Banks had to get comfortable with the municipal risk in Chengdu No.6

The financial close of the $74.5 million of debt facilities backing the development of the $106.5 million Chengdu No.6 water plant B broke new ground in several directions for the Chinese project finance market. Not only is the deal the first water build-operate-transfer (BOT) project in the country but more importantly it is the first large project financing which asks lenders to take Chinese municipal risk.

Sponsored by Compagnie Generale des Eaux Sahide (60%) and Marubeni (40%) and structured through special purpose vehicle ? Chengdu Générale des Eaux-Marubeni Waterworks ? the project consists of the construction and operation of the Chengdu No.6 Water Plant B.

The plant comprises two sets of raw water intake facilities, a water treatment plant, a 27km transmission pipeline and a production wastewater pipeline.

Coordinating arranger and underwriter on the deal is Crédit Lyonnais, along with the Asian Development Bank (ADB) and the European Investment Bank (EIB). Chengdu is just the third concession in the country's pilot BOT programme to close financing in any sector.

But of most significance is the project's concession agreement awarded by The People's Government of Chengdu City. And although the city is the capital of Sichuan province it ranks below the provincial government.

Getting comfortable with municipal risk required banks to acquire the details and then to assess the resources available to the Chengdu government. This is the first time this has been done by foreign investors in China, encompassing not just the financial health and mechanisms for public finance but also at the precise political status of the government. Much of the research centred on the relationship between the capital and the provincial and state governments. Says a spokesperson for Crédit Lyonnais in Hong Kong: ?The deal required us to assess the credit of the project and understand the public finance mechanisms at the municipal level. We also had to look at the relationship between the municipal government and central and provincial government.?

The analysis also required the arrangers to pinpoint the level of discretion the municipality would have in paying possible compensation if the project was terminated for whatever reason. In terms of the level of assets with which to provide compensation, the arrangers found they were comfortable, as they were with the municipality's overall existing financial position and its prospects.

Says a spokesperson for Crédit Lyonnais: ?The project takes place as part of the pilot BOT initiative which is backed by the State Development & Planning Commission. Banks have attached strong value to the fact that the risk may be with a municipal entity but that the project is taking place with the backing of central government.?

The project's cashflows are secured on an 18-year offtake agreement with Chengdu General Waterworks Company, with the municipal government acting as primary obligor. There is a pricing mechanism allowing the offtaker to take more than the set daily level giving the project some upside.

The water tariff is divided into two pieces. The first is a continuous fixed portion relating to the renminbi costs of the project while the second element of the tariff is flexible and features a renminbi/dollar indexation mechanism. This is a key feature of the pilot BOT programme ? allowing foreign investors to take comfort that profits from their dollar based investments will not disappear through movements in the foreign exchange markets. In addition, the transferability of revenues from the project is guaranteed by the central government.

Having the ADB and the EIB as the deal's principal supporters was important in attracting support from commercial banks at a time when Chinese assets were out of favour with the market. The ADB is involved on two tranches of the deal. The first is a direct loan for $26.5 million while the second ? a $21.5 million ABD complementary loan ? is funded by commercial banks but on-lent through the ADB.

The EIB, acting for the first time in a private sector financing in China, provided a $26.5 million direct loan. This is backed by a $29.15 million EIB guarantee facility syndicated to commercial banks ? representing a 110% over collaterialization of the EIB's direct facility which also splits commercial and political risk exposures. Commercial banks take on commercial risk while the EIB takes political risk on its lending ? should there be a political risk event the commercial banks are released from their commercial risk cover.

Tenors are set at 15 years for the ADB principal portion and 12 years for the remaining ADB and EIB tranches. The margins for the ADB complementary loan and the guarantee fee for the EIB guarantee facility are 280 basis points over Libor and 250bp respectively.

The debt was sold down on a targeted basis bringing in six banks and achieving a 28% oversubscription ? ANZ, Barclays Capital, Development Bank of Singapore, Dresdner, Fuji and KBC. Syndication is due to be signed in mid-August.

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Chengdu No.6 water plant B
Project company: Chengdu Générale des Eaux-Marubeni Waterworks Company

Project cost: $106.5 million

Debt: $74.5 million

Sponsors: Compagnie Generale des Eaux Sahide (60%) and Marubeni (40%)

Coordinating arranger and underwriter: Crédit Lyonnais

Multilaterals: ADB and EIB

Lawyers: Allen & Overy and Gide Loyrette Nouel