2. Business Theories of NRI-PPP Projects

In NRI-PPP Project, appellations that use acronyms consisting of the initial letters of the relevant words are used to describe the nature of the project; they include BOT, BOO (Build-Own-Operate) and BLT (to be discussed in Sect.1.2 of this chapter). BOO differs from BOT in that the ownership of the facilities is not transferred to the Host Country/Off-taker at the end of the project. Although, the number of BOO projects may be relatively small compared to BOT, BOO Projects are a type of NRI-PPP Project which becomes the subject of Project Finance.

Also, although the letter “B” (which refers to “Build”) is used to describe new construction projects, the letter “R” (which refers to “Rehabilitate”) may be used to describe refurbishment projects. Further, because the aspect of “Design” is included in the scope of the project, not just “Building”, the letters “DB” (which refers to “Design-Build”) are sometimes used. Although it is the personal impression of the author, these terms may not be used in a strictly unified way within this industry. For example, “B” (Building) of “BOT” usually becomes the subject of the EPC Contract, and thus, “D” (Design) should naturally be included when one refers to “B.” In this sense, necessity to use the letters “DB” for matters characterized as “B” is somewhat in question. Some specialized books just list these appellations without considering these matters appropriately. In any event, when using these appellations, it is critical to have a clear consciousness about the meanings of these letters and whether they are appropriate in the substantial sense considering the words they represent and the scope of the particular project. In this book, we use “B” with the view that it includes the meaning of “D.”

Burger P., Tyson J., Karpowicz I. and Delgado Coelho M. (2009) The Effects of the Financial Crisis on Public-Private Partnerships. IMF Working Paper (WP/09/144). http://​www.​imf.​org/​external/​pubs/​ft/​wp/​2009/​wp09144.​pdf

Cangiano M., Anderson B., Alier M., Petrie M. and Hemming R. (2006) Public-Private Partnerships, Government Guarantees, and Fiscal Risk. IMF Special Issues. https://​www.​imf.​org/​en/​Publications/​IMF-Special-Issues/​Issues/​2016/​12/​31/​Public-Private-Partnerships-Government-Guarantees-and-Fiscal-Risk-18587

It seems that a major reason why DBO Projects are used in Japan instead of PFI is that the financing cost through the issuance of local government bonds is lower than the financing cost of PFI. However, the reason the interest rates of Japanese local government bonds are lower is because they are substantially guaranteed by the Japanese Government; in that sense, the preference of DBO Projects over PFI in Japan might result from the particularities of Japan. As we will elaborate in Sect. 4.7.2 in this chapter, the most important discriminating factor between a successful NRI-PPP Project and an unsuccessful one is the business performance capability of the Sponsor and the O&M Operator. Because of this, the Host Country/Off-taker positions the Project as an integrated one under the Concession/Off-take/PPP Agreement, and lets the Project Company, whose shareholders are the Sponsor and the O&M Operator, implement the Project. On the other hand, in DBO Projects in Japan, as for the design and construction aspects, the local government enters into a Design Work Contract and a Construction Contract with a Design Firm and a Construction Company, respectively, and enters into an Operation Work Contract with the Project Company only with regard to the operations. However, this arrangement does not constitute a contractual relationship whereby the Project is subcontracted to a private business as an integrated project by depending on the business performance capability of the Sponsor and the O&M Operator. In a DBO Project in Japan, the local government enters into master agreements with the Sponsors and subcontractors which are to perform various types of work delegated by the Project Company; hence a counter-argument may be made that through these Master Agreements, the Project is implemented by a private business entity as an integrated project. However, the subject master agreements usually stipulate that each constituent company of the private business entity enters into a contract after the whole operation was divided into design, construction, operation, and maintenance as a “division of roles”. Additionally, it should be noted that this division of roles is intended to allow each role to be conducted in parallel, which, in turn, contradicts, as we will discuss in Sect. 4.7.1 of this chapter, the notion that a DBO Project is dependent on the business performance capability of the Sponsor and the O&M Operator, and that the Sponsor and the O&M Operator supervises the whole Project. Yet still another counter-argument may arise that even in PFI, the Project Company enters into an EPC Contract with the EPC Contractor and an O&M Agreement with the O&M Operator; thus both are positioned to perform their duties in parallel. However, the reason an O&M Agreement is signed is to cover the costs related to the O&M work. As we will discuss in Sect. 5.2 of this chapter, profit from the O&M work is not included in the O&M work fee. The profit for the O&M Operator is paid in the form of dividends from the Project Company to its shareholders. Therefore, any argument claiming that the O&M Agreement and the EPC Contract are performed in parallel is not appropriate. The EPC Contractor is required to be positioned as the subcontractor of the Sponsor and the O&M Operator which has the business performance capability to supervise the whole Project.

