12 March 2009
A Debt Funding Competition may prove to be a very valuable tool and part of the solution to the logjam that is starting to clog the PPP pipeline, but it presents its own challenges.
As the credit crunch has intensified and developed into the global financial crisis, the strain on all sectors of the economy that rely on private finance has increased. Procurement of public infrastructure using Public Private Partnerships (PPPs) has certainly not been immune from this. PPPs typically require significant amounts of private finance which is increasingly becoming harder to access.
The squeeze is further exacerbated when, as has traditionally been the case, governments using PPPs have required each bidder to underwrite the debt finance required at the time of lodgement of their bid. This means that two or even three times the total amount of debt required for the project needs to be sourced and committed. In this illiquid market can a Preferred Bidder Debt Funding Competition (DFC) help to get PPP projects across the line?
What is a DFC?
A DFC is an initiative that has been employed in the UK a number of times since 2000 and has been championed by the UK HM Treasury as a mechanism for government to induce competition and thereby obtain more favourable debt funding terms.
When using a DFC, government selects a preferred bidder and that preferred bidder, in consultation with government, then goes to the debt market seeking the best price for the debt funding for the project.
The objective for the UK government was to increase the competitiveness of the lending market with a view to reducing the overall cost of the project. We are now in a very different market where the primary focus of the DFC would be to source sufficient debt funders willing to lend to the project.
How could a DFC work?
In electing to use a DFC, government might either:
The first approach has been adopted in the UK and gives government the flexibility to choose a DFC if it considers the financing terms uncompetitive or that the market has changed. The second and third approaches only require full debt to be raised by the preferred bidder, avoiding duplication of effort at bid stage by lenders and bidders and reducing the overall amount of debt required to be raised. Requiring bids to be supported by one or more lenders is particularly important for projects that are considered to be either novel, large or complex, to give government comfort that the proposed funding terms are achievable.
Depending on which approach is adopted, government may need to be prepared to select a preferred bidder based on proposals absent fully underwritten debt. In such circumstances it might consider providing a set of standard debt funding assumptions for each bidder to use in the development of its proposal or alternatively normalising any aggressive terms put forward by bidders when it undertakes its evaluation of bids.
Following selection of the preferred bidder, an information package on the project prepared by that bidder could be sent out to the agreed list of potential lenders so that they can then make their bids to provide the debt funding for the project. These bids could then be evaluated by the preferred bidder, focusing on both quantitative elements (ie. financing terms, including interest rates, fees, lending margins, etc) and qualitative elements (ie. deliverability of the bid and its impact on commercial terms that have already been agreed between government and the preferred bidder).
While the selection of the successful lender/s will be made by the preferred bidder, government should supervise the evaluation process and the selection will ultimately be subject to ratification by government.
What are the potential benefits of a DFC?
Notwithstanding that the DFC was introduced into the UK to promote transparency and to capture the best value debt finance, in this illiquid market the primary benefit of using the DFC model is to increase the likelihood of raising the debt finance needed to fund the project.
Other potential benefits of running a DFC include:
What are the potential limitations of a DFC?
The primary limitation of running a DFC is the lack of certainty, particularly in an illiquid and volatile market such as this. Government takes the risk that the preferred bidder is unable to procure debt funding either in an amount sufficient to fund the project, or on the terms and cost assumed in the preferred bidder's proposal.
Other potential limitations of running a DFC include:
Is a DFC a valuable tool for PPP projects?
In the current market a DFC may prove to be a very valuable tool and part of the solution to the logjam that is starting to clog the PPP pipeline. Of course, with this new process comes complexities, risks and challenges that will have to be managed by government, bidders and lenders alike.
 Her Majesty's Treasury, 1 August 2006, "Preferred Bidder Debt Funding Competitions: Draft Outline Guidance for Feedback".
For further information, please contact David Lester.