FORUM: Public-private partnerships in the Americas

July 2013 | SPECIAL REPORT: Infrastructure & project finance

Financier Worldwide Magazine

FW moderates a discussion on public-private partnerships (PPPs) in the Americas between John S. Haythorne at Dentons, Mike Matheou at Hogan Lovells US LLP, Scott Kolbrenner at Houlihan Lokey, and Edward R. Neaher Jr. at White & Case LLP.

FW: What trends have you seen in the PPP market throughout the Americas in the last 12 months? What factors are driving these trends?

Haythorne: The Americas is really three markets at different stages of development. Canada has experienced great success in several provinces with PPP and the market continues to add projects. Mexico has just announced its intention to make the use of PPPs in the transportation sector a viable option for development of new assets. The US continues erratic use of PPPs, but there has been a recent sharp increase in the number of announced projects for which a PPP is being considered as the delivery method. Overall, PPPs are not taking over as the dominant way to implement new infrastructure, but the successes in some markets, such as Canada, cannot be ignored by other jurisdictions such as the US. Weak economies in Europe, including countries like Spain, have encouraged experienced PPP participants to look to the Americas for opportunities, and in doing so are bringing and establishing international standards for PPP agreements, including important issues such as commercial terms and risk transfer profiles.

Matheou: Most of these questions have different answers in relation to three distinct markets: Canada, the US and Latin America. Canada continues to be a strong PPP market, with a foreseeable pipeline of deals which are executed efficiently. While there continues to be a flow of deals across the social and transportation sectors, a particular current trend is the emergence of very substantial light rail projects, such as the ones in Toronto and Waterloo (Ontario) and Edmonton (Alberta). In the US, transportation continues to be the primary PPP market in the United States, with a very small number of other ad hoc partnership deals being done, such as university parking facilities. Within the transportation sector the road sub-sector continues to be the dominant market. However, there are a number of trends which can be discerned. The airport sub-sector shows good signs of being a developing sector which could gain some momentum, with the transaction at San Juan (Puerto Rico), reaching financial close, and procurements underway at Midway (Chicago), and LaGuardia (New York). Another developing sub-sector is light rail: two projects are the subject of an RFI process in Maryland, and additionally Washington, DC has announced its intention to start the procurement process for its streetcar project in the summer. In the road market, ‘managed lanes’ projects (where one or more tolled lanes are added to an existing road) are a distinct trend, with I-95 in Virginia having reached financial close, US 36 in Colorado having appointed a preferred proposer, and I-4 in Florida under procurement. As for Latin America, apart from stating the obvious point that the market is diverse and varies from country to country, it is hard to pick out discernible trends. There is a range of projects including highway concessions in Brazil, Colombia, Peru and elsewhere, hospital P3s in Chile and subway P3s in Brazil and Peru.

Kolbrenner: PPPs are slowly but surely gaining ground in the US. State and local governments continue to struggle with appropriately funding infrastructure as their own – and the federal government’s – resources continue to be constrained. Even though the overall economy is recovering, as well as that of many state and local economies, the large number of constituents seeking budget allocations – for priorities such as education, healthcare and growing pension obligations – ensures that public infrastructure funding will continue to ‘lack’ for some time.

Neaher: Debt financing for PPP infrastructure projects continues to move towards long-term institutional investors and capital markets solutions, such as private activity bonds, and away from reliance on mini-perm bank facilities. The relatively low yield environment has encouraged institutional investors to reevaluate construction risk on greenfield and brownfield projects, and equity sponsors are becoming more comfortable with institutional commitments that are ‘circled’ rather than fully committed at bid stage. The depth of the PABs market has now also been established. On the government front, new legislation is being adopted in many states to provide more robust frameworks for PPP projects – Maryland and expanded legislation in Florida are two recent examples. Finally, 2012 saw six deals come to financial close, breaking the two-a-year streak. Projects like Luis Munoz Marin airport in Puerto Rico and Indiana’s East End Crossing have provided renewed energy to the PPP market in the US.