Cangiano M., Anderson B., Alier M., Petrie M. and Hemming R. (2006) Public-Private Partnerships, Government Guarantees, and Fiscal Risk. IMF Special Issues. page 5. https://​www.​imf.​org/​en/​Publications/​IMF-Special-Issues/​Issues/​2016/​12/​31/​Public-Private-Partnerships-Government-Guarantees-and-Fiscal-Risk-18587

In PFI in Japan, evaluation that puts higher value on elements other than price has generally been said to be acceptable. The author does not intend to insist that the value-added consideration is not required without exception. However, being capable of making a clear determination in specific projects is hard thing to achieve; including who will make the determination objectively based on what standards to decide whether the added-value part is truly necessary. One business model which has been successful in Japan so far seems to be “increasing the added value and selling it high in light of that increased added value”. However, in NRI-PPP Projects in the developing countries where the Host Country/Off-taker is unable to bear significant financial burden, carefully verification is needed to determine whether the concept that “evaluation that places higher value on elements other than price is acceptable” really holds true. The subject value-added part may turn out to be just a “luxury” for the Host Country/Off-taker. Incidentally, in regard to PFI in the United Kingdom, at least in early days, it is reported that bidding competitions were basically evaluated on price alone, and only when there was no substantial difference in price, factors other than price became the subject of review.

As we will discuss in Sect. 4.1 of this chapter, the essence of an NRI-PPP Project is its operation, and the qualities of the goods and/or services to be provided by the subject operation are defined by the required level. Consequently, as long as the subject required level is satisfied, in order for VFM to be generated (increased) essentially, the extent to which the prices of the goods and/or services that the Project Company is to provide to the Host Country/Off-taker becomes cheaper is important. Whatever added value the facilities may have, whether value exists or not is determined by the Sponsor’s operational perspective, and ultimately, the value should be reflected in the prices of the goods and/or services the Project Company provides to the Host Country/Off-taker. There may be an argument that factors such as safety should be evaluated; however, such factors other than prices are essentially determined by the required level to be established in the bidding by the Host Country/Off-taker, and should be addressed by appropriately establishing the required level.

In relation to this, PFI is often referred to as “performance criteria” in Japan. This derives, as we will discuss in Sect. 5.1.2.2 of this chapter, from the fact that true PFI sets operation as its objective. When performance criteria is adopted in Accommodation PFI, a risk may arise that the required level becomes vague, thus, making it not necessarily objectively reviewable on the one hand, and on the other hand, the outcome sometimes does not meet the intention of the public side which actually is to perform the operation using the subject PFI constructed facility. Thus, ultimately, the quality of the goods and/or services to be provided by the operation is the most important consideration; in performance criteria, whether the goods and/or services provided by the operation meets the required level is important. In other words, careful consideration should be given in determining whether the output satisfies the required level, whether added value beyond the required level is needed by the Host Country/Off-taker, and who will judge objectively its necessity when needed. The most easy-to-understand example is case 2. When performance capability to provide a certain level of electric power is assured, added value beyond that capability is not usually assumed.

See e.g., Winch G., Onishi M. and Schmidt S. (2011) Taking Stock of PPP and PFI Around the World. ACCA workshop at p.12. http://​www.​accaglobal.​com/​content/​dam/​acca/​global/​PDF-technical/​public-sector/​rr-126-001.​pdf

