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8

Government Support and Credit Enhancement

Introduction

Sovereign support and additional credit enhancements, when needed, will be required for the IPT, network concession, and privatisation funding structures. As is the case for the financing of other types of infrastructure assets, the need for additional credit enhancements and sovereign support for the financing of transmission infrastructure will be largely defined by the type of financing procured, and the country’s and power sector’s economic viability. The sector’s solvency will be instrumental in defining lenders’ requirements for providing financing, including which credit enhancements are necessary and whether a sovereign guarantee will be requested.

Moreover, the lenders will have different considerations depending on whether the transmission project is corporate- or project-financed. Some of the key factors assessed by financiers in making this decision are:

Case Study — The Transener Transmission Network Concession: Argentina

In 1993, the national government of Argentina granted a whole-of-grid concession over the country’s existing high voltage system to Transener, a privately funded transmission company. Transener’s concession agreement provided for three forms of charges: connection charges, line availability charges, and variable network charges. The connection charges and line availability charges were mainly fixed charges unconnected to the use of the assets or the quantity or wholesale prices of electricity transmitted on Transener’s network. However, the revenues from the variable network charges were based on the use of the transmission assets. Specifically, these charges are connected to the quantity of electric power which is lost as heat in the transmission process and the wholesale price of that power.

To protect Transener from revenue losses arising from the volatility of the variable network charges, the government guaranteed Transener $55 million per year in variable network charges for the first five years of the concession. Any shortfall from the guaranteed amount would be covered by a corresponding surcharge on the line availability charges.

This case illustrates the importance for the government to ensure the stability of the revenues in private sector-led funding structures. While in the Transener case, the government did not undertake to cover the revenue shortfall directly, it provided initial support against the risk by a regulatory mechanism established in the concession agreement.

Under the current market conditions in SSA, it is unlikely that it will be feasible to structure the financing of a transmission infrastructure without some form of government support and/or other credit enhancements when one or more of these factors are perceived by the financiers as a significant risk.

Although there is a wide spectrum of potential government support instruments and credit enhancements, in the transmission infrastructure market in Sub-Saharan Africa, only a limited number of instruments/ products have been used to date. Nevertheless, stakeholders working towards a financeable structure should consider all options when searching for risk-mitigating measures.

Government Support

Before issuing a sovereign guarantee, governments should carefully consider all available options and assess the magnitude of the payment obligations, the related contingent liabilities and the impact these obligations will have on the country’s overall debt sustainability. Nonetheless, providing government support in favour of transmission infrastructure financing can result in many potential benefits for the host government. In making decisions about the support needed from the government, all stakeholders should have an appreciation of the various factors the government must balance when weighing the benefits and challenges of granting credit enhancement.

The need for credit support from a host government may be required both to address continuing payment risks and/or to address the ability to satisfy termination payments. A sovereign guarantee can backstop routine payments and give direct protection for termination payments and other obligations affecting the transmission utility’s ability to repay the financiers.

For the IPT model, the need for government support should be anticipated since the model will use project finance to raise the debt necessary for the transmission project. For the whole-of-grid concession and the privatisation models, the government is also likely to be requested to provide support although the scope may vary significantly depending on the level of capital investment required to be made and the specificities of the transaction. Furthermore, for the privatisation model, more government support is typically expected at the early phase of the privatisation of the transmission assets but should reduce within a few years of operations by the private transmission utility.

Government support agreements can take various forms. An “implementation agreement”, a “government guarantee”, a “government support letter” or a “put call options agreement” are just some of the names of documents under which governments can provide support to a project. Broadly speaking, they aim to achieve the same end, namely providing some form of government support to a private sector investment and investors. The government support agreement will be an important risk allocation tool that is likely to be vital in terms of ensuring that the project is capable of obtaining finance.

In some cases, the government support can extend to guaranteeing the obligations of a state-owned transmission utility (e.g. in terms of payment obligations). In almost all cases, government support will extend to a government taking responsibility for certain “political” risks, often described as events of “political force majeure”. These risks include expropriation, war, civil disturbance, and they are typically seen as risks within the government’s control. Most government support agreements provide for a form of termination compensation payable if an ongoing political force majeure event occurs. Government support documents also typically confirm the wider regulatory and enabling environment and transaction or sector-specific promises made by the government to facilitate private sector investment (e.g. as to matters relating to the tax regime, investment protections, assistance with permits etc.).

Sovereign Support for Termination Payments

Financiers are especially concerned about getting compensated if the project is terminated. Most government support agreements are usually structured such that upon termination, the government assumes ownership of the project at a purchase price, also known as a termination payment. This transfer of ownership can be executed either through a sale of the transmission assets to the government or through a sale of all the shares in the project company to a government-owned entity. The constrained nature of the termination payment compensation is important since this type of sovereign credit support is, in essence, a “last-resort” option rather than a guarantee of actions or payments that are in the regular course of business for a transmission infrastructure project.

Termination of the project agreements (the TSA or the concession agreement) and the corresponding compensation typically follow certain defined trigger events. These events may be as a result of government actions such as expropriation/nationalisation of the transmission assets or payment default. In the case of termination as a result of government actions, the project company typically terminates the project and transfers ownership to the government upon payment of the compensation. Termination may also be triggered by actions of the project company such as persistent failure to meet key performance indicators. In this case, the government may decide to terminate the project and assume ownership of the project.

In addition to defining the trigger events, the government support agreement must also carefully define the purchase price to be paid for the project assets or of the shares in a project company upon termination. The formula for the purchase price, also known as the termination payment, will be directly tied to which trigger event has led to the termination of the TSA or concession agreement.

For example, in the case of termination of the concession agreement due to payment default by the state-owned utility, the purchase price will likely include not only the value of the project assets and the outstanding project debt but also the expected return for shareholders in the project over a pre-agreed period. In the case of termination due to the project company’s default, the purchase price may be limited to just the outstanding project debt. The purchase price in the case of termination for force majeure will likely fall somewhere between these two extremes and may depend on who is directly impacted by the force majeure as between the transmission utility or government and the project company.

For a further dive into the various forms of government support agreements, please see chapter 6 titled “Sovereign Support” in the  Understanding Power Project Financing  handbook and the chapter titled "Default and Termination" in the Understanding Power Purchase Agreements  handbook.

Direct Agreements

Direct agreements are agreements that give the lenders a right to "step into the shoes" of the project company with the key project contracts if the project company — or another contractual counterparty — defaults in some way. While the counterparties to the government support agreement will be the project company, the lenders will enter into a direct agreement with the government related to the government support agreement. This direct agreement will enable the lenders to step into the shoes of the project company and directly enforce the rights of the project company in the government support agreement in an event of default.

This type of agreement is also common in a project finance context for the IPT business model. It will enable lenders to take possession of the project they have financed if there is a material default by the developer. The lenders may then decide to select a new operator to avoid complete failure of the project.

Non-sovereign credit enhancement options

Third-party financial institutions offer various credit enhancement and political risk mitigation products in the context of transmission infrastructure financing. These products can be used instead of, or together with sovereign support to provide another level of credit enhancement. They are particularly used where the credit of a sovereign itself is not strong enough to offer the level of assurance required by investors and lenders.

For a more comprehensive discussion on the various types and features of Credit Enhancements, please see chapter 7 titled “Third-Party Credit Support and Risk Mitigation” in the Understanding Power Project Financing  handbook.

Summary of Key Points

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