FW: Which sectors and regions are generating the most opportunities for PPP deals in the Americas? Are any particular projects worthy of note?

Matheou: Canada continues to produce a reliable flow of projects. Particularly noteworthy are the opportunities in Ontario for a number of light rail transit projects, including the enormous Eglinton Crosstown and Scarborough project in Toronto with further lines to follow in that city alone. In the US, states which have been in the PPP market for a number of years, such as Florida, Texas and California, continue to produce PPP opportunities, but perhaps more striking are the new states which are bringing projects to the market, with a road and a bridge project coming through in Ohio, two potential LRT projects in Maryland, and positive steps being taken in other states such as Pennsylvania to develop a legal and administrative infrastructure in which the PPP projects can be developed. In Latin America, Brazil has to be the country which produces the broadest range of opportunities across the broadest range of sectors from roads to water and sanitation, to hospitals. Beyond that, it is harder to pick out distinct regions, but better to focus on individual projects. Particular opportunities to note include highways in Colombia.

Kolbrenner: As some PPPs have progressed without major negative implications, some political decision-makers have lowered their ‘qualitative’ resistance to the idea of PPPs. Lenders and equity sources increasingly focus attention on ways to capitalise on this new direction for the construction finance markets. In our experience, the best ways for investors to maximise their chances for success are to learn from and partner with service providers to the infrastructure space.

Neaher: Transportation continues to be the principal focus for PPP projects in the US. US cities are looking at the success of Puerto Rico’s Luis Munoz Marin airport concession, the renewed efforts to implement a PPP for Midway Airport in Chicago and the LaGuardia terminal project as benchmark transactions in the airport sector. The upcoming I-4 PPP in Florida will also be a significant availability payment deal this year. The success of the Goethals Bridge and LaGuardia airport terminal efforts in New York may be the spark to realise the potential in New York, and California continues to promote PPP projects, including in the rail sector. Maryland’s P3 legislation is now more comprehensive, and the Purple Line will likely be a P3 project. Brazil’s pipeline in preparation for the World Cup in 2014 and the Olympics in 2016 is so ambitious that it will be a focal point for investors in Latin America. Right now Brazil’s rail and roads program contains their largest projects, with the $19bn Campinas-Sao-Paulo-Rio de Janeiro rail of particular note. But there is still concern over demand risk and the lack of detail about how these projects will take shape. Colombia is on everyone’s watch list as current transportation infrastructure is a serious impediment to their continued economic growth, and an ambitious program has been announced.

Haythorne: Transportation, including highways and rapid transit, seem to be popular sectors for PPP projects. In the US, the Purple and Red Lines in Maryland, the Travis County, Texas Court House, the Tampa, Florida police headquarters, and LaGuardia Airport.

FW: Have you seen any recent government policies and incentives to promote PPP opportunities in particular sectors?

Neaher: In the US, at the federal level, MAP-21 and the expansion of TIFIA funding are evidence of political will at the federal level. The increase in adoption of legislation to provide for PPP frameworks at the state level is a good signal, but there is a continuing challenge to educate the public and legislators of the benefits of PPP projects. In Latin America, Brazil and Colombia have created agencies led by experienced professionals to oversee projects. In Chile, the 2010 earthquake incentivised the government to promote a health sector pipeline that aims to build nine hospitals. The BRICs have even announced their intention to form a development bank for emerging markets. Mexico’s improved regulatory environment and its launch of the next five-year infrastructure plan this month have brightened investment prospects.

Haythorne: At the state level in the US, many jurisdictions are considering or enacting authorising legislation for PPPs. Leaders are Virginia, Florida, Texas, Pennsylvania and Indiana.

Matheou: As noted, road projects have been the mainstay of the US markets, and the two most powerful tools contributed to that market by the federal government have been the Transportation Infrastructure Finance and Innovation Act (TIFIA) loan program and the use of ‘private activity bonds’ to allow PPP transportation projects to have the same access to tax exempt financing as conventionally funded roads. Accordingly, the passage of the ‘MAP-21’ federal legislation which materially extended the scope of the TIFIA program is definitely a major boost to the market. Not only was the actual amount of money available to the TIFIA program increased, but the proportion of a project cost which TIFIA could fund was also increased. This is hard evidence of consistent support for PPP projects at the US federal level. Beyond this, the trend of individual states bringing forward PPP legislation continues as noted above, with laws coming into force recently in Pennsylvania and Maryland, to take just two examples.