In the case of infrastructure investments in emerging and developing countries, the subject investments are made in US dollars in practice. Accordingly, returns on the subject investments need to be paid in US dollars. For this reason, ensuring there are sufficient funds in US dollars for the payment of the subject returns in cases of infrastructure investments in emerging and developing countries becomes important. On the other hand, the amount of US dollar funds that emerging and developing countries can use to pay to foreign countries is limited. Therefore, emerging and developing countries cannot commit themselves unlimitedly to NRI-PPP Projects that are the subject of infrastructure investments. Recently, infrastructure investment in African countries has become a hot topic; however, careful review should be made including whether collection of funds in US dollars is really possible. Conversely, in order to develop the infrastructure of emerging and developing countries, those emerging and developing countries need to have sufficient funds denominated in US dollars, and in return, they need to receive US dollar funds through activities such as exporting their products overseas. Also, each of the emerging and developing countries prioritizes its needed infrastructure within the range of its paying ability to make return payment in US dollars. Additionally, when making investments in emerging and developing countries as pure private sector type investments, there is an inherent risk in arranging for the payment of returns in US dollars which is not limited to infrastructure investments (the so-called foreign exchange trading risk including concerns arising from legal regulations as well as regulations in practice).

As for the matters discussed at the ASEM International Conference, please refer to Public and Private Partnership (PPP) Infrastructures under Global Financial Crisis-Observation on ASEM Infrastructure PPP Conference, page 14 of the 1207th issue of International Finance, which was co-authored by Masaaki Anma and the author (2009).

See Armitstead L. (2012) UK taxpayers ‘rarely’ benefit from public-private partnerships, claims study. The Telegraph. http://​www.​telegraph.​co.​uk/​finance/​newsbySector/​constructionandp​roperty/​9196524/​UK-taxpayers-rarely-benefit-from-public-private-partnerships-claims-study.​html; Fawcett G. (2012) Public private partnerships: the record isn’t great. The Guardian. http://​www.​guardian.​co.​uk/​public-leaders-network/​blog/​2012/​apr/​11/​public-private-partnerships-the-record-isnt-great

See Treasury - 17th Report Private Finance Initiative (2011) United Kingdom, House of Commons Report. http://​www.​publications.​parliament.​uk/​pa/​cm201012/​cmselect/​cmtreasy/​1146/​114602.​htm

Standardisation of PFI Contracts Version 4 (2007) HM Treasury of the United Kingdom. p. 29. https://​ppp.​worldbank.​org/​public-private-partnership/​sites/​ppp.​worldbank.​org/​files/​documents/​UK_​Standardisation%20​of%20​PFI%20​Contracts%20​(ver4.​2007).​pdf

Strictly speaking, from the viewpoint of cash flow, money paid to the Sponsors includes not only the dividends of profit, but also repayments of invested capitals. In this sense, particularly from the viewpoint of tax, the nature of the Sponsor’s profit and the money actually paid to the Sponsor must be recognized after distinguishing the profit from the repayment of invested capital. Also, when a subordinated loan is used, payments of interest and principal of each such subordinated loan are included in the cash flow. We will discuss these topics in Chap. 3, Sect. 4.​3.

In the case of corporations, corporations cannot pay dividends as profits to their shareholders (“dividend of surplus” under Japanese law) unless amounts to be paid as dividends (“distributable amount” under Japanese law) exist. However, from the viewpoint of project finance, under the cash flow structure, if money exists that can be paid to the shareholders in accordance with the relevant payment waterfall scheme, even when there is no dividend amount available as reflected on the corporation’s balance sheet, the subject money can be used in a pay out to Sponsors, who are the shareholders of the corporation. Therefore, to avoid this limitation restricting payments to the dividend amount available, a legal entity form other than a corporation is sometimes chosen for the Project Company. Regarding this point, please refer to Chap. 3, Sect. 4.​3.

Additionally, in some projects, instead of relying on the creditworthiness of the Sponsor, the Senior Lender is asked to provide the subject payment guarantee. The essence of the relevant issue is the debt-to-equity ratio, where the issue is the extent of the risk borne by the Sponsor.

Standardisation of PFI Contracts Version 4 (2007) HM Treasury of the United Kingdom. p. https://​ppp.​worldbank.​org/​public-private-partnership/​sites/​ppp.​worldbank.​org/​files/​documents/​UK_​Standardisation%20​of%20​PFI%20​Contracts%20​(ver4.​2007).​pdf

However, under typical contracts between private business entities, because liability for damages in the case of non-performance has an upper limit, if the increased cost exceeds the upper limit of liability for damages, incentives for continuing the O&M Operation will disappear. In that sense, it should be noted that even if the Sponsor/O&M Operator becomes a contracting party of the Concession/Off-take/PPP Agreement, the increased costs relating to the O&M Operation to be borne by the Sponsor/O&M Operator should have an upper limit.

