The ?European Infrastructure Deal of the Year 1999' award recently attributed by Euromoney to the Beira Interior Shadow Toll Road project should not be regarded as mere chance. History demonstrates an essential fact ? project finance in Portugal is rapidly progressing towards maturity.

It all began in 1983 with the Pego Power Plant project. In spite of the natural difficulties associated with implementation of the concept due to its novelty, the project reached financial close with an international bank syndicate without major hurdles. Others followed, the specific case of Lusoponte, the concessionaire of the two road crossings over the River Tagus, being of particular importance as a market benchmark in the infrastructure area.

We believe Lusoponte is significant as a paradigmatic case demonstrating the market's and the Portuguese authorities' capacity to endorse the concept of project finance. The project, amounting to s900 million, reached financial close with an international bank syndicate on March 1995, completing the construction phase on February 1998 ? which, in the light of the technical and environmental difficulties faced, must be highlighted ? currently being in the stage of refinancing and renegotiating the Concession Agreement with the Grantor.

More recently, the market was surprised by the Government's strong commitment to improving the National Road Network by launching an ambitious programme of Public Tenders for the Concession of Motorways to be structured using project finance techniques. In this programme, despite the unanimous initial criticisms of its megalomania, for the time being the facts prove the State right: from the initial package, five projects have already overcome the critical financial close stage ? two with real tolls and three with shadow tolls ? among which two have their syndication ensured and three, for various reasons, are still at a pre-syndication stage. However, there are still some reservations concerning the real capacity of the international syndication market to absorb the projects that have not yet been placed.

With this, it has become very obvious that the Government is betting on the commercialisation of formerly public investments by implementing an effective allocation of risks with private entities. In this way, the bases for the increasing adoption of this mechanism as a means to energise the country's infrastructure network are laid down.

The role of the Portuguese State as Grantor

We do not ignore the essential aspect that project finance as a concept is essentially the fruit of political will, without which it would make no sense to write a word on this matter in Portugal. However, a distinction between this effective political will ? unquestionable in Portugal ? and the ways used in its implementation should be made.

In the light of experience gained in this process, several aspects may be clarified or even improved in future Tenders:

Creation of a central organisation to manage and monitor processes

The establishment of new structures should not be regarded as a mere bureaucratisation of the system; the creation of value and ease in the management of processes should also be a priority. With regard to the Grantor, Lusoponte was structured through GATTEL, a specific institution created to this end. Not wishing to discuss the merits and demerits of this specific case, as a concept the same should have been maintained for subsequent cases, instead of the method adopted of appointing a committee devoid of a legal autonomous structure.

Flexibility in negotiations

The structure adopted of appointing an assessment committee, albeit indirectly, created another problem. The size and complexity of the projects in question would justify the appointment of a set of advisers to the State with expertise and experience in similar international projects in order to overcome the Grantor's lack of flexibility with regard to certain aspects of negotiations which are clearly consensual in the international market.

Improvement in capacity to manage processes after financial close

By assuming the strategy of transferring the construction risk to the private initiative in road infrastructure concessions, some details should be the subject of greater attention on the part of the Grantor. The IEP, the public institution responsible for the management of the national road network, in the performance of its duty to defend the Grantor's interests, plays an important role in critical construction stages, in particular in the co-ordination with the Ministry for the Environment, approval of projects and opening of stretches to the public. Given the contractual rigidity imposed by the financing structure associated with project finance, meeting deadlines for approval is an essential aspect. We believe that the consequences for the entire project arising from possible delays in the approval process have not yet been fully understood by the IEP.

Length of the assessment/negotiation stages

It is necessary to reduce the time between the submission of bids and financial close of the projects witnessed in recent cases. In particular, where it is verified that the vast majority of this time is lost in the initial assessment of bids ? being extraordinary, on the other hand, the Government's capacity to impose extremely short periods of time between the selection of the two preferred bidders for negotiation and financial close. Even if the allegation that the administrative processes relating to protests submitted by non-selected bidders justifies such delays, it is also true that many of these protests may be avoided with a more careful legal structuring of the Tender Programmes.

Criteria for assessment

In infrastructure projects, assessment of bidders has been made almost exclusively on the basis of financial criteria. Even if we understand the logic of minimising the financial contribution of the State as Grantor, this should, however, be compensated by appropriate mandatory minimum technical criteria which might lead to the exclusion of the bidder in the event of non-compliance.

