Oct-16 1

Public-Private Partnership Financing: How does it work?

Lecture delivered at Islamic Finance Intellectual Discourse,18-20th October 2016,

Melaka, Malaysia

Abdul Ghafar Ismail

What is public-public partnership?

◊ Definition

“a long-term contract between a private party and a government entity, forproviding a public asset or service, in which the private party bearssignificant risk and management responsibility, and remuneration is linkedto performance“

PPPs typically do not include service contracts or turnkey constructioncontracts, which are categorized as public procurement projects, or theprivatization of utilities where there is a limited ongoing role for the publicsector

An increasing number of countries are enshrining a definition of PPP intheir laws such as Malaysia (PPP Guideline 2009, PM Department) -tailoring the definition to their RM

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What is public-public partnership?

PPP legislation and law

◊ In civil law counties - a distinction is made between public contracts such as concessions, where the private party is providing a service directly to the public and taking end user risk, and PPPs, where the private party is delivering a service to a public party in the form of a bulk supply, such as a Built-Operate-Transfer (BOT) project for a water treatment plant, or the management of existing facilities (e.g. hospital facilities) against a fee.

◊ In other countries, specific sectors are excluded from the definition, particularly those sectors which are subject to effective regulation or where there is extensive private sector initiative, such as in ICT and Telecoms. In some countries arrangements involving more limited risk transfer such as management contracts are excluded from the definition for institutional reasons as the authorities prefer that they fall under traditional procurement processes for goods and services.

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What is public-public partnership?

◊ UNCITRAL Guidance on PPP/ Concession Laws - The United Nations Commission on International Trade Law (UNCITRAL) has published a Legislative Guide on Privately Funded Infrastructure Projects in 2000 - The purpose of the Guide is to assist in the establishment of a legal framework favorable to private investment in public infrastructure. The advice provided in the Guide aims at achieving a balance between the desire to facilitate and encourage private participation in infrastructure projects, on the one hand, and various public interest concerns of the host country, on the other

◊ EBRD Core Principles for a Modern Concession Law - The European Bank for Reconstruction and Development (EBRD) defined a set of core principle for a modern concession lawi

◊ OECD Principles for Public Governance of Public-Private Partnerships

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PPP Financing – an example

◊ Doraleh Container Terminal (DCT) Background

◊ Financing Structure

◊ Risk

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PROJECT BRIEF◊ Project name : Doraleh Container Terminal S.A.R.L.

◊ Fiscal year : 2008

◊ Guarantee : 1) DP World Djibouti FZCO

holder 2) Dubai Islamic Bank PJSC

3) WestLB AG

4)Standard Chartered Bank

◊ Investor : 1) United Kingdom

country 2) Germany

3) United Arab Emirates

◊ Sector : Transportation

◊ Gross exposure : $ 427 million

LOCATION OF DJIBOUTI

DJIBOUTI PORT

PORT INFRASTRUCTURES

35,406 m² coveredarea

63,550 m² open area

= 250,000 Tons

Capacity: 15,000 TEU

2 Container Berths2 RoRo Berths

DJIBOUTI CONTAINER TERMINAL

Since October 2006Djibouti Container Terminal has been certified as ISO

28000 compliant by Lloyd’s

Register

CONTAINER TERMINAL EQUIPMENT

10 RTG

126 Reefer Plug Points

4 CRANES

13 Reach Stackers 2 Top loaders full2 Empty Handlers3 Forklift

34 Prime mover

DJIBOUTI DRY PORT

CONTAINER YARD

7 500 TEU

WAREHOUSE : 6 900 sq.m

STRIPPING YARD350 TEU

DORALEH CONTAINER TERMINAL (DCT)

◊ DCT is a joint venture company registered in Djibouti and establishedby a presidential decree, consisting of Port Autonome International deDjibouti (“PAID”) as the majority shareholder (66.66%) and DP WorldDjibouti FZE (“DPWD”), a 100% owned subsidiary of DP World(“DPW”), a leading global terminal investor and operator.

◊ Involves the development, design, construction, management,operation and maintenance of a new container port terminal in thecity of Doraleh.