As mentioned in the above comment, if the upper limit of liability for damages in the case of non-performance by the O&M Operator is stipulated in the O&M Agreement, and if the increased cost exceeds the upper limit of liability for damages, the O&M Operator’s incentives for continuing the O&M Operation will disappear, and in this sense, the bearing of increased cost related to the O&M Operation by the O&M Operator has an upper limit.

Additionally, it is a matter of course that limited liability should be separately considered for the case of damages to a third party. Even in transactions between private business entities, the upper limit amount of tort liability in relation to the third party claims is never established between the parties who carry out the transaction; and even if it should be set, it is obvious that it has no effect on the third party. However, it is sometimes argued that the Sponsor may not incur tort liability in regard to third parties because an SPC is employed. But there are many cases in this world where private business entities conduct business through their subsidiaries, and, at least, this is not an issue inherent to an NRI-PPP Project.

Regarding this point, please refer to Overseas Operation of Infrastructure Business and Issues for Japanese Corporations (Vol. 71, No. 6, page 16 of Transportation and Economy) by Satoru Madono (2011) (written in the Japanese language).

In regard to Accommodation PFI in Japan, in most of cases the investors are the EPC Contractors. However, invested capital is considered “wasted money,” and thus the invested capital is not used efficiently.

This point is more specifically explained in Issues of Japanese PFI when compared to Overseas by Masaaki Anma (2008), page 90 of the 1195th issue of International Finance. (written in the Japanese language)

Anma M. (1998) Mechanism and Risk of Project Finance. International Finance (Dec. 1998); page 30. written in the Japanese language)

Yescombe E. (2014) Principles of Project Finance. second edn. Academic Press, London, page 53.

As a matter of course, from the viewpoint of the feasibility of the project, financial capacity to carry out the project is a matter to be reviewed by the Host Country/Off-taker at the bidding stage of the NRI-PPP Project. Aside from the case where a project is to be financed100% by the bidder’s own funds, when a project is to be financed with funds from financial institutions it is important for the bidder to obtain documents from the subject financial institutions confirming their intention to lend the funds for the project, and to confirm the likelihood that such funds will be actually procured.

Before financial institutions actually sign loan agreements in general, they must go through internal review and approval procedures. To complete the internal review and approval procedures during the stage of bidding pre-qualification, review is impossible from a practical point of view. Therefore, because completing the review and approval procedures is one of the pre-conditions for signing the loan agreement, and rejection in the review and approval procedures is possible, there exists a risk that the lending intention certificates do not certify anything at all as they substantially depend upon the subsequent loan approval/disapproval determination of the financial institutions. Consequently, the acceptability of the lending intention certificates depends on the extent of the certification provide by the financial institutions.

Further, in the case of project finance, as we will discuss in Chap. 3, Sect. 2.​5, not all financial institutions are capable of granting project finance for an NRI-PPP Project in any field. Financial institutions are required to have sufficient experience in project finance in the subject matter of the relevant NRI-PPP Project, and to truly understand the project finance arrangement. In that sense, this is not a perfunctory screening that requires only the preparation of a document called the lending intention certificate. The Host Country/Off-taker also needs to sufficiently understand this point.

As for the force majeure risk, it will differ depending on the country (the difference is especially noticeable when comparing common law countries to continental (civil) law countries) and how force majeure is defined in that country. We will discuss this point in Sect. 5.1.1.5 of this chapter.

For additional information regarding these risks, please refer to the earlier referenced Practice of Project Finance by Ryuichi Kaga (2007), pages 72–93, and Mechanism and Funding of International Infrastructure Project (Chuo Keizaisha) by Ryuichi Kaga (2010), pages 45–46. (both written in the Japanese language)

Similar issues also arise sometimes in transactions between purely private business entities. For example, under a loan agreement, should a cost increase be incurred by the lender in relation to the execution or maintenance of a loan, it is a firm practice that the borrower is to bear the increased cost. This does not mean that because the lender is in a dominant position, the lender imposes the risk on the borrower. This is because if the increased cost is to be borne by the lender, not only is the lender unable to calculate the amount of the consideration to account for the risk rationally (thus, the lender takes a buffer and takes on the risks conservatively), but also the lender would need to determine the spread by adding the return for taking on the risk (it should be noted that the party which gains profits directly from the granting of the loan is the lender, and it is a lender who adds the return). In Japan, arguments sometimes arise from the borrower that there is no reason for the borrower to bear the increased costs, or the borrower should be given the option to choose between bearing the increased costs and making a prepayment in lieu of having to bear the increased costs. However, this is an assertion that does not understand that spread, a consideration, is determined within a total transaction including the bearing of increased costs, or through the cost transfer method in risk sharing, thus, it should be noted that there is no rationality to this assertion.