FW: What are the major benefits of public-private partnerships to stakeholders, the public sector and the wider community?

Haythorne: The advantages are many. Public owners are able to increase risk sharing with the private sector. Projects benefit from increased rigour and discipline that is applied by private investors who have ‘skin in the game’. Private innovation is encouraged and made more accessible to public owners through the pressure of the unified competitive procurement process under a PPP, resulting in better value for money over the life of a project. Overall, PPPs allow for supplementation of public experience and authority with private know-how and capital to achieve better quality projects that are delivered and operated more efficiently than a project sponsored solely by a public entity. In the best cases, that is delivered in spades. However, academics and commentators continue to debate the advantages and disadvantages of infrastructure projects implemented by public-private partnership. What is clear is that a poorly planned and procured project, no matter what form, will not deliver full value. With proper education about best practices for selection, development and implementation of projects, PPPs offer the promise of delivering some of the much needed infrastructure for North American economies to remain competitive globally. Investors have the opportunity to invest in what are essentially public assets in stable economies. Governments have the opportunity to continue growing their infrastructure base and, thereby, create jobs and drive innovation. At the same time, we need to face the challenges of PPPs straight on. The multi-party structure, including lenders and investors, over a longer operating term, results in a lack of flexibility that can make it difficult for the project to react to unforeseen needs that arise over the term of the Concession Agreement. For the public sector and wider community, PPP projects are more difficult to procure, taking longer to bring to market, with higher political risk, but once financial close is achieved PPP projects have an established reputation of being more reliably on budget and on schedule. In addition, the integration of design, construction and operating requirements can result in cost savings over the life of the project in a way that is difficult to achieve with other project structures.

Matheou: Public-private partnerships are not a panacea, solving all the known ills of the world, and they do not create ‘free money’. However, having the ability to implement PPP projects is a key ‘tool in the toolbox’ for governments which need to develop their infrastructure in challenging economic conditions. In the right cases, PPPs can allow projects to be developed more rapidly than conventional projects, on a model which ensures that the whole lifecycle cost of the project is taken into account, and, on that basis, to deliver projects more efficiently and economically than would otherwise be the case. Sometimes, projects can be achieved through a PPP process which could not be achieved – within current governmental resources – by other means.

Neaher: The obvious benefits are jobs and much-needed repair of infrastructure that is vital to economic growth, with the ability of the private sector to deliver projects quickly for public use. There is a good track record of PPP projects staying on budget and being delivered on time. Risk transfer to the private sector benefits the community as a whole, as private investors bear construction risk and long-term life cycle operating and maintenance risk. Governments therefore can have greater certainty with their capital budgets, and public money is freed up for other civic purposes. Local companies benefit through subcontracting and developing expertise through joint ventures with international players in their respective industries. If you look at the Indianapolis parking system PPP, the city estimates that improvements in efficiency and technology will result in more revenue for the city – six times more by their estimates – with substantially reduced risk.

FW: What legal challenges surround PPPs in the Americas? What steps can be taken to overcome these challenges?

Matheou: Once again, the answer to this question varies enormously across the markets, where there are relatively few legal challenges in Canada, but many more elsewhere. In the US, the greatest challenge is navigating the individual statutes which authorise PPPs in the different states. Most states – approaching 40 – now have legislation which permits PPPs to be carried out, but the scope and nature of the legislation varies enormously. So, to take two recent examples, Pennsylvania and Maryland have both recently passed PPP legislation, but the Pennsylvania legislation only applies to transportation infrastructure, whereas Maryland applies to transportation and to social infrastructure. As a matter of generality, the legislation frequently exhibits a strong tendency for legislatures to attempt to micro-manage the process of implementing PPP projects which can be both impractical and introduce significant political risks.