Better co-ordination among departments

The size of this type of project requires a significant co-ordination among the various organisms of the State as Grantor (in particular with regard to tax and environmental aspects). Despite the political will and understanding of problems shown by the Grantor in its dealings with the Bidders/Concessionaires, their resolution is often halted by external organisms, which have to be made aware of some particular aspects of project finance.

Legal framework

As an autonomous jurisdiction, Portuguese law has its own characteristics which have had to be tuned in order to reach a better adaptation to some standard project finance and syndicated loan principles. In spite of this generic principle, it was accepted from the outset that, given the need to adapt the legal structure of the facility agreements to international syndication, at least the whole financing package had to be structured on the basis of English law. The exception is the security package, which, in order to allow its judicial enforcement over assets located in Portugal, has been structured on the basis of Portuguese law.

The structuring of the security package under Portuguese law implies the disadvantage that certain mechanisms, whose effectiveness has already been sufficiently demonstrated in other jurisdictions, have never been tested in Portuguese courts, which may raise doubts concerning their effective applicability.

In addition to the Concession Agreements, whose structuring under Portuguese law has never been questioned by the international banking community, within the so-called project agreements particular attention has been paid to the construction contracts. The legal framework of this type of Portuguese public works agreement has always been based on the generic principle of protection of the contractor (a private entity) against possible abuse by the client (the State). Non-existent concepts in project finance such as price revisions, time extensions and additional works were largely accepted as Contractor's rights. From this perspective, the appearance of project finance obliged the creation of complex legal schemes to safeguard an effective allocation of risks between the now client (the Concessionaire) and the Contractor. Ignoring problems caused by the natural resistance of contractors to changes to agreements regarded as standard agreements, the ability always demonstrated by the parties to overcome this type of situation should be praised.

However, it should be highlighted that, with regard to the legal aspects, there is more that may (or should) be done by the Portuguese State in order to definitively be able to endorse the commitment to this type of financing structure. We mean essentially changes of a tax nature relating to, without being exhaustive, withholding tax exemptions, exceptions to the thin capitalisation rule and restrictions on the issue of bonds.

Financing structures

In terms of financing structures used in project finance, Portugal is nowadays not far off the classical rules tried and tested in similar concessions in other jurisdictions.

Share Capital

As a rule to date, major infrastructure projects in Portugal have been financed, with regard to their shareholding component, by major civil construction and public works groups. This type of interest is natural and obvious: the concessions have a strong public works component, the core business of this type of company; however, this leads to too great a focus on construction margins (which are, in theory, interests external to the concessionaire) and natural conflicts of interest between the shareholders and the contractor.

The search for specialist partners (whose creation is timidly commencing in Portugal), in spite of the strong resistance encountered in the beginning, is slowly coming to be regarded as an alternative, albeit due to an inevitable lack of liquidity on the part of the contractors to endorse capital intensive projects and long-term returns. As an alternative, domestic banks have been used as shareholders in the concessionaire, which we believe is not at all appropriate due to the natural conflicts of interest.

Subordinated Debt

Due attention has also not been paid to the structuring of subordinated debt instruments as an alternative source of financing. As a rule, it is the shareholders that have subscribed subordinated debt, regarding the return as a whole. The Portuguese market lacks structures oriented towards occupying the middle ground between the Banks and the shareholders in terms of risk. This may, however, change in the short term: the argument concerning the limited ability of contractors to provide funds for the projects is, in this respect, of particular importance and may operate as the necessary turning point. The State may also definitively foster the development of this market by changing the current restrictions on the deductibility of interest on subordinated debt for tax purposes.

Banking market

Infrastructure projects, due to their size, do not ?fit? in the Portuguese market, which implies structures designed from the outset for syndication in the international market. Portuguese banks have known to react in consequence and the most recent projects have proven their capacities in direct confrontation with the demanding European syndication market.

A word of praise is due to the EIB, which has demonstrated a strong commitment to the Portuguese market. That commitment has brought clear advantages in terms of credibility abroad, not only for the country but also the projects and local banks.

We may, however, be at a turning point. In spite of demonstrating the vitality of the Portuguese market, the current volume of projects in the structuring/syndication stage ? the road concessions are a symptomatic case ? has raised some pessimistic voices concerning the real capacity of the international market to simultaneously absorb various similar projects. The answer will be provided by the syndication departments in London.

