--By CA Rajnish Dahal

Local communities have always depended on the government to provide resources for their development. This dependency has retarded their growth and ability to take responsibility for their development as development packages and priorities vary with changes in the central government. 

Development aspirations of the local people and communities are simple. They seek roads, electricity, communication, health centres, local employment, education and market facilities. All these aspects of development are possible through the implementation PPP model. 

In Nepal PPP is relatively a new idea floated. Nepal Government is facing the challenge to meet the growing demand for infrastructure especially in electricity, roads, water supply, waste management etc. As available funding from the traditional sources and capacity in the public sector to implement many projects at the district level remain limited, public sector has found that partnership with the private sector is an attractive alternative.

Best Practices for PPP 

The partners in a PPP, usually through a legally binding contract, agree to share responsibilities related to implementation and/or operation and management of a project. This collaboration or partnership is built on the expertise of each partner that meets clearly defined public needs through the appropriate allocation of: 

• Resources • Risks • Responsibilities, and 

• Rewards 

A PPP project is viable essentially when a robust business model can be developed. 

The focus of a PPP project should not be on delivering a particular class/type of assets but on delivering specified services at defined quantity and levels. 

A PPP contract generally has a much longer tenure than a construction contract. Managing the relationship between the private company and the implementing agency over the contract tenure is vital for the success of a PPP project.

Structure of the PPP Model

The creation of a separate commercial venture called a Special Purpose/Project Vehicle (SPV) is a basic feature of this PPP Model. Individuals, local companies, local business persons, cooperatives at district level and village level can form an SPV (i.e the project Company). An SPV will be a company established under the relevant Act of a Nepal, i.e the Companies Act 2063 through an agreement between the stake holders at district level. The shareholders agreement sets out the basis on which a company is established, giving such details as its name, ownership structure, management control and corporate matters, authorized share capital and the extent of the liabilities of its members.

The SPV will be a legal entity that undertakes a project and negotiates contract agreements with other parties including the public sector. An SPV is also the preferred mode of PPP project implementation in limited or non-recourse situations, where the lenders rely on the project’s cash flow and security over its assets as the only means to repay debts. 

The Bank and financial institutions will provide the requisite finance. 

In the above model an escrow agent (normally a financial institution) will be appointed by the project company and the lenders for managing an account called escrow account. The escrow account is set up to hold funds (equity contributions, and other form of funds, including project revenues accrued to the company). The funds in the account are disbursed by the escrow agent to various parties in accordance with the conditions of the agreements. 

An important characteristic of an SPV as a company is that it cannot undertake any business that is not part of the project. An SPV as a separate legal entity protects the interests of both the lenders and the investors. 

In such a case, the SPV mechanism will also allow joining hands with other investors who could invest, bring in technical and management capacity and share risks, as necessary.

The public sector (i.e. the VDC, DDC, municipalities) will also contribute to the long-term equity capital of the SPV in exchange of shares. In such a case, the SPV is established as a joint venture company between the public and private sectors and the public sector acquires equal rights and equivalent interests to the assets within the SPV as other private sector shareholders. 

Direct local government involvement in a PPP project is usually guided by the legal and regulatory regime of the country and the government policy on PPPs. 

Since PPP model is yet to be tested and the banks and financial institutions are reluctant to finance if the deal is not structured properly. So, out of the several models for PPP, Private Finance Initiative (PFI) type of model could be more appropriate in a developing/ untested country as Nepal.

In the PFI model, asset ownership at the end of the contract period is generally transferred to the public sector. Setting up of a Special Purpose Vehicle (SPV) may not be always necessary and it may be replaced by an existing company also. For the purpose of financing, the lenders may, however, require the establishment of an SPV. 

In a PFI project, as the same entity builds and operates the services, and is paid for the successful supply of services at a pre-defined standard, the SPV / private company has no incentive to reduce the quality or quantity of services. 

This form of contractual agreement reduces the risks of cost overruns during the design and construction phases or of choosing an inefficient technology, since the operator’s future earnings depend on controlling the costs. The public sector’s main advantages lie in the relief from bearing the costs of design and construction, the transfer of certain risks to the private sector and the promise of better project design, construction and operation.

Financing under PPP Model 

Under the above PPPs model financing will be done on project basis. The project finance may come from a variety of sources. The main sources include equity, debt and government grants. Financing from these alternative sources has important implications for the project’s overall cost, cash flow, ultimate liability on concerned parties, and claims to project incomes and assets. 

Equity refers to the capital invested by stakeholders of the project. Here the main providers of equity shall be private sector, public sector and third party private investors. These parties will put in their equity in the SPV.

Debt is borrowed capital from banks and other financial institutions. Debt has fixed maturity and a fixed rate of interest is paid on the principal. Lenders of debt capital will have senior claim on the income and assets of the project. Generally, debt finance makes up the major share of investment needs (usually about 70 to 90 per cent) in PPP projects. The equity contribution will be to the tune of 30 to 10 % depending upon the willingness of BFI is to finance the project. 

Often guarantees are also used to pursue policy objectives in support of this type of projects. Public sector /governments may provide loan guarantees to cover some or all of the risk of repayment to the lenders. This shall create an additional comfort level to lenders. Guarantees can be extremely valuable in reducing the financing cost of a project and can substantially reduce the risk of loan default.

However the major hindrance in sourcing loan from the bank that comes under project finance is collateral-oriented. Nepali banks and financial institutions are risk averse by nature and are yet to learn the tricks of the risk assessment and risk management. Without credible and trusted entrepreneurs and equity contributors with collateral and adequate risk sharing arrangements and adequate guarantee the BFIs are reluctant to grant loans. 

Hence to overcome this hindrance and reduce over dependency on bank finances, other means of project finance like grants from various sources, in the form of subsidy should be available to make PPP projects commercially viable, reduce the financial risks of private investors, and perceived risk by lenders and achieve some socially desirable objectives such as to induce growth in a backward area through infrastructure development under PPP model.

(The wirter is a practicing chartered accountant and can be contacted at [email protected])