The substance of commercial relations
The substance of the commercial relations between the parties involved in a social infrastructure PPP is generally as follows:
- An infrastructure asset is built for the government by a private sector consortium. The period of this construction is called the D&C (design and construction) phase. The private sector consortium also obtains third-party financing for the cost of construction during this phase.
- Once the D&C phase is complete, the government
- continues to own the asset(s) constructed/supplied, and
- starts paying for the cost of construction, progressively paying down principal and interest over a defined term (like an amortising loan).
- The private sector consortium also operates and maintains the infrastructure. This phase is called the O&M (operation and maintenance) phase. The consortium is compensated by the government for providing this service through 'availability payments'.
- The consortium may make profits in 2 ways
- the amount it receives from the government for the cost of construction is more than its actual cost of construction and the interest incurred on the D&C Loan during construction, and/or
- the amount it receives from the government through availability payments is more than its actual costs for O&M services.
Standard form model
The standard form model typically contains the following entities and agreements.
Special purpose entities
There are generally 2 special purpose project entities established as follows:
- A project trust (Project Trust), whose role it is to carry out the design, construction, operation and maintenance of the infrastructure asset. Project Trust is usually owned by the private sector consortium’s members, and it is Project Trust that makes most of the profits from the project.
- A finance company (Finance Co), whose role it is to obtain senior debt for the project. Finance Co may be held by the consortium’s members or by a charitable trust (that is, a trust that distributes its entire income to one or more charities). Finance Co generally does not make profits from the project.
Agreements
The following agreements are generally entered:
- Project Trust enters a project deed with the government, which sets out Project Trust’s obligations to procure the D&C of the asset and then operate and maintain the asset. The deed also specifies the consideration payable by government to Project Trust, specifically
– the construction payment at the end of the D&C phase, and
– availability payments during the term of the O&M phase. - Project Trust also enters into a licence agreement covering the O&M phase with the government that allows Project Trust to access the Crown land the project is to be undertaken on. The licence payments are ostensibly the consideration for the licence agreement, but in reality, are calculated to be sufficient to repay debt (plus interest) Finance Co will owe to third-party financiers.
- Finance Co raises external debt in the form of loans or facility agreements for the D&C phase of the project. Finance Co on-lends these funds to Project Trust (the ‘D&C Loan’), which in turn, procures the design and construction of the asset. This external debt is repaid at the end of the D&C phase.
- At the end of the D&C phase, Finance Co raises long-term external debt for the O&M phase (the 'O&M Loan'). In some circumstances, the D&C Loan and the O&M Loan may not be separate, and in other circumstances it may be a different loan with different financiers.
- Finance Co enters into a securitisation agreement with the government under which it
– is assigned the licence payments Project Trust pays to the government, and
– pays the government a lump sum (called the receivables purchase payment) for the assigned licence payments. This is financed by the long-term debt. - An equalisation swap confirmation is entered into between Project Trust and Finance Co (under an International Swaps and Derivative Association (ISDA) master agreement), under which
– Finance Co’s financing costs, as modelled at the outset of the agreement, are paid to Project Trust, and
– Finance Co’s actual financing costs, taking into account any increase or decrease in financing costs as a result of any refinancing of the debt, are paid by Project Trust to Finance Co.