DORALEH CONTAINER TERMINAL (DCT) cont.:

◊ Being developed under a 30-year concession granted by thegovernment of Djibouti to the main sponsors - DP World of theUnited Arab Emirates and Port Autonome International ofDjibouti—via their joint-venture vehicle, the Doraleh ContainerTerminal S.A. (DCT).

◊ MIGA issued guarantees totaling $427m-$5m for DP World’sequity investment into DCT and $422m in Islamic ProjectFinancing - against the risks of currency transfer restriction,expropriation, breach of contract, and war and civil disturbance.

DORALEH CONTAINER TERMINAL (DCT) cont.:

◊ The Islamic project financing comprised 99% of the amountsallocated for the principal portion of the financing, DCT’s futurerental obligation, capitalized future premium, and Islamic profitrate swap facility

◊ Increase port traffic and open up new opportunities forinvestment and growth, including breaking the country’s relianceon Ethiopia’s trade and attracting other African countries to usethe port as a gateway too

THE DCT PROJECT

◊ MIGA has issued guarantees to DP World Djibouti FZCO (DPW),Standard Chartered Bank (SCB), Dubai Islamic Bank PJSC (DIB), andWestLB AG for their investments in Doraleh Container Terminal S.A.R.L.in Djibouti.

◊ The guarantees include $5 million to cover DPW’s equity investmentinto the project and $422 million to cover funding provided by DIB,SCB, West LB and other participating banks under an Islamic projectfinance facility.

THE DCT PROJECT cont.:

◊The coverage is for a period of 10 years against the risks oftransfer restriction, war and civil disturbance, expropriation,and breach of contract. MIGA’s gross exposure under theproject is $427 million (including $21 million for the SWAPcontracts).

◊When completed, the terminal will have a total quay lengthof 2,000 meters and an annual handling capacity of 1.5million 20-foot container equivalent units.

FINANCING STRUCTURE

FINANCING STRUCTURE cont.:

FINANCING STRUCTURE

◊ The project financing was designed to reflect a “debt-type” profileto ensure compliance with Islamic jurisprudence or Shariahprinciples, while satisfying the commercial requirements of bothDCT and the project financiers. The project financing wasexecuted by combining the following key concepts of Shariah:

1) Musharaka Agreement

2) Istisna’a Agreement

3) Ijara Agreement

FINANCING STRUCTURE cont.:

1. Musharaka—literally meaning “partnership,”

◊ Refers to an arrangement where two or more partners pool togetherresources (capital and contract rights) to jointly own assets orundertake a commercial venture.

◊ Through the Musharaka Agreement, DCT and the project financiersagreed to procure assets for the project jointly and committed tomaking respective capital contributions representing the financingplan’s debt and equity components.

FINANCING STRUCTURE cont:

2. Istisna’a—refers to a contractual

◊ Agreement for constructing or developing assets, allowing cashpayment in advance and future delivery of the assets.

◊ Through the Istisna’a Agreement, the partners appointed DCT as aprocurer to construct the container terminal and ensure delivery ofassets at the end of the construction period. Capital contributionsunder the Musharaka were paid to DCT, which in essence is equivalentto multiple drawdown under a conventional lending arrangement.

FINANCING STRUCTURE cont.:

3. Ijara—a mode of finance wherein the

◊ Right to use an asset is leased by the owner (the lessor) to anotherparty (the lessee) in exchange of rental payments.

◊ The Forward Lease Agreement allowed the project financiers (thelessor) to lease their co-ownership interest in the project to DCT (thelessee) in exchange of periodical rental payments linked to a floatingbenchmark.

FINANCING STRUCTURE cont.:

◊ Given that the assets were under construction, the documentationallowed the project financiers to pay advance lease rentals during theconstruction period.

◊ After delivery and commencement of lease, the project financierswere to receive periodical lease rentals based on both floating andfixed rates, reflecting amortization of the loan.

