Road craft
At the end of 1995, there were 972 km of motorways in use in
Portugal. Just five years later the total length of the motorway
network had increased by 53%, totaling 1,488 km. Of these 808 km
were built by BRISA, the main motorways concessionaire in Portugal,
and 680 km by the State. At the end of 2006, it is foreseen that
the total length of the motorway network in Portugal will reach a
total of 3,000 km, more than doubling the values existing at the
end of 2000.
How was this massive and rapid expansion achieved? In simple terms tenable public-private partnership.
In 1996, stimulated by the success of the Second Tagus Bridge deal (Lusoponte) ? a true case study as far as the local market is concerned and a benchmark in terms of core documentation ? the Government of Portugal decided to launch a programme of road concessions which ended up including 16 public tenders for the design, construction and operation of over 1,600 km of motorways.
The main Government objective was to maximize public interest by having a complete set of new motorways built in a shorter period of time and at a lower cost to the public than it would have been possible following the traditional procurement method. Thus, by the end of 2006, the new concessionaires will be operating 1,604 km of motorways, BRISA will be operating 1,106 km and the remaining stretches will be owned and operated directly by the State through its relevant body.
Of the 16 concessions, only three totaling 182 km are not yet under tender. The other 13 are in different stages of the tender process:
a) Seven concessions totaling 1,072 km were already awarded and construction is progressing, with the existing stretches being already operated by the concessionaire;
b) One concession with 115 km has reached the preferred bidder stage with the State and the preferred bidder preparing the financial close;
c) In two concessions totaling 162 km the State is evaluating the bidders best and final offer (BAFO)
d) Two concessions totaling 59 km reached the short list phase with the selected consortia waiting for the opening of negotiations to BAFO; and
e) One concession with 14 km is at bid presentation stage.
The seven concessions already awarded required the raising of around Eu4 billion of debt financing. From this amount the EIB provided about half, with the usual coverage by commercial banks guarantees. In one of the concessions (the Algarve SCUT) a wrapped bond issue was already put in place. Of the six concessions financed in the banking market four have already been syndicated ? all oversubscribed.
Key factors for the success of the programme
? Strong political will and commitment to the process were certainly the driving force behind the process.
? Portugal's acceptable risk profile was a necessary condition, allowing international banks to feel attracted by and comfortable with deals in Portugal.
? EIB strong involvement was very important given that it provided liquidity/funding and showed the financial players how committed the EU was to the program and how credible it was considered.
? Since the beginning there was a heavy involvement of the local private sector at both sponsor/contractor and bank level, bringing to the process an important local knowledge and commitment.
? The concept of financial re-balancing adopted by the State, ensured sponsors and debt providers of clarity from the Grantor over the assumptions of responsibility, namely in three particular fields: competing roads, unilaterally imposed modifications and certain non insurable force majeure events.
? From the beginning, strong shareholders' commitments, usually backed by commercial bank guarantees was part of the standard financial package, assuring debt providers that sponsors' commitments towards the projects would be met, typically in the range of 10 to 25% of total fund sources.
? The open-mindedness of the various Portuguese parties in accepting the use of English language, both as a working and documentation language, and English law, namely in the financial documents, which was a necessary condition for the international market due to unfamiliarity with the Portuguese language and Portuguese civil law code.
? The existence of turn-key fixed price EPC contracts (or similar forms of fixed price arrangements and completion guarantees) turned the structures into robust ones, overcoming the concept of unforeseen circumstances contained in Portuguese Law.
? The existence of an Administrative Law Code, provided a stable legislative framework under which the State negotiated the concession agreements.
Controversial issues regarding the process
For the future, especially for countries that are starting similar programmes, there were a number of aspects that, although they did not endanger the success of Portugal's road expansion, might have been ? and still could be ? done differently.