As for other risks, if additional costs that can be covered by insurance exist, they can be positioned as the risks to be assumed by private business entities to that extent. However, whether the subject insurance is available in the market is a matter the Host Country/Off-taker should confirm before the bidding of the project. Additionally, for example, in the case a plant is damaged by a force majeure event, if the costs related to repairing the subject plant can be covered by insurance, the subject costs can be positioned as the risk of private business entities. However, the amount equivalent to the Availability Fee during the period required for the subject repair cannot be covered by insurance (profit compensation insurance may exist, but it is expensive even if it exists, and will only push up the Availability Fee at the bidding stage to account for that amount); accordingly, the Availability Fee needs to be paid in full, and it should never be reduced as the risk borne by private business entities.

Additionally, in PFI in Japan, in cases where additional costs are incurred by the Host Country/Off-taker (not by the Project Company) due to a change-of-law risk or force majeure risk, it is sometimes asserted that part of these costs should be borne by the Project Company. However, this risk is the one that is borne by the Host Country/Off-taker when it implements the traditional public works. If this risk is imposed on private business entities, the result will be less generation of VFM (a reduction of VFM), and thus no benefits can be enjoyed by private business entities or the Host Country/Off-taker. Accordingly, additional costs arising from a change-of-law risk or force majeure risk should be borne 100% by the Host Country/Off-taker.

Incidentally, it should be noted that the risk of not selling goods and/or services due to the facilities being rendered unusable physically or functionally due to a force majeure event, would not be a market risk.

In an expressway project, for instance, ordinarily tolls are collected from the users of the expressway. However, in some cases, tolls are not collected from the users and instead, the Host Country pays the tolls in accordance with the traffic volume. This toll paid by the Host Country is called a shadow toll.

Standardisation of PFI Contracts Version 4 (2007) HM Treasury of the United Kingdom. https://​ppp.​worldbank.​org/​public-private-partnership/​sites/​ppp.​worldbank.​org/​files/​documents/​UK_​Standardisation%20​of%20​PFI%20​Contracts%20​(ver4.​2007).​pdf

The inclusion of such event as a force majeure event is one factor considered when determining whether the debtor is liable for default or is exempt from the fulfillment of its obligations upon the occurrence of such event.

“Export Credit Agency” (ECA) refers to official financial institutions of each country which are established with the objective of promoting overseas exports and imports and investments. Although only “Export” is included in its name, its function is not limited to the promotion of exports. Export-Import Bank of the United States (Ex-im Bank) in the US, and Japan Bank of International Cooperation (JBIC) and Incorporated Administrative Agency, Nippon Export and Investment Insurance (NEXI) in Japan, are examples of ECA.

“Multilateral Development Bank” (MDB) refers to international financial institutions established by multiple countries that provide lending with the objective of development. International Bank for Reconstruction and Development (IBRD) and International Finance Corporation (IFC) that belong to the World Bank, Asian Development Bank (ADB), and European Bank for Reconstruction and Development (EBRD) are examples of MDB.

In practice, it is not easy to distinguish clearly what parts of an O&M fee are expenses to be incurred by the O&M Operator, and what parts are profits from the operation. A practical solution for this may ultimately be to rely on the judgment of an independent consultant.

Although it is a small point, as we will discuss in Chap. 3, Sect. 4.​2.​5 “dividends to the Sponsors, etc.,” whether such can be paid or not requires a determination as to whether the requirements for payment of dividends, etc. have been fulfilled. Although, the requirements for payment of dividends, etc. are relevant to waterfall provisions, in view of the risk that the subject NRI-PPP Project may not be operated appropriately in the future and consequently payment of principal and interest of the Senior Loan of the project finance may not be made because the subordinated O&M fee is substantially the dividends, etc. payable to the Sponsors, payment of such fee may well be conditioned upon the satisfaction of such requirements for payment of dividends, etc.