In summer 2008, before the Lehman collapse and with oil prices well above $100 a barrel, Russian PPP looked like an attractive sector for many foreign commercial banks, particularly those that were already depressed by the very aggressive margins being offered for Russian corporate debt. And with a high level of liquidity in the domestic banking sector, sponsors were optimistic that PPP deals could be financed with long term syndicated Rouble loans, plus some smaller foreign currency tranches at realistic pricing.

But the realities of the market following the global financial crash mean that the three major pathfinder PPP projects – Pulkovo Airport, the Moscow-Minsk M1 Odintsovo Bypass and M10 Moscow-St Petersburg – closed in close succession in April, did so with the help of a small number of state owned commercial banks, and a major role for the development bank Vnesheconombank (VEB). In addition, a state infrastructure fund and government guaranteed bonds have also had to be deployed to put financing in place.

Creating climate for close

A crucial step was the signing by Prime Minister Vladimir Putin on 1 April of a decree allowing government guarantees for bonds issued by PPP sponsors for specific projects. This measure had been debated since autumn 2009, and ran into opposition in Parliament, but was finally passed. Under the terms of the decree the state can guarantee up to 50% of total PPP project costs via 20-year guaranteed bonds denominated in Roubles.

In addition to approving bonds for the M10 and M1, the decree included guarantees for the Western High Speed Diameter, which may now again include private finance despite the decision in February 2009 to go the pure public procurement route.

With global financing markets settling down towards the end of 2009, there had been hopes that domestic and some foreign commercial bank lenders might come in on the two toll roads and St Petersburg’s Pulkovo Airport. But instead of waiting, the government has pushed the M10, M1 and Pulkovo projects towards financial close, a measure of its determination to complete the first round of PPP projects even if the accent is more on the public versus private element of the PPP mix.

The M1 Moscow-Minsk Odintsovo Bypass has no bank debt at all, but relies upon support from a state infrastructure fund plus guaranteed bonds, in addition to project equity. And the Moscow-St Petersburg toll road PPP is being backed by a state owned savings bank, Russian development bank VEB, plus guaranteed bonds.

Pulkovo Airport is also heavily dependent upon multilateral development banks and VEB. However in this case there is a joint EBRD/IFC Eu190 million B Loan which is set to be syndicated in the coming months.

However, regardless of the make up of the debt packages, and the big role played by VEB and state guarantees, all the various parties from government departments to financial advisors, lawyers and bankers have learned a lot from the process. And with tens of billions of projects on the drawing board, the Russian government is committed to PPP as a way of bringing capital into the infrastructure sector, and foreign banks are likely to play a role in the future as the global financial sector continues it recovery.

“The M10 and Odintsovo Bypass projects are now considered to be role models for PPP projects which generate Rouble revenues and for which foreign exchange (FX) risk is not acceptable to lenders,” comments Andrei Sharonov, managing director and head of investment banking at Troika Dialog in Moscow. “Such FX risk cannot be hedged in large amounts for long term projects, since the maximum term of available market hedging instruments is currently 10 years, whereas most PPP projects are 20 years and more. In the future, Euro or US Dollar financing will be required for Euro or Dollar-revenue linked projects, so foreign commercial banks and international financial institutions will have an opportunity to participate in Russian PPPs,” says Sharonov.

“Pulkovo Airport uses a BOOT structure under the St Petersburg PPP Law where the project company owns the assets, whereas the two road PPPs are being implemented under a BOT scheme pursuant to the Federal Law on Concession Agreements,” notes Innokenty Ivanov, partner at Freshfields in Moscow, which represented the lenders on the Moscow St Petersburg motorway and the sponsors on Pulkovo Airport.

“Both types of legal structures have now been tested, and it is important to show the participants in the global PPP market that deals can move forward in Russia – so reaching financial close on these first three pathfinder projects is an important step forward for the development of PPP in Russia,” says Ivanov.

Odintsovo Bypass & Moscow-St Petersburg

The first of the three to close was the Odintsovo Bypass in early April. The project involves the construction of a highway connecting the Moscow Ring Road with the Moscow Minsk M1 Highway, near Odintsovo on the outskirts of Moscow. It is the first stage of Pan European transportation corridor 2 (Berlin-Minsk-Moscow-Nizhny Novgorod). As such it is eligible for European Union support, and the EBRD is involved.

The concession company is OAO Glavnaya Doroga, led by Russia’s largest asset management company Lider, which is a subsidiary of Gazprom. The other members are Stroygasconsulting, Alpine Bau of Austria, FCC of Spain and Brisa of Portugal. They will design, build, finance, operate and maintain the road, which will take two years to build. The sponsor’s financial advisors are Gazprombank and Deutsche Bank, with Linklaters as legal counsel, while Magisters and Fulbright & Jaworski advised the authorities.