The submission of BAFO takes place three to four months after the start of negotiations between the grantor and the two short-listed consortia. This short period of time, when virtually all characteristics of the proposal put forward at bid stage are subject to change, puts a lot of pressure both on the consortia and its respective banking group, due to the time constraints to perform the entire due diligence process. Rhythm is important for a negotiation process but time is essential for the parties to understand each other and reach the equilibrium in the deal.
Notwithstanding the above, typically the State takes 6 to 9 months to evaluate BAFOs and to achieve financial close, during which time banks are requested to maintain the firm and unconditional commitment for the total debt, without protective clauses like market flex or material adverse change. Although to the State the tenor and the nature of the commitment are an important aspect of the process because it gives it time to evaluate the proposals put forward without facing the risk of selecting a ?preferred un-funded bidder?, it may cause some stress to the banks supporting the consortia and potentially limit the choice of banks available at a lead arranging level and/or increase pressure on price levels. The frozen nature of the deal has also caused the project to bear the interest rate risk between BAFO and when financial close takes place, a risk that has been either covered by the sponsors or through the market.
BAFO is usually submitted without all the necessary environmental approvals being in place, because bidders are asked to select their preferred alignment. At this stage what seems the best solution for the State in terms of the amount of work the private sector will have to perform is not necessarily the best final solution. There are a number of problems that can arise further down the line...
1) the length of the construction period, which increases due to the necessary Environmental Impact Studies that have to be completed and dully approved,
2) the burden imposed both on the Concessionaire/Contractor and the Grantor, because of the potential for extra costs arising from imposed environmental mitigation measures, particularly in difficult areas, and
3) the potential for defaults in terms of meeting interim and final deadlines and to comply with the agreements, giving rise to delays and more costs.
Although it tends to be based on objective criteria the evaluation framework has a certain degree of subjectivity; because of that some of the runner up bidders have challenged the decisions that have been taken, causing some degree of turbulence particularly to the bank group supporting the winning bidder.
Sometimes, especially on two particularly extreme occasions, this has caused the winning banking group to loose some of its members. However, whatever outcome might result from the challenge the likely impact on the concessionaire is nil, because the challenge is an issue between the challenger and the grantor. Nevertheless, the more objective the evaluation criteria are, the better for the process.
Withholding tax is always an issue because there is the imposition on the borrowers to withhold on average 20% (although is can be less, depending on double taxation agreements between Portugal and the Lender's country) of the interest paid to non-resident lenders, loans granted by the EIB being exempt. However, it is now common for the Fiscal Authorities to grant special exemptions, but only on a bank by bank basis. It would be better to have a general exemption for a series of projects or, at least, on a project by project basis.
Shadow versus Real Tolls
For a variety of reasons the concept of usage paying is always controversial on PPP deals.
Motorway users paying tolls is a common feature in Portugal. Although some very localized demonstrations against tolls have occurred, there has never been a generalized negative feeling. This might not be true in all countries considering roads PPP and that has to be taken into account.
It is probably fair to say that the basic reason for the Government to choose between a shadow or a real toll scheme has been the existence of sufficient traffic foreseen to turn the concession attractive to the private sector given the toll levels imposed by the State. Because of the demographic and economic structure of the country, in general, of these new concessions the ones located in the interior or leading to the interior are shadow toll schemes and the ones located on the coastal area are real tolls.
In countries, like Portugal, where paying tolls for road usage is common, there is no reason to think there is a higher risk profile when dealing with a real toll scheme. The main variables of the equation are still investment costs, operating costs, level of tolls and the level of traffic.
Shadow toll payment structure
Portugal has adopted a method whereby the grantor calculates payments on a vehicle basis; the tariffs are fixed according to a band structure whereby a single vehicle means a tariff varying with the level of traffic. This is a structure that has proven acceptable by the private sector, even with the concessionaire bearing traffic risk, although other structures based on availability and performance indicators or even mixed structures may be considered.
