk from the perspective of the concession holder Module 5

34. Financial Profitability and Bankability of the Project • Country and project rating : assessment of the residual risk to be borne by the private concessionaire • Setting of a minimum financial profitability threshold : assessment of the bankability of the project (forecasting of the cash flows generated by the project) Module 5

35. Assessing the Project Risks by Producing a Rating • General principles : • Listing and distributing the risks to the parties best able to assume them • Reducing the exposure of the SPC to a residual risk • Quantifying the residual risk to be borne by the SPC : country and projects ratings • Assessing the background risk : country rating • Assessing the project intrinsic risks : project rating (project checklist) Module 5

36. Need to calculate theProject Discount Rate – Cost of Capital Commonly used Financial Profitability Indicators • Payback • Internal Rate of Return • Net Present Value • Investment Cover Ratio Module 5

37. Financial Debt Remuneration Requirement • Definition of the yield to maturity of debt financing • Taking inflation into account : real and nominal interest rates • Risk rating • Conclusion on Debt Remuneration Requirement : new trends in financial markets (assets/liabilities management) lead to differentiated decision-making processes Module 5

38. Equity Remuneration Requirement • Capital Asset Pricing Model (CAPM) • “Differentiated” remuneration requirements depend on the type of shareholding • Sharing of public/private financial commitments : arbitration between financial profitability and socio-economic profitability Module 5

39. Financial Implications for Port Reform • Part A : Public-Private Partnerships in Ports : risk analysis, sharing and management • Part B : Principles of Financial Modeling, Engineering and Analysis • Financial modeling of the project • Construction of the financial model • Characteristics of the port operator • Risk Management • Contractual Risks • Approach of the different partners to risk and risk management • Concluding thoughts • Measuring economic profitability from the perspective of the Concessioning authority • Rating risk from the perspective of the concession holder • Financial project engineering Module 5

40. Definition of Financial Project Engineering The financial engineering of a project consists in seeking out the optimal terms and conditions of finance and cover for the project, based on analysis of the financial constraints of the market. Module 5

41. Financial Structuring Within the Framework of a Project Finance Set-up Main measures used to define the structure of the SPC’s liabilities : • Capital Structure Ratio (CSR) • Annual Debt Service Cover Ratio (ADSCR) • Net Present Value Debt Cover Ratio (NPV DCR) • What are the minimum requirements for these ratios in the case of a port project ? > 15% > 1.3 > 1.7 Module 5

42. Debt Structuring Four Main Intrinsic Characteristics of Debt financing : • Length or maturity of the loan : date of the last repayment • Availability period : closing date of the validity of the loan • Loan repayment terms • Average length and loan duration Module 5

43. Long-term Commercial Debt • The alternative to corporate financing : project finance • Corporate financing : Public budget finance • Pre-financing by the project sponsors • Project financing : cash flows generated by the project itself • Foreign currency loans Module 5

44. Guaranteed Commercial Debt : • Export Credits : supplier credits and buyer credits (administered, pure cover or financial credits) • Financial Credits with a multilateral “umbrella” : A-loan and B-loan Module 5

45. Bonded Debt : • Advantage : enables financial terms (margins and fees) and favorable maturities to be obtained • Drawback : creation of problems for inter-creditor relations Module 5

46. Structuring Equity and Quasi Equity • Equity provided by the public sector : contribution of assets, cash contribution or guarantee contributions, using the financing vehicles of … • the budget of the concessioning authority • export credits • bilateral financing • multilateral financing • Equity invested by the project’s sponsors • Equity invested by multilateral institutions • Equity invested by bilateral institutions • Specialist investment funds Module 5

47. Financial Engineering of the Project • The interbank market or over-the-counter market (forward) : contracts are negotiated by private agreement, the bank acts as an intermediary • The organized markets (futures) : standard contracts, future contracts and option contracts are available on the international stock exchanges, which means… • imperfection of the cover • no actual delivery of the underlying securities Module 5

48. Interest Rate Risk Management • Interest rate risk results from an increase in inflation or in real interest rates • Interest rate swaps or IRSs • Firm financial instruments in the over-the-counter market : forward-forward rate and forward rate agreement (FRA) • Firm financial instruments in the organized markets • Conditional financial instruments - interest rate options : the cap and the collar. Module 5

49. Foreign Exchange Risk Management • Foreign exchange risk within the framework of a port privatization project : consolidation exchange risk or asset risk, transaction exchange risk • Foreign exchange market : transactions between banks, standard and non-standard contract markets • The principal existing cover products : forward currency sales, currency futures, foreign exchange options Module 5

50. Counterpart Risk Management • Counterpart risk : disappearance of a counterpart previously bearing part of a risk • Project sponsors’ credit risk cover : the use of performance bonds • Project financial counterpart credit risk cover : the use of credit derivatives Module 5