FINANCING STRUCTURE cont.:

In addition to the above, the financing structure also entailed:

◊ A Purchase Undertaking, which allowed the project financiers to selltheir co-ownership interest to DCT in case of a dissolution event (suchas default or change in circumstances). The exercise price under thisundertaking was an amount equal to the outstanding facility amount,any accrued and unpaid lease rentals and any other outstandingamount under the financing documents

◊ DCT was also allowed to prepay the financing via a Sale Undertaking(i.e. call option), according to which it has a right to buy out its partner(the project financiers) in return for paying off its contribution in full(equivalent to the principal of the financing)

ROLE & MISSION OF MIGA:

(MIGA) is one of the 5 agencies of World Bank

Group like IBRD (1945), AID (1950), IFC (1956)

and ICSID (1966)

Role: Stimulate the investments flows in the developing

countries.

Missions: i) Protect investors against political risk

insurance.

ii) Tools of promotion of foreign investments.

iii) Service of Mediation in case of dispute.

RISK:

1. Non-transfer and non-convertibility:

Protection against losses than can arise from the impossibility toconvert the assets coming from the project.

2. Expropriation:

Protection against Host Government from actions having foreffect to deprive the investor.

RISK cont.:

3. War and civil disturbance:

Protects against losses arising directly from degradation,destruction or disappearance of assets.

4. Breach of contract:

Covers losses resulting from a Government decision of the hostcountry to resiliate or denounce a contract.

Does it create value (MS) for money for All?

◊ Investor

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CURRENCY SWAP

(PROJECT COMPANY)

(AGENT) (FINANCIAL CONTRIBUTOR)

PROFIT RATE SWAP

Definition:

◊ Involves exchanging (swapping) interest payments on Floating-rate debtfor interest payments on Fixed-rate debt, with both payments in thesame currency.

◊ Basically an agreement to exchange profit rates between a fixed rateparty and a floating rate party, or vice versa, implemented through theexecution of a series of underlying Shariah contracts. In the currentmarket a further contract called the wa’ad contract is being utilized soas to ensure the swap reaches maturity.

PROFIT RATE SWAP cont.:

◊ Reason:

One party actually wants fixed rate debt, but can get a better deal onfloating rate; the other party wants floating rate. Both parties can gainby swapping loan payments, usually through a bank as a financialintermediary which charges a fee to broker the transaction.

PROFIT RATE SWAP cont.:

STRUCTURE OF ISLAMIC PROFIT RATE SWAP:

◊ The objective behind an Islamic profit rate swap is effectively thesame as that underlying a conventional interest rate swap, namely tomanage exposure to interest rate movements. Thus it is designed toprotect financial institutions from fluctuations in borrowing rates andto provide a risk control mechanism.

STRUCTURE OF ISLAMIC PROFIT RATE SWAP cont.:

◊ The wide-spread availability of hedging instruments acceptable inIslamic finance will ensure that investors and customers withdifferent banking requirements, as well as Islamic financialinstitutions who require balance-sheet management, can enjoybenefits which conventional banks have been experiencing for manyyears.

Does it create value for money for All?

◊ The public sector

Over the last few decades, public-private partnerships have beenincreasingly used by governments around the world to finance andmanage complex operations

However, doubts about their efficiency have been raised

Criticism of public-private partnerships reflects the fact that governmentstend to use them as "off-budget" operations, to avoid fiscal constraints

Do they generate "value for money" to the public sector? How do weassess value for money in these types of arrangements? It has becomeextremely important for public managers.

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Does it create value for money for All?

◊ The public sector

To answer this, it is necessary to estimate the costs in the case of a public procurement versus public-private partnerships payments, and to define what outcomes will be found (in order to find the value for money of the two options), to best compare and make the right decision for taxpayers

One of the most important costs to include in a public sector comparator is the risk transfer to the private sector, which is the ultimate motive for a greater level of efficiency. Having a not-optimal risk allocation will reduce the probability of a good decision from public managers

However, the scope of this work does not include, whether or not public investment should be carried out. The cost benefit analysis of the investment versus other options should be made prior to our analysis

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Contacts of the presenter Contacts of IRTI

Website: www.irti.org

Phone: +966 (0)

126466377

Fax: +966 (0) 126378927

P.O. BOX 9201 - Jeddah

21413

Kingdom of Saudi Arabia

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