Level of State preparation
Any Government launching a program of this nature must be very careful as to what are its objectives and what are the risks and rewards that it is willing to share with the private sector. Furthermore, tender documents should state very clearly what are the requirements that bidders have to fulfill and the evaluation criteria should be as transparent and objective as possible. Governments have also to be aware that this kind of projects, with its specific characteristics and needs, will probably require special (or taylor made) structures on the Grantor side, at all levels that will deal in operational terms with the project, e.g., public works, planning, treasury, environmental, etc. This is true because generally these deals are governed by contracts imposing financial responsibilities and penalties for lack of performance. An agency or other type of government body duly empowered to administrate the contracts and make sure that all the regular Government bodies performs as it is required by the agreements will be probably a suitable solution. The costs will certainly be affordable when compared to the million of Euro in compensations that poor contract management may have as consequence.
Constraints to a potentially successful programme
In order to be successful the list of details that should be taken into account when launching a road concession program is quite extensive. On top of that, there are also a group of factors that might have a negative impact in the degree of success of such a program, especially if we think of countries out of Western Europe and North America.
Countries whose exposure to will require provisioning for country risk and which face tight country limits in the international banking market will probably have a hard time selling a large program in the international market.
Likewise, countries with a thin local currency market may face some challenges in finding local currency to finance the projects in order to avoid exchange rate risk and will probably face some problems with the interest rate risk coverage.
Countries with a lack of tradition and habits of users paying tolls will have to implement some kind of shadow toll scheme, which brings to the table the sovereign risk as an issue that will have to be addressed.
The lack of a stable legislative environment, namely in terms of concession law, might also prove to be an obstacle to a successful launching.
The future
In conclusion, and even takng into account all the aspects that might have been structured or carried out in a different fashion, the success of the Portuguese programme is evidenced by the results obtained; this success is even more significant if we bear in mind its pioneer character and the dimension of this program versus the dimension of the country. This is certainly an encouragement for both Portugal in terms of future programs or initiatives in other sectors and for other countries that can gain confidence from the Portuguese experience that they will achieve their proposed objectives should they pay the right attention to the relevant details. n
Contact: Américo Carola, Director, Head of Project Finance, BCP Investimento, SA, Av. José Malhoa, Lote 1686, 1070-157 Lisboa, Portugal. Tel: +351-217 218 420. Fax: +351-217 218 308. E-mail: americo.carola@bcp.pt
How was this massive and rapid expansion achieved? In simple terms tenable public-private partnership.
In 1996, stimulated by the success of the Second Tagus Bridge deal (Lusoponte) ? a true case study as far as the local market is concerned and a benchmark in terms of core documentation ? the Government of Portugal decided to launch a programme of road concessions which ended up including 16 public tenders for the design, construction and operation of over 1,600 km of motorways.
The main Government objective was to maximize public interest by having a complete set of new motorways built in a shorter period of time and at a lower cost to the public than it would have been possible following the traditional procurement method. Thus, by the end of 2006, the new concessionaires will be operating 1,604 km of motorways, BRISA will be operating 1,106 km and the remaining stretches will be owned and operated directly by the State through its relevant body.
Of the 16 concessions, only three totaling 182 km are not yet under tender. The other 13 are in different stages of the tender process:
a) Seven concessions totaling 1,072 km were already awarded and construction is progressing, with the existing stretches being already operated by the concessionaire;
b) One concession with 115 km has reached the preferred bidder stage with the State and the preferred bidder preparing the financial close;
c) In two concessions totaling 162 km the State is evaluating the bidders best and final offer (BAFO)
d) Two concessions totaling 59 km reached the short list phase with the selected consortia waiting for the opening of negotiations to BAFO; and
e) One concession with 14 km is at bid presentation stage.
The seven concessions already awarded required the raising of around Eu4 billion of debt financing. From this amount the EIB provided about half, with the usual coverage by commercial banks guarantees. In one of the concessions (the Algarve SCUT) a wrapped bond issue was already put in place. Of the six concessions financed in the banking market four have already been syndicated ? all oversubscribed.
Key factors for the success of the programme
? Strong political will and commitment to the process were certainly the driving force behind the process.
