World Bank Port Reform Toolkit Module 5 Financial Implications of Port Reform.

World Bank Port Reform Toolkit

Module 5Financial

Implications of Port Reform

Module 52World Bank Port Reform Toolkit

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

Financial Implications for Port Reform

•Characteristics of the port operator


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


Characteristics of the port operatorand 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



•Contractual Risks•Approach of the different partners to risk and risk management•Concluding thoughts




•Characteristics of the port operator•Risk Management


Risk Management : Overview

•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

Major steps

Important principles•Properly allocate risks•Not make the operator carry risks that the public sector

could carry at a lower cost


Country Risks (1/3)

•lack of precision in the legislation

•possibility of change in the legislation

•thorough legal analysis•guarantee of legal stability •contract revision clauses•environmental study

•exchange rate fluctuations

•non-convertibility of the local currency into foreign currencies

•non-transferability

Legal risk : Mitigation :

Monetary risk : Mitigation :

•Payment of expenses in local currencies

•Hedging products•Guarantees from the

government and the Central Bank•Off-shore account


Country Risks (2/3)

Economic risk : Mitigation :

•Market survey•Macro-economic factors

Mitigation :

•Expropriations•Nationalizations•Non-compliance with

the contract•Inefficiency of

administrative authorities

Political risk :

•International arbitration•Inclusion of multilateral

organizations among the shareholders/ lenders

•Recourse to export credit agencies•Insurance cover


Country Risks (3/3)

Interference risk :

Direct intervention of the Public Authority in the management of the project

Mitigation :

•Contract clause limiting government authority intervention

•Contract provisions allowing renegotiations

•Natural risks•Industrial risks•Internal socio-political risks•Risks of war or armed

conflict

Force majeure :

•Contract clauses : suspension of reciprocal obligations of the parties

Mitigation :


Project Risks (1/3)

Construction risksConstruction 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 risksHand-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.


Project Risks (2/3)

Operating risks : countermeasures 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 risksProcurement 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.


Project Risks (3/3)

Financial risks : countermeasuresFinancial 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 risksSocial 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


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


Regulatory Risks : General View

User

Freedom of actionFreedom of action

Concessionaire

Protection of the user, Protection of the user, public interestpublic interest

Concessioning authority

RegulationRegulation

Costs

Tax-payer


Regulatory Risks : Technical regulation

• Regulation of investmentsRegulation of investments : verification of the compliance with…Functional definition of thresholds triggering new investmentConstruction standardsSpecifications relating to security or environmental protection

• Regulation of maintenanceRegulation of maintenance :Commercial risks are borne by the operator Public service obligation is defined in the performance requirements of

the concession contractThe concessioning authority may impose maintenance standards to make

sure that it will get the assets back in good condition.

• Regulation of performance : Regulation of performance : in case of weak competitionin case of weak competitionPerformance standards can concern productivity, service and capacityAlthough sometimes necessary, they are difficult to impose


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)


Regulatory Risks : Golden Share or Blocking Minority

Advantages :Advantages :

Invalidation of risk sharing

Conflict of interest

oversight of the concessioning authority from within

“right to know” about decisions of the concessionaire.

Drawbacks :Drawbacks :

To be avoided


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.

Tariff is set freely

• 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.

Tariff policy


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



•Approach of the different partners to risk and risk management•Concluding thoughts





•Contractual Risks


Contractual Risks (1/2)

Contract Management risk :Contract Management risk :

•Revision clauses•Contract termination or renewal clauses•Early termination clauses•Procedures for settlement of disputes

Clauses of the contract governing the possibility of changes or disputes about contract implementation usually include…


Risks induced by indexation :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

Financial commitments are efficiently honored through the use of bank bonds.

Contractual Risks (2/2)

Credit risk :Credit risk :



•Concluding thoughts





•Contractual Risks•Approach of the different partners to risk and risk management


Concessioning Authority

Major issuesMajor 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 InstitutionsInternational Financial Institutions can play the dual role of lenders and advisors to the concessioning authority.


Project Sponsors

Shareholders :Shareholders : Objectives :Objectives :

•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


Lenders

Imposable constraints :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


Concluding Thoughts

Port AuthorityFair competition

Proper protection of the interests of users

Oversight Authority

Commercial activity

Public service dimension



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





•Measuring economic profitability from the perspective of the Concessioning authority


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


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


Assessing the “economic costs” of the project

•Assessment of “market” economic costs Investment costs Maintenance and operation equipment Induced infrastructure costs

•Assessment of “non-market” economic costsCosts related to transferring traffic from one transport route to anotherPossible effects of the project on town planningEnvironmental and safety impacts

• Assessment of “positive externalities” of the projectIncrease in national added value (job creation, increase in company

profits)Increase in real income for consumers and in profits for companies (price

reduction)




•Financial project engineering•Financial modeling of the project•Construction of the financial model






•Rating risk from the perspective of the concession holder


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)


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)


Commonly used Financial Profitability Indicators

• Payback

• Internal Rate of Return

• Net Present Value

• Investment Cover Ratio

Need to calculate the Project Discount Rate – Cost of Capital


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


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




•Financial modeling of the project•Construction of the financial model






•Rating risk from the perspective of the concession holder•Financial project engineering


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.


Financial Structuring Within the Framework of a Project Finance Set-up

• 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 ?

Main measures used to define the structure of the SPC’s liabilities :

> 15%

> 1.3

> 1.7


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


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


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


Bonded Debt :

•Advantage : enables financial terms (margins and fees) and favorable maturities to be obtained

•Drawback : creation of problems for inter-creditor relations


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 financingmultilateral financing

• Equity invested by the project’s sponsors• Equity invested by multilateral institutions• Equity invested by bilateral institutions• Specialist investment funds


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


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.


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


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


Financial Engineering and Political Risk Management

• Political risks : use of investment guarantees

• Guarantees offered by multilateral agencies : MIGA, World Bank

• Guarantees offered by Export Credit agencies

• Use of Private Insurers




•Construction of the financial model






•Rating risk from the perspective of the concession holder•Financial project engineering•Financial modeling of the project


Construction of the economic model

• Capital expenditure : Investment breakdown

Investment phasing Investment currencies Economic depreciation and tax allowances statements Residual value of the investment at the end of the concession

• Operating revenues and expenses : Operating revenue / Charges in terminal management operations Operating finance requirement Operating account balance : GOS and OCS

• Tax Flows









•Rating risk from the perspective of the concession holder•Financial project engineering•Financial modeling of the project

•Construction of the financial model


Construction of the financial model

• Cash flow statement

• Profit and Loss Account (Income Statement)

• Balance sheet

World Bank Port Reform Toolkit Module 5 Financial Implications of Port Reform.

Documents

Transcript of World Bank Port Reform Toolkit Module 5 Financial Implications of Port Reform.