Wednesday, July 4, 2012

Special Purpose Vehicle(SPV) and PPP Projects

Any company(for that matter even SPV) is financed majorly through two sources - Equity & Debt !! Composition of these form, what is called CAPITAL STRUCTURE of the company. Equity and Debt can be present in varying composition in different companies. 

Equity - This type of funding provides the fund provider with ownership in company's assets, which is NOT there for debt providers. It is basically of two types:

Preferred Equity - provider of this equity has fixed dividends and preference over common equity holder in event of bankruptcy

Common Equity - they are the common shareholders who purchase shares of the company and get certain percentage ownership in the company's assets. These shareholders get dividends from time to time(thought not fixed), based on profits the company makes.

Debt - These are bank loans which any commercial bank lends. Such type of funding source DO NOT provide the fund provider with any ownership, but gets his return in form on interests on the principle amount he loaned to the company. 

Senior Debt - debts by commercial banks. In event of liquidty/bankruptcy of the company, this type of loans needs to be paid first (even before paying to the equity holders).

Sub-ordinate debt - type of debt which has lower preference over senior debt at time of bankruptcy of the company. 

PPP and SPV !! 

Recently PM Manmohan Singh met with key infrastructure ministers and secretaries and Planning Commission to set targets for Infrastructure for 2012-13. He said and I quote

"The needs of the infrastructure sector are vast – estimated at over $ 1 trillion in the next five years. The government alone cannot invest such huge amounts and therefore it is important that we involve the private sector in our efforts, through Public Private Partnerships." - PIB 6th June 2012

In past, govt. used to finance infrastructure projects through budgetary allotments. However, for an emerging economy like ours, there are a huge demand for infrastructure and due to financial constriants, govt. has looked to the private sector to provide financial resources, innovation and technical expertise. 

Public Private Partnership(PPPs) are a "cooperative venture" between the public and private sectors, built on the expertise of each partner, by appropriately allocating resources, risks and returns. 

Public and private sector relationship is not new, but PPP is a new type of public-private relationship of which one main feature is creation of a SPECIAL PURPOSE VEHICLE (SPV)

A private sponsor of the project usually creates a SPV by pulling out some assets from its parent company, isolating it and creating a new company under Companies Act 1956 (if in India). The assets or activities are distanced from the parent company and this is a very important feature of SPV. 

(Remember the Dhabhol Enron Debacle ? The SPV and the originating company was not fully separated and hence it caused major debacle later on) 

With the investment of equity in SPV, the project sponsor gets its ownership. If govt. invests equity then it will also have ownership in the SPV. and depending on how much money govt. invests, it accordingly holds majority or minority stake in the SPV. So a SPV is a legal entity that enables the coming together of many different parties and facilitates the allocation and diversification of risk and financing requirements to more than one party. From a legal perspective, it is the SPV that undertakes the project and therefore all contractual agreements between the various parties will be negotiated between themselves and the SPV. 

A typical SPV structure would look like this:

Its the Govt. which usually determines the terms and conditions like the tenure of this SPV, how much tariff the SPV would charge the customers, what will be sources of funds for the SPV etc. This is done through a document called "Memorandum of Association(MoA)". 

PPP are usually operated in one of the following models :

Its the type II which is most popular in India in various express highway , national highway, airports and other infrastructure constructions. So, the private entity will Design, Build, & Operate the project. They are allowed to collect toll, taxes or other user fee at a govt. determined rates. 

SPV developments in India:

SPV through PPP is the buzz word these days. You see almost all infrastructure projects, new central govt. development plans being executed through PPP mode. 

Some example of it are:

1. Indian Govt. had recently formed "India Infrastructure Finance Company Ltd." a SPV for all infrastucture projects in India. This SPV is for smoother financing of infrastructure projects. 

2. Similarly cabinet recently cleared way for creation of SPV for quicker approvals for all projects in India. Usually the land aquisitions, environmental clearances, getting coal linkages, water linkages and other necessary approvals takes a lot of time, thereby increasing the project costs. It is estimated that it is in this phase that the risk of cost escalation is the highest and therefore the investors who invest money wants max. returns on their investments. Once construction is over and the cash flow from operations has begun, project risks drop off substantially and it is possible for sponsors to refinance at a much lower cost. 

So govt. recently planned to formulate an SPV dedicatedly to look into project clearances and other necessary approvals and once that is done, it is then handed over to a private entity for a PPP project. This way the the PPP project cost comes out to be less and investors feel safe and willing to invest in that PPP project.

3. PURA 2.0 - Provision of Urban Amenities in Rural Area is a MoRD initiative which is scheduled to be executed in PPP mode. Here govt. has planned to foot for majority of initial capital cost(CAPEX) and wants the private entity to foot for the operating maintenance(OPEX) and other costs for the next 10 yrs after the infrastructure is built. So say, if a road is built, govt. will initially foot majority of its cost and then expect private entity to maintain that road every year. The private entity will be allowed to charge user fee from consumers but at a govt. determined rate. 

4. All the UMPP (Ultra Mega Power Projects) in India is planned to be implemented in PPP mode. Almost all expresshighways are built this ways. Talks were also on to allow Metro Rail projects to be implemented in this way. 

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