Neaher: Challenges to PPP legislation and projects in the courts is an issue in the US. In March, it looked as though Cincinnati Parking was headed for a successful PPP transaction, in April an injunction was issued stopping the process, and in early June an appeals court upheld the PPP plan. Recently, a Virginia state lower court issued an adverse ruling for a PPP highway and tunnel project casting doubt on the constitutionality of the Virginia PPP statute. Potential private investors now have to consider public interest litigation in their risk analysis. In other markets, the adoption of a clear and comprehensive legal regime for PPPs is the key to attracting investment. Proper allocation of risk between the public and private sectors is also fundamental in this regard – for example, investors may shy away from markets where environmental risk is allocated solely to the private party.

Haythorne: The common legal challenge to PPPs in the Americas is that in many jurisdictions, for example in many areas of the US, current legislation does not permit, or at least discourages, PPPs. A common form of PPP has the concessionaire’s rights based completely on a project agreement. In that structure the legal framework must be such that there is no question the project agreement is legally valid and enforceable. Enactment of amendment to legislation requires political support, which has been difficult to obtain. Some jurisdictions, such as Brazil, have adopted enabling legislation, but included strict rules, in many cases unique to the jurisdiction, that are not always conducive to international investment.

FW: Are there any other major challenges which frequently surface in PPPs in the Americas? How should investors prepare for and manage these issues?

Neaher: Political stability is always a factor, since a new government can withdraw support for a project, or have made commitments to a constituency that is a hostile stakeholder. A significant challenge exists in dealing with stakeholder concerns that a public asset will be taken over by a private company whose only motivation is profit with little regard for public policy. The key to managing these types of challenges is frequent communication of the benefits of PPP projects, and a track record of successful PPP projects. Partnering with the local community can help build wider support. A successful example of such a partnership can be found in Colombia where a low-income community was receiving its water through expensive delivery trucks. The private-sector partner of the water PPP ran a campaign to demonstrate how much people would save through piped water and meters. The campaign was a success, and through it the developer learned about the issues of importance to customers, such as the need to find a way for customers to pay the water bill when they do not have bank accounts.

Haythorne: The main challenge is the lack of general understanding as to how PPPs work, including a widespread concern that a PPP structure necessarily results in private ownership and control of the asset. Educating the general public is difficult because supporters of PPPs, particularly private-sector supporters, are viewed with suspicion as being only interested in making a profit at the expense of the public.

Matheou: In the US, at least, political risk is a significant issue. As a result of most states working on – in effect – a two-year political cycle between main elections and mid-terms, the political dynamic affecting projects can change rapidly and unpredictably. So, for example, the new governor in Florida stopped the proposed high speed rail PPP project there in its tracks a couple of years ago, just as it was about to enter procurement and – more alarmingly – the governor of Georgia killed a PPP road project in Atlanta just as the preferred proposer was about to be selected, on grounds which appear to be no more nor less than a simple political change of heart.

FW: How can investors improve their chances of creating value and generating expected returns in a PPP?

Kolbrenner: Most major contractors and design firms – the service firms with the earliest and most insight, and who have the most to lose from being wrong in their assessment – have spent meaningful time and money to construct PPP-focused business development strategies. However, since many of these engineering & construction (E&C) firms are still looking to understand how they can best work with investors in the sector, infrastructure investors will benefit most by seeking out E&C firms years in advance of opportunities in order to partner their ‘smart capital’ with E&C firms’ smart, on-the-ground resources.

Haythorne: This is surprisingly simple. There are well developed best practices for economic terms and operating principles in successful PPPs that differ substantially from projects delivered by other procurement methods. Investors need to see that the best practices are understood and followed by owners that are administering the project, including market-based analysis of risk analysis and allocation.

Matheou: It’s all about preparation: thorough due diligence needs to be carried out into the project itself, and the political, economic and social environment of the state where it will be implemented. That then needs to be reflected by appropriate risk allocation embodied in contractual drafting, which reflects the outcome of the bidding process through which the contract is concluded.