? Portugal's acceptable risk profile was a necessary condition, allowing international banks to feel attracted by and comfortable with deals in Portugal.
? EIB strong involvement was very important given that it provided liquidity/funding and showed the financial players how committed the EU was to the program and how credible it was considered.
? Since the beginning there was a heavy involvement of the local private sector at both sponsor/contractor and bank level, bringing to the process an important local knowledge and commitment.
? The concept of financial re-balancing adopted by the State, ensured sponsors and debt providers of clarity from the Grantor over the assumptions of responsibility, namely in three particular fields: competing roads, unilaterally imposed modifications and certain non insurable force majeure events.
? From the beginning, strong shareholders' commitments, usually backed by commercial bank guarantees was part of the standard financial package, assuring debt providers that sponsors' commitments towards the projects would be met, typically in the range of 10 to 25% of total fund sources.
? The open-mindedness of the various Portuguese parties in accepting the use of English language, both as a working and documentation language, and English law, namely in the financial documents, which was a necessary condition for the international market due to unfamiliarity with the Portuguese language and Portuguese civil law code.
? The existence of turn-key fixed price EPC contracts (or similar forms of fixed price arrangements and completion guarantees) turned the structures into robust ones, overcoming the concept of unforeseen circumstances contained in Portuguese Law.
? The existence of an Administrative Law Code, provided a stable legislative framework under which the State negotiated the concession agreements.
Controversial issues regarding the process
For the future, especially for countries that are starting similar programmes, there were a number of aspects that, although they did not endanger the success of Portugal's road expansion, might have been ? and still could be ? done differently.
The submission of BAFO takes place three to four months after the start of negotiations between the grantor and the two short-listed consortia. This short period of time, when virtually all characteristics of the proposal put forward at bid stage are subject to change, puts a lot of pressure both on the consortia and its respective banking group, due to the time constraints to perform the entire due diligence process. Rhythm is important for a negotiation process but time is essential for the parties to understand each other and reach the equilibrium in the deal.
Notwithstanding the above, typically the State takes 6 to 9 months to evaluate BAFOs and to achieve financial close, during which time banks are requested to maintain the firm and unconditional commitment for the total debt, without protective clauses like market flex or material adverse change. Although to the State the tenor and the nature of the commitment are an important aspect of the process because it gives it time to evaluate the proposals put forward without facing the risk of selecting a ?preferred un-funded bidder?, it may cause some stress to the banks supporting the consortia and potentially limit the choice of banks available at a lead arranging level and/or increase pressure on price levels. The frozen nature of the deal has also caused the project to bear the interest rate risk between BAFO and when financial close takes place, a risk that has been either covered by the sponsors or through the market.
BAFO is usually submitted without all the necessary environmental approvals being in place, because bidders are asked to select their preferred alignment. At this stage what seems the best solution for the State in terms of the amount of work the private sector will have to perform is not necessarily the best final solution. There are a number of problems that can arise further down the line...
1) the length of the construction period, which increases due to the necessary Environmental Impact Studies that have to be completed and dully approved,
2) the burden imposed both on the Concessionaire/Contractor and the Grantor, because of the potential for extra costs arising from imposed environmental mitigation measures, particularly in difficult areas, and
3) the potential for defaults in terms of meeting interim and final deadlines and to comply with the agreements, giving rise to delays and more costs.
Although it tends to be based on objective criteria the evaluation framework has a certain degree of subjectivity; because of that some of the runner up bidders have challenged the decisions that have been taken, causing some degree of turbulence particularly to the bank group supporting the winning bidder.
Sometimes, especially on two particularly extreme occasions, this has caused the winning banking group to loose some of its members. However, whatever outcome might result from the challenge the likely impact on the concessionaire is nil, because the challenge is an issue between the challenger and the grantor. Nevertheless, the more objective the evaluation criteria are, the better for the process.