Finally, a small remark on the issue of price. Books teach us that price should depend on the project risk. Project finance, at least in Portugal, has changed this to make it dependent on the syndication risk.

Bonds

Attempts to implement this type of financing structure in Portugal have been timid. Various causes may be pointed to as justification for this: (i) the incipient stage of most projects, (ii) legal restrictions, and (iii) tight structuring deadlines in the light of their complexity when regarded as a financing alternative ab initio. However, the market has its own financing logic, which leads us to believe that a strong entry of bonds is unavoidable. The position of large European finance houses already demonstrates this fact. Unfortunately for traditional banks, the impossibility of competing in terms of pricing and tenor is, to start with, unquestionable.

We believe, however, that a strong entry of bonds should be postponed until the construction risk is completely overcome. Even if an earlier structuring is possible, the ?investment grade? label, indispensable for the participation of the monolines and a precondition for the success of the placement, is too onerous for the standard investor in this type of concession in Portugal in monetary and balance sheet terms.

State

In specific cases, where the return on the project is not, on its own, in line with the risk to be assumed by private initiative, the State has accepted to overcome this difference by means of grants or even subordinated debt issues whose repayment is subject to the project's performance. Naturally, the minimisation of the financial contribution required from the State has been a factor taken into account in the tenders.

Securitization

The spreading of credit risk by means of securitization in infrastructure projects cannot yet be regarded as a reality in Portugal. Important steps have been taken recently with the creation of specific legislation, although this type of structure may not be regarded as a novelty even for the Portuguese market. Once again, the signs given by foreign banks are quite obvious, Portuguese banks currently being at an assimilation and preparation stage. In the long term, this type of structure may help to resolve problems of high exposure to a certain sector risk, in particular in assets in infrastructure projects.

Post closing

It still cannot be assumed that Portugal is watertight against all potential project problems ? continued defaults, termination and enforcement of security.

The big test for project finance in Portugal ? as well as for the Portuguese Government's commitment ? will be the market's reaction, in particular the international market, to a serious problem leading to enforcement of a security package. The two possible responses ? clear identification of the causes and consequent individualisation of the problem without repercussions, or widespread panic with general interpretations, even if ungrounded ? will dictate the future of project finance in Portugal. We believe, however, that if a serious problem occurs, the State as Grantor will intervene in the name and interest of public service, safeguarding the project and interests associated therewith.

Fortunately for the countries and parties involved to date, in the light of what is known concerning the projects in progress, for the time being this does not seem to be more than a utopian scenario, even considering the quantity of projects in the construction stage, unanimously considered the riskiest.

Opportunities

If a lot has been done, a lot remains to be done:

a) Road Network: Currently the major dynamic factor in the activity. In the ambitious restructuring programme for the road network launched by the Government, of the seven shadow toll concessions tendered only one is syndicated. In gross terms, we estimate that the market will still have to absorb more than s3.9 billion in road infrastructure projects, which means that it is necessary to ensure the conditions required for these transactions to achieve a successful syndication phase from the outset.

b) Railways: To date, projects launched have not been of a size sufficient to justify an international syndication. As such, the decision to structure the transactions under Portuguese law, with the consequent full absorption of the financing by the domestic market, has been taken. Current rumours about the TGV project may possibly reverse this trend. It should be noted, however, that little appetite on the part of international banks to finance projects in Portugal not structured under English law has been witnessed.

c) Harbours: A situation identical to or even more characteristic than that of the railways. There are various projects in the pipeline, but all of an immaterial size for the international market (around s60 million per project). As such, they have been absorbed by domestic banks, no major changes in this regard being foreseen in the medium term;

d) New Lisbon airport: The cherry on the cake. The project, estimated at approximately s2.5 billion, will definitively mark an era of project finance in Portugal. The political decision to move forward with this project having been made, the State is currently selecting advisers ? selection of the financial adviser is in progress ? to subsequently launch the bases of the Tender, which should also include ANA (the public organisation responsible for the management of the Lisbon, Oporto and Faro airports) in the package. It is foreseen that the public tender will be launched in 2001 so that the Airport may enter into operation in 2010. The struggle in forming of consortia is fierce, with the major names in the sector securing positions well before the decision to move to the tender was even announced.

Conclusion

Portugal is in good health. Projects go through their successive development stages without major problems, understanding with international banks is operating well, the pace of new tenders is maintained and the image of the country is improving.

New challenges will certainly appear and with them new difficulties. Next? The new Lisbon Airport.