Neaher: Focusing on the benefit of lifecycle costing for infrastructure assets is one benchmark. Too often government agencies budget expenditure on their annual cycle without any consideration of how an asset can best be operated and maintained for its useful life. Private investors can provide significant value to communities by changing this focus. Matching the cost of government funding in the shorter term is a challenge, but the ability to achieve long-term funding for an asset will provide state and municipal governments with greater predictability for budgetary needs. Availability payment transactions that permit the government to retain primary control of the relationship with users, while affording predictable budgetary requirements, is one way forward.

FW: How important is it for PPP investors to understand and evaluate their contractual obligations under the deal? Are you seeing an increase in disputes arising from PPP arrangements?

Haythorne: It is extremely important for investors to understand the concessionaire’s obligations under a PPP Agreement. In the mature markets this understanding is generally present because ‘standard’ documentation has been developed in these jurisdictions which are understood by the market. It is not our experience that there is an increase in disputes under PPPs.

Matheou: It is critical for PPP investors to understand and evaluate their contractual obligations. Perhaps, unlike many other lines of business, PPP contracts embody all of the risks in the business, and often – in availability payment projects – are the means of generating the revenues from which returns are earned. Experienced PPP investors understand this and pay great attention to understanding their contracts. Possibly because so much due diligence goes into the pre-contract phase, and because so much care and attention is given over to contractual risk allocation and drafting, there are remarkably few disputes arising from PPP arrangements, and certainly very few which go through the formal dispute resolution processes in the contracts.

Neaher: Obviously it is critically important that investors understand their contractual obligations, as risk allocation is a big part of PPP transactions. Investors in PPP transactions, however, typically are sophisticated players, with teams of advisers that assist in evaluating risk allocation and financial and technical obligations. The bidding processes are comprehensive in general, with bidders providing input on draft contracts prior to the actual bid. So there is heavy scrutiny of contractual obligations going into a bid. I don’t see an increase in disputes in PPP transactions. There will be disputes from time to time among public and private participants – witness the disputes over tariffs in PPP airport projects in Ecuador and Costa Rica. But macroeconomic conditions are often the underlying catalyst for these types of disputes.

FW: What are your predictions for the PPP market in the Americas in 2013 and beyond? What is your general advice to investors considering a public-private partnership in the Americas?

Neaher: The US market is ascendant and Latin America, particularly Brazil, Colombia and Peru, will be an engine for growth in the Americas. Transportation will continue to dominate PPP pipelines. There may be a new push for social infrastructure PPPs, particularly in South America. Investors should look for a stable legal framework, hire local partners who are familiar with the market, ensure there is proper risk allocation and learn if public opposition can be mitigated. PPP is most successful when there is more engagement with all stakeholders, constant communication and attempts are made to obtain buy-in from all stakeholders up front. Simply negotiating a PPP contract with a public entity is not sufficient for a successful project.

Haythorne: We believe there will be a gradual increase in the use of PPPs across the Americas but it will not be sudden. For example, the State of Florida recently enacted amendments to its existing and successful PPP statute to allow projects other than transportation. We expect developments like this to repeat across the US market, but it will take time. Jurisdictions like Canada, where there is already an active PPP market, will continue, but will be constrained by the amount of public funds available for investment in infrastructure. Other jurisdictions will follow because of the general pressure on governments to upgrade, replace and develop new infrastructure. Infrastructure costs are enormous and even marginal cost savings, which PPPs arguably offer, will continue to make them attractive.

Matheou: There are probably more projects visible as opportunities for investment in the PPP market in the Americas in 2013 than at any time in the past. This market will continue to grow. It will, however, continue to have its frustrations, and implementing the projects will often be subject to political risk on a country-by-country, or state-by-state, basis.

THE PANELLISTS

John S. Haythorne

Dentons

Mike Matheou

Hogan Lovells US LLP

Scott Kolbrenner

Houlihan Lokey

Edward R. Neaher Jr.

White & Case LLP