Withholding tax is always an issue because there is the imposition on the borrowers to withhold on average 20% (although is can be less, depending on double taxation agreements between Portugal and the Lender's country) of the interest paid to non-resident lenders, loans granted by the EIB being exempt. However, it is now common for the Fiscal Authorities to grant special exemptions, but only on a bank by bank basis. It would be better to have a general exemption for a series of projects or, at least, on a project by project basis.
Shadow versus Real Tolls
For a variety of reasons the concept of usage paying is always controversial on PPP deals.
Motorway users paying tolls is a common feature in Portugal. Although some very localized demonstrations against tolls have occurred, there has never been a generalized negative feeling. This might not be true in all countries considering roads PPP and that has to be taken into account.
It is probably fair to say that the basic reason for the Government to choose between a shadow or a real toll scheme has been the existence of sufficient traffic foreseen to turn the concession attractive to the private sector given the toll levels imposed by the State. Because of the demographic and economic structure of the country, in general, of these new concessions the ones located in the interior or leading to the interior are shadow toll schemes and the ones located on the coastal area are real tolls.
In countries, like Portugal, where paying tolls for road usage is common, there is no reason to think there is a higher risk profile when dealing with a real toll scheme. The main variables of the equation are still investment costs, operating costs, level of tolls and the level of traffic.
Shadow toll payment structure
Portugal has adopted a method whereby the grantor calculates payments on a vehicle basis; the tariffs are fixed according to a band structure whereby a single vehicle means a tariff varying with the level of traffic. This is a structure that has proven acceptable by the private sector, even with the concessionaire bearing traffic risk, although other structures based on availability and performance indicators or even mixed structures may be considered.
Level of State preparation
Any Government launching a program of this nature must be very careful as to what are its objectives and what are the risks and rewards that it is willing to share with the private sector. Furthermore, tender documents should state very clearly what are the requirements that bidders have to fulfill and the evaluation criteria should be as transparent and objective as possible. Governments have also to be aware that this kind of projects, with its specific characteristics and needs, will probably require special (or taylor made) structures on the Grantor side, at all levels that will deal in operational terms with the project, e.g., public works, planning, treasury, environmental, etc. This is true because generally these deals are governed by contracts imposing financial responsibilities and penalties for lack of performance. An agency or other type of government body duly empowered to administrate the contracts and make sure that all the regular Government bodies performs as it is required by the agreements will be probably a suitable solution. The costs will certainly be affordable when compared to the million of Euro in compensations that poor contract management may have as consequence.
Constraints to a potentially successful programme
In order to be successful the list of details that should be taken into account when launching a road concession program is quite extensive. On top of that, there are also a group of factors that might have a negative impact in the degree of success of such a program, especially if we think of countries out of Western Europe and North America.
Countries whose exposure to will require provisioning for country risk and which face tight country limits in the international banking market will probably have a hard time selling a large program in the international market.
Likewise, countries with a thin local currency market may face some challenges in finding local currency to finance the projects in order to avoid exchange rate risk and will probably face some problems with the interest rate risk coverage.
Countries with a lack of tradition and habits of users paying tolls will have to implement some kind of shadow toll scheme, which brings to the table the sovereign risk as an issue that will have to be addressed.
The lack of a stable legislative environment, namely in terms of concession law, might also prove to be an obstacle to a successful launching.
The future
In conclusion, and even takng into account all the aspects that might have been structured or carried out in a different fashion, the success of the Portuguese programme is evidenced by the results obtained; this success is even more significant if we bear in mind its pioneer character and the dimension of this program versus the dimension of the country. This is certainly an encouragement for both Portugal in terms of future programs or initiatives in other sectors and for other countries that can gain confidence from the Portuguese experience that they will achieve their proposed objectives should they pay the right attention to the relevant details. n
Contact: Américo Carola, Director, Head of Project Finance, BCP Investimento, SA, Av. José Malhoa, Lote 1686, 1070-157 Lisboa, Portugal. Tel: +351-217 218 420. Fax: +351-217 218 308. E-mail: americo.carola@bcp.pt
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