Odintsovo was cleared to receive up to RUB11 billion in guarantees, making up 43% of the total project cost of RUB25.6 billion. Bankers say that it will use most of that, with plans for a single RUB8.2 billion bond maturing in 2027. In addition to project equity, the project is being financed by a grant from the State Investment Fund. Thus there is no bank debt.

The provision of state guarantees on bonds was also the final piece of the puzzle for the Moscow-St Petersburg Highway PPP, led by Vinci as part of the North West Concession Company, which closed at the end of April. Societe Generale were advisors, with Freshfields as legal counsel.

In mid-April Sberbank CEO German Gref met with Prime Minister Vladimir Putin and revealed that the bank would be lending into the Moscow-St Petersburg Highway with a very long 20-year tenor, having worked jointly with Vnesheconombank on the deal. VEB and Sberbank are providing a RUB29.2 billion facility with 50:50 participation. In addition, Sberbank is providing a RUB4.5 billion VAT bridge for the construction phase of the project.

According to the agreed financing structure, RUB10 billion of state guaranteed bonds will be placed in the market. This is expected to happen soon. Some or all of these bonds might be placed with VEB, a VEB managed state pension fund and Sberbank (the biggest bank in Russia and largest provider of mortgage finance). Since the bonds are inflation adjusted they are attractive to investors such as pension funds.

The local partners are going to change – Vnesheconombank said in a statement that as part of the financing scheme it was planning to take part in purchasing up to 70% of North West Concession Company shares, effectively replacing the existing local partners, and giving it a high level of control over the project.

VEB has also said that it will co-operate with the EBRD to get it to participate in the project. Bankers say that as the deal headed towards financial close time ran out for involving both the EIB and EBRD, but that both may yet come in with financing later in the year.

Pulkovo airport

The lack of foreign bank involvement on the two road deals was not surprising given their Rouble-denominated revenues, though pre-Lehman collapse most advisors would have expected some small tranches of foreign bank debt.

Pulkovo Airport in St Petersburg is a different case, since it does generate foreign currency. The concession company, Northern Capital Gateway, is led by VTB Capital, and features Fraport as lead operator, plus Greek investment and business group Copelouzos.

The involvement of Fraport would have been expected to ensure interest from foreign banks, but in the end the deal was done with a collection of development banks; EBRD (Eu100 million A loan , Eu98 million B loan), IFC (Eu70 million A loan, Eu98 million B loan), Vnesheconombank (RUB10 billion), Eurasian Development Bank ($90 million); Nordic Investment Bank (Eu50 million); and Black Sea Trade and Development Bank (Eu15 million). They are providing term loans totalling Eu716 million with maturity in 2024.

The difficulties in bringing foreign banks in on Pulkovo Airport could suggest that the legal and political risk associated with Russian PPPs is something that many foreign lenders still do not feel comfortable with. They will however be involved as covered lenders alongside the EBRD and IFC under the A/B loan structure.

With these three deals done, market participants can now look forward to the next round of projects.

Upcoming projects

The immediate focus is on the $1.6 billion Orlovsky Tunnel in St Petersburg, awarded to Vinci in March. This will be followed by Western High Speed Diameter, where state guarantees for bonds have already been approved in principle under the April 1 decree. The Western High Speed Diameter has an estimated total cost of RUB213 billion and the second tender for the project is expected to launch in 2011.

There is also second stage of the Moscow-St Petersburg Highway, bearing in mind that the first stage (the 15km-58km mark) is for only 43km of an existing 600km road. And the planned Moscow Ring Road is likely to involve a number of PPP concessions. However, observers say that a deal involving Sheremtyevo Airport may end up as a simple privatisation rather than a PPP.

Clearly as global commercial banks gradually make their way out of the financial crisis they may have more appetite on future deals. On the other hand, these first group of PPPs were extremely high profile, and have had the close interest and commitment of Prime Minister Putin.

Some of the less high profile regional deals may seem even more politically risky to international banks, but they may be interested in the various road segments, and may come in on refinancings once construction is finished.

Meanwhile the Russian banking sector needs to take the next step in its development in order to provide the kind of long term financing required in the PPP sector. “The involvement of private Russian commercial banks was not practical in the current environment, especially since tenors of this length are unprecedented in the Russian bank lending market,” says one analyst. “However, as projects mature it may be the case that project sponsors look to private banks for refinancing.”