ACRAA Financing and Rating Infrastructure
Credit Issues and Risk
Management Practices
October 16, 2015, Hotel Intercon, Makati City
When I was invited by good
friend Santi to be part of a panel for this conference, i did so on the
condition that i did not have to prepare anything. And without knowing who are
the participants.
Now, that I know you are much
more expert on the field than I, am feeling quite intimidated. It is just
that i could not say no to Santi, who i should call Uncle Santi, as he is a
friend and school mate of my mother in law.
So let me start by begging
everyone’s indulgence for this somewhat generalist appreciation of the subject
and rambling impressions
My own experience starts in
the nineties on the government side at the Dept of Finance, then later an
occasional adviser on both policy and a few PPP projects on the transactions
end. And finally, I now do see some of this at a high level as a Board
director at a bank, and companies in power, telecom.
I was given the assignment of
“macro view”, so perhaps I can get away with glossing over. As the first
speaker, meant to get the ball rolling, provide the framework, Santi said.
The best macro framework on
the subject I was able to find is from the World Economic Forum. They reduced
the subject into two big slides. We have all seen these before, but allow me to
flash them briefly.
1.
First the various
risk factors, divided between political and regulatory, arising during the
three phases of the project. There are nine which are project specific,
and i enumerate them. Cancellation and change of scope risk, environmental and
other permit risk, community risk, expropriation risk both sudden and creeping,
breach of contract risk, asset specific regulation risk, concession
duration/renewal risk, asset transfer risk, decommissioning risk. Then there
are the five that affect a sector or entire economy—
Change of industry regulation,
taxation risk, currency transfer risk, judicial risk, and corruption/market
distortion risks. I believe you have had two days of discussion of
these in various sectors, which unfortunately I was unable to join.
2.
On the mitigation
side, WEF has a beautiful three story house. One floor is private sector
measures—made of four rooms: appropriate use of financial instruments, with two
beds one risk guarantees and political risk insurance, another on tradeable
instruments and ownership structure. And three others very interrelated--
effective interaction with the public sector, inclusive community engagement,
and responsible business conduct.
3.
A second floor is
on what the public sector needs to do. We are all familiar with these, and
are aware of limitations in emerging economies in government’s ability to
deliver on these. I enumerate them for completeness, and you can view them
on the screen. Five rooms-- robust infra regulation and contracts,
general stability of laws and regulation, reliable and efficient
administration, reliable dispute resolution mechanisms, international
commitments such as international investment agreements and transnational
programs like the TPP.
4.
There is a third
floor of joint public-private measures. The key room here is the management of
risk perception and return expectation. And the elements that go into this are
preparing projects rigorously, a dedicated marketing team, proper sounding out
of the market and proper preparation of tender. In the Philippines, the
involvement of development partners like ADB, AusAid, et al, which
supported the PPP Center via the hiring of international transactions advisers,
have been critical.
Having presented this really
broad view, allow me to share some issues that have come my way over the years
on managing the risks in infra.
1.
Political and
regulatory risks from design to operation. Proper risk allocation. The party
who can best carry the risk should bear it, is a cardinal precept in risk
allocation/ structuring of a PPP. The principle is simple to appreciate
but not so easy to implement in practice. Negotiating the appropriate risk
sharing has often been most difficult. In the case of the Philippines, in a
recent example of mass transport, insistence by government that private sector
carry the risk associated with risks of increases in taxes by local governments
have led to long delays and failures in bidding before the lesson was
learned.
At
an earlier period when I was in government in the early 90’s, the Ramos
administration, the sovereign has had to take demand risks for power via a take
or pay contract. And this was an important to do in a situation where
there was no capital market, weak or no experience in BOT. It did what had to
be done—address a power crisis. Power was restored in good time, and the
administration and the country regained confidence of the people and
investors.
2.
