Return to Equity, Financial structure & Risk contracting in Infrastructure

1. Infrastructure Project Financing
2. Allocation of Risk
a) Project Completion Risk
b) Market Risk
c) Foreign Exchange Risk
d) Supply of Inputs
e) Government Guarantees
i) Country risk
1) Currency Transfer 3) War & Civil Disturbance
2) Expropriation 4) Breach of contract by the host Government
ii) Sector policy risk
iii) Commercial risk
3. Financial Structure of Infrastructure Projects
a) Appropriate Return to Equity & Financial Structure
b) Return on Equity
c) Financial Structure
d) Return on equity & infrastructure Projects
Large investments, long gestation periods and very specific domestic
markets usually characterize infrastructure projects.
The Build – Own – Operate – Transfer (BOOT) scheme is a form of
Project Financing designed to attract private participation in financing,
constructing & operating infrastructure projects.
Tolls and tariffs are set to recover operating costs and provide a return on
capital – the interest & repayment of debt and the return on equity.
Return to equity will depend upon the risk of cash flows from the project &
the financial structure.

Infrastructure Project Financing
In a BOOT scheme, a private project company builds a project, operates it
for a sufficient period f time to earn an adequate return on investment &
then transfers it to the government.
The BOOT scheme is essentially an extension of Project Financing.
Project Financing is made possible by combining undertakings & various
kinds of guarantees by parties interested in a project being built in such a
way that no one party alone has to assume the full credit responsibility of
the project.
Traditionally, project financing has been widely used for major mineral
extraction & processing development.
In recent times, the most common use of project financing has been for
electric power plants.
BOOT projects can be either solicited or unsolicited.
Power & roads are the two sectors with the largest number of projects.

Allocation of Risks
Following are the main allocation of risks.
Project completion risk, Market risk, foreign currency risk, and supply of
Inputs risk.
 Project Completion Risk
This is major risk factor in most infrastructure projects.
It is usually covered by …
1. A fixed price
2. A firm date
3. Turnkey construction contract with liquidated damages for delay
supported by performance bonds.
 Market Risk
This risk is covered by having long term quantity and price agreements.
PPA – Power Purchase Agreement
For power projects in India, the government has evolved a system of two
part tariffs.
1. The First Part – Ensures recovery of fixed cost based on performance
at normative parameters.
Fixed costs include depreciation, operating & maintenance expenses,
Tax on income, interests on loans & working capital & a return on
Equity.
2. The Second Part – Variable expenses based on the units of electricity
actually supplied.
Variable costs are the costs of primary and secondary fuel based on
Set norms for fuel consumption.
In case of transport projects, rolls have to be collected from the public and
not a government agency.
 Foreign Exchange Risk
This is the single largest concern of foreign financiers investing in
developing countries.
The risk is at two levels macroeconomic convertibility.
1. Whether the project will have access to foreign exchange to cover debt
service and equity payments and tariff adjustment for currency
depreciation.
2. Whether the foreign exchange equivalent of the project’s local
revenues will be adequate to service foreign debts & equity.
 Supply of Inputs
This is important in the case of power projects, which require a reliable
supply of quality fuels.
This risk is covered through a contract with a fuel supply agency.
 Government Guarantees
Government guarantees relate to country risk, sector policy risk and
commercial risk.
Country risk includes risks of currency transfer, expropriation, war & civil
disturbance & breach of contract b the host government.
The Multilateral Investment Guarantee Agency (MIGA) of the World Bank
provides guarantee against country risk for an appropriate premium.
Export credit agencies also provide such guarantees from the host
government.
Sector policy risk refers to the risks in certain sectors because of the role
of government agencies in those sectors.
Such guarantees have been offered by the Turkish government for its
power projects & the Philippine government for the Metro Manila gas
turbine project.
For toll roads, government support may be necessary to enforce toll
collection.
In case of municipal services, such as water supply and solid waste
disposal, support of the municipal authorities is important.
In each case, the government may guarantee contract compliance of the
respective agencies.
Commercial risk refers to the risk to profitability arising from market
demand and price, inputs availability & price & variations in operating
efficiency.
In case of Second Tagus Crossing, Lisbon project, the government is
obliged to reestablish financial equilibrium of the project company in the
event of force majeure and changes to construction or operating regime
required by the government.
According to Euromoney, "to be successful, transport projects will need to
have considerable government participati