Using public-private partnership (PPP) for project financing viola-funding November 8, 2023

Using public-private partnership (PPP) for project financing

Public-private partnership for project financing
Public-private partnership for project financing

Using Public-private partnership for project financing to implement large projects contributes to the expansion of business opportunities, the growth of the competitiveness of strategic sectors and the satisfaction of the urgent needs of society.

World experience in project financing shows that the use of public-private partnership (PPP) mechanisms creates the necessary conditions for attracting resources and developing capital-intensive projects in many sectors of strategic importance for the society.

Public-private partnership for project financing is lengthy and complex process that requires a thorough assessment of a particular project.

These mechanisms are most applicable in infrastructure, environmental, agricultural and other projects.

Definition and brief description of Public-private partnership

In the developed world, the most popular sources of financing for large PPP projects are equity capital and long-term investment loans. Bond issues and mezzanine investment instruments are also widely used. On the other hand, developing countries more often use equity capital, loans from international financial institutions and other borrowed instruments, while bond issues and mezzanine funding in such countries are ineffective and not widespread enough.

The most common form of attracting investments for PPP projects has long been lending, which is more accessible and more flexible with the support of the state financial and regulatory machinery. However, structural weaknesses in the banking sector and misuse of the potential for long-term lending over the past decades have led to higher financing costs and a growing mismatch between societal needs and the availability of capital. All this gradually leads to a reduction in the share of bank loans in PPP projects and an increase in the role of international financial institutions.

The structure of financing public-private partnership projects varies significantly depending on the specific area.

According to Eurostat, in the mid-2010s, the equity capital share of PPP projects in healthcare and education was slightly above 5%, while in infrastructure projects it reached 20%.

The evolution of the legal framework of banking activities has a direct impact on the financing of public-private partnership projects in the long term. For example, the adoption of Basel III had a negative impact on the ability of major world banks to provide long-term financing of PPP projects. The change in liquidity coverage ratios required banks to reduce the share of risky assets, including long-term PPP investments.

The share of banks from China, Japan, Australia and other countries in financing PPP projects in the Old World is growing. It is safe to say that the largest banks will continue to finance such projects and expand the geography of their services until the cash flows are predictable and reliable.

Trends in financing public-private partnership project

The global financial crisis corrected the trend: funding for public private partnership projects for some time decreased in most countries and sectors, but during 2010-2011 there was a revival, especially in the field of water resources management and recycling of household waste. During this period, there is a more active use of PPP mechanisms to solve the social problems of developing countries (for example, the development of the healthcare system in Africa).

The main trend in the development of PPPs in the world is the infrastructure focus of projects, when governments implement socially important projects through the joint efforts of public authorities and private capital, increasing the quantity and quality of infrastructure services. This trend is observed in the USA, Canada, Australia and many Asian countries.

Another trend of PPP development is the priority state support of certain types of projects and industries. During the preparation of public-private partnership projects, governments promote certain sectors of the economy for which PPPs are deemed most appropriate or socially important.

The situation is somewhat different in developing countries. According to the World Bank, about 2.8 thousand PPP projects have been implemented in these countries since the 1990s.

During 2010-2018, in developing countries, most of the GSP projects were implemented in the energy sector, the construction of roads, as well as the modernization of water supply and sanitation systems.

The focal point areas for Public-private partnership for project financing can be divided into two groups:

• Projects that represent industries or areas that are slowly innovating but require modernization or restructuring. These are infrastructure facilities, healthcare and education, the energy sector, and transport systems. Such projects are able to provide long-term profits to the private sector in the framework of PPP projects.

• Projects that represent rapidly growing industries or areas that are undergoing significant innovation change. These are, in particular, information and communication technologies that can provide the private sector with quick profits.

The fifth trend is the development of PPPs in the field of innovation. In the United States, the largest example of the use of PPP to stimulate private sector research projects is the Small Business Innovation Research Program (SBIR), which was launched in 1982. Thus, science and education can become an important part of public-private initiatives.

The main global directions for Public-private partnership for project financing are;

• Evolution of public-private partnership mechanisms towards the emergence of its new forms, such as ESCO contracts in the energy sector.

• Diversification of PPP against the background of geopolitical instability, growing differences between countries and the globalization of the market for financing public-private partnership projects (development of international projects).

If you are looking for more information on financing large projects, please contact Viola Funding Limited.

We provide a full range of services in the field of project finance, financial modeling, investment engineering and consulting.

Mechanisms for financing PPP projects

Significant forms of public-private partnerships that provide partnerships between business and the state are consulting services, the transfer of infrastructure for rent, outsourcing, leasing, concession and other joint activities. According to leading financial experts, the best form of partnership between the state and business on local infrastructure facilities is a concession.

A concessional is a system of relations between the state (grantor) and a private legal entity (concessionaire) that arises as a result of granting the concessionaire the rights to use public property on a paid and repayable basis.

These agreements also include the right to engage in certain activities, usually controlled by the state. The obvious advantage of the concession is the lack of competition in the market of social infrastructure facilities, guaranteed sales of products (services), as well as a long-term nature that allows business to plan activities in the long term.

According to financial experts, the implementation of outsourcing agreements as a form of public-private partnership allows the customer company in some cases to reduce operating costs by almost 35% and increase the return on capital by an average of 5-6%.

Creating an effective mechanism for Public-private partnership for project financing is impossible without the creation of an authorized body that would directly provide financial support to market participants.

In the European Union, this body is the European Investment Bank, in Canada it is the Royal Bank of Canada. Guided by national financial legislation and international standards, these regulators should support strategic initiatives in infrastructure, energy, the environment and other areas.

Long-term investment loans received from government institutions and IFIs are today a stable source of financing for PPP projects, the importance and share of which is growing every year. This can partly be explained by the difficulty of attracting financial resources from traditional sources.

For many developing countries, attracting long-term loans and equity appears to be difficult.

The participation of special development banks in the implementation of large PPP projects helps these countries reduce risks that affect investors and hinder project financing. The 30-year concession agreement for the construction of the fourth subway line in Sao Paulo (Brazil) can serve as a prime example of how development finance institutions help in the implementation of PPP projects.

Financial experts identify a wide range of mezzanine financing instruments that can be successfully used to implement public-private projects in developing countries. Among them are subordinated loans, preferred shares, convertible bonds with warrants and other instruments. Through the use of mezzanine funding sources, SPV achieves a better debt-to-equity ratio, albeit at a higher cost.

Since it is difficult to obtain a loan on adequate terms for some long-term projects, the role of mezzanine for Public-private partnership for project financing can hardly be overestimated.

Looking for financing for large projects in the energy sector, industry, mining, real estate, tourism or other sectors?

Viola Funding Limited is ready to provide you with comprehensive services at any stage of the project.

Contact us for further details.

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