However, the
story does not end there, the improvements in the credit situation of the
country and the excess in power reserves as a result of reduced demand with the
onset of the Asian Financial Crisis, became reasons for the succeeding
administration of Pres. Estrada to contend that earlier contracts were
overly generous and to pressure the private proponents to renegotiate the
contract. I have read such actions referred to in the literature as
creeping expropriation
3.
The contracts
were only mildly renegotiated by reducing the current charges in exchange for
lengthening the project life. I think it helped maintain the sanctity of
contracts that IFC was an equity investor and JEXIM a creditor in a number of
them. So this particular risk mitigation seemed to have worked in
this instance.
4.
Much more
recently, most of us are quite familiar with an internationally recognized and
awarded Manila Water concessions, hailed as the biggest water privatization in
1997, where, the government contracting party unilaterally disallowed certain
cost recovery components provided for in the concession agreement upheld for 17
years. The matter has been under international arbitration and has
also been brought up to the Philippine Supreme Court. IFC was also a
small equity investor here as with two Japanese companies, Mitsubishi (with
Manila Water) and Marubeni (with Maynilad), but this did not seem to have
swayed the government side.
5.
A further example
of not honouring contracts signed by earlier administrations is this dispute
that Shell with Philippine authorities has with respect to Malampaya natural
gas project—again over a tax issue. In this case, the Philippine Dept of
Energy is on the side of Shell but it is not being allowed by a constitutional
body, the Commission on Audit to comply with its contractual obligations on a
question that goes back to interpretation of the contract and laws. I believe
this is going to international arbitration in Singapore. Such provisions for
international arbitration have been an important part of risk mitigation, but
not always full proof. As can still be challenged in Philippine courts,
under grave abuse of discretion clause in the Constitution. I will talk about
how this loophole can perhaps be mitigated by recourse to MIGA, at least for
foreign investors.
6.
I am aware
of is Phl toll roads fare adjustment. As I understand it, here the regulator
simply has not acted on what was agreed to be automatic adjustment per contract
for the past three years. I guess Mr. Franco will be talking to us about
that.
I am not sure how unique the
Philippines is in this problem of inter-administration compliance with
stipulated tariff adjustments and contractual payments obligations.
As the Philippines moves from projects with attractive real estate plays
and with an existing cash flow as in the case of extension of a toll road or
mass transport operation, into those that require availability payments like a
prisons, the issue of reliability of government payments come into greater
play. Especially for a country like ours where Congress is a separate
branch and the budget appropriation is an annual process, without multi-year
obligations other than for debt service. I guess this issue of
“bankability” of such projects is something that will be addressed by Mr.
Montes.
There is a wide range of
insurance products that are available to cover country and political risks.
Private commercial insurers would offer great flexibility and speed,
albeit at rates reflecting market perceptions of the specific country risk,
which may be overly pessimistic. As different insurers may have quite
different perceptions, it is advisable for the investor to retain an
experienced specialized broker. Bilateral risk coverage programs are
available in many countries (but seldom in emerging market countries) in
support of their nationals. Rates may be to some extent subsidized but coverage
is often conditioned by national commercial or political priorities.
The Multilateral
Investment Guarantee Agency (MIGA), where I have been involved in the
negotiations of the Charter in the 80’s, is the major international
agency operating in this field and has
rather unique characteristics. Being a member of the World
Bank Group, its coverage is available to nationals of all member countries,
with the only exception of local investors in their own country. Rates
and coverage products are in line with the market, but its distinctive feature
is the cooperative relationship with the host member country, which
defuses the political dimension (often confrontational) inherent in bilateral
insurance programs. I note that MIGA would cover the non payment of
arbitral awards.
Finally, some mitigating
measures, at least if only for delays, can be built into the structure of the
contracts themselves. As credit rating agencies looking after interest of
bond investors, you are more concerned, perhaps even more than bankers like me,
about even delays in debt service. So here perhaps such risks can be
covered by some form of limited recourse to sponsors or a waterfall and
other payment terms and profiles that adjust to the differences in preferences
between bankers, bond holders and equity owners.
I stop here and happily pass
the mike.
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